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Market Wrap

Global Bear Market?

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Many market reporters are now using the term global bear market but despite the major declines in many indexes it is still just a correction. The fear of rising inflation and slowing economic growth is also being blamed despite continuing strong economics in the major world markets. Japan is also getting the blame for ending its long standing free money stance causing an unwinding of the years old carry trade. While economists and market technicians argue the cause of the declines it is up to us to find a way to trade them.

Fear of rising inflation was given as a reason for this weeks decline before the PPI and CPI reports. The May Producer Price Index released this morning showed a headline increase of +0.2% and a core rate increase of +0.3%. Core intermediate goods rose +1.1% and core crude goods rose +6.2%. This shows the acceleration of price inflation at the producer level due to a rise in energy prices. Gasoline prices rose by +2.2% on top of a +12.3% rise in the prior month. The PPI is not as critical to Fed policy as the CPI, which is due out tomorrow, but you can bet that jump in energy related inflation and the +0.3% gain in the core rate will be just one more data point supporting a rate hike in two weeks. The headline number on the Consumer Price Index is also expected to jump by +0.3% but the core rate is currently expected to gain +0.2%. That would push the year over year rate one more notch above the Fed's comfort level.


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Retail sales for May eked out a +0.1% gain and inline with estimates. April sales were revised up from +0.5% to +0.8% largely on the strength of gasoline stations. That is not where you want to see increased sales growth as it puts pressure on regular consumer buying of clothes, electronics and other consumer goods. I guess somebody forgot to tell those consumers shopping at Best Buy. Best Buy blew away profit estimates of 36 cents with earnings of 47 cents. Same store sales rose +4.9% with a monster jump of +22% in sales at its high-end home theater stores. The main driver was sales of big screen TVs. A survey showed that 17% of consumers have already taken the plunge and that is expected to rise to 26% before year-end and 36% before the end of 2007. Personally I think people who can afford a $2500 flat panel TV or a $20,000 home theater are probably not worried about an extra $20 a week for gasoline.

The big story in the markets today was not the global economics or even the US economics. It was the continued meltdown of markets across the globe. Several indexes were down more than -4% and trading was halted on several. It was a massive implosion on markets that had already seen declines of double digits. The graphics below shows how dramatic the drop has been from the May highs. Given the severity of the corrections the drops for today were even more amazing.

Table of correction status by country

Drops in global indexes for today only

The US markets continued their swoon but compared to the major drops shown above our losses were minimal. I had to update my graphic below to show a -10%/-20% columns rather than the -5%/10% I had been using for the last four weeks. Only four US indexes have yet to reach the -10% level with the NYSE Composite joining the correction club today. The broadest index, the Wilshire 5000 is only 155 points away from -10% and one more day at the current rate of decline.

US Indexes Correction Levels

The Dow declined to 10701 intraday before a strong buy program triggered at 3:PM caused a +100 point rally back to 10800. The euphoria was brief with the index plunging back to 10700 only minutes after the buy program ended. For me this was the turning point for the day. 10700 was supposed to be decent support and the buy program failed to bring any traders off the sidelines. The quick retracement of the gains back to 10700 was even more evidence of how weak the markets really are. There was no hang time at 10800 only a large pickup in volume as sellers jumped on the spike with enthusiasm.

The chart below shows the strong support at 10700, actually from 10650-10700 and as of Tuesday's close it has now been tested twice and held. Note the huge volume increase AFTER the buy program pushed the Dow back to 10800. Sellers jumped on the spike and crushed it with strong volume. There are no signs of bullishness on these charts.

Dow Bar Chart - Daily

Dow Chart - 5 min

The Nasdaq tacked another -19 points on to its -11% correction and the outlook is not good. The next tentative support is in the 2030-2050 range with 1900 looking more likely as each day passes. The Nasdaq has eight consecutive days of losses matching the streak from May. In order to find two back to back months of consecutive 8-day losing streaks you would have to go all the way back to 1990. The Nasdaq is getting no help from the Russell or the SOX and comments today from Western Digital removed any hope of the PC sector rebounding. Western Digital said in an SEC filing that PC sales had been seasonally soft and that prices are under pressure. With only two weeks to go in the quarter WDC said that quarterly results would depend on business over the remainder of June. That is not a positive statement this late in the earnings cycle despite assurances that the hard drive industry's long-term fundamentals are in "excellent shape." The WDC comments suggest we could see a pickup in earnings warnings from tech companies.

Nasdaq Chart - Weekly

The S&P-500 has broken two-year uptrend support at 1235 and appears destined to hit that 1194 -10% correction level. Major support lies just below at 1175 and I think we would see some definite bargain hunting should that level be reached. The 100-week average at 1209 could provide a speed bump on any continued decline but I doubt it would hold for long with 1194 squarely in the bear's sights.

S&P-500 Chart - Weekly

The Semiconductor Index has broken several levels of converging support at 450 and appears to be headed lower. The next material support is 375. The Nasdaq will remain hostage to the SOX and more news from companies like Western Digital will not be a positive influence.

SOX Chart - Weekly

Stocks making the mover list today included Apple Computer with another upgrade to a buy at Needham & Co. This is just another in a string and AAPL gained +1.66 for the day. Analysts can't seem to say enough good things and are projecting a breakout quarter. Maverick Tube, (MVK) a pipe supplier to the energy industry was the target of a $3.19B takeover offer by Tenaris. MVK jumped +$16.99 but ending -$3 below the $65 cash offer by Tenaris. Other suppliers in the energy sector saw buying interest on thoughts of more consolidation ahead. Jabil Circuit cut its profit outlook and was hammered for a -$7 loss. The estimate cut shaved about a dime off the 43 cents analysts expected. The company said the shortfall was due to "operational issues within the company."

Metals stocks imploded once again with the sector off -4% but the damage was really in the precious metals. Silver was off -13% and gold fell -$44 to $566.80 and its lowest level since the $732.50 high back in May. That is a -23% correction and still going. Support at $545 should hold unless the dollar continues to rise. The dollar has found support as a safe haven currency in times of global market stress.

Gold Chart - Daily

Dollar Chart - Daily

The global liquidity drain is said to have been caused by Japan. They announced at the end of March they were going to end the free money period and remove excess liquidity from the market in preparation for a series of rate hikes over the coming years. Since Japan had nearly a zero interest rate it was the bank of choice for speculative investors. Over the last several weeks Japan has withdrawn more than $200 billion from the market and that is helping push speculative rates higher and give support to the dollar. Unfortunately it is making those speculators with cheap loans run for cover. With 9500 hedge funds managing over $1.3 trillion in assets there are probably quite a few more than you would expect with loans from Japanese banks.

We have been hearing over the last week of margin calls on some US funds. As the markets accelerate to the downside there are probably quite a few in severe distress. Leverage is a wonderful thing as long as the market is going in your direction. Once it turns that leverage bites badly to the downside. So far there has not been any rumors of any pending fund failures. The real stress is going to come when investors get their second quarter statements. If you have any doubt about the impact of hedge funds in the market you only need to look at the NYSE program trading statistics. For the latest week available ended June 2nd, 73% of trading volume was due to program trades. That is the highest number I can remember and well over the 58% average for the year. According to the NYSE program trade volume across all markets averaged 2.422 billion shares PER DAY for the week.

There was a lot of trader chatter today about an increase in margin calls on retail investors. The 2:PM selling increased sharply both days this week and that typically suggests the closing of margin positions as well as the favorite time for afternoon program trades to execute. If individual investors are being forced out of positions then we may be closer to that missing bottom.

Oil prices have returned to support at $68.50 ahead of Wednesday's inventory report. Crude is expected to show a -1mb decline with gasoline showing a +2mb build. That is not really what is producing the selling in crude. Crude, like gold, silver, etc, is being crushed by the same selling forces that have hit the global markets. When you need to raise cash to protect other positions or to cover shortfalls in other areas you have to sell what you have that still holds value. Oil still holds value and is only off -8% from its highs. Had Alberto headed a little farther west that decline may have been averted. Oil stocks have been crushed far more severely than oil itself. Many stocks are off more than 25% and it does not matter what sub sector they are in. Oil service, drillers, coal, gas, refiners, etc, are all down strong. It is simply a matter of raising cash and taking profits. There is nothing different between the energy sector and the other sectors getting hammered other than it has been a standout for the last two years and leaders in every sector are being kicked off the life raft.

Merrill Lynch released a survey today showing that 61% of economists expect the economy to weaken over the next 12 months. I think the other 39% were asleep. That view is nothing new to those of you that read Option Investor but for the Merrill survey it was a sharp increase from the 43% reported on the May survey. 34% expect corporate profits to drop and that was up from just 9% in May. But bullishness still exists in those hallowed halls with 59% expecting higher markets six months from now.

For the rest of the week we have two more hurdles to cross. They are the CPI and the Fed Beige Book on Wednesday. All other remaining economic reports pale by comparison to those. The CPI is going to be dangerous only if the core rate explodes to the upside. Any number of +0.2% or less would be market friendly as already baked into the cake. BUT, much of the selling we have seen recently has not been related to economics per se. That has been used as an excuse but what we are seeing is a combination of a global margin call, the removal of an appetite for risk, repatriation of funds from emerging markets and simple profit taking. I showed you some charts recently of the +50% gain in emerging markets just since Jan-1st. That was an unsupportable spike generated by vast amounts of cash going into global ETFs and that cash is coming back home now that the bubble has burst. Actually that cash is waiting on the sidelines for the carnage to quit before jumping back into the US market. At least that is what analysts are hoping.

The market internals are not improving regardless of what support level we reach. Note the imbalance between the new highs and new lows in the following table. Also note that we were not that far from another 7 billion share day. In the markets you follow the volume to determine their real health and 5:1 down volume on 6.6B shares should be a strong clue.

Table of Market Internals

With the Dow, Russell-2000, Nasdaq-100 and even the Transports at what could be called critical support there is always the chance, however slim, of a technical rebound. However, this is OpEx week and we have seen no signs of buyers. I would nibble at some long positions if we did see a rebound appear on strong volume but I would really want to see some traction before making an entry. The gap and crap we saw this morning and the failed +100 point spike this afternoon is a prime example of why caution is advised. Futures are positive overnight and rising but the night is still young. The VIX closed at a new 3-year high at 23.35. Add that to a bullish reading on the TRIN at 1.56 and an index put/call ratio of 1.99 and there may be enough oversold to attract at least a few bargain hunters. Let's hope they all appear at once and all buy semiconductor stocks. That may be the only hope we have for a rally that sticks. The Federal Open Mouth Committee (FOMC), thank you Rick Riley for that acronym, has been on a speaking rampage this week and it is far from over. Bernanke has already spoken twice, Bies and Olson once. Still to come are Bies on Wednesday, Bernanke and Kroszner on Thursday and Kohn and Kroszner on Friday. Bernanke said he was going to provide open and transparent communication from the Fed to the market. Ben, enough is enough! Fedspeak has turned into Overspeak and we need a little less transparency and a little less talk.

In closing I am going to use one of Art Cashin's famous lines. "I don't care it it's irrational--just give me some exuberance!"

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