There could be a new ending to the fairy tale if the current trend of economic numbers continues. According to the media the market is celebrating the positive data after weeks of questionable reports that seemed to be predicting a recession rather than a soft landing. The bearish outlook for the economy, the markets and for bonds continues to improve and there is no sign of a rally stealing Christmas Grinch.
Dow Chart - Daily
Nasdaq Chart - Daily
The Consumer Price Index (CPI) for November was released on Friday and surprised almost everyone with an unchanged reading after dropping -0.5% in October. The expectations were for a gain of +0.2%. The declines came from apparel -0.3%, new vehicles -0.7%, gasoline -1.6% and airline fares -4.8%. The drop in airline fares came mainly from a reduction in fuel surcharges. The core CPI, minus the volatile food and energy components, dropped to 2.6%. This is the number the Fed watches for evidence of inflation in the CPI. The high was seen in September at +2.9%. The year over year drop to 2.6% follows a drop to 2.8% in October and is strong evidence that the Fed's slowing inflation story is tracking as they expected. Lower energy prices are a strong factor in the continued drop but the OPEC decision this week could reverse those declines.
The core inflation evidenced in the CPI shows a peak in September and a steady decline that should give the Fed a sign of relief. Relief that the inflation scenario is proceeding as they expected and relief for the markets that the Fed has less reason to raise rates. The drop is still not strong enough to expect a rate cut in the near future. At this rate it could be summer before the Fed feels comfortable in easing the rate. The Fed funds futures for April dropped -8% on the news to indicate only a 12% chance of a rate cut before April. Without another sharp drop in housing or a couple months of job losses the Fed could remain on hold for a long time. This is positive for the markets because there is less apprehension about the Fed's direction now that inflation has slowed for two months. It also means the economy is recovering slowly and not at a pace that could fuel further inflation gains. For the time being the Goldilocks economy should provide traders with no reason to fear stocks. The risk for traders now will be a return to higher prices for oil. As higher prices filter through the supply chain the rate of inflationary decline could slow or even reverse.
Industrial production for November rose +0.2% after being flat in October and down -0.4% in September. This could be the first sign of a bottom forming in manufacturing. Capacity utilization was flat at 80.3 and the low for this cycle. The Fed would like to see utilization slip further indicating rising excess capacity. As excess capacity increases prices for manufactured products tend to fall as competition for market share increases. If utilization rises product prices tend to rise as producers compete for existing capacity. Rising utilization means retail consumption is rising and rising consumption pushes prices higher. It is a complicated cycle but the key for the Fed is a desire for lower utilization to keep prices down. The major driver in the November production gain came from a surprise increase in motor vehicle production.
The Economy.com Risk of Recession report for November came in at 21.0% up from 16.8% in October. This is the highest level since September 2005 and well above the cycle lows at 15.4% set last June. The current reading of 21% is still very tame and at the low end of the historical range. The only really weak component is housing and that appears to be improving. The inverted yield curve continues to be a problem but with rates rising in anticipation of the Fed remaining on hold for many months ahead that curve discrepancy is shrinking.
For next week the economic calendar is filed with data but only a handful will be material to any traders not already on vacation. We will get another look at the housing data on Mon/Tue and expectations are for another small improvement. The Producer Price index on Tuesday will give us a look at the inflation picture at the manufacturer level. The GDP on Thursday should not be a market mover since this is the third revision for Q3. There is not expected to be any material change but should one appear it could suddenly become very important. The Philly Fed survey also on Thursday has been very volatile of late with August spiking to 18.5 but Sep/Oct both showing contractions in activity in the -0.5 range. November rebounded to a more normal range at +5.1 meaning next week's number could be anywhere on the scale. A positive reading slightly over 5.0 would be the best for the market. A decline could bring back worries of recession and another spike could bring back worries about a possible continuation of Fed hikes. There is never a dull moment since no two reports or two economists ever agree. They say if you lined up all the economists in the world they still could not reach a conclusion.
Weekly Economic Calendar
It was a busy day on Friday with the markets getting off to a good start on the tame inflation. Leading the charge was GE, the second largest market cap company in the US. GE continued the gains, which began on Wednesday with a +1.15 jump on Friday. The better than $2 gain from Tuesday's close produced the biggest two-day gain for GE since Nov-2003. The sparks were seen as affirmed guidance early in the week, an increased dividend payable to holders of record as of next week and a rumor they were going to announce a sale of their plastics business. They also announced a record order of gas turbines from Saudi Arabia. GE has been in a trading range for years under $36.50 and this could have been fueled by short covering as well. GE closed at a new two-year high.
GE Chart - Monthly
Harrah's (HET) announced it had received another offer somewhere around $88.50 per share or $16.5 billion in cash and stock from Penn National Gaming. The board said it was considering the various offers including a recapitalization of its own shares, which would include a one-time cash dividend. Harrah's closed at $79.55 and well under the PENN offer at $88.50. There is too much confusion surrounding the various offers and the threat of a large cash dividend for investors to push the stock higher. Confusion is never conducive to higher prices.
Captain Kirk announced back in late November he was offering $55 for up to 15 million shares of MGM. The casino company said on Friday a special committee decided not to make a recommendation to shareholders whether they should accept Kerkorian's offer. MGM closed at $55.31 on Friday, down -89 cents. The last trading day before captain Kirk made the offer MGM closed at $49. Kerkorian already owns 56% of MGM and the additional 15 million shares would boost his ownership to 61.3%. MGM would still remain a public company if shareholders accepted his offer. With the rising bids on Harrah's Kerkorian is probably wanting to add to his holdings on MGM thinking the gaming sector is due for a continued rise.
Apple Computer said it would delay filing its annual report as more time was needed to calculate restatements to prior years. Apple has been under the gun for their stock options handling and CEO Steve Jobs has admitted he was aware of the problem. Jobs does not appear to be at risk as are some other CEOs, some who have had charges filed. Apple claims there was no wrongdoing. They will however have to restate as much as ten years of earnings to correct the problems. That is a tough dance to say we did nothing wrong but we will have to restate nearly ten years of financials. Dell also announced they would delay filing their Q3 reports due to their continued investigation into accounting irregularities.
Weyerhaeuser (WY) jumped +2.44 after an activist fund, Franklin Mutual Shares, a large shareholder in WY went public with concerns over the pace of corporate restructuring. This prompted Deutsche Bank to upgrade WY to buy from hold and raise their price target to $80 from $65. Franklin Mutual is also pushing WY to convert from a C-corp to a more tax advantaged REIT structure.
E*Trade Financial (ET) is moving back to the Nasdaq on Dec-26th after several years as a resident on the NYSE. Their new symbol will be ETFC and not to be confused with their old Nasdaq symbol EGRP. "We are pleased to join Nasdaq, a true innovator whose value proposition parallels our own, leveraging technology to provide customers with low fees, superior service and fair, efficient and transparent market access and execution," says E*Trade's CEO, Mitch Caplan. E*Trade initially listed on the Nasdaq with their IPO in 1996 but switched to the NYSE in 2001 when tech stocks and the Nasdaq were out of favor. Rumor has it they wanted to move to the big board to be more respected like Merrill Lynch and Charles Schwab. E*Trade is not the only one to move to the Nasdaq. Charles Schwab (SCHW) formerly (SCH) also made the switch to the Nasdaq to become a big fish in a small pond. Maybe ET became jealous that Schwab was rubbing shoulders with all E*Trade's old Nasdaq buddies.
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Adobe (ADBE) reported earnings inline with estimates Thursday night but released strong guidance and the stock spiked +$2 on Friday to a new six year high. Adobe bought Macromedia and has been working hard to produce a new version of Creative Suite 3 which bundles Flash and Dreamweaver to be released in the second quarter of 2007. Investors evidently liked the news. They overlooked the warnings from several companies that Q1 is likely to be a tough quarter for software companies but focused on what should be a good second half of 2007.
Google (GOOG) lost -$2 to $480 after announcing they were finally entering the domain name registration business. They became a reseller two years ago but never acted upon their license. Now they are going to partner with GoDaddy and eNom to sell registrations at $10 a year. Google hopes to sell more of its services to people that register domain names through Google. Google also announced they were creating a private market for employee stock options. Employees could sell their vested options to qualified financial institutions through private auctions. Institutions could buy the options as an investment.
Not all news was positive on the stock front. Black & Decker (BDK) cut its full year guidance for the third time this year and investors promptly cut -10% or -$8 off its stock price. BDK said the slowdown in the housing sector was causing a drop in orders for things like Kwikset locks, Price Pfister faucets and DeWalt tools. BDK expects weak conditions to continue in 2007 until the housing market finally finds legs for a strong rebound jump. BDK went so far as to say it appears ALL manufacturers are seeing the same order drop. Thank you BDK for dragging everyone else into your pity party. Stanley Works (SWK) dropped -$2 due to this guilt by association. I can't blame it all on BDK because Illinois Tool Works (ITW) also warned that North American sales were weak. ITW is in a slightly different sub sector but gave back a week of gains just the same. Terex, also in a different tool sector was knocked for a loss but recovered after the bell on some unexpected news.
Navistar (NAV) is being delisted by the NYSE for non-compliance due to delayed financials. On a conference call with investors about the delayed financials Navistar CEO Dan Ustian said, "If you have a lot of money, come over and see us" alluding to their willingness to being bought by somebody with deep pockets. CNBC repeated this comment all day on TV, sometimes in a degrading manner. Late in the afternoon the CEO said he was making the comment in jest after he apparently caught heat from investors. Sure, just a joke, ha ha. Investors did not appreciate the -12% drop in stock price from a combination of the joke and the delisting worry. The stock of NAV did recover late in the day to lose only -1.14 or -3%. Hey, the board just decided to cut your pay by 50%. They will tell you if it is a joke sometime next week. (I am just kidding)
After the bell S&P announced they were replacing Navistar in the S&P-500 with Terex. TEX bounced +$3 in after hours. Of course that was after I was stopped out of some short-term calls this morning on the BDK, ITW fiasco. TEX closed after hours trading at $61.35, a new all time high. S&P also said it was replacing American Italian Pasta (PLB) in the S&P-600 with Mannatech (MTEX).
Dow Transports Chart - Daily
Shipping company YRC Worldwide (YRCW) fell to a two month low after warning that Q4 earnings would fall short of estimates due to the slowing US economy. YRCW said pricing was weak and tonnage shipped would be down by around -5%. YRCW had been downgraded by a handful of analysts just a couple weeks earlier on worries that shipping was slowing. UPS and FDX failed to weaken but their time is coming. The holiday season is nearly over and Q1 package shipments should slow drastically. You could not tell it from the UPS truck in my neighborhood today. I think he stopped at 8 of the 11 houses on my cul-de-sac including dropping off 4 packages at my house. The postman also cussed me when she dropped off six priority mail and parcel post packages Friday morning.
I expect Ebay to post some monster numbers for Q4 based on the amount of trouble I have seen on their website the last three weeks. I am a PowerSeller on Ebay and would be a PowerBuyer if they had a similar designation for buyers. I have never seen Ebay have such slow response time as the two weeks prior to Dec-12th. Dec-12th was the last day you could depend on buying something with regular shipping and actually have it arrive before Christmas. I was literally uploading items to sell on three different computers at the same time because the wait time was so bad. I have probably gotten over 100 web page errors in the last week just checking on things I bought or things I was searching for. I am hoping this means Ebay is snowed under with volume rather than their IT dept has gone to the dogs. Under normal circumstances above normal volume would result in a buy recommendation for a company but even though Ebay may post decent profits they historically fall off a cliff about mid January. (3 of the last 5 years) If you are looking for a recommendation it would be a sell/put about Jan-3rd.
Ebay Chart - Weekly
January Crude Oil Chart - Daily
It would not be a market commentary without discussing oil. You probably already heard that OPEC agreed to cut another 500,000 bpd starting Feb-1st if the basket of OPEC crude is trading below $60. The OPEC basket of crude typically sells for about -$5 less than the light sweet crude, which ended at $63.50 on Friday. That implies they are targeting $65 for sweet crude. That cut also assumes they can find enough OPEC members willing to actually make the cuts at that time. The allocation among members has not been made yet. Want more evidence this is talk and not action? Petro-logistics, a very well connected research firm dealing in the shadowy business of tracking "actual" oil shipments, said OPEC November shipments were only -100,000 bpd lower than October. The -1.2 mbpd cut was supposed to have begun on November 1st. All that OPEC talk and almost no real cut. With oil at $60 it does not surprise me. The two most vocal proponents of the November cut, Venezuela and Nigeria, did not cut any production. For January several OPEC members have warned customers they will be shipping less oil. They also warned some of them in December but we have to wait a couple more weeks to see if they followed through with their plan. Several oil refiners have said they were told on the side they could have anything they wanted. Regardless of what is really going to happen with the November cut or even the announced February cut the price of oil rose on Friday to close at 63.48. That is exactly on resistance, which has held for two months. With only one day left to trade the January contract it appears there were more shorts than longs as the contract comes to a close. The end of day buying was very sharp lifting the price from its morning low of $62.28. Next week the February contract become front month and it only closed about +75 cents higher than the January on Friday.
Multiple analysts came out recommending oil late this week including Dennis Gartman of the Gartman Letter and Birinyi and Associates to name just a couple. Gartman said he expects oil to rise to $75-$85 in 2007 and $55 is probably ancient history. With demand continuing to grow, the world absorbing the unofficial post cut OPEC production and OPEC apparently committed to keep oil above $60 the odds of higher prices are nearing 100%. The only thing that would prevent it would be a cooling of the global economy. From all estimates that is not going to happen. There was also more violence in Nigeria with rebels seizing a production facility and forcing them to shutdown. There are sporadic outages all over the northern hemisphere for weather and equipment problems. The Houston ship channel was nearly closed for two days due to dense fog and 77 ships were queued up waiting for the fog to clear. The US administration said they would open the strategic petroleum reserve if the fog did not clear soon. FedEx CEO Fred Smith said this week the world is racing to a disaster if something is not done about the coming oil shortage very soon. Fred is very credible but unfortunately he and I are preaching to deaf ears. I will explain why in my Peak Oil Update I am producing for year-end subscribers.
Birinyi and Associates said they surveyed 30 commodity analysts regarding price expectations for 2007. For metals traders the picture is grim assuming their predictions are correct. Of the 12 commodities surveyed only three were expected to rise. Gold was expected to rise +7.19%, Oil +2.84% and Natural gas +1.96%. Those metals that led the charge in 2006 were expected to plunge in 2007 led by nickel -38%, lead -39%, zinc -30% and tin -30%. Considering these metals had rocketed higher on strong demand in 2006 you would expect some profit taking eventually. Analysts blame the expected drops on new supply coming online. Record high prices caused miners to rush to bring on new supply to capture the boom. Analysts don't expect demand to slow just more metal to fill that demand. I seriously object to the expected decline in uranium of -6% for fundamental reasons. Uranium demand is expanding much faster than supply. Supply is actually falling due to problems at some mines. Whoever came up with the uranium number failed to do their homework and to me that calls into question their estimates for the other metals.
Birinyi Commodity Chart
The media blamed last week's gains on favorable economic reports and merger mania. There were some positive earnings stories but I believe there was more negative guidance than positive. As far as economics go it just depends on what week you are in with alternating weeks bringing a completely different economic view. Remember just the week before Bill Gross was on CNBC saying bond yields were going under 3%. There are always many reasons for any rally or crash. This was also a quadruple witching Friday, which only occurs once every quarter. Given the market and commodity moves over the quarter it was not surprising we saw some volatility ahead of expiration. Still I don't think those are the real reasons. They may be contributors but I think there is a broader move afoot.
We saw yields on the ten-year note reach 5.5% back in late June. Everyone was expecting the Fed to keep raising rates because inflation was soaring. The housing sector was imploding and the potential for an economic crash landing loomed large. Conservative institutions and funds began pouring money into bonds for a safe 5% yield to wait out the storm. A funny thing happened on the way to the recession. A bottom began to form in housing and inflation stalled putting the Fed on hold at 5.25% since June. Once the Fed paused the bond groupies began setting up for a future rate cut. When the Fed is cutting rates you want to be in equities not bonds. The top in the bond yields was put in place at exactly the bottom in equities. Once the trend reversed those same institutions began bottom fishing in equities. Just a little here and there all the while keeping a solid bond ratio as a fall back position. As the rally continued fund managers began to increase stock positions but also kept their hand on the trigger just in case the economy got worse.
Dow/Ten-year Note Yield Comparison Chart - Daily
As the indexes began to hit new highs back in late Oct and early Nov the economic data took a sudden turn for the worse. Short interest grew and in early December reached levels not seen since the mid 1990s. Everyone "knew" the markets were going to roll over. Much to their surprise the economics suddenly reversed and fund managers were caught betting against the market and still heavy into bonds. Suddenly it became a race and bonds began to be sold in early December. The indexes struggled to move over that new high resistance but refused to die. All sorts of bad news had no impact and good news was a strong shot in the arm. Now that it appears inflation is actually falling and the 2006 time clock is expiring it is a new race by managers to position themselves in equities so they appear smart when their year-end portfolios are released. I am sure the quadruple expirations had a substantial impact in accelerating short covering this week but the fire was already lit. The expiration simply fanned the flames.
With nine trading days left in 2006 we should see another move higher as managers chase performance. Retail investors are probably being sucked off the sidelines and into equities in droves. I have had more email this week asking about specific stocks and targets than I have had all quarter. Nothing drags money off the sidelines better than new highs in the markets. Worst case we should see fund managers trying to run out the clock at this level to protect year-end bonuses.
Now for the bad news. All is not well behind the scenes and the small caps are weakening. The small caps as evidenced by the Russell-2000 have not made a new high since Dec-5th. Were it not for a burst of short covering on Thursday at the open we could be -20 points off the highs this weekend. The rally has been exclusively in the large caps, the bluest of the blue chips. While the blue chips have been rising the small caps are turning blue from lack of cash inflows. On the broader market the internals are slipping with individual new highs at 598 on Friday well off the 956 high for the year set on Dec-5th. Actually, on the S&P-500 there has not been a single stock with a new 52-week low since Dec-6th. Friday's new highs of 67 were the highest since Oct-18th when the S&P first hit 1375. At the same time the new lows on the Russell have been increasing since Dec-5th. No new lows on the S&P but increasing new lows on the Russell. That should be a convincing piece of market trivia suggesting there is trouble ahead. Not necessarily next week or even the week after but definitely early next year.
Russell-2000 Chart - 30 min
The media claims the big caps are in favor because they have international exposure. That may be true in some cases but I believe the big caps are in favor because they are highly liquid. GE traded nearly 90 million shares on Friday when their average is only 26 million. I know an extra 3 cents on the dividend did not produce that monster surge. GE is so liquid you can dump a million shares over the space of a few minutes and not impact the price. ExxonMobil traded nearly 40 million shares when their average is only 20 million. Granted some of this volume was due to the S&P quarterly rebalance after the close on Friday and I am sure some index funds were getting in early to avoid the rush. However, the point I want to make is that the big caps are seeing by far the biggest inflows of cash while the small caps are just limping along. The small caps are the best indicator of the fund manager mindset. If they think there is a bull market ahead they will flee the safety of big caps and take the more risky positions. Instead it appears they are fleeing to the safety of the big caps this week and that bothers me longer term. On Friday the Dow, Nasdaq and S&P closed at or near their recent highs with gains for the day. The Russell-2000, NYSE Composite, Dow Transports, Drug index, HMO Index, Homebuilders Index and all the oil indexes closed with losses for the day. It was not as positive as the media would have you believe. CNBC kept running a header above all their content all day bragging about new highs on the Dow and S&P.
For the rest of December we should remain in the clutches of Goldilocks mania. As long as the PPI, GDP and Philly Fed next week are market friendly the love fest for big caps should continue. Remember, worst case the fund managers will be trying to run out the clock at this level. Conversely should support suddenly fade they can just as easily turn tail and bail. It may be the investor's money but for the next two weeks it is all about the manager bonuses.
We are still at risk for tax selling in individual issues. Those that have been big winners or big losers are the biggest risk. I believe we saw some of that on Friday in the energy sector. Oil closed at its high for the week but the major energy stocks were all weak.
The Dow closed at a new historic high at 12445 and only a decent day's gain below 12500. I am not sure it matters at this point since the headlines this weekend will be bragging about the new highs. Support is well below at 12250 so we are way out on a limb if market sentiment suddenly turns negative.
The S&P-500 is still well below its historic high at 1552 and high close at 1527 on Feb-24th 2000 but nobody is complaining about a new six year high at 1431 on Friday. If it was due to the quarterly rebalancing then Monday could see some weakness. If it is an influx of cash chasing performance or simply portfolio positioning for year-end then our hang time should be about three weeks, more or less. If a true Santa Claus rally is going to appear it should begin next week. Unfortunately Santa has been very unreliable recently.
S&P-500 Chart - Daily
The Nasdaq managed to post a new multiyear high by only 1.6 points at 2470. The old high was 2468.42 set back on Nov-24th. Considering most analysts are promoting techs as the best performers for 2007 you would think investors would be showing more interest. Instead we have weakness in the chips and that is a cancer that eats away at tech support levels. Current support is well below at 2420 so a lot of ugly can appear before any material damage is done.
VIX Chart - Monthly - Ten Years
The Volatility Index (VIX) hit better than a ten year low on Friday at 9.39. This is a screaming sell signal but nobody is listening. With the holidays ahead any further rally could push it even lower. Under 9.0 I am backing up the truck.
For next week I would continue to remain cautiously long. The last two weeks of December typically have a bullish bias but a quick check of the charts shows only about a 50:50 performance over the last six years. Nothing is ever carved in stone but long term the historical averages favor a continued bullish bias. Remember, we could also remain range bound as managers try to run out the clock. That said I would remain cautiously long. If we dip back below 1420 I would probably consider taking some profits on any weaker positions. If by some remote chance the managers can't keep it pinned to the highs I would definitely bail under 1405. I realize that is a broad range but that could easily be the range we trade in for the rest of December. I would love to tell you 1450 is just a day away but I would be just playing to your bullish desires. The only sure thing I can recommend is to buy energy stocks on the dips. With plenty of profits waiting to be taken we could see another energy dip before year end.