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Market Wrap

Bad News Bulls Save the Day

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For bulls it was a tough morning but they dodged the salvo of negative news and used each news event as a stepping-stone higher. Well, maybe not higher but they did try really hard and prevented what could have been a major disaster. The possible return of the Asian Contagion was ignored. The strongest inflation at the producer level in more than 25 years was ignored. Falling housing permits were ignored. A hawkish speech by Fed President Fisher was ignored. From the bullish sentiment evident in the market you would think Santa Claus was coming to town.

Dow Chart - 180 min

Nasdaq Chart - 180 min

The headline number on the Producer Price Index (PPI) came in at +2.0% and a rate not seen in 30 years. The core rate minus food and energy rose at +1.3% and a rate not seen in 25 years. This was blowout inflation numbers but after the required reaction dip at the open the bulls calmly bought the dip and returned the indexes to positive territory. This was pretty amazing in my opinion. The reason given for ignoring the PPI was the very sharp drop in the prior month of 1.6% and 0.9% respectively. The urge to average the months and call it even was given as the reason for a lack of material reaction. Secondly the rise in energy prices and a sudden spike in auto prices were the two main contributors to the headline gain. Prices for intermediate energy goods rose +4.2% while prices for crude energy products rose +35.8% due mostly to a rise in natural gas prices. Intermediate food prices also rose by +3.4% with prices for food products rose +2.4%. The reason given was a sharp rise in prices for corn with larger quantities being used for ethanol. This raises feed prices for cattle as well as raw corn inputs for human food. Maybe the "let's average the last 3 months" crowd has it right since the headline PPI number is only up +0.9% for the last 12 months and well below the +4.0% level we were seeing back in the April-June timeframe. With oil prices holding above $60 the odds of a continued energy price pass through into the PPI will continue. I am sure glad as individuals we dont need food and energy so that rising inflation does not impact us. (grin)

Major PPI Components

New Residential construction starts rose +6.7% to 1.588 million units on an annualized basis in November. This was well above the estimates and you would have expected it to be greeted warmly on Wall Street. Instead the street turned negative on housing because the same report showed that permits fell 3% to a nine year low. Permits are generally seen as an indication of future starts since they are the first step in building a new home. This was the 10th consecutive month that permit numbers fell. Also weighing on traders was a downward revision of 14,000 starts for the Sep/Oct period. November single family starts, the one number that impacts us as homeowners the most, rose +8.1%. This would suggest builders are beginning to shake off the crash and add to inventory levels for spring sales. We also saw a small uptick in the single-family buyers six-month outlook component from 45 to 48 in the NAHB Housing Market Index on Monday. It would seem all the news was good with the exception of the continued dip in permits although fewer new homes raises the price of existing homes when a real rebound begins.

Hovnanian Enterprises reported earnings that swung to a loss rather than earnings as analyst's had expected. HOV lost 1.88 after taking $315 million in charges related to inventory impairments and land option write-offs. Hovnanian said this would help their financials in future quarters. Most builders buy land for development years in advance with options where they can walk away from the contract if housing conditions change before they are ready to build on that land. All the builders have taken hits from abandoning optioned land over the last year. On the bright side HOV said they expect the market to stabilize early in 2007. The CEO said buyers were out there but they were waiting for increased discounts and incentives before making a purchase. Once the spring buying season arrives we could see a flurry of buying as those tired of waiting snap up the best bargains. HOV said it was too early to call for a bottom in the market and they were anticipating a continued decline in prices into that spring season.


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The biggest event for the morning happened overnight when Thailand established rules for investing in their country. In attempt to slow speculative investment the government issued a rule requiring all investments funds to remain in the country for a full year or face a tax of up to 30%. The Thailand SET stock exchange fell 15% as more than $20 billion in foreign capital was either withdrawn or lost due to falling prices. This is roughly 12% of the entire GDP of Thailand. Other Asian markets suffered as the reaction wave spread across the globe. Suddenly worries of another Asian Contagion began to be discussed. In 1997 Thailand created another ripple in the currency markets that caused profound ramifications worldwide. Fears of another event caused investors to withdraw bids or close positions almost instantly. The difference between the two events is simple. In 1997 it was a lack of liquidity that caused the problem as fears of defaults rose. Today it is the opposite with too much liquidity flowing into Thailand and sending their Bhat currency soaring. The Bhat hit a 9-year high against the dollar on Monday. This was distorting their trade balances and the government wanted to slow this influx of foreign cash to equalize the currency pressures. What they got was a massive reaction and an instant liquidity drain. By day's end the government said "kings-x" we changed our mind and will not institute the rule as previously described. They said cash inflows into the equity markets would be exempt, maybe. Late tonight it is still unclear exactly what their position will be and investors will likely be cautious in returning.

Amazingly none of this inflation, housing or currency data affected the bond market. The yield on the ten-year note held flat at 4.59% and the Fed funds futures were basically unchanged despite the potential uptick in inflation. There are still no changes in the Fed rate being indicated though April. It appears the Fed is still on hold. However, the Dallas Fed President, Richard Fisher, said in a speech the "risk of unacceptably high inflation still outweighs the risk of substandard economic growth." He also said, "he would have no choice but to advocate tightening monetary policy further if inflation does not ratchet downward." And, "We cannot yet say with conviction that we have turned the corner and have this problem fully contained." These comments helped spook the market but only for a very short time. It appears there is no amount of negative news that can prevent the bulls from expecting a Santa Claus rally.

We know from experience that betting against Santa Claus or better yet betting against the bull's anticipation of Santa, is normally a losing proposition. Only 13 times in the last 78 years has the market actually posted a loss between Dec-13th and New Years Eve. That is an 83% record for Santa and that takes into account terrorist attacks, wars and sick reindeer. The anticipation seems to overcome all the macro-economic events with euphoric holiday buying. It is as if adult investors still want to believe in their version of Santa even though they are now old enough to know there is nobody dropping gifts down their chimney at home. Don't confuse them with the facts, just buy, buy, buy. When Santa does arrive in style the gains average about +3%. In leaner years a +1.6% average is the norm. Last year the market dropped -1.4%. It has been 73 years since the market fell for two consecutive years during this period. Could lightning strike twice? It is entirely possible but the bulls seem determined not to let it happen this year. Last year January saw a strong gain the first two weeks after December closed at its lows for the month. But remember the Wall Street adage, "When Santa fails to call the bears will roam at Broad and Wall." If we don't end the year with a rally I would not bet on January returns two years in a row.

Whatever your belief about the direction of the markets for the rest of the year you may have to wait until after Christmas for that move to develop. The market volatility continues to slide along with volume and the market internals indicate a lack of interest. Everyone has the holidays and last minute shopping on their mind and few traders are around to act on any news positive or negative. Unfortunately for Oracle holders there were enough sellers around today to knock them back about -5% after their earnings report showed license revenue to be weak. Oracle shares had hit a 5-year high in November but fell to a 3-month low on Tuesday. Combined license revenue rose only +14% and that was less than the 15-20% they had previously predicted. New application sales rose +28% but Wall Street was looking for +40%. When asked on the conference call if database sales would be more or less than 10% next year Larry Ellison said combined sales would be in the "double digits" and database sales themselves might be in the single digits. When analysts were expecting growth rates from 20%-40% it is amazing the stock was not cut in half. Had there been more traders at work that may have been the scenario.

After the bell PALM reported earnings of +12 cents that fell sharply from the comparison quarter in 2005 but beat the street's lowered expectations. PALM said a delay in the launch of a new Treo model had already caused them to cut earnings estimates in late November to 10-11 cents from 15-18 cents. PALM hit a new 52-week low just before the close and failed to move significantly in after hours falling only a dime. Again, traders were more interested in leaving early to shop than concentrate on a lackluster earnings report.

Micron (MU) hit a new 52-week low at $13.35 after WR Hambrecht cut the stock to a hold from a buy. The analysts said that while the current DRAM market is stable he feared it would soften considerably in Q2 as the initial Vista demands fade and excess supply now in production arrives in the market. He also saw increasing competition in Micron's core business segments suggesting investors move to the sidelines ahead of the softness in chips expected in 2007. The Semiconductor Index continues to weaken but has so far been able to cling to support at 470 but each day it appears a failure is imminent. Late tonight the Semi Book-to-Bill report was released showing that only $97 in orders were received for every $100 in orders shipped in November. This was the 4th consecutive month that orders were less than shipments. October was also revised down from .95 to .94.

Oil prices fell to $61.65 overnight after reaching $63.50 again on Monday. It was simply expiration pressures as the contract expired at 2:30 today. Short covering just before the close sent prices soaring right back to $63.45. It was a good day to be trading oil futures and the expiration gave us that nice dip to buy that we were expecting in energy stocks. The February contract is now the front month and it declined to $63.37 to meet the expiring January contract price. The February high this week was $64.15. I do not expect the price to fall significantly as investors move forward one month. Conditions in the energy sector are beginning to show geopolitical stress once again. The US said it was going to bolster its presence in the Persian Gulf as a warning to Iran's increasingly defiant government. This would include adding another carrier task force group to the Gulf. Recent Iranian naval exercises, support for Shiite militias in Iraq and blatant defiance regarding the UN demand to halt uranium enrichment were given as the need for the upgrade in forces. Meanwhile Iranian President Mahmoud Ahmadinejad said that UN sanctions would not stop Iran from its nuclear goals. Remember there is a large number of military analysts who believe Bush will attack Iran before he leaves office in order to degrade their ability to make war once the US leaves Iraq. It will be blamed on the nuclear issue but that is only one reason it will probably happen. By putting another carrier group in the Gulf and saying it is to warn Iran is like waving a red cape in front of an angry bull. It may only be a matter of time before Iran takes a shot at a US ship or plane to show they are not afraid of the US. That will be all that is needed for the US to rain down bombs on every military target in Iran. Iran needs to be very careful about antagonizing an armed opponent that is itching for a reason to fight.

January Crude Oil Chart - Daily

The increase of tensions regarding Iran is only one reason oil prices may not weaken. There were two more attacks in Nigeria and the violence shows no end in sight. The ship channels in the Houston/Louisiana area are still suffering a crippling attack of dense fog. It has been five days since the fog settled in to stay with dozens of tankers in a holding pattern offshore waiting for it to lift. The weatherman says that may not happen until Thursday. The Houston/Texas City channel sees imports of 2.3 mbpd. Beaumont/Port Arthur 1.1 mbpd and Lake Charles 675 kbpd. With shipments virtually on hold that is a lot of oil backing up in the Gulf but with inventory levels still at multiyear highs it is not really a problem. It just makes good press. How that will impact the inventory report tomorrow is unknown since the fog did not arrive until last Thursday. JP Morgan is expecting a drop of -1.5mb in crude and a build in gasoline and distillates.

The weather forecast for warmer weather in the Midwest and Northeast sent the price of natural gas plunging below $7 intraday. Obviously traders did not see the winter storm hitting Colorado and points north and west of us. They are predicting 10-20 inches of snow over the next 48 hours. We all know that eventually this weather system will move eastward and probably just in time for a white Christmas in the northeast and another weather prediction down the tubes. Gas producers are just praying for a front that comes and stays but so far that has not happened. Citigroup cut ratings on Devon (DVN +1.14), Noble (NBL +1.15) and Anadarko (APC -0.35) from buy to hold on worries that the gas glut could continue if we don't have a normal winter. Stocks were already beaten up from the dip in oil prices and profit taking from last week's strong rally. The reactions were minimal as you can see in the prices.

The Dow recovered from a -40 point loss at the open and rallied another +30 points to yet another record high close at 12471. Past intraday high resistance at 12485 continues to hold but the lack of a downdraft on today's news should guarantee a breakout ahead. Of course just saying it guarantees a breakout is the kiss of death. There are no guarantees but the bulls appear to be determined and short of a terrorist attack in the US the fix appears to be in place. Support has risen to 12400 and that could be the next launching pad.

The Nasdaq has joined the Russell-2000 in the tank and support at 2420 was in danger of breaking most of the day. A late afternoon rally saved the day but the Nasdaq still ended the day -6. That was a far cry from the nearly -30 point drop at the open. Techs are being hurt by weakness in the chips and the data is not getting any better.

I warned about the Russell-2000 on Sunday and nothing has changed. It did manage to finish fractionally positive today after a monster rout on Monday. With the Dow flat on the Monday the Russell lost -10 points. This continues to be a leading indicator of an underlying weakness in the broader market with blue chip defensive issues being the investment vehicle of choice. Utilities, tobacco, gold and other defensive issues were the sector leaders today. The Russell came within 2 points of the low for the month at 773 set back on Dec-1st. Everybody needs to pay attention to this index because it is telling us the fund managers are setting up for a future dump by moving out of illiquid small caps and into highly liquid blue chips. It is a textbook setup.

The internals on the broader market are also deteriorating. The new 52-week highs fell to 267 and the lowest level since Nov-28th. New 52-week lows rose to 97 and the highest level since Nov-14th. New highs on the Russell fell to 29 and the lowest level in a month. Low and behold the S&P-500 saw 2 individual new lows on Tuesday, the first new lows since December 6th. Maybe the large cap index is also beginning to crack as well. New lows on the Nasdaq hit 64 and the highest level since Nov-2nd. Meanwhile the VIX remains firmly pegged to just over 10 after hitting 8.60 at the open on Monday. That was a better than 10-year low. Experienced investors know what these indicators suggest and this is just another reason I am switching my bias to bearish.

Russell-2000 Chart - Daily

S&P-500 Chart - Daily

The S&P-500 is testing me. I suggested on Sunday that although I would retain my long bias into the holidays I would consider paring long positions should it move under 1420. It spent most of the day between 1418-1420 before an end of day rebound pushed it back to 1425. I took my own medicine and actually took profits on the majority of my positions. I am now changing my bias to bearish but not immediately. I believe the complete disregard for today's news suggests the bulls are going to continue to try for new highs. Whether they are successful or not remains to be seen. I do believe there is some weakness ahead and I want to be ready when it appears. I will look to short any weakness on a retest of the highs at 1431 or a failure of 1418. Today's 4-hour hold at 1418 gives us the exact point where we should switch to a flat/short position with 1405 as the first support target. If you are still long I would ride it as long as possible since a Santa rally can be strong at times. They may be content to tag 12500 and call it quits or they could make a run for 13000 but I seriously doubt it. Until the Russell internals improve I am putting on my fur coat. That may not be a bad idea anyway with 10-20 inches of snow headed my way tonight.

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