The markets finished the week back at their highs and there is little indication of the weakness that plagued us in early January. Sector rotation out of emerging markets, metals and energy produced significant cash flows into techs, blue chips and even some small caps. It appeared as though funds were just holding their breath for the first week of January to see if a correction would appear. Once they were confident support was going to hold they put their energy, metals and emerging market profits from 2006 back to work in techs and brokers. The Nasdaq 100 was the strongest index for the week with a +3.3% gain while the broker/dealer sector saw the strongest influx of cash with a +5.9% gain.
Dow Chart - Daily
Nasdaq Chart - Daily
Economically it was an off week with a peppering of non-critical reports that were mostly ignored by the markets. It was a week where oil news took center stage followed by earnings warnings, the iPhone and the Cisco/Apple battle over the name. Those companies that did warn saw their shares punished but we did not see the sectors collapsing as we have seen in the past. All in all the market was very well behaved, volume was strong and internals improved daily.
Next week the economy will be back on the front line with our first real look at the full month of December. Leading the list of critical reports will be the Producer Price Index (PPI) on Wednesday. The PPI came in at a very hot 2.0% for November and the December number is expected to decline to +0.4% due mostly to the continued slide in energy prices. This will be welcome news for the Fed to see prices at the producer level soften. However, on Wednesday the Consumer Price Index is expected to rise +0.4% compared to its flat reading in the prior month. This will be only a slight blip on the Fed radar since they know the prices for Jan/Feb are likely to take a significant drop due to the further collapse of energy prices in 2007.
Overall the reports this week should show a growing economy, shrinking inflation and the soft landing relatively intact. If anything the numbers could begin to show more of a touch and go for the economy rather than any landing at all. This expectation has produced a rise in the yield on the ten-year note to 4.77% and nearly a 3-month high. You may recall the yield hit a ten month low back on Dec-1st at 4.4% and analysts at the time were calling for an eventual 2-handle due to the softening economy. That means a rate somewhere in the 2.x% range. Expectations have changed significantly over the last month, as have expectations for Fed policy. Currently there are no expectations for a Fed rate cut through September and many analysts are quickly reverting to expectations for the next move to be a hike if the economy continues to rebound at its present presumed pace. Some analysts were thinking Q4 GDP could have fallen into the 1% range as late as month ago. Now there is talk of a rebound into the 3% range which would put the Fed right back into hike mode if that growth failed to moderate in Q1.
Investors will get an idea about Bernanke's economic view when he testifies before the new Senate Banking Committee on Thursday. That could be a tense time in the markets if Bernanke uses the opportunity to talk tough to the markets. Analysts believe the various Fed heads will begin to take a harsher stance in their public appearances and try to talk up rates rather than actually be forced to raise them. This will not be market friendly if Bernanke fires the opening salvo on Thursday.
The Fed Beige Book will also be a look into how the Fed sees economic activity developing across the country. There are several other economic reports of note I have highlighted in the graphic below.
The market will also be more focused on the Q4 earnings cycle as the larger companies begin to report. Intel will be critical on Tuesday and even more so after AMD warned this week that the chip war was taking a serious toll on AMD profits. Analysts expect Intel to post positive results but the key will of course be the guidance. Some feel Intel has been popping out new chip models at a rate that cannot be absorbed by the market. Multiple new models means corporate buyers have too many decisions to make and too many options. This can fragment the market and not produce enough sales in any one model to make it cost effective. The other models that were quickly bypassed end up languishing in inventory and lead to future write-downs. AMD has been fighting a good fight and they may have impacted Intel margins more than analysts expect. AMD warned on Thursday that revenues would be up a mere +3% for Q4 compared to prior estimates of +6% to +13%. Intel has been turning out new processors on almost a monthly basis while cutting prices at the same time to regain market share. Just how much those price cuts and new product production expenses have impacted Intel profits won't be known until Tuesday night. Although the AMD warning subtracted -9% from AMD stock on Friday it is hard to imagine any Intel news that would burst the current Intel bubble. It is always possible but just hard to imagine today. AMD traded 123 million shares with average volume only 17 million. Goldman Sachs downgraded them to a sell two weeks ago. Good call.
Market research firm NDP Group reported this week that corporate users were warming to Vista much quicker than expected. The sales results for December showed an adoption rate that was only -4% below the same rate for the Windows XP release. Considering the major impact of this release and the significant challenges of hardware upgrades needed for Vista this should suggest a strong hardware cycle in progress. Microsoft surged on this news to a new 52-week high. This should have been a benefit to Intel as well so Tuesday's earnings will be interesting to say the least.
Apple reports on Wednesday and everyone will be looking for any notes to earnings related to the stock options violations for Steve Jobs. GE, Citigroup and Motorola will close out the week with their reports on Friday. GE could have news about the projected sale of their plastics business. Motorola has already warned but will give the exact details on Friday. Samsung, the 3rd largest handset maker, reported earnings last week that fell -8%. Mobile phone sales rose to 32 million from 30.7 million in Q3 but profit margins dropped as much as -11% as margins were squeezed in an increasingly competitive market place.
Oil field services company Schlumberger (SLB) also reports on Friday and earnings are expected to be strong despite the drop in oil prices. SLB has said that US gas well services have slowed as drilling declined slightly with prices but international demand for services is continuing to climb. After warnings from BP, Chevron and Conoco it will be our first real look into earnings not directly related to refining and production. Service companies and drillers are expected to post strong results. Earnings for the entire energy sector are only expected to decline -2.7% because oil prices in Q4-2006 were comparable with Q4-2005. The next two quarters will have favorable comparisons since oil prices did not peak until early August.
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In stock news on Friday BP saw a huge bounce in its stock price, +3.05 (+5%) when it was announced that CEO Lord John Browne would retire earlier than expected. He will step down at the end of July instead of sometime in late 2008. Browne started with BP in 1966 and rose through the ranks to eventually become what some called the worst CEO in business in 1995. He will be replaced by Tony Hayward who is currently the head of exploration and production at BP. Browne has been blamed for dozens of major BP problems that developed during his reign. Having new leadership of the floundering oil giant is a definite positive for BP shareholders.
Conoco Phillips announced a $1 billion buyback that was good for a +$2 bounce.
Back in December Chevron announced a $5 billion buyback over the next three
years. Both have warned that production levels are slipping and they can't add
reserves at the rate they are currently producing. Instead of putting this money
to work trying to find more oil they would rather give it back to investors for
a temporary pop in the stock price. This is bad news for future production
because it proves they have nowhere to explore that has not already been drilled
or is in hostile hands.
While on the subject of oil we heard on Friday that OPEC may hold an emergency meeting in February and "might" cut another 500,000 bpd in February. This is about as wimpy as it gets. You have to make the November cuts of -1.2 mbpd first then the previously announced February cuts of -500,000 bpd before you can expect anyone to believe you are going to cut another -500K. OPEC has no credibility in light of recent production volumes and this may be the strongest evidence that a substantial cut must occur. According to Platts OPEC production was 27 mbpd in January, +700,000 bpd above their stated target. According to Petro Logistics actual shipments only fell -100,000 bpd in Nov and Dec and were on track to rise in January. According to tanker tracker Oil Movements OPEC shipments have actually risen +350,000 bpd in January. Obviously everyone has different numbers but they are all showing substantial shipments over the stated OPEC quotas.
Now, because they did not cut as promised they have an even bigger problem and it will cost them more money now to fix it. Had they cut production back in November to keep oil over $60 they would still be getting $60+ for that lowered production level. Now with oil hovering around $50 they will still have to cut production but they are going to be getting $10 less per bbl for that lowered production. Their greed is going to cost them big time. They know how this story ends if they don't follow through with their cuts. Oil will continue falling and they will end up selling their basket of OPEC crude for $40 rather than $60 and that is a major blow to countries already strapped for cash. They had the opportunity to control prices at a much higher level and blew it. Now every day that passes costs them even more money and that same tough medicine is waiting to be taken. $50 is seen as a key psychological level and they will need a major announcement with teeth next week to keep that level from breaking.
Bloomberg surveyed 47 analysts, dealers, traders and brokers and 20 said prices
will decline next week, 11 expect an increase and 16 predicted little
Last week 23 expected a drop. In the weekly Commitment of Traders report as of
Jan-9th commercial positions increased to a net long status while speculators
reversed into a net short position. Speculators increased their short positions
by 21,161 contracts or +13% for the week while reducing their longs by -3,391
contracts. Typically commercials are on the right side of the trade and
speculators are on the wrong side. This suggests we may be near a turn in the
sell off is overdone and while we may not have seen the exact bottom
it may not be far from here. Oil settled at $53 on Friday
February Crude Oil Chart - Weekly
Ethanol is going to significantly raise the price of your food in 2007. The 2006 corn harvest was the 3rd largest ever in the US but global supplies will drop to the lowest level since 1978 according to the USDA. The US is the largest corn producer and exporter in the world. The USDA said global consumption this year will rise to a record 725.8 million tons, exceeding production for the sixth year out of the last seven. Global inventories will drop to 86.4 million tons, down -55% since 2000. Corn futures rose +20 cents to $3.965 a bushel on the USDA news. This was a lock limit move and the maximum allowed for any single day of trading. Late in the afternoon there were 60,000 contracts bid and none for sale ahead of trading next week. It appears Tuesday will also be limit up and anybody short is in a world of pain. With no sellers and 60,000 contracts to buy it could be several days before they can cover. A full size contract is 5,000 bushels and each 1/4-cent move is worth $12.50 per contract. The limit move is worth $1000 per contract. Good if you were long but painful if you were short. Yes, there were shorts. Over the first five days of the month corn prices fell 45 cents from what had been the closing high for 2006 at $3.90. You can bet there were shorts on that decline given the +$1.40 rise the prior 3 months. That is an unheard of move in corn futures and plenty of traders were probably expecting it to decline back to some decent price in early 2007.
March Corn Futures Chart - Daily
The shortage of corn suggests to analysts that acreage devoted to wheat and soybeans will shrink as farmers try to capture this bull market in corn. They estimate 7.5% more land will be moved to corn farming with soybeans taking the biggest acreage hit. Corn also requires more nitrogen fertilizer, which comes primarily from natural gas. Companies benefiting from this expectation are John Deere (DE +3.83) for additional corn specific tractors and Potash (POT +6.23) for fertilizer. Other related stocks are AGU, CF, MOS and TRA. You can also buy the new Powershares Agriculture ETF (DBA +2.00), which is not specifically corn but covers four commodities, corn, wheat, soybeans and sugar. It was up +8% on Friday to $27.30.
DB Powershares Agriculture ETF Chart - 15 min
Last week was the strongest week in the markets since November with the Dow, Nasdaq and S&P closing at new 6-year highs. As I stated on Tuesday the Nasdaq was leading the charge and that was clearly evident over the last three days. That tech-based charge may not be as strong as it appears on the charts. The charge was led by the big caps MSFT, INTC, AAPL, CSCO, GOOG, SHLD, etc. The big caps impact the index by a much larger margin than the smaller stocks. For instance on Friday Microsoft rose +0.51 cents but that was worth +2.02 in index points. On the reverse Amylin Pharma (AMLN) gained +2.27 but that only represents 0.33 index points. Intuitive Surgical (ISRG) gained +2.79 but that was only worth +0.18 index points. Since Wednesday's low Microsoft gained +$2 and that was worth +7.92 index points or +13% of the 60 points gained by the NDX over the same period. I am sure you get the idea. Big cap techs suddenly found themselves in favor again and the index was rewarded with a strong sprint higher. I am sure there are good reasons for suddenly buying Intel and Microsoft and their tech sisters but I still believe one good reason is liquidity. Fund managers are not completely convinced there is not a correction lurking around the corner and are more comfortable in parking money in those big cap pockets of liquidity than a smaller stock that only trades a 2-3 million a day. Intel traded 90 million shares on Friday and Microsoft 104 million. It is not a bad sign that the index moved higher because the big caps excelled because it would have been nearly impossible to move without them. It is just a reason for concern, a point we need to keep tucked away in out mental bias for next week.
The Dow rallied to another new high, the 24th since October and tacked on +41 points on Friday to close at 12550. Like the Nasdaq the Dow benefited from strong gains in a few key issues. Exxon lead the winners with +1.68 on the rebound in oil prices. HPQ was up on the benefits of the price war between Intel and AMD. Dupont benefited from the fertilizer story and IBM rose on an upgrade. All good reasons but only 18 of the Dow 30 posted gains on Friday. Yes, it was a new high but the index is looking a little tired. It has good reason to be tired. It has not seen a -2% drop since July-06 or a -10% drop since early 2003. The current bull run for the Dow has lasted more than 1500 days for a +72% gain. This is the second longest streak on record and the 3rd longest cyclical bull out of 34 since 1900. It is no wonder fund managers are worried about putting money to work in this market.
Earnings are slipping simply because you can't continue to improve double digits forever. Q4 is suspected to produce +9.4% earnings across the entire S&P-500. Not bad but just not as good as the prior four years. However, conditions are looking up for the bulls. If the economy is rebounding as analysts currently expect then the Fed did manage to pull off the soft landing without a crash. If the economy does continue to improve the Fed may have to hike rates again by summer but rising rates in a rising economy are somewhat tolerable. Eventually the bull train will derail but possibly not until 2008. This hope is what fund managers are betting on. One more year of strong gains, a neutral Fed and decent earnings.
Next week could either cement those hopes or send them crashing to the pavement. The economics for December will be revealed and the earnings cycle will start in earnest. Traders will be willing to overlook almost anything next week in hopes of keeping the dream alive. Hopefully any bad economic news will be easier for us to stomach than the medicine in front of OPEC next week. Heck, some soft economics might be just what the doctor ordered to keep the Fed in check and the dream alive. Strong reports could wake up the Fed and have them back in the picture before managers are ready to weather the storm.
SS&P-500 Chart - Daily
The S&P-500 rose over resistance at 1415 and came to a dead stop at 1430 on
Friday. Obviously it is reading my articles and knew that was our short/long
decision point and exactly where
I was expecting a repeat failure. After
watching the market internals this week I believe there is a good chance we
could see a breakout on this attempt. Instead of each bounce weakening the
internals just kept getting better. For whatever reason market sentiment has
improved significantly over the prior week. This leaves me with a bullish bias
for next week if we can make that break over 1430. Otherwise I will be riding
the SPX back down again with any failure at that level. A lot
of the gain on the
S&P was due to buy programs on Thursday and Friday morning followed by some late
afternoon short covering on Friday. I am always leery of gains made entirely on
the back of program trades. It is better to see a gradual climb supported by
broad based buying instead. So, for next week we will be going long over 1430
and short on any failure of that level. Since Monday is a holiday I will be back
with you Tuesday night to report on Intel and the outcome of the