Blowout earnings and upgraded guidance by Dow components Caterpillar (CAT) and Honeywell (HON) launched the market into uncharted territory at Friday's open. The Dow launch was also helped by earnings gains in American Express (AXP) and a strong move by Exxon Mobil (XOM). All four are Dow components are all four were up more than $2 with CAT clawing its way to the top with a +3.20 gain. Together those four stocks accounted for nearly +100 points of the Dow's gain.
Dow Chart - Daily
Nasdaq Chart - Daily
There were no material economic reports on Friday with the monthly Mass Layoffs the only calendar event. Layoffs rose less than expected at 1,276 events impacting 130,700 workers. This was almost exactly equal to the announced layoffs in the prior months of 1,280 events and 144,000 workers. Announced layoffs are expected to increase slightly over the next few months as the housing problem continues and high energy costs pressure manufacturers to cut costs elsewhere. However, the labor market remains tight and these cuts should be absorbed into other areas with minimal impact to the economy.
Next week's economic calendar is mostly filler with another round of regional Fed reports as well as new updates on the new and existing home sales. The two key reports for me are the Fed Beige Book on Wednesday and the GDP on Friday. The Beige Book is a report from the various Fed regions regarding business conditions in their region. The Q1 GDP report is going to be important because analysts are expecting a sharp drop to only 1.9% growth in Q1 from the last revision to Q4 showing 2.5% growth. Analysts will be keying on this GDP number to confirm their own estimates of current economic growth. A major surprise in either direction could be a market mover.
Several positive earnings surprises gave the market wings last week but that trend is not likely to continue. As of Friday slightly more than 45% of S&P-500 companies have reported with earnings growth currently setting at +6.1%. 66% of companies have beaten estimates, 18% reported inline and 16% have missed estimates. By the end of next week more than 70% of S&P companies will have reported. The expectations are for that earnings growth number to decline to something less than 5%. The early reporters are normally the strongest and the farther we get into the cycle the worse the earnings become. The earnings table below covering next week shows a cross section of sectors and leaders in those sectors. The companies with the most impact on the market could be Amazon, Microsoft, 3M, Apple, Texas Instruments and Qualcomm.
Partial Earnings Calendar for Next Week
Microsoft will be the primary focus with the company expected to give an update on Vista sales progress. Steve Jobs is reportedly circulating an email calling Vista the new Coke. This is a reference to the change in the formula for Coca Cola that nearly sent the company into financial ruin before they relented and re-released the original formula. The reluctance of many users to upgrade to Vista is increasing. Microsoft has already said they will quit selling Windows XP in Jan-2008 so the squeeze is coming. Investors want to know how the public is accepting Vista and how sales are tracking compared to estimates. Microsoft had shifted revenue into Q1 due to the delay in releasing the product and to account for the upgrade certificates manufacturers had been shipping with systems. It will be interesting to see how Microsoft accounts for copies sold and their projections for future sales.
Other earnings to watch include Amazon, Apple and Broadcom in the tech sector and 3M, UPS and Whirlpool for evidence of general economic indications. Amazon is going to be challenged after loosing Borders as a major retail partner. Margins are expected to shrink as well as revenue according to some analysts. This will be the last quarter for Apple without any impact from the coming iPhone. They may have additional expenses related to the iPhone, Mac OS X and various other products in the pipeline but not yet available for sale. Broadcom, along with TXN and QCOM will give us better insight into the fortunes of companies that feed chips into products marketed by Intel, Cisco and other major equipment manufacturers. 3M could give us indications for business and consumer activity. UPS is a direct window into business shipments and online consumer activity. Strong earnings and guidance from UPS could be very beneficial to offset a weak GDP. Whirlpool is a major products manufacturer of consumer goods. Sales of dishwashers, refrigerators and microwave ovens will tell us if the consumer is alive and well or starting to go back into hoarding mode again.
There are dozens of oil companies reporting next week led by four of the majors, XOM, COP, CVX and OXY. Oil companies are expected to report strong earnings but they have strong comparisons after the sharp drop in oil prices to $55 in January. The average price of crude in Q1-2006 was around $67 per barrel. The average price in Q1-2007 was closer to $62. This will cause comparison problems with most companies that depend on the price of oil for their profits. Service companies and drillers should not have same problems but I expect them to relate stories of slower drilling due mostly to the collapse in natural gas prices in North America. There was also some serious weather challenges in Canada that caused a halt in drilling activity several times during the winter. Most analysts expect lower profits from the energy sector to produce a drag on the overall S&P numbers.
Google posted a +69% jump in profits to beat analyst expectations by +38 cents. Google's stock price only saw a gain of +$10 on the strong report. Although several brokers raised price targets once again the general public is finding it progressively harder to get excited about Google's performance. After several years of blowout earnings nearly every Google investor expects future blowouts and anything less is seen as a disappointment. It makes no difference that they beat estimates by 38 cents if investors are hoping for a $1 beat. Whisper numbers are normally out of sight and Google has little chance of hitting them. This is the same scenario many retail favorites have faced before with the most remembered being Dell Computer. They blew away estimates every quarter for years and investors rewarded them with an ever-escalating stock price. Since it is a mathematical impossibility to keep growing a business by 50% every quarter forever investors are eventually doomed to be disappointed. Google is facing this problem sooner rather than later since their initial revenue/earnings growth after going public was off the scale. It is tough to compete with off the scale results even if you post a 69% jump in quarterly profits.
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One of the largest surprises of this quarter is the lack of subprime impact to financial earnings. Everyone warned that various companies would show substantial hits from subprime loans but the actual impact has been almost invisible. Since financials account for 21% of the S&P this was expected to be a substantial drag on earnings. The lack of an earnings implosion in the sector is actually providing an upward revision to overall Q1 estimates.
Homebuilders found themselves the recipients of a significant sentiment boost over the last week. On Tuesday the New Residential Construction headline number jumped to 1.518 million homes, an increase from the 1.506 million seen in February. This was a huge surprise with analysts expecting a sharp drop to something in the 1.42M to 1.48M range. Homebuilders saw investors race back into their stocks and a 4-day rally begin. With a couple builders reporting earnings next week that excitement could be dashed but bad news could also be ignored. Investors tend to ignore bad news once they have made up their mind. It would not be news they had not heard before and any positive guidance with those earnings would just provide additional fuel for the current rally.
April is turning into a very strong month for the major indexes. The Dow is up 15 of the last 16 days and appears on track to touch 13,000 early next week. However the indexes are trading very strangely. The major moves are coming from buy programs at the open with little follow through from traders during the day. Friday's opening gains were attributed to CAT, HON, AXP earnings but +140 points of those gains came on the opening spike. There were some extreme imbalances in volume on stocks that were not related to those earnings stories. That volume died immediately after the open and prices declined for the next four hours. The closing rally had the distinct appearance of short covering with volume increasing sharply the closer we got to the close.
Friday was also an option expiration Friday and I believe a lot of our volatility was related to that expiration. Expectations had been for a week of negative earnings and with a strong flurry of positive surprises the bears had nowhere to run with their expiring options but to the exits on Friday. This may have provided the bullish boost.
Further complicating the market analysis was the negative breadth for Tue/Wed/Thr on strong volume. We had the strong gap up on Monday and a duplicate gap on Friday. The rest of the week was lackluster. The long-term trend may be higher but it is being built on the back of buy programs at the open not steady buying by investors. Volume increased all week, which is another indication of possible expiration driven activity.
Market Internals Table
"Sell in May and go away" Everybody in the market for any length of time should already be familiar with that saying. The period from May-1st through Oct-31st is seen as normally the worst six months of the year. In theory an investor that exits in May and reenters at the end of October will do significantly better than a buy and hold investor that holds over that period. According to the Stock Traders Almanac a trader that began with $10,000 invested in the Dow-30 in 1950 and followed the sell in May, buy in November advice would have accumulated $492,000 on that initial $10,000 investment. If you had reversed the process and entered the market on May-1st and exited on Oct-31st you would have a loss of -$318 for your 56 years of investing effort. The S&P-500 would have returned $349,165 using the best six months and gains of $7,102 over the worst six months.
These results typically reflect a weaker second quarter and a listless market over the summer as traders take vacations. The first quarter usually benefits from end of year bonuses and holiday shopping trends. Once spring arrives investors start spending more time outdoors and away from the market. Vacations and children's spring/summer sports produce an alternative to after hours market research. The summer is seen as a time for fund managers to shuffle portfolios and get ready for the best six months period. They want to be fully invested by the end of October in order to ride the rally into spring. This means they use the second quarter to eliminate unwanted positions and plan their end of year strategy. The normal October dip gives everyone a final buying opportunity and Halloween begins the best six months of the year.
Of course the market rarely follows the script that investors are expecting. Sometimes it works like a charm and sometimes investors are cursed with performance where performance should not exist. In 2006 the Dow lost nearly 1000 points from the May-10th high of 11670 to the July 18th low of 10683. In 2005 the crash began earlier on March 7th with a nearly 1000-point decline into the lows at the end of April. In 2004 the high was made in February at 10753 with four successive declines terminating at 9708 on Oct-25th. It never works out with a picture perfect chart pattern but it does come true more often than not to make the returns and the saying worth remembering.
In researching these comments I discovered a striking comparison between our current chart pattern and one that occurred in 2001. The highs were set in February and a sharp drop on economic concerns began in late February. As earnings were announced in late April and early May the market rebounded to new highs despite fears of an approaching recession. A new high was set on May-21st just as the economic data took a negative turn. The market began a multi-month decline, which accelerated sharply in early September just before 9/11. Even without 9/11 the odds would have been very good that we would have tested the March lows as the recession appeared.
Dow Dip Feb/Mar 2001
Nobody knows what script the market will follow in 2007. Our task as investors will be to watch the indexes and see if conditions appear that could be interpreted as the beginning of a summer decline. The current market is already acting strangely despite hitting new highs. I believe caution is advised especially in light of recent economic data and the Fed's flurry of inflation fighting comments. The markets appear to be ignoring the possibility of future rate hikes rather than reacting to the almost daily Fed comments. How long they will continue to ignore the facts is anybody's guess.
The Dow is very close to 13,000 and despite the attention being focused on that number by the mainstream press it has no material relevance to the current scenario. I would be more worried by the 15 days of gains over the last 16 days of trading as a more important indicator than an arbitrary line on the chart at 13,000. The Dow has rallied +1020 points since the March 14th low. The bears are still circling and the bulls continue to trample them on every unexpected breakout. Without the shorts we would still be stuck back at 12500. Eventually the bulls will run out of steam and the current spike will end. 13,000 could become that unlucky number but that remains to be seen today.
S&P-500 Chart - Daily
S&P-500 Chart - Monthly
A more important number would be 1502-1527 on the S&P-500. This is real resistance as the 1502 closing level on Sept-7th 2000 followed by the all time closing high of 1527 on March-24th 2000. These are real resistance levels that have yet to be tested and levels that will likely hold given the current economic/earnings conditions and the length of the current rally. The S&P and the Dow are overbought and due for a rest. Where that rest will begin is likely to be just over 1500 on the S&P.
The Nasdaq managed to post a multi-year closing high at 2526 and just slightly over the 2525 close back on Feb-22nd. The Friday rebound hit a solid wall at 2525 and exactly where strong resistance was expected. With a lot of tech earnings due out next week there will be plenty of opportunity for volatility and potentially a breakout. Any break of 2525 could run into tougher resistance at 2550.
Russell 2000 Chart - Daily
NYSE Composite Chart - Daily
Dow Transport Chart - Daily
The sentiment indexes continue to be mixed. The NYSE Composite continues to push higher to new historic highs but the Russell-2000 is lagging. The Russell took a major hit on Thursday dropping back to 816 after peeking out to a new high on Tuesday at nearly 832. Several tech earnings misses knocked the props from under the Russell and it appeared fund managers were getting ready to bail. The lack of a new high retest on Friday is disconcerting in my view. Nobody wanted to hold short over the weekend given the rash of merger Monday's we have seen recently. If it were not for the expiration pressures the markets could have coasted into the close with snores on all sides.
Next week should be key for direction. Well over 500 companies will report
earnings as well as a dozen economic reports as the month comes to a close. By
Thursday we will know for sure how the earnings are going to play out for the
quarter. 75% of the S&P will have reported and all the guesswork will be behind
us. Sadly all the excitement and expectations about the earnings cycle will also
be over. The remaining 25% of reporters will drag out over the next six weeks
and with Dell,
Cisco and HPQ the only sporadic highlights in mid May. By next
weekend we could be looking at an entirely different market. The sheer number of
on air analysts calling for investors to buy the current breakout should give
everyone a cause for concern.