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Market Wrap

Santa Has Left the Building

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The pre Christmas holiday cheer lost its fizz like a week old open bottle of pop. The post holiday markets were still in celebration mode until news of the Pakistani assassination killed the enthusiasm and reminded traders what a fragile world we live in. Fears of an Al Qaeda takeover of a nuclear-armed country put the world on watch and the markets on hold. Volume fell sharply and traders went into hold mode until next week. Any year-end shuffling has already been completed and we are waiting for the New Years ball to drop over Time Square to trigger a new trading year.

Dow Chart - Daily

Nasdaq Chart - Daily

If you were looking for a reason to trade on Friday you had to look hard and I doubt you found good one. The economics were mixed but I doubt anyone was paying attention. The surprise came from the Chicago PMI with a headline number jumping nearly 4 points to 56.6 for December. That was the second month of strong gains from the October 8-month low at 49.7. The unexpected spike pushed the index to a 6-month high. Expectations were for a decline to 51.0 from last months 52.9. The spike was powered by a sudden jump in backorders from 45.9 to 60.7 and new orders from 53.9 to 58.4. Even more surprising was the drop in prices paid by more than 12 points. The strength in the PMI is in stark contrast to the rest of the regional manufacturing reports, which show activity slowing. This surprising strength suggests the national ISM on Wednesday could be stronger than the weak number previously expected. If these economic reports continue to show improvement the Fed will be hard pressed to make any further rate cuts.

Chicago PMI Table

The NAPM-NY report also showed an unexpected gain to 449.1 from 445.0. That was the third consecutive month of gains that pushed it to the highest point since June. Activity levels increased but both the current conditions component and the six-month outlook fell by 2 points. Business is improving but respondents are unsure it will continue. Hiring slowed but that is common in December. Unemployment is holding at 4.6% and inline with the national rate but initial unemployment claims are rising. Given the turbulence in the financial markets centered in New York hiring was expected to be even weaker. This was a positive report given the pessimism surrounding the impact of the current financial woes on the New York area.

The report that did not surprise anyone was the New Home Sales for November. Sales fell to 647,000 annualized units falling -9% from October and -34% from the prior November. This was the steepest year-over-year decline so far in this cycle. The biggest decline came from the Midwest with a month-to-month drop of 27.6%. Months of supply on the market increased to 9.3 months. Surprisingly the median price of a home sold rose +7.3% due mostly to a firming of sales on the west coast. The NAHB Housing Market Index is still holding at its record low of 19 where it has been for the last 3-months. The high for the year was 39 back in February. You could say two months without a decline in the index may be positive since we are only 3-months away from the start of the spring sales season. Builders may start showing signs of hope once the holiday doldrums have passed. December is the worst month for home sales because potential consumers have their attentions focused elsewhere.

New Home Sales Chart

Next week's economic calendar has some important events. The calendar will start out grim with the existing home sales on Monday and they should also show a sharp decline. The ISM Index for December will follow on Wednesday and analysts are not expecting any major change. However with the unexpected jump in the PMI (Purchasing Manager Index) we could see a positive surprise in the ISM. Also on Wednesday the FOMC minutes for the Dec-11th meeting will be released and we will get to see what the Fed was thinking when they cut rates by a quarter point. Future rate cut hopes for the Jan-29th meeting will ride on these FOMC minutes, the ISM and on Friday's employment report.

The Nonfarm Payroll report on Friday is officially expected to show a gain of 70,000 jobs but the unofficial whisper numbers are dropping fast. Most are in the 50K range but some are nearing zero. Unexpected strength here would turn the Fed off completely but unexpected weakness could pull the Fed back into the picture. It should be an interesting economic week.

Economic Calendar

It has been an interesting year in the markets. The Dow is on track to post a +7% gain, S&P +4% and Nasdaq +11%. The Russell is on track to lose 2% for the full year and that is significantly better than the -7% drop we were seeing back on Dec 18th. The Santa bounce tacked +65 points on the Russell before the assassination killed interest in small caps. The biggest Dow gainer was Honeywell (HON) at +35% and the biggest loser was Citigroup (C) at -48%. The leading sector was energy at +33% and financials at -21% were the losers.

We are only a week away from the start of the earnings season and surprisingly the number of warnings has been minimal once the initial flurry passed. Next week will be the last chance many will have to confess before the actual earnings cycle begins with the first Dow component, Alcoa (AA), reporting on Jan-8th.

This was a window dressing week and it was progressing pretty well until the assassination spoiled the party. Monday is going to be a full trading day but not likely a day full of trading. The real trading will begin on Wednesday and the start of tax selling. Anyone holding their gains to avoid taxes in 2007 will be free to dump away on Wednesday. This should be a short 2-3 day event and can be offset by the end of year retirement contributions hitting the market. Mutual funds who dressed up their portfolios heading into year-end will also be free to shuffle the books heading into a new trading year. Since funds wanting to buy had no reason to wait the bias could be to the downside for the first couple days of 2008. Expect those stocks with the biggest 2007 gains to see the sharpest selling.

The dog shoppers will be active and you can expect a temporary bounce in those stocks most out of favor in 2007. There is a long track record of winning trades from buying the dogs of the Dow early in the year. Historically the average gains on the dogs of the Dow are around 14% for the year. The Dow dogs analysts are pointing to this year are GM, PFE, DD, C and CAT. Conversely the Dow stocks going into January with the best ratings typically return the least for the full year. The stocks analysts following this strategy suggest avoiding are HPQ, T, MO, WMT and AIG.


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Warren Buffett was feeling the holiday spirit last week with multiple purchases. On Friday he agreed to buy the NRG reinsurance business from ING for $441 million. He also announced a move to setup a municipal bond insurer with a triple-A rating to compete with companies like MBIA and Ambac. The new company will initially operate in New York but is expected to apply for licenses in other states as well. This company is going to be a competitive threat given Berkshire's stronger financial position. MBIA (MBI) fell 14% and Ambac (ABK) lost 12% on the news. Buffett announced on Christmas Day that Berkshire was spending $4.5 billion to buy 60% of Marmon. This is the industrial conglomerate controlled by the Pritzker family. Berkshire currently has $50 billion in excess cash and has been rumored to be looking at positions in a major financial entity. However, Buffett told CNBC he has not seen anything yet that caused him to get excited. "Everybody knows our phone number but nobody has brought us anything we are willing to move on."

Citigroup and HSBC were in the news on Friday as the Wall Street Journal claimed they were preparing to sell off units to raise capital and prepare for rough times ahead. Citigroup is expected to sell or shutter several of its mid-sized units worth $12 billion or more. These are considered non-critical assets and could be sold to raise additional capital. Units possibly up for sale include Student Loan Corp, its North American auto lending business, Brazilian credit card company Redecard SA and its Japanese finance business. HSBC could exit all or part of its $13 billion auto finance business according to the Journal. Citi is expected to announce more job cuts above the already announced 17,000. Citi employs 300,000 workers in over 100 countries.

The NYSE won the bragging rights for new business in 2007. There were 425 new IPOs worth more than $78 billion. There is no news yet about the potential for a repeat in 2008. 25 of those IPOs were Chinese companies. With the Chinese market up +97% for the year the odds are good there will be some more IPOs to follow. Meanwhile the CME is about to break initial support on the news the 12 major banks are going to start their own futures exchange.

CME Chart - 60 min

Amazon moved close to a new high on Friday after it was announced they were selling 17 Nintendo Wii games per second when the games were in stock prior to Christmas. Amazon said this was the best holiday season in its 13 years as a web merchant. Dec-10th was the busiest day with customers buying 5.4 million items. They shipped 3.9 million items on their biggest shipping day. I cannot even conceive of the scale needed to process and ship 3.9 million orders in one day. Just exactly how many UPS trucks does that take to make the pickup? Amazon has definitely grown up into the dominant merchant on the web. Now the real trick will be if their stock can avoid the normal January decline. Shorting AMZN on Jan-2nd has been a consistent winning trade but recent strong earnings may have jinxed that trend.

Amazon Chart - Daily

Wal-Mart closed its movie download service that it launched less than a year ago. Wal-Mart accounts for 40% of all DVD sales but the download service was never a big hit. Wal-Mart tried a DVD rental business as well but gave up on that in 2005 and turned the service over to Netflix. Wal-Mart still operates a music download service. Wal-Mart blamed the decision on Hewlett-Packard, which provided the software running the site. Wal-Mart said Hewlett "made a business decision to discontinue its video download merchant store service." HPQ said it dropped the service because it was not performing as expected. Last month AOL scrapped its pay-for-download movie service. That leaves only Apple iTunes and Amazon's Unbox service as the remaining video download options. WMT stock failed to move on the announcement. The problem with the video download service is the time required for the download and they won't run on normal DVD players. Watching a movie on your PC just has not caught on yet when players like cable giant Comcast offer thousands of videos at a cheaper price that play on your TV. ITunes just announced an alliance with News Corp's Fox to rent digital movie downloads. With more and more entertainment center receivers offering iPod connections it appears companies like Blockbuster and Netflix have another wave of competitive pressure ahead. Netflix passed on a partnership with Tivo to allow movies to be downloaded directly so it may have shot itself in the foot with that decision.

The indexes are leaving 2007 right in the middle of their congestion ranges. The Dow found support the prior week at 13200 and resistance this week at 13550. Both levels are bracketed by even stronger resistance/support about 400 points further in each direction. If it were not for the window dressing the week would have been a bigger bust than it was. We still can't apply much weight to the market action since stock news was slim and volume slimmer. The last three days barely broke 4 billion in volume across all the exchanges. The NYSE managed to break 2 billion on Friday but only barely. It is year-end, everyone has already positioned their portfolios for the end of the tax year and now we just wait until Jan-2nd to execute the next plan. The Dow should test 13200 again next week and how it reacts to that support will give us an initial direction but we need to get past the lingering holiday volume and beginning of year trades before any real direction should appear. That means any volatility next week should be ignored with Tuesday Jan-8th the first real day of 2008.

The Nasdaq showed the most strength with a two-week rebound to retest resistance at 2725. Whether that was just window dressing or retail traders spending their holiday bonus is unclear. The Nasdaq held the high ground pretty well with only a -50 point decline on the Bhutto killing. Since the Nasdaq is being held up by gains in AAPL, RIMM and AMZN with help from INTC and MSFT the odds are good we could see a continued dip late next week. Those first three are up on expectations of a strong holiday season and now that it is over the tendency is to take profits rather than be disappointed by earnings. There is no guarantee but AAPL and AMZN have both had a good run.

The S&P-500 is again back below resistance at 1490. The two-day attempt to hold Monday's breakout was very lackluster but that could also be due to end of year window dressing and position squaring rather than real buying interest. I still think we should be long over 1490 and short below that level.

S&P-500 Chart - Daily

Russell-2000 Chart - Daily

The Russell was the surprise in the velocity it attained going into the holidays but it was no surprise to see it fail at 800 once again. That is very strong resistance that has been with us since August. We are at that point on the calendar where small caps should be our guide. After the first couple days of 2008 pass we need to be watching the Russell very carefully to see if fund managers are buying or selling small caps. That tells us if they are confident of market direction or afraid of further market weakness. Support on the Russell is 740 and resistance 800. We closed on Friday at 771 almost exactly in the middle.

I would not get too excited about trading on Monday even though it is a full day. Volume is going to be sparse and without some external event direction will be entirely chaotic. It is a day to spend getting ready to party the New Year in rather than donating spreads to the market makers.

Happy New Year!

Jim Brown

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