At 8:30 on Friday morning the big news was the 49,000 job losses for the month of May. That headline lasted about an hour before oil grabbed the headlines in a steel grip that lasted all day. I will get to the reasons later but the key metric was the +$10.75 rise for the day to close at $138.50. This was the biggest price move in the history of the Nymex and the biggest percentage move since Iraq invaded Kuwait. The rest as they say is history as the explosion in oil greased the general market decline.
Wilshire Total Market Index Chart - Daily
Before I get to the oil story I need to touch on the economics. The biggest economic report on Friday was the Non-Farm Payrolls for May. The report showed the economy lost 49,000 jobs, which was actually less than the -60,000 loss analysts expected. The component that grabbed the headline was the spike in unemployment to 5.5%. The +0.5% spike in unemployment was the biggest single month jump in 22 years. The loss of jobs has now stretched for five consecutive months. However, the losses are minor compared to prior recessions. At the same point in prior cycles we were seeing 150,000 to 250,000 job losses per month. The current average decline for this cycle has only been -65,000 jobs. This has been a very tame economic slowdown.
The Jobs report captured the headlines with the 22-year spike in unemployment but that was an accounting anomaly rather than a real number to worry about. There was a shift into May by a large number of teenagers and college students looking for summer jobs. The youth employment market is being the hardest hit by the rise in prices and cost cutting by employers trying to trim expenses. The majority of teenage jobs are in fast food and restaurants and those are exactly the retail outlets suffering the most by high gasoline prices. An obscure factoid I heard was teenage unemployment at a 60 year high. There was a one-week shift in the accounting period and that also skewed the numbers.
May Non-Farm Payrolls
The economics for next week will be highlighted by the Fed's Beige Book on Wednesday and the Consumer Price Index on Friday. The Beige book will tell us how the various Fed regions are doing in this economic slowdown. Do they see the economic activity in their region slowing or rebounding? This is always a volatile event.
The biggest report for the week will be the Consumer Price Index. How much of the higher oil price has filtered through into consumer products? I can't conceive that oil prices have not influenced consumer prices. The Fed takes out direct food and energy prices as too volatile to track monthly but the indirect costs for transportation and raw materials has got to be pushing inflation higher. The Fed is facing the worst of all scenarios. Oil prices are out of control. The tax rebate stimulus has been consumed by the increase in the price of gasoline. Unemployment is rising at least on the surface and the economy is bordering on a recession. This is the return of stagflation in its purest form. No growth and soaring inflation. The Fed has to raise rates if the CPI shows an inflation spike but raising rates will slow the economy even further. They can't move in either direction on rates without escalating either inflation or recession. Their best move would probably be to cover their eyes and ears and do nothing in hopes the economic situation recovers on its own. James Bullard, President of the St. Louis Fed, basically agreed with that plan saying the Fed could remain neutral for the rest of the year. However, he also said the dominant policy concern was rapidly changing from the credit crisis to pressing inflationary concerns. The next Fed meeting is June 24th.
Now to the real market story. Oil prices declined to $121.61 on Wednesday night and then rebounded to $128 on Thursday. The net gain was a record $5.50 on Thursday. That was the largest single day dollar gain on record. It was nothing compared to Friday. On Friday crude prices added to that Thursday spike with another gain of $10.75 to close at $138.50 and another record high and the largest single day price gain in the history of the Nymex. It was the second largest percentage gain since Iraq invaded Kuwait in 1991.
The reasons for the spike were numerous. You hear people, including me, using the perfect storm analogy all the time but this was the perfect example. For purposes of clarity I will try to list all the reasons.
First there was a serious drop in open interest of roughly 50% as the lawmakers and the CFTC were discussing futures trading and energy market manipulation. Short interest rose significantly in anticipation of some sweeping change that could crater the energy market. When both parties made some calming comments on Wed/Thr that suggested it would be a couple months before any changes were made the bulls jumped back into the market and a monster short squeeze began on Thursday with the $5.50 gain. Volume was still low as though traders were still not convinced.
On Friday the market opened with the shorts worst nightmare. Morgan Stanley said the stage was set for $150 oil before July 4th because of supply constraints and increased global demand. July 4th is only 27 days away and $28 from the Wednesday lows. That gave new urgency for longs to reenter the market and for shorts to cover.
At the same time Shaul Mofaz, former chief of staff and defense minister in Israel said an Israeli attack on Iran would be unavoidable if they did not immediately halt their nuclear program. "If Iran continues its nuclear arms program we will attack it." Iran's President Mahmoud Ahmadinejad has more than once called for the elimination of Israel. Mofaz said Ahmadinejad would disappear before Israel does. Iran is the 4th or 5th largest oil exporter depending on whose numbers you believe. If Israel did attack their nuclear facilities it should have no impact on oil production but you never know. They could cripple their oil capability at the same time just for spite. There is precedent for an Israeli attack. In 1981 Israel planes destroyed an unfinished reactor in Iraq to prevent Iraq from gaining nuclear weapons. They struck another reactor under construction in Syria several months ago. Reportedly the U.S. has already approved an Israeli attack but I strongly doubt it. Regardless this was a comment that oil traders could not ignore. 25% of the world's oil goes through the Straits of Hormuz and Iran could block that passage to cripple the west for supporting Israel in an attack. Venezuela has also threatened to halt oil shipments to the U.S. if Iran is attacked.
At the same time Obama vowed to eliminate the threat posed by Iran to world security. "The danger from Iran is grave and real and my goal will be to eliminate this threat." He also said he would do everything possible to prevent Iran from obtaining a nuclear weapon. It appears the potential next president of the U.S. is already positioning himself to attack Iran. That gave oil traders one more excuse to buy oil.
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Also pushing oil higher was a limit up move on heating oil. Heating oil is seen as a proxy for diesel since both are products of the distillate process. A barrel of crude produces an average of 9.21 gallons of diesel, 1.75 gal of heating oil and 1.76 gal of fuel oil from the distillate process. There are also 19.15 gallons of gasoline and 3.82 gal of jet fuel. Depending on demand for a particular product additional refining steps can be taken to increase the percentage of a specific product. Demand on diesel is growing sharply and that puts pressure on the other distillates like heating oil. Trading heating oil therefore is a proxy for diesel. A limit up in heating oil puts pressure on all the crude products.
Also fueling the spike was the third consecutive weekly drop in crude inventories. This week's drop was -4.8 million barrels and that brings the total three week decline to -19 million barrels. If there is so much oil in the world then where is it? Current U.S. crude inventories are 11% below 2007 levels.
The weekly EIA report showed that over the last four weeks total crude consumption had fallen only 1.1% compared to the 3%-4% numbers being reported in the retail surveys. Gasoline demand had only declined -1.4% nationwide compared to the MasterCard Spending Pulse report showing a -4.7% drop for the week. This EIA demand picture was much more bullish since it was significantly less of a drop and suggested consumers were getting over the high prices and continuing life as normal.
The better than expected jobs report also boosted demand estimates since a stable job market contributes to stable consumption of crude products. Since many economists believe the economy has passed the bottom and is beginning to recover that jobs report was bullish for demand estimates.
Finally the war of words over rates between the ECB and the Fed effectively killed the rally in the dollar over the last two weeks. The last two days were extremely ugly after ECB President Jean-Claude Trichet said the ECB was considering raising rates as early as next month to fight inflation. Since the Fed is going to be challenged by recent economic events to raise rates that meant the dollar lost ground against the Euro. The two-day plunge on the chart below was just an added factor for the rise in crude.
USD Index Chart
Those events above contributed to the perfect storm for crude prices. Shorts were squeezed even harder by the lack of volume and the bulls kept buying everything in sight. There was a school of thought that shorting Thursday's close at $128 was the right thing to do technically. When that did not work they were forced to cover and that made the prior high at $135 the next obvious short. For four hours that $135 short resistance held on Friday but as the close approached with a volatile weekend ahead the bears were forced to cover and the last hour of trading saw another $4.50 gain. This spike should translate into another 10-15 cents per gallon at the pump by Wednesday of next week. It could be even more for diesel. AAA said the national average for gasoline was $3.99 on Wednesday making a jump over $4 next week almost certain.
The $150 price target by Morgan Stanley and several other firms is looking like a self-fulfilling prophecy today. With the close at $138.50 that is only $11.50 away. According to NOAA there is a tropical wave building in the Atlantic that has the potential to turn into a storm as it moves into the southeastern Caribbean. If this turns into a storm by Monday we will be looking at additional pressure for prices to move higher. Goldman's short-term target of $141 was ridiculed when they made it two months ago. Friday's high of $139.12 was close enough for them to claim a win. Boone Pickens said $150 by November. Stepping out a little farther there are predictions of $200-$225 in 12-18 months and $250-$500 in 36 months.
Remember my crude oil chart from last Sunday? I have reprinted it here for review. Note the comment on the chart. Wednesday's close was $122.30. I did not expect the move we got but those who followed my suggestion did well.
Last Week's Crude Chart
This Week's Crude Chart
The two-day $15 spike in oil prices crushed the transports, which closed at a new historic high on Thursday at 5493. For the life of me I can't understand why the transports were doing so well when the airline sector is tanking so hard. Continental joined the diet club and said it would ground 67 planes, cut jobs and reduce capacity due to oil prices. So far in the last 90 days the U.S. airline sector has seen over 500 planes either taken out of service or plans announced to ground them. Over 14,000 jobs have been cut and existing capacity has been reduced by 15%. They will save a lot of money with those changes but with oil prices rising so fast they are still losing ground. One analyst said the gains in oil prices over the last two days alone have increased the fuel bill for U.S. airlines by $4 billion. They were already projected to have moved from year-end 2007 expectations of a $4 billion profit in 2008 to a $2.3 billion loss if fuel stayed around $110 for the rest of the year. At $130 that loss was expected to grow to $6.1 billion and at Friday's close at $138.50 that loss was expected to grow to $10 billion for the year. You can't continue to lose that kind of money and stay in business. Analysts claim the airlines will have to raise prices by 25% to 35% just to break even. With the airlines in the tank and UPS and FDX bleeding profits from higher fuel costs, where is the strength in transports? Railroads of course. They are the winners in any continued high oil scenario but even they crumbled on Friday.
Ironically even the oil stocks lost ground on Friday. Refiners were sold hard as crack spreads disappeared at $138. Valero lost -3.31. Exxon with the largest reserves of any public company lost -$2.52. Even the drillers, the companies expected to benefit most by increased exploration, were knocked off their rigs. Transocean lost $4 to cap a $20 drop over the last three weeks.
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Can anybody say tough market? Nothing is working more than a day or two and the markets are becoming increasingly volatile. When energy companies can't even rally on a $15 spike in oil then no company is safe. The indexes remain strongly diverged with the Russell and Nasdaq still holding the high ground while the Dow and S&P have both broken strong support. To illustrate the divergence the Russell only lost -8 points for the week while the Dow lost -428.
The Dow and S&P are falling on the continued decline in financials. The brokers are expected to report in two weeks but rumors of an earlier release by Lehman are circulating. Their official release date is June 16th but they are currently trying to attract additional capital. To do this they may need to release earnings earlier in order to put investors at ease. The shorts are punishing Lehman and volume has been huge. There are worries that Lehman could turn into another Bear Stearns because they can't deleverage fast enough. An early earnings release that was better than expected could do wonders for investor confidence.
The Dow lost -394 points on Friday to close at 12209. This is below several levels of recent support and appears to be targeting the March lows of 11750. Granted this is due mostly to the implosion in the financial sector with AIG under pressure again on Friday. Boeing was also a major decliner as traders flee the stock on worries airlines are going to cancel orders. Once the brokers report earnings in two weeks the Dow could recover. However, I believe sentiment may have been damaged significantly by this week's results. The +209 gain on Thursday was attributed to an asset allocation program where treasuries were sold and market indexes were bought. Many retail investors jumped on for the ride and were rewarded with Friday's -400 point loss. Frustration is setting in as traders start contemplating summer vacations, barbecues and yard work rather than fight the markets. I had more than one trader email me in the last couple of weeks expressing their frustration with the market. It is called summer and the opposite of our current extreme volatility is the approaching summer doldrums where nothing happens. It makes you appreciate the "sell in May" strategy.
Dow Chart - Daily
The S&P mirrors the Dow for the reasons I listed above and Friday's close at 1360 was a loss of -43 points. Critical support at 1370 was broken and critical resistance at 1405 has now held twice in the last two weeks. Both the Dow and S&P have clear chart failures and are projecting drops to lower levels. These are not charts I would buy.
The Nasdaq is struggling to hold on to its recent gains and Friday's -75 point beating knocked it back to 2475. Over 2440 the trend is still intact but the Nasdaq is not going to survive a continued swoon by the Dow and S&P. The chip sector is still strong with support on the SOX at 400. Intel was a drag on Friday after South Korea fined them $25 million for antitrust claims. I am neutral on the Nasdaq over 2440, bearish below that level. I would be bullish over Thursday's high at 2550. Cisco hit a five-month high on Thursday so tech is still alive but having a tough time carrying the Dow on its back.
Nasdaq Composite Chart - Daily
The strongest chart is still the Russell 2000 and I am confused as to why. The Russell should not be leading the pack given the weakness in the Dow and S&P. I have been bullish over 730 and it closed at 740 on Friday. I thought we were good to go after the 762 breakout and close on Thursday. Obviously I was very depressed to see the decline on Friday despite it being better than the other indexes. You can still lose money on a falling leader. I am turning neutral on the market in general but I will continue to have a slightly bullish bias over 730 on the Russell. Under 730 I would be short or flat.
Crude prices should remain volatile and that is actually a negative. Many traders are walking away from trading crude because of the volatility. This reduces liquidity and actually makes it even more volatile. Expect some more big moves but they should all be news related.
The biggest stock even for next week is the Apple announcement on Monday. Steve Jobs is expected to announce the 3G iPhone at 10:00 and the market for Apple stock should be extremely volatile around the announcement. Many think the news is already priced into the stock while others think Jobs will pull another rabbit out of his hat with some astounding features. Some feel the iPhone novelty is wearing off and there are no big features other than the 3G capability. One analyst pointed out that adding the 3G feature added nearly 700 million potential customers in Europe and Asia. Those customers were prevented from buying a regular iPhone because no network in their area supported it. This should give Apple a significant new audience.
I would be cautious about entering new positions next week. This is a traders market and not a scenario for buy and hold investors. There is no need for an investor to be in the market at all times. Wait for a key inflection point and use smaller positions until a trend develops again. Lost opportunity is better than lost capital.