Easy come, easy go. The GDP short squeeze on Thursday was erased by the Dell drop on Friday. Traders had been selling commodities and buying tech for the last few weeks and that trend may have ended on Friday. However, in a low volume market moves of this kind should be ignored. Last week was month end ahead of the historically bearish month of September. Traders are dazed and confused and hoping a real trend appears soon.
NYSE Composite Index Chart - Daily
Wilshire-5000 Total Market Index Chart - Weekly
Friday's economics were mixed but several key points emerged. The Personal Income and Spending for July showed personal income dropped a whopping -0.7%. Real spending fell 0.4%. The income number made waves in the market but it was really reported incorrectly. The impact of the tax rebates pushed June higher and distributions fell by 50% in July. This skewed the numbers and anyone bothering to look would have seen real income up, ex rebates, +0.5% for the month and the strongest level so far this year. The decline in spending was mostly a result of falling auto sales and consumers hurt by $4 gasoline. The core PCE deflator rose +0.3% and the fastest monthly rate since September. This pushed the core inflation rate to 2.4% over the last 12 months. The top-line PCE rate rose by +0.6% in July pushing the overall inflation rate to +4.5% over the last 12 months. That is a 17-year high. Not since 1991 has inflation been this high. This was actually a positive report on the income side but the market took it badly because of the inaccurate headline number. The sharp spike in the inflation rate also knocked the market down a few notches in expectation of future Fed rate hikes.
The final update on Consumer Sentiment for August came in at 63.0 compared to the first reading of 61.7 and the July level at 61.2. Consumer sentiment is really rebounding and that is a strong positive for the economy and the markets. The biggest gain came from the expectations component at 57.9, up from 53.5. That is nearly +9 points from their June low. However, the present conditions component continued to drop to 71.0 from July's 73.1. This suggests the end of the back to school shopping season is not going to be robust.
Consumer Sentiment Chart
The Chicago PMI exploded higher by 7 points to 57.9 from 50.8 in July. This was well above expectations for a minor +1 point gain. This is the highest level since June of 2007. The prices paid component fell sharply from 90.7 to 80.6 and that should be good news for the Fed. The production component gained a whopping +14 points from negative territory at 49.2 to a very positive 63.4. Order backlogs also exploded to 63.0 from 45.7. This current spike in the components cannot continue but it was an amazing jump in economic activity. A strong demand for exports has been instrumental in the improving economic conditions. If the ISM next week shows gains even close to the PMI it would be very market positive.
Chicago PMI Chart
In stark contrast to the Chicago PMI the New York NAPM showed exactly the opposite in conditions. The NAPM fell to 409.5 and the lowest reading since July 2006. The six-month outlook rallied +20 points to 64.1, current conditions +7 points to 45.3 and purchase quantity +8 points to 46.3 but the overall index still declined. The decline is credited with the continuing credit crisis and the impact on the financial sector in New York. Companies are cutting back on expenses, cutting employees and slashing expectations for bonuses. New York is probably the most tied to the financial sector than any other city in the world. With the markets in bear territory and banks in trouble that pretty well spells trouble for the New York economy. Analysts expect a drop in employment of 60,000 financial jobs in the New York area over the next year. I was encouraged by the +20 point spike in expectations.
Next week has a heavy schedule of economic reports with several of major interest. Heading the list on Tuesday is the ISM Index for August. This is similar to the Chicago PMI only on a national basis. The ISM has risen off its February lows in contraction territory of 48.3 but is struggling to move back into positive territory over 50. If the ISM follows the PMI report higher it would be a strong positive for the markets. Expectations are for a flat report with the potential for a minor decline.
On Wednesday the Factory Orders report is expected to show only a minor +0.1% gain for July. This is a lagging report and the market is probably not going to care what is says as long as there are no surprises. The Fed Beige Book is also due out on Wednesday and all eyes will be focused on it. The Beige Book spells out economic conditions in the various Fed regions and is of much more interest to Fed watchers. On Thursday the ISM Services report is also expected to be flat and remain in negative territory. I believe we have the potential for a positive surprise in both ISMs.
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The Non-Farm payroll report on Friday is the biggest report for the week. The economy is expected to have lost -75,000 jobs compared to the -51,000 reported last month. This would be the eighth month of consecutive job losses with the last three months averaging -50,000 each. You may recall the unemployment rate spiked to 5.7% in July after hitting a cycle low of 4.4% in late 2006 and early 2007. Analysts are expecting this rate to climb over 6% as the financial crisis continues. I would like to stress again that during a normal recession monthly job losses are normally in the 250,000-350,000 range. We are a long way from that level and it appears we are going to dodge the recession bullet.
We are closing in on the OPEC meeting date and the FOMC meeting and that will start impacting equities as we get closer.
The inflation numbers shocked the market on Friday but the real downer was Dell. The computer company was widely expected to post better than expected results after Hewlett-Packard posted good results for the quarter. Dell disappointed analysts with its -17% drop in earnings and its falling gross margin. Michael Dell said the company might have been overzealous in cutting prices to compete with Hewlett Packard. He said the damage done to Dell earnings in Q2 was self-inflicted. Analysts pointed out that Dell sold more low-end computers rather than the high performance, high profit models. Where Hewlett Packard can make up for weak PC sales with hundreds of other products Dell is tied more to computer sales for the majority of its income. Dell has cut 8,500 workers since it began restructuring in 2007. Dell also said it could not give specific guidance for the current quarter but said it was seeing weaker technology spending spreading from the U.S. to Western Europe and Asia. Dell added they expect that weakening trend to continue. Dell's stock was hammered for nearly a 14% loss on Friday to $21.73. It was the biggest one-day loss for Dell in the last eight years.
Marvell (MRVL) was knocked for a loss after posting better than expected earnings. The problem came from their conservative guidance. Analysts felt the guidance was overly conservative and nearly everyone suggested buying the dip. The company said it was still uncertain about the impact of the weakening U.S. economy and predicted revenue growth below Wall Street expectations. The biggest problem for tech stocks came from the impact of that conservative guidance. Marvell chips are used in both the iPhone and the BlackBerry. If they are seeing weakness in those products then trouble is headed our way. As a result of the Marvell guidance Apple (AAPL) lost -$4.21 and Research in Motion (RIMM) lost -5.15.
The lowered guidance from both Dell and Marvell crushed nearly all the big techs and knocked the Nasdaq for a -44 point loss. Tech stocks have been the leaders of the recent rebound and these warnings along with others over the last couple weeks are making traders reconsider being long tech into the worst month of the year. Investors have to be worrying now that the slowdown in tech is telling us the global economic decline is increasing. Do the bulls continue to buy tech or do they pull in their horns and wait for September to pass?
This was the week that wasn't. Volume the last two days barely broke five billion shares. There was no trend and volatility was huge. It was exactly what I warned about last week. Nothing worked in terms of trading. Not even oil worked ahead of two different hurricane threats and a warning from Russia. Crude traded in an $8 range and ended the week only a buck higher than where it started. With the NOAA painting a bulls-eye on the oil patch you would think oil prices would be soaring but every bounce was sold. The problem it seems is coming from "private" weather forecasters. The rumor on Friday had Gustav coming ashore in Texas instead of Louisiana and at a Cat-1 intensity instead of the Cat-3 the NOAA is predicting. I would bet a few of these private forecasters are going to be out of a job if they miss this very public call. Also hurting the price of oil was a statement from the government that they would release oil immediately from the strategic petroleum reserve and continue to release it until any shortfall from damage was recovered. In reality that is a longer process to get the oil released but it sounded good as a sound bite and had the desired reaction of keeping prices in check.
October Crude Oil Chart - Daily
Gustav was upgraded to a category four hurricane Saturday afternoon as it moved away from land and intensified over water. It will cross Cuba by Sunday morning and be over the water in the gulf and gaining intensity again. NOAA was projecting it to be a category three when it hits the oil patch but after the sudden strengthening on Saturday they are now projecting it to be a category 5. A category three may not sound as devastating as a category five but it is still capable of inflicting damage. Katrina was "only" a cat-3 when she hit Louisiana. This is also exactly the same week that Katrina hit in 2005. Rita hit two weeks later in the same area. These two storms are going to put a major crimp in oil deliveries by tanker over the next 10 days.
The description of the categories of hurricanes include:
Category 1: Winds 74-95 mph, storm surge 4-5 ft.
It is even more surprising that oil prices are not rising because tropical storm Hanna is strengthening and is now moving towards the gulf instead of northward as previously predicted. Hanna is now on roughly the same track as Katrina in 2005. That track is headed for the gap between Florida and Cuba with the potential for a right turn into the oil patch only a couple days after Gustav. The potential for damaging winds and waves is intensified from back to back storms. I am going to show a lot of charts today because I want you to see the potential for a rocky week. The last chart is a map of the major oil installations in the gulf and the tracks for hurricanes Katrina and Rita. There are over 4,000 installations in the gulf but these are the major platforms. Gustav is headed right between those two tracks.
NOAA Gustav Storm Track as of Saturday evening
NOAA Hanna Storm Track as of Saturday evening
Combined Wind Warning Tracks
Gulf Oil Installations (left track RITA, right track Katrina)
On the positive side a study of the markets after 15 major storms made landfall showed a bullish market. The rebuilding efforts after a major storm reportedly produced an average of a 5% gain in the S&P within six months. While I could understand that logic I disagree with the conclusions. Since major storms occur in August and September, the two worst months of the year for the markets, I don't believe the gain in the S&P is related to the storms. It is a timing issue. The fourth quarter is normally the most bullish quarter of the year. My birthday is in early September. As a statistician I could probably come up with a statistic that said the markets responded with a 5% gain over the next six months whenever I had an even number birthday or an odd number birthday, take your pick. My wife says all my birthdays are odd but I don't think she means in the years. The point I am making is that hurricanes do promote building cycles but I doubt they are responsible for routine market rallies of 5%. Some statistician simply had too much time on his hands and failed to take the calendar into his analysis.
While generally on the subject of oil I need to mention Russia. Russia has gone from ignoring threats of sanctions from NATO and the West to outright threats of violence. The world is moving ever closer to a real confrontation with Russia and most people don't even know it. The West along with many NATO countries have been very vocal about punishing Russia for its foray into Georgia and up until now Russia has been fairly quiet. Several events on Thursday suggest those taunting Russia and talking about sanctions may be walking on thin ice.
The NATO countries, spurred forward by the West and the European Union have threatened sanctions against Russia if they don't return the two breakaway countries to the state they were before the conflict began. That may be even more difficult after South Ossetia announced on Saturday it would join the "one united Russian state" and they would sign an agreement on Tuesday to allow Russia to build military bases there. Georgia announced on Friday they were severing ties with Russia and calling diplomats home. In response Russia may be preparing to cut off oil supplies to Germany and Poland as early as this weekend in retaliation according to an article in Britain's Daily Telegraph. On Friday Russia denied they would cut supplies to any country. "We are a responsible energy provider." I guess that is a new position because they have not been afraid to cut supplies in the past when things did not go their way.
Stratfor reported Russian President Dmitri Medvedev flew to Tajikistan on Wednesday for a summit with China and four central Asian countries who were previously members of the former Soviet Union. The meeting had been scheduled for some time but it took on more significance given the talk about sanctions by the EU. News out on Friday said the four nations in the Singapore Council slammed him for his war in Georgia. It is unclear to what length Russia will go to rebuild the former Soviet Union and bring all the breakaway states back into the fold but Russia does appear headed in that direction and they are not bashful about using their wealth of oil and gas supplies to do it. Satellite photos out Friday showed ethnic neighborhoods were torched and refugees making their way to shelters told of ethnic cleansing murders by Russian soldiers.
Russia also warned NATO about a possible confrontation between Russia, NATO and
the West in the Black Sea. Vladimir Putin called it a potential flash point for
conflict with the NATO and warned about any further warships entering the Black
Sea. He warned there could be direct confrontations should NATO or its member
nations increase their presence in the area.
There are currently four NATO ships in the Black Sea on a previously scheduled exercise called Active Endeavor. Putin also explicitly warned that there could be consequences if additional vessels belonging to NATO countries but not under NATO command were to attempt entry. For instance a British or American warship not under NATO command. Putin basically posted a "Keep Out" sign on the Black Sea and that may not go over well with the West or those NATO countries. Nobody likes to be told you can't go anywhere and in the case if the U.S. they tend to test those restrictions very quickly just to prove their dominance of the seas. They do it against China all the time. We found out on Friday that the U.S. sent several warships in this week to "deliver aid to Georgia." Russia stepped up the rhetoric on Friday saying the U.S. was responsible for the 5-day war. VP Dick Cheney will be in Georgia on Tuesday as a show of support for the country. NATO is moving to strengthen its forces close to the Russian borders in expectations of more attempted land grabs. Britain called off September's scheduled military exercises in Georgia when Moscow warned it would be seen as a declaration of war.
I explained all this because Russia is the second largest oil producer on the
planet and in the top five gas producers. Most of Europe is hostage to the
Russian supplies and Russia has doubled the prices over the last two years and
turned off the supplies when the countries protested. Russia understands the
power of oil and is not afraid to use it as a weapon. This Georgia skirmish is
taking on all the appearances of the beginning of a bigger problem. What better
time for Russia to
make its moves than with America tied down in Iraq,
Afghanistan and with a lame duck president and the final stages of a political
campaign? You can bet this skirmish has been planned for sometime. Russia also
announced it test fired a new "stealth nuclear missile" on Thursday. Was that
just a coincidence?
The new U.S. president is going to have his hands full the moment he takes the oath of office. For us as traders next week will have an economic focus as we move into September. I believe the Dell drop was Dell specific and overdone but the warnings of slowing technology spending may linger. I have mentioned several times that September is historically the worst month of the year for the markets. That trend tends to reverse in election years but I have to think the market has got a lot more on its mind this year than the election. The biggest election gains tend to come after the election when one half of the worries are taken out of the market. Right now professional traders are hedging against both candidates and their anticipated moves once in office. That suggests this September may be choppy rather than directional. That is even more a possibility with the new tech worries and oil that won't move higher in the face of hurricanes and war. When the markets move against conventional wisdom we have to focus on the charts and pick our entries carefully.
The Dow rallied on the Thursday short squeeze to a dead stop at resistance at 11700. I struggled to find a convincing pattern in the Dow's movement and the only thing that stood out was the solid resistance at 11700 and a very minor pattern of higher lows into Tuesday. I would not want to bet the farm on the eventual outcome. The Dow and S&P are tied to the financials and the XLF has rallied for the last three days with a stop at initial resistance at 21.50 on Friday. Is the rally over or just getting started? We have the insurers; MBI and ABK up huge over the last two weeks, as conditions seem to be improving for them. MBI has gone ballistic with a breakout over $15. Fannie and Freddie were up all week with minor profit taking on Friday. Their financial health does not seem as dire as analysts were predicting a couple weeks ago. Lehman is reportedly ready to announce a restructuring of billions in problem loans and will move them off its balance sheet soon. Lehman also rallied for the last three days. Does this mean the financials are about to lead the faithful out of the Wall Street desert? Obviously nobody knows and that makes the Dow chart irrelevant for next week unless we suddenly get a breakout over 11700 or a breakdown under 11350. The key to the Dow will be the financials. The FDIC announced late Friday they closed the Integrity Bank of Alpharetta Georgia. This was the 10th bank to fail this year as banks fail at the fastest rate in 14 years. The bank had assets of $1.1 billion and operated five branches. The bank will be taken over by Regions Bank and will reopen on Tuesday.
Dow Chart - 120 Min
S&P-500 Chart - 120 Min
The S&P is following the Dow and remains stuck in its recent range of 1250-1300. A breakout over 1300 would be a buy signal given the strong resistance waiting there. Under 1250 would have me looking for a new low in October. If the hurricanes evaporate before hitting the oil patch I truly believe oil is going to test $100 ahead of the OPEC meeting. To not rally over $120 ahead of these storms is absolute proof the speculation in oil is dead. A declining oil sector will weaken the S&P making it even more critical to watch the financials.
The Nasdaq is ugly. Every short squeeze for the last three weeks has been sold hard. We had two major gap down opens just last week. Investors may have been buying techs in hopes of a Q4 rally but they are very skittish and lack conviction. Tech leaders Apple and RIMM both closed at new 3-week lows on Friday and appear to be in trouble. I am sure the phone faithful will find a dip to buy in both but it remains to be seen if it will stick. The Nasdaq has solid support at 2350 and falling resistance now at 2410. A break under 2350 is the kiss of death for me and I could see a retest of 2200. That may be too grim an outlook but after a couple of lower highs it looks like the momentum has disappeared.
Nasdaq Chart - Daily
Russell Chart - Daily
The Russell was the strongest index this week but I believe it was calendar related. The Russell tends to do well the last three days of the month and the first two days as retirement deposits are put to work. It also does well on a rising dollar and the dollar index came very close to a new 8-month high last week. I am not ready to jump on the Russell as a long candidate with strong resistance at 760. Critical support is still 720. I know I sound like a broken record but that is the facts and they have not changed.
Remember last week I said the low volume and high volatility would probably push the market around unreasonably. That is exactly what happened. I warned that any moves could be quickly erased once traders returned to work next week. That is why we can't apply too much importance to what happened on five billion share days leading up to a holiday weekend. Historically the day after Labor Day has opened higher 11 of the last 13 years. If that happens again it will be a real test for the bulls because the ISM will be released at 10:AM. If the markets open higher and the ISM surprises to the upside we could get another monster short squeeze. Conversely if the ISM surprises to the downside we could see any opening rally quickly fade. However, just like last week I would not apply too much importance to the day after a holiday. We want to see a trend develop not just a series of triple digit days with alternating directions. The markets will also be reacting to what happened in the oil patch since the current track suggests it will all be over by midnight Monday night. I would continue to maintain a cautious outlook and trade the moves but don't get married to them. Under Nasdaq 2350, Russell 720 I would become much more bearish.
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