The Dow has now lost ground for the last seven trading days and the S&P the last five days. This is the worst consecutive loosing streak in a year.
The market has fallen and can't get up. Every intraday rebound attempt fails and we have a bad case of sell the close syndrome. The economic news continues to get worse despite some high profile analyst claims that we are not going to double dip. Abby Joseph Cohen was on CNBC last week pumping up sentiment and repeating her 1275 S&P call. That would be about a 26% gain from here. Abbey has been able to move the market in the past but the only movement this week was down.
The big economic report for Friday was the nonfarm payrolls. The headline number showed a loss of -125,000 jobs driven by 225,000 census job terminations. The consensus estimate was for a loss of -155,000 jobs but they were also expecting a loss of -325,000 census jobs. Quick napkin math shows that there were 100,000 fewer census jobs lost which should have improved the consensus estimate to only -55,000 jobs lost compared to the actual headline number showing -125,000 jobs were lost.
The number should have been much better than the estimate but nearly hit the estimate anyway. The net number after removing census terminations showed that the private sector hired 83,000. That was also less than expected. April and May private sector hiring was also revised down by 57,000 jobs total.
The unemployment rate declined to 9.5% but this was due to a contraction in the labor force with 652,000 people giving up on finding a job. Nearly one million workers gave up on looking for a job in just the last two months. That suggests confidence in the labor market is rapidly declining. The average hourly workweek declined to 34.1 hours and average hourly earnings fell as well. The trend to increase production by having employees work more hours appears to have ended.
Since many analysts were expecting a lot higher number of job losses I thought this was a better than expected report. However, the three-month average of +119,000 new private sector jobs appears to be slowing. If recent economic reports are correct it could easily go negative. Moody's is still projecting growth of 150,000 private sector jobs every month for the rest of 2010 and rising to 200,000 in 2011. At that rate it will take more than six years to return to full employment. We need 150,000 new jobs per month just to keep up with population growth and legal immigration.
It is tough to put a positive spin on the report since there are still another 175,000 census workers to cut in July and the economic recovery seems to have hit a wall. The weekly unemployment claims refuses to go down with 472,000 on Thursday.
The separate Household Survey showed a loss of -301,000 jobs or -363,000 if you do the same seasonal adjustment done in the BLS survey.
Factory orders for May fell -1.4% and inline with recent estimates. This compares to a gain of +1.2% in April. Inventories rose for the fifth consecutive month suggesting that the positive GDP impact from inventory rebuilding is about over. This is a lagging report and did not get much press coverage but the trend is definitely lower since March.
The Weekly Leading Index at 122.2 is leading lower again after a brief blip higher in the prior week. This was the seventh decline in eight weeks. This is the lowest level since July 2009. The annualized growth rate declined to -7.7% and another new low for the year and the fourth week in negative territory. This was the 12th decline in 13 weeks for the growth rate. The rate decline in the WLI is very troubling because it does not represent just a hiccup like we saw in November and February. This is a serious change in economic sentiment.
Weekly Leading Index Chart
Even though the ISM was on Thursday I am going to touch on it again. The national ISM dropped sharply from 59.7 to 56.2 for June and this was the second consecutive decline and the lowest level since December. The production, new orders and employment components all declined.
Manufacturing has been powering the U.S. economic growth for the last year. Now we have seen in the factory order report and the ISM that manufacturing is dropping sharply. Something happened and it is not an isolated incident or region. The manufacturing sector hit a proverbial wall.
Even more disturbing was a -20 point drop in the prices paid component from 77.5 to 57.0. This is the lowest level since November 2007. This could be suggesting we are heading into a deflationary environment.
There have only been two depressions in the last 100+ years but their impact is lasting. In a high debt environment this would be a disaster. The government needs inflation to take us out of the recession and give the government cheap dollars to pay back debt. Deflation is many times more serious than inflation to our long-term economic health. Bernanke and company will use every tool at their disposal to avoid a depression and I suspect we will start seeing some of those tools come out of the closet very soon.
The economy is coming to a crossroads and the options are not pretty. The nation is facing the biggest tax increase in history in 2011. No deductions are sacred and because of the breadth of the changes we could all see our individual taxes go up by 15% or more. I know the marginal tax rates are only going up 3-5% but the loss of deductibility on almost everything means your taxable income will be a lot higher. Deductions for children are going down. Health savings accounts are going away. The marriage penalty returns along with the death tax, medicine cabinet tax, alternative minimum tax, etc. The alternative minimum tax hit four million people in 2009. That will jump to 28.5 million in 2011. Taxes on dividends will jump from 15% to 39.6% with another 3.8% hike in 2013. Here is a link to a brief checklist of the most onerous tax changes. Largest tax increase in history
The new Federal taxes will remove about 1% of U.S. GDP and new state and local taxes are going to remove another 1%. With GDP only projected to be +2% later this year that means the tax increases alone could push us back into recession. John Mauldin claims that tax cuts or increases have a 3X multiplier effect on the economy where tax increases have a negative effect and tax cuts a positive effect.
These higher taxes will depress consumer spending, depress small businesses and cost hundreds of thousands of jobs. This new weight on the economy comes just as the stimulus spending ends and the government "supposedly" begins to cut spending in an attempt at austerity. The government has been borrowing from future generations for decades and those bills are finally coming due simply because they can't borrow any more money. By 2015 the interest will be over $1 trillion per year. The European debt crisis has highlighted the coming U.S. debt crisis and at a time that the U.S. is no longer the world's growth engine. (According to Tim Geithner last week)
I don't want to turn into a preacher of doom and gloom but we are rapidly approaching the point where continuing to do what we have been doing will no longer be an option. As investors we should be aware of the coming economic problems because they will impact our investments and our income.
The market is already taking into account the coming problems. The yield on the 10-year was under 2.9% on Thursday and the yield on the 2-year treasury was under 0.6% and a new historic low. Investors are searching for safety and U.S. debt is still considered safe by many despite our huge debt load. To put this into perspective, investors are so sure that equities will not provide a return over the next two years that they are buying bonds instead at less than 1% return.
Consumer confidence is tanking badly with more than a 10-point drop in June to 52.9. The present situation component fell to 25.5 because of worries over jobs and home values. Analyst Greg Weldon pointed out that the number of people planning vacations has fallen by -35% over the last three years to the second lowest number ever. People planning on buying appliances are near a 16-year low according to the confidence survey. Over 17% of survey respondents claim their income is decreasing.
Pending home sales fell -30% in May. That was due to the expiration of the homebuyer tax credit in April but regardless of the reason sales fell off the cliff and the results to the economy are the same.
Home Sales Chart
The market is discounting all those points above and the Dow has been down for seven consecutive days. The economic data is clearly pointing to a slowing economy and with the great recession still vividly on our consciousness, investors are fleeing the potential for a double dip. The stimulus is over or it will be by the end of 2010. Lawmakers and the president have said there will be no further stimulus. That means we are going to have to tough out the next 6-12 months. With the Fed at zero percent it is time for helicopter Ben to start warming up those helicopters for money drops to head off not just the second dip but the possibility of deflation. I expect the Fed to start announcing new programs soon. There is far too much deflation risk to wait.
Economics for next week are very slim. This is clearly a holiday week calendar with no material events. I had to stretch to even highlight the ISM Services and jobless claims as important.
We are still a week away from the start of the Q2 earnings cycle with Alcoa's announcement on Monday July 12th. Quite a few companies join Alcoa on that Monday followed by Intel and YUM on Tuesday, Google and JPM on Thursday. The following week is a tsunami of announcements as everyone of importance piles into that week.
I am going out on a limb here and suggest we will see a rally into earnings. Despite the stronger comparisons and the potential for some lackluster guidance I believe we will see an attempt to trade the earnings cycle. However, I don't think the rally will last. I think it will be temporary and we will see lower lows before Q3 is over. There will be some individual winners but I think overall the market is not done going down.
The last double dip recession was 1980-1982 so investor memory is still somewhat intact. Fortunately if we do have a double dip it won't be for the same reasons as the 2008 recession. Big banks are not going to be failing on a weekly basis. There is no subprime problem to suddenly appear and wreck the banking system. If we have a double dip the second dip will be the garden-variety recession brought on by a declining business climate and a lack of consumer spending. The Q2 earnings reports will tell us through their guidance if this is really a possibility or just another case of over cautious analysts.
In stock news, what little there was to see on Friday, Apple said it was shocked to find out that the iPhone signal strength indicator (bars) had been incorrect since 2008. I am shocked that Apple really expects the consuming public to believe that they did not know the problem existed. In fact there is a large contingent of iPhone users that believes Apple knowingly showed an incorrect number of bars in order to deflect criticism of the horrible AT&T network.
The problem started in 2008 when iPhone users kept complaining that they only had one or two bars of service and could not make calls or calls kept cutting out or dropping. Apple promised to fix it and had users download a new OS (2.1). Suddenly two bars went to four and everything was fine. At least fine until you tried to make a call and couldn't and connected calls still dropped. CNET ran tests that suggested there was no difference and Apple had just changed the bar display. As many as 40% of iPhone users believed Apple just changed the programming to show more bars as AT&T scrambled to upgrade their network.
Fast forward to 2010 and Apple said on Friday it was "stunned" to find out the iPhone has been exaggerating signal strength since 2008 by displaying too many bars indicating there was stronger reception than actually existed. Apple claims it was a bug in the software that will be fixed soon. Apple claims it discovered the problem while trying to debug the mystery of the disappearing bars on the iPhone 4 after users complained about the disappearing signal strength bars when the phone was held a certain way.
For a company that is positively fanatic about the details and features on their phones it strikes me as exceedingly strange that this "glitch" went unnoticed for two years across multiple versions of operating systems. That would assume that nobody tested the new operating systems to see if they were outputting the correct information. I find that highly unlikely and plenty of iPhone customers fell the same way. AT&T posted a letter on their website declining to comment on the problem and referring questions on the issue to Apple. To top it off customers are reporting even worse dropped calls on the new phone than the 3GS they were using before. Three separate lawsuits were filed last week alleging Apple knowingly sold a defective product. Apple shares have fallen from $279 just before the phone became available to a low of $243 on Friday. Despite the glitches in the signal strength and the antenna problem I would still be a buyer of Apple at $235-240. Most analysts have a price target at $325-$350 once the market shakes off this weakness.
The Dow has given back -908 points since the high at 10594 on June 21st. That is an average of -100 points per day and an 8.5% drop. If you were only looking at the Dow I would say there is further pain ahead. The S&P has fallen -109 points from the 1131 high for a 9.6% decline. The intraday low on Thursday was 1011 and only one point above the 38% fib retracement level from the March 2009 bottom. This should not be material support but the S&P did rebound from that level. On Friday the low was 1015 but the volume was very anemic at just a hair over 7.0 billion shares. The holiday weekend started early for most traders.
While I don't see 1010 as material support it is a crossroad that the S&P did not violate on the first attempt. When the S&P began to rally on Friday afternoon to 1029 I expected the normal Friday afternoon short covering after a big down week. When it failed to hold it suggested the shorts were so confident about further declines that they were in no hurry to exit even ahead of a three-day weekend. That would be some brave or possibly foolhardy traders.
Possibly they were looking at the death cross about to occur with the 50/200-day averages. A death cross is when the 50-day average crosses through the 200-day average. It can be any set of averages but in reference to the S&P those are the averages commonly followed. Both averages closed on 1111 on Friday. Since averages don't reverse instantly there is no way to avoid the death cross on Tuesday. If you want to be a stickler for detail the 50 at 1111.66 has already crossed the 200 at 1111.77 but that is a little too technical for me.
S&P Chart with Death Cross
With a three-day weekend there is always the possibility of some foreign market event pushing the futures higher on Monday and causing a gap open on Tuesday. Of course with the news we have had lately there is a much better chance of a gap down and that probably kept traders short.
Funds that had fully invested ahead of the end of the quarter on Wednesday probably took advantage of Thr/Fri to uninvest that cash again. Volume was high at more than 11 billion shares on Thursday. All the gaming should be over and next week should stand on its own for market direction.
The perfect scenario would be for the S&P to gap down at Tuesday's open and retest that fib support at 1010 then rebound and close positive. Next week is going to be a light volume week with no material earnings or economics so the market will be left to trade on news events and short covering. If the S&P could close higher on Tue/Wed we might get a decent bout of short covering that could lead into a brief earnings rally.
Initial support is 1010 but there is pretty solid resistance at 1045. Any rally for any reason would face a serious challenge crossing that barrier. A further break and close under 1010 is lights out in my book. That means there is no buying sentiment even for a trade for earnings.
The Dow chart has Friday's closing candle hanging in uncharted territory and below support. The nearest light support is the 38% Fib level at 9439 but that is probably wishful thinking. The 50/200 have not crossed yet but they will this week. Friday's close was a new low for the year and like I said earlier just looking at the Dow chart paints an ugly picture of more losses to come.
The Nasdaq is a different picture. The Nasdaq Composite has decent support in the 2050-2063 range with Friday's close at 2091. The 2063 level is the 50% Fib retracement and it should be decent support. There were also some support lows from Oct/Nov around 2050, which should also sustain the first retest. If RIMM and AAPL were not racing each other lower the Nasdaq would be a lot better off. Techs are not normally in favor in the summer and especially not in favor as long as there is worry over a double dip. The Nasdaq has the seasonal problems to overcome but there are some support points from which to mount a defense.
In summary I don't expect volume to pickup next week. We could easily see a major move at Tuesday's open but the direction will be left up to the overseas markets. We are still seeing forced margin selling as underwater investors are liquidated. Putting off selling a losing position because you can't afford to take the loss will eventually get you a bigger loss when the broker closes the margined position against your will. This happened every day last week.
We need that big down day to flush all the remaining weak holders and give the funds an excuse to buy ahead of earnings. If we had a big decline on Tuesday I would be a buyer for a trade. If the shorts can be convinced to cover we could have a decent rally into the first real week of earnings but I suspect we will be heading lower before the month is out.