January closed with a whimper today with the averages mixed but it was still a great month. Unfortunately that suggests February could be ugly.
For January the Dow gained +3.4%, Nasdaq +8.1%, S&P +4.4% and the Russell 2000 +6%. The biotech sector rallied +21%, housing +12%, semiconductors +12%, oil services +10%, gold +11% and silver +19%. While that was a great start and definitely an exception to the historical 80% chance of a late January decline it has triggered another historical trend. Historically whenever January is up more than 2% there is a correction in February 70% of the time.
There are multiple reasons for this trend. Q4 earnings are basically over because more than 350 S&P companies have reported. We know what the rest are likely to say and the excitement is waning. Secondly the normal January cash infusion into retirement accounts is over. That money has been invested and now fund managers settle in for a long year of managing based on performance and news events. The next cash surge is at the end of March but it will be minimal compared to the normal flows in January.
That makes this rally even more unbelievable. I reported over the weekend that domestic equity funds saw outflows in four of the last five weeks yet the markets still rallied. Bad news from Europe, bad earnings and bad guidance all failed to depress the market. In my mind's eye for a brief moment I saw pigs flying.
We can discount nearly all the fundamentals using the rationale that investors have grown tired of bonds and money market yields and they are willing to take some risk in 2012 rather than waste another year of sub inflation rate returns. Of course that assumes there will be returns. That has yet to be seen. With GDP for 2012 estimated to be only 2% or less and earnings expectations for the next quarter barely in positive territory the assumption that market risk may be higher than most investors think.
When in Rome do as the Romans do and in investing it is best to follow the trend until it ends. Trying to time reversals has cost investors untold trillions of dollars in the last year alone. You know the old saying, "the market can remain irrational far longer than you can remain liquid."
Logically February should suffer from some serious profit taking. However, given the events of the last three weeks logically the market should have declined. Never look to the stock market for logic. Looking for logical moves in the market is like watching a roulette table produce red numbers three spins in a row. Logically a black number should appear soon so everyone bets on black. Unfortunately the table has no memory and every spin stands on its own. At least the market has a memory. That memory is held by millions of investors who have made and lost money in all markets under all conditions. That memory could be working against us in February. The market has rallied pretty consistently for the last six weeks. Very few rallies in good economic times can maintain a rally longer than six weeks. The Dow has seen 19 consecutive days of less than 100 point moves. The last time that happened started on Dec 3rd 2010 and ran for 34 days. After a one day dip the trend resumed to end on February 21st. That was a +1,400 point rally followed by a -800 point correction that started on the 22nd.
I am sure everyone would be thrilled to see the trend from 2010-2011 repeat but just remember nothing goes straight up forever. The trend is your friend until it ends. We just need to be careful to anticipate that end rather than assume the paradigm has changed and corrections are a thing of the past. Don't assume because it did not rain in January that it won't rain in February, unless of course you live in Phoenix.
Dow Chart Dec 2010 - Feb 2011
Dow Chart Dec 2011 - Jan 2012
On the positive side of the historical trend we have the January effect. Historically, how January goes, so goes the year. I am sure some investors will be going a little bit further and betting on the larger trend. Over the last 25 years whenever the S&P gained more than 4% in January the gains continued with an average of +23.3% for the rest of the year. Obviously you can make statistics say anything you want if you broaden or narrow your focus to just that dataset that fits your bias. For instance those January's with more than 4% gains were in 1988, 1989, 1991, 1997 and 1999. Comparing those years with today's market and economy would be wasted effort. We have nothing in common today with those years in the past but it makes a nice statistic.
Problems weighing on the markets today included a drop the Consumer Confidence for January. The headline number declined to 61.1 from 64.5. That was also well below the consensus estimates of 68.0. The present situations component led the decline with a drop to 38.4 from 46.5. This could be due to multiple reasons. When the holiday bills come due we normally see confidence fall. Secondly, the political campaigns are heating up and the mudslinging is is picking up. Politicians get votes by telling you how bad it is now and offering their solutions on how they will make it better. People tend to remember the bad and seriously doubt their promises for the future. The expectations component barely declined to 76.2 from 77.0. Those planning on buying a home fell from 5.4% to 4.2%.
To put this headline decline into perspective we need to compare it to the +20 point gain over the last three months from the 40.9 low in October. Confidence was due for a rest. There was a sharp drop in those who felt jobs were easy to get and a corresponding jump in those who felt jobs were hard to find. January's confidence numbers are just one data point in the economic outlook and should not be seen as a reason for a market reversal.
Consumer Confidence Chart
Another negative indicator was the Chicago PMI, which declined to 60.2 from 62.2. The index remains in expansion territory but it is struggling to maintain its gains. Consensus expectations were for a rise to 63.0. New orders declined to 63.6 from 67.1 for the third decline in the last four months and the largest decline since May. Back orders fell sharply to 48.3 from 57.3 and back into contraction territory. That was the largest decline since May 2009. Employment declined to 54.7 from 59.2.
The drop in activity in Chicago suggests we could see a decline in auto sales for January. The weakness in the Chicago ISM is troubling. It suggests the expectations for economic improvement got ahead of reality and the deepening recession in Europe is going to weigh on manufacturing in the USA. This was not a bullish report.
Chicago ISM Chart
Case-Shiller updated its Home Price Indexes for November and prices were down nationwide by -3.7% year over year. That compares to -3.4% in the prior reading. This is a severely lagging economic report for the November period and it was ignored.
The calendar for Wednesday has the first payroll report with ADP expected to show a gain of +180,000 jobs compared to +325,000 in December. This number rarely agrees with the Nonfarm Payrolls coming out on Friday. There are some new whisper numbers coming out on the Nonfarm Payrolls because of a major revision in the birth-death estimates for businesses. That is the estimate of how many businesses were created or closed over the reporting period. I have heard numbers under 100,000 for the Nonfarm Payrolls.
The national ISM Manufacturing is also due out on Wednesday and given the decline in the Chicago ISM there is a very good possibility that number will disappoint as well.
The biggest earnings report for the day came after the close. Amazon reported a major earnings miss and the stock was crushed. Amazon reported earnings of 38-cents compared to estimates of 17-cents. On the surface that would appear to be outstanding but there was a $101 million benefit from currency translation.
The problems came in the top line revenue numbers. Amazon reported revenue of $17.4 billion compared to estimates of $18.3 billion. Also hurting the stock was lowered guidance. Amazon is predicting revenue in Q1 with a midrange of $12.7 billion and analysts were expecting $13.42 billion. Amazon also predicted the possibility of a loss of as much as $200 million in Q1.
Sales of the Kindle nearly tripled in Q4 although they don't release specific numbers. However, they said Kindle content surged to more than $6 billion for the quarter. With that kind of volume they could give the Kindles away and still make money long term. Sales of electronics, including the Kindle, rose +48% to $10.9 billion.
Unfortunately they grew expenses as fast as sales. Employees grew by 67% to 56,000 workers. Expenses rose by 38% to $17.2 billion. Amazon has been investing heavily into new product fulfillment centers in expectations for future growth. However, churning $17.4 billion to only make $200 million in profits is an extremely risky endeavor. The slightest drop in sales and the company is going to be hit with steep losses.
Shares of Amazon declined -$20 after the report. For reference they dropped -$30 after earnings in October.
Dow component Exxon (XOM) reported earnings in line with estimates but the stock declined on lackluster production. Exxon earned +$1.97 compared to $1.85 in the year ago quarter. Analysts were expecting $1.96 so results were in line. Revenue rose +16% to $121.6 billion exceeding estimates of $119.7 billion. Exxon was helped by higher prices received for oil that overcame the decline in gas prices. However, profits in its refining business declined -13% and the chemicals and plastics unit declined -49%.
Production declined -9% despite record capex spending. Exxon spent $36.8 billion on capex in 2011 and will spend $32.7 billion in 2012. The cheap oil has already been found and if you can't increase production on more than $30 billion a year that is clear proof oil prices will continue to go higher. Shares of Exxon declined -2% on the news.
Dow component Pfizer (PFE) reported adjusted earnings of 50-cents and slightly above analyst estimates of 47-cents. However, they lowered their full year estimates to a midrange of $2.25 and analysts were expecting $2.28. Revenue declined -4% to $16.75 billion thanks to falling sales of Lipitor after it went off patent in November. Lipitor sales fell -24%, including a 42% decline in the USA. Sales of Enbrel, Celebrex and Viagra all rose and helped to offset the Lipitor loss. Shares of PFE declined slightly on the news.
United Parcel (UPS) reported earnings of $1.28 compares to estimates of $1.26. Revenue rose +6% go $14.2 billion. UPS raised 2012 estimates to 9% to 15% growth. The company said it shipped more than 500 million packages between Thanksgiving and Christmas and 1.3 billion for the entire quarter. The CEO said he would not characterize the U.S. economy as robust, the small package market was performing better than he expected several months ago.
Netflix (NFLX) declined -$5 after British Sky Broadcasting said it was developing a new Internet TV service to offset the decline in regular pay TV service. BSkyB said it would offer the streaming content to 12.5 million UK households that don't already subscribe to its service. I don't think this is materially relevant to NetFlix and the stock decline was a knee jerk reaction to the news.
Aflac (AFL) quacked its way to $1.48 in Q4 profits compared to estimates of $1.52. Guidance was mixed and shares declined -2% in after hours.
Broadcom (BRCM) reported adjusted earnings of 68-cents compared to estimates of 64-cents. Revenue fell -6% to $1.82 billion. The company raised guidance for Q1 to $1.75 billion and slightly above the $1.73 billion analysts expected. They said the Android platform was the major driver of growth in the tech sector. Shares rose fractionally in after hours.
The big lower for the day was Radio Shack (RSH). Shares fell -30% after the company warned last night that earnings would be in the range of 13-17 cents and analysts were expecting 37-cents. Sames store sales rose only +2% and revenues rose +6%. The company said it was being hurt by customers transitioning to more online shopping. Best Buy shares were also down after this warning.
Radio Shack Chart
The S&P-500 dipped below strong support of 1310 on Monday but quickly rebounded to close over that level. The dip was repeated today but the rebound was less robust. In fact it was lackluster. The decline in the economics as well as the lingering debt swap problem in Greece continued to weigh on the markets.
However, cash is trash and the dip was bought. Volume of 7.1 billion was about one billion shares higher than Monday and the internals were dead even. They say a day like this is a deadlock between buyers and sellers and that was definitely true.
Technically the S&P saw the "golden cross" achieved where the 50-day average crosses above the 200-day average. In theory this is supposed to be a bullish signal indicating an improving trend. Whether that has any relevance to our markets today is still unknown.
This is a headline driven market and the headlines recently have been more negative than positive. Eventually that will have to change or investors will reconsider their decision.
There was one news flash today on Greece. The prime minister said they expected to have the debt swap deal done by this weekend. Unfortunately that is the same thing he said each week for the last three weeks. News reports claim the deal has been agreed to but cannot be completed until the government gives some assurances to the creditors committee of certain austerity measures to be enacted in the coming months. Apparently the creditors don't want to discount their debt by 70% if there is no real hope of eventually being paid back. Personally I think they lost that hope long ago and the rumors of a Greek plan to leave the euro in March are growing. That means the creditors would be paid back in drachmas at what could be 10-cents on the dollar.
This is the geopolitical cloud that will continue to hang over the market for weeks to come. Should we see a resolution, even if in principle only, the market could rally strongly. I believe investors are betting on that resolution.
Support is 1310 followed by 1300 and 1280.
The Dow continues to trade in a narrow range although it did close about 90 points off its high. The morning spike was quickly sold although support at 12,600 did hold. The Dow is moving sideways while we wade through the earnings from the rest of the Dow components. Once those are done there will not be any further catalysts to propel it higher. At some point it will have to return to trading on fundamentals.
Strong resistance awaits at 12,750 to 12,810. The last three days could be seen as a consolidation period for the prior gains. That theory holds only as long as support at 12,600 also holds. A break of 12,600 could see 12,300.
The Nasdaq short term chart is what traders dream about. A nice steady uptrend with limited volatility that honors support at every step. That uptrend may be about to crack with the -$20 drop in Amazon tonight. The Nasdaq futures are only down about five points and S&P futures are flat. The impact of Amazon may be seen as strictly an Amazon specific event and not a system wide problem. Time will tell.
The Broadcom earnings were the offsetting headline with the company making several positive comments about the 2012 outlook.
Initial support is 2800 followed by 2770.
The Russell remains our coal mine canary and investors did not flee the small caps on Tuesday. I continue to be amazed that negative earnings, negative economics and negative European headlines have not caused fund managers to run to the sidelines in panic. Support is 790 followed by 780. Resistance is 800. Should we see some kind of token resolution in Greece and the small caps break over 800 I believe we would be off to the races.
I continue to be increasingly cautious about the market. We can't fight the trend if it continues to rise but we have to be ever vigilant about tightening stops because eventually there will be a serious dip. Whether that is two days or two weeks is of course unknown but I believe we are living on borrowed time. The market is rising on hope and fueled by cheap dollars and the expectations of further Fed easing. At some point the reality of weak economics will offset the lure of cheap money.
Watch for a break and close below 1310 on the S&P as a signal there is trouble ahead. At this point I would still be a dip buyer on any material dip. That does not mean a -70 point opening gap. I would be looking for a decent drop to equalize the pressure from six weeks of gains. We will know it when we see it.
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