Speaker Boehner failed to garner enough votes for the Plan B tax bill to even bring it to the floor for a vote and Friday's market reaction was immediate and dramatic.
S&P futures declined -52 points overnight from Thursday's close at 1446. There was significant pressure from declines overseas after Speaker Boehner failed to get enough republican support to pass the Plan B tax bill. There was an immediate rebound to 1425 where it held through the open when the futures expired.
In regular trading the Dow lost -121 after being down -189 at the open. The Nasdaq lost -29 and the S&P -13. Even with the declines the major indexes still finished with a gain for the week.
The market fell as a result of the cancelled vote because of the implications for an even bigger vote next week. If the Speaker could not get enough votes for a "show vote" on a republican sponsored bill then how will he get enough votes when the there are real issues on the line and bigger tax cuts in the mix?
The outlook for a grand bargain with the President and democrats is weakening every day. The president is going to get his wish for a tax hike if we go over the cliff on Dec 31st. That is his ace in the hole. He can use that looming tax hike to possibly do a small deal with Boehner next week that will extend the cuts and the rest of the cliff issues for 60-90 days and remove the immediate pressure on the market.
Boehner still holds the bigger trump card of the debt ceiling that will shut down the government by the end of February if it is not raised. Boehner can play that card next week as a bargaining chip on the tax hike. If the president and Boehner can't agree on an extension next week and we go over the cliff then the debt ceiling card will become even more important as we move into January and closer to the ceiling.
We saw the potential for a small deal late Friday when president Obama announced he had talked to Reid and Boehner and thought there was common ground for a deal to extend the tax cuts, extend unemployment insurance on two million workers and "structure a framework" for the rest of the cliff issues that would allow "cooler heads" to work out the details in 2013.
This offer to kick the cliff can well into 2013 has been expected. I have written about the possibility several times. Nobody wants to take on the big issues under the glaring light of the press. Lawmakers would rather kick the issues into 2013 and then work on details in committee where the press can't see the back room bargains being made.
The tradeoff Obama wants to allow the can kicking is to raise taxes on everyone making more than $250,000 and extend unemployment insurance benefits on two million people for another year. With the republican rebellion in the House it is going to be tough to get this done. House democrats will have to come to Boehner's rescue.
Institutional investors understand the growing risk of a bigger market disruption if negotiations breakdown completely. Next week is going to be very rocky if the headlines turn negative. The carrot Obama offered Friday night could keep the markets from selling off on Monday. The Senate and House have left town for the holidays so cliff headlines on Monday should be minimal. The urgency will increase after Christmas.
Friday was a busy day economically with several high profile reports that surprised to the upside. The Q3 GDP was revised up from +2.67% to +3.11% growth. The initial reading was +2.0% and it was revised higher in the prior report to +2.7%. This compares to only +1.25% growth in Q2.
The big gains came from strong nonfarm inventory investment and the largest contribution from government spending. A drag on growth came from lower farm inventories as a result of the drought.
Government spending rose by +3.9% and the fastest rate in more than three years. Exports rose +1.9% and investment in residential structures rose by 13.5%. Consumer spending, the biggest component in the GDP, rose by +1.6%. Corporate profits rose by +2.4% but below estimates of +3.5% growth.
On a trailing 12 month basis the headline GDP has risen by +2.6%. This is decent but not enough to improve employment and insulate the economy from fiscal shocks. Real GDP income only rose +1.4% but that was twice the +0.7% rate in Q2.
The impact of Sandy at the end of October was not seen in the Q3 GDP but will be reflected in the Q4 numbers. While it would have depressed GDP in the early weeks it should have been positive for GDP once the rebuilding effort began.
The headline number on the Kansas Fed Manufacturing Survey rose from -6.0 to -2.0. While still in negative territory it was an improvement. New orders improved from -14 to -8 but have been negative for four months. Back orders also improved slightly from -25 to -19 but have also been negative for four months.
Obviously it is hard to be positive about a manufacturing report with all the components still in negative territory but it is still an improvement. Unfortunately capital expenditure plans remain at two-year lows so a boom in activity is not expected by manufacturers. Survey respondents cited uncertainty over taxes and rising healthcare costs as the main factors depressing sentiment.
Kansas Fed Manufacturing Survey Chart
Durable goods orders for November rose +0.7% compared to expectations for a -0.1% decline. This compares to zero movement in October. Excluding transportation, new orders rose by +1.6%. Core capital goods rose +2.7% and shipments rose +1.8%.
Nondefense aircraft orders declined -13.9% but this is a very volatile number since orders are random and they total billions of dollars when they arrive.
This was a very good report given the weakness in other reports like the Kansas Fed survey above. The Philly Fed Manufacturing Survey the day before surged from -10.7 to +8.1 so there are strong spots in the economy.
On the negative side the final Consumer Sentiment report for December declined to 72.9 from the first reading of 74.5. That is the lowest level since July. That was also down from the November headline number of 82.7. The -9.8 point decline was significantly more than analysts expected and shows how the fiscal cliff headlines are impacting sentiment.
The current conditions component only declined -3.7 points to 87.0 but the expectations component imploded with a decline of -13.8 points from 77.6 to 63.8. That is the lowest level since last December.
Moody's said the implied decline for the second half of December was 70.5 suggesting the next Sentiment number could be even lower.
Low gasoline prices were actually a benefit to sentiment or the numbers would have been a lot worse.
Consumer Sentiment Chart
Mass layoffs spiked unexpectedly to 1,759 from 1,360 for November and that was the highest number since late 2009. The number of workers impacted rose to 173,558 from 131,173 in October. Analysts claim the numbers were impacted by Sandy and the increase will be temporary. However, California had the largest number of new layoffs and there was no storm on the West Coast. The next three states were NY, NJ and PA and those were storm driven.
Moody's Mass Layoff Chart
Next week will be a short week with the markets closing at 1:PM on Monday and closed for Christmas on Tuesday. That squeezes many of the normal reports into the final three days but it is still a very light calendar.
The Richmond Fed Survey on Wednesday should be positive but it will probably be ignored as the fiscal cliff headlines heat up again. The Chicago ISM on Friday is also expected to improve but it should also be ignored since Friday is the last full trading day ahead of the cliff deadline.
Next week is the "last minute" for cliff negotiations. The urgency is going to increase and that means it will be accompanied by a headline frenzy that will be pushing the market all over the map.
Volume will be very low and that can either produce a dull market or a one that looks like an EKG. Economics will not matter next week.
In stock news, Electronic Arts (EA) and Gamestop (GME) continued to decline on fears the government will step in and restrict violence in games like Grand Theft Auto and Call of Duty. There is a growing unrest about these violent games where people shoot other soldiers, people, cops, kids, etc randomly without consequence. Some analysts are claiming the games desensitize the player to violence in the real world.
The NRA held a press conference on Friday and pointed out there is even an online game called Kindergarten Killer where the shooter (you) wanders through a school killing principals, teachers and kids at random. You get points for the number of kids you kill. Link to Game Alan Lanza reportedly played 40-50 hours of violent video games like Call of Duty every week.
Investors are selling shares of game providers because the odds are good there will be stricter rules on who can buy these games in the future. There will probably be tighter parental controls as the topic winds its way through the press and congress.
GME lost -10% since the shooting, EA -13%, ATVI -10%, RGR -17% but has rebounded slightly and SWHC -18%. Semi-auto rifle prices have tripled and a check of multiple distributors shows they are all sold out.
I reported on Tuesday that the Colorado Bureau of Investigations (CBI), the agency that handles the background checks for firearms sales in Colorado, was reporting record volumes. On the day of the shooting the normal wait time for an "instant check" was 23 minutes in the morning and had increased to 4 hours by day's end. They processed a record 4,154 checks the day after the shooting. I checked again on Saturday and the instant check was now 4-5 days behind and there were more than 9,200 applications backlogged in the system. This would actually be more but all the gun dealers in the Denver area are sold out. I have a friend that runs a sporting goods store and he said all the firearm distributors are out of inventory. I checked online at GalleryofGuns.com, a website run by Davidsons, one of the largest gun wholesalers, and they were out of stock on all semi-auto rifles. I checked several other online supply houses with the same result. Several had messages on their website saying they were no longer accepting orders.
This story is far from over. Manufacturers are going to report record profits for Q4 and Q1 but any gains in the share price will be short lived as future sales dry up. We need to watch for shorting opportunities after the Q4 earnings.
Electronic Arts Chart
Smith & Wesson Chart
Micron (MU) reported a loss of -27 cents for Q3 compared to a -19 cent loss in the year ago quarter. Revenue fell -12% to $1.83 billion. Analysts were expecting a loss of -20 cents on revenue of $2.0 billion. Shares fell -10% after Micron said chip prices fell -11% on average and PC shipments for 2012 had declined for the first time in more than ten years. Makers of PCs, servers and network equipment had overstocked and cut orders as a result.
Micron has agreed to acquire bankrupt Elpida Memory for $2.37 billion and has received approvals from Japan, the U.S., Czech Republic and Korea. Several other countries still need to approve it but the acquisition is expected to be completed in the first half of 2013. Micron has reported losses for six quarters and analysts expect that to continue for another two quarters until cutbacks in the industry reduce the supply of chips.
Research in Motion (RIMM) declined -23% after reporting earnings Thursday after the close. This was the largest percentage drop in RIMM since Sept 2008. The company also reported that subscribers declined from 80 million to 79 million. Relatively speaking that does not seem that bad given the tens of millions of phones being sold by Apple and Samsung.
RIMM announced a fee change along with earnings with the new fee structure to be introduced with the BlackBerry 10 in late January. However, when an analyst on the conference call asked how service fees paid by consumers and businesses would be impacted by the release of the BB10 devices in January VP Paul Carpino, said "We are not providing that info at this time. You will have to wait." Shares had rallied in afterhours trading after the better than expected earnings but they immediately crashed on that comment. Service charges now account for 35% of RIMM's revenue. If those charges were to change with the new OS and phones then RIMM's revenue would drop.
RIMM said some subscribers would continue to pay for enhanced services like advanced security but under the new structure some other services would account for less revenue or even none at all.
The company also said the BB10 launch at the end of January could burn up to one third of the company's cash, now at $2.9 billion.
Shares of Herbalife (HLF) continued to plunge after Pershing Square Capital Management's CEO William Ackman called the company a pyramid scheme and announced he was shorting the stock. Ackman claims he has been shorting the stock for several months and it now represents a major position for his company. He called it "enormous."
Ackman and associates showed several hundred slides during a presentation at the Sohn Conference Foundation meeting in New York. See presentation PDF here He has been widely assailed for his position against the 32-year-old company. The Herbalife CEO has been extremely hostile in several recent interviews claiming this kind of attack represents stock manipulation and should be researched by the SEC.
On Friday Ackman launched a website named www.FactsAboutHerbalife.com with the source data used to create the Sohn Conference presentation. Ackman claims Herbalife is misrepresenting financial information and disguising information to hide the true pyramid nature of the organization. I read the presentation I listed above and it is pretty convincing. Ackman said Herbalife shares are going to zero once regulators understand the fact he is presenting. After reading his research I would not be surprised if HLF did go to zero or close to it.
Herbalife has announced an analyst meeting for Jan 7th to rebut the Ackman claims.
Herbalife has more than three million distributors in more than 80 countries. Unfortunately, it is not too big to fail.
Nu Skin (NUS) is suffering the same fate as Herbalife even though they are not under direct attack by Ackman and Einhorn. Also a multilevel, shareholders are fleeing now rather than wait for somebody to put the dreaded pyramid tag on them as well.
Yum Brands (YUM) fell -4% after China said it was investigating the company for using chickens treated with unapproved levels of antibiotics at its KFC stores. The Shanghai FDA said tests conducted by a third party agency found eight batches of chickens supplied by Liuhe Group had levels of antibiotics that were higher than allowed.
Shares declined on the news. Late in the day YUM said it is cooperating with the government probe and review of its suppliers and doesn't anticipate a shortage of product. YUM said it quit buying from the two suppliers in question in August. YUM received 44% of its revenue from China in 2011. The company has 4,900 locations in China.
The Dow Transports have broken through eight-month resistance at 5200 and are approaching 52-week resistance at 5360. The motive power behind this is the airlines. Delta (DAL), United Continental (UAL), Sky West (SKYW) and Jet Blu (JBLU) are all sitting at multi-month highs. Occupancy is high and fuel costs are falling. The railroads are not doing nearly as well but rising volumes of oil are helping keep them in the black. Even UPS and FDX are at multi-week highs.
In Dow Theory the Dow should now confirm the rally by surpassing its October high of 13,610. Failure to do so would trigger a sell signal.
Dow Theory watcher Richard Russell said in a note to clients "for the good of the country and for the health and safety of my subscribers and family, I certainly hope the Dow confirms the transports." That sounds rather ominous since a failure of the Dow to confirm would trigger that sell signal in his mind.
Richard Moroney, editor of Dow Theory Forecasts, said a failure to confirm would be "discouraging" since "it would set the table for a bear-market signal."
Jack Schannep of TheDowTheory.com was not as bearish about the possible non-confirmation because he believes Dow Theory is already on a sell signal.
Dow Transports Chart
The S&P rallied to nearly 1450 on Tuesday and held that level for three days. The Boehner Plan B Blunder on Thursday along with December option expirations and the Russell index rebalancing knocked it back to prior resistance at 1430 at the close.
Spending a lot of time talking about the technical merits of the S&P at this level would be pointless. Resistance is 1450 followed by 1465 and support is 1425 followed by 1400. However, the direction and speed of movement will be determined by the political theater in Washington after Christmas. There is likely to be very little movement on Monday unless we are hit with a new headline.
Market movement the rest of 2012 is going to be strictly headline based. Typically the market is up between Christmas and New Years about 70% of the time. This is not a typical year so normal rules do not apply.
The Dow fell back below prior resistance at 13,279 but remains close enough to retry that level on any positive news about the cliff negotiations. A further decline below 13,125 and the low on December 14th would be negative and bring the 12900-13000 level back into play.
The Nasdaq dipped to support at 3,000 at the open and rebounded immediately. That level was tested again at 11:30 and another rebound ensued to push the index to close at the high of the day. Apple, Google, Amazon and Priceline were all negative so the Nasdaq did not have a chance for a positive close.
The Russell 2000 also closed near the high of the day and managed a loss of only -4 points. The Russell gained +2.9% for the week and more than double the other major indexes. Some would say this is the January effect where fund managers buy small caps for the new year.
I believe it is a truer picture of fund manager sentiment and a break over resistance at 860 by year end would be very bullish.
Russell 2000 Chart
The market will be hostage to the headlines for the rest of the year. Fundamentals and technicals will have little to do with market direction. It will be purely sentiment driven based on the fiscal cliff headlines.
There will more than likely be some window dressing as we approach year end. The tax selling by funds is over and they will be using any available cash to dress up their portfolios in lieu of a market dip.
I was reading an article this weekend by Pimco's El-Erian. He reminded me how we got to the fiscal cliff. When the debt ceiling debate in the summer of 2011 was going nowhere Speaker Boehner and President Obama agreed to agree on future spending cuts instead of current cuts. This got them both past the election without having to face the voters and be responsible for their decisions. They kicked the can down the road in typical political fashion. However, in order to keep both players honest they created a very big stick or set of circumstances that both thought the other would never be able to accept in January 2013. This was the "default" option. It would force them to deal later. With 16 months to work out a compromise they both thought the default option would never be enacted.
Since can kicking in an election year is a political art neither party wanted to tackle taxes or spending ahead of the election. Surely, once the election is over we can solve this problem quickly. Obviously Boehner was hoping Romney would win and the problem solved. When Obama won and no longer faces reelection the choices for the republicans suddenly took a turn for the worse. The unlikely default option that everyone thought was too ugly to ever come to pass is now only a week away and Obama and Boehner are right back at the same impasse they had in August 2011.
The fiscal cliff is a self inflicted wound. They never believed it would be allowed to come to pass so they were willing to agree to unrealistic cuts because they could change it later. Unfortunately later never came.
Now we are again facing the 11th hour deadline and the choices are worse today than they were in 2011 only this time the president has nothing to lose. Boehner is finding his caucus to be unrelenting in terms of tax hikes and offsetting spending cuts and the president is proving to be just as unrelenting in his demands.
It will be interesting to see if they can structure yet another can kick deep into 2013 and do it before the December 31st deadline. With the president in Hawaii and the House and Senate adjourned until Thursday the time to act is quickly fading.
Even if the worst cliff outcome arrives, don't fight the Fed. Peter Cook from Bloomberg TV asked Bernanke at the post FOMC press conference: "if lawmakers were not to agree to some sort of deficit deal by the end of this year and we were to go over the fiscal cliff, could the size of these asset purchases grow in response to that?"
Bernanke's response: "We would perhaps increase a bit."
Definitely, enter passively and exit aggressively over the next week!
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The most bullish thing the stock market can do is go up.
Old market saying
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