The shutdown has been forgotten and worries over the short term budget extension are nonexistent.
The markets exploded higher last week on expectations that everything would work out ok and return to normal. The end of the shutdown and avoidance of the debt ceiling coincided perfectly with some strong earnings surprises and money came flooding back into the market.
The S&P rebounded +98 points or +5.9% since the 1,646 low on October 9th to close at 1,744 and a new high. The Russell 2000 rallied +76 points or +7.3% from the 1,038 low to close at a new high at 1,114.77. The Nasdaq rebounded +246 points or +7.2% from the 3,650 low to close at a new 13-year high at 3,914. The Dow was the laggard with a +577 point or +3.9% gain to 15,396 but well below the prior high of 15,676. The Dow was hit with some major losses from stocks like IBM, GS, HD, MRK and UNH so it is a wonder there were any gains at all on the index.
The shutdown is over temporarily and all is forgotten until the select budget committee fails in reaching a bipartisan solution on budget cuts in mid December. The headlines will begin again but should not heat up until early January. Without a budget agreement the shutdown process will repeat unless cooler heads prevail. Fortunately investors have short memories and the focus is now on earnings. With the government back in business the economic reports will begin to flow again with the two-week late Nonfarm Payrolls scheduled for Tuesday.
The payroll report is expected to show a gain of only 160,000 jobs, down from 169,000 in August. This report covers the period before the government shutdown so there should be almost zero impact from that event. The report for October is likely to show a sharp decline to something in the 125,000 range. The BLS will have their work cut out for them to do their normal survey polling with only two weeks left in October. Fortunately the calendar is favorable with the report rescheduled for November 8th so they gain time there as well.
We will also get the manufacturing updates from Chicago, Richmond and Kansas as well as the three largest housing reports. Home sales numbers are expected to decline as a result of higher interest rates and the end of the traditional summer selling season. Very few people want to move in the snow.
The FOMC meets the following week but at this point they are just a footnote to the economy. The shutdown could have subtracted a half point from an already weak GDP and the Fed is not going to taper QE any time soon. The existence of the January 15th deadline could reduce it by another .2% as corporations hold back on spending until the future is clearer.
Some analysts are now predicting a June announcement but the majority are betting on March as the earliest taper announcement. There are analysts that believe it could be 2015 before QE is cut if the Q4 GDP declines enough. With Yellen the assumed Fed head for 2014 there will be no rush to cut stimulus. Not only will the economic numbers be weak over the next 60 days as a result of the shutdown the accuracy of the numbers will also be questioned because of the lack of data.
However, two new hawks will rotate into voting position in 2014. The chart below came from Credit Suisse by way of ZeroHedge. Esther George, a strong and vocal advocate for cutting QE now, rotates out as a voting member in 2014. Two other vocal hawks will take her place with Plosser and Fisher rotating back into voting position. Even with the addition of one more hawk the roster for 2014 is strongly dovish. The market is sensing there will be no changes in the near future. Evans said late Friday that tapering would not be an option at the October meeting. He said, "I have not seen anything like what I thought it would take in order to get us to a 'yes' vote on tapering." Also, "economic data gathered during and after the shutdown will include noise." Unless he resigns, Bernanke will remain on the committee as a Fed governor through Jan-2020 even though he will no longer be chairman.
Fed Open Market Committee (FOMC)
Non U.S. events are the HSBC China PMI on Wednesday night and the Eurozone PMI on Thursday. The G7 meeting begins on Friday but it rarely impacts the market.
After a slow start to earnings with several high profile misses early in this cycle the reports over the last couple of days have been surprising. Google reported earnings on Thursday night that beat estimates by 40 cents and the stock surged +$122 (+13.9%) on Friday to close at $1,011. Google cofounder Larry Page saw his net worth rise +$3.0 billion on Friday. He is ranked as the 13th richest person in the U.S. with $28.3 billion. Cofounder Sergey Brin is listed as the 14th richest and saw his net worth rose +$2.9 billion to $27.7 billion. He has slightly fewer shares than Page.
Google shares are now in an elite group of stocks priced over $1,000. The other members are Berkshire Hathaway (BRK.a) $175,345, PriceLine (PCLN) at $1,048 and Seaboard Corp (SEB) at $2,827. In years past when a stock price moved into triple digits it was normally followed by a stock split. The theory was a cheaper stock price allowed more people to invest. There were higher commissions on odd lots of shares that prevented investors from buying 20-30 shares of a high dollar stock. Smaller accounts could buy 100 share lots of a $50 stock so corporations would split their shares. This tended to work in the 1990s and prior.
Since the Great Recession there have been very few stock splits. Companies like Amazon (AMZN), Chipolte (CMG), Intuitive Surgical (ISRG), NetFlix (NFLX), Apple (AAPL) and NVR Inc (NVR) have refused to split their stock. Different companies have different reasons. Some say the bookkeeping from having millions of tiny shareholders is the reason. They would rather have a high stock price where most of their shareholders are funds with large block ownership. Others believe the high share price is a status symbol. Lastly, having billions of shares slows the stock appreciation. Microsoft is an example. They split continually in the momentum days and now have 8.36 billion shares outstanding and the stock barely moves. There is too much volume so there are always ready buyers and sellers. There is no competition for shares because there are so many. Funds or shorts can't push it around. Volume in MSFT was 41.8 million shares on Friday. Google only has 274 million shares outstanding. They could afford to split 4:1 and still have one-eighth the outstanding shares as Microsoft.
Chipotle Mexican Group (CMG) posted earnings that rose +15% on revenue that climbed +18% and raised its guidance for the year. The company also said it was going to raise prices for the first time in three years. Same store sales rose +6.2% and well above estimates of +4.7% thanks to an aggressive advertising campaign. Advertising expenses would rise from 1.3% to 1.6% of sales. Management said Q4 sales growth would be similar or slightly better. CMG is carrying a PE of 44 and the highest of North American restaurants.
UBS upgraded Amazon (AMZN) to buy from hold and the stock jumped +$18. The broker raised the price target from $305 to $385. There were other reasons for the stock spike. Amazon said their latest Kindle Fire HDX began shipping on Friday. The New York Times said the new Kindle Fire "is a lightweight, sharp-screened, superfast pleasure." It has a quad core processor, double the memory, super sharp screen and 11 hour battery life in either full size or mini. Nearly every reviewer has raved about it and the timing of the delivery could not be better.
In France and Germany Amazon listings for the Apple TV suddenly went to an out of stock status. They said the boxes would not be available until October 23rd and one day after Apple is scheduled to make another new product announcement. That announcement is expected to be various iPads but you never know for sure. For Amazon to suddenly be out of the Apple TV product a week before a mystery announcement the conspiracy theorists went crazy. Rumors of a set-top box from Amazon are rampant. There are also rumors Amazon has struck a deal with NetFlix to stream its content to an Amazon product.
With Amazon releasing its HDX tablet with a starting price of $229 it puts more pressure on Apple. Suppliers for Apple have reportedly been having trouble producing enough screens for the smaller Retina displays. That means supplies of the new iPads may be limited. With cheap Android tablets flooding the market Apple needs to be able to deliver. Amazon earnings are next Thursday.
Netflix (NFLX) rallied ahead of next week's earnings on expectations for strong subscriber growth. Increased content and new partnerships are expected to fuel that growth. The new generation of Smart TVs that come complete with a Netflix interface already built in are helping spread the news about the service. Now with private content they have moved into a new realm of marketing. That sets them apart from Amazon or Hulu. A real deal with Amazon could catapult them even higher.
While on the topic of Apple's announcement the stock is threatening to break out over two month resistance at $510. The sell off appears to be over and the normal holiday rally is starting. On a purely technical basis I would but a breakout over $510 BUT on a sentiment basis I would be wary. Apple has a history of major declines after product announcements. With the market in stampede mode that post announcement decline could be negated.
Not all the news was good. Intuitive Surgical (ISRG) reported earnings that missed on revenue with a -7.2% drop. That was down from a +7.8% rise in Q2 and +23.5% in Q1. Company sales are not just declining they are plunging. Safety concerns are weighing on the company with a FDA probe underway. Reporters claim there is 50% unused capacity on Da Vinci machines already in the market. The company sold 101 Da Vinci robots in Q3 compared to 155 in the year ago quarter. They warned that pressures from Obamacare were forcing hospitals to reevaluate capital spending given the new insurance reimbursement rules under the program.
GE posted the biggest gain on earnings in a long time after they reported earnings that beat by a penny. The excitement came from a 13% spike in order backlogs. Industrial segments grew earnings by +11% with energy rising +18% and aviation spiking +12%. Power and water equipment was the only division declining at -10%. They said wind power was surging again and that would return that division to profitability. The company said earnings growth would rise in Q4 with more volume and lower costs.
Ebay (EBAY) reported earnings earlier in the week and the stock was crushed after the company warned on a weak Q4. The warning was based on comScore data showing the e-commerce market had weakened significantly ahead of and during the government shutdown. The CFO Bob Swan called it a "dramatically decelerating U.S. e-commerce growth." Company officials were reaching out to analysts late in the week saying "perhaps we were too negative." The CEO, John Donahue, told AllThingsD that "Bob and I both have colds, I think it came across more negative than intended." He said they were also facing a shorter holiday season because of a late Thanksgiving in 2013. That is a problem we can't overcome but it impacts all retailers alike. He said, "I don't think we are seeing anything different than other retailers, we just reported it first." Also, "We try to be consistent in having a conservative outlook...but we didn't intend to be that negative." Shares rebounded slightly on the apology.
After the bell Wall Street Journal reported JPM had reached a settlement deal with the Federal Housing Finance Agency (FHFA). The agency said the bank misrepresented $33 billion in loans that were sold to the agency prior to the subprime crisis. Actually more than 80% of the loans came from Bear Stearns and Washington Mutual. Those were two companies that JP Morgan ended up buying to keep them from failing. Jamie Dimon has complained multiple times about having to pay a fine on loans that were originated by the failing companies because regulators "encouraged" JPM to bail out the companies and prevent a recurrence of Lehman Brothers. JP Morgan was considered to be the strongest bank at the time. Several researchers have written about the strong arm tactics regulators used to force JPM to take over the companies. Now they are making the bank pay for their sins. JPM now has more than $23 billion in loss reserves for possible legal fees and settlements. The bank took a $7.2 billion charge in Q3 earnings. The news came right at the close and the stock did not have time to react to the news.
IBM was crushed on Thursday as a result of a dramatic drop in hardware and services sales to BRIC nations, especially Asia. Sales of zSeries equipment, mostly mainframes, declined -40% to -50% in China. Unix and Linux server sales fell -38%. Those are the machines that power the major cloud systems. Teradata, a company that sells analytic tools for Big Data warned that quarterly revenues fell -21% in Asia and -19% in the Middle East. So what changed so suddenly in Asia? In a word "Snowden."
China realized from the Snowden leaks that the NSA had backdoor deals with U.S. equipment, software and services providers that allowed them access to their cloud systems. Initially the NSA wanted to stop U.S. providers from supplying highly encrypted technology to Asia because the NSA would no longer be able to eavesdrop on their data and communication. After a fight the NSA eventually agreed to let U.S. companies continue the sales but they had to give the NSA a key that would allow them to access the data. Essentially they said give China and Asia whatever they want but just give us the key to unlock it.
As a result of the Snowden revelations the Shanghai Securities News, a branch of the state owned Xinhua News Agency, found out that IBM, EMC and Oracle had become targets of the Ministry of Public Security because of the backdoor access by the NSA. The Chinese security apparatus probably alerted IT buyers in government agencies, state owned enterprises and major independent corporations to halt orders for sensitive products. Sales of high technology equipment to China was booming until Q3 when it fell off a cliff. We can expect this to also affect sales to the other BRIC nations since nobody wants the NSA scanning their state secrets. This may have long lasting effects on the tech community.
With the short term budget deal now history the dollar has imploded. The shutdown and the potential for a repeat deadlock in January the prospect for QE tapering has evaporated. This means another six months or more of $85 billion a month in Fed purchases. That is another half trillion in bond purchases by the Fed and weakening of the dollar. This is good for stocks and commodities.
Friday was October option expiration and we saw a lot of bearish option positions being unwound. With the market outlook so negative in the first half of the month the options positions were bearish. Unwinding those positions was bullish for the market. Volume was 6.6 billion shares on Friday and while it was not strong it was the best day of the week. New highs were breaking out all over. The new highs across all markets totaled 1,306 compared to new lows at 86. That was the most new highs since November 4th, 2010.
The S&P and Nasdaq broke out to new highs thanks to the monster gains in those very high dollar stocks I profiled above. With Google spiking $122, Amazon $19, etc it would be very surprising to see the S&P and Nasdaq not post major gains.
The S&P 500's new record high was fueled by an eight-day rebound of nearly 100 points. The length of that gain in any short term period should cause investors to pause before jumping on board. However, as we all know markets can remain irrational for long periods of time. The earnings surprises late in the week could be a preview of next week when the flood gates really open.
Fund managers will be the key now that October options have expired and the fiscal year end for funds is just nine trading days away. Will they take profits and restructure portfolios before Halloween or will they stick with the positions they have today?
Resistance on the S&P is 1,750 followed by 1,775. Strong support is well below at 1,700 and I would be very surprised to see that break over the next couple of weeks. Initial support would be 1,715
The Dow rebounded to gain +162 points for the week and come to a halt just under resistance at 15,400. The Dow's progression has been marred by some disappointing earnings and weak guidance by several Dow components. Unlike the Nasdaq it did not have a bunch of stocks with triple digit prices soaring for big gains.
The Dow struggled to post only a +28 point gain on Friday when the Nasdaq gained +51 thanks to Google. The Dow has some solid resistance at 15,400, 15,500, 15,600 and the prior high at 15,683. It will not be a cake walk to a new high. It will be a fight.
The Nasdaq list of winners was impressive with the top 20 gainers posting big wins. The losers list only had a handful of symbols you would probably recognize with ISRG losing four times as much as the second place finisher.
Given the index weighting of GOOG, AMZN, PCLN, BIDU, NFLX and AAPL nobody should have been surprised about the +51 point gain on the index. The Nasdaq blew through resistance at 3,875 and closed well into new 13-year high territory at 3,914. What will the index do for an encore after that performance?
I strongly doubt those double digit gainers below will repeat that performance on Monday. It would be natural for those stocks to see some profit taking and for the Nasdaq to take a post rebound rest.
Support is 3,875 and 3,850.
Nasdaq Winners and Sinners
The Russell 2000 continues to amaze with another +12 point gain to a new historic high at 1,114.77. The next material hurdle would be uptrend resistance at 1,130. I think the Russell may be close to running out of steam. The rebound has been very strong and fund managers are probably drinking champagne for breakfast they are so excited. However, with the fiscal year end for funds only 9 trading days away there is a good chance we will see some profit taking. They have to balance their desire to take profits with the desire to have winners in the portfolio for the year end statements. The next 9 days will be interesting.
The budget agreement settled nothing. The only agreement was to continue funding at the prior levels until January and a promise to talk about the 2014 budget before December 13th. The house wants deep spending cuts and no new taxes. The senate wants large tax increases and no spending cuts. Both sides are rock solid in their positions and the special budget committee is likely to fail exactly like the one in 2011 that was tasked with exactly the same goals. If they don't come up with a bipartisan agreement the sequester cuts are scheduled to increase in January. This is the trump card for the republicans. They can just wait and spending will decline again in January. The sequester is a meat cleaver approach rather than a scalpel but it does reduce spending.
The national debt jumped +$328 billion on Thursday to $17.075 trillion. The jump came as the Treasury "replenished" the funds it had used that belonged to other Federal accounts. In other words the Treasury used segregated funds from places like highway funds and state grants. These are funds allocated to other uses but the Treasury dipped into those accounts using what it called "extraordinary measures" to avoid the debt ceiling. The instant the debt ceiling was lifted the law allows the Treasury to borrow money to replenish the extraordinary measures slush funds.
The agreement passed last week did not set a new debt limit. It suspended the debt limit until February 7th. That means the government can borrow whatever it wants and analysts believe that will raise the debt by about $750 billion. If the bipartisan budget talks do not go well and it appears we are heading into another battle in late January I would expect the Treasury Dept to load up on additional debt ahead of the February 7th deadline. That would allow them to weather any new deadlock for a couple additional months using that extra cash before resorting to the extraordinary measures again.
The market is exploding higher but not because all earnings have improved. It is moving higher because sentiment is bullish. It is bullish because the markets are moving higher. This is a circular argument and it could go on for some time or it could fail at any moment. The S&P is up +22% for the year. However, S&P earnings are up less than +5%. The other 19% of market gain is the result of increased market valuation on those earnings. In other words the market went up four times as fast as earnings. Much of those earnings gains came from cost savings and stock buybacks that reduced the number of shares outstanding. The gains did not come from rapidly increasing revenue. Over the last several quarters revenue gains have been in the low single digits. Of the 99 S&P companies that have reported Q3 earnings only 38% beat on revenue. That compares to 45% in Q2.
Historically the earnings multiple increases after major recessions. Stocks are beaten down by the recession and they cut staff, close unprofitable divisions and return to a minimalist posture. When the economy rebounds after a recession the product demand returns and companies are wildly profitable with their new lower cost structure. Only this time the economy has posted the weakest rebound of any major recession. In fact it has been the slowest six-years of GDP growth since 1936. With GDP averaging about 1.5% growth this year the lack of product demand has stalled the normal business expansion cycle. However, the equity market is acting like there is a real economic rebound underway and stocks are being priced for that scenario.
There may be trouble ahead. Some analysts believe we will return to recession in 2014 as a result of Obamacare. Depending on which study you believe 77% to 83% of all jobs created in 2013 have been part time to get under the 30 hour threshold for full time workers. Employers can take three 40 hour workers and cut them back to 30 hours each and then hire a new worker at 30 hours and the same amount of work is performed. Only the 120 hours are now spread between four workers instead of three and the employer does not have to provide insurance.
Those four workers have seen their full time wages cut -25% to part time wages. On top of that they have to buy their own insurance through Obamacare at rates that are 25% to 50% higher than 2013 levels. They now have less income and more outgo. This is a recipe for drastically reduced consumer spending in 2014.
For the reported 1% that have actually made it though the website signup procedure the sticker shock on prices has been horrendous. In some states the rates have gone up far more than 50%. In this graphic the 2012 rates are contrasted with 2014 Obamacare rates. Be glad you don't live in Arkansas with a +171% hike, Georgia with a +168% hike or Virginia with a whopping +252% hike.
What this is going to mean is a lot more uninsured people with no access to healthcare. For those who can't pay those rates above they have the option of paying a fine of 1% of your gross income in 2014 that rises to 2.5% in 2015.
The flaw in the plan is the need for 7 million healthy young people to sign up for insurance and pay the rates listed above and subsidize the older people who use more healthcare. The poverty level people who can't afford to pay and will be subsidized as well. How many healthy young people under the age of 27 are going to rush right out and sign up for a $250 a month insurance plan they might only use once a year? That could be very darn few. They will pay the minimal fine and life for them will go on. That will force prices up for everyone else and that means less consumer spending down the road.
While the recessionary impact of the Affordable Care Act (ACA) may not be felt until the second quarter of 2014 I believe it will continue to increase in severity as the year increases. With consumer spending already slowing as a result of the change to a part time workforce I believe it will slow even further as individuals and families are forced to pay for insurance in 2014. This is effectively a new tax on American workers. That is how lawyers described it to the Supreme Court and the judges bought off on the argument. Now we are about ready to see that tax come home to roost. In reality there were 20 new taxes created in the ACA and while some have already started the majority will begin on January 1st. Analysts believe the taxes will average about $6,000 per person. You won't see them all directly because they are taxes on medical devices, hospitals, drugs and higher Medicare fees but you will pay them in some form. There is even a tanning tax for people that use tanning salons. The IRS received $500 million to setup enforcement of the new taxes and regulations.
Stocks may continue to rally into November but eventually fundamentals will matter again. The economic data returns next week with the nonfarm payrolls on Tuesday. If the economics continue to decline it will only complicate the earnings fundamentals for Q4. We have already seen numerous companies warn for Q4 and we are barely into the earnings cycle. Yes, there have been some positive earnings surprises but they were magnified by the negative sentiment from the prior two weeks. Google beat the street estimates by 40 cents with earnings of $10.74 per share compared to estimates of $10.34. Is that worth a $122 spike in the stock price? Any good news in a negative market will produce outsized reactions. There will be more negative surprises like IBM and Goldman Sachs. We can count on it. If those companies can't prosper in this environment that should be a clue as to our real economic health.
Eventually cautious investors will realize that nothing was solved in the agreement and just like the Ground Hog Day movie we will get to repeat the scenario again in January. That gives funds about two months to strategize and decide how they want to setup for year end. The headlines over disagreements in the bipartisan budget committee will probably begin in early December. That will be the signal to start boarding up the windows for the next big storm.
The way the Washington calendar is setting up we could see the entire Santa Claus rally pulled forward into the next six weeks leaving December and January as potentially bearish months.
Just because we are not falling off a budget cliff today is no reason for the market to party until year end as some are predicting.
Enter passively and exit aggressively!
Send Jim an email
"Of all the speculative blunders there are few greater than trying to
average a losing game. Always sell what shows you a loss and keep what shows you a profit."