The post FOMC Santa Claus Rally began to run out of gas on Thursday and 3% interest rates dealt it another blow on Friday.
While every knowledgeable investor has known for months that interest rates are going to rise the arrival of the 3% yield on the ten-year treasury was a speed bump on the rally road. The 3% level represents a 100% increase in yields/rates since July 2012. Rates have almost doubled just since May of this year. Now that the Fed has finally embarked on the taper program the yields should continue to rise and most analysts believe we will see 3.5% or even 4% yields in 2014. It all depends on how quickly the Fed tapers.
With the Fed buying 75% of the treasuries in the market they have been able to keep rates low but even with that massive buying power the rates have doubled over the last year. As the Fed leaves the market you can imagine how quickly rates could accelerate higher.
Everyone knew rates were going higher but that tick over 3% on Friday was a dose of reality. In September everyone knows winter is coming but until the first frost appears the approaching winter is ignored. The 3% yield level was our frost warning.
Another dose of reality is just ahead with Q4 earnings. The number of negative guidance warnings is running more than 10:1 over positive guidance and that is more than three times the normal rate. There was a late surge in retail buying that overwhelmed UPS and FedEx but was it enough to rescue the retailers from what was an otherwise lackluster holiday season? We won't know for a month but we have been getting warnings from other sectors over the last month. Warnings could pickup now that the holidays are over and companies know what the final week of sales produced.
One company not warning is Amazon. There have been multiple articles about the surge in business at Amazon over the last month. Amazon has become the shopping center of choice for holiday shopping. Amazon is second only to Walmart in retail sales volume.
Flurry Analytics tracks more than 400,000 apps on more than 1.2 billion mobile devices. They compared the number of device activations on Christmas Day to what the average was for the first three weeks in December. Amazon devices were the clear leader. Amazon device activations jumped a whopping 24 times normal on Christmas Day. Acer, Apple and Samsung were so far down the volume list they barely register. IPads, Samsung and Acer tablets pale in unit volume compared to Kindles as gifts.
Amazon said it had to limit signups to its Prime Membership program during the peak shopping period in order to protect current member orders from the surge in prime memberships. Amazon Prime members get free two day shipping on almost everything Amazon sells. As the pre Christmas shopping season winds down there is always a rush of new customers signing up for Prime just to get the free 2 day delivery. Amazon said even with the limits in place they added more than one million new Prime customers in the third week of December alone.
Amazon has built a network of monster warehouses to store products close to population centers so that almost every order can ship from a warehouse within a two-day UPS delivery window. Amazon spends more than $6 billion a year on shipping so putting those warehouses next to population centers saves billions in shipping costs. Even with those extra steps some Amazon products were delayed.
Amazon said it received 36.8 million orders on Cyber Monday or 426 orders per second. Amazon said it delivered all orders to delivery carriers on time for pre-holiday delivery. After UPS and FedEx failed to deliver all the packages Amazon said it was "reviewing the performance of the delivery carriers" and "would refund all shipping charges for delayed packages and offer a $20 gift card to customers who did not receive packages on time."
FedEx and UPS blamed weather in some areas but admitted the last minute crush of packages overloaded their systems and prevented deliveries. FedEx allowed some customers to come to delivery centers to pickup packages that did not make it onto trucks.
UPS said it brought in extra workers on Wednesday night to try and unsnarl the mountain of packages backing up in their shipping centers. UPS said the volume of packages to be shipped by air was significantly greater than forecast and exceeded the capacity of the system. UPS even increased the size of its air fleet ahead of the holidays and all planes were operating to capacity. The flood of packages into the UPS hub in Louisville Kentucky caused delays all down the chain when trucks and planes filled up and could not take on more packages. UPS had expected to deliver 132 million packages for the five days prior to Christmas and the UPS spokesman said "obviously we greatly exceeded that number." Third party estimates put the undelivered packages in the range of 1.0-1.5 million.
Online sales were thought to have risen by +14% according to ComScore and +15% according to Forrester Research. However, after the last minute surge in orders they may have to revise those numbers higher. According to IBM Smarter Ecommerce, a unit that tracks 800 U.S. retailers, sales rose more than 37% for the Friday-Sunday before Christmas. On Christmas Day online sales rose +16.5% compared to 2012.
Amazon may not be profitable at the current time but it is only because Jeff Bezos continues to pour billions into building the business and creating a virtual online superstore where you can buy everything from books to refrigerators with the click of a mouse. Eventually they will be greatly profitable because of their size, buying power and audience reach. I just wish they would split their stock so the options would become more affordable.
Friday's economics did nothing to lift the market because the reports were limited to the oil and gas inventories. Crude inventories fell -4.7 million barrels as refiners rush to push refined product into the retail distribution channel and avoid having to pay property taxes on a lot of oil on December 31st. This seasonal decline is normal.
Gas inventories fell -177 Bcf for the week after a record decline of -285 Bcf the prior week. The back to back winter storms have been responsible for the abnormal inventory declines. The country only produces about 70 Bcf a day and during the winter we consume more than we produce. The excess comes from gas in storage. In the prior week we consumed about 42 Bcf per day more gas than was produced. To combat this supply problem excess gas is injected into storage in the spring and fall to be withdrawn again in the winter. Currently gas inventories are 16.1% below year ago levels and -9.2% below the five-year average. We should not be worried since there are 3,071 Bcf currently in storage. We could withstand many more weeks of -100 Bcf declines but should the ultra cold weather continue we only have about 15 weeks of gas in storage. In normal years gas in storage declines to about 1,600 Bcf by late February. This could be a record year if the cold continues.
Economics next week will be highlighted by the ISM Manufacturing on Thursday. Expectations are for a slight decline from 57.3 to 57.0. Second in importance will be the ISM Chicago on Tuesday with an expected decline from 63.0 to 61.0.
The Pending Home Sales Index on Monday has declined for the last five months and is expected to come in at 102.1. May was the cycle high at 111.3.
The impact of economics on the market should be minimal. Next week is a very low volume week and fund flows will be the key.
Year end fund flows or normally the strongest of the year. This is where the quarterly contributions come from retirement accounts but also from individual accounts where annual bonuses are being put to work.
In January 2013 we saw the largest market spike in years as a result of the fund flows and the QE program already in place. The S&P rallied +250 points in five months.
In 2012 the S&P rallied +225 points from December 20th though the end of March before beginning a -150 point decline that lasted two months.
The 2011 rally started off on December 1st and lasted until Mid February for a gain of +160 points. Unfortunately the fluctuation in the Fed's QE plans and the fiscal cliff in Washington saw a -300 point S&P decline by early October.
Not all January's are so lucky. In 2010 the S&P gained only 35 points in early January before collapsing more than -100 points into early February. A rebound finally appeared that lasted three months before an even bigger sell off to knock the S&P back to 1,010.
January 2009 is not a reason we should be worried. The S&P opened up the first three days then plummeted -260 points to the 666 low on March 9th. We should not worry about January 2014 because it is not the same market or economy today.
The market was still in freefall from the 2008 financial crisis and the January decline was simply a continuation of the 2008 market crash. There were no funds flowing into the market and in fact funds were bleeding cash as investors were scrambling to take money out of the market.
Should we worry about January 2014? Let's look at some facts. The earnings are likely to be bad but as we have seen over the past year the market has ignored bad earnings and powered forward. The economy is lackluster and we will probably see weaker job numbers in January but even the slow U.S. is still a bright spot in the global economy.
Interest rates are going to be moving above 3% but after a little sticker shock the market should accept it and move on.
The most positive point is the Fed's QE purchases at $75 billion a month. That should keep a floor under the market even though they are planning on reducing that number in a calm and orderly fashion. Estimates are for $650 billion in QE purchases in 2014. That is not a small number.
Lastly There Is No Alternative. (TINA) With interest rates rising there is nowhere else to put your money other than equities or commodities. Putting money into treasuries would be a losing proposition. You could go into corporate bonds but the rising interest rates would still be a damper to gains.
However, the most negative worry for the January market is simply the gains over the last year. The Dow is up +26%, S&P +29%, Nasdaq +38%, Russell 2000 +37%, Semiconductors +38%, Transports +39%, Biotechs +51% and Brokerage Sector +68%. These are huge numbers and accomplished without any material dips in 2013.
The market never goes straight up forever. The market cycles according to many factors but even when economics and earnings are good it will find time for profit taking. With those sizeable gains still on the table it is time for a profit taking cycle.
Just because we are due does not mean it will happen. There are broker estimates for the S&P for 2,200 at year end. That does not mean we are going straight up only that we could end there. We also have broker estimates for lower numbers as well. Citigroup forecast 1,900 last week and I know there is an estimate for 1,850 as well. That implies considerable volatility or consolidation over the full year.
Citigroup advised taking some risk off the table and moving to safer sectors or investments. With interest rates going up that would not be treasuries. They favor industrials with dividends. The broker said, "When the momentum music stops you don't want to be the person without a chair."
I believe we could see profit taking appear in January but I doubt it will be long lasting. The momentum is still intact and in theory there are better economic times ahead. I personally believe the ACA will eventually cause a recession due to higher rates but there are no signs in the immediate future. I would be a dip buyer in January but not the first drop. I can guarantee you there are a lot of newbies waiting breathlessly for the slightest dip to buy and they may be disappointed. I would love to see a 5% or greater dip but it remains to be seen if it will happen.
I believe the longer term 3-6 months direction is still up so we need to look for buying opportunities. We could get those around the regular Fed meetings as investors worry the Fed will accelerate the taper on better economics.
There have been 17 years since 1950 the S&P gained more than 20%. In 14 of those years (82%) stocks were up again the following year. On 12 occasions they gained more than 7% with the average gain +11.27%.
In stock news Apple's board voted against Carl Icahn's proposal for an additional $50 billion share repurchase. The board said in an SEC filing, "the global marketplace imposes a dynamic competitive landscape, and the company's rapid pace of innovation requires unprecedented investment, flexibility and access to resources." One analyst speculated they could buy Sony, market cap of $18 billion, and gain a wealth of knowledge about TV manufacturing and have their own content generator for the iProducts.
Now Icahn will have to decide if he wants to go into full activist mode against the Apple board or simply take his profits and find another playground to bully.
General Motors China is recalling 1.46 million cars for a defect in the fuel pump bracket. This is one of the largest recalls on record. The cars were made by Shanghai General Motors Ltd, GM's joint venture with SAIC Motor Corp. The bracket reportedly weakens with age and may crack and lead to fuel leaks. The recall affects the Buick Excelle and Chevrolet Sail. GM shares declined slightly on the news.
It was also announced that Ford would be recalling 81,000 Kuga crossovers for a steering part problem. Last month Volkswagen recalled 640,309 vehicles to check the type of oil in the transmission. Some were using mineral oil instead of synthetic oil to avoid gearbox-related electronic flaws. It also recalled 207,778 Tiguan SUV due to malfunctions in the lights.
Auto sales in China have risen +13.5% from January through November to 19.86 million vehicles. Car sales rose +15.1% to 16.15 million. In the U.S. total vehicle production is only expected to be 16.1 million vehicles in 2013.
The Nasdaq (NDAQ) said it will be compensating firms for the botched Facebook IPO. Nasdaq will pay out $41.6 million on December 31st for qualifying claims related to the IPO problems. Failure to clear or report trades left some firms in the dark as to their position or liability for hours and in some cases days. The market makers claim they lost $500 million collectively. Firms that had qualified claims had until December 23rd to agree not to sue the Nasdaq in order to receive the one-time voluntary payout. The SEC fined Nasdaq $10 million for the error.
Twitter (TWTR) finally saw at least a temporary end to the December momentum run. Shares of TWTR rallied from $40 to $74.73 in December with the last climax buying spike on Thursday coming on four times the average volume. Option volume has been huge at eight times normal. On Friday TWTR fell -13% to close at $63.79 and the low of the day.
The decline on Friday came in part from a sell call by Scott Kessler at S&P Capital IQ. He reiterated his "resolute sell" saying TWTR's rise has become some sort of mania and the valuation is very excessive for a company that has never reported earnings as a public company. At Thursday's close Twitter was valued at $50 billion and a larger market cap then the majority of the S&P.
Also on Friday Macquarie downgraded Twitter to underperform from neutral with a $46 price target. Since it is trading at $64 that is an implied sell rating.
The post FOMC rally has pushed the Volatility Index back to the lows of the year at 12. This has deflated option premiums and suggests everyone has turned bullish. That is normally a challenge when everyone ends up on the same side in the market. I suspect we are going to see a volatility event in early 2014 that will take it back to the 20 level or higher. That will be our buying opportunity.
One last point of warning. With the Fed now tapering we are seeing currencies declining in places like Thailand, Indonesia, Turkey, etc. Bloomberg reported the Thai Baht has fallen -5.1% and international investors have pulled $2.75 billion out of equities in Thailand since the end of October. That is the worst outflow in 14 years. You may remember that a collapse in the Baht was responsible for the 1997 Asian financial crisis and the implosion in Long Term Capital Management (LTCM) causing the Fed to rush to their aid to prevent a market collapse. Will these events cause a new crisis? Probably not but you never know where the next market event will begin.
Turkey is on the edge of collapse with reshuffling of the cabinet due to "corruption" but many claim it is actually a collapse of leadership by Prime Minister Erdogan causing the problem. The Turkish Lira is under siege with it hitting record lows last week. A collapse of Turkey presents a serious geopolitical risk given its location and being a member of NATO.
Italy is expected to default on its debt and restructure sometime in 2014. Inflation in Italy has declined to +0.6% and just barely above deflation. Their debt to GDP is 126% and rising. Falling prices and massive debts is a lethal combination. Italy has the third largest bond market in the world and a default/restructuring here would send shockwaves around the world.
Europe is very close to another crisis of confidence. Numerous anti European Union groups are expected to come into power this year and once they do they will form a majority in the European Parliament. This will put up many roadblocks to budgets, blocking legislation and vetoing the appointment of commissioners. When this happens the euro currency will be the first casualty.
Closer to home Venezuela is on the verge of collapse. Inflation was running at 54% annually in October and the government has delayed the November inflation report for more than two weeks with no estimate on when it will be released. It simply disappeared and the government is ignoring questions. Hiding the real rate of inflation may solve the publicity problem today but it will not solve the inflation problem and could make it worse as people assume the worst and begin implementing more aggressive steps to protect their wealth.
In the U.S. markets nearly every sector has moved into overbought territory. The S&P is now more than two standard deviations above its 50-day average and the most overbought since May. Going into a calendar year change this could be dangerous. Bespoke Investment Group had a nice graphic showing the overbought extremes of each sector. The vertical black line is the 50-day average. The pink represents 1-2 standard deviations above the 50-day and the red zone represents between 2-3 standard deviations. Read article here
Another warning sign is the CBOE SKEW Index currently at its second highest level ever. The higher the SKEW the greater the chance for a volatility event. The CBOE describes it this way.
"The CBOE SKEW Index (SKEW) is an index derived from the price of S&P 500 tail risk. Similar to VIX, the price of S&P 500 tail risk is calculated from the prices of S&P 500 out-of-the-money options. SKEW typically ranges from 100 to 150. A SKEW value of 100 means that the perceived distribution of S&P 500 log-returns is normal, and the probability of outlier returns is therefore negligible. As SKEW rises above 100, the left tail of the S&P 500 distribution acquires more weight, and the probabilities of outlier returns become more significant."
Note the S&P performance at prior SKEW highs.
Graphic from Lyons Fund Management
Need more convincing the U.S. markets could be poised for a dip? The AAII Investor Sentiment Survey saw bullish sentiment climb +7.6 points to 55.1% last week and the highest level in three years. The last time sentiment was this high was January 6th, 2011 at 55.9%. Bearish sentiment declined -6.5 points to 18.5%.
Before you start pushing the exit button the January 2011 high saw the market continue to rise for four more weeks and the gain of another 70 S&P points. This is just one more data point of irrational exuberance but the sell bell has not yet rung.
The S&P is definitely in nosebleed territory heading into year-end. After gaining +70 points in just six days it deserves a rest. Historically the days ahead of year end are bullish but New Years Eve is negative. I am sure that has to do with investors clearing the tax books for year-end so they can start over with a clean slate in the New Year.
The S&P stalled at 1,841 and well over uptrend resistance. Other than hesitance after a quick glance at the string of green candles on the chart there really nothing keeping the index from moving higher. Once into 2014 and past the initial fund flows into equities the uneasiness should begin. The new target is 1,850.
The Dow chart is even more extreme with the +720 point gain over the last two weeks. The Dow is very overextended and susceptible to some profit taking. The Dow's gains are the result of fund managers parking money in large cap stocks until the calendar year expires. They will immediately rotate out of these positions with any weakness in January.
The Dow has round number resistance at 16,500 but it did not stray far from that level after an opening gap to 16,529 on Friday. The resistance is light given the amount of bullishness in the market.
The Nasdaq showed a little more negativity on Friday than the other indexes. The Nasdaq lost -11 points to close near the low of the day at 4,156. The Nasdaq has gained +195 points since the 3,980 low on the 18th. That is a very healthy bounce and it may be time for the tech bulls to give it a rest.
Note the number of high profile tech stocks in the biggest loser column on Friday.
Support on the Nasdaq is around 4,075 followed by 3,995.
The Russell 2000 declined for the second consecutive day but the drop was minimal. The Russell has failed to break above uptrend resistance unlike the big cap indexes. This suggests fund managers are being cautious about adding to small cap positions ahead of expected volatility in January.
There is no reason the markets can't continue higher over the New Year's week but I would be cautious about adding to long positions. Remain long but cautious. As I showed in the history lesson earlier the January period can be very bullish and this could be one of those times. I am simply cautious because of the strong gains in 2013 and the potential for weak earnings from Q4. Everything else is just noise.
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Most of the indexes are near new highs and the outlook for the future is improving. If we can just keep the Fed from rocking the boat too hard we could have a good 2014 as well. Analyst year-end estimates are ranging from 1950 to 2200 for the S&P by year end 2014. Don't go through 2014 alone. Take advantage of the 15th annual End of Year Renewal Special today. Don't wait until the last minute.
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