The market rebound from Friday's sell-off.

Introduction

The market rebound from Friday's sell-off but I'm not convinced the correction is over. The strong NFP report has helped to cushion the fall but I think that we have not yet seen the end of it. Earnings season is just about over so there are few catalysts until the next round of monthly data, earnings outlook is negative and we have an FOMC meeting on the horizon. All reasons for the market to pause.

Market Statistics

The first day of daylight saving time began in the red. International markets were quiet and largely influenced by Friday's sell-off. Asian indices closed mostly lower while those in Europe were able to shake off early blah's and rise to break even by the close of their trading day. Our market were indicated higher from the start. Futures were indicating the market would open a few points above Friday's close and it did. There was no economic data today and very little news with a real effect on market direction.

A few company specific news events moved individual stocks with the most attention paid to Apple. The long awaited, eagerly anticipated and heavily speculated Apple “Spring Forward” event was this afternoon and came to pass with the usual amount of hoopla. After the opening bell the market moved higher throughout the day but was not able to regain the losses suffered on Friday.

Economic Calendar

The Economy

This week Moody's Survey Of Business Confidence declined by nearly 2 points to 38.2. This is the fifth week of decline and matches the lowest levels of the year. Despite the decline the index remains near the all-time high, set 5 weeks ago, and indicates positive forward outlook among global businesses. In his summary Mark Zandi remains upbeat but the exuberance in his earlier reports is lacking. He says;

“Business sentiment remains upbeat, although it weakened a bit in early March. Confidence is especially strong in the U.S. It is weakest in South America. U.S. businesses are feeling good about sales, hiring and investment. Pricing is holding up well despite heightened deflation concerns in much of the developed world. The survey results are consistent with an economy that is expanding well above its potential.”


According to data from FactSet, 496 S&P 500 companies have reported earnings so far this season. Of those, 75% have beaten the mean estimate for earnings and 58% have beaten on sales. The blended growth rate stands at 3.7%, up 2% from expectations at the start of the quarter. This is in line with recent trends but not strong or exciting. Within the index seven of the ten sectors have beaten expectations while three have not, led by earnings declines in the energy sector. So far 82 companies have issued negative guidance for the current quarter, again led by energy. Four of the seven sub-sectors showed declines but surprisingly, two have reported double digit earnings growth. These are equipment services and refining & marketing.

Looking at the ten year chart of S&P 500 compared to forward P/E it is obvious that valuation has far exceeded expected earnings for this index. The question is whether or not valuation is leading expected earnings or the other way around. In the near term P/E may lead the index lower until earnings expectations begin to rise. I still think that earnings ex-energy are going to be more important to watch over the next quarter than overall earnings due to the expected weakness in energy. Stripping out the energy sector for the current reporting period would elevate the blended rate to 6.8%. Considering the expected boost to the consumer and the economy due to low gasoline, and economic tail winds, it is possible for earnings growth in the S&P 500 ex-energy.


There isn't very much data due out this week. Tomorrow is JOLTs, look for high levels of job openings and strong levels on the quits rate. Later in the week look out for wholesale and business inventories for January, February retail sales, PPI and Michigan Sentiment. As a heads up the next FOMC is meeting is next week and will likely overshadow any other single piece of data until then.

The Oil Index

West Texas Intermediate persists in trading around $50. Today's action began with prices slightly below $50 and then later lifted to just over $50 on news from Cushing. The latest report shows storage levels had risen less than expected. Prices remain volatile but less so each day as prices appear to be stabilizing around $50, supply and demand balance remains cloudy. Supply levels are still rising although OPEC says there will be a shortfall soon, the US rig count is falling and fighting in the Middle East is threatening production in Libya, Iraq and other locations.

The Oil Index traded to the upside although momentum remains bearish. The index gained about a half percent in today's session, rising from the low set Friday, but still well below resistance. The indicators are bearish and in line with the move downward with targets near my support lines. Target for support is the long term trend line, near 1,250. The indicators, while bearish in the near term and pointing to a test of support, are also consistent with the longer term uptrend and a possible continuation of that trend. Because of this I will be looking for a bounce at that level. Resistance is now at 1,350 and the short term moving average. Oil prices will of course keep this index moving in day-to-day action.


The Gold Index

Gold fell hard on Friday. The NFP data, which was stronger even than I thought it would be, has spooked the market into thinking the FOMC will raise interest rates sooner than expected. What I find interesting is that the rising chances of FOMC interest rate hikes was at least part of why gold prices rallied in January so why are these same speculations causing prices to fall now? It may be due to rising dollar values but the dollar has been rising for months.

The gold miners continued the sell off begun Friday, the sector ETF GDX losing 3.5% and falling below my rising support line. The ETF is moving lower in tandem with gold prices and will likely test support near the long term low in the least. The indicators are bearish and gaining strength in the near term, convergent with the current move and pointing to lower prices. Next target is near $16.50 provided there is no rebound in gold prices.


In The News, Story Stocks and Earnings

Apple of course was the biggest name in stock news today. The worlds largest company revealed a full line up of new gadgets, including the watch. Along with it the company also announced a new iTV with lower price as well as an exclusive deal with HBO. Now HBO shows will be available over the iTV where before they were only available through cable or satellite. They also launched a new, slimmer Macbook and gave an update on the Pay service. Now there are over 2,500 banks on board with the program, and over 700K merchants. The watch looks cool and for $349 is likely to sell out pretty quick. Shares of Apple traded higher up and into the event, which started around 1PM, until the watch was unveiled. At that time shares fell, but remained above break even for the day. Apple is trading below $130 which may become resistance.


GM announced a $5 billion share buy back today, a move that helped to send the stock up by over 3%. The announcement was met with mixed approval as some see it as a negative. Moody's Investor Service said the buy back was a credit negative although they held their rating steady. The statement given mentions that it would “delay any potential consideration for an upgrade”, which sounds to me like GM was in the running for an upgrade. Shares are now trading just below $38 and the 12 month high with weak indicators. A drop from here would find some support along $37 and just below near the short term moving average. A break above $38 would be bullish and could take it as high as $40 before hitting the next significant resistance.


McDonald's announced further declines in comp store sales. My New Year resolution to stop eating french fries is having its affect. Global comps fell -1.7%, more than double the expected -0.8%. Losses were led by the Asia/Pacific region but there was weakness in other major regions as well. US comp sales declined with a 4 handle, due in part to increased competition in the burger space. Europe posted a surprising gain of +0.7% which, along with emerging markets, helped to keep global sales from being much worse. Shares of McDonald's rallied on the news, I presume because investors expect quicker action from management now that sales declines are worsening, and gained nearly 1%.


Urban Outfitters reported earnings after the bell. The hip teen retailer was expected to earn in the range of $0.57 per share and beat estimates, due largely to share repurchasing over the last quarter. Revenue declined significantly but an increase in earnings per share was reported due to a decline in the number of shares outstaning. The stock traded in a tight range just under resistance all day but surged in the after hours market by 2.5%.


The Indices

The indices traded positive all day but were not able to hold the highs. Today's action was more of an upward drift than anything else and resulted in small bodied candles on most of the charts. Today's action was led by the Dow Jones Industrial Average. The blue chips gained 0.71% at the close, after trading as high as 0.91% during the day, but did not close above 18,000. The index moved above 18,000 at one point but was not able hold the level. The index is just above the short term moving average but below resistance so needs to quickly regain 18,000 or risk deeper correction. The indicators are bearish but not yet showing strength so the moving average could hold; MACD is only just peaking on the bear side, very weak, and stochastic is just now falling out of the upper signal zone. If the index continues to fall my target is near 17,250, about 4.5% lower.


The S&P 500 is next up with a gain of 0.39%. The broad market is in a slightly different position than the blue chips, it is above support and below the moving average. In this case the moving average could pressure the index another 30 points lower, which the index has done every time it has crossed under the EMA for the last 12 months at least. The indicators are bearish and gaining strength, although still rather weak, and suggest further downside is possible. This could lead to a testing of support in the 2,050 to 2,060 region, coincident with the top of the January trading range. If support does not hold the index could move down as far as 1,990, about 4% below the current level.


The NASDAQ Composite still looks like an index that is trending higher, much different than the first two. This index gained 0.31% today, trading above the short term moving average and just off of a 15 year high. The problem is that the 15 year high is a significant are of resistance be it round-number resistance or any other kind you can think of and could be expected to produce some form of pull-back or correction, even if the trend is up. The indicators are bearish and in line with this peak suggesting a move down to the moving average is at hand. If the EMA doesn't hold there are other areas of potentially strong support at 4,800 and 4,700, about 250 points or 5% below the current level.


The Dow Jones Transportation Average brings up the rear today with a gain of 0.23%. The transports made the smallest move but look most determined to move lower. The index is trapped within a trading range dating back to the first of November and does not look like it is going to break out of it this week. The index is moving lower, near the middle of the range, below the moving average, with bearish indicators and no real expectation of bullish catalysts this week. The indicators are weak and consistent with a range having support just below 8,750 and resistance above 9,250.


The indices look like they are set up for a correction, or at least a pull back, of around 5%. There isn't really a reason for it that I can think of, other than natural market cycles and the disparity between valuation and forward P/E. This disparity could result in values coming down, or forward expectations coming up but I think it more likely that valuation will fall before expectations are raised. How deep of a correction, if one does come, is yet to be determined.

What I want to suggest is that what might actually be happening is a sector rotation. Aggregate earnings expectations are shifting due to low oil prices and are could be causing a shift in portfolio positions around the world. The good news is that we are largely expected to return to growth by the third quarter at the latest, which may help the indices to hold their long term trend lines and support levels rather than began a protracted sell-off.

Even now 7 of the 10 S&P 500 sectors still growing and with the added benefit of low oil prices and economic tailwinds could begin to grow faster than expected. It is quite possible that investors are merely shifting out of the weaker stocks as revealed by this seasons earnings reports, and into the stronger companies that have shown the benefit of low gas prices and are expected to grow. The way that analysts change their minds I would not be surprised to see expectations begin to rise in the next couple of months.

Until then, remember the trend!

Thomas Hughes