Since 1994, the market has tended to rise for no apparent reason on the day before a FOMC meeting. The Federal Reserve even did a study on Fed "drift."
While Fed announcements that contain a rate hike tend to produce volatility, the long-term averages surrounding the FOMC meeting are positive. The Fed commissioned a paper to study this phenomenon. Fed Drift Study
The chart below shows the difference between a Fed announcement week and a normal week. The markets rise into the meeting and typically are up the day after the meeting. This chart is skewed slightly since the period covered did not have the two-day meeting schedule we have today. The meetings in the period covered were normally one-day meetings. New York Fed Article
The gains are probably caused by short covering ahead of the meeting and speculation buys from traders expecting a positive result. The Fed said even after the study the reason for the drift remained a puzzle.
The economic reports did not add to the expectations the Fed would hike this week. The four reports all came in weaker than expected suggesting the Fed may be challenged to make the rate hike decision.
The New York Empire State Manufacturing Survey came in at -14.7 after a -14.9 reading in August. The consensus forecast was for a rise to -1.0. There was no rebound after the -17.8 point drop in August and the lowest level since the Great Recession. New orders improved only slightly from -15.7 to -12.9 but remained well into contraction territory. Backorders fell even farther into contraction declining from -4.6 to -8.3. Employment declined from +1.8 to -6.2. That is down from a high of 18.6 in March.
August retail sales rose only +0.2% compared to a +0.7% rise in July. Since this was the prime back to school shopping month this minor gain was disappointing. Excluding autos, sales rose only +0.1%. The motor vehicles and food service sectors gained the most at +0.7% each. Declining sectors included furniture -0.9%, building materials -1.8% and gasoline stations -1.8%. Retail sales growth over the last 12 months declined from 2.6% in July to 2.2% in August.
This report was not good for the economic outlook. Manufacturing has been slowing in multiple regions and retail sales are lackluster.
Industrial production for August declined -0.4% after a +0.9% rise in July. Manufacturing declined -0.5%, durable goods -0.9%, business equipment -0.4% and mining -0.6%. Capacity utilization declined from 78.0% to 77.6%. Trailing 12-month production declined to +0.9% and the lowest level since the recession.
Business inventories for July rose only +0.1% after a +0.8% gain in June. The June number was revised down to +0.65%. Manufacturing inventories fell -0.09% and wholesale inventories declined -0.12%. If it were not for a +1.4% gain in motor vehicles and parts the headline number would have been much worse.
For an economy that is facing a potential rate hike, the economic numbers have been "lousy." That is an obscure accounting term rarely used in the press. The Fed is going to have to swallow a lot of bad numbers in order to justify any rate hike. They may run out of lipstick for the economic pig.
Yields on the ten-year treasuries rallied nearly 5% on Tuesday on no news. Analysts were speculating investors were fleeing treasuries in favor of equities ahead of a potential rate hike. Others were speculating about continued sales by China, Japan and Saudi Arabia as they try to replenish their cash accounts depleted by events specific to their countries. If they believe the fed is going to hike then today was the last minute to dump treasuries ahead of the event.
The yield on the two-year treasury spiked +12.33% to the highest level since 2011. Since the two-year is not a note owned by other countries this caused even more confusion about the spike.
Reports due out on Wednesday include the Consumer Price Index and you can bet the Fed will be paying close attention to that one. The other report is the NAHB Housing Market Index. Neither report is expected to move the market.
Oil prices rallied during the day after news broke that the House was planning a vote on removing the oil export embargo. That would be a plus for producers because Europe would love to have our ultra light crude oil that produces lower emissions when refined. However, oil dipped late in the day when the White House said President Obama would not support lifting the ban on crude exports. He hinted he might support it if oil companies would agree to end subsidies and spend billions of dollars on solar and wind efforts. This goes along with the president's agenda to focus on climate change for the rest of his term.
The API oil inventory report after the close showed an unexpected decline of -3.1 million barrels. This lifted oil prices to $45.20 in afterhours.
Another surprising headline in the energy sector came from Iran. The country told western oil companies operating Iraq that they are going to have to cut spending over the next year because of the drop in crude prices. This means exploration and production efforts will be slowed because Iraq is running out of money. Even though production is up sharply over the last two years the country is receiving less than half the revenue it made two years ago. The country told oil producers it would not have any funds available to continue to fund expansion of energy production in 2016. Iraq asked companies to submit plans for 2016 that scaled back on exploration and concentrated only on maintaining existing production. I suspect this same problem exists in other OPEC countries and future production will suffer. That will eventually revive the oil cycle with higher prices.
Sirona Dental (SIRO) and DentSply Intl (XRAY) announced a merger of equals to create a $13 billion dental supply firm. The new company will have revenue of $3.8 billion and adjusted EBITDA of more than $900 million. Sirona shareholders will receive 1.8142 shares of DentSply (XRAY) for each existing SIRO share. That equates to about $98.65 at today's close with SIRO trading at $99.31 at the close. Shares spiked to $104 on the afterhours news then crashed back to $98 once everyone did the math.
FitBit (FIT) was started at Pacific Crest with a buy rating and a $47 price target. The analyst said FitBit was growing "ridiculously fast" and investors should not be worried about the Apple Watch. In a survey of fitness tracker owners, only 52% owned a FitBit. However, 65% of those planning to buy a tracker said they were planning on buying a FitBit. For the total survey, only 18% of respondents owned a fitness tracker and 22% were planning on buying one within the year. The analyst said FitBit was pursuing a corporate wellness program with major corporations that would result in sales of thousands of trackers at each company.
In a survey of devices, FitBit batteries lasted 5-7 days while batteries in the Apple Watch lasted only 18-24 hours. Battery life was a strong sales factor. The analyst said the pullback in FIT to just above the IPO price provided an excellent buying opportunity.
Sonic shares (SONC) declined -8.4% after the chain said same store sales rose +4.9% compared to a forecast for 5.3%. The company guided to 2016 earnings growth of 14% to 18% and same store sales gains of 2% to 4%. Those same store sales gains were less than half the 7.3% growth rate in the current year. Oops!
UPS (UPS) shares rallied +3.6% after saying they would hire up to 95,000 workers for the holiday season. The company said it was better prepared to handle the holiday crush this year after spending $150 million over the last two years to improve facilities and processes. They are also requiring shippers to warn them in advance about the number of orders they expect to receive and when. UPS currently has about 450,000 employees.
Cheniere Energy (LNG) posted a small gain after investor Carl Icahn said he boosted his stake in the company from 8.2% to 9.6%. He announced the initial stake about four weeks ago and was rewarded with two seats on the board. Last week Jim Chanos said Cheniere was a big short position for his funds. Shares declined on Friday after that news broke. That probably prompted Icahn to buy more and make the announcement to prevent a further decline in the shares. I would not bet against Icahn doing everything he can to cause a short squeeze and knock Chanos out of the position.
Facebook (FB) held a town hall meeting today and announced several changes. The one getting the most attention is a "dislike" button. Zuckerberg said it was to express emotion about the post rather than demote a post. For instance, if some announces they just found out a family member died, people may not "like" the post. However, they can "dislike" the post meaning they are sad the person has died. I know, it sounds kind of crazy but we are talking about Facebook.
When you like a post, the Facebook search engine adds that topic to your profile and you are more than likely to see advertisements or news articles related to that topic. How are they going to do that with a dislike button? I dislike people dying announcements so I will never see death announcement again?
Just ten months ago Zuckerberg said he would never build that dislike function because it would be detrimental to the Facebook community. However, he was thinking at the time about a different use for the dislike function. Maybe a republican posts a political comment favoring some candidate. A democrat could then dislike that post. How that would work other than just showing your displeasure is unknown. Zuckerberg thought the potential for a dislike appearing on a person's post would deter them from posting and negatively impact the Facebook community. He said he did not want to create an environment where everyone "voted" on all the posts.
A better button would have been an "I am sorry" button. If somebody posts something negative occurring in their life then friends could click sorry to show they sympathize with the original poster.
Wynn Resorts (WYNN) shook off the negative news from last week and rallied +3% today. The first headline was another decline of -35% in Macau gambling revenue in August. That was worse than expected and weighed on all the casino stocks. The second story was the theft of $258 million from a Wynn casino in Macau. The theft was from a junket operating inside the Wynn Macau and not specifically from the casino itself. However, Wynn may have some liability in the loss since the junket was operating in the Wynn casino. Employees of Dore Holdings, the operator of the junket are believed to be the people that made off with the cash.
A junket operator is like a travel agency that offers vacation packages and operates inside and in conjunction with major hotels. They rent blocks of rooms and resell them to VIP customers that buy their tour packages. They also operate gambling rooms inside the hotel where their own VIP customers gamble. The junket operator gets a cut of the winnings.
In April 2014, another $1.3 billion was stolen from the junket Kimren. When the theft was reported gamblers immediately began withdrawing their money from the junket and caused a liquidity problem that hit the casino as well. People taking money out of the casino are not likely to gamble in that casino in the future. The same problem is expected from the current theft.
There has been an acceleration in closures of junkets in recent months. According to Daiwa Capital Markets, 11 VIP rooms are closing in Aug/Sept alone. The CEO of Las Vegas Sands said last week "The junket system in Macau is broken."
I expect the rebound in Wynn will be short lived.
Ambarella (AMBA) shares rallied +7% after Stifel Nicolaus reiterated a buy rating with a $115 price target. The analyst said Ambarella was poised to expand its lead over competitors with a new chip for "computer vision" that would allow computers to "see" their world. The company acquired VisLab in July and that will give Ambarella at least a one-year lead on competitors. VisLab has developed algorithms for converting video collected by automobile into sensors for autonomous driving.
To quote a line from the first Star Wars movie, "Nothing to see here, move along." Despite the +228 gain in the Dow and +25 point jump in the S&P nothing has really changed in the market. The indexes did move closer to critical resistance in both cases but it was on low volume of 5.8 billion shares after a very light 5.3 billion on Monday.
The market is in portfolio positioning mode ahead of the FOMC meeting. Regardless of why the market moved higher today, it is still operating in the same range it has since the August flash crash.
The chart below is the same one I have been using for the last two weeks with only a change to the text. The index is creeping up to test the resistance range from 1990-2005 and it will probably happen after the Fed announcement on Thursday. Obviously, a breakout over that range would be very bullish. A failure there with a decline back below 1950 would be very bearish.
The Dow moved up to within 65 points of critical resistance at 16,666 thanks to 29 of the 30 components posting gains. Disney was the only decliner with a fractional loss. Banks rose on the potential for higher interest rates and Goldman Sachs gained +3.50 to add 27 Dow points.
With the Dow only a handful of points below resistance, we are going to have a critical test over the next couple days. A breakout could cause short covering in some of the heavily shorted Dow stocks.
On the positive side the Nasdaq broke through the same resistance levels currently showing on the Dow and S&P. The move over 4,835 suggests the Nasdaq is going to be the leader on any post Fed rally. If the Nasdaq continues higher the next material resistance if 4,900 and the lows from May and July. Support is now 4,790.
The Russell 2000 closed 1 point over resistance at 1,165. That was a one-month high since the August crash. With small caps and the Nasdaq moving over resistance we have a good chance of the large caps following suit.
The last Fed rate hike was in 2006. That was before the iPhone and the iPad and the smart phone revolution. Blackberry was the leading mobile phone for those that could afford it. Shares of BBRY were on their way to $147 and a far cry from their $7 price today.
Things have changed significantly since the last Fed rate hike. Many investors today have never been through a rate hike cycle. This is new to them and we do not know how they will react if the Fed actually raises rates.
Historically, the market dips on the announcement and then rallies over the months that follow to add about 10% in the next 12 months. A Fed rate hike normally occurs because the economy is growing strongly and the Fed needs to slow inflation brought on by strong employment and rising prices. Unfortunately, none of that exists today. The economy is growing weakly and there is a good chance of a global recession in 2016 as a result of the weak Asian economies. We do not know what the Fed is thinking other than they need to reload their monetary weapons and they can only do it with rate hikes.
If the Fed hikes on Thursday and I hope they do, we could see a rally for the rest of the year. The uncertainty would be gone and hopefully not return until well into 2016. If they do not hike this week, the uncertainty will simply reset with an October time line and we may get to relive the volatility all over again.
While I expect the market will continue higher nobody can promise that. Max Gunther wrote a book called The Zurich Axioms. He wrote, "Distrust anyone who claims to know the future, however dimly."
Enter passively, exit aggressively!
Send Jim an email
If you like the market commentary you have been receiving and you are on a free trial then now is the time to subscribe. Don't wait until you miss a newsletter to decide you want to take the plunge.