Only two days into a week of heavy earnings and the market outlook is already slipping again. Great results from Dow components IBM, MMM, MER and UTX have failed to encourage traders and the indexes are struggling to remain afloat in choppy trading. Last weeks rebound is losing traction as oil prices weaken and earnings fail to excite buyers. October is rapidly expiring and without a rally in sight some tough questions need to be asked.
Dow Chart - Daily
Nasdaq Chart - Daily
The morning started with a nasty headline number on the Producer Price Index with a 1.9% rise. Inflation pressures are rising sharply with energy costs filtering through the manufacturing process. Consensus estimates for a gain of 1.1% were already almost double last month's 0.6% headline number and today's report more than tripled that rate. The energy price component saw a 7.1% jump. Like the CPI last week the numbers drop substantially to only a 0.3% jump if you leave out food and energy. Finished goods inflation has now risen to 6.9% over the last twelve months with core inflation at 2.6%. Intermediate goods rose 8.4% over the last year. Crude materials rose 10.2% in September with a sharp jump in core items of 5.3%. Iron and steel jumped 22.8%. The gap between the headline number and core inflation is now 4.2% and the largest gap in 30 years with the PPI the highest level in 15 years. With energy prices holding at high levels and not expected to move much lower it is almost impossible to prevent higher costs from eventually being passed on to the consumer in the form of higher prices on everything we buy. Add in the impact on building products and raw materials due to Katrina and Rita and that price pass through is coming sooner than later. Higher natural gas prices will also impact everything in the production cycle since gas is used in many manufacturing processes and for electrical generation.
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Colder weather helped push retail sales to their fourth week of gains with a 0.4% headline number. Year over year growth rose 3.3% and the strongest gain in five weeks. The ICSC did report that 60% of consumers surveyed said they were reducing discretionary spending to offset high energy prices. This was the highest level since they began taking these surveys. The survey taken in the Sept-22 cycle found only 54% of consumers were cutting back, compared to 50% in July and 40% in March.
Stock investors don't seem to be excited by the current crop of earnings. While some stocks beating the street are rewarded the vast majority are being ignored. IBM was the biggest news after the bell on Monday with strong gains in earnings but those gains could not be translated into gains in the stock price. IBM managed to hold on to only 89 cents of its morning spike to close at $83.45. Revenue was a little lighter than analysts had hoped but that is likely to be the same story for everyone after the Katrina lull.
Merrill Lynch reported earnings of $1.40 that beat the street estimates of $1.18 by a mile but the stock only managed to gain 12 cents in today's market. Trading revenues jumped substantially with profits from energy trading more than doubling in the quarter. Wells Fargo beat the street by a penny while showing strong gains in customer business. This was the 7th consecutive quarter of increased earnings but the stock lost ground in today's trading.
MMM was the exception to the rule today with a sharp $2.24 jump after posting earnings that beat estimates by 4 cents. 3M has been successful in passing rising energy costs through to buyers. They also raised the bottom end of their estimates for full year profits. GE also reported strong earnings and offered a strong outlook for the full year but failed to hold on to its gains. GE and MMM offered strong outlooks but the markets have failed to move on the news.
After the bell today Intel posted earnings of 32 cents but a penny shy of analyst estimates. Intel saw record revenue of $9.96 billion on an 18% increase in sales. Intel said Q4 revenue would be in the $10.2 to $10.8 billion range giving a midpoint of $10.5B. Analysts were expecting something above $10.7B. INTC fell about a buck after the announcement. Intel said they saw inventory build slightly at large customers, which is a cause for concern that consumer sales may be slowing. Intel is still seeing a shift into higher profit laptops and projected grow margins for Q4 to rise to 63% from 59.7% last quarter.
Yahoo also reported after the close and beat the street by 2 cents. Revenue jumped to $1.33 billion from $906 million in the prior year. After commissions paid to partners that revenue shrank to $932 million but it was still more than analysts expected. Despite the good news YHOO only rose about 25 cents after the news. Yahoo is still adding to its audience with Nielsen saying it attracted 99.3 million unique visitors last month.
Motorola also reported after the bell and beat estimates by 2 cents on stronger than expected sales. Motorola shipped 38.7 million phones in Q3 with many of them high end, high profit phones. CEO Ed Zander said the stars and moon were aligned to make it one of the best quarters in many years. The company raised their outlook to $10.3B to $10.5B for Q4 and right inline with analyst estimates at $10.4B. MOT rose 20 cents in after hours trading. Novellus fell -3.06 after reporting earnings that disappointed on Monday.
Kraft (KFT) also posted disappointing earnings after the bell and fell -1.25 in after hours.
Peabody Energy (BTU) announced earnings of 84 cents that more than doubled the 33 cents in the same period in 2004. More than doubled but they missed the analyst estimate by a penny. Despite monster revenue gains and a strong forecast for another record year in 2006 and for the next several years the stock was crushed. BTU fell -6.70 on the great news. To be fair it was simply profit taking from the recent strong gains. It was up $5.11 on Monday so a retracement of -$6 is not out of line. For those readers currently in other energy stocks with strong gains this is a real lesson of why you do not want to hold over earnings.
Are you seeing the trend here? Even companies reporting strong earnings are failing to rally higher. 82 S&P companies have reported earnings and so far the growth in earnings has been just over 10%. Still double digits but only barely. Revenues have been rising about 10.2%. The earnings estimate for the entire S&P is still over 15% but it will take some strong energy earnings next week to lift the overall growth rate from 10% to that projected 15% growth. 68 of the 82 companies reported have met estimates or beaten them yet the market is still lackluster and last weeks rally has faded.
The problem has many faces. First the expectations for earnings have already been priced into the market. The "double digit" S&P growth has been tossed around for weeks and earnings are falling right into the expected range. Secondly the inflation monster is about to hatch and rise out of the depths of the economy like Godzilla rising from the sea in a low budget horror flick.
With inflation growing at record rates, today's PPI jump was a 30-year high, the chances for continued Fed rate hikes in 2006 are rising. Fed president Janet Yellen said today that her neutral range was between 3.5% and 5.5% and continued steady rate hikes remains the best policy for the Fed. However, she said inflation as represented by the PCE is already at the top of her comfort range. All the Fed heads continue to claim wage and salary growth are well contained and thus core inflation should remain contained as well. Companies are telling the Fed that fierce competition is preventing them from passing higher energy prices through to consumers. Evidently 3M is the exception to the rule. The impact to the market is clear as inflation fears continue to grow and expectations for higher interest rates, lower profits and higher costs loom in the future. Greenspan added to the gloom today in a speech overseas. He said energy prices would depress future economic growth and the world should get used to higher energy costs from now on. This is a somewhat negative pronouncement from the retiring Fed head but he is right on target. The age of cheap energy has passed and the world better get used to higher costs for everything. After the bell today Fed Vice Chairman Ferguson warned that real business spending for equipment and software had fallen from 14% in 2004 to single digits for some unknown reason. He speculated it could be rising energy costs or fear of economic unknowns. In a 3200-word speech on the "Economic Outlook for the United States" over 1250 words were devoted to the long-term impact of higher oil prices. In a nutshell the Fed believes the price of oil will remain high with far dated futures still over $60. In prior spikes far dated futures remained anchored to a base price such as $20 indicating the expectations for prices to decline over the next couple years. This is not happening this time with futures as far out as 2009 still hovering just under $60. Ferguson said the persistent high prices of oil could lead to higher costs being passed on to consumers and wage pressures as employees tried to maintain their buying power. In the long run persistent energy prices would then produce a drag on not only the U.S. economy but also the global economy. After all the expressed concerns he finished with a warning that the Fed could escalate their rate hikes if the data justified the move BUT the most likely policy would continue to be at a measured pace. They will continue saying this until the data becomes overwhelming and a drastic change is required. Link to speech
The expectations for growth are shrinking as each earnings report is released. This is nothing new but investors were hoping for strong beats and much higher guidance. Unfortunately it is not happening but the week is still young. Several hundred companies will report before the week is out but I would not expect anything but more of the same.
Another reason for the market weakness is the impending options expiration. Those traders using October options to capture any earnings gains are fighting a losing battle with time running out. This means there is also downside pressure from the expiration event.
November Crude Futures - Daily
Lastly we saw the energy sector get crushed again as the track for Hurricane Wilma veered slightly eastward with the potential to miss the already battered Gulf oil region. Oil futures fell about a buck but the damage to the oil stocks was huge. There was also a specific market event at 1:PM that knocked support from the entire sector. XOM, a Dow component and the third largest company by market cap, dropped -1.25 in just a couple minutes after a large 24 million share block order hit the tape from Goldman Sachs. This represents a $1.4 billion trade. This is extremely rare for an order of this size to be floated as one chunk. Normally they will break it up into a lot of little pieces to prevent a major drop in the price before the entire lot has been sold. Program computers saw the volume spike and drop in price and this triggered copycat sales in the rest of the oil stocks. This accelerated the drop in the sector and knocked dozens of stocks for better than a -$3 loss. IMO -5.38, SWN -5.17, THX -5.07, ATW -4.86, CNX -4.66, AHC -4.64, EOG -4.37, TOT -4.32, UPL -4.03, BR -3.88 to name just a few. It was ugly and it is not expected to get any better for at least two weeks. There are only about 30 institutions with the position size to sell 24 million shares of XOM. The unknown reason for the sale of this magnitude and method of the sale indicating a rush to the exit has put a cloud over all energy stocks. With the majority of the sector set to announce earnings next week that cloud is likely to linger until after those earnings. Without the support of 350 energy stocks the indexes, especially the Russell and S&P, could remain weak. For energy investors we are in that limbo period where we have to wait before entering any new trades. Wilma could veer west again and send prices higher but that may not break them out of their current slump until earnings have passed.
The fear of rising inflation/rates and the oil implosion knocked the Dow back below 10300 after failing twice this week at 10350. The Nasdaq failed at 2070 and fell to rest just over support at 2050 at the close. Of the three major indexes the SPX showed the most pronounced drop with a double failure at 1190 and a close at 1178. Yep, you guessed it. We are back into a bearish bias under our 1185 directional trigger. The SOX was struggling under 445 before the NVLS earnings and the Intel miss tonight is probably not going to provide any material boost. Possibly Motorola will offset some of the Intel negativity but there is still some trouble ahead. The Book-to-bill for September was released tonight and at 1.02 it is down from the 1.05 we saw in august. This was the first hiccup in the BTB since the bottom of this cycle in February at 0.77. It has been a steady, although slow, upward progress for chips and this minor retracement along with the Intel miss may be one more straw for our struggling market camel. The market internals were really nasty with down volume 3:1 over advancing volume with decliners outpacing decliners 5:2. This camel may be headed for the chiropractor soon.
Using the NYSE composite index to avoid the individual component problems in the Dow we see that the $NYA closed at 7278 and -92.93 for the day. Since the Dow fell only -63 you can see the broader market was weaker than the Dow would have you believe.
Dow Chart - 30 min
NYSE Composite Chart - 30 min
SPX Chart - 30 min
I was hoping to be reporting about a continued earnings rally tonight but that is not the case. The rebound we saw last Friday failed and we are faced with trying to find a direction based on inline earnings and cloudy economics. Historically October normally produces a bottom for the second half of the year and we are rapidly running out of days for this to happen. Only nine days remain and the bulls are nowhere to be seen. They may yet appear as there is no bell to ring to signify a bottom or time to buy. It would only require one or two major funds to begin buying stocks for short to start getting squeezed. Bottoms are sometimes produced suddenly by the strangest of circumstances. It could even be a large earnings miss by a major firm that produces the capitulation dip where buyers begin to appear. Never count a market out until the closing bell rings.
We still have a lot of earnings left in the week and anything is possible. The list is populated by more than a dozen chip stocks and this could be the make or break factor for the Nasdaq. Tomorrow we will also see EBAY, JNPR, ET and EMC. Thursday GOOG, MCD, PFE, SNDK, UPS and Friday CAT, MYG and SLB. I would hesitate to enter any new positions until the week is over and the OpEx uncertainty passes. By next week we should have a clear direction as October winds down. Hopefully that direction will be up but we must remain open to the idea that a historical October bottom may not be in the cards. Until then, enter any position passively, long or short, and only when the price comes to you. Be ready to exit aggressively if the trend you expected changes suddenly.
SurModics - SRDX - close: 40.95 chg: 2.14 stop: 39.49
Why We Like It:
BUY CALL NOV 40.00 UZF-KH OI=686 current ask $2.55
Picked on October 18 at $ 40.95
eBay Inc. - EBAY - close: 40.42 chg: -0.42 stop: n/a
Why We Like It:
BUY CALL NOV 45.00 XBA-KI OI=8584 current ask $0.65
We'd like to keep our total investment in the $1.00-1.15 range if possible. Our goal is to double our money so we'll plan on selling if either option trades in the $2.00-2.30 range.
Picked on October 18 at $ 40.42
Harman Intl - HAR - cls: 100.80 chg: -0.80 stop: n/a
Why We Like It:
BUY CALL NOV 110.00 HAR-KB OI=319 current ask $2.05
This put our cost around $3.80. We probably don't want to play more than $4.00 if we can avoid it. We'll aim for a 50% profit so we'll sell if either option rises to $6.00 or more.
Picked on October 18 at $100.80
Biosite Inc. - BSTE - close: 66.65 chg: -0.56 stop: 61.49
Shares of BSTE tagged a new five-year high today but couldn't hold it. Yesterday we suggested the stock is due for some profit taking and we hold the same view today. Watch for a dip into the $64-65 range. Our secondary target is the $69.50-70.00 range.
Picked on October 13 at $ 63.39
Cardinal Health - CAH - close: 62.92 chg: -0.33 stop: 61.95
Healthcare and drug stocks were a little weak today and CAH was no exception. The stock continues to churn sideways. Considering the amount of time we have left in this play before CAH's earnings report we're not suggesting new positions.
Picked on September 25 at $ 61.95
Pre Paid Legal - PPD - close: 40.66 chg: 0.22 stop: 37.85
PPD bucked the bearish trend in the markets today with a minor gain. The stock seemed to find support at the $40.60 level all day long.
Picked on October 10 at $ 40.10
Target Corp - TGT - close: 53.22 change: -0.04 stop: 51.49
TGT tried to rally this morning and did make it over its simple 50-dma but it couldn't breakout over the $54.00 level. We remain on the sidelines untriggered. Considering the failed rally in the major averages today we would be very hesitant to initiate new bullish positions in TGT. Currently our trigger to buy calls is at $54.01.
Picked on October xx at $ xx.xx <-- see TRIGGER
Teleflex Inc. - TFX - close: 65.64 chg: -1.20 stop: 69.01
TFX could not escape the market weakness today and fell almost 1.8% on the session. The stock looks poised to test round-number support at the $65 mark and technical support at the 100-dma. Our target is the $62.50-62.00 range but we plan to exit ahead of next week's earnings report.
Picked on October 13 at $ 66.49
(What is a strangle? It's when a trader buys an out-of-the-money (OTM) call and an OTM put on the same stock. The strategy is neutral. You do not care what direction the stock moves as long as the move is big enough to make your investment profitable.)
AmerisourceBergen - ABC - cls: 76.17 chg: 0.65 stop: n/a
ABC has continued to rebound and the move over $76 has closed our window to initiate strangle positions. We're not in a wait-and-see mode.
Picked on October 16 at $ 74.81
E*trade Financial - ET - close: 16.50 chg: 0.15 stop: n/a
Tomorrow should produce some volatility for ET and probably set the new direction in the stock price. The company is due to report earnings after the closing bell tomorrow. Wall Street is looking for ET to turn in earnings of $0.27 a share. We are no longer suggesting new strangle positions as the strategy moves into a wait-and-see mode. We plan to exit if either option trades in the $1.60-2.00 range. Our time frame is before the November expiration.
Picked on October 16 at $ 16.28
General Dynamics - GD - cls: 119.92 chg: -0.30 stop: n/a
The excitement should begin tomorrow. GD is expected to report earnings before the opening bell tomorrow morning. Analysts are looking for profits of $1.76 a share. The stock has essentially been treading water for the last four weeks so we are expecting a reaction in the stock price. Remember, our goal was to double our money. If either option in our strangle trades at $4.00 or more we'll exit.
Picked on October 09 at $119.59
Google Inc. - GOOG - close: 303.28 chg: -1.72 stop: n/a
GOOG seems to be struggling to build on yesterday's bullish move. The stock is moving back toward the $300 level, which might offer another entry point to initiate strangle positions. Don't forget we are suggesting that investors launch positions before GOOG reports earnings on Thursday. In the news today GOOG was upgraded to a "buy" with a $360 price target. After hours it looks like GOOG is ticking higher after a positive earnings report from YHOO.
Picked on October 16 at $296.14
Legg Mason - LM - cls: 101.60 chg: -1.48 stop: n/a
The decline in LM could be good news for us. The stock did breakdown under its simple 100-dma and it did under perform its peers in the broker-dealer sector. However, the pull back toward the $100.00 level makes for a better entry point for our strangle positions. We're suggesting the November $110 calls and the November $90 puts.
Picked on October 12 at $102.59
O'Reilly Auto. - ORLY - close: 26.11 chg: -0.53 stop: n/a
We see no change from our previous updates on ORLY. Today's two-percent decline has the stock poised to breakdown under the $26 level. We're expecting to see more volatility following the October 25th earnings report. We are not suggesting new plays.
Picked on October 09 at $ 28.23
Verifone Holdings - PAY - cls: 20.19 chg: 0.21 stop: n/a
PAY continues to vacillate on either side of the $20.00 level. We would continue to suggest new strangle positions as long as shares trade within the $19.50-20.50 region. We're suggesting the January $22.50 call and the January $17.50 put. More aggressive traders might want to consider the November strikes (see our weekend play for more details).
Picked on October 12 at $ 19.98
Burlington North/Santa Fe - BNI - cls: 56.19 chg: -1.28 stop: 55.99
There could be trouble ahead for BNI. The stock was immediately weak on Tuesday and dipped under the $56.00 level this afternoon to hit our stop loss at $55.99. We were cautious when we listed the play and we were cautious yesterday with the lack of bullish follow through. If BNI breaks down under the simple 50-dma it would suggest a deeper consolidation in progress and we'd keep an eye on the simple 200-dma.
Picked on October 16 at $ 57.43
3M Co. - MMM - close: 74.71 chg: 2.24 stop: n/a
Target achieved. MMM's earnings report produced the needed volatility to push the calls into our target range. The company reported earnings before the bell this morning. Depending on whom you want to believe MMM beat analysts' estimates by 2 or 4 cents a share. This pushed the stock to gap higher and shares hit a high of $75.39 intraday. The intraday strength pushed the November $75.00 call (MMM-KO) to an intraday high of $1.85. Our target was to sell if either option traded into the $1.60-2.00 range. We're closing the play. More aggressive traders may want to think about holding open a small position since today's breakout could represent a change in direction for the stock. However, the company's guidance going forward was pretty humdrum. The major stock averages produced a failed rally today and they look poised to turn lower tomorrow so that raises the chances of some profit taking in MMM tomorrow.
Picked on October 12 at $ 70.38
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