A variety of events combined to produce a harsh wake up call for the bulls. Even a monster -$2.01 drop in the price of oil could not slow the pace of selling in equities. A combination of good economic news and bad earnings news sent investors to the sidelines to wait for a clearer picture of the future.
Dow Chart - Daily
Nasdaq Chart - 30 min
SPX chart - 30 min
The good news came in the form of rising GDP estimates from leading Wall Street analysts. JP Morgan said they were expecting +5.0% GDP growth in the current quarter and had nothing but good things to say about the economy. Not to be outdone Morgan Stanley raised their estimates to +5.5% GDP for Q1 and said job growth and wages were accelerating rapidly. While this may be good news compared to the +1.1% GDP growth in Q4 it is bad news for the Fed. The Fed does not want to see soaring wage growth or a GDP much over +3.5%. This suggests Fed rates are going to continue to rise in an effort to slow this runaway growth. The Fed just can't get the economic porridge just right. It is either too hot or too cold and if these analysts are right the Fed has a lot of work to do to slow economic growth. Personally I think the numbers and the outlook are questionable at best. We just finished several months of sub par growth and a jump from +1.1% to +5.5% GDP growth from quarter to quarter would be huge. There is a major qualification here and that is the hurricane impact. Most analysts think the +1.1% Q4 GDP was a direct result of damage to the system from the hurricanes and that may be entirely true. There was also a slowdown on a global basis due to high oil prices. Those oil prices were already at record levels before the hurricanes hit.
We saw oil prices fall to $63 on Tuesday and analysts were quick to claim oil was back in its comfort range. However, oil at $63 is still at the high end of its recent levels and still a strong deterrent to global growth. At that price it should continue to create a drag on U.S. and global GDP growth. Did everyone just forget the weaker than expected economic numbers on multiple reports in January? Were those numbers just a fleeting daydream and not relative to the current situation. I think not but then I don't have a degree in economics, just a healthy dose of skepticism.
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The bad news came from Toll Brothers. Toll said new orders fell sharply and home deliveries this year would be weaker than expected. Toll said new contracts dropped -21% to only $1.14 billion for the quarter. Toll now expects to deliver only 9,200-9,900 homes in 2006 compared to prior projections of 9,500-10,200 homes. In 2005 Toll delivered 8,769 homes. Offsetting this lowered guidance were some strong results for the last quarter. Toll said revenue rose +35% to $1.33 billion, good but still slightly less than the $1.38 billion analysts had expected. Backlog at the builder as of Jan-31st rose +22% to $5.95 billion. Toll said sales had slowed due to the increased number of prior speculators trying to dump inventory. Toll had previously said they had strong visibility through 2010 and today's news was a sharp change in that guidance. Still the current guidance is not bad, just lower than the previously predicted. Guidance from homebuilders who have reported earnings for Q4 is still for growth of +8% in 2006. Considering 2005 was a record year ANY additional growth is still good news. The Toll news pushed them to a new 52-week low at $29.40 but the -$1.85 drop was not as bad as you would have expected. However the ripples were felt throughout the entire sector.
The commodity sector also took a substantial hit as profit taking appeared across the board. Gold fell -$20 or -3.2%, Palladium -7.2%, silver -3.7% and copper -2.3%. Bonds also cratered with the short-term yields rising over the long-term yields once again. Bonds are worried about a potential economic slowdown ahead while Wall Street analysts are predicting those strong gains I mentioned above. This confusion on direction produces a lack of conviction by traders.
Crude Oil Chart - 60 min
Oil prices imploded with the price of crude falling -$2.01 to close at $63 for the day. This represents a -10% drop from the $69 high five days ago. We have been expecting this drop for several weeks since there was no fundamental reason for the high prices. It was entirely motivated by geopolitical concerns centered on Iran. At the CERA conference in Houston today the Saudi Oil Minister said they would attempt to replace any shortfall from Iran if sanctions were imposed. This was the final straw for speculators hoping to capitalize on the Iran problem. Saudi continues to claim they are trying to raise production over the next five years to 12.5 mbpd from the current 11 mbpd. I wish them luck given the current declines from other OPEC members. The Saudi Oil Minister also said they going to double their refining capacity from 3mbpd to 6mbpd over the next five years. The main problem for Saudi in the past is the lack of refining capacity for their heavy, sour crude. It is harder to refine especially with progressively lower sulfur emissions allowed by EPA standards. By adding global refining capacity for its specific type of crude it allows them to produce and sell more crude and get a higher price for the refined products. This is a good move for Saudi but one that will be very expensive to implement. They estimate at least five years will be required to build these new refineries.
The drop in crude prices to $63 sent oil stocks to new four week lows in most cases. There were no favorites that escaped the carnage with all 100 energy stocks I watch on a daily basis down more than a buck with Tenaris (TS) leading the list of losers down more than -$10 for the day. Oil at $63 is only the first level of support with $58 the real support level I expect to be heavily defended. I would target anything under $60 for an entry point for summer longs. Remember, the Iran problem will come back to haunt the sector in early March if not before. Today's drop is simply profit taking from the geopolitical spike and buyers will appear before the summer demand surge begins.
The Chicago Mercantile Exchange (CME) took a major hit of -$18 intraday on worries that the NYMEX was going to steal some of their business. Google also took a significant hit of -$17 intraday on fears they might have to start paying to access the high bandwidth of Internet service providers. Providers claim they are spending billions to increase Internet bandwidth capacity and Google and others supplying terabytes of content daily are using it for free. The Senate held hearings today to decide if there was justification for charging content providers to use the bandwidth of others. Don't hold your breath on this one since the odds of it coming to pass are very slim. Google also confirmed today that they were testing a pre-installed package of Google software on Dell computers. Dell would install the Google software on all PCs sold and that would give Google one more weapon against Microsoft in the desktop PC war. The Google software would enable not only web searches but searches of all files on the users PC. There would be a Google powered Dell home page, Google Desktop Search and Google Toolbar.
Cisco reported earnings after the bell that beat expectations by a penny. On the conference call Chambers said business had been stronger than expected with orders growing in double digits and the book-to-bill positive for Q2. They said demand in the U.S. was stronger with orders gaining momentum over the last three months. Cisco added nearly 400 sales personnel over the last quarter. Buybacks were not a factor with Cisco conserving cash to complete its acquisition of Scientific Altanta (SFA).
GM announced a -50% cut in its dividend today in another step towards reducing the red ink. GM also announced a cut in executive pay levels of -10% to -50%. GM had been paying a dividend of $1 representing a 8.6% yield. The drop to 50 cents cut that yield to 4.3% and one more reason not to own GM stock. The yield had been given as a reason to own GM while the stock was falling from $37.50 to $18.50 over the last six months. Yep, that makes sense to me. Collect $1 in dividends for every -$18 in stock losses. I have warned several times over the last year that the dividend would drop significantly or even disappear as GM tried to stem the bleeding. That possibility was dismissed by numerous analysts and readers since so many retirement funds held GM long term. I rest my case.
At the CERA meeting in Houston the President of China National Oil Company, CNOOC (CEO) said they replaced 100% of their reserves in 2005. Their target for 2006 is 130% replacement. Over the last year China has purchased reserves in nearly every geographical location where there is substantial production. Canada, Venezuela, Kazakhstan and even Cuba to name a few. CNOOC tried to buy Unocal but was unsuccessful. With China on such a strong acquisition binge it is only a matter of time before this develops into a real competition for the remaining global oil assets. The CNOOC president said demand in China would not be as strong as 2005 but was still growing sharply. Outside estimates are for +6% to +9% demand growth in 2006.
EExxon is being kicked out of Venezuela according to various news reports. Venezuela removed Exxon from a $3 billion petrochemicals project due to differences with Hugo Chavez. Exxon is also protesting the new nationalism tax on 32 privately run fields that will now be dominated by PDVSA after Venezuela cancelled all prior contracts, imposed taxes retroactively and told companies it would let them know how much of future proceeds they would receive. Exxon has already sold a stake in these fields rather than buckle under to the new terms. Exxon was the only company to protest the changes and that protest put them on the black list. PDVSA President Rafael Ramirez said the doors are now closed to Exxon in Venezuela. President Hugo Chavez, a sworn enemy of America, also warned this week that gasoline prices would soar if he wanted to shutdown his Citgo gas stations and refineries in America. Citgo refines more than 1 mbpd in the U.S. and is one of the largest petrochemical suppliers in the nation. They are the largest asphalt refiner and marketer on the East Coast. Citgo supplies fuel to more than 14,000 retail locations. I am sure President Bush cusses Chavez and the stranglehold they have on America at least once a day. You don't want your sworn enemy to have that much control of your food chain.
For the U.S. markets the outlook is grim. We are seeing profit taking from nearly all sectors that benefited from the January gains. With oil prices imploding there was no help for the indexes from the 450 or so energy stocks. The Toll Brothers news hammered the homebuilder sector and that overflowed into financials. The drop in commodities prices wiped out billions in value in materials stocks. Phelps Dodge was the poster child for commodity abuse with a drop of -$12 after coming within $1.25 of a new historic high on Monday. To put it bluntly, winners turned into sinners overnight and this time around it could get ugly. The economic calendar is very slim this week and with earnings fading there is simply no reason to buy stocks. Recent developments suggest the Fed could take rates to 6% and that could be a death knell for the markets unless some Fedspeak to the contrary appears soon.
The Dow collapsed back to 10750 and very close to the 10675-10700 support that keep us out of trouble back in January. Without any material catalyst this should be the level where dip buyers make a stand. Should that level break we could see a substantial decline as summer approaches. Earnings guidance was simply not strong enough to provide conviction for the bulls and the Fed failed to convince investors they were done.
The Nasdaq retreated to support at 2240 and is right on the verge of a major breakdown with 2200 the next bump in the road. The -14 drop today would have been worse were it not for returning strength in the semiconductor sector. The SOX found support at 530 on Friday and has added +10 points this week. This is far from exciting but any positive SOX moves in the face of four days of market drop is surprising. There were several comments from analysts today claiming an expected rise in technology spending in 2006. This should put a floor under techs but not until the current profit taking has run its course. A break under 2200 would be a sign of more serious problems. The NDX has also declined to just above critical support at 1640 and a break there could get ugly.
The SPX, our indicator of choice for market direction, broke 1270 last Thursday and closed at 1255 today. The decline seems to be gaining momentum and 1245-1250 is the next line in the sand to be defended. Several levels of interim support have crumbled since 1270 with very little attempt at a rebound.
The Russell has also turned negative with an -11 drop today and a break below support at 720. It appears funds are taking profits in small caps and there are plenty of profits still at risk. The next support level is 700-705 followed by stronger support much lower at 670.
The NYSE Composite also declined to critical support at 7925 and showed no material attempt at a closing rebound. This level has provided support four times in 2006 and odds are good this will be the failure of that support.
NYSE Composite Chart - 60 min
Now that the SPX has declined significantly below our 1270 short indicator when will it be time to go long? I know the easiest and most visible level attracting attention would be 1250. I would like to think we could see a bounce there but I also think that would be a sucker play. I would buy a bounce at 1250 for a trading play only but I do expect that level to eventually break. I think 1200 is a better range to target and that could take several weeks to appear. I know it is tempting to try and buy this dip but there are many factors that suggest otherwise. The biggest negatives facing the market are a Fed that could take rates to 6%, rising inflation, weak earnings guidance and a forecast for a return to single digit earnings growth. These challenges could keep the markets under pressure for more than a couple days. I just don't see any good reason to buy stocks this week but the good news from Cisco after the bell could convince may retail traders to jump back in. Cisco is up +$1 after their earnings. We have also seen four days of selling and being oversold at critical support on the Nasdaq is always a good excuse for some to buy. My recommendation would be for caution. I would look to short any post Cisco bounce once weakness begins to appear.
For energy traders that $63 low on Tuesday will look awfully inviting but I think there is a lower low in our future. Try to restrain yourself until we see a dip under $60. I believe OPEC will start making comments about production cuts around $58 and support a price in the $55 range. That should provide support for any speculative entry.
Administaff - ASF - close: 40.25 change: -1.71 stop: 42.65
Why We Like It:
BUY PUT MAR 45 ASF-OI open interest= 0 current ask $5.80
Picked on February xx at $ xx.xx <-- see TRIGGER
Cameco Corp. - CCJ - close: 68.57 change: -4.21 stop: 73.76
Why We Like It:
BUY PUT MAR 70 CCJ-ON open interest=1482 current ask $5.20
Picked on February 07 at $ 68.57
Cummins Inc. - CMI - close: 99.46 change: -2.55 stop: 96.95
News that the SEC had performed an informal probe into CMI's accounting may have sent shares a bit lower than normal today. Fortunately, the SEC has closed their inquiry and failed to find any fraud. The government agency filed a cease and desist order targeted at some forms of financial reporting but failed to fine the company. On a technical basis this abrupt reversal following yesterday's new high is not encouraging. We are not suggesting new positions. There is potential support at the 10-dma near $98.30 but CMI appears to have slightly stronger support near $96 and a pull back to $96 would stop us out.
Picked on February 2 at $101.01
Express Scripts - ESRX - close: 90.55 chg: +0.79 stop: 87.45
The bull-bear tug-of-war in ESRX continues. The stock bounced back above the $90.00 level but failed to hit any new highs. We remain very cautious here.
Picked on January 29 at $ 92.42
Universal Health - UHS - close: 49.76 chg: +0.06 stop: 48.49
Wow! That was a close call today. UHS broke out over resistance at the $50.00 level on an intraday basis today. Our trigger to buy calls is at $50.51 but shares only traded to $50.39 so we remain on the sidelines. We label it a close call because UHS failed to maintain its gains. Our trigger at $50.51 is still valid but we hesitate to open new bullish positions with the major averages looking weak. If triggered then we'll target a rally into the $54.50-55.00 range. The P&F chart is bullish with a $61 target. We do not want to hold over the late February earnings report.
Picked on February x at $ xx.xx <-- see TRIGGER
Ambac Fincl. - ABK - close: 75.90 change: +0.05 stop: 78.05
ABK churned sideways on Tuesday. We're not that encouraged by its failure to move lower but the trend remains bearish. There is some short-term technical support at its exponential 200-dma and simple 100-dma near the $74 level. We do expect a bounce there. Our target is $71.00. Our time frame is four to six weeks, probably sooner.
Picked on February 05 at $ 76.09
Intl Bus. Mach. - IBM - close: 79.85 change: +0.34 stop: 82.05
IBM produced a bit of an oversold bounce today but the stock continues to look bearish following its breakdown below the 200-dma and the $80 level. Our target is the $75.25-75.00 range.
Picked on February 06 at $ 79.49
Johnson Controls - JCI - cls: 67.24 chg: -0.75 stop: 70.05*new*
JCI continues to slide and today's failed rally at the 100-dma looks good for the bears. Our target is the $65.50-65.00 range. We're going to lower our stop loss to $70.05.
Picked on January 25 at $ 69.90
MGIG Invest. - MTG - close: 63.10 change: +0.11 stop: 66.05
MTG produced a bit of an oversold bounce today but it looks like the bounce failed near its 200-dma just south of the $64 level. We remain bearish on the stock here. Our target is the $58.00-57.50 range.
Picked on February 06 at $ 63.70
Meritage Homes - MTH - close: 58.13 chg: -2.27 stop: 62.05
Negative news from Toll Brothers (TOL) took its toll on the homebuilding industry. TOL reported that orders in January fell more than expected and the company reduced its guidance for 2006. The DJUSHB home construction index fell more than 3% on the news. Shares of MTH gapped lower and closed with a 3.75% loss. This looks like a new entry point to buy puts on MTH. Our target is the $52.00-50.00 range.
Picked on February 02 at $ 58.76
(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.)
Building Materials - BMHC - cls: 72.30 chg: -6.30 stop: n/a
It was a rough day for BMHC. The company reported earnings this morning and missed Wall Street's estimates by 8 cents a share. The market reacted negatively and BMHC gapped open at $72.01 and closed with an 8% loss. We are not suggesting new strangle positions at this time. The options in our strangle play are the March $90 calls (BGU-CR) and the March $70 puts (BGU-ON). Our estimated cost is $8.20. Our target is $12.50 by March expiration.
Picked on December 18 at $ 80.95
Encana Corp. - ECA - close: 45.02 chg: -2.63 stop: n/a
A pull back in oil and forecasts for warmer weather sent shares of ECA falling lower. The stock lost 5.5% and is near support at $45.00 and its 200-dma near $44.30. A warm winter will put less demand on heating oil and some suspect there could actually be a glut. If you remember just a couple of months ago the markets were worried about a heating oil shortage if the winter was too cold. We're not suggesting new positions in ECA right now. Our strategy involves the April $50 calls (ECA-DJ) and the April $40 puts (ECA-PH). Our estimated cost is $3.45. We are aiming for a rise to $5.95.
Picked on January 10 at $ 45.56
Google Inc. - GOOG - close: 337.92 chg: -17.18 stop: n/a
The profit taking in GOOG continues. Shares slipped another 4.4% and have closed under technical support at the 100-dma. The put side of our strangle, the February $420 puts (GOP-ND), hit a high today of $56.00 and is currently trading at $52.10bid/$52.50ask. We want to remind readers that this is still a very aggressive play. GOOG could bounce at any time and we have less than two weeks before February options expire. The target for our strangle is $60.00. Our estimated cost is $40.10. It would be very tempting to exit now for a 30% gain. If you choose not to exit then consider putting a stop loss on your put option (we'd consider $35 or even $40). We are keeping the play open and won't hesitate to exit at $60.
Picked on January 29 at $433.49
Ryland Group - RYL - close: 67.62 change: -2.01 stop: n/a
A warning from Toll Brothers (TOL) hit the housing sector hard today. Shares of RYL lost 2.88% on above average volume. We're not suggesting new positions. Our play involves the April $80 calls (RYL-DP) and the April $70 puts (RYL-PN). Our estimated cost is $7.00. Our target is $12.00.
Picked on January 22 at $ 75.19
Aetna - AET - close: 96.63 change: -0.97 stop: 93.99
We were planning to exit on Wednesday to avoid AET's Thursday earnings report but the stock's weakness today and failed rally at $98.72 is our cue to jump out. If you had the intuition to exit this morning near the high then kudos to you. Our target was the $99.00 level.
Picked on January 30 at $ 94.05
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