So far the Bernanke reign has been very market friendly. Uncle Ben again proved to be a kinder, gentler and more easily understandable Fed chairman. His positive view of the economy and his calm outlook for inflation provided the bulls with another chance to buy the dip and race to new highs. Just when it appeared to the bears the markets were going to break support and take a much-needed rest they found themselves racing to cover their shorts on the Bernanke comments. The bears have nothing to cheer about this week, this month or this year. Every shorting opportunity has turned into a monster short squeeze that pushed the markets to new highs. Eventually they will be right but for now the bulls remain in control.
Dow Chart - Daily
Nasdaq Chart - Daily
The week was peppered with mixed economic results and Friday was no different. The Producer Price Index (PPI) showed a headline drop of -0.6% and a sharper dip than was expected. The majority of the decline was led by the impact of lower energy prices still filtering through the system from the Q4 lows. Core producer prices, which exclude food and energy rose +0.2% and inline with expectations. Finished energy products fell by 4.6% after two months of strong gains while crude energy products fell 16.2%. Gasoline prices fell 13% in January. However, early February indications are that prices for all products related to oil are rising sharply.
Housing starts for new residential construction fell -14.3% to 1.408 million on an annualized basis. This was down from the 1.643 million pace seen in December. That was the biggest decline in nearly ten years. While this seems disastrous on the surface it should be taken in context. Both the November and December numbers showed sharp gains of 5% or more as unseasonably warm weather spurred an abnormal winter build cycle. In January winter arrived with a vengeance and starts slowed to a crawl due to heavy snow cover and zero degree temperatures. Remember ice storms and snowplows in the news in California and airport shutdowns in multiple states? This was simply a weather related dip and not evidence of a new downturn in the sector. Actually a drop in starts would mean less inventory for spring and help bolster sagging prices for new homes. Starts for single-family homes are down 40% from year ago levels.
Consumer Sentiment for February fell sharply to 93.3 from the last reading of 96.9 for January. That January reading was a two-year high. Both the present conditions component and the expectations component fell thee points or more. Rising jobless claims, a resetting of ARM loans at higher interest rates and a high rate of foreclosures due to a lack of rebound in housing prices is impacting consumer sentiment. Gasoline may be under $2 a gallon in some places but the home equity ATM is running dry to pay for it.
After a week chock full of economic reports next week will seem like a holiday with Wednesday the only day with market moving possibilities. The Consumer Price Index will be key for its insight into the continuing progress of inflation. The FOMC minutes will provide an insight into what the Fed was thinking in their recent meeting and which Fed officials wanted higher rates. Thursday's Kansas Fed Survey will be of interest but it is not normally a market mover. The Wednesday oil inventory levels will be moved forward a day to Thursday due to the government holiday on Monday.
Friday was a lazy day for the markets with many traders leaving early for the 3-day weekend. The markets will be closed on Monday for President's Day. The biggest news items were a rumored buyout of American Airlines, a GM buyout of Chrysler and a warning of sorts from Microsoft.
AMR, parent of American Airlines spiked on a rumor that a partnership of British Airways and Goldman Sachs were preparing a bid of $46-$52 for the carrier. Reuters and Bloomberg immediately countered with comments that no deal was imminent or possible. AMR has far too much debt at $18 billion to be attractive and especially at that price. There is also a rule preventing more than 25% foreign ownership of an American airline. The rumor was sparked by an upcoming article in Businessweek suggesting this buyout may be in the works. Prudential, Morgan Stanley and numerous other brokers said the deal would never fly even if the rumor were true.
Much more interesting was news that GM may be in talks to acquire Chrysler. That rumor drew praise from some and ridicule from others. Chrysler is the number three car maker in the US with a 14% market share and sells two million units annually. They have 3400 dealerships and numerous manufacturing plants in the US. GM is the largest automaker although Toyota is expected to pass them soon. GM has 7100 dealerships and a 22% market share. Should the buyout happen it would cause dramatic problems for GM but give them a 36% market share. GM probably would not be considering this move except to keep a Chinese company from buying Chrysler and getting an immediate foothold and major market share in GM's home market. Daimler Chrysler has been looking for a takeout of Chrysler and a GM buy would be seen as self defense rather than an offensive move.
Jonas Ferris picks good companies whose insiders are buying, too. With this record, it's easy to see that tracking insiders works; now see how we make it easy.
GM has been shifting away from cars manufactured in America due to the higher costs of unions and health care. They are moving to a foreign manufactured model where cars are made outside the US with far cheaper overhead. By acquiring Chrysler they would be picking up numerous North American production facilities and that would lead to even more plant closures and layoffs. Chrysler announced a restructuring plan this week that will eliminate 13,000 jobs. There were so many analysts coming out against this deal that it probably has little chance of occurring as an outright acquisition. Personally I think it would be an interesting move. GM would eliminate a major competitor at a time when competition is heating up against the onslaught of foreign makers. There would be a lot of duplication in product lines but if GM owned Chrysler it could eliminate that duplication and increase share for the surviving model. GM would pickup 3400 dealerships and broaden its marketing footprint. That would be a blessing and a curse since some would have to be eliminated as product lines were narrowed. GM would pickup the profitable Jeep, truck and minivan lines and could shed the far less popular passenger car models. By combining model lines and streamlining production they could sell more units of the remaining models at a lower cost. It would not be an easy acquisition and could cause GM to assume a huge amount of additional debt. It would also cement GM as the largest domestic automaker for years to come. With the eventual cost savings from reducing model overlap they might be able to pay off some of their monstrous debt. Just my two cents and that is about what my opinion is worth to GM. Analysts are so negative it will probably never happen but it was an interesting scenario.
Steve Ballmer, CEO at Microsoft, said late Thursday that revenue projections for Vista were "overly aggressive." That was the first crack in the Microsoft armor and one I have been speculating would be coming. It was not a real profit warning but more of a first attempt to talk down estimates with lots of time left in this quarter. Vista is not flying off the shelves and most experts are now recommending NOT to buy the software only for a do it yourself upgrade. The number of hardware challenges and the large number of bugs being reported are a daunting challenge for the normal consumer. Experts suggest waiting until you upgrade to a new computer to move to Vista. They suggest letting the hardware manufacturers solve all the compatibility problems for you. Those same experts are now saying if you just have to upgrade then at least wait for the release of the first service pack (SP1) before taking the plunge. This service pack is said to be growing in size as each day passes and will solve hundreds of reported problems once installed. Another reason Microsoft is trying to talk down Vista expectations is the strength of the sales in emerging markets. Microsoft typically heavily discounts sales to emerging markets to compensate for the lower income levels, stiff competition from piracy and lower pain threshold by early adopters. Analysts fear that the sales of deeply discounted Vista to emerging markets is outstripping sales at full retail in the US. In a presentation to analysts Ballmer said Vista would create a "small surge" in PC sales over the next year but would NOT spur a big increase over normal growth rates. This is not what the analyst community had been expecting and not what Microsoft had been informally talking about for the last year. Ballmer said, "Some of the revenue models and revenue forecasts I've seen out there for Windows Vista are overly aggressive. I don't think that much new money will race out of the consumers pockets into PCs." Since 75 cents of every dollar of Microsoft profit comes from the Windows operating systems a slow acceptance of Vista could cause profit pains at Microsoft. MSFT stock rose +30% since June ahead of the Vista release. MSFT has lost ground in 3 of the 13 trading days since the Vista release. Friday's close at $28.72 was a new three-month low.
Microsoft Chart - Daily
After the bell the semiconductor sector took another blow after SanDisk warned that it was cutting 10% of its payroll and cutting salaries of all executives by as much as 20% due to declining prices for flash memory. Salaries for all remaining employees would be frozen as well as new hiring. SanDisk said profit margins would remain under pressure for several quarters to come. The cost cutting measures were designed to cut costs by $30-$35 million a year. SanDisk said weak Q1 demand had caused prices to decline by 50% over the last two months. In order to maintain market share SanDisk said it was cutting prices by as much as 40%. You may remember it was Micron who warned last Friday that flash memory prices would be down 30% to 40% in the current quarter. That caused a sharp drop in the Nasdaq last Friday. SanDisk waited until after the close but you can bet the impact will be felt on Tuesday. SanDisk said they were confident the sharply lower prices would accelerate demand and stimulate new markets for the products. Since those new markets would be predicated on the lower prices for chips it appears SanDisk and Micron have a long rough road ahead to regain any profit margins.
In the energy sector the price of oil rebounded from a two week low at $56.62 on Thursday to close at $59.40 and right back to that $60 resistance level. Supporting the rebound was a warning from the US government that Nigerian militants were planning to escalate their attacks. Possible new targets included expatriate personnel, Western businesses or facilities and locales visited by tourists in other regions of Nigeria. Meanwhile OPEC's new secretary-general, Abdullah Salem el-Badri, said the global oil market had become more balanced thanks to compliance with recent production cut agreements. He said supply and demand are now balanced at 86 mbpd and adherence to the announced cuts was about 66%. In OPEC a 66% compliance is like 100% everywhere else. The announced cuts totaled 1.7 mbpd putting 66% compliance at only 1,122,000 bpd. Independent surveys put the cuts more like 50% at 850,000 bpd. If these production cuts continue we should see prices eventually move back over the $60 level. OPEC also said they were raising their demand estimates for OPEC crude by 200,000 bpd. The reason is failing supplies at non-OPEC suppliers. OPEC expects supply from non-OPEC sources to drop by 170,000 bpd compared to expectations in late 2006 for an increase from those same suppliers.
March Crude Oil Chart - Daily
April Crude Oil Chart - Daily
The International Energy Agency raised their world demand estimates earlier this week by 273,000 bpd in 2007 and warned that the OPEC cuts could seriously tighten the markets and push prices higher. The IEA said demand from China would grow by 500,000 bpd to 7.6 mbpd in 2007. Vehicle sales in China rose by 25% to a record 7.2 million units in 2006. Despite strict controls put in place to curb this growth in autos another 25% growth year is expected for 2007.
Next Wednesday we will also see the head of the International Atomic Energy Agency (IAEA), Mohammed el-Baradei, give a report to the UN Security Council on the compliance by Iran with the halt of uranium enrichment. It should be a short report. No compliance. The council will then decide on additional sanctions to force compliance. Given reluctance by Russia and China that could be another long debate. However, they did come around and allow the present sanctions and Iran has rebuffed them at every turn. Last Sunday Iranian President Mahmoud Ahmadinejad vowed to never give up enrichment but refrained from making the huge announcement that was expected and from showing his wilder side during the speech on the 28th anniversary of the Islamic revolution. He had announced he would make a major nuclear announcement but there was no announcement. Analysts believe he presented a calmer demeanor because of the IAEA/UN event next Wednesday. It is easier to pass additional sanctions against a wild man than a leader showing restraint.
Also supporting prices was the impending expiration of the March crude futures contract next Tuesday. Traders short that contract ahead of the 3-day weekend decided to exit at the close rather than risk some event over the weekend that would put them in a world of pain before the markets opened to thin trading on Tuesday. Next Friday the March options will expire on heating oil, reformulated gasoline and natural gas. That could produce some further volatility in those products. The national weather service NOAA said warmer than normal temperatures are expected for next week and that should have pressured prices but the long weekend and pending expiration prevented that downward move.
Speaking of downward moves there were none in the market this week. After Monday's dip by the Dow to initial support at 12550 ahead of Bernanke's testimony the rebound was vertical from there. The Bernanke testimony convinced investors that inflation was slowing, the economy was growing steadily and the Fed, although watchful, was going to be on the sidelines for quite sometime. The Dow soared past the prior resistance high from last week at 12700 and continued to set new highs right into Friday's close. The mixed economics on Friday caused the markets to dip only slightly intraday. The Dow traded in only a 25-point range before closing only slightly positive with a +2.56 gain but yet another new historic high close at 12767.89. It is hard to draw any resistance lines on the Dow that are not unbelievable. Any breakout chart is always difficult to really tell where the next resistance level might be. The only way to chart it that is reasonably correct would show 12800 to be the next challenge. It also suggests that a breakout over 12800 could go ballistic very quickly to the stratospheric level of 13000. There is simply no selling pressure and no fear with the VIX hovering at lows near 10. Until this trend breaks the bulls will keep buying any dips to the 30-day average like popcorn for a buck at the movies. With popcorn going for the inflated price of $5-$8 a barrel the same thing for a buck would create a serious feeding frenzy. The bulls may not be in frenzy mode yet but if the Dow breaks out again it could be a real fun ride.
Before the SanDisk implosion after the close on Friday the Nasdaq was calmly putting in higher highs and higher lows as it approached 2500 again in stealth mode. The last trip to 2500 ended badly and the slow pace of movement this time virtually assured a breakout until the SanDisk disaster on Friday night. How that will impact the Nasdaq on Tuesday is unclear since Micron already warned of the same price problem. SanDisk is just reacting to the same circumstances but a lot sharper. After the close SNDK fell -$2 to $38 and a new six month low. Traders will probably hammer SNDK on Tuesday but it remains to be seen if the rest of the chips will follow suit. Micron was the only reactor I saw in after hours on Friday. Of course it was a holiday Friday and very few traders were even around to see the warning much less react to it.
S&P-500 Chart - Daily
On Tuesday the S&P recovered from its Monday drop to 1431 to come to a dead stop at 1440 and our prior long/short indicator. It hovered there for about 2 hours but finally broke out to begin a run to 1455 where it closed on Friday. Last Sunday I suggested not going long again over 1440 but to look to short any unexpected return to 1450 BEFORE the Bernanke testimony. I cautioned that should he say something positive it could change the ballgame and we should be prepared to change the plan if that happened. Obviously it happened and it was very obvious once it started so I hope everyone "changed the plan" back to a long bias over 1440. I remain the stubborn one and after three days of being pinned to 1455 I took a small futures short into Friday's close. If the market shakes off the SanDisk news on Tuesday I will be the first to go long again over 1458. The S&P has been using the 30-day average for support since August and last week's dip did nothing to change that. The 50-day, currently at 1427, has not even been touched since July. A move below the 50-day would be a game changer.
Russell-2000 Chart - Weekly
NYSE Composite Chart - Weekly
Wilshire-5000 Chart - Weekly
If you recall the last couple of weeks I have been discussing the rebirth of the Russell-2000 and small cap stocks. The Russell suffered the same Micron induced bout of profit taking last Friday as the large cap indexes but it was back to historic highs when Bernanke blessed the economy. Friday's close at 818 was a new historic closing high. As long as the small caps are in favor the rest of the market will also prosper. The Russell appears ready to finally make that break over 818 and also go blue sky on us. With a move over 820 the Russell could easily sprint to 850 before reaching the next material resistance level. I would love to be along for that ride. The Russell is my sentiment indicator for the rest of the market and it was waving flags and popping champagne at Friday's close.
Assisting in the flag waving was the Dow transports with another close over 5100. The breakout on the Transports and the Russell in the same week represents very strong bullish sentiment. The NYSE Composite closed at 9432 and while that was -3 points from Thursday's record close it was still very bullish. The Wilshire-5000, the broadest index also closed at a new record high. The problem with all this extreme bullishness is simply that it is extreme! All the signs are pointing to a very strong week ahead and there are no signs of any impending correction. That should worry everyone but it does not seem to matter. Everyone with money burning a hole in their pocket is throwing it at the market on every minor dip. Eventually this is going to bite the bulls but the setup this weekend looks very bullish. Extremely bullish! My advice today would be to buy any SanDisk dip on Tuesday. Actually it would be to buy the "rebound" from any SanDisk dip. We want to make sure there will be a rebound before spending those bucks. SPX 1440 is off the table for next week. Instead monitor Russell 820, SPX 1458, Dow 12800, NYSE Composite 9450 and Wilshire 14750. A move over any or all of these levels should produce a race to levels we could only dream about back in December. Eventually there will be an event appear out of nowhere to trigger a real reversal but this weekend I can't imagine what it would be. We have had bad news from nearly every corner both in guidance warnings and economic reports and nothing seems to faze the bulls. When the bulls are stampeding it is best to follow and not stand in their path. As Richard Gere said in Pretty Woman, just try to avoid the steaming divots. In this case it would be a divot like SanDisk.
Allegheny Tech - ATI - cls: 102.59 change: +0.23 stop: 97.45
Why We Like It:
BUY CALL MAR 100 ATI-CT open interest=2593 current ask $5.80
BUY CALL APR 100 ATI-DT open interest=2127 current ask $8.20
Picked on February 18 at $102.59
Boeing - BA - close: 90.94 change: -0.77 stop: 87.99
Why We Like It:
BUY CALL MAR 90.00 BA-CR open interest=2984 current ask $2.65
BUY CALL MAY 90.00 BA-ER open interest=6574 current ask $4.90
Picked on February xx at $ xx.xx <-- see TRIGGER
Chinese iShares - FXI - close: 106.90 chg: +0.70 stop: 103.99
Why We Like It:
BUY CALL MAR 105.00 FJJ-CA open interest=428 current ask $4.30
BUY CALL MAY 105.00 FJJ-EA open interest=509 current ask $7.70
Picked on February 18 at $106.90
Research In Motion - RIMM - cls: 138.82 chg: +3.68 stop: 132.39
Why We Like It:
BUY CALL MAR 135 RFY-CG open interest=6636 current ask $8.50
Picked on February xx at $ xx.xx <-- see TRIGGER
Diageo - DEO - close: 81.38 change: -0.85 stop: 78.45
DEO lost 1% in profit taking on Friday after hitting new all-time highs on Thursday, which followed a bullish breakout over resistance near $80.00 on Wednesday. All in all it was a strong week for DEO. The stock broke out from a six-week consolidation under $80 and the company raised its guidance on Thursday morning. The dip on Friday was enough to "fill the gap" from Thursday morning and traders bought the dip. We see the rebound from Friday morning as another entry point to buy calls. Our short-term target is the $84.75-85.00 range although more aggressive traders may want to aim higher. FYI: The P&F chart points to an $89 target.
BUY CALL MAR 80.00 DEO-CP open interest=335 current ask $2.10
Picked on February 14 at $ 81.04
OM Group - OMG - close: 51.36 change: +0.18 stop: 48.05 *new*
Shares of OMG have spent the last two weeks consolidating under resistance at the $52.00 level. So far the stock has continued to trade with a bullish pattern of higher lows, which would normally suggest that OMG is merely building up steam before breaking out over the $52 level. We are not suggesting new bullish call positions at this time although a breakout over $52 could be used as a new entry point. If you choose to buy a new breakout consider raising your target. We're only aiming for the $54.00-55.00 range. Please note that we're adjusting the stop loss to breakeven at $48.05 but more conservative traders may want to adjust theirs toward $49 or even $50. The early March earnings report is still unconfirmed but at the moment we only have a couple of weeks left.
Picked on January 25 at $ 48.05
RTI Int. - RTI - close: 83.84 change: +0.17 stop: 79.75
RTI has also spent the last two weeks consolidating under resistance. We initially suggested buying calls on the bullish breakout above resistance near $80.00. Unfortunately, the stock has been caught in an $80-85 trading range. The stock has been hugging its trendline of support (see chart) since the dip back toward $80.00 around February 9th. We are not suggesting new positions at this time but technically a breakout over $85 could be used for a new entry point. Bear in mind that we are already targeting the $88.00-90.00 range.
Picked on January 31 at $ 81.75
Rio Tinto - RTP - cls: 220.80 chg: -0.86 stop: 212.45
Shares of RTP can be volatile but the stock hasn't shown much volatility over the last couple of sessions. Volume has also come in pretty low over Thursday and Friday. Overall we do not see any changes from our original play description on Wednesday night. The stock broke out over significant resistance earlier this past week and now we're just waiting on the follow through. Readers can choose to buy calls now or wait for a potential dip near $215 or its 10-dma. Technical indicators on both the weekly and daily charts are turning positive. RTP will probably have some resistance at its November 2006 highs near $230 but our target is the $237.50-240.00 range. FYI: RTP is a high-dollar stock and is bound to see some bigger swings (volatility) and this makes the options somewhat "expensive". Consider this a more aggressive play.
BUY CALL MAR 210 RTP-CB open interest= 221 current ask $13.40
BUY CALL APR 220 RTP-DD open interest=1203 current ask $10.10
Picked on February 14 at $221.15
Sears Holding - SHLD - cls: 187.26 chg: +1.15 stop: 176.45
SHLD displayed relative strength on Friday. The stock hit a new intraday all-time high at $187.50. Shares closed right at last week's high and the stock saw above average volume behind Friday's gains, which tends to be bullish. Yet we probably would not want to buy calls right here with SHLD at last week's highs and possible resistance. Look for a move over $187.50 or a dip back toward the 10-dma near $182.00. More conservative traders may want to tighten their stops toward the $180 level. The Point & Figure chart points to a $228 target. We are aiming for the $195.00-200.00 range. We do not want to hold over the mid March earnings.
Picked on February 14 at $183.64
Harley Davidson - HOG - cls: 68.04 chg: -1.05 stop: 70.11
Be careful with your positions in HOG. Friday's show of relative weakness with a 1.5% decline looks like a failed rally under HOG's trendline of resistance and thus a new entry point for puts. However, a couple of hours after the closing bell on Friday HOG announced a tentative agreement with the 2,800 strikers at its Pennsylvania plant. As we expected news of a settlement with the striking workers sent the stock higher. In after hours on Friday HOG was trading near $69 again. Therefore, we would wait and watch for another failed rally under $69 or more likely the $70 area before considering new positions. It is very possible that the reaction to the news will send HOG past $70 and stop us out. Our target is the $63.00-62.00 range but more conservative traders may want to exit early near $65.00.
Picked on February 11 at $ 67.80
MarineMax - HZO - close: 22.52 change: -0.19 stop: 24.25
The consolidation in HZO may be ending soon. Shares spent the last week trading sideways in a narrow range. The lack of movement can be painful and frustrating if we own options on the stock. Fortunately, on Friday the stock displayed some relative weakness with a 0.8% decline. Both daily and weekly technical indicators are bearish and the P&F chart is very bearish with a $2.00 price target. We would still consider new positions here but more conservative readers may want to use a trigger under $22.00 and a tighter stop loss before opening new plays. Our target is the $20.25-20.00 range.
BUY PUT MAR 25.00 HZO-OE open interest= 41 current ask $2.90
Picked on February 11 at $ 22.59
Meritage - MTH - close: 43.56 change: +0.01 stop: 45.26
The homebuilders were in focus again on Friday after the Friday morning housing starts report surprised everyone. Housing starts for January dropped over 14% to a new ten-year low. The initial reaction sent the homebuilders sharply lower but then surprisingly they bounced almost as quickly. The overall pattern in the group and MTH still looks bearish but we hesitate to open new put plays following Friday's intraday rebound. We would wait for a new decline under $42.00 before buying puts again. More conservative traders might want to tighten their stops. The P&F chart has produced a triple-breakdown sell signal with a $37.00 target. We are aiming for the $37.50-37.00 range.
Picked on February 11 at $ 41.99
Nike - NKE - close: 106.30 change: +0.79 stop: 99.89
Target achieved. NKE announced a two-for-one stock split this morning and the news sent shares to an intraday high of $107.51. Our target was the $107.50-110.00 range. More aggressive traders may want to keep their play open and aim higher. However, we would caution that NKE is up nine days in a row and way overdue for some profit taking. The stock split is due in early April.
Picked on February 06 at $101.17
Sealed Air - SEE - close: 66.25 chg: +0.17 stop: 65.26
We are dropping SEE as a bearish candidate. The stock bounced from technical support at its 50-dma early last week and never looked back. While technical indicators are mixed the daily MACD just produced a new buy signal. Shares of SEE look poised to breakout to new 52-week highs soon and challenge the all-time highs set in 1999 and 1998. It was our plan to buy puts on a breakdown below the 50-dma with a trigger at $63.75. Nimble traders may want to consider new bullish positions if SEE can breakout to a new relative high over $66.50.
Picked on February xx at $ xx.xx <-- see TRIGGER
Google - GOOG - cls: 469.94 change: + 8.47 stop: n/a
Our strangle plays in GOOG have come to an end with February option expiration. The post-earnings reaction was not quite as sharp or strong as we expected and left our strangles with a loss.
Picked on January 28 at $495.84
United Parcel Srv. - UPS - cls: 74.04 chg: -0.44 stop: n/a
UPS spent most of the last two weeks trading sideways and the post earnings reaction in the stock price was not near large enough to give our strangles a chance. The February options expiration has ended the play.
Picked on January 28 at $ 72.49
Recently, OptionInvestor writers were cautioned not to throw out too many of the acronyms seasoned investors use. New subscribers don't always know what they mean.
I identified. As a newbie trader, I barely knew Alan Greenspan's name and had less of an idea what "FOMC" meant. I learned quickly. An FOMC meeting adversely affected a trade that had been rocking along just fine until the statement accompanying an FOMC meeting hit the wires.
In the current climate, traders had better understand something about the FOMC, but they need to go beyond the FOMC. They need a basic knowledge of which reports the FOMC watches. Why? Any one of them can turn a profitable play into a losing one. Quickly.
Don't worry. You're not going to get anything more than the basics in this article. No rants about FOMC policy. No discussions of the relative merits of Greenspan's Greenspeak versus Bernanke's clarity. No deep discussions of economics. I was amused by Greenspan's Greenspeak and don't feel qualified to discuss the rest. The article might be livelier with those rants, however. I warn you that the information, although necessary for traders, prove rather dry.
Let's start with the FOMC. The letters stand for the Federal Open Market Committee, the part of the Federal Reserve that makes policy. This committee sets the federal-funds rate, the rate banks charge each other for overnight loans. The committee also sets the discount rate, the rate the Federal Reserve charges banks for overnight loans at what's termed the "discount window." Those kinds of "discount window" loans are rare now, and it's the other rate, the so-called "interest rate" we hear about on FOMC meeting days, that most rivets traders' attention.
I was intrigued to learn that the FOMC didn't always announce the rate it was setting. According to the Wall Street Journal's book, COMPLETE MONEY & INVESTING GUIDELINE, markets watchers once had to do their best to estimate that rate. While many laughed about Alan Greenspan's obfuscating language, this former Fed chairman's tenure can be credited with providing more clarity for the everyday trader. Rates were published and statements were provided in which the FOMC assessed various economic strengths and concerns.
Chief among those concerns lately has been inflationary pressure, with the fear being that the FOMC will raise rates enough that both businesses and the average person feel the squeeze. I'm old enough and have been married long enough that my husband and I were buying a house during an inflationary era. Our mortgage rate was above 13 percent, and we avoided an even higher mortgage rate only because we had such good credit.
Although current FOMC Chairman Ben Bernanke reassured members of Congress this week that inflation appeared to be under control, markets remain jittery about the prospect of higher inflation and, therefore, higher rates. Relief buoyed markets this week, and that relief certainly impacted traders, adversely impacting anyone caught in a short or bearish trade. Traders have to look back only so far as the stock-market reaction after the release of the minutes of the December 12 meeting to see an opposite reaction. That one also proves that we've been in a period when any signs that the FOMC might have to raise rates again can pummel equity markets. Signs that rates might not have to be raised can buoy them.
Why should that whole interest-rate thing bother stock-market investors? Why are markets reacting so strongly? Homebuyers aren't the only ones borrowing money. Companies need to do so, too, and some companies are hit harder than others when they need to borrow money in a rising-rate environment. Just as my husband and I got a preferential rate during an inflationary period because we had such good credit, companies with good credit get better rates, too. Start-ups, small companies and especially troubled companies pay higher rates. That makes the small-caps more vulnerable to higher interest rates, but rising rates impact all companies. Money gets "tighter," another way of saying that it's harder to get the needed loan to finance new equipment or make other changes.
The FOMC doesn't want to raise rates so high and make money so tight that the consumer and companies both suffer, hurting economic growth. We're also currently in a period in which the economy is softening a bit, a welcome development if all that softening accomplishes is to prevent inflationary pressures from building. The softening is an unwelcome development if the economy softens enough to cascade the economy into a recession. So, both the FOMC and market participants are also closely watching for any signs that the market is softening too much, and that could swing over into the most prevailing concern if the market if such signs appear. The minutes of the December 12 FOMC meeting also mentioned that the economy softened "a touch" more than the committee had expected, so that market bulls were hit twice that month, with worries about inflation growing more than wanted and the economy softening more than wanted. Market bears were hit twice this week, because Chairman Bernanke's testimony was encouraging about both the economy and the lessening of inflation risk.
It should be clear that traders don't want to be blindsided by an FOMC meeting, as I was that time, or even by a speaking engagement, as I know at least one trader was this week despite the newsletter's calendar of events. OIN publishes a calendar in the newsletter each weekend that details the next week's economic events. FOMC meetings and most speaking engagements by FOMC members will be detailed there. If you want to keep the FOMC's schedule bookmarked on your computer, it can be found at http://www.federalreserve.gov/fomc/.
The need to avoid being blindsided makes those other acronyms in the title important, too. According to the WSJ and other sources, the FOMC watches several key economic reports to gauge the inflationary pressures and economic strengths. If the FOMC is watching those reports, traders better be, too. Among those reports are the ISM, the CPI and the jobs data or non-farm payrolls.
ISM stands for the Institute for Supply Management, the entity that produces reports on both manufacturers and service providers. Of the two, the manufacturing ISM is probably still the most important, although our economy is becoming a service-oriented rather than manufacturing-oriented one. On the ISM's website (www.ism.ws), the ISM states that this report is released on the first business day of each month at 10:00 and posted to the website after 10:10 EST.
The ISM surveys manufacturers across the nation, making sure that the manufacturers surveyed are diversified across several industry groups. The resulting report gives traders--and the FOMC--a glimpse into such aspects of manufacturers' business as production, supplier deliveries, new orders, backlog of orders, new export orders, imports, prices and employment. The various components of the group are assigned a percentage, with the ISM site explaining how the percentages and diffusion indices are calculated. You don't need to know how to calculate these. What you need to know is that a number above 50 percent indicates economic expansion and a number below that indicates contraction.
The manufacturing ISM gives the FOMC insight into the health of the economy and inflationary pressures. If the manufacturing sector is expanding too quickly, especially if the employment component is also expanding rapidly, inflation pressures may build.
January's ISM was 49.3, slipping below that 50 benchmark. A number below 50 percent indicates that manufacturing is contracting. One market watcher recently commented that the FOMC won't let that manufacturing ISM remain below 50 percent for too many consecutive months before it cuts rates. Some market participants appear to be betting on that scenario, also betting that the economy won't slip too far. Otherwise, they might not be so bullish on equities, but the current hope appears to be that the perfect Goldilocks scenario of a just-right softening is occurring.
The ISM makes a point of advising those reading its reports that its report is different from the various regional reports on manufacturing, but a couple of those regional manufacturing reports can provide a heads-up to likely changes in the ISM. Those are the Philadelphia Fed Index, the so-called "Philly Fed," and the Chicago PMI. The Philly Fed is released the third week of the month it covers, so it precedes the ISM. This week's past week's release of the February Philly Fed proved disappointing, with the Philly Fed barely clawing out a hold above its benchmark 0.0 level, coming in at 0.6.
The Chicago PMI or purchasing-managers' index also appears before the ISM. It is released on the last day of each month.
FOMC members also purportedly watch the CPI or the Consumer Price Index. This inflationary measure is produced by the Bureau of Labor Statistics in the U.S. Department of Labor and released at 8:30 about the 13th of each month, with the data covering the prior month. The government compiles a basket of goods and services that consumers purchase and releases a figure that shows the percentage by which prices for that basket of goods changed in that prior month.
However, this number is not without controversy. Food and energy products are among the components of that fixed basket of goods, and their prices can fluctuate quite a bit over a month's time. Therefore, the Bureau of Labor Statistics also strips out those goods to produce another figure, the core CPI. Reportedly, this is the FOMC's key inflation measure.
Other market watchers argue that consumers must pay for food and energy, and that these should be included in any inflation measures. I tend to agree, but if it's the core number that the FOMC purportedly watches and to which the market reacts, then that's the one I'm going to watch, too.
How the market reacts to this number depends not only on the number itself, but also on the environment. In 2006, Japanese market watchers wanted to see a rise in their CPI as a sign that the country was pulling out of a long period of deflation. Here in the U.S., though, when market watchers are afraid that the FOMC will go too far and raise rates at least one time too many, market watchers don't want to see an inflationary CPI number.
Traders should also be aware when another number, the PPI, is released, as it was this last week. Although this Producers Price Index is not considered the main inflation guide, a steep rise in the prices producers pay may result in those producers trying to pass on the higher costs to consumers. It can then be a leading indicator of what might happen to the CPI. However, it's not always possible for producers to pass those prices on, so there isn't always a direct this-happens-then-that-happens relationship between the two. This week, some components of the PPI number showed more economic weakening than traders wanted to see, but, ultimately, this number didn't impact markets much this week, either. Then again, it proved hard to tell, since it was released on a day when eight other economic numbers were released and Chairman Bernanke was finishing up his testimony before Congress.
Still, traders should put this release on their calendars, too, since a big surprise, especially one that heightens inflation worries, can sometimes move the markets. This number is released around the 11th of each month and covers the prior month. It's released at 8:30.
A third report that the FOMC reportedly watches closely is known variously as the jobs report, the employment numbers, and the non-farm payroll report. They're all the same thing, differentiated from the weekly initial claims or jobless claims, which is different. The Labor Department prepares this non-farm payroll report and releases it at 8:30 on the first Friday of each month. This number has two key parts, the new jobs created and the unemployment rate, and also includes some less-often-watched components such as the average number of hours worked each week. The unemployment rate measures the percentage of the total work force that is unable to find a job.
When the economy is expanding, new jobs are typically being created, and when the economy is contracting, fewer new jobs are being created. This is a bit simplistic, but the general idea holds. If unemployment rates rise too high, consumers spend less and save more. If that pattern swings too far, demand for consumer goods lessens and the economy is hurt.
That must mean that low unemployment rates are a good thing, right? Not if they're too low. If they're too low, companies must pay high salaries and offer better benefits to attract and keep employees. Chairman Bernanke mentioned this effect this week when he noted that some of his contacts were telling him that it was becoming difficult to find highly skilled or highly placed employees.
That cost of giving incentives to attract or hold key employees builds inflationary pressures. In other climates, market participants might be glad to see many new jobs being created and unemployment rates particularly low, but when the FOMC and other market participants are watching for inflation risks, they don't want those numbers to show that employment costs are adding to those inflation pressures.
A couple of releases help traders gauge how the jobs numbers might shake out, giving a preview. First is the previously mentioned weekly release of initial claims or jobless claims. These come on Thursday mornings at 8:30 and include figures on the number of people filing for new unemployment insurance claims and the number who are continuing to collect on unemployment insurance benefits. Although there's not a direct correlation between the non-farms payrolls and these claims, they do at least provide a window into the employment figures.
A bigger window is provided by the ADP National Employment Report, a number that's been provided to traders over the last year. ADP gathers information during the same time period and using the same methodology as that employed by the Labor Department for its non-farm payrolls number, and produces a measure of non-farm private employment. This number is released the Wednesday before the non-farm payrolls number, providing market participants with an estimate of the non-farm payrolls a couple of days before the government releases those figures. An estimate of government jobs must be added to the ADP's National Employment Report, since that ADP report covers only private-sector jobs. Twice during 2006, the ADP report overestimated the number of jobs, once spectacularly last summer, and it has underestimated, too. It's not a perfect predictor of the non-farms payroll number, but traders need to be aware of its impending release a couple of days before the non-farm payrolls number because markets can often react strongly to this number, ahead of the non-farm payrolls.
Reportedly, former FOMC Chairman Alan Greenspan avidly watched the ECI, the Employment Cost Index, released each quarter, as another measure of employment strength.
Other important indicators of economic health and inflationary pressures exist and are reported throughout the month. Those include, of course, the GDP, or Gross Domestic Product. The Treasury Department releases several versions for each quarter: an initial number that is released a few weeks after a quarter ends, several revisions and then the final number that isn't seen until about three months after a quarter ends. This GDP number expresses the percentage by which the economy has grown or contracted. The market reaction depends on the climate, as it does with other economic releases. Market participants want that Goldilocks scenario in which the economy grows just enough to keep expanding but not enough that inflationary pressures build. The optimum percentage is one that market participants are often forced to guess, as the FOMC doesn't always give a target number they have in mind.
Currently, there's some fear that the next revision of the GDP, due February 28, will show more softening than is optimum or than had previously been anticipated. This week, some experts speculated that the GDP might be revised to show growth of only 2.2 percent, down from the previous 3.4 percent. You might add that February 28 date to your trading calendars and make decisions about whether you want to hold trades open ahead of that release.
Other measures that can impact trading are Housing Starts, Retail Sales figure and Consumer Sentiment, among others that I'm probably forgetting. However, those figures are often more easily understood, while new market participants sometimes don't understand the ramifications and importance to the FOMC of the ISM, CPI and non-farm payrolls. Keep on the watch for these three releases, because they can swamp a previously profitable play. In particularly volatile times, when markets perch precariously just under resistance or just above support, these releases can change the trading environment.
Conservative traders sometimes elect to exit trades before an important release, such as one of these. That's a decision for each trader to make. Hopefully knowing which of the reports is likely to be most important will help you formulate your plan and avoid being blindsided as I once was.
Today's Newsletter Notes: Market Wrap by Jim Brown, Trader's Corner by Linda Piazza, and all other plays and content by the Option Investor staff.
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