April's PPI was released this morning with a headline number of +0.2 percent. That was not a surprise as it was inline with expectations. The surprise came from the core rate, which excludes food and energy and spiked by 0.4%. Core prices for crude materials rose by a whopping +7.9%. The bleed over from energy prices into the core components was much higher than analysts expected. This was not good news for Fed watchers. Normally the core rate is lower than the headline number because those pesky food and energy costs are ignored. In April those rising costs bled over into the core items like autos and furniture. Transportation and materials costs are rising because of higher fuel costs and higher commodity prices. Specific problems are being seen in the core intermediate goods, which are often thought of as leading indicators for consumer inflation. Materials used in durable goods manufacturing rose +1.9% for the month. These are huge increases when the Fed is hoping for an inflation rate of less than 2% for the year. The higher inflation reading suggests the Fed is not going to be cutting rates again any time soon.
Wilshire 5000 Chart - Daily
Another report released today was the Chicago Fed National Activity Index for April. The CFNAI showed a drop to -1.17 and erased last month's minor gain. The cycle low is still the -1.59 headline reading from February. The chart below shows the 3-month moving average, which smoothes out the volatile month-to-month swings. On the 3-month average the -1.24 posted in April was the lowest level since Nov-2001. This level is consistent with a severe recession. The Fed believes that five consecutive months below -0.7 indicates an economy already in recession. Since 1967 that sub -0.7 5-month consecutive reading has occurred seven times and six of them were recessions. This report is backward looking and lags current conditions by about 60 days. That means we could already be recovering but this report will not show it for two months.
Those two reports were the most important for the week and that leaves the calendar open as head towards the holiday weekend. Traders will not be able to blame the economy for further market weakness. I believe the Fed will release the minutes on the last meeting on Wednesday afternoon and that could be the week's last volatile event.
Earnings reports and warnings are still producing market problems. Home Depot posted earnings that beat the street but guided analysts to the low end of its prior range for full year results. Profits were 41 cents per share and analysts were only expecting 37-cents. Same store sales fell -6.5% and revenue fell to $17.91 billion. HD guided analysts for a 19% to 24% decline in earnings for the full year. The HD CEO said they were seeing more risks than opportunities for the rest of 2008. HD said it was going to do the unthinkable and close 15 of its flagship stores and cut down on its expansion plans until the housing sector begins to rebound. HD said there was still no housing recovery in progress and in some areas it was continuing to get worse. Elsewhere in the sector Lowe's reported an 18% drop in earnings on Monday.
Monday's comments from Sandisk CEO Eli Harai were still weighing on the market on Tuesday. Eli told reporters "With oil prices hitting $127 a barrel, discretionary spending is going to be affected." He also said there was a chip glut that the market had to work through. SNDK shares fell -7% on his comments. The entire market tumble from his comments carried over into Tuesday. I believe it was just a handy excuse for the selling since every investor has already made that connection between high oil prices and slowing consumer spending. Smart Modular (SMOD) added to the gloom with a guidance warning citing a difficult pricing environment. The chip sector was still falling on Tuesday with more than -20 points erased since his comments.
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Target (TGT) reported on Tuesday that weaker than expected sales forced an earnings decline of 8%. The retailer reported that sales of non-essential items like lawn furniture were dropping fast while sales of commodity items like milk and diapers were still strong. It is just one more picture of discretionary spending curbs as consumers try and make their budgets stretch for the entire month. The CEO said they were increasing their ads in newspapers in an effort to capture as much of the tax rebates as possible. He also said credit charge offs rose 63% as cash strapped consumers failed to pay their debts. Saks reported profits that missed estimates and also said consumers were under pressure with sales shifting to the lower priced, lower margin items.
Noted Oppenheimer financial analyst Meredith Whitney is now saying that the credit crisis is "far from over" and believes losses could be far worse than even the most pessimistic estimates suggest. In a research note late Monday she said the crisis could extend well into 2009 and perhaps beyond. She said banks are being forced to reverse revenue they never should have booked in the first place. Many borrowed money in order to leverage into profitable mortgage loans and now those loans are going bad. Leverage is a wonderful thing when the trade is moving in your favor but it becomes especially nasty when it turns against you. Using leveraged funds for risk investments can require the banks to come up with cash they don't have when those investments turn negative. Meredith is expecting $170 billion in losses on just the banks she covers. Losses could be "far worse than even the most draconian estimates." We have seen the rebound in financials slow over the last two weeks and the XLF hit a 4-week low on Tuesday. With financials 21% of the S&P it would be extremely difficult for the S&P to move higher until the financials find a bottom again.
After the bell Hewlett Packard (HPQ) officially reported earnings of 87 cents per share but it was no surprise. They preannounced last week so there was little drama and the shares of HPQ barely moved after the announcement. The affirmed their prior forecast for the current quarter for $27.3 billion in revenue and 82-83 cents in profits.
June Crude Futures Chart - Daily
Oil prices hit a new intraday high at $129.58 and closed at $129.07 as the June futures contract expired. Boone Pickens was on CNBC's Squawk Box well before the open and forcefully reiterating his call for $150 oil in 2008. This call was discussed over and over all day and those still short that expiring June contract suffered a final squeeze. The expiring June contract gained +$2 for the day but the longer dated contracts positively exploded. The Dec-2016 contract closed at $138.85 for a whopping $8.87 gain. The more analysts predict higher prices in the short term the more these contracts are going to rise.
Oil Futures Gains Table
Meanwhile Alan Greenspan was saying that we are just seeing a speculative bubble in oil and it will decline. Since he retired from the Fed he has been a lightning rod on key issues. Unfortunately he has often been wrong and he is ruining his legacy with sound bite after sound bite of increasingly stupid remarks.
However the House of Representatives proved to be even dumber when they passed a bill allowing the Justice Dept to sue OPEC for the high prices. I have written about this several times lately and the stupidity of this action. OPEC nations don't like the U.S. and would not take kindly to any legal action. When somebody has a knife at your throat you don't continue to scream obscenities in their face and dare them to kill you. The U.S. has never complained over the last 40 years when OPEC kept prices lower by means of their production quotas. OPEC was seen as a good thing because oil prices remained relatively steady and allowed planners to know what oil was going to cost for years in advance. If the Justice department sues OPEC the group can just disband and then cut production individually and our oil prices will go to $200 instead of $70. The U.S. has no legal leverage on OPEC and they are holding all the cards. Targeting OPEC member country assets in the U.S. would surely lead to retaliatory action against America's oil consumption habit. Bush said he would veto the bill if it made it to his desk. My advice to the House would be to go do something useful like passing bills that would allow drilling in Alaska and off our coasts. Cuba is selling leases just off the coast of Florida but U.S. companies cannot drill there. Somebody please wake up and notice the price of gasoline before it is too late.
The case is building against Yahoo remaining independent. Another hedge fund, Third Point, is putting its five million shares of support behind Icahn and said they may increase that stake to 10 million. Boone Pickens also said he had bought 10 million shares to support Icahn. Paulson and Co. disclosed last week that it had acquired 50 million shares and is supporting Icahn. Carl also has options to buy another 49 million shares. Meanwhile Microsoft is back in talks with Yahoo on some kind of joint venture where Microsoft would buy the search business, invest in Yahoo and structure some kind of sell off of non core assets. Microsoft says this new proposal is worth more than $33 to Yahoo but there are not enough details available to do the math ourselves.
The inflation packed PPI this morning brought many investors back to reality. That reality is a Fed that will no longer be in rate cut mode and may soon be in rate hike mode. Analysts are now saying the Fed could begin raising rates by November at the latest. Of course that assumes the economy does not get any weaker. With the various economics reports giving mixed messages it is going to be a rough summer for analyst predictions. The reality that low rates may be ending is not pleasant on the surface but that also assumes the economy will be growing again. Investors would easily trade a booming economy for higher rates any day. It is the transition phase that is tricky.
The Dow fell to a low of 12781 intraday but quickly rebounded to close over support at 12800. That drop was 354 points from the 13135 high on Monday. While that sounds like a major disaster it simply erased four days of gains and knocked the Dow back to support. It was not a disaster and not a new trend. However, it is worrisome since this week is the last 5 days of the "Sell in May" cycle. If funds are going to use that strategy and go to cash over the summer then the prime time to exit is right after last Friday's option expiration. Any positions they had hedged with options are now at risk and they have to make the exit call or hedge the positions again.
Dow Chart - Daily
Nasdaq Chart - Daily
The Nasdaq was another picture perfect return to support and there was no change in the prior uptrend. The Nasdaq closed at 2491 and could decline to 2450 without damaging the trend. Ditto on the S&P-500. Nothing has changed despite the highly visible decline from Monday's high. Support remains 1390-1400 and the trend is still intact.
More encouraging for me was the strong showing by the Russell 2000 with only a -2.81 point drop today. The Russell declined to support at 732 and that support was solid. The Russell is still suggesting to me that fund managers are not selling stocks. They may not be strongly embracing the possibility of a summer rally but they are nibbling on every dip.
S&P-500 Chart - Daily
Russell-2000 Chart - Daily
The challenge remains volume. Without volume there is no conviction in either direction. Volume has remained in the 6.5-6.8 billion share range for the last six days. Internals are still positive despite the increase in declining volume over the last three days. There is some selling occurring but so far it is not a problem. As I said on Sunday we have to get past this week to be able to say the sell in May cycle is not going to happen this year. That gives us three more days of potential volatility. Remember, we are watching the Russell 2000 level of 730-732 as our long/short indicator. We want to buy dips to 730 and stay flat or short under that level. The Dow, S&P and Russell all did battle with resistance at the 200-day average and lost. That does not mean they lost the war, just the battle. Once over the 200-day averages this turns into a long-term fund buy signal. The key word there is "over" the averages. Until that battle has been won the markets could remain volatile.
Play Editor's Note: Nimble and aggressive traders may want to look at a few of the coal stocks as potential bullish candidates. I think many of them look overbought and due for a correction but ACI is just now breaking out from its recent consolidation. I had the entire call play for ACI already written up but chose not to add it. Coal stocks are rising, in part, because of the rally in crude oil. Just look at the chart for crude and a chart of ACI. There is a very close correlation in movement between the two. If we think crude oil is about to see a sell-off then coal stocks will likely see profit taking as well. Conversely, if you think oil will keep going higher from here then ACI may very well be a great candidate for you.
If you are looking for a bearish play, consider buying puts on the XLF financial ETF. The XLF broke down from its two-week consolidation and under technical support at its 50-dma today.
IHOP Corp. - IHP - close: 51.28 change: +0.98 stop: 49.49
Why We Like It:
Note: we have to label this a more aggressive play because the option spreads are so wide.
BUY CALL JUN 50.00 IHP-FJ open interest=2147 current ask $3.50
Picked on May xx at $ xx.xx <-- see TRIGGER
Alliant Techsystems - ATK - cls: 110.57 chg: -1.80 stop: 109.45
Tuesday's market pull back sent ATK back toward support near $110 but traders bought the dip near support. This looks like another entry point to buy calls but if you're feeling cautious more conservative traders could tighten their stops. Our target is the $118.00-120.00 range. The Point & Figure chart is bullish with a $145 target.
Picked on May 19 at $112.80 *triggered
Carbo Ceramics - CRR - close: 49.36 change: -0.05 stop: 45.95
We were pleasantly surprised by the relative strength in shares of CRR today. After yesterday's failed rally near $50.00 CRR was poised for a correction. We're not suggesting new positions at this time. We're aiming for the $52.00-52.50 zone.
Picked on May 11 at $ 47.45
Fortune Brands - FO - close: 71.03 change: -0.48 stop: 69.45
FO also displayed some relative strength with a 0.6% loss compared to larger losses in the S&P 500 and the DJIA. At this time I would expect a dip back toward support near $70.00. Our target is the $74.00-75.00 range. The 200-dma is technical resistance near $74.50. The P&F chart is bullish with a $95 target.
Picked on May 07 at $ 70.05 *triggered
Harsco - HSC - close: 62.94 change: +0.12 stop: 59.85
HSC displayed some strength today. Bulls bought the dip at $62.00 and shares look poised to move higher. We're not suggesting new positions at this time. Our target is the $64.50-65.00 range but more aggressive traders may want to aim higher.
Picked on May 01 at $ 60.38
Intl.Bus.Mach. - IBM - cls: 125.18 chg: -1.31 stop: 123.49
Big blue under performed today. Broken resistance at $125.00 should have been support. It didn't hold. IBM dipped to $124.45 before investors started defending it. Shares could fall toward $122ish and still be inside its bullish channel. A bounce back over $125.00 can be used as a new bullish entry point but consider a tighter stop under today's low or near $124 as a potential stop. Our target is the $129.50 mark.
Picked on April 30 at $120.75 */1st target achieved 124.90
iShares Russ.2000 - IWM - cls: 73.70 chg: -0.27 stop: 71.45
The small caps were rebounding this afternoon and the IWM looks a lot better than some of the other indices. We're not suggesting new positions at this time. More conservative traders might want to use a stop under today's low (72.80). Our multi-week target is the $77.50-80.00 zone. The P&F chart is bullish with an $87 target.
Picked on April 28 at $ 72.55 *triggered
Joy Global - JOYG - close: 80.16 chg: +0.44 stop: 76.90
JOYG bounced from its intraday low of $77.61 and powered back above the $80 level by session's end. The move is certainly encouraging and keeps the bullish trend alive. We had been warning readers that the stock might dip to $77.50. More conservative traders could ratchet up their stops toward $77.50. We continue to recommend that readers take profits in their bullish positions. Our secondary, more aggressive target is the $84.00-85.00 range. We will plan to exit ahead of the May 29th earnings report. The P&F chart is already bullish with an $88 target.
Picked on April 16 at $ 72.55 */ fist target exceeded
Lufkin Industries - LUFK - cls: 80.98 chg: -0.74 stop: 77.85
LUFK did not escape the profit taking and it may not be over yet. The trend is still bullish but look for dips near the 10-dma as a potential entry point. We had been suggesting a pull back into the $80-78 zone as a potential entry and we got one today. The short-term target is $84.75-85.00. The P&F chart is bullish with an $87 target.
Picked on May 18 at $ 80.59
Reliance Steel - RS - close: 67.37 chg: +0.52 stop: 59.99
I'm starting to wonder if we are going to get a chance to buy a dip in RS. The stock fell to $65.10 this morning and bulls rushed in to buy the pull back near RS' rising 10-dma. Today's bounce may prove to be a new entry point for bullish positions but we're going to stick to our plan for now. Our suggested entry point is a pull back into the $64.75-64.00 zone. If triggered we're setting two targets. Our first target is the $69.50-70.00 range. Our secondary, more aggressive target is the $73.00-75.00 range. The P&F chart is bullish with a $73 target.
Picked on May xx at $ xx.xx <-- see TRIGGER
Apollo Group - APOL - close: 45.39 chg: -0.10 stop: 50.05
The closing numbers in APOL do not tell the whole story. A BAC analyst downgraded four education stocks today and the whole group plunged this morning. APOL slipped to $42.80 before bouncing back. Yet the rebound failed to make it past what appears to be resistance near $46.00. We remain bearish but we're not suggesting new positions at this time. Our target is the $40.50-40.00 zone.
Picked on May 18 at $ 46.71
United States Oil Fund - USO - cls: 104.30 chg: +1.50 stop: 105.55*new*
It looks like another day of short covering sent crude oil to another new high and the USO gapped open higher at $103.91 and hit $104.62 at its best levels. We still suspect some profit taking in crude oil to occur this week. The question is how much risk are you willing to take. We are actually going to widen our stop loss to $105.55 just to give the USO a little bit more room to maneuver. More conservative traders may want to keep a tight stop but remember this is a high-risk, speculative put play. Right now our target is the $96.50 mark.
Picked on May 19 at $102.80
(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.)
McDonald's - MCD - close: 59.68 chg: -0.77 stop: n/a
MCD appears to be breaking down from its sideways consolidation even though the stock had its price target raised to $67 this morning. We don't see any changes from our previous comments. The options we suggested were the June $62.50 calls (MCD-FZ) and the June $57.50 puts (MCD-RY). Our estimated cost was $1.10. We want to sell if either option hits $1.65 or higher.
Picked on May 18 at $ 60.53
China Telecom - CHA - cls: 67.75 chg: -2.92 stop: 69.49
A sharp sell-off in the Chinese stock market (-4.4%) led shares of CHA to a 4.1% decline and a breakdown from its bullish pattern. The stock gapped open lower here in the U.S. at $69.25, which was under our stop loss at $69.49. The play is closed.
Picked on May 18 at $ 72.35 *stopped out 69.49
Today's Newsletter Notes: Market Wrap by Jim Brown and all other plays and content by the Option Investor staff.
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