The Dow declined -1.1% and the S&P -0.5% while the Nasdaq gained ground. Hopefully all future sell offs follow this minimalist trend.
Last week may have been the worst week of the year for the Dow but the other indexes were showing no material weakness. The minor -7 point decline on the S&P left it just under 1400 but still holding substantial gains from the 1340 low on March 6th. The Nasdaq shook off some minor selling in Apple but closed the week with a gain thanks to Amazon, Priceline, Netflix and a $20 gain in Google.
Weighing on the market for the week were economic worries from China and Europe, earnings in the U.S. and some disappointing housing data.
Friday's disappointing news included the New Home Sales for February. The headline number at 313,000 was well below consensus at 325,000 and Moody's at 332,000. This was the second month of slowing sales since the 336,000 pace in December and 318,000 pace in January. However, even at 313,000 that still represents an 11% gain over the same period in 2011. Year over year sales have risen for six consecutive months and the longest streak since 2005. Sales in the West are up +33% compared to February 2011, Midwest +29% and Northeast +26%. The laggard is the South with sales down -1%.
Months of inventory ticked up to 5.8 from 5.7 in January and 5.5 in December. Those levels are still -17% below the prior record low from 1967. The rising inventory ahead of the spring/summer selling season is to be expected. There is a good chance the low rates and the tax incentives pulled some buyers into December. That slight dip in buyers in February should only be temporary as we move into the spring selling season.
New Home Sales
That minor miss in New Home Sales punctuated a week of disappointing housing sector news. On Wednesday the existing home sales for February rose slightly to 4.59 million from the previously announced 4.57 million. However, January was revised higher to 4.63 million so that headline number was actually a decline. Expectations were for a gain to 4.64 million. Months of inventory increased slightly to 6.4 but that is still a six year low.
Existing Home Sales Chart
On Tuesday new residential construction starts declined slightly to an annual pace of 698,000, down -1,000 from January. However, permits, a precursor to starts, rose sharply to 568,000 from 535,000 so builders are ramping up for the spring selling season.
On Monday the NAHB Housing Market Index was flat at 28 after a one point downward revision for January.
The slightly lower numbers across all the various housing reports put a damper on the housing sector and a small cloud over the market. On Friday the Q4 earnings from KB Homes (KBH) were an even bigger depressant. KBH posted a loss of 59-cents compared to estimates for a loss of 24-cents. KBH shares declined -9% on the news.
The CEO, Jeff Mezger, was not helping with his comments. "Don't expect this to be a broad based, rocket ship recovery. The overall housing market is better, but this is definitely a localized recoveryâ€¦and in some case, a zip-code by zip-code recovery."
I believe this loss by KBH was unique to KBH. Their lender, MetLife Home Loans, announced unexpectedly in January they were shutting down retail mortgage operations. Mezger said the spike in cancellations was due to the lack of loan availability. He said the punishing standards used by mortgage providers were creating a troubling trend. Despite having preapproval letters more loans were failing to close than before.
Despite the KBH earnings being specific to KBH mortgage lender problems the entire sector sold off slightly on Friday.
XHB Homebuilder ETF
Mass Layoffs for February declined to 1,293 events from 1,434 events. An event tracked in this report must involve at least 50 workers. Impacted workers declined to 119,463 from 129,920 in January. We are nearing the multiyear low at 118,523 we saw in March 2011. This bodes well for the Nonfarm Payroll report due out on April 6th. That report should be interesting since it comes on Good Friday and the equity markets are closed. So far there has not been an announced date change for the payroll report.
The economic calendar for next week is focused on regional Fed surveys. The Chicago Fed report on Monday and Richmond Fed on Tuesday will be key. The Kansas Fed on Thursday is inflated by the increased pace of auto manufacturing.
The GDP report on Thursday is expected to show the final Q4 reading at +3.0%. It will not be important for the market unless there is a dramatic change. Current estimates for Q1 are for a decline to +1.7% growth. Q2 should rise to +2.3% and Q3 +2.8%. This pace of growth is very slow and very questionable. There are dozens of factors that could drag those estimates lower and the biggest of those factors is $4 gasoline.
The average price for a gallon of gasoline in the U.S. rose to $3.89 on Friday. With crude prices rising we could see $4 by next weekend. Diesel rose to $4.84 per gallon. For a trip down memory lane the price of gasoline first broke above $1 in September 1979. $2 on May 19th 2004, $3 on Sept 3rd 2005. The high of $4.11 per gallon was set on July 17th, 2008. The last time the average price was below $1 was March 1999, below $2 March 25th, 2009 and $3 on December 22, 2010. Ten years ago today it was $1.32.
AAA Gasoline Price Map
On Friday at 10:AM the WTI contract rallied from its $105.16 low for the day to $108.25 in the space of about 30 minutes. The spike was immediately sold but WTI closed at $106.75 and right back in the middle of its recent range. Brent, the crude that determines the price of our gasoline, spiked to $127.
The reason for the spike was a report on Reuters that Iranian exports have fallen about -300,000 bpd in March. That is a -14% decline due to the sanctions and they are just now beginning to take effect. Iran exported a four year high of 2.66 mbpd in January. The IEA expects the sanctions to reduce exports by -800,000 to 1.0 mbpd by July.
Crude prices declined early in the week after Saudi Arabia said it had hired the largest number of supertankers in years and they will begin loading Saudi oil over the next two weeks and deliver a "wall of oil" to the U.S. Gulf Coast 40 days later. Saudi Arabia is doing this to try and a) capitalize on the high prices and b) show they can impact prices with their excess production and c) try to head off a global recession caused by high fuel prices as a result of the Iranian sanctions. It also helps rebuild their image as the biggest producer on the planet, the saviour of the global economy and friend to the USA.
Meanwhile tanker trackers will be monitoring Saudi loadings to see if they can accurately determine how much Saudi is actually producing. Because of their large storage facilities this oil they are loading could have been produced months ago when demand was lower and put in storage until Saudi's oil minister was ready to make his grandstand play. Saudi claims it is producing 10.0 mbpd and the highest level in decades with additional excess capacity of 2.5 mbpd. Almost nobody believes that. The guesstimate is excess capacity somewhere between 1.0-1.5 mbpd. If the Iranian embargo was very successful and managed to cut Iranian exports in half (-1.33 mbpd) we would see a real test of Saudi's capacity.
Regardless of how this transpires we should see a national average of $4 gasoline very soon. I filled up my wife's suburban on Friday for $135. That is painful and it will reduce her spontaneous trips. Multiply that by the 200+ million cars in the USA and Target, Wal-Mart and Kohl's will be seeing a lot fewer shoppers or at least a smaller average register receipt.
Food for thought: Since 1950 whenever gasoline has spiked to the same relative level adjusted for inflation ($4.00) there has NEVER been a spike that was not followed by a recession. Given the current weak economy I seriously doubt if this time will be an exception to that pattern.
Gasoline Futures Chart - Weekly
WTI Crude Chart - Daily
Brent Crude Oil Chart - Daily
The weakness in the housing sector caused a decline in the dollar to a two week low. The euro has been in rally mode for the last week now that Greece has received its first tranche of funds and has dropped out of the daily headlines until after the election in April.
The decline in the dollar helped to produce a bottom in gold prices and some commodities but worries over China's economy remained the bigger issue.
I drew a potential reverse head and shoulders pattern on the gold chart. "If" that pattern completes the upside target would be $2,042 according to analyst Peter Brandt.
The dollar may continue to weaken as we move farther into the election cycle. Once the eventual republican candidate begins to spar with Obama the economy will take center stage and every headline will be a negative rehash of the last four years and a forecast for the next four. Elections tend to produce negativity as they attempt to convince voters the situation is bad but will get better if a particular party wins.
Add in the high gasoline prices and consumer sentiment is sure to decline.
Dollar Index Chart
Friday was the second anniversary of the signing of the Affordable Care Act. The term "affordable" is taking on a new meaning today. Remember all the arguments about how it was "paid for" with various taxes and fees? The supposedly nonpartisan Congressional Budget Office (CBO) said last week the cost of the ACA is now expected to be $1.76 trillion dollars for the ten years starting in 2013. Since the act was signed the average family insurance bill has climbed +$2,200 per year according to a study by Kaiser Permanente. A different study by McKinsey found that 30% to 50% of small employers will drop health insurance as a benefit starting in 2014. That will force four million workers into the government system. The majority of the increase in costs comes from the addition of 32.5 million currently uninsured people into the system plus the addition of hundreds, yes hundreds, of new government bureaucracies in order to manage ACA.
Clearly somebody is going to have to pay for that $1.76 trillion and that burden will fall on taxpayers. The Supreme Court will begin hearings on ACA on Monday. Twenty six states have filed suit to stop ACA and its expanded Medicaid provisions as a violation of the Tenth Amendment. A recent Gallup poll found that 45% of Americans believe the ACA was a good thing that Congress passed compared to 44% that believe it was bad. However, an astonishing 72% believe it is unconstitutional. The court will hear arguments for three days next week but the decision is not expected until June or July.
In stock news Apple (AAPL) shares fell -9% at the open. There was only one trade for 100 shares trading at $542.80 and it was cancelled after it triggered the single stock circuit breaker on the Nasdaq. The trade took place on the BATS Global Markets system but that was not the big news for the day on BATS. The company had planned to begin trading on its own IPO on Friday but only one trade was triggered. The stock priced at $16 but opened at $15.25 and was then halted. The BZX Exchange issued an alert saying it was investigating a technical problem that prevented all shares with a symbol range starting at "A through BFZZZ" from trading. BATS is the third largest exchange operator in the U.S. but their IPO was a monster debacle. Shares never reopened and at the end of the day BATS said the IPO had been cancelled and all trades voided. It is not a good day when an exchange can't even launch their own IPO on their own equipment. Morgan Stanley (MS), Credit Suisse (CS) and Citigroup (C) may lose $7.1 million in fees from the cancelled IPO.
BATS is not the first company to cancel an IPO. Wilt Chamberlain's Restaurants retracted its IPO in 1993 after shares declined -30% from the offering price. Normandy America Inc, a reinsurance company that tried to copy Buffett's investment strategies, withdrew a $180 million IPO in 1995, two days after it priced. IPOs normally close three days after they are priced after which the sales are final.
Apple shares declined a relatively minor -$3.29 for the day after word of a new problem on the New iPad. Reportedly the battery on the iPad claims it is fully charged at 80% rather than 100%. Apple said this was not a problem and 80% is the level that provides the stated 10 hours of device life. They actually said if you continue to charge it past the 80% level you could harm the battery. This sounds like another Apple PR problem rather than an actual hardware problem. This is similar to the antenna-gate problem on the iPhone where the service bars showed a drop in service if you held the phone by the edges. I seriously doubt battery-gate or the overheating in the press last week will slow down iPad sales.
Zynga's (ZNGA) shares declined on Friday after the founder and others filed to sell 43 million shares in a public offering. Founder and CEO Mark Pincus along with other privileged insiders will sell their shares only three months after the initial IPO and three months before the lockup expires for everyone else. Pincus said by selling some shares now there will be less to flood the market when the initial lockup expires at the end of six months. That excuse sounds like something a guilty husband would concoct while trying to explain why he had a mistress. "Really dear, I just wanted to save you the stress of having to be my wife 24/7." I doubt those owners who have three months left on their lockup are going to view this favorably.
Pincus will sell 16.5 million shares worth $221 million. Other insiders will sell the remaining 26.5 million shares. Pincus already had favorable treatment with his shares. His Class B shares have seven times the voting power of a Class A share. As part of this IPO all his Class B shares will be converted to Class A. Don't worry about him losing control. His Class C shares he will be keeping have seventy times the voting power of a Class A share. He will retain 35% of the company.
Politics and geopolitical events are really boosting gun sales. Gun maker Sturm Ruger (RGR) announced last week it was not accepting any more gun orders from dealers until later this year. Ruger said it had received orders for more than one million guns since January 1st. "The incoming order rate exceeds our capacity to fulfill these orders." They expect to resume accepting orders by June 1st.
It is commonly feared by gun owners that President Obama might win reelection. His stance on firearms is very clear. The following comment created an uproar among gun owners and religious people. "They cling to guns or religion or antipathy to people who aren't like them or anti-immigrant sentiment or anti-trade sentiment as a way to explain their frustrations."
Many people claim his comments and actions suggest he is biding his time until after the election to pass some draconian gun laws. The NRA is a powerful enough force that he can't make these changes before the election but once reelected he has nothing to fear for the next four years. There are numerous references on the web to comments he has made to various officials but it is tough to know what is true and what is false. In 1996 he filed an information questionnaire when he was running for Illinois State Senate.
35. Do you support state legislation to:
a. Ban the manufacture, sale and possession of handguns? Yes
b. Ban assault weapons? Yes
c. Mandatory waiting periods and background checks? Yes
He said during his campaign he wanted to reinstate the assault weapon ban, close gun shows and outlaw certain types of bullets. The Supreme court case DC vs Heller in June 2008 made those goals a little tougher but still achievable by a president wanting to increase gun control. When the president began routinely issuing executive orders to get around the gridlock in Congress the purchases of guns and ammo increased.
Ammo sales have gone through the roof since he won the nomination in 2007. Ammo prices have more than doubled for some calibers. Gun prices have risen significantly. With the 2012 election polls narrowing and the possibility of his reelection increasing with every fragmented republican primary contest the public is ramping up their stockpiling of firearms and ammo. Nearly one million NCIC background checks were done in January alone. The 920,840 checks were a record and a +17.3% increase over Jan 2011. That was the 20th consecutive month of increases. Business is good for Ruger with an 800% rally since the president took office. If a republican wins in November this could be a good put candidate.
Goldman Sachs (GS) made headlines on Wednesday with a detailed 40 page report calling this a once in a lifetime opportunity to switch out of bonds and into stocks. Goldman strategists claimed it was time to say a "long good bye" to bonds and embrace the "long good buy for equities." Goldman analysts based the call on valuations and "overstated" risks from tighter credit, investment spending and an aging population. "Our global projections show that the next decade is likely to be a peak period for global growth." They did not say "Muppets", as some Goldman mangers call clients, go buy stocks but they came close.
Do you remember Goldman's call for S&P 1450 last May at almost exactly the market top? Could it be that this "lifetime opportunity" call is a signal of a market top? If Goldman is telling all the Muppets to buy then Goldman must be selling. Or, maybe I am just becoming more cynical in my old age.
I am developing an economic view that the economy may not improve much over 2% for a very long time. This view is built on the outlook for the baby boomer retirement cycle and their growing aversion to risk. Plus the likelihood that China has grown too far, too fast and will need years if not decades to "normalize" to a sustainable growth model based on internal consumption. Add in the rising fuel prices that will continue to cycle higher for the rest of the decade and there may be some serious economic changes ahead. I will expound on this more in future articles after I complete my research.
Is Goldman right today? I could easily agree with their view based on bonds declining in value as investors shift into equities. That is a circular argument. If bonds continue to decline because a few investors are shifting to equities then more investors will follow suit until it becomes a tsunami of cash moving to equities. As more investors switch it will cause more investors to switch until everyone is long equities and the trend reverse. The fly in this soup is the Fed's very strong desire to keep interest rates low and their need to buy treasuries to accomplish this.
Not everyone at Goldman is singing from the same hymnal. David Kostin initially expected the S&P to reach 1325 and then decline to 1250 by year end. While he missed that call he is still expecting declines ahead based on a) stagnating U.S. economy, b) stagnating P/E multiples, c) minimal earnings growth. Read Kostin update here.
Goldman may be playing the seasonal card here. April is typically the best month in the first six months of the year for market gains. The average gain over the last ten years has been more than +2%. If you just use the last five years that jumps to +4.5%. This is a result of the Q1 earnings reporting cycle and the guidance for the rest of the year. Unfortunately this is not likely to be a strong earnings cycle. If you remove Apple from the S&P 500 earnings estimates we are already seriously negative on Q1 estimates. Even with Apple we are right at +0.5% growth. Not exactly a roaring reason to buy the earnings cycle.
You know what comes after April. "Sell in May and go away." I hope I am wrong but I am expecting a potentially strong decline in May/June. Historically June is the worst month in the first six with an average loss of -2%. Given our major rally over the last three months we could see some lack of follow through on Goldman's rally call.
If you need another reason to be cautious on the market you have to look no further than Iran. Art Cashin has suggested more than once that an attack on Iran could knock -1,000 points off the Dow in a single day. In the geopolitical chaos that would result from the attack the dollar would be a safe haven and we could see massive flight from Middle East deposits into U.S. investments. The dollar and bonds would spike and equities decline.
There were rumors all week of a hostile takeover in China. Supposedly there were tanks in the streets and gun shots around the Forbidden City. All Internet reports disappeared within 24 hours as China erased the events. China is preparing for its once per decade realignment of the senior leadership and apparently there has been conflicts, infighting and confusion.
Lastly the April 24th Fed meeting could throw a wrench into the summer outlook. The Fed's Operation Twist program comes to an end in June. The Fed has to say something at the end of April on the end of Twist or its replacement. Since the Fed will see the end of Twist (QE light) as tightening policy they have to replace it with something. That something may be a sterilized QE3 where they buy treasuries but then remove those same funds from the market by using repos. While that may keep interest rates low it may not do anything to support the equity market. Whenever a central bank ends its loose monetary policy the market always goes down. If their end of April announcement is not seen as some sort of new QE program the market may react badly.
There are far more reasons why the market may go down in the summer than there are reasons why it should move higher. Markets do climb these walls of worry and the current rally has been doing that since October and using the European debt crisis as a step ladder on its way up. It is too early to know if the market can overcome the summer worry wall but we need to be anticipating a change in sentiment long before it occurs.
The S&P only declined -0.5% for the week and that is hardly the beginning of a correction or even a decent dip. It was just a bump in the road. It would take a decline below initial support at 1390 or a retest of 1375 to produce a serious pause in trader sentiment. We could decline to strong support all the way back at 1340 without really breaking the long term uptrend. However, that would probably strike fear into the hearts of casual investors since it has been three months without a material hiccup in the trend.
S&P Chart - 120 Min
S&P Chart - Daily
The Dow bounced exactly where you would have expected support to appear at 13,000. However, the rebound was lackluster and that would appear to suggest it will be retested. A break of 13,000 would also be a break of the short term uptrend support but it would take a break of support at 12,750 to negate the longer term trend. I don't expect 12,750 to be broken in the next two weeks.
Dow Chart - 120 Min
Dow Chart - Daily
The Nasdaq Composite slowed its climb somewhat last week but still finished the week with a gain to stretch its positive streak to six weeks. Resistance at 3,075 is still intact and the index is well above support at 3,000 and 2,900. As long as the big caps continue to add to their gains the rest of the pack will tag along.
Nasdaq Chart - 120 Min
Nasdaq Chart - Daily
The Nasdaq 100, the big cap tech stocks, stretched their streak to 12 consecutive weeks of gains. That is the longest streak since January 1999. The gains can be traced back to the ten or so megacaps in the tech sector including Apple, Google, Amazon, Priceline, etc. There are billions of dollars flowing into these highly liquid stocks in order for fund managers to participate in the rally but still be able to bail at a moment's notice. When the selling finally arrives it could be brutal given the strength and length of the rally.
Nasdaq 100 Chart - Daily
Nasdaq 100 Chart - 30 Min
The Russell 2000 gave us more of the same last week. The unexpected short squeeze on Monday push the index over very strong resistance at 832 but the hang time was very brief. However, sellers were equally unable to break support as buyers failed to retest resistance.
The Russell did post a +1.04% gain on Friday when the rest of the major indexes were barely able to remain in the green. I believe this was part of the end of the quarter window dressing effort by fund managers. This suggests we could be moving higher next week.
Russell Chart - 120 Min
Russell Chart - Daily
The Russell Microcap Index posted a whopping +1.36% gain on Friday and after the early morning market dip the buying in the micro caps was slow and steady the rest of the day. This is bullish for the broader market. When the smallest of the small caps begin to suddenly find a steady stream of buyers it suggests bullish sentiment is expanding or in this case funds are dressing up portfolios for quarter end.
Russell Microcap Index Chart - 2 Min
Russell Microcap Index Chart - 120 Min
On the other side of the spectrum the Wilshire 5000 is the broadest index of 5000 stocks. Resistance at 14,400 was broken the prior week and the Thursday dip was unable to retrace to that level. There is strong support for all indexes just under the surface. Dip buying is alive and well.
Wilshire 5000 Chart - Weekly
The Volatility Index (VIX) spent the entire week at five year lows. This is normally signs of an extreme overbought condition. However, if you look at the April levels over the last several years, with the exception of 2009, April has seen lows for the year. This is a result of the +4.5% average gain for the S&P in April over the last five years.
Normally I would be recommending closing bullish positions and switching to a bearish stance when the VIX is so low. In this case I think we are premature. The VIX can remain at these levels for several weeks but once the trend reverses it can get ugly very fast.
Vix Chart - Weekly
Analysts will tell you that fund managers are lagging the market because they were hesitant to chase prices earlier in the quarter. As the quarter ends they are forced to throw money at the market in order to dress up their statements.
Other analysts will tell you that retail traders have been resisting new longs since early January due to a serious lack of conviction over Greece, Europe, U.S. economy, earnings, etc. When the markets began to break out to multiyear highs those same investors began throwing caution to the wind and chasing stocks. When bonds began to sell off over the last couple weeks that rotation into equities increased. Bonds have rallied over the last three days and that may give those slow to react an opportunity to exit bonds at a better price than they could have gotten last Tuesday when yields were at five month highs.
Regardless of which class of investor we see buying stocks next week I think equity prices will rise into quarter end. After the quarter ends we could see some normal selling as investors cash out positions to pay Uncle Sam. It is hard to theorize how the tax payments will impact the markets because I always seem to get it wrong. Given the volatility in 2011 it is possible most investors don't have a big tax bill and the market will not suffer from cash withdrawals.
We should always be prepared for the unexpected and in this case for the inevitable end to the current rally sometime over the next several weeks. The "sell in May" trade could be crowded this year and that means it could start early. If the first couple weeks of earnings are negative the current market trend could quickly reverse.
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"There are an enormous number of managers who have retired on the job."
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