When everyone was expecting a further decline a rally suddenly appeared. It is real or a mirage?
After looking at more than 500 individual stock charts on Friday afternoon I would say this rally as a good chance of being real and not just a temporary rebound. Quite a few stocks had rebounded above initial resistance levels after a stop clearing dip early this week. The strength of the rebound in individual stocks suggests the shorts were squeezed out and investors were putting money back to work.
Last year in the midst of the best year in a decade we had three dips in the 4-5% range and three in the 2-3% range. Each was rumored to be the "big one" but all six were bought and the markets closed at the highs for the year. Traders and to some extent investors have a short term memory. If something has worked in the recent past they tend to believe it will work again. A rebound from a -5% dip is what the average investor expected. It was only the professional traders and market analysts that expected the January decline to surprise to the downside.
One reason why I think this rebound has legs is the response to the Nonfarm Payrolls on Friday. The report disappointed for the second month in a row with a gain of only +113,000 jobs compared to lowered estimates for +180,000. December's dreadful +74,000 gain was only revised up +1,000 to 75,000. Everyone was already prepared to blame the weather but economists including the BLS said no. While there was some small weather impact, the big decline was not weather related. Oops! The BLS said the survey week was a relatively warm and a storm free week so weather was not a significant factor.
The unemployment rate declined -0.1 to 6.6% and the labor force participation rate rose from 62.8 to 63.0%. The benchmark revision that happens in January added +509,000 jobs for all of 2013. This revision is done every year to update for the business birth/death rate, final updates from actual data that was submitted late and seasonal data revisions. Historically, the benchmark revision adds to the overall employment for the year. For 2013 BLS found an error that subtracted -119,000 jobs or the revision would have been higher.
Why was the market rebounding on bad news? First, it was not all bad. The separate Household Survey showed a gain of +616,000 jobs compared to a loss of -347,000 in December. This pushed up the labor force participation rate from 35 year low. November jobs were revised +33,000 higher to +274,000 and the strongest month since January 2012. That makes the three month average ending in November of +225,000 jobs per month. The last two months have averaged only +98,000 but nearly every traders believes it was weather related even when the BLS and others are saying it was not material.
As an example of the weather impact there was a decline of -22,000 construction jobs in December that may have been weather related or simply seasonal. In January, with horrible weather, the construction sector added +48,000 jobs. Manufacturing payrolls rose from +8,000 in December to +21,000 in January. Government employment fell -29,000 jobs, which were concentrated in the Postal Service and education. The postal service is thinning the ranks so that is not likely weather related.
Also, the manufacturing portion of the economy created 76,000 jobs and that was the highest number in seven years according to David Rosenberg of Gluskin Sheff. The service portion of the economy only produced 37,000 jobs and that was the lowest number since June 2012. Analysts claim the spike in manufacturing employment was positive because the service sector will follow manufacturing. Secondly, you can always find something to like and hate in every report. Highlighting one number from an ugly report does not make it a good report.
Lastly, the BLS publishes a number for people "not at work due to weather." That number for January 2014 was 226,000. However, in five of the last six years the number was actually higher. Only January 2012 was lower at 200,000 so that effectively kills the "weather" excuse for the low number of new jobs.
Lastly, the BLS published a disclaimer in the January report. The warning says "Establishment survey data has been revised as a result of the annual benchmarking process and the updating of seasonal adjustment factors. Also, the household survey data for January 2014 reflects updated population estimates." They changed the base data, the total population estimates and the seasonal adjustments. They added 2,103,000 jobs to the actual January numbers as a "seasonal adjustment" to get to that final +113,000 number. The Nonfarm Payroll numbers are more fiction than fact as a result of all the manipulation they go through to get a "satisfactory" final number.
I can only guess that two months of significantly lower job creation may have given investors the impression that the Fed will taper it's taper and slow the removal of QE. Why else would investors be bullish when other economic reports have been bearish and job creation is slowing?
I suspect the market simply rebounded from an oversold condition on the theory bad news is good news once again. We had weaker than expected numbers from the Nonfarm Payrolls, ADP Employment, Factory Orders, Vehicle Sales, ISM Manufacturing, Construction Spending, Pending Home Sales, Durable Goods, New Home Sales, Existing Home Sales, etc. While retail traders may think this data will force the Fed to taper the taper there is little possibility of that now that they are well into the process.
However, some investors do believe this sudden downturn in economics could be lasting and the Fed could possibly halt the taper. Gold posted the biggest weekly gain in a month to close at $1,262.90 an ounce. Gold futures are showing a potential breakout over $1,270 if economic worries continue.
Earnings are going to fade next week with 60% of the S&P already reported. So far 67% have beaten on earnings with the earnings growth rate now approaching +7.5%.
If we expand our universe to the 1,100+ companies that have reported earnings so far the numbers improve dramatically. Of that number 65% have beaten EPS estimates and 64% have beaten on revenue. If this trend continues it will be the strongest earnings beat rate since Q4-2010 according to Bespoke and the strongest revenue beat rate since Q2-2011.
The Bespoke data is contrary to the narrower S&P data we have been seeing with only about 50% beating on revenue. However, about 59% of the S&P companies giving guidance have lowered their 2014 forecast. What does that say about Q1 earnings expectations?
The economic calendar for next week is minimal. The most important event is not economic but Janet Yellen's first testimony to Congress on the state of the economy. This is likely to be a pivotal point for the markets. How she presents herself and her plans will set the tone for the first year of her tenure. It could be a rocky day for the markets and there is always the potential for a market spike if her dovish side makes an appearance.
The current debt ceiling authorization expired on Friday. Treasury Secretary Jack Lew warned Speaker Boehner that the Treasury would exhaust its "extraordinary measures" and run out of money by February 27th. By that date the government's available cash would fall below $50 billion and could no longer guarantee payment of America's debts.
The debt ceiling debate is going to start heating up over the next two weeks and it could get ugly again. However, I believe the republicans will want to keep it from becoming a hindrance to the November elections and will give up quickly in their attempt to attach some concession to the debt ceiling extension. Over the last 50 years almost every time the debt ceiling has come up for a vote there have been conditions attached. The prior demands are almost equally split between the democrats and republicans so neither party has a record of clean debt limit extensions.
As Friday's go it was very quiet in the market. Not summer Friday quiet but the headlines were few and far between. There were the obligatory earnings updates and a constant rehash of the Nonfarm numbers and debate over tapering but the intensity was missing. Even the report of an attempted plane hijacking to Sochi was little noticed. Volume was almost identical to Thursday with 6.95 billion shares compared to 6.91 billion. These were the lowest volumes for the week with Monday's crash coming on 9.55 billion shares. Apparently traders were content with watching the rebound rather than chasing it.
The earnings leader for the day was AthenaHealth Inc. (ATHN). The company reported earnings of 57 cents compared to estimates for 44 cents and 16 cents in the year ago quarter. AthenaHealth is an electronic health records service provider. They said their network of doctors increased by 28% and bookings were up 30%. The strong earnings came after several quarters of earnings misses and apparently many traders were expecting another miss. Shares of ATHN rose $35 or +25% on the news.
Barron's said ATHN was in the strongest position to profit from the coming revamp of the World Health Organization's disease codes called ICD-10. Barron's estimated that of the 1.1 million healthcare providers in the U.S. as many as 25% will be transitioned to an outsourced billing service following the implementation of ICD-10 in October. Barron's believes that will add 10,400 new doctor's offices to the AthenaCollector service in 2014. Barron's said AthenaCollector was the better mousetrap for outsourced billing for hospitals and independent practices.
LinkedIn needs a better mousetrap to capture new users. Earnings for Q4 fell -67% to 3 cents while revenue rose +47% to $447.2 million. The company projected revenue in Q1 of just over $455 million compared to analyst estimates of $469.4 million. The new revenue forecast for 41% growth was down from prior estimates for 72% growth. Membership rose +37% to 277 million but analysts were expecting closer to 290 million. The slowing growth weighed on the stock for a $14 drop to $209.
Expedia (EXPE) shares rallied after gross bookings rose +21% for the quarter driven by room night growth at its Hotels.com brand. An increase in flights booked online also drove revenue higher. Earnings were 92 cents compared to estimates of 85 cents. Revenue rose +18% to $1.15 billion. Shares rallied +14% on the news. As you can see in the chart it is either feast or famine for Expedia when earnings are reported. There is either a gap up or a gap down every time.
Cigna (CI) shares fell -9% after reporting earnings of $1.39 compared to estimates of $1.48. Revenue rose +7% to $7.62 billion but missed estimates of $8.06 billion. More bad news came from the guidance. Cigna is expecting to earn between $6.80-$7.20 for 2014 but analysts were expecting $7.29.
Verisign (VRSN) shares dropped -6% on worries the company's profit margins are shrinking. The company's earnings of 67 cents were up +8% and in line with estimates but forecasts for $1.0-$1.02 billion in revenue for 2014 was lower than analyst estimates at $1.03 billion. The company added 1.29 million net new domain names in Q4 compared to 1.55 million in Q3. Active .com and .net names increased +5% to 127.2 million. Verisign processed 8.2 million new domain name registrations for the quarter and down slightly from the 8.3 million in the prior quarter. The company bought back 4.1 million shares in the quarter and the board upgraded the outstanding approval from $472 million to $1.0 billion for buybacks in 2014.
Another company benefitting from a share buyback plan was Outerwall (OUTR) the parent of the Redbox DVD rental business. The company said it was going to purchase $350 million in shares through a modified Dutch auction tender offer. If fully subscribed that will bring the total dollar amount of shares purchased since February 2013 to $555 million. The company reported earnings of $1.68 on revenue of $593.7 million compared to estimates of $1.24 and $596.1 million. Earnings rose +81% and revenue +5%. Shares rose +12% on the news.
IBM shares rallied +2.50 on Friday after the company hired Goldman Sachs to help it find a partner for its chip business. IBM has been trying to sell the division for some time with no luck. By switching to a partnership IBM can continue to control the design and intellectual property and the new partner gets the benefit of a deep pocketed and knowledgeable benefactor.
IBM shares have rebounded from the $172 level for the third time in four months and this should be decent support. IBM is selling low margin divisions to concentrate on its high margin businesses. I think IBM shares will come roaring back later in 2014.
Apple (AAPL) shares rallied +$7 to $520 after the company said it had bought back $14 billion in stock over the past two weeks. CEO Tim Cook said in an interview with the WSJ that he was "surprised" by the -8% decline after they reported earnings that included disappointing iPhone sales. That brings the total buybacks to $40 billion over the last 12 months. Carl Icahn is pressuring Apple to buy back another $50 billion in addition to the $100 billion program they are currently working on completing. That $100 billion includes buybacks and dividends. Icahn wants the buybacks to be completed in 2014. Icahn raised his stake to $3.6 billion after adding $500 million in shares after the post earnings drop.
The markets seem to have avoided a 10% correction with the late week rebound but it is too soon to know for sure. Investors withdrew money from equity funds at the fastest rate on record with a $28.3 billion outflow so far in 2014. Investors put about half of that cash to work in bond funds, which saw inflows of $14.8 billion. We have been waiting for a year for the "great rotation" to begin where cash would come out of bonds and into equities as the Fed ended the QE program and interest rates moved higher. The massive outflow from equities and into bonds has gone the other way and it appears the rotation is from equity risk to bond safety as a result of the weak economics and weak market.
At the S&P low for the week at 1,737 that was a -6% dip from the 1,848 high close on January 15th. After Monday's monster -326 point decline in the Dow and -40 drop in the S&P the fear factor increased significantly with the VIX hitting 21.48 intraday. That was the high point for the week as the 21 level is seen as a buying opportunity in most cases. The VIX has reached that level four times since late 2012. Each time a rally began over the next several days. Eventually that plan is not going to work since the VIX can go up another 200-300% in times of real stress.
Since 1945 there have been 27 corrections of 10% or more with 12 bear markets with losses of 20% or more. The average correction loses -13.3% and takes an average of 71 days. Since the bottom of the market in March 2009 we have had three corrections. In 2010 there was a 69 day drop of -16%. In the summer of 2011 there was a 154 day correction of -19%. In 2012 there was a -9.9% correction of 59 days. (Data courtesy of Josh Brown) The -6.5% drop in 2014 was still just a pothole in the market highway unless the market rolls over again soon.
Also helping the U.S. markets recover was a rebound in the Nikkei and the emerging markets in general. The Nikkei rebounded +462 from a three month low. The Nikkei plunge to 14,000 put the index in a seriously oversold condition and it was due for at least a dead cat bounce. Since every decline does not magically stop at a large round number the test will be whether the rebound continues next week or goes back to retest that 14,000 level.
The S&P tested the 1,740 level on Monday and Wednesday with the low for the week on Wednesday at 1,737. The rebound recovered 60 points of the decline to put the index right back at 1,797 and just under the key 1,800 resistance level. Not only is that the resistance high from the prior week but also the longer term uptrend resistance from May.
A +60 point rebound is more than enough to relieve the oversold conditions and clear out the majority of the shorts. Thursday's short squeeze stopped right at the prior support of 1,775 and some shorts probably reloaded at the close ahead of the payroll report. They were punished again on Friday when the bad news bulls bought the dip after the report.
If the S&P moves over 1,800 with any velocity then the sell off is over. If it struggles to gain a handful of points the bears will jump right back in and the fight will begin anew.
The worry for pattern traders is that we struggle at the 1,800 level for a week and build a right shoulder on the daily chart before going back to retest the 1,740 level again. That would be a very bearish setup.
The Dow tested the 15,350 level twice last week before sprinting for +437 points into Friday's close. The index is now entering a resistance range from 15,800 to 15,940. I doubt it will be a straight run with a breakout on Monday ahead of Yellen's testimony but anything is possible.
Numerous Dow stocks were severely oversold with very bearish charts and the shorts were clearly shaken lose. It remains to be seen if they reload those positions or go find a different trade.
If the Dow does continue higher the bigger challenge will be the 16,000 level where it could find right shoulder resistance similar to the S&P. A continued run to 16,000 would be +640 points from the lows and it would be extended and in need of a rest.
Only one Dow component was negative on Friday and that was Coca Cola by -8 cents.
The Nasdaq Composite had the best recovery of the big three indexes according to the charts. The +68 point rebound on Friday pushed it over resistance at 4,100 and positioned it nicely for an attempt to recapture 4,200. The sell off punched through the 4,000 level intraday but could not hold it but that was probably enough to flush out the weak holders. The +168 point rebound (+61%) was impressive. At its lows the Nasdaq was down -275 or -6.5% from the 4,243 closing high on January 22nd. I believe the Nasdaq has an easier task to regain the prior highs than the Dow and S&P. Support on any weakness would be 4,050.
Unfortunately the Russell 2000 is well below the relative levels of the other indexes. The decline pierced support at 1,100 and the rebound was lackluster relative to the points lost. The Russell declined -99 points to a low of 1,082 and rebounded only +34 points or basically one-third of its loss where the Nasdaq regained +61% of its losses.
The Russell did not return to 1,140, which would be the same relative resistance level seen on the Dow and Nasdaq. This means any future gains will require a +24 point move just to get to the level the other indexes are at today.
The Russell 2000 LOST -1.27% for the week.
I believe the key for next week will be the S&P moving over 1,800. If it happens on volume then the correction is probably over. If it is a lackluster move of just a few points I would be cautious about piling on a bunch of long positions. There is plenty of time to trade as long as you have capital. The Yellen testimony is going to be a pivotal event. Waiting until after her interrogation could be worthwhile.
David Woo, head of global rates and currencies at BofA, released a report last week saying there is a direct correlation between temperature and Q1 economic growth over the last decade. He said January was the coldest since 1988 and February is on track to be colder than normal. He found that a 1 degree Celsius drop (-1.8 F) in the average temperature in the first quarter is associated with a -1.5 percentage point drop in GDP growth since 2004. He said retail sales are much more sensitive to cold weather in Q1 when consumers don't have to shop compared to Q4 when consumers are forced to shop for the holidays. Bottom line, Q1 GDP may be significantly below estimates.
The Q4 GDP of 3.2% was mostly due to a buildup in unsold inventory and that will detract from GDP in future quarters.
Don't ignore the January Barometer. Here is an article by Jeffrey Hirsch on why we should be worried about the negative January. Prepare for Weakness
Months without electricity? It may be closer than you think. In what may have been a trial run a group of trained shooters shutdown a San Jose electrical substation in 2013 by firing 120 rounds in a 7 minute attack on 17 transformers from 40 yards outside the chain link fence. The location was scouted in advance and fiber optic cables were cut to eliminate communication from the station. This scenario has been a concern for planners for years. Targeted attacks on key substations could knock out the electrical grid to specific states or regions with very little risk to the terrorists. The transformers are expensive, made overseas and take months to replace in any quantity. Electrical Terrorists
Where is the gold? I reported on this back in 2012 but it is getting worse. In 2012 Germany told the Fed it wanted a third party audit of the 300 metric tons of gold stored at the New York Federal Reserve Bank. The Fed refused to allow an audit. Not to be denied they then told the Fed they wanted full custody and would repatriate the gold to Germany. The Fed said ok but not now. We will return it over the next seven years. Obviously this raises significant questions. Is the gold there or not? If it is there why would it take 7 years to return it? That suggests the gold is not there. In the year since the Germans requested the return of their gold only 5 tons has been released. If it is there why only 5 tons in a year? The conspiracy theorist in me is going crazy with this one. Even more of a problem is the rapid accumulation of gold by China. That is the second part of this article. Who Has the Gold
Comstock Partners laid out their reasons for claiming we are in a cyclical downturn in the markets. Are they right? Cyclical Downtrend Underway
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"Even being right 3 or 4 times out of 10 should yield a person a fortune, if he has the sense to cut his losses quickly on the ventures where he has been wrong."
Bernard Baruch (Financier, speculator, statesman, presidential adviser, 1870-1965)