Enough time has passed that current economic reports are beginning to show the results of Katrina and $3 gas prices. Major swings in economic numbers announced this week might just be the beginning of a deluge of negativity. On the surface it appeared a -1.75 drop in oil prices helped to defuse the economic numbers and allow the market to rally but the real motive power came from option and futures expiration and a rebalance in the S&P.
Dow Chart - Daily
Nasdaq Chart - Daily
SPX Chart - Weekly
The morning started off with a bang after Consumer Sentiment came in for September at only 76.9 and more than -12 points below the August final at 89.1. This was nearly -20 points below the July level at 96.5. The -12 point drop was the largest drop since December 1980 and the 76.9 level was the lowest level seen since 1992. The expectations component fell to 63.6 from 76.9 and present conditions fell to 97.7 from 108.2. The drop was three times the consensus estimate. There was only a -10 point drop after 9/11 and this shows the result of the double whammy of $3 gas and the Katrina damage. Expectations are for a substantial rebound in the next release. Wholesale gasoline prices have dropped sharply and the recovery efforts in New Orleans are moving faster than expected. This should smooth over fears by consumers as they see more positive news reports and fewer negative sound bites.
On Thursday we saw a corresponding drop in the Philly Fed Survey from 17.5 to 2.2 as the shock of the hurricane damage rippled outward from the disaster zone. In prior hurricanes Andrew and Ivan the Philly Fed number dropped -12 and -13 points respectively. The biggest component drop in this report came in New Orders from 19.8 to -0.5, a drop of more than 20 points. Back Orders fell from 7.2 to -10.9 a drop of -18 points. It is hard for me to believe that orders, especially back orders fell this much in only three weeks due to a hurricane in a southern state. This suggests a substantial portion of the downtrend was already in place before the hurricane impacted the data. The six-month outlook component fell by -26.4 points to only 7.0 and a level not seen since Jan-2001. 50% of respondents felt high energy prices would have a negative impact on business while 58% said those prices would slow production levels due to decreased demand.
Find out which insiders are dumping shares, and which executives are buying back shares of their own stock. Click here now to get your free report of the top insider buy and sell transactions:
Also on Thursday new Jobless Claims spiked to 398,000 for the week from only 320,000 the prior week. That 320K number was adjusted up by +7,000 to 327K in the same release. 68,000 claims were attributed to the hurricane. Considering the number of people unemployed by the storm that 68K number is only a trickle ahead of a flood. With few locations to file claims coupled with the difficulty of just trying to find a place to live and food to eat many have undoubtedly put off filing for unemployment. Expectations are for something in the 500,000 range or even higher as the reporting infrastructure is reactivated. This was the largest jump in unemployment claims in a decade.
The Bush speech on Thursday has prompted a host of questions and worries. With estimates of the rebuilding cost now running well over $200 billion maybe as large as $400 billion the potential for inflation and higher taxes is looming large. Those taxpayers who don't live in the hurricane zone are already complaining about the potential for having taxes raised to pay for the recovery. The potential for inflation as a result of the rebuilding demand and high-energy prices pushed December gold prices to $463 and a high for the year.
December Gold Chart - Daily
Next Tuesday the Fed meets again and the Fed Funds Futures are showing an 85% chance of another 25-point hike. Initially there was a strong feeling that the disaster would push the Fed to the sidelines as the country recovered from the initial shock. With the magnitude of the rebuilding effort growing exponentially the odds of this cash inflow sparking inflation are also growing rapidly. The Prices Paid component in the Philly Fed Survey on Thursday jumped from 25.9 to 52.7, an unheard of rate of increase. The same component in the NY-Empire State Manufacturing Survey also released on Thursday jumped from 29.0 to 53.4. Obviously it was NOT a regional problem and it shows that inflation has already spiked sharply higher over the last month.
While the initial hope was a halt to the Fed rate hike cycle it now appears the Fed may have to accelerate their hikes to 50 points very soon. They may pause at next weeks meeting simply to ease sentiment but the outlook is for stronger hikes ahead.
The high energy prices are already contributing to a steady stream of warnings as we move deeper into earnings warnings season. Dana Corp, (DCN), for instance fell -25% this week after warning that high energy prices and higher steel costs would impact future profits. This story was echoed over and over all week and we are just barely into the warnings cycle. The closer we get to the end of September the more we should expect this pace to increase.
Energy prices are not likely to drop much more anytime soon. The Minerals Management Service said on Friday that 56% of oil production and 34% of gas production is still offline. They said 46 production platforms were destroyed and 20 were seriously damaged. However, a recent survey showed that there was no significant damage to the undersea pipelines. After hurricane Ivan there was serious damage from undersea mudslides, which kept production offline for months in some cases. This good news about the pipelines helped push oil prices back for another retest of support at $63 and exactly where they closed. Should this level fail the most likely support level to hold is $60 and the 100-day average. Since the overall outlook for oil and gas has not changed I seriously doubt we will break that level. I am still recommending buying oil on any dip and a dip into the $60-$63 range is buyable in my opinion.
Crude Oil Chart - Daily
We have seen a slowing of demand due to both the end of the driving season and the removal of an entire region from the daily commute process. This is a temporary reprieve and in light of the IEA comments oil prices should recover soon. The IEA said it was not going to change the quantity of oil (60mb) or the time (30-days) it had allocated to ease the U.S. over the disaster. They refused to extend the time period or quantity and told OPEC to pump more if necessary and to increase its output capability. By closing the exit door on the chance of additional releases it puts the burden of supply back on the normal supply chains and the Gulf. With 56% of oil production still offline it will not take long for us to consume those strategic releases. Also, there will not be any natural gas supplies coming to our rescue. There are no strategic supplies of natural gas to offset the 34% of gas production still offline. We are in the lull between cooling and heating seasons but once the thermostats start creeping higher there could be a serious shortage.
Encana sold its holdings in Ecuador last week to a holding company called Andes Petroleum. The company is actually a front for China according to recent reports. Either way Encana got rid of a serious problem for more than five times cash flow. Ecuador has been a hotspot lately with protestors blowing up oil facilities in hopes of getting oil companies to give them more jobs. Somehow I don't see the logic in this. Neither did Encana and they bailed for a profit. Occidental also has property there and could be in talks with China on selling those assets as well. Wonder if China instigated the riots to make the companies more eager to sell. Enquiring minds want to know. On the other side of the world five Chinese naval ships were spotted near the Chunxiao gas feld in the East China Sea. This is the site of a long term territorial dispute between China and Japan. A Japanese plane monitored the vessels, which included four missile boats, a destroyer, two frigates and an observation support ship as they cruised near the gas field. This was the first time Chinese ships had been spotted near the gas field. Tensions between the two powers over oil and gas assets in the region are escalating and this could have been the first step towards shots being fired. Japan has recently awarded drilling rights to the field to Teikoku Oil Co. and China has already begun drilling in the disputed waters. Sounds like trouble to me and it all comes from China's increasing oil demand. China's demand has increased +40% in the last four years and +7% year to date in 2005. China appears determined to lock up all the oil assets it can well in advance of its future needs. Keep watching for more news of Chinese acquisitions as it paints a dreary picture for the rest of the global oil consumers.
The rally on Friday came mostly on the back of a S&P rebalance event. The rebalance caused an extra two billion shares to be traded as Friday drew to a close. S&P has finally switched to weighting the S&P-500 based on shares available to trade rather than shares outstanding. For instance a very large number of Wal-Mart shares are held by the family and various trusts. They are not available for sale. S&P has now removed those shares from the outstanding shares to calculate market cap weighting. This has the effect of reducing market cap substantially. This meant index fund managers had to sell shares of companies like Wal-Mart and buy shares of other S&P companies to adjust their portfolios to the new S&P weighting. While there were very large sell-on-close orders for numerous large caps including WMT and MSFT those sales were not final until after the close. Meanwhile the accumulation of the smaller companies took place all afternoon. If you are selling 5-million shares of WMT or 10-million of MSFT plus dozens of others it means you have to buy shares in hundreds of companies who had their rankings raised by default. The only way for all the funds to sell those massive amounts of shares is to do it with market on close orders but buying small amounts of hundreds of replacement companies can occur all day. This buying helped push the indexes higher while the major selling was lumped into the close. Index arbitragers were also active trying to front run the funds as the imbalances were posted. What this will do to the indexes on Monday morning is still undetermined since the amount of buying/selling still undone is unknown. We also don't know how much stock the arbitragers are still holding. Still, the point is the rally was again artificially induced and does not represent real buying. Just for reference WMT traded 96 million shares, 10x daily average and 40 million of those shares came five minutes after the close. Other shares traded after the close include nearly 25M in MSFT, 3M in INTC, 6M in GE, etc. Volume across all the indexes soared to 5.9 billion and nearly two billion (+50%) above any other day this week. Volume had been heavier the prior three days but still just a fraction over 4B each day. An extra two billion shares traded will definitely skew the indexes and the bias by default was to the upside.
SPX Chart - 5 min
Despite the extra two billion shares the Dow was not able to close positive for the week. The +83 gain on Friday came close but the index still lost ground for the week as did the other indexes. The Dow rallied to 10650 before running out of steam at the close. The Nasdaq hit 2160 before the bell. The S&P, the index most likely to be erratic from the rebalancing jumped +10 to 1238 and nearly to the 1243 resistance we saw last week. Even the SOX got in on the act as it spiked +5 points to 475 just before the close. Personally I believe any artificial bounce is begging to be sold once the artificial stimulus is removed. Once any remaining portfolio rebalancing occurs at the open on Monday I would be a seller of the broader market on any weakness. This is especially true given the recent spikes in the inflation indicators and the impending Fed meeting on Tuesday.
I heard one analyst saying they expected $500 million in routers and switches to be sold into the disaster zone with Cisco, Juniper and Lucent benefiting. Another was saying over a billion in personal computers would need to be replaced. Still others were talking about massive amounts of cell phone equipment to replace an entire city of towers and bases. I completely agree that these events will come to pass but not until the pumping is over, the cleanup completed and the carpenters leave. Look for it in Q1 not Q4. Also, an extra $200-$300 million for Cisco is a drop in the bucket given their $25 billion in annual sales. Dell could get a large portion of the PC replacement cycle but with $50 billion in annual sales it will not really make a serious dent. It will also be a long-term replacement cycle as the recovery continues not a lump sum event.
the anticipated replenishment cycle is still many months away for things
other than wood, sheetrock and other building supplies, I don't see any material
reason to buy stocks ahead of the normal end of September and early October
weakness. I would much rather buy the dip than buy the top. I would continue to
watch SPX 1225 which acted as support once again on Thursday. SPX 1230 was
earlier interim support but it lasted barely more than a day. On Friday it was
intraday support once again
and a failure there should predict a failure at 1225
as well. I would short any break of those levels with an eye on lower levels for
the next couple weeks. Earnings warnings will increase and the Fed is likely to
say things the market will not like. As always, remember to enter passively and
exit aggressively and definitely don't get married to your positions or your
New Long Plays
Mckesson - MCK - close: 46.47 chg: +0.25 stop: 44.85
Why We Like It:
Picked on September 18 at $46.47
Steel Dynamics - STLD - close: 33.91 chg: +1.42 stop: 31.49
Why We Like It:
Picked on September 18 at $33.91
New Short Plays
Long Play Updates
Forest Labs - FRX - close: 44.24 chg: -0.60 stop: 42.49*new*
Biotech stocks did not participate much in Friday's rally. FRX failed to participate at all and actually displayed relative weakness with a decline toward the bottom of its three-week trading range. The relative weakness has us feeling cautious and the technical picture for FRX is suddenly looking a lot weaker. We would not suggest new plays until FRX trades back over $45.00 or even $45.20. In the meantime we are raising the stop loss to $42.49. More conservative traders may want to put their stop closer to $43.00.
Picked on September 14
Idex Corp - IEX - close: 44.62 change: -0.21 stop: 41.99
We do not have much new to report on for IEX. We suggested longs on the bullish breakout over resistance at $44.00, which was also the top of its five-week trading range. Thursday's intraday dip looked like a new bullish entry point. The long-term trend remains bullish. If IEX dips again the $44 level should act as support and bounces from $44 can be used as new entry points. Our target is the $47.50-48.00 range.
Picked on September 11 at $44.43
Rowan Cos - RDC - close: 36.53 chg: +0.10 stop: 34.95
RDC continues to inch higher. Shares recently broke through short-term resistance after testing support at its trendline of higher lows. Wall Street is bullish on RDC since the company stands to benefit from higher demand and rates for its services as the oil industry tries to rebuild in the Gulf of Mexico following hurricane Katrina. We would suggest new longs anywhere above $36.00. Our target is the $39.50-40.00 range.
Picked on September 14 at $36.31
Radian Group - RDN - close: 52.75 chg: +0.64 stop: 49.99
Shares of RDN continue to show relative strength. On Friday the stock pushed to another new two-week high and its MACD indicator produced a new buy signal. More conservative traders may want to consider tightening their stops toward the 50-dma near 51.20. We are targeting a move into the $54.00-54.25 range.
Picked on September 07 at $51.10
Ryerson Tull - RT - close: 21.32 change: +0.12 stop: 19.49
Shares of RT are still stuck in their narrow trading range between $21.00 and $21.50. We continue to have a bullish bias on the stock but we would not suggest new entries here. Instead wait for another pull back toward the $20.50 level and buy a bounce there (be sure to wait for the bounce). Our target is the $23.50 level.
Picked on August 31 at $20.54
Short Play Updates
Anheuser Busch - BUD - cls: 45.20 chg: +0.15 stop: 46.25
We are still playing BUD as a bearish candidate off its longer-term trends. BUD has been slowly bleeding lower in a descending channel for the last 18 months. Currently the stock should find resistance at its simple 100-dma just south of the $46.00 mark. We initially planned to target a decline toward $40.00 by BUD's late October earnings but shares are moving even slower than we expected. We are not suggesting new plays at this time but readers can watch for a couple of various entry points. Aggressive traders can short a failed rally under $46.00. More conservative traders can wait for another decline under $44.00.
Picked on July 28 at $44.77
Intl Game Tech. - IGT - cls: 27.40 chg: +0.19 stop: 28.01
On Thursday we said that if IGT breaks out over its simple 50-dma we would plan to close this play early. On Friday the stock did trade above the 50-dma but it couldn't hold it. This could be another failed rally so we're going to give IGT another day to see what happens. If IGT closes over $27.50 we're exiting early. More conservative traders may want to tighten their stops. We are not suggesting new plays here.
Picked on July 21 at $27.21
Nautilus Inc. - NLS - close: 23.84 chg: +0.44 stop: 26.10
On Wednesday this past week shares of NLS broke down sharply through major support near $25.00, its 200-dma and through the bottom of its two-year rising channel. The follow through on Thursday was met with a sharp bounce. We suspect that NLS will continue to produce an oversold bounce until it retests broken support near $25.00 as new overhead resistance. Readers can watch and wait for a failed rally under $25.00 as a new bearish entry point. Our target is the $20.50-20.00 range before its late October earnings report.
Picked on September 14 at $23.80
Wal-Mart - WMT - close: 43.87 change: -0.45 stop: 46.05*new*
WMT saw a massive surge of volume at the end of the day on Friday as funds dumped shares to realign with the S&P rebalancing. The stock broke down under the $44.00 level and its MACD indicator has produced a new sell signal. The overall pattern looks pretty dismal for WMT but short-term we're beginning to believe that the stock is oversold and due for another bounce. We would not suggest new positions at this time. We are going to lower the stop loss to $46.05. We are adjusting our target to the $42.50 level.
Picked on August 24 at $45.95
YUM Brands - YUM - close: 50.58 change: +0.59 stop: 51.01
We think the market rally helped fuel the bounce in shares of YUM and that the rally lacks conviction. That's why YUM is still trading under its six-week trendline of lower highs. Of course we chose to play with a relatively tight stop so that if we're wrong we're taking out of the play quickly. Our plan was to try and scalp a couple of points as YUM fills the gap from September 7th. At this time we would not suggest new plays. Readers may want to consider new positions if YUM trades under $50.00 again or wait for a new decline under the 200-dma (49.43). Our target is the $48 level.
Picked on September 13 at $49.98
Closed Long Plays
Closed Short Plays
Fincl. Sel. SPDR - XLF - close: 29.95 chg: +0.42 stop: 30.01
We are going to exit early on the XLF. Friday's session witnessed a very strong bullish reversal in the financial sector. The BIX and BKX banking indices broke out over significant resistance. While the XLF has not yet broken through resistance at the $30.00 level we are not going to wait around to find out.
Picked on September 13 at $29.71
Today's Newsletter Notes: Market Wrap by Jim Brown and all other plays and content by the Option Investor staff.
Option Investor Inc is neither a registered Investment Advisor nor a Broker/Dealer. Readers are advised that all information is issued solely for informational purposes and is not to be construed as an offer to sell or the solicitation of an offer to buy, nor is it to be construed as a recommendation to buy, hold or sell (short or otherwise) any security. All opinions, analyses and information included herein are based on sources believed to be reliable and written in good faith, but no representation or warranty of any kind, expressed or implied, is made including but not limited to any representation or warranty concerning accuracy, completeness, correctness, timeliness or appropriateness. In addition, we do not necessarily update such opinions, analysis or information. Owners, employees and writers may have long or short positions in the securities that are discussed.
Readers are urged to consult with their own independent financial advisors with respect to any investment. All information contained in this report and website should be independently verified.
To ensure you continue to receive email from Option Investor please add "firstname.lastname@example.org"
Option Investor Inc