A stronger than expected drop in the Philly Fed survey was blamed for the two-day drop in the markets. While that was an unexpected drop in the Philly numbers there were numerous other factors also contributing to the market weakness. High on the list was the strong overbought conditions as the markets rebounded to retest the multiyear highs. This was stretched even further as traders anticipated the Fed would remain on the sidelines and pushed the markets higher. Once the Fed announcement was made there was nothing else to motivate buyers ahead of the historical Sep/Oct weakness. The Philly Fed report was simply the catalyst that triggered the much needed profit taking to return the indexes to primary support levels. Now that the overbought conditions have eased next week will be a critical test of bullish convictions.
Dow Chart - Daily
Chart - Daily
The dramatic drop in the Philly Fed from +18.5 to a negative -0.4 significantly shocked analysts and investors. Sometimes you have to be careful what you wish for or you might just get it. Everybody wanted the Fed to be done cutting rates and that required a significant deterioration in economic fundamentals. The Philly Fed was the first of what could be many evidences of that economic slowing. Basically investors got their wish but now they want to retract it. This was the first time the survey has been in negative territory since April 2003. It was also the largest drop since the -19 point drop in January 2001 only two months before the last recession. The headline number at -0.4 hid more serious negatives in several components. Shipments fell from 22.3 to -6.8. New orders fell to -1.3 from 15.7 and unfilled orders dropped to -5.3 from 0.6. The Philly Fed survey is normally seen as a leading indicator of national manufacturing activity. Negative numbers are seen as slowing activity while positive numbers represent an expansion of activity.
The sharp drop in the Philly Fed numbers will put more emphasis on the Chicago PMI next Friday and the National ISM the following Monday. Unlike the Philly Fed any number over 50 on these reports is considered expansion while a number under 50 indicates a contraction. The Chicago PMI came in at 57.1 last month and the ISM was barely expansionary at 53.5. The economic bears came out of the woodwork this week with predictions of gloom and doom in every sound bite.
Chart of Ten-Year Note Yields - Daily
Bonds suddenly found favor again and the yield on the ten-year note fell to 4.59% and a level not seen since March 2nd. With the Fed funds rate at 5.25% there is a serious disconnect between the economic outlook of bond buyers and the outlook of equity traders. The chances of another rate hike are less than zero. With meetings in Oct, Dec and January the February futures are now pricing in a 40% chance of a quarter point cut at one of those meetings. The November futures are showing a miniscule 4% chance of a cut in October. However, the most likely scenario is a continued pass for the rest of 2006 to avoid any political connotations surrounding the elections and then a cut at the January meeting. The sharp drop in yields, -25 basis points since the Monday high at 4.85% and the largest drop in 17 months, is very bullish for the housing sector. Part of Friday's drop in yields was attributed to comments from Greenspan that were interpreted as dovish for future rates. He also said that the current low rates would provide support for housing and help slow the current housing decline.
Bonds are finding favor as a safe trade ahead of potentially rocky economics. Next week the calendar starts off with Existing Home Sales on Monday and New Home Sales on Wednesday. With homebuilders very oversold and real interest rates crashing it may be time to speculate in some long-term calls. Any bad news will probably be ignored. The key economic reports are the three manufacturing surveys, the Chicago PMI on Friday and the ISM on the following Monday.
Next week is earnings warning week. The quarter is basically over for accounting purposes and companies now know if they are going to hit their forecasts. We have seen a flurry of warnings over the last week with warning ratios rising. These companies warned on earnings or cautioned on guidance, DCX, MAS, FBN, STLY, LEA, BWA, FDX, BSX, NYT, YHOO, MCHP, XLNX, MXIM, AATI, MSCC and of course the homebuilders continued to predict the earth would open and swallow their various projects. The ratio of negative to positive warnings rose to 2.4 compared to 2.09 in Q3-2005 and the historical average of 2.2. This means the number of negative guidance announcements is rising above historical norms. Analysts still don't think this is a major problem and Thomson Financial is still predicting S&P earnings growth of +14.2%. There have been some sector downgrades such as consumer discretionary companies from +20% growth to only +9%. Holding up the averages Thomson is expecting earnings from the materials sector to rise +46%, finance +28% and energy +17%. Remember Q3-2005 was a strong quarter for energy stocks after the sharp price gains surrounding Katrina. This will make earnings comparisons difficult. Thomson says this will be the 13th straight quarter of double-digit earnings growth and only the second time this has happened with the other being the streak from 1992-1995.
According to the analysts earnings will not be a problem but in reality the overall average will be held up by a few strong sectors. Nothing new but there will be individual problems that could sour investor sentiment. Remember Dell is expected to warn and their frantic attempts to regain share and unload inventory could cause profit shrinkage in the rest of the PC sector. As you can see by that list of warnings above many of those are chip stocks. I am not going to spend a lot of time speculating on which stocks or sectors could cause problems next week because we have another problem facing next week us that will be more evident.
That problem is the end of quarter portfolio games. The third quarter is a critical quarter for funds with the Q3 portfolio statements seen as a setup for the next year. Funds do not want to show losers in their Q3 statements. They want to show recent winners so investors think they are smarter than they really are. This means the next week should see more selling in those losers already down hard and more buying in the recent winners. The sector hardest hit is of course the energy sector. I would say homebuilders as well but the selling has already moderated in those as bottom fishers have already created support. That leaves energy as the scapegoat and the sector most likely to get dumped again next week. Sectors likely to find additional buyers would be financials, broker dealers, drugs and telecoms. Fund managers trying to mark up their portfolios will be buying more of stocks like Goldman Sachs (GS), Morgan Stanley (MS), MetLife (MET), Electronic Arts (ERTS), Apple Computer (AAPL), Nvidia (NVDA), Corning (GLW), China Life (LFC), AT&T (T) and takeover target BellSouth (BLS), Verizon (VZ) and the Telecom Holders (TTH). Their plan will be to push those stocks they already own higher in order to dress up their end of quarter statements. This buying should be spread out early in the week since the SEC has begun monitoring the last couple days of the month for fund abuses.
November Crude Oil Chart - Daily
Helping to push energy prices lower next week was the drop to $60 in the November contract for crude and a new two-year low for natural gas at $4.59. We saw a nice attempt at a rebound once the selling related to the expiring October contract had passed but $62 remained firm resistance with another flush into Friday's close. This could be a really rocky week for energy but that could change the first week in October. We are seeing that end of quarter flush stimulated even more by the lack of any outside events. No hurricanes, BP will restart production in Alaska next week, Iran is talking nice to anybody who will listen and inventories are at multiyear highs. It will not be a permanent drop but funds will probably dump some of their window dressing stocks once September ends and start buying energy again for the winter rebound.
Tanker tracker PetroLogistics said OPEC shipments have dropped -400,000 bbls per day in September, mostly from Saudi Arabia. This could be a leading indicator that OPEC is already reducing output to support the price above $60. Saudi can get nearly the same revenue by selling 8.1 mbpd at $65 as they can by selling 9.1 mbpd at $58. The difference is only $1.3 million. A drop in the bucket compared to the $527.8 million or so they currently receive each day. (Those numbers are based on the price of light crude and Saudi actually sells a mix of crude at a lower average price but you get the idea.) The Saudi Oil Minister Ali Al Nuaimi said in one interview that oil prices were still lucrative for producers and at a satisfactory level. In another quote he said current prices are "fair" which was a change in stance from "unreasonable" in prior comments. This is probably another clue that $60 is going to be supported and maybe slightly higher. Of course he also said Saudi was still producing its full OPEC quota of 9.1 mbpd and nearly everyone on the planet knows this is not true. Shipments in August had fallen to about 8.1 mbpd and if Petrologistics is correct they have slipped even more in September. Time will tell but you can bet they have grown very accustomed to receiving $65 and above. EIA senior analyst Doug Macintyre said on Friday the EIA expects prices to return to the mid to upper $60s later this year and possibly back over $70. Goldman Sachs also maintains their $70+ price target for Q4. I hope they are right and I plan on adding to positions on weakness next week.
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I saw an interesting statistic this week about the new "low" gasoline prices. According to the bean counters the average price for a gallon of unleaded fell to $2.44 last week. While I would bet many of our readers have not seen prices that low yet you can rest assured they are coming. The statistic in question showed that US consumers were paying $266 million less per week for gasoline than just a month ago when the average price was $3.10. $266 million is a huge number and that is about where the Powerball lottery will be by next weekend if nobody wins the estimated $203 million jackpot this week. If you find yourself pumping that cheap gas this weekend you might reconsider not buying that Powerball ticket. I know it is a tax on the mathematically impaired but what the heck you are saving $266 million a week. Splurge a little and remember me if you win.
Natural gas inventories grew by +91 BCF last week to 3,177 BCF. This is the highest level of gas in storage for this time of year as seen over the last 13 years. If we only see injections at the average rate for the next five weeks it would be an additional +264 BCF and raise gas in storage to theoretical levels of 3,541 BCF. There has never been this much gas in storage before and nobody knows if it will fit or will the increased pressure cause leaks in the underground caverns. The EIA recently did a study of the maximum gas ever stored at each of the individual locations. Each operator was asked what was the most gas they ever stored in their current configurations. Those results were tallied to produce a theoretical "Peak Volume" capacity of 3,608 BCF. It has never been that high and because of pipeline limits and current usage trends it may never reach that high. For instance if one pipeline serves a lot of power plants the drain on that pipeline may be such that storage on that line never reaches maximum levels. Other pipelines could theoretically max out while others continue to supply consumers at peak pipeline rates. The official capacity estimate for the entire system is 4,054 BCF but many of the storage areas have never seen pressures required to reach that level. It should be interesting as we near the assumed safe capacity of 3,500-3,600 BCF. We are already seeing gas price competition and prices are going to continue to fall as suppliers compete for the remaining available storage. On the positive side cold weather is barreling down on the plains and mountain states. It is snowing in Colorado today and we have a winter storm watch for the weekend. It may not be winter yet but it is coming. The cooler weather will consume more gas than the prior two weeks suggesting injections into storage will slow. That would be bullish for prices but don't expect any real rebound until late October, early November.
Temperature Map of the US - Friday Night
Stocks headlining the news on Friday were HPQ, FDRY, COGN, FDX and BSX. I will spare you the Hewlett Packard soap opera and focus on real news. Foundry (FDRY) joined the stock options crowd with an announcement they were going to review results to correct prior back dating events. Cognos (COGN) beat estimates on Friday and several analysts raised guidance on the company. COGN rose +3.17 on the news. FedEx broke even after posting a stronger than expected +43 cent increase in earnings to $1.53 per share. The problem was a cautious outlook saying the economy was moderating although still growing at a healthy and sustainable pace. This is a prime example of FedEx managing earnings expectations. They typically under promise and over deliver then give cautious guidance. UPS stunk up the sector back in July after they forecasted slower growth despite strong Q2 profits. Merrill cut UPS to a sell at the time after UPS cut estimates to nearly a dime under those of analysts. Boston Scientific fell about -10% on Friday after warning that sales could drop as much as -10% below analyst's estimates. Earnings were still expected to be in the range of 15-19 cents with analyst expecting 16 cents. Downgrades fell like rain as the stock was hammered to a new 4-year low at $14.85.
Seems like just yesterday I wrote about the indexes being at multiyear highs, the lack of bullish conviction and the potential for a historical October dip. But, two trading days have passed since I penned that Wednesday commentary with the talking heads projecting 1450 on the S&P and 12500 on the Dow. I did not hear much talk about those new highs as the markets rolled over for two consecutive days. Now the talk has reverted to recession worries and the rally in the bond market. It seems traders are not happy regardless of the circumstances. When the markets were testing the highs it was tough to find any bullish conviction or bearish conviction either. It was as though both sides were content to wait passively while the stealth rally added points in stutter steps to reach those highs. For next week we are faced with the end of quarter window dressing scenario. That should see buying early in the week followed by slowing support as the week/quarter draws to a close.
The indexes could not have performed the script more perfectly than they did. The Dow eased off its highs at 11625 to coast to a stop on support at 11500. Every dip below that level was bought with just enough intensity to hold the line but still without conviction. The S&P relinquished its hold on 1325-1328 and plunged back to support at 1315 and exactly where we had decided to draw the line on Wednesday night. Friday's trading saw it vacillate just under 1315 all day but never out of reach. Buying at the close put the index at 1314.68. Close enough for me. The Nasdaq did exactly the same thing with 2220 after a -45 point drop from just over 2260. In each case critical resistance held despite being under attack for most of the day on Friday. Support on the Russell at 715 and the Wilshire 5000 at 13100 mirrored the other indexes. You would almost think traders were actually watching their charts. In reality it was the fund managers holding the line and preparing for next week's costume party. As long as they could close them at support they have a good chance of a rebound when the window dressing begins in earnest next week. If they had let that support fail it would have been a race to the exits and out of their control. For the retail bulls it simply appears that profits were taken and it is time to buy the dip again.
Russell-2000 Chart - Daily
Wilshire-5000 Chart - Daily
SPX Chart - Daily
Based on the end of quarter scenario I am neutral for next week. I am going to
follow my own advice with only a slight modification. On Wednesday I suggested
buying a dip to 1315 and go short/flat below that level. Since we traded -2
points under 1315 nearly all day Friday that line in
the sand was erased by
millions of hoof and paw marks making it unreliable as a dual trigger. I am
changing the recommendation to 1310 as our short indicator. The new plan will be
to remain long over 1315 and short under 1310. That makes it easier to
differentiate the signals since both triggers can't be touched at the same time.
It also makes stop losses easier since each becomes the stop for the other.
Since nobody can accurately predict how next week will play out in the absence
of a normal September dip scenario we will put our biases on the shelf and
simply follow the plan. The early week economics should not be a factor but
additional earnings warnings could disrupt the window dressing plan. Economic
reports later in the week could produce additional weakness so be aware in
advance that the ice gets thinner as the week progresses. I would love to see a
rally appear on Monday that takes us to new highs but that is my bias talking
and we know how unreliable
biases can be. Follow the plan and it will not matter
which direction we trade because we will be following the trend.
New Long Plays
New Short Plays
Ladish - LDSH - close: 29.93 change: +0.55 stop: 31.01
Why We Like It:
Picked on September xx at $xx.xx <-- see TRIGGER
Linear Tech. - LLTC - close: 31.97 chg: -0.14 stop: 32.66
Why We Like It:
Picked on September xx at $xx.xx <-- see TRIGGER
Reliance Steel - RS - close: 29.35 change: -0.90 stop: 31.01
Why We Like It:
Picked on September 24 at $29.35
Long Play Updates
Advance Auto Parts - AAP - cls: 33.31 chg: +0.49 stop: 31.89
AAP displayed relative strength on Friday with a bounce from its rising 10-dma and a 1.49% gain. Volume was a little light on Friday's session but we're not complaining. The pattern for AAP continues to look bullish but shares are facing resistance directly overhead at its descending 100-dma. Plus, we're concerned about market direction over the next few weeks so we'd hesitate to open new long positions now. Our target remains the $35.80-36.00 range. We do not want to hold over the early November earnings report for AAP.
Picked on September 12 at $32.93
Hovnanian - HOV - close: 29.28 change: +1.17 stop: 27.74
We will admit that we're impressed that the homebuilders can rally on bad news. On Thursday night KBH became the latest in a long line of homebuilders to issue a profit warning in the sector. Yet the DJUSHB home construction index added 1.9% and HOV rebounded with a 4.1% gain. We suspect the real strength in homebuilders was due to the plunge in bond yields, which pushes down the interest rates on mortgages. Aggressive traders might want to speculate in HOV right now with the big bounce on Friday. However, bear in mind that the sector might see some selling this week as fund managers do some window dressing to dump their losers. We're going to stock to our plan and wait for a breakout over $30.00. Our suggested entry point to go long is at $30.11. If we're triggered at $30.11 our target is the $34-35 range. Our time frame is six to eight weeks.
Picked on September xx at $xx.xx <-- see TRIGGER
Intl. Game Tech. - IGT - close: 39.24 chg: -0.25 stop: 38.95*new*
We considered cutting our losses right here in IGT but the stock is still holding above short-term support at $39.00 and its intermediate support with the six-week trendline of higher lows. More aggressive traders may still want to consider long positions here but we'd rather wait for a show of strength and a move over $40.32 before initiating new positions. We're still cautious on the market direction so we're going to raise our stop loss to $38.95. Our target is the $44.00-45.00 range. We do not want to hold over the early November earnings report. FYI: The P&F chart points to a $57 target.
Picked on September
17 at $40.26
United Tech. - UTX - close: 62.30 chg: -0.60 stop: 61.99
Traders need to turn defensive here. The trading this past week in UTX has been bearish with a failed rally and a reversal in some of the technical indicators. Friday's decline helped the MACD produce a new sell signal. The stock has found support near $62.00 in the past so we're expecting a bounce but if the major averages show any weakness early next week then we'd expect to be stopped out. We would hesitate to open new plays even on a bounce from $62.
Picked on September 10 at $63.34
WebEx Comm. - WEBX - close: 38.41 chg: +0.18 stop: 35.99
We are still urging caution with WEBX. The upward momentum in the NASDAQ is waning and the momentum indicators for the INX Internet index have already produced new sell signals. The MACD indicator for WEBX is nearing a new sell signal. In spite of the recent market weakness WEBX has been holding in a rough trading range between $37.40 and $39.50. More conservative traders may want to tighten their stops toward the bottom of this range. We're not suggesting new positions at this time. There is the possibility that WEBX will surprise us next week with another rally. This is the last week before the third quarter ends and fund managers will be selling their losers and buying more of the winners to dress up their portfolios. WEBX, as something of a winner this past quarter, could see more buying interest. Our target remains the $42.50-44.00 range. The P&F chart is very positive with a bullish triangle breakout buy signal.
Picked on September 12 at $38.49
Short Play Updates
Charlotte Russe - CHIC - close: 25.77 chg: -0.12 stop: 27.05
News that CHIC received another analyst "buy" rating on Friday was not enough to stop the stock from breaking down further. Shares have closed under support at the $26 level and its 50-dma. We had a trigger to short the stock at $25.75 and CHIC hit that trigger on Friday so the play is now open. We believe that the 200-dma will offer technical support near the $22 level so we're aiming for a decline into the $22.10-22.00 range. We also expect to see a bounce from what is likely to be short-term support near $24 and its 100-dma. We do not want to hold over the mid October earnings report. FYI: The latest (August) data puts short interest at 6.9% of CHIC's 22.2 million-share float.
Picked on September 22 at $25.75
Commercial Metals - CMC - close: 19.14 chg: -0.86 stop: 21.55
The sell-off in metal and steel-related stocks continued on Friday. Shares of CMC lost another 4.3% on top of Thursday's breakdown under support at the $20 level. Volume came in above average on Friday's decline, which is another bearish sign. If you're looking for a new entry point traders have a choice to either chase it here or wait for a potential bounce. We do see potential support on the weekly chart with a trendline extending toward Friday's low. It might pay off to wait for a bounce before initiating new positions. Broken support at $20.00 should now act as new resistance. Our target is the $17.50-17.00 range. We do not want to hold over the late October earnings report.
Picked on September 21 at
CSX Corp. - CSX - close: 30.57 change: +0.02 stop: 31.26
Friday saw CSX dip toward its 200-dma near $30 and bounce. Shares closed virtually unchanged. We do not see any changes from our Thursday night new play description so we're posting it here:
In spite of plunging oil prices the Dow Jones transportation sector has been unable to breakout over resistance in the 4475-45.00 region and its 200-dma. Thursday the transport index lost 1.5% and broke down under its 50-dma. The Dow Jones railroad index produced a similar decline and breakdown. Shares of CSX followed with a 2.3% loss and its own slide under the 50-dma. Several railroad stocks, including CSX, had produced a pretty impressive bullish breakout just two weeks ago but that rally has reversed and shares of CSX look poised to begin a new leg lower. We want to see a breakdown under round-number support at $30.00 and its 200-dma before initiating positions. Thus we're suggesting a trigger to open bearish plays at $29.75. If triggered our target is the $27.00-26.00 range. We do not want to hold over the mid October earnings report so that gives us about four weeks.
Picked on September
xx at $xx.xx <-- see TRIGGER
Hormel Foods - HRL - close: 36.02 chg: -0.23 stop: 36.51
We have nothing new to report on for HRL. The stock's oversold bounce appears to be rolling over under its 21-dma. The technical picture is mixed with the various time frames showing both bullish and bearish signals. We are not suggesting new positions at this time and we continue to aim for the $35.00-34.50 range where HRL is likely to find support near its 200-dma.
Picked on August 31 at $36.65
NTL Inc. - NTLI - close: 24.98 chg: -0.03 stop: 26.05
We do not see any changes from our Thursday night new play description so we're reposting it here:
Several days ago NTLI broke down from a narrow five-week trading range. The recent bounce has failed at old support/new resistance near $26.00. This looks like a relatively low risk entry point to short the stock. We're going to stick our stop loss just above resistance (26.05) and we'll aim for a decline toward support in the $21.00-20.00 range. More conservative traders may want to exit near $23.00 (see chart). We do not want to hold over the early November earnings report.
Picked on September 21 at $25.01
Tessera Tech. - TSRA - close: 31.90 chg: +0.36 stop: 32.81
TSRA is not cooperating. The stock is seeing a battle occur between the bulls and the bears as it jerks back and forth between support and its overhead trendline of resistance. The SOX semiconductor index turned lower on Friday and actually closed under what should have been support at the 450 level. The SOX is also on the verge of breaking down under its two-month trendline of support. Yet this weakness in the sector index failed to have an impact on TSRA. The stock bounced from its lows near $31.15 in an uncharacteristic show of strength. This lack of follow through lower on Thursday's bearish reversal/failed rally could be a warning sign. We are suggesting that readers wait for another decline under $31.00 before considering new positions. Our target is the $26.00-25.00 range. FYI: Readers should note that the latest (August) data puts short interest at 11.7% of the stock's 42.8 million-share float. That is a relatively high amount of short interest and makes this a higher-risk play.
Picked on September 19 at $30.95
Washington Group Intl. - WGII - cls: 56.51 chg: +0.53 stop: 57.25
Well it doesn't get much closer! WGII dipped to $55.46 on Friday near its 200-dma before bouncing back to close with a gain. We have a suggested trigger to short the stock at $55.45 so we're still sitting on the sidelines. Our market bias is not bullish and we expect that WGII will breakdown further but short-term shares may bounce toward their 10-dma. We're reposting our Thursday night new play description here:
The rally from WGII's June lows has run into trouble with resistance near $60.00. The stock has struggled with resistance in the $60 region since it first climbed to this level back in January 2006. Now the momentum indicators are suggesting that WGII has run out of gas and the next move will be lower. The stock has already broken its 3 1/2 month trendline of support and its 50-dma so more aggressive traders may want to open positions right now. We are suggesting that readers wait for a breakdown under its 200-dma. Therefore we're using a trigger at $55.45. You may want to wait for a decline under $55.00. Our target is the $51.00-50.00 range. We do not want to hold over the November earnings report.
Picked on September xx at $xx.xx <-- see TRIGGER
Closed Long Plays
Regal Beloite - RBC - close: 42.95 chg: -1.09 stop: 42.85
We have been stopped out of RBC at $42.85. We warned readers on Thursday that the stock has produced a bearish engulfing candlestick pattern and another failed rally near $45 and that the next move was probably lower. The stock's pattern is beginning to form more of a sideways trading range between $42 and $45.
Picked on September 15 at $45.11
Closed Short Plays
Today's Newsletter Notes: Market Wrap by Jim Brown and all other plays and content by the Option Investor staff.
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