For the last week the markets have been holding their breath and waiting for the Fed meeting and decision about rates. Dueling analysts argued nonstop about the chances for a future rate hike or rate cut. Tensions built to the breaking point this morning with several noted analysts going on record as expecting a surprise rate hike. Fed policy expectations are more volatile than popcorn in hot grease and this week was no exception. The Fed funds futures for March have been projecting as little as a 20% chance of a rate cut by March to as much as an 81% chance in just the last ten days. The meeting is now history and nothing changed from the last meeting with the Fed keeping the rate at 5.25% and maintaining a bias towards tightening. All that worry was for nothing.
Dow Chart - Daily
Nasdaq Chart - Daily
The Fed statement was a carbon copy of the October statement with two minor exceptions. The only change was the addition of several words to the two key sentences. The rest of the statement was exactly identical. The phrasing of the October statement was:
Economic growth has slowed over the course of the year, partly reflecting a cooling of the housing market. Going forward, the economy seems likely to expand at a moderate pace.
It changed to this:
Economic growth has slowed over the course of the year, partly reflecting a substantial cooling of the housing market. Although recent indicators have been mixed, the economy seems likely to expand at a moderate pace on balance over coming quarters.
The keywords there are obviously "substantial" and "mixed." The Fed does not make these wording changes haphazardly and each word and connotation is carefully structured. By adding "substantial" the Fed is letting us know they are aware the housing market has continued to weaken since October and they are ready to act if it deteriorates further. While the actual housing internals have firmed the closing of three subprime mortgage companies and distress in several others bring up the specter of a potential washout ahead if the housing sector is allowed to weaken further. The severity of the situation was not lost on the Fed and they are telling us they are aware.
Secondly the addition of the "recent indicators have been mixed" also tells us that the Fed is less convinced about the state of the economy in general. They are seeing conflicting signals now but are still hopeful the recovery will continue in 2007. The addition of "on balance over coming quarters" suggests the weakness could drag out further than previously expected. The initial phrasing suggested we were at or near a bottom and the economy seemed likely to expand from there. The current statement suggests the bottom could be lengthened and could be rocky as evidenced by the "on balance" comment.
Overall this was a more dovish statement and one that would seem to indicate they were closer to starting a rate cut cycle. The addition of weaker phraseology should mute the claims of those expecting further hikes. However, as several analysts noted the statement still contains the inflation risk paragraph although it was unchanged. After saying "Readings on core inflation have been elevated" they continue to say that inflation is the main worry.
Nonetheless, the Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.
To summarize the Fed still thinks the risks of inflation remain but also felt the economy is weaker than in October. Is this stagflation coming back to haunt us? Let's hope not! There were also those who felt the Fed was trying to balance its statement so that everyone would not be leaning towards a rate cut in the near future but the way I read it the chances of a cut are even more likely than before. Jeffery Lacker closed out his term as a voting member of the committee with his third consecutive dissention and voting for a hike of 25 points.
Many in the analyst community were not happy with the statement because many feel the economy is hurtling towards a recession in 2007. They point to the continued inversion of the yield curve as near positive proof that the Fed is ignoring. Historically an inverted yield curve of this duration has been accurate in predicting recessions 88% of the time. Six of the last seven recessions were preceded by an inverted yield curve. With the yield on the ten-year note three rate cuts below the current Fed rate they wanted the Fed to present an even more dovish statement suggesting they were willing to cut rates in Q1 to avoid a 2007 crash. The Fed did acknowledge that early 2007 was likely to be rough with the "on balance" phrase. Many analysts claim "it is different this time" but those long time market historians claim it is always different until the recession appears and the trap slams shut. Time will tell but you can expect this argument to continue to surface until one side or another is proved right.
The two jobs reports released today both confirmed a strong employment picture and somewhat stronger than the Non-farm Payrolls we saw last Friday. As long as employment continues to firm and real interest rates remain low the potential for a successful soft landing increases. The International Trade deficit fell sharply in October to -$58.9 billion, down from -$64.3B in September. This was the lowest level in 14 months and the largest percentage decrease in five years. Exports increased, imports fell and the price of crude dropped sharply cutting outflows for oil by nearly -$5 billion. The deficit with China rose by +5.8%, Europe +21.3% and Japan +18.5%. Those deficit increases were offset by the drop in oil prices. The November Treasury budget deficit rose to -$75.6 billion from -$49.3 billion in October. This was $7.5B less than the deficit in November 2005. Receipts were up +8% year over year for the first two months of fiscal 2007. The total deficit for all of 2007 is expected to be -$300 billion.
In stock news Goldman Sachs posted earnings that soared +95% and posted its largest quarterly profit ever of $9.4 billion. Profit attributable to shareholders rose to $3.1 billion or $6.59 per share. This beat street estimates by +55 cents. This compares to profit of $3.35 per share in the comparison quarter in 2005. Goldman said it was allocating $16.5 billion for salaries, bonuses and benefits for year-end. That equates to $622,000 for each employee but the big deal makers will get the largest cut. Goldman fell -2.52 on the news as some analysts suggested they have nowhere to go but down in 2007. Goldman has been on a very strong rise since leaving the $150 range back in September to top at $206 last week. It may be time to just take profits and move on to something else ahead of year-end.
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GE made the news late in the day when they affirmed their earnings guidance for the rest of 2006 and all of 2007. They said full year earnings for 2006 would be $1.97-$1.99 compared to their prior estimates of $1.94-$2.02. For all of 2007 GE now estimates profits of $2.17-$2.23 per share. The street consensus was $2.24 but nobody seemed to care. GE also raised their dividend to 28 cents from 25 cents, a +12% increase. GE spiked +60 cents on the news but closed with only a +42 cent gain. Yawn.
Farm equipment maker Agco (AG) fell by -1.31 after giving guidance for 2007 that was below analyst estimates. Agco was expecting 2007 profit growth of +30% compared to analyst's estimates of +34%. Agco said sales in North America and Europe to be flat while South America sales were expected to decline -5% to -10%. While Agco is not a household name it prompted drops in others that were. Caterpillar was the biggest drag on the Dow with a -1.25 intraday drop as a result of the Agco warning. Deere (DE) was also weak losing -2.66.
Nucor (NUE), the country's second largest steel producer, warned that lower prices and slowing shipments would impact Q4 earnings. Nucor said shipments would fall between -12% to -15% from the third quarter. The warning hammered other metals stocks including Dow components Alcoa (AA) and Du Pont (DD). This was also a factor in the CAT drop although lower steel prices should benefit CAT. NUE fell -4.75 on the news.
Best Buy (BBY) said heavy competition lowered margins and forced them to sacrifice profit to retain market share. Q3 profits for the quarter ended on Nov-25th, rose to 31 cents from 28 cents in the prior year but analysts had expected profits of 35 cents. The company said Q4 should be good with all stores stocked and ready for the holiday rush. They said margins would improve in Q4 and said full year profits would still be in the range of $2.65 to $2.80. Analysts were expecting $2.81. Same store sales growth is expected to be in the 5% range. The positive comments about Q4 failed to help the stock, which dropped -$2.62 for the day.
Celestica (CLS) fell -1.14 after warning of slowing demand and rising inventory. They lowered their guidance for profits to be flat to a gain of +6 cents from prior guidance of +15 to +23 cents. CLS is a contract manufacturer of electronic components for computers, aerospace, telecommunications and consumer electronics. CLS lost -12% or -1.14 to close at $8.25. This pushed the SOX to retest support at 470 and weighed on chip manufacturers and box makers.
The Hewlett Packard CEO said today that HPQ was a company in transformation not a transformed company. He said that as he outlined expectations for further cost cutting efforts in 2007. HPQ has already cut -15,000 jobs but more are coming. He also made the first public forecast for 2008 saying revenue would grow between 4-6 percent to something in the $101-$103 billion range and earnings in the $2.78-$2.98 range. It appears Hurd checked analyst estimates before giving that guidance. Analysts were expecting $102B and $2.88 per share. Both numbers were exactly in the middle of Hurd's guidance. That is too precise to be an accident.
Citigroup gave back some of its gains from Friday after there were rumors top management would be shuffled. The only announced shuffle today was the appointment of Robert Druskin to the post of COO. Druskin was already the head of corporate and investment banking for Citigroup. Citigroup pulled back from its 6-year high hit on the rumor of changes in the wings.
UPS offered severance packages to 650 more employees at its headquarters and Supply Chain Solutions division. Those receiving offers were at least 50 years old and had 10-years with the company. UPS announced 1200 job cuts back in October. CEO Mike Eskew said we know we have to reduce costs and execute better than in the past. UPS fell -$1 on the news.
Notice how many companies are warning and lowering guidance? The warnings cycle doesn't really kick off for another week or so but we have seen numerous companies confess early rather than wait for the crowd. Is it that they are just trying to get business handled before the staff leaves for the holiday break or is it a warning that we have a flood of confessions ahead. I think it is too early to tell but a couple more of these high profile events and the markets are going to find it very tough to rally into year-end.
The SEC announced today they are planning on changing the rules for hedge fund investors. They are going to require accredited investors to have a liquid net worth of $2.5 million compared to the current $1 million requirement. That will be exclusive of your primary residence or any business property currently in use. This could take a lot of current hedge fund investors out of the hedge fund market. How that will impact the broader market is unknown and it is not an immediate event. The SEC is expected to present the rule change to a full vote of the SEC commissioners as early as Wednesday. There has been no mention of an effective date or any grand fathering of current investors. Removing personal homes from consideration is expected to be a sharp blow to the many thousands of investors stretching to join the club.
Oil prices fell to a two-week low at $61 and -2.65 below Friday's high. We expected this as I warned in the weekend commentary. The January crude contract ceases trading next Tuesday and those who were hoping for some event to cause a break of the strong resistance at $63.50 were disappointed. Now it is time to bail on their long positions but I am sure many are still clinging to hope that OPEC will announce another cut overnight on Wednesday. At this point I doubt it will help the January contract since any actual cut will likely be slated to start on Jan-1st and have zero impact on the currently expiring futures contract. I view any decline into Friday as a buying opportunity. With OPEC looming I would be surprised to see support at $58 retested but anything is possible.
Crude Oil Chart - Daily
The EIA said today OPEC reduced production to 26.97 mbpd in November compared to 27.4 mbpd in October. However the official production target was for a cut to 26.3 mbpd. In other words they produced 670,000 bpd more than they said they would. Cheating is still a common method of operation in the OPEC fold. EIA also said OPEC is expected to further reduce production another -800,000 bpd in December as the cuts announced in October continue to take effect. That has nothing to do with any potential new cut announced this Thursday. Venezuela and Nigeria, both countries that aggressively pushed for the production cut left their output unchanged. A prime example of "do as I say, not as I do." The comments out of OPEC this week claim there is still 700,000 bpd of excess production, which they are planning adjust at this week's meeting. Since talk is cheap and action is limited it could be just another exercise by the OPEC spin-doctors to try and talk the price higher.
I am not sure any effort by the equity spin doctors to talk up the markets into year end will have any impact. The Dow plunged to 12250 at 11:30 and well before the Fed announcement. It was a decent sell program and could have been profit taking from somebody hoping for a pre Fed rally that did not occur. Dow 12250 is decent support but 12350 is much stronger resistance. With warnings and lower guidance stealing the headlines it may be tough to manage a move higher. After the Fed announcement there were three distinct buy programs but they were unable to even recapture the lethargic highs from earlier in the morning.
The Nasdaq suffered even more and failed to mount a credible rebound on those same buy programs. The TXN and CLS warnings after a string of weak chip guidance last week have taken all the bounce out of the techs. Support is 2420 followed by 2400 and it gets positively ugly if both those levels break.
S&P-500 Chart - Daily
The S&P-500 continues to hold the high ground but it too is showing its age. The recommendation from Sunday was to remain long over 1405 but reverse to a short/flat position on a break below that level. We saw a good test of 1405 on Friday and another strong support test again today that saw a low of 1404.75. Obviously there are plenty of traders watching that level besides us. One reader emailed today after the dip to 1404.75 asking if my recommendations were for daily closes under a specific level or just a move below that level. For my index recommendations I believe they are valid for any move past the trigger point. We could easily see a -10 to -20 point move under the right circumstances so I would not want to wait for an end of day close to act. It should also be obvious that you can't just set a programmed stop at 1404.75 and dump everything and revert to a short. These are general recommendations and I expect traders to exercise a little judgment in managing their positions. If we move below 1405 on decent volume and internals are weakening then I would not hesitate to make the switch. However, if we have another day like today where support is tested then it is just a test not a break. Since everyone is likely in long options on individual stocks or indexes you can watch the event evolve for a few minutes while you make your decision. It is not like dodging a bullet where the decision has to be instantaneous or its fatal. Fortunately nothing surrounding a trading decision at 1405 is fatal. Any decision made can be reversed just as easily if it turns out to be a head fake rather than a solid break.
For the rest of the week I am still recommending a reversal to a flat/short position on a break below 1405. Historically the market trades lower nearly 80% of the time after a Fed meeting regardless of the decision. Will it repeat this time is anybody's guess? There is a lot of profit at risk from the summer rebound and a lot of bonuses at risk as well. There are probably quite a few tax sales, which have yet to occur. Then of course there are the bulls eager to climb the wall of worry ahead of expected year-end cash inflows. Nothing is ever certain so we need to just let the market tell us how to trade. Remain long over 1405 and short/flat below that level. This takes all the guesswork out of our decision and let's us sleep at night.
New Long Plays
New Short Plays
Long Play Updates
Amer. Electric - AEP - close: 42.51 change: +0.31 stop: 40.89
AEP continues to show relative strength. The stock rose 0.7%. Furthermore the three-day bounce is doing a lot to improve the technical picture. The move past $42.00 (and $42.25) is a new bullish entry point. More conservative traders might want to tighten their stops toward $41.50. Our short-term target is the $44.90-45.00 range. The P&F chart points to a $50 target. FYI: We do not expect shares of AEP to move very fast so it could take a few weeks to reach our target.
Picked on December 03 at $42.03
ALON USA Ener. - ALJ - close: 29.34 chg: -0.58 stop: 28.85
Warning! ALJ continues to show relative weakness. The stock lost another 1.9% following yesterday's gap lower. Today's decline puts ALJ under its 200-dma. Shares are now testing support at the $29.00 level. We are not suggesting new positions and more conservative traders may want to exit early or tighten their stops.
Picked on November 21 at $30.15
Beazer Homes - BZH - close: 45.58 change: -1.03 stop: 44.25
The homebuilders continued to see profit taking and BZH under performed its peers with a 2.2% decline. The stock is now under its simple 10-dma and looks poised to test the $45.00 level soon. We would watch for a bounce near $45.00 as a potential entry point. Currently our target is the $49.50-50.00 range.
Picked on December 03 at $45.84
Carrizo Oil & Gas - CRZO - cls: 31.26 chg: -0.81 stop: 29.75
Danger! The profit taking in CRZO is getting worse. Shares lost 2.5% and look poised to continue lower. We reiterate our suggestion from yesterday that more conservative traders may want to exit now to limit any losses. If we do not see a bounce in CRZO near $31.00 we will exit early. We are not suggesting new positions at this time.
Picked on November 29 at $32.15
D.R.Horton - DHI - close: 26.75 change: -0.02 stop: 24.95
DHI managed to fare better than most of its peers in the homebuilding sector. The stock consolidated sideways and only closed with a minor loss. Traders can choose to buy the dip here or wait for a dip toward $26.00, which should be support. Our short-term target is the $29.90-30.00 range. The P&F chart points to a $36 target.
Picked on December 03 at $26.59
Florida East Coast - FLA - close: 61.85 change: +0.21 stop: 58.99
FLA is still trying to rally but is being hampered by weakness in the transportation index and the railroad index. We remain bullish and would still consider new positions but more conservative traders may want to wait for a new relative high above $62.32. The P&F chart is bullish with a triple-top breakout buy signal (formed this week) with a $94 target. Our target is the $67.00-70.00 range.
Picked on December 05 at $62.14
GulfMark - GMRK - close: 38.23 change: -0.08 stop: 37.39
We do not see any change from our previous update on GMRK. The stock is still trading sideways and a breakout seems imminent. We'd wait for a rally past $39.00 before considering new longs. More conservative traders may want to use a tighter stop. We're aiming for the $42.50-43.00 range.
Picked on November 28 at $38.70
Guitar Center - GTRC - close: 46.28 change: +0.00 stop: 43.99
We see no change from our previous updates. Traders bought the dip in GTRC but the stock closed unchanged for the session. There is still a good chance that GTRC will dip toward $45.00, which is where we would look for a new entry point. Our short-term target is the $49.75-50.00 range but more aggressive traders may want to aim higher.
Picked on December 05 at $46.40
Noble Energy - NBL - close: 52.04 change: -0.15 stop: 49.75
There are no changes from our previous updates on NBL. We would wait for a dip near $51.00 or maybe the $50.00 level before considering new positions in NBL. The P&F chart looks very bullish with a $76 target. Our target is the $57.50-60.00 range.
Picked on November 29 at $53.11
ONEOK Inc. - OKE - close: 43.15 change: -0.20 stop: 41.75*new*
OKE is still slipping lower and nearing what should be short-term support at the $43.00 level. If $43 fails then OKE should have additional support in the $42.00-42.25 region. We are raising our stop loss to $41.75. Our target is the $45.00-46.00 range.
Picked on November 28 at $42.25
Rowan Cos. - RDC - close: 35.40 change: -0.16 stop: 34.45
We are waiting on a bullish breakout over resistance. Currently we're suggesting a trigger to buy the stock at $37.05. If we are triggered at $37.05 our target will be the $41.00-42.00 range. More conservative traders may want to exit early near $40.00, which might be round-number resistance.
Picked on December xx at $xx.xx <-- see TRIGGER
Raytheon - RTN - close: 52.36 change: -0.02 stop: 49.85
Lack of upward momentum is beginning to turn the technical picture bearish. Short-term we'd look for another dip to $52.00 or its 10-dma. If $52 fails then RTN should have some support near old resistance at $51.00. Our target is the $54.50-55.00 range.
Picked on November 29 at $51.05
Short Play Updates
Cheesecake Factory - CAKE - cls: 26.03 chg: -0.32 stop: 27.01
CAKE seems to be steadily losing altitude and is near support at $26.00 and its 100-dma. There have been some bearish analyst comments focused on the restaurant sector recently, which may have contributed to the downturn in CAKE. Currently we're suggesting a trigger to short the stock at $25.65. If triggered at $25.65 our target is the $22.25-22.00 range. We do expect some support near $24.00 but given the bearish technicals on the weekly chart we think any bounce at $24 would be temporary. The P&F chart currently points to a $4.00 target. FYI: The most recent (November) data puts short interest at 11.8% of CAKE's 73.7 million-share float. That is relatively high short interest and could raise the risk of a short-squeeze if CAKE manages to rally.
Picked on December xx at $xx.xx <-- see TRIGGER
New Century - NEW - close: 34.32 change: -0.23 stop: 36.55
We don't see any changes from our previous updates. NEW is still floundering around the $34 level. Traders can choose to open positions here or wait for a bounce and failed rally near $35.00-35.50 as a potential entry point. Our target is the $31.00-30.00 range. FYI: The most recent (November) data put short interest at 22% of the company's 50 million-share float. That is a very high degree of short interest and it does raise the risk of a short squeeze if NEW reverses sharply higher.
Picked on December 10 at $34.47
NTL Inc. - NTLI - close: 24.39 change: -0.01 stop: 26.01
Traders bought the dip in NTLI at the $24.00 level. The afternoon bounce doesn't look over yet and we would expect NTLI to rally toward the $25 level tomorrow. Wait for signs of a failed rally under $25.00 or $25.50 before considering new plays. There does seem to be some support near the $23.50 region but the Point & Figure chart points to a $9.00 target. We will target a decline into the $21.00-20.00 range. FYI: The most recent (November) data put short interest at 3.5% of the company's 324 million-share float.
Picked on December 10 at $24.44
21st Century - TCHC - close: 25.08 change: +0.02 stop: 26.75
The good news with TCHC today is the lack of follow through higher on yesterday's big intraday rebound. We remain defensive on the stock. We would wait for a new decline under $24.84 or even $24.75 before considering new shorts. More conservative traders may want to tighten their stops toward the $26.00 level. Our target is the $21.50-20.00 range. The most recent (November) data puts short interest at over 6% of TCHC's 6.4% float. That's a very small float so 6% might be enough short interest to really increase the risk of a short squeeze should TCHC reverse higher. Bear that in mind when considering positions as you may want a tighter stop loss.
Picked on December 10 at $24.84
Closed Long Plays
Chesapeake Energy - CHK - cls: 31.29 chg: -0.49 stop: 31.49
We have been stopped out of CHK at $31.49. The stock continued to sell-off and shares broke down under support at its 50-dma and 100-dma. The weakness began last week with the company's announcement to offer more stock in a secondary offering.
Picked on November 29 at $33.98
Worthington Ind. - WOR - close: 17.97 chg: -0.63 stop: 17.99
We have been stopped out of WOR at $17.99. An earnings warning from steel-maker Nucor (NUE) sparked a sharp sell-off across the steel sector. WOR closed with a 3.3% decline on above average volume. Today's decline produced a new MACD sell signal.
Picked on November 19 at $17.96
Closed Short Plays
Imperial Sugar - IPSU - close: 26.57 change: +3.50 stop: 23.55
We have been stopped out of IPSU. Today's trading in IPSU is a perfect example of why we do not want to hold over an earnings report. The company reported earnings this morning that blew away the analysts' estimates. On top of crushing the estimates the company noted an improvement in its margins and announced a special one-time $3.00 cash dividend for shareholders. Our problem was the earnings announcement date. The source we checked had IPSU's next earnings date listed as January 27th next year. Our stop loss was at $23.55 but shares gapped open higher at $27.04 and closed with a 15% gain on huge volume.
Picked on December 03 at $22.00
Today's Newsletter Notes: Market Wrap by Jim Brown and all other plays and content by the Option Investor staff.
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