Traders bought Monday's dip and the bears were beaten back again and again as the indexes spiked to new highs on Wednesday. The rally surprised everyone and looked for a while like it had legs. On Thursday negative news in the housing sector was blamed for a triple digit loss but I doubt that was the case. On Friday positive housing news was unable to produce a rebound. If housing was really the cause of Thursday's drop then a sharp spike of nearly 5% in new home sales should have erased the small -0.8% drop in existing home sales we saw on Thursday. Something does not add up. What does add up is a 200-point range on the Dow for the week that produced motion sickness for the bulls. Add in the fear of future Fed rate hikes and you get an Excedrin headache along with that upset stomach.
Dow Chart - Daily
Nasdaq Chart - Daily
The bottom in new home sales appears to be firmly in place with the July reading of 1.01 million homes on an annualized basis. The sales in December spiked to 1.12 million units for a +4.8% jump. November sales were also revised higher to 1.07 million from 1.05. The monthly supply of homes on the market dropped to 5.9 months from a high of 7.0 months back in October. This appears to be great news for the sector since December is hardly seen as a month to buy new homes. For the entire fourth quarter home sales increased +24% quarter over quarter and nearly reversing the -27% drop in Q3. For all of 2006 sales still declined by -16% and the sharpest drop since 1989. The strong sales were blamed on unseasonably warm weather in the northeast where sales spiked +27.3%. Couples out for a drive in the sunshine must have stopped at the model homes and made that impulse buy. Prices have not declined significantly on the surface but the official price does not account for promotional costs of free furniture, decorating, upgrades and discounted mortgages.
Mortgages are still a problem with rates rising again and more than a trillion dollars in ARM loans headed for a pricey reset in 2007. Subprime lenders are watching their loan portfolios rot on the vine with foreclosures accelerating. Analysts fear a flood of upside down foreclosures where the loan balances are more than the property is worth. Just before the bell on Friday news hit the wire that Bank of America (BAC) was in talks to acquire Countrywide Financial (CFC). Countrywide has heavy exposure to subprime loans. An acquisition would be in the $30 billion range and fill a hole in Bank of America's portfolio. BofA bought Fleet Boston Financial for $48B in 2004 and MBNA for $34B in 2006. BofA is the largest branch bank with 5,747 branches, the largest credit card issuer and controls 9% of all U.S. banking deposits. Countrywide claims loan originations of $462 billion in 2006. When the news broke CFC spiked +12% and the options activity exploded. 35,850 calls and 28,920 puts were traded and that was six times the daily average.
Real interest rates continued to climb with the yield on the ten-year note hitting 4.9% intraday. This is a six-month high and shows no signs of fading. This number is being fed by strong economics and accelerating signs of growth. The Durable Goods numbers for December rose +3.1% to a four month high. Core Capital Goods rose +2.4% after two months of decline. Add that to the spike in New Home Sales and it appears the economic rebound is gaining speed. Next Wednesday we will get the first look at the GDP for Q4 and estimates are as high as +3.5% in some circles. Officially the forecast is 3.0% but even that is well above the +2.4% expected just last month.
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The stronger growth is bringing the Fed back into the picture with a 2-day FOMC meeting next week. The chance for a rate cut through July has shrunk from 90% to only 4% in just two months. The expectations for 3 or possibly 4 rate cuts in 2007 has changed to expectations of either ONE or NONE and possibly even another hike later this year. The bond market is factoring in the Fed expectations resulting in the rising yields. This is actually positive since bond yields impact the economy significantly more than the Fed funds rate. It can impact the economy faster than a Fed hike and essentially do the Fed's work for them.
The outcome of the FOMC meeting next week is likely to be some strong language regarding inflation as the Fed takes a get tough stance in light of the accelerating growth. The Fed will try to talk rates higher rather than actually hike again. To do this they will have to emphasize the inflation risk of an economy that really did not cool off as much as they wanted. If it appears GDP for Q1, currently estimated at +2.1% is actually going to spike back over 3% then the Fed will come out with guns blazing at the May meeting. The only meeting between next week and May is another 2-day in late March. Currently there are rumors that the Q2-Q3 GDP for 2006 could be revised substantially upward. That would erase all the soft landing conversations of the last 9 months in one blow. It would also light an even hotter fire under the Fed for 2007.
There are a lot of critical economic reports next week other than the Q4-GDP. The Chicago PMI is also on Wednesday with expectations for a positive reading of 51.8. You may recall that it fell under 50 in November and substantially off the 62.1 high in Sept. Next up of special importance is the ISM on Thursday with expectations of a positive 51.5 number. On both reports any number under 50 represents economic contraction. The ISM also hit a low of 49.5 in November before a slight rebound to 51.4 in December. This is where the rubber meets the road. If the economy is really heating up it should show in the ISM. Last but not least is the January Nonfarm Payrolls on Friday with expectations for a slight decline to 140,000 jobs. This has been San Francisco Fed President Janet Yellin's hot button. She has questioned several times in speeches why jobs continue to rise if the economy was supposed to be slowing. Evidently she had it right and the economy was not slowing as much as the Fed had expected. Friday's number could be better than expected and that would continue to increase the Fed cloud over the market.
Weekly Economic Calendar
In stock news Microsoft gained a whopping 15 cents on Friday after reporting better than expected earnings despite the delay in Vista. MSFT has risen nearly +45% since June after they warned the last time about Vista being delayed into 2007. They were due for some profit taking and that could appear next week. Vista is due to be released on Monday to the general public. One local store had 600 Vista equipped laptops in the backroom this week waiting for the embargo to be lifted and only a couple of WinXP laptops on the shelves for sale at highly discounted prices. They were effectively giving the WinXP models away to avoid the XP/Vista question on future sales. Once the doors open on Tuesday it will only be Vista for sale. Rumors continue to abound that it takes a gig of memory just to boot it and 8-10 minutes on some computers. Memory manufacturers must love the coming upgrade cycle. Once this is available for existing computers there will be a massive upgrade cycle similar to the Y2K buying binge if Microsoft expectations can be believed. Don Hays was on CNBC on Friday saying the SOX could double over the next 12-24 months. That is a monster prediction and would suggest a huge Vista driven rally.
MEMC Electronics (WFR) spiked +$8.59 after reporting earnings that more than doubled and guided the street significantly higher. MEMC makes the silicon wafers that chip companies use to start the production process. MEMC is also feeding wafers to the solar power crowd at good prices whenever capacity is available. This fall back market is free money when the demand in the normal chip sector slows. There is a shortage of silicon and MEMC appears to be in the right place in the supply line.
CDW Corp (CDWC) lost -6.17 after missing estimates on rising costs. CDW retails more than 100,000 technology products including names like Adobe, Apple, Cisco, HPQ, IBM, Lenovo, Sony, Symantec, etc. Average daily sales of $28.95 million rose +13.5% year over year and profits of $284 million increased +14.2%. Earnings fell -22.1% primarily to higher expenses and several special items including a litigation settlement and an acquisition. Business was good and growing but evidently traders saw "earnings down -22%, missed by a nickel" and headed for the exits. They should do well selling upgrades once Vista hits the retail shelves.
AMGN lost -3.35 after reporting mixed earnings results and negative results on three of its potential new drugs. KB Homes lost -1.14 after the SEC turned an informal inquiry into a formal inquiry regarding their stock option granting procedures. Google gained +7.75 ahead of its earnings due out next Wednesday. They are expected to beat the street but the real interest is how YouTube is going to benefit them in the future. Shares of aluminum products maker Novelis (NVL) jumped +7 after a +5 jump on Thursday after saying it was in talks to be acquired for something in the $6 billion range.
The exchanges continue to soar with the CME gaining +9.86 on Friday. It helps to be nearly a $600 stock to post that type of gain but it is near a new high once again. The Intercontinental Exchange (ICE) gained +3.43 to $135.
Next week earnings will begin to lose the big names on the reporting schedule. 40% of the S&P has reported and most of the recognizable household names like Intel, IBM, Microsoft have already reported. The list will begin to decline in quality but not in quantity as the smaller companies step up to the microphone. About 40% of S&P companies have reported. 68% have beaten the street, 17% reported inline and 15% have missed estimates. With the quality declining as January comes to a close we can expect those ratios to change in favor of those missing estimates.
Crude Oil Chart - 60 min
Oil prices surprised everyone with a continued rise to close at 55.50 for a +1.20 gain. Everything was blamed including cold weather, continued Nigerian attacks, U.S. posturing against Iran, Chavez threatening to kick the U.S. ambassador out of Venezuela and the filling of the SPR. For whatever reason it rose I am not complaining. The complaints are coming from the Dow Transports, which lost -146 points or -3% for the week. It was just a week ago that the transports were testing resistance highs just over 4850. I warned last Tuesday that this was strong resistance and a failure there could weaken the Dow. I don't know which fell first the Dow or the Transports but both definitely headed south. The airlines were the loss leaders with AMR -11%, US Air -11%, UAUA -12%, CAL -15% and XJT -16%. Earnings disappointments abound within the sector after the storms closed airports across the country.
Dow Transports Chart - Daily
The Dow and S&P made a really nice run on Wednesday and I was almost ready to relinquish my bearish bias by the close. I think I was more in shock than simply surprised to see the new highs. When the futures started turning negative Wednesday night I saw the writing on the wall and Thursday turned out even more bearish than I expected. I was really surprised to see the post speech bounce since there was nothing earthshaking in the speech. All the ethanol stocks rolled over right on cue Wednesday morning but the broader markets continued higher to the surprise of nearly everyone. But, that is what makes a market. If everyone "knew" exactly what would happen there would never be anyone to take the other side of the trade.
The Dow respected initial support at 12450 but the nearly -200 point decline from Wednesday's high had to hurt investor sentiment. Every material dip since August has been bought and the bulls rewarded for their efforts. Anyone buying the Monday dip had a nice trade but the buy and hold guys got killed. The rebound at the close on Friday could be attributed to short covering more than eager buyers. There were two minor buy programs that produced most of the rebound.
The Nasdaq erased all its gains for the week to touch a new three week low at 2420 and the following rebound was weak at best. For me it would be a sure bet that 2400 gets tested next week. The S&P tagged 1440 on Thursday and 1417 on Friday. That was a serious implosion that was followed by only a minimal +5 point rebound into the close. That spells trouble for me. It reinforced my short-term bearish bias and increased expectations that we could see 1405 next week. A dip to 1405 would only be -2.5% off the highs so hardly a real correction. It would not even qualify as indigestion in the greater scheme of things. A dip to strong support at 1385 would still be less than a -4% retracement.
S&P-500 Chart - Daily
I heard a lot of talk late in the week about support on the S&P from the 50-day moving average. I have been showing this average on my charts for the last couple weeks. I think the 30 and 50 are critical and we can expect major moves when they cross. The S&P has not even touched the 50 since late July while the 30 has provided short-term support several times. Currently the 50-day is at 1413 with decent horizontal support at 1405. This suggests a break of that range would trigger technical selling from a variety of different scenarios. However, the bulls are alive and well as evidenced by the nearly complete lack of movement in the VIX. After trading as low as 9.86 on Wednesday we did see a small bounce to 11.50 on Thursday's drop but that just put it back into a neutral range. I hate to think what it is going to take to produce a true volatility spike. As long as the bulls are in dip buying mode rather than put buying mode the major indexes are not going much lower. Eventually that trend will break but there is nothing visible on the horizon to make me think it is imminent.
The recent evidence suggests the economy is stronger than expected and
improving. The Fed will try to talk rates higher next week and that could cause
some additional spasms as traders change sides but unless there is fire and
brimstone in the FOMC announcement it should
be business as usual. A strong
economy can withstand 5% Fed funds and the market should celebrate until the Fed
steps off the sidelines later this year. Even if we saw weaker than expected ISM
numbers or non-farm Payrolls it should not deter the bulls. That would be Fed
positive and give the bulls another excuse to buy. The only real hurdle on my
radar is the fear of a normal correction. Corrections don't normally warn in
advance. They come when least expected and continue until
fear returns to the
market. It is worry about a pending correction that could keep the bulls under
control. We have not had a even a minor 4% retracement on the S&P since July
making us definitely overdue. That would be a minimum of 1385 on the S&P. In the
long term view that would just be a step back to the launching pad for an even
stronger move higher later this year. We are under 1430 so maintain a short bias
with a buy target around 1385. Expect a pause at 1405 if traders
decide to take that -4% dip.
New Long Plays
Foundation Coal - FCL - cls: 31.94 change: +0.74 stop: 30.59
Why We Like It:
Picked on January xx at $xx.xx <-- see TRIGGER
PeopleSupport - PSPT - close: 23.24 change: +0.54 stop: 20.99
Why We Like It:
Picked on January 28 at $23.24
New Short Plays
Teledyne Tech - TDY - close: 37.80 change: -1.03 stop: 40.35
Why We Like
Picked on January 28 at $37.80
Long Play Updates
Arch Coal - ACI - close: 29.31 change: +0.51 stop: 27.99*new*
Stocks in the coal industry were generally higher on Friday as the market responded positively to an earnings report from Massey Energy (MEE). ACI reacted with a 1.77% gain but the rally seemed to struggle with the $29.50 level. Overall it looks like ACI is poised to move higher but we are running out of time. ACI is due to report earnings on February 2nd. Therefore we plan to exit on Thursday, February 1st at the closing bell to avoid holding over the announcement. We hesitate to suggest new positions given our lack of time. Please note that we are inching up our stop loss to $27.99. Our target is the $32.50 level.
Picked on January 21 at $29.08
Anadarko Petrol. - APC - close: 41.92 change: -0.01 stop: 41.75
We were a little surprised to see shares of APC trading lower on Friday with crude oil futures posting another gain. APC spent the session trading sideways but still closed under what should have been support near $42.00 and its 10-dma. We're going to stick to our plan and wait for a breakout over $44.00 with a suggested trigger to buy the stock at $44.05. More aggressive traders might want to consider jumping the gun and opening positions early with a rise past $43.00. Don't forget that we plan to exit ahead of the February 5th earnings report so we only have a week, which might make this play a bit optimistic with a $47.50 target.
Picked on January xx at $xx.xx <-- see TRIGGER
Cascade - CAE - close: 53.51 chg: +0.90 stop: 52.45
Last week was more of the same for shares of CAE. The stock has been stuck in a trading range. The good news, if there is any, is that the range appears to be narrowing somewhat and that could be hinting at a breakout sooner rather than later. The technicals on the weekly chart suggest the next move is going to be down so nimble traders might want to consider shorting CAE on a break under $51, under its 100-dma or under $50.00. Currently we are waiting for a breakout over resistance at $55.50. Our suggested trigger to buy the stock is at $55.75. If triggered our target is the $59.76-60.00 range. FYI: We do not want to hold over the early March earnings report.
Picked on January xx at $xx.xx <-- see TRIGGER
Comcast Corp. - CMCSK - cls: 42.52 chg: -0.12 stop: 41.75
We are running out of time with CMCSK. The company is due to report earnings on February 1st and we don't want to hold over the announcement. Therefore we plan to exit on Wednesday at the closing bell. That is assuming we don't get stopped out first. Shares of CMCSK are in a relatively steady up trend but the stock has pulled back toward its trendline of support near the rising 50-dma. Short-term technicals have turned bearish. We're not suggesting new positions at this time. Our target was the $46.00 level. More conservative traders may want to exit early!
Picked on January 14 at $43.32
Commscope - CTV - close: 32.49 change: +1.31 stop: 29.99
Entry point alert! Traders did indeed buy the dip (again). Shares of CTV rallied 4.2% on Friday and broke out to a new relative high. We suggested on Thursday that a new move over $32 could be used as an entry point to buy the stock. More conservative traders might want to consider a tighter stop loss. Our target is the $34.85-36.00 range. We do not want to hold over the late February earnings report. FYI: The P&F chart is bearish.
Picked on January 24 at $32.05
Granite Constr. - GVA - close: 52.37 change: -0.18 stop: 50.79
We do not see any changes from our comments on Thursday. The dip continues to look like a bullish entry point. The stock has pulled back toward the bottom of its bullish four-week channel (see chart). More conservative traders may want to consider a tighter stop near $51.50 or wait for a new rally past $53.00 before considering new positions. Our target is the $57.50 mark. We do not want to hold over the mid February earnings report.
Picked on January 21 at $52.41
Bankrate Inc. - RATE - close: 37.90 chg: +0.12 stop: 35.95
Some of the banking and mortgage stocks managed to out perform on Friday thanks to the Bank of America and Countrywide news about a potential merger or alliance. Shares of RATE bounced strongly from its lows (36.70) and the stock actually closed in the green. It certainly looks like shares of RATE are poised to move higher but readers may want to wait for a rise past $39.00 before opening new positions...if not $39.00 then maybe $38.40. Our target is the $41.90-42.00 range. More aggressive traders may want to aim higher. FYI: The most recent (December) data put short interest at more than 35% of RATE's 11.2 million-share float. We do not want to hold over the early February earnings report!
Picked on January 11 at $38.25
TJX Cos. - TJX - close: 29.50 change: -0.29 stop: 28.95
We need to turn defensive here. The retail sector failed to bounce on Friday as crude oil rose again. It might seem like investors are ignoring the positive economic news suggesting a strong and improving economy but it was only a few days ago that the RLX retail index was hitting new highs. The bad news today is that the RLX index has produced a bearish engulfing candlestick pattern on its weekly chart. This pattern is typically seen as a bearish reversal, especially near a relative high. Meanwhile TJX is struggling to breakout over the $30 level and the stock slipped almost 1% on Friday. Friday's weakness helped the MACD indicator produce a new sell signal. More conservative traders may want to exit early to limit any losses. We're not suggesting new positions at this time. Our target is the $32.50-33.00 range. We do not want to hold over the mid February earnings report.
Picked on January 24 at $30.21
Toll Bros. - TOL - close: 32.43 change: -0.29 stop: 30.89
The homebuilders continued to see selling even though Friday offered some good news with December new home sales up better than expected. The big news within the industry was a story about the SEC pursuing a formal inquiry into KB Homes (KBH) about their option practices. Shares of TOL slipped almost 0.9% and closed near its 10-dma. We would watch for a bounce near $32.00 before considering any potential entry points and more conservative traders may want to tighten their stops. Our target is the $34.75-35.00 range.
Picked on January 21 at $32.42
Short Play Updates
Comverse Tech. - CMVT - cls: 19.77 change: -0.12 stop: 20.51
CMVT continues to sink under a steady diet of lower highs. The stock looks ready to breakdown under the $19.75 level and if it does there shouldn't be any support until the $18.90 region. We would consider new plays right here! Our target is the $17.75-17.50 range. Please note that this play might have an extra risk concerning the company's earnings report. The problem is we can't find one and we can't find when it is due to report next. History would suggest CMVT tends to report in March but we can't support that for 2007. Earnings reports are always a risk because there are too many variables and the stock could move sharply either direction on the news. We did find one source that said CMVT's subsidiaries VRNT and ULCM are due to report in March.
Picked on January 22 at $19.85
Safety Ins. Group - SAFT - cls: 47.38 chg: +0.26 stop: 50.05
We do not see any changes from our previous updates. Shares of SAFT continue to drift lower although there was no follow through on Thursday's breakdown. The stock appears to be trading in a narrow, descending channel (see chart). We would only consider new short positions on a failed rally under $48.75. More conservative traders might want to tighten their stops toward the $49.00 region. We have two targets. Our conservative target is $45.10. Our aggressive target is the $42.50 level. FYI: The latest (December) data put short interest at 7% of SAFT's 13.1 million-share float. That does raise the risk of a short squeeze.
Picked on January 08 at $ 48.49
Closed Long Plays
MedImmune - MEDI - close: 33.74 change: -0.40 stop: 33.65
After all our waiting we have been stopped out of MEDI. A negative earnings report from Amgen undermined the entire biotech sector. Shares of MEDI dipped to an intraday low of $33.45 before bouncing. We have been stopped out at $33.65.
Picked on January 05 at $33.98 *gap open entry*
Raymond James - RJF - close: 31.28 chg: -0.12 stop: 30.95
We have been stopped out of RJF at $30.95. The stock mirrored the action in the broker-dealer index with an early low followed by an afternoon bounce. The stock's bearish reversal during Wednesday and Thursday is not a good sign for shareholders.
Picked on January 24 at $32.19
Raytheon - RTN - close: 51.45 change: -0.40 stop: 50.95
We are suggesting an early exit in RTN. The stock failed to bounce at its 50-dma on Friday. Shares slipped 0.77% and look poised for more profit taking. The decline puts RTN in jeopardy of breaking significant support.
Picked on January 21 at $52.30
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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