For the second consecutive week the markets wandered sideways to down as shorts gained confidence only to be surprised by another one-day short squeeze to spike the indexes higher.
Four days last week the markets struggled to hold over support at 9000 only to have a monster short squeeze on Thursday add +200 points and to close the week right at 9200. For four days this week the markets again struggled to hold that 9200 level only to see another short squeeze on Friday push the Dow over 9400 at the open. The Dow was unable to keep all the gains and closed 70 points off the highs but with another +200 point gain for the week. Maybe we should just open the markets one day a week and save all that frustration.
The short squeeze generator for the week was the Non-Farm Payrolls report on Friday. The report showed the U.S. lost another -247,000 jobs in July but that was better than the latest consensus estimate of -320,000. It was also much better than the -467,000 jobs lost in June. The -467K number was revised down to -433K in this report. The unemployment rate actually dropped to 9.4% from June's 27-year high of 9.5%. Expectations were for a rise to 9.7%. Does that make the 9.4% unemployment rate for July good news or just less bad? Evidently somebody thought it was good news to start the short squeeze.
Possibly the Fed's Plunge Protection Team (PPT) is working in the market to keep the rally going. Since interest rates are zero for government funds this would be a cheap way to keep the market moving and keep sentiment positive. Buying a few thousand S&P futures contracts at exactly the right moment each week to squeeze the shorts would be cheap insurance and insurance that could be trickled back into the market over the following week to reload the gun for the next time it was needed. Too bad they don't have to publish a record of their actions. I am sure it would be very interesting reading.
The surprising drop in the unemployment rate and the better than expected job losses helped to fuel hopes that the recession is over or at least the bottom is behind us. The administration was quick to take credit for the improvement in the economy because of the $787 billion stimulus program despite less than 33% of the money being obligated and only 9% actually spent. Most analysts claim the economic rebound has been due to the Fed's zero interest policy plus the various financial rescue programs implemented by the Fed and the Treasury.
Despite the market reaction to the report it should be noted that 247,000 still lost their jobs. This was the 19th consecutive month of job losses but this was the smallest loss since August 2008. Nearly 14.5 million workers remained unemployed in July. Since December of 2007 when the recession began more than 6.7 million workers have lost their jobs. Those unemployed for more than 27 weeks rose +585,000 to nearly 5 million in July. After you have been unemployed over 27 weeks you fall off the governments employment rolls and your unemployment benefits end.
Those working part time to pay the bills while looking for full time work in their field rose to 8.8 million. These are people who are technically employed and therefore not considered "unemployed" by the government. That means if you are an aeronautical engineer and you take a job waiting tables in the evening while waiting for another engineer job to come available you are not unemployed according to the government.
Add those 8.8 million people to the 14.5 million officially unemployed and the unemployment rate would be around 15%. Since normal unemployment is about 4.5 million workers this means we need to create about 15 million jobs over the next couple years to get back to full employment. We need to create another 150,000 jobs per month just to absorb new workers into the system. Those are high school and college graduates and new legal immigrants looking for work. Over 1.3 million people are expected to immigrate legally into the U.S. in 2009.
Non-Farm Payroll Chart
The economic calendar next week is crowded with reports but none are really critical. The big news will be the FOMC meeting on Tue/Wed and their announcement on interest rates. They are not expected to make any changes but there is always the danger that they will modify their statement to include some indication of when they will start raising rates. The bond market is already pricing in higher rates with the 10-year note yield closing on Friday at 3.85% and the highest in nearly two months. The prospect of a rebounding economy is being felt in the bond market.
If the Fed wants to keep rates low to fuel the still fledging rebound they will have to take further action of some sort soon. They could do this with another strongly worded post meeting announcement saying again that rates will remain low for a considerable period. However, they may have to take other action like purchasing some more debt in order to stop the four-week climb in bond yields.
Another reason to knock rates back down is the constant need for the Treasury to sell more debt to fund the deficit and the various bailout programs. Over $75 billion in debt will be sold this week and interest rates are rising. The Fed could help the Treasury by applying pressure to rates in order to make the auctions go smoother. There are $37B in 3-year notes on Tuesday, $23B in 10-year notes on Wednesday and $15B in 30-year bonds on Thursday. We have seen several auctions recently that concluded successfully but only rank a grade of C on the A-F scale. This was because the number of bidders is dwindling and the indirect bidders (foreign banks) have dropped sharply. Remember, if we see an auction fail it will be a very bad day for the equities market.
The earnings cycle is nearly over with more than 450 of the S&P-500 already reported. Next week there were so few major companies reporting that I was able to add them to the economic calendar instead of producing a separate graphic.
The most watched company next week will be Wal-Mart (Nyse:WMT) when it reports on Thursday. Wal-Mart accounts for 8-cents of every dollar spent at retail in the United States. Wal-Mart quit reporting same store sales in May and that leaves analysts in the dark as to how that 8-cents is being spent. Wal-Mart is the true indicator of how the average consumer is doing during as the recession progresses. Analysts believe that an improvement in Wal-Mart sales would mean the economy was rebounding but weak sales would mean the recession was still with us. Wal-Mart same store sales for the May-July period are expected to be flat to +3%. The consensus is for a rise of +1.1%. If Wal-Mart surprised with a negative number it would be viewed negatively by the market. Last week JC Penny (Nyse:JCP) reported a double-digit drop in same store sales for July. Analysts are expecting 86 cents in earnings with the whisper number 88-cents. As always the guidance will be critical since many analysts are already on record as saying the back to school shopping season could be a disaster.
Nvidia (Nasdaq:NVDA) jumped +6% early Friday on a strong earnings beat Thursday night and on a strong outlook for sales. That gain was cut to only +1.3% by the close. NVDA earned +7-cents compared to estimates for a 2-cent loss. The company said revenue would rise +5% to +7% to $822 million and well over the analyst estimate for $758 million. The CEO said he was seeing strength across the board in their graphics business. Nvidia stock is up about 80% from the March lows so quite a bit of expectations is already factored into the price. Based on the chart a more over $14 would be bullish.
Crocs (Nasdaq:CROX) spiked +28% after beating estimates Thursday night. CEO John Duerden said "The rumors of our demise have been greatly exaggerated" and quoting Mark Twain. The CEO said Crocs was on track to be profitable again in 2010. Crocs has repaid in full a $17 million line of credit and reduced their inventory to more manageable levels.
(Nyse:AIG) stock more than doubled in price last week as shorts covered in advance of earnings. It appears there was a leak of what those earnings might be and all the shorts ran to the exits. The chart show AIG trading over $1400 in 2007 but this was before a 1 for 20 reverse split back on July 1st. Even today's respectable price of $27.14 only equates to $1.357 pre split. AIG reported its first profit in seven quarters on Friday. I use the term profit loosely since the $1.8 billion profit was after removing billions in adjustments. The $2.57 per share profit was nearly twice the $1.33 analysts expected. The government and taxpayers own 80% of AIG thanks to the $180 billion of Federal aid. AIG lost $99 billion in 2008 and currently has only a $4 billion market cap. To illustrate the absurdity of that $4 billion market cap, AIG has more than $1.3 trillion in outstanding derivatives. That is 13% less than the prior quarter. With this kind of exposure it is no wonder they are having trouble writing new insurance.
Freddie Mac (Nyse:FRE) reported a profit for the first time in two years and said it would not need any further government money this quarter. This was dramatically different from Fannie Mae (Nyse:FNM), which reported a $14.8 billion loss and requested another $10.7 billion from the Treasury. FNM has received $45.9 billion from the Treasury and FRE $51.7 billion. Getting out from under this cloud is going to be difficult. For instance FRE owes $5.2 billion a year in annual preferred dividends on the borrowed money. How would you like to have that as a debt payment?
They are going to continue to lose money because of the nine million loans up for modification. In order to do a modification to avoid a foreclosure as mandated by President Obama the company must buy the loan out of whatever mortgage-backed security it belongs. This means they have to pay off the balance, say $250K and then modify the loan and rewrite it for a reduced amount, say $200K and that means they have to eat that $50K loss. Multiply that by nine million and it is a big number. Together FRE/FNM own more than $5 trillion in mortgages.
Freddie Mac Chart
A day late and $1 billion short. Actually a couple months late since Intel booked its $1 billion fine levied by the EU last quarter. The EU claimed Intel (Nasdaq:INTC) used its monopoly power to force buyers to choose Intel chips over AMD (Nyse:AMD) and fined Intel $1 billion. Late Friday a European Union ombudsman Nikiforos Diamandouros said the EU Commission failed to take into account critical information from Dell when it levied the fine. Documents from Dell claim they bought Intel chips instead of AMD because the Intel chips were more technically advanced and not because of monopoly pressure as had been previously thought.
In the meeting Dell (Nasdaq:DELL) had compared the performance of the chips from both companies and said the performance of the AMD chip was "very poor." The ombudsman cannot force the ruling to be overturned but it is likely the commission will be a little more careful in future cases knowing the ombudsman is watching and not afraid to deliver the stinging rebuke in the press. Unfortunately for Intel the fine will stand unless the EU Commission suddenly decides to reverse its own ruling but that has zero chance of happening since it would admit they were wrong and had not considered evidence contrary to their mindset. Intel was up on the news in after hours on Friday despite the fact the fine will not change.
Target (Nyse:TGT) announced they were dropping Amazon (Nasdaq:AMZN) as their website operator. Since 2001 Amazon has operated the Target website and produced $1.8 billion in sales for Target in 2008. Amazon earned $100 million in fees from the operation. Target said it was time to build its own e-commerce platform and quit relying on Amazon. Amazon also supplied the order fulfillment, which means they inventoried, packaged and shipped the merchandize.
JP Morgan said Amazon would not really lose since the build out would take two years and the $100 million was less than 1% of Amazon's revenue. Morgan also said Amazon would likely benefit from any missteps by Target in providing a seamless customer experience. Building and operating a top-20 e-commerce site from scratch along with the fulfillment is no easy task and likely to hit several bumps in the road. Since Amazon already knows what products Target is selling and which make a profit you can bet there will be some Amazon competition for Target in the near future.
Genzyme (Nasdaq:GENZ) just can't get any respect lately. Last week Genzyme was crushed when the FDA said they were going to re-inspect a plant for a virus that Genzyme already claimed had been eradicated. GENZ lost $5 on the news. This week Goldman Sachs put GENZ on the dreaded "conviction sell" list and the losses continued to grow. GENZ has fallen from $57 to just under $48 on the plant problems. Today's close at $48.19 is a new 52-week low.
Two Florida banks were closed on Friday bringing the total for 2009 to 71. The Community National Bank of Sarasota and the First State Bank of Sarasota both failed. Stearns Bank of St Cloud MN will take over the failed banks. The FDIC said it would share losses of $364 million with Stearns.
Friday was a slow news day but in politics that means papers hunt for something to print. A WSJ story making headlines was the $550 million purchase of 8 new jets, including three new Gulfstreams for use by Congress. These are the same people who complained loudly about corporate CEOs riding to Washington on corporate jets and demanding they sell them and fly commercial. This story produced outrage all over the web and on the network talk shows. There was a little more to the story if you did the research. The Air Force actually manages the government fleet and congressional members only use them about 15% of the time. The other 85% is used for other government officials. Also firing up hostility was the claim that the Air Force did not request the new planes.
This really enhanced the anti congress anger about the hypocrisy of the lawmakers. Actually the Air Force is getting rid of seven older and more expensive to operate planes making the net increase of one plane. There was no mention of how much the government would get for the seven planes they sell and thereby offsetting the $550 million price tag or how much cheaper the new planes would be to operate. In an environment where congressional lawmakers are fair game for some members of the press the headline was all anyone needed to see to generate ample hostility. As much as I would like to trash certain members of congress I think this story should be seen as summer Friday sensationalism.
Earning are over, now what? With more than 450 of the S&P-500 stocks already reported there is little left in the form of earnings to generate excitement. The markets waited last week for Cisco (Nasdaq:CSCO) and boy were they surprised. The normally bullish John Chambers sounded like Alan Greenspan trying to double speak his way out of a tight spot. The markets were not impressed.
One thing obvious from the earnings was that only one sector showed top line growth. That was the healthcare sector. People continued to get sick but they did not continue to buy things, take trips and work on their homes. This means that the recession impact is likely still being felt by most companies and Q3 is not going to be a barnburner for earnings. There will probably be some growth but Q4/Q1 is where the action will be.
Does that mean traders are just going to wait on the sidelines until Q4 begins to buy stocks? I doubt it but it does mean that the bloom may be fading from the rally rose. However, money is still moving out of the safety of bonds and into higher risk investments including stocks.
I saw on Friday that some month end figures for July fund performance had many funds up only 3-4% when the markets gained 8% for the month. This is a perfect example of what we have been discussing for the last few weeks. Funds are under invested because they thought they would get another entry point and it never came.
Steve Grasso, a NYSE floor trader, said whenever the markets pull back slightly as they did for several days over the last couple weeks he gets a pickup in the flow of buy orders from funds. He said they are not large orders but just a constant stream just under the market whenever it is weak. He said they are not chasing the price. If the price moves higher they are simply waiting for it to return. He said the orders he was getting on the rallies were from retail buyers and not from funds.
This goes along with my premise that funds remain underinvested and they still expect another entry point. Is August going to supply that entry point? Remember, August and September are historically the two weakest months of the year. This has got to be weighing on under invested fund managers. Do we buy now or wait? They can't afford to be out of the market but they can't afford to be buying in volume here if there is a normal 10% correction in our immediate future. Instead they are just average costing into positions on every dip so they don't get left behind entirely if another explosion appears.
The markets are going higher by year-end. There are so many reasons I could not list them all here. One reason is the inventory replacement cycle ahead. Because the recession was so severe many companies allowed inventory levels to decline to almost nothing rather than have stale inventory taking up space in their warehouse. This inventory replacement cycle will have to occur soon in order to be ready for the holiday season.
Another reason the economy and the market may recover faster than analysts expected a couple months ago is the severity of the cost cutting. When it appeared we were on the edge of another Great Depression back in September/October 2008 we saw companies begin slashing jobs at a ferocious rate. This continued through the first quarter with massive job cuts in December through March.
However, if you look backwards we have gone from pricing in another great depression to just a severe recession and then to a recovery in just five months. A company CEO who was slashing employees like Atilla the Hun in Q4/Q1 to keep his company from being depression road kill
is now faced with estimates for as much as a +3% GDP in Q4. This CEO is now faced with having to fill the ranks again to handle the anticipated recovery.
Atilla, the epitome of cruelty in Western Europe in 450-AD
I believe we are right on the verge of that hiring cycle. Everything has happened too fast for companies to suddenly go from facing an apocalyptic event to facing a monster rebound in only 3-5 months. They have not started hiring yet but they probably have already drawn up their plans just in case the recovery sticks.
The CEO for CareerBuilder.com was interviewed on Friday and he said there was no shortage of jobs. For instance he has over 80,000 positions advertised just in sales and marketing. I did not write down all the categories he mentioned but there was hundreds of thousands of positions. This is significantly better than just three months ago. He said employers were being picky because of the number of applicants but once they see the recovery is for real it will be a race to fill the vacancies.
Are we there yet? I don't think so and that is why August/September could see some market weakness. The comments from John Chambers last week were critical. When he did not confirm a recovery or even a bottom it took the wind out of a lot of tech sails. Comments like "Q2 could have been a tipping point" instead of "I believe we bottomed in Q2 and I expect much better sales in Q3" confused investors and CEOs across the country. This lack of visibility from the normally bullish Chambers was a wet blanket to the Nasdaq rally and to those seeing green shoots in every economic report. Cisco is now in 40 different product sectors other than just routers and switches. If they are not seeing an improvement in orders enough to call a bottom then maybe the Q2 bottom was just wishful thinking.
I prefer to believe that Q1 was the bottom. That does not mean that the only direction is up. The severity of the financial crisis disrupted the entire global financial network. Businesses are still having trouble financing inventory and expansion. There is money available but banks are not loaning as fast as they have in the past. The actual amount of money available on bank balance sheets has risen for the last three months but the numbers of loans have not increased along the same trend. Banks are increasing their hoard of cash. Until that mentality passes the recovery faces a tough up hill battle.
I am sure you have heard comments about a "V" bottom recession. That is the preferred type of recession. It is a quick decline followed by a quick recovery. There are other types and until the recession is over we won't know which kind we had. A "U" recession is a quick decline with several months of no growth at the bottom before recovering sharply. A "W" is a recession with a second bottom after a false recovery runs out of steam. That is the kind of recession most companies are afraid of now. They don't want to rehire workers and restart plants if there is another dip ahead.
Image from Lindsey Dawson
Lately economists have been discussing the hockey stick recession. That is one with a long flat period of recession and a slow recovery at the end. Until investors have a better idea of what type of recession we are in the market may not move much higher. (Famous last words)
Two-Year GDP Chart
In the GDP chart above all we have is the decline. The ski jump uptick at the end is not yet statistically relevant. It could easily morph into any of the alphabet soup recession types. The problem is the severity of the dip. We went from +2.12% to -6.43% in about four quarters. In stock lingo the -6.43 low in Q1 was severely oversold. Almost any stock could perform a satisfactory dead cat bounce under those conditions. So far the Q2 rebound could have been just that, an oversold bounce. Until we get another couple revisions of the Q2-GDP number we don't even know if that bounce will stick. The Q1 number dropped a full point in the fourth and final revision just last week and that was for Q1. The Q2 number of -1.02% could be a couple points better or worse before it is final reading in October.
Let me try to net it out because I know I have confused everyone. CEOs were listening to economists over the last several weeks and thinking they were going to have to buy a mower because there were so many green shoots. Then the earnings cycle showed 54% of companies missed on top line revenue growth and lowered guidance again for Q3. Finally the Cisco bull gives his no visibility comments. Now they are sitting on low inventory levels, low employment and watching the order flow every day like a cardiac doctor watching an EKG. CEOs are trying to decide if the patient is going to recover or will the Fed need to apply the defibrillator paddles again?
Investors jumped the gun and bought already overextended stocks when the Intel earnings surprise started off the earnings cycle with a bang. Now that Cisco closed it with a whimper they don't know whether to buy, sell or hold. I doubt there is anyone except maybe Nouriel Roubini or Bill Fleckenstein who doubts the markets will be higher by year-end. Even Abbey Joseph Cohen is predicting 1100-1150 on the S&P but that should be no surprise. In theory everyone should just buy stocks and not open their broker screen again until January. Of course theory has never worked for me and watching positions decline 15-20% between now and January is more than most traders can withstand.
The problem is complicated even more because most 401K/IRA owners have already seen their portfolios drop by 50% over the last couple years. Now that the S&P has rebounded 50% from its lows and reached the pre-October crash levels they are thinking a lot harder about stop losses. Fool me once shame on you, fool me twice shame on me. Of course everybody knows that once those stop losses are placed the market considers it a personal challenge to dive just deep enough to trigger them before blasting off into the stratosphere and leaving you in cash. This is the eternal conundrum that investors face.
Heck, even if you were smart enough to close all your positions on July 1st 2008 and buy new ones on March 9th 2009, the question bugging you today is when to take profits? Once the markets really start to develop more than some intraday weakness that urge to pull the exit trigger will begin to grow worse than a crack addict's need for a fix.
Here we are in the second week of August on the eve of a Fed meeting, earnings are over and the Nasdaq can't get over long-term resistance at 2000. If you were advising somebody else you would probably be telling them to take profits. Of course we are much smarter that everyone else so we are going to let it ride just like a craps player that just pressed that pass line bet for the fifth consecutive time. All his winnings for the last five shooters (five months of gains) is bet in hopes of win number six. You know how this story ends. Eventually the current shooter will roll a seven just like the market will eventually correct. The only question is when?
As investors/traders we need to continually watch for clues in the market that telegraph the next move. This can be a lot of stocks creeping off the bottom and ready to explode higher. It can also be some key stocks rolling over at the top after a strong run. Friday was a big rally day, right? Did you know that Goldman Sachs lost $3 after being up several dollars in the morning? Same with Bank America, which closed negative after rolling over. Several energy stocks led the sector decline with sharp losses. Crude itself ended the day off -1.37 at $70.57. The Semiconductor Index or $SOX closed negative and dead on its critical support at 298. Tech stocks won't be rallying in August if the chips crumble.
Sam Stovall, chief investment strategist at S&P predicted on Wednesday that the S&P would stall in the 1007-1020 range. He said it was overbought for this cycle and an attempt to reach 1020 would represent a "topping phase." Raymond James chief investment strategist Jeffrey Staut, who called the bottom back on March 2nd, said the correlation of cycles points to a peak in late July or early August. Hugh Johnston, CIS for Johnson Illington Advisors, claims the rally is overdone based on what we now know about earnings. I could go on but you get the picture and for every cautious strategist there are just as many laying out the bullish case. Actually all three of those I mentioned still believe that any pause to reload will be muted and temporary. However, getting anyone to define "muted and temporary" is a challenge. They don't keep their jobs long if they say the S&P will drop 100 points and it only drops 20. Predictions are always shrouded in analystspeak.
I don't have the luxury of having a chief investment strategist on my payroll that I can blame for missed market calls and replace 2-3 times a year. I have to blame myself and fire myself on a quarterly basis when the market does not do exactly as I predict.
I have been cautious on the market for several weeks but in hold my nose and buy mode until proven wrong. You can go broke fighting the tape a lot quicker than following the trend. However, for next week I am going to turn a little more cautious. The SOX scares me. The rollover in the financial stocks scares me. The failure of the Nasdaq to hold over 2000 and the support on the SOX scares me. The fact that the Dow and S&P really moved higher on only three days in the last three weeks scares me. Short squeezes are good for markets but a lack of follow through is a clear sign of concern.
S&P Chart - 30 min
Volume scares me. If you just looked at the increasing volume numbers it would appear that there was tremendous buying power coming into the market. However, the market has only risen materially in two of the last ten days. High volume and no movement is also indicative of market tops.
Over the last three weeks the average daily volume has risen from the high 7, low 8 billion share range to over 11 billion shares per day. Monday was a decent day with three times the advancers than decliners and 329 new 52-week highs. The markets all set new highs. However, on Friday with the markets significantly higher than on Monday the new 52-week highs fell to only 213. If the market is making new highs why did the individual new highs decline? That was the pattern all week with declining numbers of stocks making new highs. This means the number of stocks leading the rally is shrinking. Meanwhile the volume is increasing. Maybe it is just me but that makes me worry.
I mentioned the SOX and the Nasdaq several times so I will start with that chart. The Nasdaq is fighting strong downtrend resistance from November 2007 and horizontal resistance at 2000 from July 2006. This 2000-2010 resistance was a solid top for the Nasdaq last week. Now with the weakness in the SOX it may become even tougher to move higher without a pause to reload. Initial support is still 1980.
Nasdaq Chart - Weekly
Nasdaq Chart - 30 min
The Dow hit 8100 on July 10th and traded over 9400 on Friday. That is +1300 points in only four weeks. It is seriously over extended. The Dow is fighting resistance from the Fib 38% retracement level dating back to the Oct-2007 high. This is one of the most recognizable Fib levels and one that bears watching on any chart. Resistance is 9422 and the Dow intraday high on Friday was 9437 but it was only a brief spike. A failure here finds support at 9200 and again at 9000.
Dow Chart - Daily
Dow Chart - 30 min
The S&P-500 has the same Fib resistance at 1014 and almost exactly where it failed on Friday. Add in the various other resistance levels I outlined on Tuesday from 1001 to 1020 and this is a solid barrier that could take a major event to conquer. What that event might be is a mystery today. There are more possibilities for a negative news event next week than a positive one. Support is 990 followed by 980.
SPX Monthly Chart
The biggest hurdle next week is a Fed that is under pressure to once again restate their case for keeping rates flat for a "considerable period." If they are successful in making their case the market could continue to creep higher. The motive power could be funds trying to build positions on every little dip and a potential short squeeze for those expecting the Fed to change their statement towards tightening.
Unfortunately I am not convinced that even the most eloquent Fed statement will be able to push overbought stocks higher without a rest. This rest could simply be 2-3 days of minimal declines like we saw for the past two weeks. I would call this a "consolidation" in lieu of a correction. While a real 10% correction would be the best thing for the market and provide an entry point for thousands of funds and institutions I doubt it will happen. I would welcome it but with funds already buying the dips I think it would take a seriously negative event to knock us back -10%. That would be -900 points on the Dow and I just don't see it happening. Dow 8800 would be a stretch for me but definitely possible. That would be about 930 on the S&P but I would be real surprised to see it.
While I am slightly more cautious this week I still believe that any material dip is a buying opportunity. I have no doubt that 2009 will end higher than we are today and if Q3 profits and guidance improves we could go a lot higher. That is the lure that will keep the funds coming back to the market to buy the dip. How quickly and in what volume remains to be seen.
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