I wanted to use that headline while I still could. The Dow and S&P gains all came on Tuesday with persistent weakness eating away at that rally over the last three days.
The markets may be up in 2012 but the year is still very young. One week does not make a trend. Tuesday's buying came as a result of the calendar rolling over and not much else. Once the first trading day of 2012 had passed the momentum evaporated. Problems in Europe continue to weigh on the markets and there were no major rumors on Friday to lift the financials. Tech stocks continued to post gains and closed at the high of the week while the other indexes struggled. Netflix, Amazon, Apple and Apollo were the big leaders on the tech side with news driving NFLX, AMZN and APOL.
I was surprised to see such strength in the Nasdaq after RF Micro Devices (RFMD) warned on Thursday evening and declined -19% on Friday. Despite the warning the chip sector posted gains for the day. If you are looking for logic don't look in the equity markets. Sometimes the biggest moves are the ones contrary to the conventional wisdom.
You would have thought the markets would have had a banner day after a much better than expected Nonfarm Payroll report. The headline number rose to show +200,000 jobs created in December, up from 100,000 in November and well over estimates of 150,000. The November number was revised down from 120,000. The October number was revised higher to 112,000 from 100,000.
Private payrolls rose by +212,000 while government workers declined by -12,000. The unemployment rate fell to 8.5% from 8.7%. The decline in the unemployment rate was again due to a drop in the labor force of -50,000. That was smaller than the -120,000 decline in November.
The separate household survey showed an increase of +176,000 jobs. The growth in jobs was almost entirely in full time workers. They climbed by +553,000 while the number of part time workers declined by -338,000. That was the most in a year.
While the headline number was a positive surprise there were some problems in the internal components. Transportation workers rose by +50,000 and retail added +28,000 on top of the November hire of +39,000. Since most of those hires were probably seasonal we could see a major hit to the January report of -117,000 seasonal terminations. We know FDX and UPS hired more than 75,000 temporary workers (55,000 UPS, 20,000 FDX) over the last two months and all of those will be back pounding the street looking for jobs in January. In January 2011 there was a drop of 48,700 transportation jobs. In Jan 2009 that number was 40,800.
In Jan 2011 there were only 68,000 jobs created compared to 152,000 in Dec 2010. I would expect as similar decline in the next report.
With more than a third of the December jobs taken by seasonal workers the net hires of roughly 125,000 permanent workers would have been below the consensus estimates.
Secondly, with the ADP report on Thursday showing a +325,000 jobs gain the Nonfarm Payrolls even at +200,000 was sort of anticlimactic. Buy the rumor, sell the news.
Nonfarm Payrolls Chart
There were some anecdotal reports on Friday from companies claiming they were putting hiring and capital expenditures on hold until there was some further clarity from Europe. Nobody wants to climb out on the expenditure limb again while Europe is plunging back into recession at a high rate of speed. International companies get a large part of their earnings from Europe and they will be cautious until they see how deep the recession will be and how quickly the EU will recover.
German manufacturing contracted for the third month in December with the PMI at 48.1 as new orders continue to shrink. New orders came in at 43.9 and well into contraction territory under 50. German exports posted their largest decline in six months. Germany is considered the strongest country in the euro zone. If their economy is accelerating into decline then the weaker countries are probably having an even tougher time. That is especially true for those undergoing forced austerity.
China's officials said the country would grow at less than an 8% rate in 2012. That was not good news only emphasizes the potential for a hard landing. China was not expected to admit the economy was actually growing below the 8% rate, which is considered the threshold rate for China. Growth below that level is insufficient to keep the labor force employed and support the move to a consumer society.
Those growing problems in Europe and China are the reasons we could see jobs stagnate in the U.S. in 2012. I would love to pound the table and talk up the +200,000 jobs gain but that may be a peak for several months. The future is obscured by the global economic cloud. The U.S. may be the dog with the least fleas but our dependence on the other dogs in the pack could allow some of their fleas to migrate in our direction.
The Monster Employment Index measures the number of help wanted ads placed online by U.S. employers. The index fell -7 points in December, a decline of about 5%. This pushed the index to 140 and its lowest level since March. However, the index normally declines in December as corporations put off recruiting until the New Year. All nine census divisions posted declines. We should not worry about the Monster Index unless it declines again January. That would indicate the normal January rebound in hiring activity failed to appear.
Moody's Monster Index Chart
The economic calendar next week is relatively light. The Fed Beige Book on Wednesday is the most important U.S. report. There are two rate decisions from Europe on Thursday and dramatic changes there could be market movers. With Europe falling into a recession there could be some changes in policy.
The focus shifts to earnings starting next week. On Monday Alcoa is the first Dow stock to report. Alcoa warned last week it would take a charge related to cutting capacity by -12% in order to firm up prices. The official consensus for Alcoa earnings is a profit of 4-cents but the whisper number is a loss of 2-cents. Three months ago the estimate was for a profit of 21-cents.
Chip maker OCZ will also report on Monday and they could have some decent earnings. They are big in the solid state hard drive market. The shortages of mechanical drives due to the Thailand floods probably helped fuel a very good quarter for them.
Changing the focus to earnings may not be such a positive event for Q4. On Sept 30th analysts projected Q4 earnings for the S&P would grow by +14.1%, down from +16.2% on Sept 1st. Some analysts were expecting as much as +19.2% earnings growth. As of Jan 3rd those consensus estimates have fallen to only +6.2% growth. If you take AIG's questionable estimates out of the mix that falls to only +4.2% growth. That is quite a change in the outlook driven by Europe, politics and the slow growth in the U.S. economy. Energy is the only sector still expected to produce double digit earnings growth.
The chief equity strategist at Blackrock, Bob Doll, is only expecting 6% earnings growth for all of 2012. However, he believes that will lead to double digit investing returns as the S&P PE multiples increase for the first time since the Great Recession.
Historically, investors who have bought the S&P at its current PE of 14 saw ten year returns annualized at +15% according to Bank of America. Those that bought the S&P at a PE of 20 saw only 7% returns.
I saw several comments in print about "record Q4 earnings warnings" but I was unable to track the comments back to a verifiable source. I know there have been quite a few warnings but I can't confirm they broke a record. John Butters, senior earnings analyst at FactSet Research said more than 75% of the recent Q4 guidance has been warnings. Typically that is more in the 65% range. Companies expecting to beat estimates rarely issue guidance just in case their numbers change, while those failing to make estimates are forced to warn to avoid regulatory problems.
GDP in Q4 is expected to be over +3% growth but that is mostly due to inventory calculations and will not be repeatable in Q1. Most estimates for 2012 have the U.S. growing at just 1.8% to 2% for the first two quarters.
Despite the continuing problems in Europe, the slowdown in China and slow growth in the U.S., Goldman analysts believe the S&P will gain as much as +16% in 2012. Another contingent of analysts are looking for only +7% growth. Goldman's own equity guy, David Kostin, sees a -1.5% decline to 1250 by year end due to the contagion from Europe.
I saw an interesting analogy about Europe on Friday. We write constantly about the possible contagion from Europe impacting the U.S. and other countries. That does not seem to relate for retail traders. Picture this. You live on a cul-de-sac with about 25 houses on your block. One day you look out and a house several doors away is on fire with flames engulfing the structure. (Greece) Several other homes are starting to smolder as sparks from Greece land on their roofs and start new fires. (Italy, Spain, Portugal, Ireland) Would you go back in the house and turn on the TV to catch the next edition of American Idol and ignore the blazes several houses away from your home? I seriously doubt it.
Half of the euro zone is either on fire or smoldering. Is it really possible for the U.S. to decouple from Europe and charge off on our own while Europe fights its own fires? Odds are very good that won't happen. We need to be proactive to keep the fire from spreading to the U.S. and contaminating our debt. We have far more debt than Europe but as long as our roof is not on fire the bond vigilantes will leave us alone.
Investors in U.S. markets have been pulling money out for years. According to Doug Kass, U.S. retail investors have withdrawn more than $450 billion from domestic equity funds since 2007. Over that same period they put more than $850 billion in the fixed income markets. Once Europe is on the right track that trend will reverse and that money will come back into equities. Holding a 2% bond does not even keep up with inflation.
That desire to increase returns is the underlying bid in the market. Bad news is being ignored as investors grow tired of the European scenario constantly spoiling the headlines. Eventually they will ignore those headlines but we are not quite there yet.
Our economy is (was) improving. Nobody knows what 2012 is going to bring. It is that uncertainty that is holding the market back. Even with the declining estimates the consensus year end close for the S&P in 2012 is 1,360. Obviously if we are at 1,277 today and only rose to 1,360 over the next 12 months it would be another nightmare because there would likely be volatility like we had in 2011. Traders can stand volatility as long as there is an underlying trend.
It would appear investors are still worried about the outlook. U.S. equity funds saw a ninth consecutive week of withdrawals totaling $1.1 billion. That is not a lot of money but the constant drain saps the strength out of the market. The prior week saw $1.7 billion withdrawn.
The bullish case is the slowly growing economy, (dog with the fewest fleas), improving employment and low interest rates. Corporate profits are still expected to be strong even though they will decline from the prior two quarters. Corporate cash is sitting at obscene levels of $1.5 to $2.0 trillion. The pothole in this road to riches is the guidance for 2012. As companies report Q4 earnings they will typically give initial guidance for the year. Guidance is likely to be ugly. This will be a quarter of purposefully weak estimates because of the European and Asian uncertainties.
How will investors react to lowered guidance and cautious outlooks? In theory they would withdraw into cash and wait for a positive outlook. While they are waiting we are likely to get several weak jobs reports along with some weak regional activity reports as corporations wait to invest until they see how Europe is going to get out of its problem.
Most analysts believe it will be 2013 before Europe improves and 2020 before they get well. They believe the ECB will eventually agree to backstop debt from weak countries by printing trillions of euros to buy bonds. Reportedly they were buying Italian and Spanish debt in the market last week. Apparently those buys were not enough to push yields lower because Italy ended the week with a 7.14% yield on the ten year bond.
Logically we should expect a lackluster first half of 2012. Since logic does not apply to the markets we will have to wait and see what kind of market appears.
The Cyprus central bank governor said in an interview on Friday that Greece should halt the 50% haircut for private investors because it was setting a dangerous precedent. Since the haircut scenario appeared the appetite for euro zone debt and yields have risen sharply. He said, "By making the political decision to impose haircuts on Greece, we have created doubts about possible haircuts in other countries." Athanasios Orphanides called for Greece to cancel the talks but he got no response from his fellow leaders. He is right. That decision caused the flight of investors from other sovereign debt.
The euro fell to a 16-month low on Friday and closed under 127. The good thing about the falling euro is the economic benefit to Europe. It will cause more tourists to visit and make their goods cheaper.
The bad thing about the falling euro is the upward pressure on the dollar and the downward pressure on commodities and equities. This has a long way to go and our markets will suffer until the euro finds a bottom.
Dollar Index Chart
Analysts seem united in expecting a rise in the markets in 2012. Since they are all normally bullish at the beginning of the year this should not surprise anyone. If they can convince investors, both retail and institutional, that stocks are going higher the odds are better they will rise.
Prudential put out a note on Friday saying 2012 could be the start of a "historic decade" for stocks. They predicted 2012 would be the start of a decade where stocks outperform bonds for the first time in a generation. Bonds have outperformed for the last three decades. Of course that assumes you bought and held both for that period. Stocks have been up and down 50% to 100% numerous times over the last 30 years.
Prudential's Chief Investment Strategist, John Praven, predicts the S&P will rise +13% in 2012 to 1430. He cites near record low interest rates, robust corporate earnings, modest growth in the economy that will continue to increase and low stock valuations. While risks remain that includes the euro zone and gridlock in Washington he believes there is a significantly higher chance of a long term rally than a surprise to the downside. "The risks are already discounted into current stock prices."
He said stock valuations are near the recession lows and the earnings growth and low interest rates will provide for multiple expansion. (Higher PE ratios)
For the contrary view Adam Parker, U.S. Equity Strategist at Morgan Stanley, believes investors will not pay up for earnings as long as the euro cloud hangs over the market. "You don't want to pay higher multiples as long as there is a negative skew." He believes the S&P will lose -8% to close at 1167. His bear case sees the S&P falling to 944, a -25% decline.
Phil Orlando, Chief Equity Strategist at Federated Investors, said without Europe, Washington gridlock and the election politics the S&P would be at 1800 by year end.
Normally the election is a positive force but analysts are expecting the opposite in 2012. The main campaign themes are going to be cutting spending by slashing entitlements and class warfare. The battle is going to be ugly.
I compiled a list of analysts and their predictions for 2012. The most notable on the list is Jeremy Grantham. He expects the S&P to decline to about 800 and stay there for the next four years. I did not include his estimate in the overall average. Adam Parker from Morgan Stanley is the next most bearish with his -8% decline.
The most bullish are Craig Callahan, President of ICON Funds and Doug Kass, Seabreeze Partners.
S&P Forecast List
Of course we know those estimates are not worth the digital ink it took to print them. As we have seen in recent years conventional wisdom is consistently wrong. Uncertainty will continue and we should always expect the unexpected. 2012 is likely to fool everyone and uncertainty will persist.
Hopefully by mid 2012 the uncertainty from Europe will ease. The ECB will continue to take additional measures to kick the can down the road until the austerity measures can be implemented. Once that occurs the uncertainty will fade but we will be left with Europe in what could be a deep recession as they try to pay down their debt and rebuild their economies. It will be a long process. They did not grow their debt to more than 100% of GDP overnight. We know from several hundred years of experience in hundreds of governments the only quick way out of a debt problem is restructuring. Since that is not likely in the euro zone countries the only path left is the long road of slashed spending, higher taxes and slowly paying down debt. Once that path is established and the uncertainty fades we will see the European economies begin to grow again. I only hope I live long enough to see it since most analysts seem to be fixated on 2020 as a return to a normal economy in Europe.
I believe investors are growing numb to the European problems. Our markets have been hostage to Europe for the last two years. When the euro rose so did our markets because the dollar declined. When the dollar rose, the euro fell and the S&P also declined.
However, note the divergence over the last month. The euro is plunging and the S&P is rising. The euro closed at a 16 month low on Friday and quite a few analysts are expecting it to continue declining. Some believe it will reach parity with the dollar. This is very beneficial for Europe since it make their exports cheaper and encourages tourism to Europe.
The U.S. dollar is being temporarily rescued from its eventual fate by this euro decline. Eventually the dollar is going to return to its lows because of the quantitative easing and the monster U.S. debt load. The U.S. needs a cheaper dollar to help pay down its debt but the administration, regardless of party, will always claim they favor a strong dollar policy. Trust what they do not what they say.
S&P vs Euro Chart
Dollar vs Euro Chart
If investors have grown numb to Europe and decided taking a risk in stocks is better than 2% in bonds then we could see some gains in 2012. However, once investors begin focusing on stocks the fundamentals come back into play. With the U.S. economy expected to grow a minimal +1.8% to +2.0% in the first half of 2012 that does not provide a very robust playing field for U.S. companies to prosper. It will take more cost cutting and less capital expenditures until a real recovery actually arrives.
Just wanting to invest in stocks does not mean stocks are ready to move higher. The chart of the S&P appears to be setting up for a breakout but appearances can be deceiving. The October closing high at 1285 is proving to be solid resistance. Should we actually move higher the next major resistance is 1350 and that is almost exactly the average estimate of those 45 analysts listed above. If we were to hit that number early in the year there would be a contingent of investors who would take profits and settle in for the eventual late summer decline.
While no two years are alike we did hit the highs for the year in May of 2011 at 1363. How many thousands of investors do you think are just waiting for a return to that level so they can bail out without a loss? The decline in July/August was dramatic. The S&P declined -245 points in only 17 days. Many "traders" became accidental investors during that decline. That happens when you don't have stop losses and you are not paying close attention to the market. You end up being buried in a position and waiting patiently for it to return to the prior levels so you can exit without a loss.
When the S&P hits the 1350-1360 level we are going to see quite a few accidental investors running for the sidelines. This is going to be very strong resistance.
S&P Chart - Weekly
In the short term the S&P is wedging up for an attempted breakout over 1285 and the Oct high close. Initial support should be in the 1260-1265 range and the 200-day average at 1258. If the normal January surprise decline happens we could see uptrend support at 1225 tested or even support from the December lows at 1200.
Last week I pointed out there had been a significant sell off in mid January in 12 of the last 15 years. (Thanks to Art Cashin for passing that tidbit on to his readers!) While you can't invest on historical trends you should be aware of them because they tend to repeat for a reason. A failure next week at 1285 and retreat to uptrend support would be buyable in my opinion. I do believe we will test the 1350 level over the next several months. Whether we break through is dependent on fear and fundamentals. If the fear of Europe continues to fade and stock fundamentals improve then maybe we move higher.
S&P Chart - Daily
The Dow broke through solid resistance at 12,300 at the open on Tuesday and then faded the rest of the week. Traders were buying the dip but there was no conviction. Volume was only slightly better than the holiday week with an average of 6.5 billion shares per day. However, advancing volume did beat declining volume on three of the four days thanks to the Nasdaq.
The Dow has decent support at 12,200 that should hold any lackluster selling. It also has decent resistance at 12,425 that was rock solid the last three days.
Alcoa (AA) is the first Dow component to report earnings and that will happen on Monday after the close. They have already warned they will be taking a big charge and possibly a loss for the quarter. Three months ago earnings estimates were 21-cents. Today they are right around zero. This is the impact of the global economic slowdown. With a share price of $9 they are not a major Dow mover but sentiment counts. If they post ugly numbers because of slowing demand for aluminum then the global recession worries will begin to return. Watch them for sentiment reasons not for decent earnings. They are the Iowa Caucus of earnings. The actual results are not as important as the sentiment.
Tuesday's spike was never met with any follow through gains although each intraday dip saw nearly immediate buying. There was simply not enough dip buyers to overcome the sellers. Mornings were rough but there were minor afternoon recoveries.
A break below 12,300 would be a sell signal.
Dow Chart - 30 Min
Dow Chart - Daily
The Nasdaq was the leader on Thursday but struggled to remain in the green on Friday. The downtrend resistance at 2680 was solid. Netflix, Apple and Amazon were strongly positive and that kept the Nasdaq from going negative. The RF Micro warning on Thursday night may have damaged sentiment but the SOX did close positive.
The only interesting tech stock reporting earnings next week is OCZ but there could be a continued parade of warnings from those scheduled to report later in the cycle.
After a week of gains on the Nasdaq you have to wonder if tech investors are going to continue to buy stocks if the broader market is still weak.
Initial support 2660, initial resistance 2680.
Nasdaq Chart - 5 Min
The Russell 2000 has been the steady Eddie of the bunch. Gaining +2, losing -2, etc, it remains stubbornly stable at strong resistance at 750. In theory it is coiling for a breakout. However, it could also be failing on that breakout because of a lack of conviction by fund managers. They are still putting money into large cap techs rather than going with the normal January winners like the small caps.
The lack of enthusiasm on the Russell translates to a lack of enthusiasm in the market. Money managers are walking on eggshells in fear of a news headline that will push the market back into a serious decline. That also suggests they will have a hair trigger on those exit stops if the market does decide to look for support.
The Russell remains our clearest trading indicator for next week. A break above 750 is a signal to go long and a dip to 735 is a dip to buy. Below 735 is a signal to put on the bear coats once again.
Russell Chart - Daily
The Dow transports have remained stubbornly bullish despite the four day fade on the Dow and the new highs on oil prices. I am having a hard time justifying a breakout for an economy running at +1.8% for Q1 GDP estimates, a slowdown in China and Europe dropping into a deep recession. Why would transports see those details as bullish? I know the market is supposed to be looking six months into the future but do you really expect it to be that much better?
In trading we have to go with the charts. The $TRAN is being stubbornly bullish and of all the charts it has the most optimistic setup. While I may not understand why the transports should move higher I don't want to miss the move if it comes. That is why we have an IYT call play in the Option Investor play section although it does have a tight stop.
Dow Transports Chart - Daily
Next week will be governed by the three E's, Europe, Economy and Earnings. Europe is the headline risk with multiple meetings among the various EU leaders. There are also high profile debt auctions in France, Italy and Spain if I remember correctly. As we know from experience a busted auction can cause havoc with our markets with financials leading the way down.
On the economic front the Fed Beige Book is the only material report and it should continue to show slow growth in all 12 Fed regions. Should conditions have deteriorated from the prior release it would not set well with the market. The next Fed meeting is in two weeks and there is a growing chance they could implement some new monetary policy based on their new communications policy announced last week. That expectation could keep a bid under the market but I think the odds of a change are slim.
Lastly will investors get excited about Q4 expected earnings growth of +4.2%? I doubt it. Fortunately the earnings calendar is slim and it will be another week before the onslaught of real earnings begins. That won't keep more companies from warning this week and that could keep a lid on the market.
This is the prime week for a decline based on my research of the last 15 January's. I would be cautious of any longs and keep a tight stop.
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