Surprise headlines were popping up all over today and the result was a super short squeeze.
Last Tuesday may have been Super Tuesday for the Republican candidates but today was a Super Tuesday for the bulls. The markets opened bullish on much stronger Retail Sales for February and cruised to a triple digit gain over critical resistance before the Fed announcement. After the Fed the markets digested a hiccup but then rocketed higher after JP Morgan released news it had passed the Fed stress test. The results of those tests were not supposed to be released until Thursday. This sudden deluge of positive bank news triggered a monster short squeeze on those traders who had been shorting the Fed statement in anticipation of a decline on no mention of QE3. It was a day of surprises all around and I will report on them in sequence.
February Retail Sales rose +1.1% compared to +0.6% in January and +0.3% in November and December. This was the strongest sales since September's +1.3% and came despite the rise in fuel prices. The prior two months were also revised higher. Analysts claim the warmer winter weather enticed consumers out of the house and into stores. Ex-autos sales rose +0.9%. Excluding autos and gasoline that declines to +0.6%. Autos and parts exploded for a +1.6% gain as pent up buying and warmer weather brought consumers into the auto dealers.
Electronics rose +1.0%, building materials +1.4%, Clothing +1.8%, sporting goods & hobbies +1.0%. The only decline was furniture at -1.2%.
A big gainer that is negative for future sales was the whopping +3.3% increase in gasoline station sales.
Year over year sales growth rocketed to +6.5%. Year over year building materials sales are now up +14%.
Consumer fundamentals are improving with employment increasing strongly for the last three months and suggesting a new trend higher.
The Job Opening Labor Turnover Survey (JOLTS) showed job openings declined only slightly in January from 3,540,000 to 3,459,000. However, separations declined sharply from 4,023,000 to 3,944,000 with layoffs dropping to 1,646,000 from 1,685,000. This is a lagging report and was mostly ignored.
The Manpower Employment Survey for Q2 showed a marked improvement. In the U.S. the number of respondents planning on hiring in Q2 rose to 18% from 14%. Those planning on layoffs declined to 6% from 9%. In Canada 21% of respondents were planning to hire, up from 16%. Even 9% of the U.K. respondents were planning on hiring, up from 6%.
The markets were already in rally mode from the economic data when the FOMC announcement was released at 2:15. The Fed statement caused the normal volatility and the Dow started leaning to the downside and declined to 13,050 just before 3:PM.
The Fed did not say anything new but cleaned up and rereleased their announcement from the prior meeting. They added a couple adjectives but overall continued to say that the recovery was progressing at a moderate pace. Slack in the economy would prevent inflation in the long term although gasoline prices might cause a temporary short term spike.
The Fed seems obsessed with keeping the economic outlook restrained as evidenced by their comments on employment saying that although market conditions had "improved further" and unemployment had fallen "notably" the unemployment rate would only "gradually" decline.
They said the economic conditions had expanded "moderately" which is the same term used in the prior statements. The Fed said they expected only "moderate" growth in the coming months compared to "modest" in prior statements. They continue to say the global financial markets pose a "significant downside risk" to the outlook.
There was no mention of a potential QE3 and the statement remained constant on the Operation Twist saying it would conclude those purchases by midyear. Operation Twist is the selling of short term treasuries in the Fed's portfolio and using the proceeds to buy longer term treasuries to force long term rates lower on mortgages. This is scheduled to end in June and the Fed will have to say something specific at the April meeting on whether it will actually end or be extended. Most analysts believe it will be extended. However, the Fed is about to run out of short term securities to sell. This means they will either have to use funds from other sources like maturing securities or create new money by increasing their balance sheet. With nearly $3 trillion in securities on their balance sheet and a decreasing amount of short term treasuries the Fed is becoming increasingly at risk of interest rates rising.
This is why the Fed is being so cautious in their economic assessments. If they suddenly became a cheerleader for the economy the short term interest rates would spike higher and they would be forced to again balance their portfolio by selling long term and mortgage rates would rise.
They are walking a tightrope. They need to create inflation to stimulate the economy and the markets but they can't over stimulate because they are reaching an inflection point where a sudden increase in rates could kill the recovery plus force the government to pay significantly more in interest on the national debt.
Bernanke wants the outlook for the economy to remain muted as long as possible because that means it will be easier for him to keep rates low. Eventually this rate saga is going to end badly. Every time a central bank has ended a QE program and begins to raise rates the market and the economy suffers. That is why Bernanke wants to make sure the economy is on a sturdy footing before he is forced to change the interest rate policy. I have no idea how he is going to remove $3 trillion in accommodation without a disaster.
The April 24th FOMC meeting is a two day meeting. As I said in the weekend commentary I expect a major move at that meeting. It is the last chance Bernanke has to do something significant before moving to the sidelines before the election. There are still a lot of analysts that believe we will see QE3 as an insurance policy against an economic slowdown. Historically the U.S. sees a recession every 3-5 years. With the last recession at the end of 2008, early 2009 the three year clock has expired and we are rapidly approaching the midline. With the U.S. budget set to explode in 2013 along with a number of major tax increases the economy needs to be running full speed by Q1-2013 or the sudden collapse is going to be ugly. Since the forecast is for a GDP of less than 3% in Q4 that is well below optimum. We still need another push to achieve liftoff.
The economic calendar for the rest of the week is highlighted by the Philly Fed Survey. This is the mid month look at economic activity. The Philly Fed is thought to be a preview of the ISM two weeks later.
The market rallied on the opening economics but flat lined about 11:30 as traders waited on the Fed statement. As usual the statement generated some volatility and the Dow began to decline because there was no mention of QE2 or extending Twist. About 2:45 JP Morgan shocked the market with a $15 billion stock buyback and the increase in the dividend from 25-cents to 30-cents.
Immediately analysts and market reporters jumped to the conclusion they had passed the Fed's stress test because they would not be allowed to expand their capital return to shareholders without Fed permission. Since the Fed was not due to release the results of the stress tests until Thursday traders were not prepared for a sudden burst of positive banking news.
Those traders and hedge funds that had been shorting the FOMC statement in anticipation of the normal post statement decline were instantly caught off guard. With JPM, BAC and AXP members of the Dow the sudden spike in their shares caused a monster spike in the Dow and the associated ETFs like the DIA. Since nearly all of the nineteen banks being tested are members of the S&P the SPY ETF immediately exploded higher.
Dow Chart - 2 Min
The sudden announcement by JP Morgan immediately spawned several announcements by other banks not wanting to be left out of the rally. U.S. Bank (USB) said it would boost its annual dividend +56% to 78 cents and repurchase 100 million shares of stock. Wells Fargo said it would increase its dividend to 22 cents from 12 cents. Unfortunately JPM had jumped the gun on the Fed. The Fed had announced on Monday it was going to release the test results on Thursday. After the sudden flurry of bank announcements late today the Fed was forced to accelerate its timetable and quickly announced it would release all the results at 4:30 today. Meanwhile the banks were quickly moving higher as shorts were forced to cover in a panic.
The financial sector ETF (XLF) rallied +4% in just the last 30 min of trading. The KBW Banking Index rallied +4.58%.
XLF Financial ETF Chart
KBW Bank Index Chart
The stress test for this cycle was extremely rough. The banks had to show they could survive unemployment at 13%, a 50% decline in the stock market and home prices falling -21% from today's levels. The Fed said the banks would have lost $534 billion under that scenario. Could you survive that test?
Unfortunately not all the results were good. When the Fed finally released the list at 4:30 there were four banks that failed. Clearly that will temper the continued gains for Wednesday because Citigroup was one of the failures. Citi is the third largest bank in the U.S. and the Fed said it lacked enough capital to withstand another severe economic and financial crisis. Citi fell -4% in afterhours trading. Citi said it only failed because it had requested to return additional capital. They will continue to pay their 1-cent dividend. They were just not approved for a higher dividend.
MetLife (MET) failed the test as well. After rising +5% on the rumor to $39.50 it collapsed in afterhours trading to $36.81 before settling at $38.00. MetLife had requested to buyback $2 billion and raise its dividend from 74-cents to $1.01. SunTrust (STI) also failed and gave back -5% in afterhours.
Ally Financial, the former GMAC bank, was the worst performer in the test. The U.S. Treasury still owns 74% of Ally. The company protested the results saying the Fed analysts overstated the potential mortgage risk in its portfolios. Dang, given the parameters of the test you would think any mortgage lender would be in serious trouble but JPM/BAC passed.
The table below shows the tier one capital ratios before allowing any capital distributions and then the tier one capital ratio if the banks were allowed to raise dividends and buybacks as requested. The banks had to submit their capital plans to the Fed along with the stress test data.
I was surprised JP Morgan was not higher on the list given their aggressive capital distribution plans. They announced a $15 billion stock buyback with $12 billion in 2012 and $3 billion in the first quarter of 2013 plus expanding their dividend. The caveat was the new buyback replaced an old and incomplete buyback of $6 billion. The devil is always in the details. They are only expected to earn $18 billion in 2012 so that is a really strong buyback. The announcement did have the desired impact on JPM shares with a +7% gain.
Stress Test Results on Capital Distribution
The combination of the Retail Sales, FOMC announcement and the Stress Test revelations combined to produce a blowout in the markets and a major contraction in volatility. The dollar moved to a new two month high and that pressured gold as an inflation hedge.
Gold declined -$23 to support at $1675 and that is critical support. If the Fed is not going to announce any new QE measures the case for gold loses some of its luster. A rising economy creates a stronger dollar without competition from the euro until they get past their current debt crisis problems.
Crude oil did rise slightly in the U.S. and a bit more overseas because stronger economic numbers suggests future demand will rise. The Brent price continues to rise on worries over Iran. That country agreed to let inspectors into its Parchin military complex where it was suspected of conducting nuclear experiments. However, satellite photos showed a sudden influx of bulldozers and trucks knocking down buildings and clearing fields. They did this once before when inspectors wanted to investigate a specific building. That building suddenly disappeared. This is keeping the Iranian security premium on Brent crude and it will likely rise as the summer progresses.
WTI Crude Chart
Brent Crude Chart
The rally today pushed volatility to a five year low. The VIX hit 13.99 intraday and it has not been this low since 2007. On a contrarian basis this is a screaming sell signal. However, as you see on the chart it can remain at low levels for a long time before a cataclysmic decline in equities occurs.
VIX Chart - Weekly
The Dow closed well over 13,000 at 13,177 for a clear breakout. The Nasdaq gained +56 points to 3,039 and also a clear breakout. The S&P closed at 1,395 and well over the 1375 level that caused us so much grief over the last two months. While those breakouts are key the more important breakout could be the yield on the ten-year note. At the 2.10% close that is a four month high and suggests the big move from fixed investments to equities is about to occur.
With equities at new multiyear highs and good news breaking out all over how much longer are bonds going to be in favor. There are hundreds of billions of dollars that has moved from equities to fixed income over the last four years that is currently yielding less than the rate of inflation. Eventually a significant number of those investors are going to decide safety is no longer safe and begin fleeing to equities. Today may have been the day that triggers this exodus.
Ten Year Note Yield Chart
Volume on Monday was only 5.1 billion shares. That was the lowest volume since Dec-29th and the Friday before New Years. Clearly investors were waiting for the Fed. The volume over the last month has been 33% lower than the average for all last year. Eventually this has to change. Today's volume was 7.33 billion shares but given the big rally you would have expected it to be higher. Advancing volume was seven times declining volume. New 52-week highs were 538 and that was the highest since February 3rd.
The S&P sprinted past prior resistance and came within four points of 1,400. That breakout occurred well before the FOMC announcement and the Stress test results. This suggests investors were already pushing the envelope before the short squeeze began. That would also suggest the banking news was just icing on the cake but I am not going to complain. This should put to rest the lack of conviction worries over the last month.
That does not mean the markets will just continue sprinting higher. There is always another resistance level to fight but I am very glad to see the S&P move through that 1375 resistance level. Now we get to fight the same battle at 1400 and 1425 but at least it will be a new fight.
S&P Chart - 180 Min
S&P Chart - Daily
The Dow blasted past strong resistance at 13,000 by nearly +200 points thanks to the strong gains by the three banks in the Dow. Caterpillar helped a lot with a +4.36 gain and IBM +2.78, UTX +2.58. When unexplained short covering begins it is a race to cover all shorts and then ask why. Anyone short anything in the Dow was racing to close it.
The Dow actually has some room to run but I would be surprised if we did not see a pause for profit taking. Anyone long those Dow stocks from the dip last week will want to take profits and look for another trade. It is hard to point out support on a move like this but it would now appear that 13,000 should be that resistance. I would REALLY hate to test that theory this week but nobody asked me.
Dow Chart - Daily
Dow Chart - 120 Min
The Nasdaq finally broke through the barrier at 3,000 and it has not closed at this level since November 2000. The Nasdaq could easily fall back to test that 3,000 level as support but tech stocks seem to have been the preferred investment vehicle since the dip last week. Technology is trading at the lowest multiple since 1990. The mega caps have been driving the market and a broadening of interest in tech stocks in general could push the index significantly higher. Rising tech stocks are a major lure for hesitant investors currently in cash.
Nasdaq Chart - 120 Min
In any family gathering there is always one person that does not fit in the family. They are late to the party, seemingly operating under a different set of assumptions and dressed like they just came from the thrift store. Today that would be the Russell 2000. The Russell did rally like the rest of the indexes but it failed to breakout and remains well below the same relative highs the other indexes have already broken.
Small caps may have tagged along but they are really well back from the crowd. Ironically the Russell posted the largest percentage gain of the day compared to the other indexes but it remains the laggard in terms of relative positioning.
This is going to be our market canary. If the Russell can break over that strong resistance at 831 then the broader market rally has a chance. The Dow and S&P are highly influenced by the big cap financials where the Russell is not. A continued move higher by the Russell will be evidence investors, not traders, are returning to the market.
Russell Chart - 120 Min
Russell 2000 Chart - Daily
It should not be a surprise the S&P futures are trading down tonight. This is especially true since we did not find out until well after the close that Citi, MET, STI and Ally failed the test. That will temper the enthusiasm somewhat but I think it will pass.
I would NOT buy the open on Wednesday. We need to let some of this fizz evaporate and see where support appears. I am encouraged about the breakouts but in the final analysis it was simply a super short squeeze. The real key is what happens after the squeeze is over.
Send Jim an email
Have you tried the new Ultimate Investor newsletter? This publication focuses on "investing" not "trading." The goal is to enter lower volatility positions with strong fundamentals and sleep comfortably at night. Click here for the newsletter description