The markets continued higher and analysts provided a variety of reasons based on hope and fear.
The excuses for the market spike were plentiful. Excuses are like noses, everybody has one. The potential for a rate cut by the ECB when it meets this week was cited. Others thought China was ready to announce aggressive stimulus as early as this week to stimulate their sagging economy. However, if China did announce something they normally do it on Sunday so a Tuesday rally on China hopes is not realistic.
A Bank of America note that bearishness had reached multiyear highs not seen since the financial crisis was also given as a contrarian reason for the rally. Think that through. Earnings are expected to be the worst in ten quarters with estimates dropping daily and bearishness is a reason to rush out and buy stocks?
Some said investors were just protecting themselves ahead of the holiday by covering their shorts. While I do agree that being short any time the global markets are open and U.S. markets are closed is probably not a good idea I don't think that was a factor today except maybe for commodities. After all what "good" news is likely to appear unexpectedly to offset the far greater potential for bad news?
My personal favorite as an excuse is an asset allocation move by institutional funds. Yields on treasuries rose again as the underlying securities were sold. The yields have been in a narrow range since early June after solid buying in treasuries since the March peak. Funds that are required to keep a certain percentage of their assets in stocks, bonds, etc, have to reallocate those assets at the end of every quarter or at least twice a year. Since the second half of the year began on Monday this could be an asset allocation move by funds to bring those investment ratios back into balance.
Yield Chart on Ten Year Note
Yields on treasuries rose on Tuesday after an unexpectedly strong surge in factory orders for May. Orders rose by +0.7% compared to consensus estimates for a -0.2% decline. April had a -0.7% decline and March -2.1%. Turning positive after two months of decline was good for investor sentiment. Durable goods orders rose +1.3% compared to a -0.3% decline in April.
However, the factory orders report is lagging data and as seen in the chart below it is very volatile. The sharp decline in the Manufacturing ISM on Monday is much more telling and I suspect the factory orders for June will be ugly.
Moody's Factory Orders Chart
The headline number on the Manufacturing ISM fell to 49.7 from 53.5 and analysts had only expected a decline to 52.6. This was the largest drop since last July. The internal components were also weak. New orders fell a whopping -12 points from 60.1 to 47.8 and into contraction territory. Backorders fell further into contraction for the third consecutive month with a decline to 44.5 from 47.0. New export orders fell -6 points to 47.5.
The prices paid component suggests there is a lot of slack in the manufacturing sector. Prices declined -10.5 points to 37 and the lowest level since April 2009. There is zero inflation in the system and this kind of drop suggests deflationary pressures are rising. The Fed will not be happy with this report.
The global weakness is being felt by manufacturers as reflected in the falling export orders. All indicators point to the weakness continuing in the months ahead. Eventually this is going to impact employment and we could see signs of that in the Nonfarm payrolls on Friday.
The June ISM New York was released on Tuesday and it declined for the second consecutive month but the decline was minimal. The ISM-NY index only declined -0.1 point to 557.2 after a similar decline in May. The six month expectations component declined from 60.2 to 56.7 suggesting the New York area managers are not optimistic about the top line gains continuing. This is the lowest outlook since October. A number over 50 represents expansion but the pace of expansion is rapidly slowing from the 79.5 cycle high reading we saw in March. The current conditions component declined slightly to 49.7 from 49.9 but this is the second month in contraction territory.
Late Tuesday afternoon the vehicle sales for June were released. The headline number rose to 14.1 million units, annualized, from 13.8 million in May. The jump in sales was spurred by fleet purchases and commercial vehicles. Falling gasoline prices for the last 12 weeks stimulated purchases by individuals. Light truck sales rose by +200,000 units accounting for 7.1 million of the headline number. That is the highest truck sales rate since December. In the last consumer sentiment survey the number of respondents planning on buying a vehicle rose to 3.7% in June from 2.9% in May.
Investors will have no rest from economic numbers after the holiday. The ADP and ISM Nonmanufacturing will likely be disappointing on Thursday and set the stage for the Nonfarm payrolls on Friday. The official consensus is holding at a gain of 90,000 jobs in Friday's payroll report but that could change based on what the ADP report shows on Thursday. A low nonfarm number could energize the Fed to take action and there are plenty of analysts who believe that action is imminent.
Another factor investors will have to contend with is the escalating earnings warnings. Microsoft (MSFT) warned after the close that is was taking a $6.2 billion charge in Q2 that would wipe out expected earnings and possibly create a loss for the quarter. The charge was related to the $6.3 billion it paid for aQuantive, an advertising firm Microsoft bought in 2007 in an effort to challenge Google for online advertising. Taking the charge today basically means the company is now worthless. It never followed through on the hopes of improving advertising sales.
The company also warned that expectations for future growth and profitability at its online services unit, including Bing and MSN.com "are lower than previous estimates." The company did not say what those internal estimates were but that unit has been losing about $500 million a quarter. That unit has lost more than $5 billion in the last three years. Bing has doubled its market share to 15% over that period but remains far behind Google at 67% and just barely ahead of Yahoo at 13%. Microsoft was expected to post a profit of $5.25 billion or 62-cents when it reports earnings on July 19th.
MSFT shares declined slightly after the close but nobody was paying attention since most traders had already left for the holiday. This was perfect timing by Microsoft since their announcement was mostly ignored in the rush to hit the highways.
JP Morgan (JPM) declined slightly after Meredith Whitney downgraded the bank to hold ahead of their earnings. She said the lingering cloud of the unknown loss on the whale trade warranted caution. Recent headlines have suggested the loss could be as high as $9 billion but others still pin the loss closer to $2 billion thanks to some aggressive crisis management by JPM.
The bank is also under investigation by Federal regulators on claims it manipulated the power market to drive up electricity payments. The U.S. Federal Energy Regulatory Commission (FERC) claims three bidding techniques used by JP Morgan Ventures Energy Corp, a subsidiary of JPM, increased payments from grid operators in California by $73 million according to a Bloomberg article.
The first set of "Living Wills" from the major banks as required by Dodd-Frank were made public on Tuesday and they were less than exciting reading. Basically these wills are supposed to give regulators a roadmap for liquidating the bank in case of another disaster. The will is supposed to show which assets should be kept to maintain a functioning bank and which could be sold quickly to raise cash.
JP Morgan's plan outlined how the bank losses could be handled. JPM said, "The Resolution Plan would not require extraordinary government support, and would not result in losses being borne by the U.S. government." Regulators have to give feedback on the plans by September and they can force changes to the structure of banks and institutions if they believe the firms could not be easily liquidated under adverse situations.
Dow component Home Depot (HD) fell -2.5% on Tuesday despite announcing it was adding Whirlpool, Electrolux and Frigidaire to the chain's appliance offerings. The drop occurred at the open and there was no other news that would have accounted for the sudden selling. The decline knocked it back to recent support levels.
Investors were probably bailing out of retail positions ahead of the June retail sales numbers due out on Thursday. Bad weather and power outages cut the sales month short and that could impact earnings. The International Council of Shopping Centers said same store sales fell last week and the ICSC lowered its guidance fo r the month.
Home Depot Chart
Research in Motion CEO, Thorsten Heins, said in a radio interview that RIMM was not in a death spiral. He said they were in the "middle of a transition." I wonder what chart he is looking at. Also, "RIMM is not ignoring the world out there" indicating market share gains by Apple and Google. He said RIMM could have rushed the introduction of the new BlackBerry but they wanted to make sure the new OS will last "for the next ten years." Since RIMM itself may not last another ten years in its present form that is a very optimistic goal. He declined to discuss splitting up the company but said "we are looking into all options." RIMM shares fell another -2% on the news.
Activist investor Daniel Loeb and his $8.7 billion hedge fund Third Point listed Chesapeake Energy as its fourth largest position according to an email sent to investors. CHK shares rallied on the news but unfortunately the email did not say if Third Point was long or short the position. Investors are betting it is a long position given the fact Cark Icahn is also increasing his long positions.
CHK is in the middle of a restructuring push to sell up to $15 billion in assets in order to fund its ambitious drilling program. The company has plenty of assets but the high profile CEO Aubrey McClendon has become the poster child for bad financial management.
Chesapeake Energy Chart
JC Penny (JCP) fell -3.7% after customers received emails advertising large "discounts" for 4th of July week. The retailer said its "every day low price" strategy was still in place but it seems to be breaking down as they announce monthly specials and holiday discounts, etc.
Credit Suisse analyst, Michael Exstein, lowered his price target and earnings estimates saying the company had not corrected its problems after a disappointing Q1. A different retail consultant believes JCP same store sales will decline as much as 25% in Q2 compared to -18% in Q1. Shoppers have been conditioned to want a deal rather than an everyday low price. "Deals" or sales are assumed to be lower than normal prices.
Exstein said "In the history of the department store industry, we have not been able to find a situation where sales volumes fell so quickly and dramatically as we project for JCP in 2012. In terms of JCP, we project that nearly $4.8B in sales will have been lost between the companyâ€™s peak in 2006 and our 2012 estimates, with $2.1B of that loss coming in 2012 alone." Also, "The departure of top marketing executive, Michael Francis, could produce further instability at JCP."
The analyst believes the slow sales will result in further markdowns and lower margins as the year progresses.
The currency markets were crazy on Tuesday with the dollar falling and euro rising even though the ECB is expected to cut rates later this week. The euro spiked on Friday and gave back a little of the gains on Monday but the currency was in rally mode on Tuesday.
This pushed commodities higher led by gold, oil and grains. While I think the currency fluctuations had some impact I think it was mostly a desire not to be short over the holiday with global markets open and U.S. markets closed. Corn prices rallied again by +3%. Farmers planted the largest corn crop since 1937 but a lack of rain for the last five weeks has put that crop in jeopardy.
The "no shorts" move was most evident in the oil futures. WTI gained nearly $4 to close at $87.50 as Iran increased its saber rattling in the Persian Gulf. The Iranian parliament introduced a bill to halt tanker traffic through the Strait of Hormuz for any tankers headed to a country that is not buying oil from Iran. This is mostly symbolic since a) they can't actually halt traffic for more than a day or two and b) they have no way of knowing where the tankers are going after they leave the Persian Gulf.
They also announced three days of "missile tests" to simulate a reaction to an attack on Iran. One of the missiles launched was the Shahab 3, which has a range of 2,000 kilometers and is theoretically capable of hitting Israel. Iran said it also destroyed targets representing enemy forces from "outside the region" using seven "attack drones."
The "Grand Prophet 7" maneuvers were aimed at sending a message to the U.S. and Israel to think twice about the possibility of attacking Iran. General Salami, the second in command of the Revolutionary Guards, said it is a reaction to those who are politically discourteous to the Iranian people by saying "all options are on the table." This is in reference to president Obama claiming the all options are on the table.
WTI Crude Chart
Thursday and Friday could be peppered with earnings warnings if the Microsoft news today is any indicator. S&P updated their earnings outlook today and they are now calling for negative earnings growth for Q2 of -1%. This will be the worst quarter after ten consecutive quarters of earnings growth. Q4 posted double digit earnings and Q1 had earnings growth in the high single digits but the streak of positive quarters is destined to end this month.
Only three sectors are expected to show positive earnings growth. Those are industrials +9%, technology +7% and consumer staples +1.3%. The other six sectors are expected to post earnings declines. Declining consumer sales, businesses hoarding capital and currency conversion issues will be the biggest drags on earnings. The recession in Europe is having a major impact on profits for multinationals and slowing job growth in the U.S. is weighing on retails sales here. That should be borne out in Thursday's retail numbers for June.
There is no fundamental reason for stocks to be moving higher when earnings are turning negative and manufacturing is contracting.
A little over a week ago Goldman Sachs made headlines with its "short the market" call and a target of 1285 on the S&P. That call turned into a market bottom not the beginning of a major decline. Goldman admitted this week they were stopped out on their short. If you want proof that market direction is nearly impossible to predict accurately that is a prime example.
The S&P rallied to close at two month highs on Friday at 1374. That was well over the prior resistance of the 100-day average at 1360 and would appear to be a clear breakout. The next resistance target is 1400 and that is not far ahead and "should" depend on some positive payroll numbers later this week. The key word there was should. Since the markets are moving higher in spite of negative news you have to wonder when the magic spell will wear off and reality return.
A market saying claims "bull markets climb a wall of worry" and that appears to be what we are seeing here. Obviously three days do not make a trend since the Thursday low at 1313 but the S&P has rebounded +61 points since that low. July is normally the best month in the third quarter with September normally posting lows well below July's highs. Time will tell.
The next chart event we should watch for would be a double top just over 1400 on the S&P. The April high close was 1422 and the resistance high prior to that was 1426 back in May 2008. For the S&P to just push right through those levels given the current economic environment would be practically impossible in my estimation. Stranger things have happened and I certainly don't want to say it is impossible. It just seems highly improbably at this point.
The resistance band over 1420 coupled with the macroeconomic picture and earnings deterioration would seem to paint a picture of trouble ahead. We will have to watch and wait for the outcome but I would hesitate to be overly long as that barrier approaches.
S&P Chart - Weekly
S&P Chart - Daily
The Dow extended its rebound from the 12,450 lows of last week and has added about +500 points. This is astounding but remember +400 of those came as a result of the EU summit short squeeze. Add in another 100 points for the beginning of the second half asset allocation programs and now we are at two-month highs.
Seven Dow components were negative for the day including HD, T, DIS, PFE, JPM, GE and MRK. That left most of the heavy lifting to CAT +2.78, CVX +1.51, WMT +1.40 and BA +1.09. The rest were only fractionally higher. On a side note Boeing raised sales estimates for the aircraft industry between now and 2035 from $4.0 trillion to $4.5 trillion.
Like the S&P, I can't conceive the Dow will just continue rebounding to 13,275 but in this market anything is possible. I am not brave enough to short it for another 10-14 days, I want to see a week of earnings first, but I do believe we will have that short opportunity soon.
The Nasdaq continued to climb closer to psychological resistance at 3000 but is still well below technical resistance at 3050-3060. The 3000 level has figured prominently in trading earlier this year and it should come back to haunt us once again.
Leading the Nasdaq higher was Apple (AAPL). The stock finally broke out of its two month consolidation range with a textbook respect for the 100-day average. Apple shares hit a dead stop at $600 on Tuesday but if the gains continue later in the week the Nasdaq could punch through 3000.
The Nasdaq has rallied +156 points since last Thursday's low or roughly +5.6% and closed at the highs of the day on Tuesday. That is an extreme three day run and "should" be due for some profit taking.
Nasdaq Point Gainers
Clearly I am questioning the recent rebound but I am not yet ready to bet against it. Selloffs and short squeezes can always run farther and faster than technicians expect. They tend to feed on themselves and fuel their own continuance as traders react to events rather than anticipate them. The first week of a quarter and first ten days of a half are typically bullish as funds put new cash to work and restructure existing portfolios. I believe that is adding fuel to the EU short squeeze from last week. Eventually that fuel will run out. Until then I would sit back and enjoy the gains. The payroll reports on Thr/Fri could be speed bumps to this yellow brick road
Anyone long this market should have a happy 4th of July. Just apply sunscreen liberally and beware the hangover.
Enter passively, exit aggressively!
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I was baptized alongside my mother when I was 8 years old. Since then I have tried to walk a Christian life. And now that I'm getting older I realize that I'm walking even closer with my God.
Andy Griffith, born 1926, died today at age 86.