The Dow traded in the smallest range in more than five months as volume and volatility both left the market.
The VIX sank to the lowest close since June 2007 at 13.36 suggesting all the bears have left the market. The AAII Investor Sentiment Survey showed 47% of respondents were bullish on the market. That is an 11-month high. The normal range is 39%. Volume fell to 5.8 billion shares and nearly a two week low. The major indexes closed mixed after rebounding from minor losses at the open. The S&P lost 7-cents and the Russell 2000 47-cents while the Dow gained a lackluster +17 and the Nasdaq +3.
There was no interest in the market despite what I considered was good earnings from Wells Fargo and better than expected economic news from multiple sources.
The indexes were trapped in the pre earnings zone where expectations are for a mildly positive earnings cycle. The bets have been placed and traders are now waiting for the big reveal.
One analyst had a perfect analogy for what is ahead. He called it the report card market. Many of the major companies had notes sent home from the teacher in the middle of the semester saying they were in danger of flunking the quarter. More than 73% of the S&P guided lower on revenue for Q4.
We are approaching the release of the report cards with a bunch of D- students. Expectations are low, very low. However, the potential for an upside surprise is very strong. ANY grade a D- student brings home that is better than a D- is a pleasant surprise for the parents. There is only one grade worse, an F, and a lot of room for improvement. The analyst claimed this could be a C+ quarter. Nothing to get excited about but definitely better than a D- or an F.
Of the 27 S&P companies that have already reported, 67% have beaten estimates. Only 19% missed estimates and 15% reported as expected. Earnings growth averaged +4% and revenue growth +1%. As bleak as those numbers would appear on the surface they are still better than Q3.
With 473 companies still to report it is hard to call it a trend. However, if that trend continues it would mean Q3 was the trough in earnings and estimates and stocks would begin to rise in anticipation of a better 2013.
That is a lot of assumptions and the actual outlook is very cloudy. That is why the markets struggled to close fractionally positive on Friday.
The other factor weighing on the market was the coming debt threat but lawmakers have gone into quiet mode and there was very little in the way of sound bites to worry traders. They have not forgotten about the debt threat but it is more like "out of sight, out of mind." As long as the politicians stay away from the microphone the market should creep slowly higher. If earnings continue to beat estimates we could see some decent moves.
Eventually the debt debate will come back to the forefront and we are going down but that is a story for another day.
There was nothing really exciting on the economic front with budget and trade data leading the list. The trade deficit increased from -$42.2 billion to -$48.7 billion for November. That was the biggest deficit in seven months. If oil prices had not declined it would have been worse. Exports grew in all categories except for food and beverages with automotive exports rising by 6.4%. However, a surge in imports across all categories overpowered the decent export numbers. Imports of consumer goods rose by +11.2% with automotive and beverages up by +6.3% each.
To be fair this was for November. Companies were still importing products for holiday sales so the numbers should have been strong. Also, hurricane Sandy disrupted October shipping and closed harbors and some of that pushed imports into November that would normally have been in the October period. This was also a lagging report for November and considered old news.
Moody's Trade Balance Chart
The Treasury budget for December only went into the red by -$300 million compared to the -$292 billion deficit year to date. The U.S. budget begins on Oct 1st so December is the third month of the year. The -$300 million for the month versus -$292 billion for the first two months was simply a timing issue.
Worries over the fiscal cliff forced taxpayers to move taxable events into 2012 and that resulted in a +12% increase in total receipts in December. That was an increase of $30 billion. Individual income tax payments were +19.8% higher than December 2011.
This acceleration of taxable events into 2012 will obviously mean a larger deficit in early 2013 since the tax payments, which would have been made in the first quarter, are no longer there. Normally this would mean a larger deficit in the Q1 months but the current hold on spending will push those expenses into March and after the debt debate has ended.
The economic calendar for next week is crowded with reports that matter. The NY Empire Manufacturing Survey is well down the list critical reports but still important. The consensus is for a rebound from a -8.1 headline number in December to at least zero for January.
The Producer Price Index and Consumer Price Index are important because of the impact of the Fed's QE programs on the economy and inflation. As long as price inflation remains low they will continue the programs. Nobody is expecting any gains and the Fed is more worried about deflation than inflation.
The Housing Market Index is a major indicator for the housing sector and we need to see a continued improvement to keep the gains in the housing stocks. The New Residential Construction on Thursday is expected to show a strong spike in new housing starts to 890,000.
The Beige Book on Wednesday is a look at the economic conditions in all 12 Fed regions. This should show a continued but slow improvement.
The biggest manufacturing report is the Philly Fed Survey on Thursday. That has a high correlation to the national ISM two weeks from now so it is seen as an advance look at the national data. Analysts are actually expecting a decline in the headline number as a result of Sandy.
The more important calendar is the earnings for the financial sector. Nearly every major bank in the sector reports. Wednesday we will see GS, JPM and USB. Thursday is BAC and COF and Friday is MS.
The three biggest non-financials are Ebay on Wednesday, Intel on Thursday and GE on Friday. We will also get the first look at the energy sector with SLB on Friday.
Because Q4 is the last quarter of the fiscal year for most S&P companies the real flood of earnings does not begin until the next week. However, we have enough diversity in the coming week to know how the entire earnings cycle is going to end. That could be good news or bad news depending on how it plays out.
On Friday Wells Fargo (WFC) was the first major bank to report earnings and I thought they were great. Revenues rose +7% to $21.9 billion. Fully year profits rose +19% to $18.98 billion.
This was a record quarter for WFC with profits of $5.1 billion. It was the 12th quarter of earnings growth and the seventh consecutive quarter of record earnings. Earnings per share rose by +26% to 92 cents and that beat the 89 cent estimate.
Shares of WFC declined slightly because the Net Interest Margin or NIM fell by ten basis points. That is nothing. How many angels can dance on the head of a pin? That is how insignificant that number is. The NIM is the interest earned on customers deposited cash minus the interest WFC pays out. If they pay 0.25% and earn 0.50% then the difference is their profit or NIM.
The problem with WFC in Q4 was too much money. Deposits rose by $30 billion in Q4. That must be a nice problem to have but it was far more than Wells expected. They had so much money they could not find a home for it and had to buy short term treasuries or the equivalent and the very low interest on the treasuries brought down the average NIM.
The CEO blamed the Fed's QE programs that are keeping interest rates near zero. The 3-year note is yielding 0.38% today. There is no way for Wells to keep NIM up until the Fed lets rates rise. He said "we are not going to turn away deposits from customers just because the NIM might decline."
Personally I would rather have a bank that is raking in $30 billion in new cash and turning out profits of $5 billion every quarter instead of one that is ultra conservative and growing at a snail's pace.
The CEO said there were $81 billion in home loan applications pending at the end of the quarter. That was down from $97 billion at the end of Q3. Wells did write $125 billion in mortgages in Q4 compared to $139 billion in Q3.
Wells kept $9.7 billion in mortgages in house and did not sell them to Fannie or Freddie simply because the interest rate was far better than anything else Wells could do with the money. Total loans increased to $799.6 billion.
The bank repurchased 42 million shares in the quarter.
Wells Fargo Chart
American Express (AXP) reported preliminary earnings a week before the scheduled report and caught many traders off guard. Earnings were $1.09 compared to estimates of $1.05. The company reported a restructuring charge of $400 million related to the expected termination of 5,400 workers in 2013. AXP said the job cuts were mostly in the travel services division as the digital age had cut into the dynamics of business travel. They currently employ 63,500. Revenue was $8.1 billion, up +5% from the year ago quarter. The company said cardholders increased spending +8% with charge offs at a historic low of 2%. The full earnings will be on January 17th. The premiminary release was a surprise after they formerly announced the Jan 17th date just last week.
AXP shares gained 50 cents on the news.
Infosys (INFY) spiked $8 after reporting earnings of 76 cents compared to estimates of 73 cents. Revenue rose +6% to $1.91 billion. The spark for the big gain came after the company raised revenue guidance for the full year to $7.45 billion, up from $7.3 billion. Earnings forecast of $2.97 did not change and was in line with analyst estimates.
The company said it added roughly 50 new clients during the quarter and won eight business and information technology deals. They also said they were beginning to see stability in pricing.
Best Buy (BBY) does not report earnings until Feb 28th but shares rallied +16% after the company reported U.S. same store sales that declined -1.4% for the nine weeks ended Jan 5th. International sales fell -6.4%. Yes, you read that correctly. Shares spiked after same store sales declined. Analysts had expected an even bigger decline and shorts had loaded up in anticipation. Also, the better than expected sales paves the way for the Richard Schulze buyout offer in February. If results had been worse the offer would have been lower. Better sales suggests a better offer.
The company said sales were strong in cell phones, tablets, electronic readers and appliances but sales fell in televisions, entertainment devices and computer related items. Best Buy is trying to compete with Amazon and others by improving its online offerings so customers can "showroom" at the BBY store then buy online at BBY instead of Amazon.
Research in Motion (RIMM) came back from the dead on Friday after the company said it was going to launch at least six BlackBerry 10 phones this year and target multiple price points and market layers. Only two devices will be announced at the end of January, one with a touch screen and the other a QWERTY keypad. RIMM will launch BB10 with all four major carriers in the U.S. and more than 150 carriers globally. RIMM has 80 million current subscribers and they are hoping to keep those 80 and add news ones in the weeks ahead. The iPhone and Android models have been steadily eroding RIMM's base but there are still plenty of faithful devotees. RIMM only shipped 6.9 million phones in Q4. That is a 50% decline year over year. Unfortunately the BB10 OS is not supported by existing enterprise servers and that makes the upgrade process more risky. The BB10 devices will require an upgrade to the new Blackberry Device Service, which will manage the new range of mobile devices including the Playbook tablets.
NetFlix (NFLX) rallied another $3 after the president signed the Video Privacy Protection Act (VPPA) into law on Thursday. The law changes a 1988 restriction that prohibited a "video provider" from revealing customer information without customer's written consent. Now users on sites like Facebook and Netflix can allow their history to be shared if they opt-in to sharing. The original law was spawned after a reporter, researching Robert Bork during his nomination to the Supreme Court, convinced a video store clerk to give him Bork's rental history. Lawmakers panicked over the implications and the law was born. In today's digital Internet world where everything is shared on places like Facebook that law was outdated.
Apple (AAPL) shares declined again and moved closer to support at $500 after the Chinese newspaper that reported earlier in the week that marketing chief Phil Schiller said "Apple will never make a cheap iPhone" retracted its claims. The paper now says the better translation for the Schiller comment is "Apple has always focused on providing the best products for its consumers, we've never blindly chased market share."
The Wall Street Journal had said earlier in the week that Apple was working on a lower priced iPhone. That would by necessity mean lower margins and the potential to cannibalize sales from the more profitable full price model. The model was rumored to be made with a plastic body and use components from older iPhone models. Apple's market share has fallen from 23% in Q4-2011 to 14.6% in Q4-2012. The Android operating system phones are surging and Samsung is projected to increase market share to 35% by year end. They currently have 31.3%, up +8% from the end of 2010. Under Steve Jobs Apple focused on selling only one, top of the line product, for a premium price rather than a broad offering of multiple models. Of course the playing field has changed since the Steve Jobs era.
Herbalife (HLF) held a shareholder meeting on Thursday to rebut the clams by Ackman. The volatility surrounding the meeting was huge but there was little movement in the stock. The Ackman position is being hurt by multiple high profile hedge funds coming out in support of Herbalife. Unfortunately the CEO was interviewed on CNBC after the meeting and the stock weakened after he was unable to answer certain questions with convincing answers. Unprepared or caught off guard by some pointed questions? Investors were not sure and shares declined. They recovered some of that decline on Friday to end at $40.
The dollar fell to a two-week low on the weak trade data and that helped to lift commodities and probably had a positive influence on stocks. The euro rallied to a nine-month high despite some negative data out of Germany. Greece, Spain and Italy did not fall off the map and the eurozone debt crisis appears to be old news.
The dollar index is only 60 cents above strong support at 79.00 and a break below that level could power a strong commodity rally.
Dollar Index Chart
There were some interesting numbers on fund flows out last week. For background the net inflows to stock funds in 2012 was $3 billion. That is miniscule. Fast forward to 2013 and for the week ended Jan 9th there were inflows of $18.1 billion or six times the total for all of 2012. That is the biggest inflows since June 2008 and the fourth largest since 2000. It is not just the USA. EPFR Global reported that $22 billion flowed into equity funds in the global markets for the biggest inflow since data was started in 1996.
Funds are starting to come out of the bond market. The yield on the ten-year treasury rose to 1.95% on January 4th and has not declined much with a 1.875% close on Friday. Those are six month high yields and represent selling in treasuries. The 30-year has a similar pattern with yields rising to 3.17% before declining to 3.05% on Friday. Those are also six month highs.
The fear is twofold. Investors are afraid the stock market is going to breakout to new highs and begin a new leg to the current bull market. They don't want to be left behind in treasuries and minimal yields. Even worse the FOMC minutes suggested the Fed could halt its QE purchases before the end of 2013 and that would cause a major sell off in treasuries and a sharp hike in interest rates.
Neither outlook is bullish for bonds. With the U.S. economy slowly recovering and China in rebound mode the market for equities is improving daily at least on the surface. The S&P hit a five year high on Friday along with the Russell 2000 and the NYSE Composite. That is a siren call for investors to dump treasuries and rush into equities.
The rotation out of treasuries is still in the infant stage and will probably remain there until after the debt debate in February. Once that debate is "successfully" concluded there could be a stampede into equities. The fear factor of a government meltdown would have passed and expectations for a stronger second half of 2013 would take its place.
However, until the Fed actually begins to pullback on the bond buying the rates will have trouble rising. The Fed is currently buying about 50% of the monthly issuance of government debt and they are close to 90% of the mortgage backed security debt. As long as they keep pouring $85 billion into the bond/treasury market the bond bubble bursting will only be a slow leak and not an actual burst.
Art Cashin believes the actual bursting of the bond bubble will be easily recognized by the stampede of investors into the equity markets and interest rates rising over key levels. Until then it is only a stealth leak.
Earnings have been better than expected but then there have only been a few reports. The big news will come from the financial sector this week and then the tech sector the following week. If those reports continue to beat estimates the markets should continue to creep higher in anticipation of a successful debt conclusion.
Remember the market rallied into the fiscal cliff deadline because investors "knew" lawmakers would eventually get something done. The markets could rally into early February for the same reason but once the rhetoric increases there could be a repeat of the August 2011 market crash. Earnings will be mostly over and profits will need to be taken to avoid a loss if the debate does not go well.
Another reason for the sudden influx of cash could be related to the fiscal cliff. Many investors may have cashed out profitable positions in November and December in order to receive favorable tax treatments since they were unsure what taxes would be in 2013. They had to wait for the fiscal cliff resolution on Jan 1st and then they put that cash back to work. The early December sell off ahead of the cliff negotiations was far more than $20 billion so putting some of that money back to work in 2013 could have been the reason behind the surge.
The market has become numb to the political headlines. Since every intelligent investor already knows there is going to be a headline war in February they have been vaccinated against catching the debt debate virus. However, we all know that getting a flu vaccination may make us feel protected there is still a 38% chance we will catch the flu. Just knowing there is going to be a monster battle in the middle of February does not protect us against the irrationality of the market. It may allow us to capture profits from both sides. We can profit as the market rises during the earnings cycle and then profit from the eventual decline during the debate and then the rebound when a deal is announced. If only life was that easy.
There are multiple reasons for a long term bull market but there are always potholes along the way. Don't fight the Fed is the number one reason to focus on equities. China has bottomed and the German DAX is only 2% from an all time high. That is good news for Europe despite their current recession. Market breadth is expanding and volume is increasing. The U.S. economy is growing although at a snail's pace. It is expected to accelerate in the second half of 2013.
In investing you can't wait for the all clear signal to go long. You have to anticipate future conditions and take a chance. If you wait for the all clear you may always find yourself buying the top of the market.
Speaking of tops, I keep seeing the monthly chart of the S&P with warnings over the impending triple top and corresponding sell off. While that is entirely possible anyone worrying over that today could miss a good rally before that top actually occurs. The stated "top" that everyone is worried about is 1550 and the S&P closed at 1471 on Friday. That would be a +79 point gain in a perfect world. There is no guarantee the market is going to roll over at that level and just the fact that so many people are worried about it gives us a strong chance it won't happen. The herd is normally wrong. However, with so many people expecting it there will be a boatload of shorts at that level.
In his book Bulkowski warns that nearly 50% of all triple tops fail to meet the target price on the third top because of speculative anticipation of the top. Murphy warns that triple top failures "more often than not" tend to reverse and breakout to new highs. There is an initial sell off but the dip is bought with new eagerness. Bulkowski also cautions that rallies after a triple top are common. Technicians Edwards and Magee advice not "jumping the gun" on a triple top (shorting/selling early) because the pattern can fail to complete and just as easily recommence as an upwards trend. Just because there may be a triple top in our future does not mean the market is going to crash. I will revisit this triple top discussion if we gain another 75 points.
S&P Chart - Monthly
The S&P closed within pennies of the high of the week on Friday after a breakout over strong resistance. When you think about it there should have been profit taking at the close but instead there were reluctant buyers. With positive news from overseas and a decent start to earnings we did not see a lot of traders throwing in the towel. They were buying the dips all week.
Support is 1450 but it would take a major surprise to knock us back to that level. The financial earnings next week could be the spark that powers the next stage for the rally. The decline in Wells Fargo after good earnings was NORMAL. Typically the financial stocks rally ahead of earnings and then investors take profits after the first big report to avoid the risk of negative surprises. I don't see any major negatives in the financial sector. The Basel III change last week to a less strict set of rules was a positive. The various settlements over the subprime loans and the foreclosure process are also a positive. The banks are getting their affairs in order and should be guiding higher. That will lead the S&P higher as well.
S&P Chart - Daily
The Dow is a little more than 100 points away from the September resistance highs. That equates to a couple of positive earnings surprises and a day when Boeing does not have 787 problems in the news. The Boeing losses last week hurt the Dow's momentum.
Every day last week had an intraday dip and every dip was bought to see the Dow close at a two month high. You can't complain about gains. The glass half empty analysts are whining about a double top at 13,625 and a crash into summer. That seems a little extreme to me. If IBM, MMM, CAT and companies like that post positive earnings we are not going to crash but there could be some hesitancy at that strong resistance. Support is now 13,300.
The Dow Transports closed over multiyear resistance for the last three days. The transports were only 1.43 points away from a new historic high, which was set on Thursday. This chart is on the verge of a major breakout if we can get just a couple more pieces of good economic news. The Dow needs to move over 13,625 and confirm the Transport rally to really light a fire under the market.
Dow Transport Chart
The Nasdaq shook off an early decline to close right at resistance at 3125. Apple was slightly negative but the weakness came from the biotech sector with several names in the top ten losers list. If the Nasdaq can move over that resistance we could see sentiment improve. Ebay and Intel report earnings this week. The Intel report on Thursday will be the highlight for the tech sector and the inflection point for traders.
Nasdaq Top 20 Lists
The Russell 2000 small caps made a new historic high on Thursday and almost a new high on Friday. This is a bullish chart with the Friday close at the highs. Fund managers are clearly not dumping their yearend positions and there is no fear of an impending market correction. The small caps telegraph fund manager sentiment and this is bullish.
Russell 2000 Chart
The NYSE Composite closed at a four year high on improving market breadth. The NYSE Composite is an index of 3,211 stocks from the very smallest to the very largest and is very indicative of broad market sentiment. This is bullish.
NYSE Composite Chart
The market appears to be poised for a breakout on any decent earnings news next week. Nothing prevents us from taking profits but the indicators are pointing higher. Japan and China are sparring with jet fighters over the disputed islands but so far no war has broken out. U.S. politicians are fighting a war of words but the volume has been turned down ahead of the inauguration. Lawmakers may try to kindle a new fire in the press but investors appear to be immune to the attack and counter attack.
At this point I think it would take some spectacular earnings misses to seriously derail the market. Dips are being bought on a daily basis and the trend is definitely higher. Until that trend changes there is no reason not to follow suit.
If the earnings reports next week are positive we could be off to the races. A continued series of new highs in January will set us up for a strong bout of profit taking when the debt debate begins to weigh on investors once again. We will cross that bridge when we get to February.
Enter passively and exit aggressively!
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