The -148 point Dow drop on Friday may have been a triple digit decline but it was only a blip in the overall picture. After rebounding +1461 points Friday's decline was not even decent profit taking.
Friday was a throw away day. Volume was the lowest since Feb-13th with only 9.7 billion shares traded. The news flow was anemic and some of the news that did make headlines was not positive. The end of quarter window dressing has run its course and funds will have their hands full keeping the indexes at these levels for two more days. It was a day to play golf, take in a movie or dig out from under as much as two feet of snow as we did here in Denver.
Market Internals Table
There were no economic reports of note with the March Consumer Sentiment Survey the only item of interest. Despite the improvement in the markets, gains in housing prices and sales and in many of the economic indicators the headline sentiment number rose only one point to 57.3 from 56.3. This is a very minor gain given the improvement in the markets and economy. The big factor weighing on sentiment is still unemployment. In March seven states posted double digit unemployment and that was up from four states in February. The gains in sentiment came from improvements in the expectations component, which rose by +3 points while the present conditions component actually fell -2 points. The jobs report next Friday will be the next hurdle for consumer sentiment.
The economic calendar for next week is pretty full and headlined by the ISM on Wednesday and Non-Farm Payrolls on Friday. The ISM Manufacturing Index has risen for the last couple months but remains well into contraction territory at 35.8. Estimates for the March report are for a gain of only 0.2 to 36.0. This is growth at a snail's pace but it would be the third month of gains. Until the manufacturing sector finds some traction and begins to hire again the economy will continue to lag.
The Non-Farm payrolls on Friday are expected to show a loss of 640,000 jobs in March. This is only slightly below the 651,000 jobs lost in February. Unlike the February cycle I have not heard any whisper numbers over 700,000. We were hearing some estimates for February as high as a million jobs. The tone for this cycle is much better with some noted analysts hedging their bets to the downside with estimates of 550,000 to 650,000 jobs lost. I don't know if we should be encouraged by the lower expectations or concerned about the potential for a negative surprise. Regardless of the expectations there is likely to be some trepidation ahead of the report.
The markets developed indigestion early Friday as President Obama hosted leaders of the major U.S. banks for lunch and to talk about the bailouts in progress. After the uproar about retroactive rules on companies that received bailout funds this was going to be a cautious meeting. Many banks have said they were going to give the money back rather than be exposed to retroactive rules. Unfortunately the Treasury will not let them give the money back.
The official answer is that the Treasury wants to complete the stress tests before allowing the banks to return the money. Unofficially the Treasury does not want the strong banks giving back the money because it will highlight those banks that are still weak. The original TARP plan had the Treasury telling the top 20-25 banks to take this money whether you need it or not. If everybody takes it there will be no stigma by highlighting those who actually needed it. To let 15 banks give it back now would clearly indicate the remaining ten were the weak ones.
After the lunch meeting CNBC interviewed several of the major CEOs and several indicated they wanted to give it back but Treasury would not let them. Even Ken Lewis, CEO of Bank or America, said they wanted to give it back, $45 billion in his case, and more importantly when asked if the bank was able to give it back he responded "absolutely, we can pay it back."
With Goldman Sachs, JP Morgan Chase, Bank America, US Bank and TCF Bank all claiming they want to give the money back that suggests the financial crisis is over. How they phrased those answers was a lesson in Greenspeak as we used to call Greenspan's clever use of phraseology. Of course they could all just give their money to Citigroup and Citi would still need more. Citi CEO Vikram Pandit avoided reporters after the White House lunch and would not answer questions while those others mentioned above were happy to sit down for an interview.
The leading banks interviewed all said business was good although Jamie Dimon and Ken Lewis both said the trading book in March was not as good as Jan/Feb but they were still profitable. Let's see, March has seen the biggest three-week rally since 1982 with the major indexes up +19-21% through Thursday. That suggests those banks were heavily short going into March and were caught in the big short squeeze.
The CEOs tried to be careful in their interview remarks about the meeting with the president but you could tell there were some hostilities simmering under the surface. The scuttlebutt in the market suggests entire trading desks have threatened to quit in masse because of the limits on salaries and bonuses. Most CEOs have already gone on record in saying they were in discussions with lawmakers about compensation programs and the topic did come up in the luncheon. The fact that all the major banks have the same TARP restrictions on salary is probably the only thing preventing a massive loss of key employees. They have nowhere to go until somebody succeeds in giving the money back and removing the salary caps.
There is a curse on the TALF. At least it seems like nobody holding toxic assets wants to discuss it. The subject is taboo either because nobody wants to admit their assets are toxic or they don't want to admit they are not going to put them up for sale. This continues to be elephant in the room. Banks are holding their breath that the mark-to-market rule changes proposed by FASB under Congressional mandate will be approved. The rule changes would suspend the mark-to-market rule for "assets in distressed markets" and widen the definition of "temporary impairments" of troubled assets. This would allow banks to write-up the value of toxic assets and remove the additional capital requirements the TARP/TALF were created to solve. This could eliminate the need for the TALF in all but the worst-case situations.
You would think the Treasury dept would want the rule changed to eliminate the need to keep raising money. This rule change, if it is approved, is expected on Thursday. FASB issued the proposed rule changes two weeks ago after Congress grilled FASB officials and almost demanded the changes be made. There was a two-week public comment period, which ends on April fools day, April 1st. A fitting date for changing the accounting rules to allow much of the reasons for the worst financial crisis in history to simply be erased. The full FASB board is expected to approve the changes on Thursday.
FASB has already said the changes would be effective immediately, even prior to the full board approval on April 2nd. This pre-approval allows banks to make adjustments in their financials before they report earnings for this cycle. The vote is technically in Q2 but the pre-approval directive in March allows it to be applied to Q1 financials.
The actual operation of the TALF is not going to occur until probably mid May. They are taking applications for fund managers and trying to raise the private capital required. Based on the posted schedules I seriously doubt anything will be auctioned in April. Monday's rally on the toxic asset plan was a month premature. I was criticized for not reporting on the toxic plan details in last weekend's newsletter. However, when I posted my commentary late Friday night for Saturday's newsletter there had been no announcement.
This was my last paragraph last week.
This would be a good week for Turbo Tax Tim Geithner to finally give us some details on the public-private bad bank fund. Several times now the administration, specifically Geithner, has promised details will be released. Investors wanting to invest in the bad bank assets are frustrated because they are being kept on hold while Geithner decides how to play his cards. At this point I would expect the president to make the announcement because nobody will believe Turbo Tim. Should this event finally take place it could be a major market mover.
Obviously the announcement on Sunday was a market mover. The problem we have now is that there is no potential announcement left for the Fed and Treasury to make to spike the markets next week. That will be left up to the FASB committee vote on April 2nd on the mark-to-market rule changes. Since the rules have already gone into effect I am not sure how the actual vote for approval will be received. Sell the news on the vote or rally because most people don't know the rules are already in effect?
Elsewhere on the economic front the dollar rose again on weaker than expected data from Europe and comments from the German finance minister about a single world currency. The comments from China earlier in the week about the need for a single currency also roiled the markets. The Chinese are concerned that the dollar will eventually fall because of the $13 trillion in announced stimulus programs. They are right and it will happen but not until the rest of the world begins to strengthen. The U.S. is still the strongest currency circling the drain but once Europe and Asia begin to rebound from the recession it could be a different story.
Commodity prices fell as the dollar rose with oil prices finally seeing a break in the upward trend. Crude lost -$2 to close at $52.34 after trading near $55 on Thursday. Oil prices have been trading like there was a shortage just ahead when the opposite is true. Crude inventories rose by 3.3 million barrels over the last week, more than three times what analysts had expected. Inventory levels are now 14.4% higher than the same period last year. Tanker tracker Petrologistics said OPEC shipments in March averaged one million barrels per day over OPEC quotas and shipments rose over the last week since the OPEC meeting. This suggests that members left the meeting and bumped up production instead of holding the party line. Seeing others cheat and get away with it probably emboldened several more. Crude oil imports into the U.S. rose by 204,000 bpd marking the fourth consecutive weekly gain. Oil prices should not be rising like we saw over the last two weeks.
Crude Oil Chart
GM is facing another viability plan deadline next week and the odds are good they will miss it again. The current deadline is March 31st and GM is reportedly going to try to come up with the third version of its viability plan. On Friday the White House announced that President Obama would announce a further aid package for GM and Chrysler on Monday. GM has been unable to come to terms with its bondholders or unions as required by the Congressional bailout package. GM has $27 billion in outstanding bonds with a $1 billion debt payment due on June 1st. GM has been told to reduce that debt by two-thirds by getting the bondholders to take stock instead. Under GM's offer to the bondholders they would get 90% of the stock in GM and a minor amount of cash in exchange for the debt. The offers to the union equates to about 55 cents on the dollar and bondholders would get about 33 cents on the dollar.
GM and Chrysler are shifting their production to economical cars to cater to the whim of lawmakers. The White House announced on Friday new mileage standards to force automakers to downsize cars even further. By 2011 the average gas mileage of cars produced must be over 30 mpg and over 24 mpg for trucks. The White House claims this will save 900 million gallons of gasoline over the lifetime of all vehicles produced in 2011. The current average mpg (city/hwy) requirement for cars is 27.5 mpg. Congress has mandated that cars average 35 mpg by 2020. The new 857-page regulations will cost automakers another $1.4 billion in engineering changes. By 2030 we will be back to the Fred Flintstone model where your feet reach through the floorboard to get a running start from stop signs.
The housing sector continued its rally this week after new home sales rose +4.7% in February and existing home sales rose 5.1%. They are probably breaking out the champagne on a nightly basis in all the model homes around the country in celebration of the lowered mortgage rates and rising sales. Mortgage rates hit an historic low last week with 30-year rates at 4.75%. The Fed is committed to keeping rates low with periodic purchases of treasuries and GSE debt but analysts think this is about as close to the bottom as we will get. The MBA mortgage applications index jumped +32% for the week and the third week of double digit increases. The REFI index jumped 41.5% due to the flood of applications.
I jumped on that bandwagon and refinanced my mortgage at Chase and they are making money by the truckload. I am an existing Chase mortgage customer and they still charged a $750 non-refundable application fee and two points. Still I dropped my rate from 6.5% to the high 4% range and I was happy to pay it. I am always asking questions and probing behind the scenes and the Chase agents said they were working overtime six days a week to process applications. On Friday I was in a TCF Bank (TCB) branch and there was a line of people making applications and closing loans. I was also in a US Bank branch twice on Friday and it was a ghost town both times. That should give you a clue who will be profitable in Q1 and who will be back in the pack. If rates stay this low through the spring home buying season it should produce a major wave of buying for those who still have jobs.
Amazon.com (AMZN) fell -$3 after announcing it was closing three distribution centers and Goldman Sachs took the stock off their conviction list. Goldman did raise the price target to $81 from $70. Investors dumped the stock on fears the economic downturn was causing the closures. Amazon came out later and said that was not the case. They are adding several hundred thousand square feet to the Arizona facility and they operate more than two dozen other distribution centers. Amazon said they were just aligning their distribution network to better balance product mix and increase efficiency. The 210 workers who will be impacted were given 8-weeks of severance pay and offered jobs at other distribution centers.
Google (GOOG) gave back -$5.60 after announcing its third round of job cuts with the layoff of 200 sales and marketing personnel. Google defended its actions saying it had "over hired" in some areas and still had over 360 job openings on the website. Google has been cutting nonproductive areas like its radio advertising effort and shifting workers to other areas. The company has said that Internet advertising is slowing with the economic downturn and the new finance chief has made controlling costs a new priority. Google has also slowed its pace of buying companies so the digestion process is less hectic.
Chip stocks continued their climb with the SOX breaking out to a new five month high and noted chip analyst Dan Niles still likes them despite the gains. He is short term bearish on the market but believes the chips will lead the techs higher. Intel filed a shelf registration statement allowing the company to sell $1 billion in common stock to fund future acquisitions of businesses, assets or securities. Interesting reason. I wonder what they have in mind?
Intel is going to announce a new server chip on Monday that is expected to be a lot faster processor without using any more power. Less power produces less heat and makes the servers run cooler, cheaper and last longer. The Nehalem microprocessor is widely believed to be the subject of the presentation. Credit Suisse analyst John Pitzer said the new chip features some of the most important innovations since the introduction of the Pentium in 1993.
Conoco Phillips Chart
Conoco Phillips (COP) was upgraded to a buy at Goldman Sachs because it was undervalued to its peers and to the value of its assets. Shares are down -23% while domestic integrated oils are up +7%. Conoco has exposure to Russia and with Moscow becoming an energy terrorist there were fears their investment in Russia could be at risk. Those fears are easing now that oil prices have rebounded. Amgen (AMGN) was upgraded to a buy at JP Morgan based on valuation and "strong upside potential." DuPont (DD) was rated a buy at UBS on rising agriculture demand. Monsanto (MON) $86 was rated a buy at UBS with a price target of $115 for the same improving agriculture demand. Deckers (DECK) was cut to underperform at Credit Suisse on worries that the Ugg brand, which accounts for 84% of sales, has run its course.
While I was writing this commentary I received an email warning of financial Armageddon. This is the scenario. Last week we saw a UK debt auction fail. The UK Gilt auction was the first failure since 1995. This followed a German Bund auction that failed in January and again in February. An auction fails when there are not enough bids to cover all the debt being sold. For instance $20 billon in bids on $40 billion in bonds offered. These failed auctions in Europe are the leading edge of what could be a monster problem in the USA.
When an auction fails the yields spike and suddenly the number of future buyers drops significantly. The auction after a failed auction typically receives less bids and at lower prices and it can turn into a rout very quickly. When an auction fails the bonds in question lose value very quickly from lack of interest. Bond buyers want safety not volatility.
If a U.S. bond auction fails because of the policies in place today and the vast quantities of bonds we are going to need to sell over the next couple years the commentator writing this bond article said, "The maw of the Abyss will open up and swallow up the entire global financial system." This is probably an accurate analysis. Current holders of US Bonds will begin dumping and probably led in volume by China's $1.4 trillion holding of our treasuries. Bernanke may understand what is coming and his announcement last week about buying Treasuries is an attempt to forestall the inevitable. As long as the Fed is backstopping the auctions with their own bids it will disguise the declining interest from other parties. If/when a U.S. bond auction fails with hundreds of billions in supply still in the pipeline our paper will turn to junk status faster than last week's Washington Post.
I would not have normally have paid much attention to a bond article but the Bernanke link hit me like a freight train. What if his real reason for buying treasuries is NOT quantitative easing but to protect the value and market for the trillion in bonds the U.S. needs to sell over the next couple years? This is even more suspicious a move by Bernanke because quantitative easing is essentially the nuclear option for the Fed. Only instead of an act of mass destruction it is more like mass desperation. Is the economy really that bad that Ben had to go nuclear? What will he do for an encore if this fails? What is bigger than a nuke? I would not get worked up over this possibility today but when the first U.S. bond auction fails you need to remember this and immediately go to cash instead of equities regardless of the market conditions at the time.
I stumbled over a real time survey imbedded in a news item asking thoughts on market direction for next week. You vote first then a results screen pops up. Of the 9,400 votes on Friday night 1,206 were bullish, 7,688 bearish and 511 neutral. They listed 24 sectors and asked which would likely go up and which would go down next week. The average vote to go up was about 200 votes with the exception of precious metals at 6,804 to go up. The next highest sector was commercial banks at 442 followed by integrated oil at 250. Sectors expected to decline was led by commercial banks with 6,994 votes followed by brokers with 337 votes and autos at 314 votes. These Internet surveys are far from scientific but I was shocked by the extreme imbalance of 15:1 on the bullish sector and 20:1 on the bearish sector over the next highest sector in each. The herd mentality is seldom this polarized. It will be interesting to see how this plays out. On the market direction question 84% of responders were expecting the market to fall.
We are rapidly approaching the Q1 earnings cycle with only two weeks before the flood of reports begin. Analysts are still downgrading their expectations for both Q1 and full year guidance. This is a good thing since the farther they downgrade the better chance of a positive surprise. However, fear over earnings results could keep a lid on stock prices after a +20% rebound.
The markets had a good year over the last three weeks. A 20% gain in a mutual fund means a fat bonus at year-end. Of course that assumes they were in cash and bought the bottom but you get the idea. The markets may have rebounded 20% but all the major indexes failed at strong resistance. It simply gets harder and harder to maintain momentum after a long run. Those of us over 40, in my case way over 40, understand that long run momentum theory very well. Every time I climb on the treadmill it seems like it takes longer to cover that last half-mile. Given the last three-week sprint these markets should be tired and ready to consolidate into the non-farm payrolls next Friday.
The bulls believe that the worst bear market since 1932 should produce a monster lasting rally. I have no complaint there but we still need a fundamental reason to rally. I believe the improvements in the housing market, the obvious signs of improvement in the financial sector and the subtle but apparent improvements in many of the economic reports suggest the tide has turned and the bottom is behind us. The markets precede the economy by 6 months. If the economy is going to recover in the second half of the year then the markets were right in rebounding in March.
I had an interesting discussion with an analyst on Friday. He was pointing out all the reasons for the market to pullback to as low as 50% of its gains based on historic norms, calendar cycles, rally durations, etc. I found myself arguing the bullish case on a purely fundamental basis. I think I could argue it both ways today but I believe in the fundamental case rather than list 87 reasons why this is just a big short squeeze from historical oversold conditions. It may be but it still looks good fundamentally.
All bull markets start out with a short squeeze. It is what gives them their starting line sprint. In order for the sprint to turn into a marathon a true bull market has to be built on fundamentals. If it is just a trading game then the direction will fail and fail repeatedly. I agree this three-week sprint started out and was fed by multiple short squeezes. If that 84% of survey respondents listed above all voted with their trades then the short interest should have taken a big jump again the last couple days. More fuel for the fire or the beginning of the next decline?
A typical bear market rally typically begins suddenly and is short lived although average gains are in the 10% to 20% range. Thursday we hit that 20% upper trigger. Don Worden had a nice one-line warning in his weekend report. Bear market rallies can be especially dangerous because of their tendency to stimulate relief and false confidence. Take me to the trading doctor, I feel like I have contracted that false confidence disease. I would like to think we were starting a run like we saw from the July 2006 lows (+3000 points) but common sense suggests otherwise unless earnings surprise to the upside.
I am still in buy the dip mode but we have some major events next week to watch. The end of quarter window dressing could return on Mon/Tue and that could keep this decline from going any deeper early in the week. The Thursday FASB vote on mark-to-market is the next hurdle. A positive outcome would benefit financials even though the changes have already been put into effect while a negative result, the changes voted down, would probably spark a serious sell off. Starting on Wednesday we have the danger of the early quarter window undressing ahead of the Friday jobs report. All of these factors suggest next week could contain some wide swings in the markets.
The Dow rallied 1,461 points from the March 6th lows of 6,470 to Thursday's high of 7,931. That is 22.5% and as I said before that was a good year in only three weeks. However, I don't believe we are going to finish the year here. I believe we will end the year back well over 9000 as long as we don't step in another pothole like a collapse in the commercial real estate market or a failed bond auction.
The Dow has uptrend support at 7600 and 7700 and it would take a dip back to 7200 for a 50% retracement of the March gains. On the upside 7900 could be decent resistance followed by 8400 and 9000. Obviously after we develop a confirmed uptrend the resistance points are clearly defined and limited to only a couple major areas thanks to our four months of consolidation.
Dow Chart - Daily
Dow Chart - 180 Min
The S&P has a love-hate relationship with 805. After rebounding from that level in January it broke through with a sharp decline in February and then saw a solid failure again on March 18/19th. After consolidation to regain strength the short squeeze last Monday saw that level broken to the upside. All week that prior resistance became support and I believe it should hold unless conditions take a turn for the worse. The uptrend support from the March lows is 815 but I don't have much confidence it will hold. The last two moves away from support had less velocity and suggest the bulls are tired. After all who would want to buy the top on a 20% run?
S&P-500 Chart - 180 min
SPX Chart - 90 Min
The Nasdaq failure at strong resistance at 1600 was as clear a breaking point as you could possibly diagram. With the Nasdaq leading the rally it was no surprise the other indexes gave up the fight so easily. Once the Nasdaq failed at the strong 1600 resistance level it flashed an exit warning to all the momentum traders. The -41 point drop on Friday was actually better than I expected. I could easily have seen a much bigger drop. At the 1545 close it was only a handful of points under potential support at 1550 and that would be an easy launching pad for the next attempt at 1600 although probably too optimistic given the recent gains. Nasdaq 1500 is much more likely as dip support since it filled that purpose very nicely on Wednesday. I would buy any dip back to the 1495-1500 range.
Nasdaq Chart - Daily
Nasdaq Chart - 30 Min
The Russell is mirroring the Nasdaq only with more volatility. For instance the Russell lost -3.66% on Friday compared to the -2.63% drop in the Nasdaq. This is due to a lack of confidence by fund managers. They are still not sure this rally has legs and they are trading scared. The Russell ETFs are trading huge volume with the IWM trading 78 million shares around $43 each on Friday. This is how managers are getting their exposure to small caps but are still able to enter/exit quickly. Initial support is 420 followed by 400.
Russell 2000 Chart - Daily
To reiterate my concerns for next week. I would buy the dip but I would like to see some evidence of a rebound first. There may be some false bounces as the eager bulls jump in on the first decline only to be ambushed by the bears trailing the prices lower. Thursday's potential mark-to-market vote by the full FASB board could produce some volatility and Friday's jobs report could produce some hesitation on Wed/Thr. Be patient this week. Regardless of direction there is no need for frantic entries.