I am sure Coca Cola won't mind if I use their advertising slogan to describe the calm decline in the markets as they head into month end. This could be the pause that refreshes the bulls.
The market slide extended to three days with a slightly negative close on Friday. Helping put the pressure on equities was a drop in the sales of existing homes to 5.1 million from 5.24 million. That is an annualized rate and this was a lagging report for August. This should not have surprised anyone because home sales always decline as the summer ends and kids go back to school. Home prices improved to only a -12.5% year over year decline and months of inventory also fell to 8.5 months and the lowest level since April 2007. The 12-month average of existing inventory is 9.7 months. Sales fell -2.7% for the month but the pace of sales is definitely in recovery mode with sales up +3.4% over the same period in 2008. Considering there will be nearly 2.5 million distressed sales in 2009 and another 2.0 million sales in 2010 the overall improvement in sales is encouraging.
Existing Home Sales
Counteracting the slight negativity of the home sales was a sharp boost in Consumer Sentiment. The first reading for September sentiment came in at 70.2. That jumped to 73.5 in the final revision for the month. This is the highest level since January 2008 and well over the 65.7 reading for August. Sentiment is definitely improving and the political dip in July/Aug has been erased. Both the expectations component and the current conditions components spiked to 73.5/73.4 from their 65.0/66.6 readings in August. As you can see in the chart below we are still a long way from the 2006 levels but well above the recession lows. This should be a long term positive for the stock market since it suggests consumers will begin to spend money as employment improves. Most are still trying to restructure their debts and replace lost credit lines. This is being helped by relatively low energy prices and low prices on retail goods.
Consumer Sentiment Chart
Durable goods orders fell -2.4% in August but this was just a correction to the +4.9% anomaly in July. This August drop should be ignored as just a correction of the July blip.
Durable Goods Chart
Next week is going to be a major week for economic reports. On Monday we get the last look at the Q2 GDP and it is expected to decline to -1.1% from the -1.01% in the last revision. This should not be a problem for the markets unless there is a major deviation from the expectations.
On Wednesday the Chicago ISM is expected to rise slightly to 51.1 from 50.0 and will be a preview of the national ISM due out on Thursday. The national ISM for September is expected to rise to 54.0 from 52.9 in August. Again, this should not be a significant market event unless the numbers are materially different than what is expected.
The big report for the week will be the Non-Farm Payrolls on Friday. The consensus is for a loss of -188,000 jobs and less than the -216,000 jobs lost in August. Morgan Stanley believes the losses will be under 150,0000. This time around I am not hearing any "out in left field" comments about a possible positive job growth number. I think most analysts have finally accepted the inevitable that the recovery may be jobless until early 2010. This could be a VERY volatile economic event. The Fed won't move off their "extended period" statement until we start adding jobs again. When we get a month of positive job growth the real worry over the Fed rate changes will begin. I seriously doubt it will be this month but everyone will be holding their breath until the numbers are announced.
Initial Jobless Claims fell by 21,000 to 530,000 last week. That was the third consecutive weekly drop. This compares to a peak of 674,000 in March. They need to decline to something in the range of 350,000 to be considered normal in a growing economy.
Initial Jobless Claims
On Wednesday the Fed made comments that were more optimistic than in prior statements and suggesting that the economy was moving out of the recession. They retained the comments about keeping rates under .25% for an extended period and also extended the time period over which they will buy Fannie and Freddie mortgage backed debt.
The statement changed from "economic activity is leveling out" to "economic activity has picked up following the severe downturn." Bernanke said the prior week that he believed the recession was likely over and this Fed statement agreed. However, they also left in the "economic growth is likely to remain weak for a time" but said current stimulus would eventually provide a "resumption of sustainable growth." They still believe inflation will "remain subdued for some time."
All the outward signs suggest the Fed will wait as long as possible before letting the punchbowl run dry. The markets breathed a sigh of relief and went on about the business of trading. On Friday Fed Governor Kevin Warsh spoke at a banking conference. His speech did not come from the same playbook as the Wednesday FOMC statement. Warsh warned that the Fed cannot wait too long before beginning to remove the monetary stimulus. Warsh also suggested the Fed needs to be as aggressive on the way up as they were on the way down. He warned that the risk of a policy mistake remained high.
He also downplayed the "extended period" portion of the FOMC statement and suggested the Fed should raise rates aggressively once they drop that language. Since Warsh voted for the FOMC statement on Wednesday his hawkish speech on Friday roiled the markets. We all know that it will be a rocky road when the Fed decides to start raising rates and the rapidity will be a key factor. Greenspan was widely criticized well after the fact for removing the post 9/11 stimulus too slowly and allowing the economy to overheat and produced the housing bubble. The table below shows the rate hike progression and the rate after the change. It took Greenspan two years to raise rates +4%. Warsh is suggesting the Fed not repeat that mistake and act aggressively once they start.
Fed Rate Table
The FDIC closed the 95th bank of the year on Friday. The Georgian Bank of Atlanta was closed and sold to First Citizens Bank and Trust. This was the 19th bank closed in Georgia in 2009. The FDIC said the cost to the insurance fund would be $892 million. The bank had $2 billion in assets and roughly $2 billion in deposits. I am sure the FDIC knows what bank will be the 100th to close this year but we will have to wait for the announcement over the coming weeks.
The current estimate for all of 2009 is 125-135 banks will be closed followed by another 100+ in 2010. The FDIC is under the gun and rapidly running out of money. They have various untapped lines of credit with the Fed and Treasury but up till now they have not needed to use them. There were rumors this week that the FDIC would borrow money from several major banks it insures. FDIC Chair Shelia Bair downplayed that scenario on Friday saying it was authorized in their charter to issue debt but not needed given their credit lines.
The government auctioned $112 billion in notes of various terms last week and half the debt was purchased by foreign central banks. U.S. primary dealers are buying less and less but so far the foreign banks have picked up the slack. Banks are reportedly buying the debt to mitigate losses in their dollar positions. This is voodoo economics to me but the bottom line is our fate in the hands of overseas debt buyers. If we make them mad with a sudden surge of dumb moves then they will have the hammer on us. Famous money manager Julian Robertson said last week we were facing Armageddon because of our massively growing debt. There are some that predict interest rates could go back to double digits over the next several years if something is not done promptly. I have lived through double-digit rates back in the 1970s and it was not pleasant. I had a 12% mortgage on my house and was happy to get it at the time. How would that affect your credit card rates today?
In stock news Research in Motion (RIMM) was crushed for a 17% loss (-$14.15) after reporting earnings that were less than investors expected. RIMM reported sales of $3.53 billion, a +37% increase, but analysts were expecting $3.62 billion. They predicted sales of $3.60-$3.85 billion in the current quarter and analysts were looking for $3.92 billion. This was the second consecutive quarter that RIMM missed revenue forecasts. RIMM added 3.8 million new subscribers during the quarter but the forecast range was 3.8-4.1 million. Everything was on the low end of expectations. Personally I think they are doing a great job competing against Apple and Palm but they are a victim of their own success. Analysts constantly bid up their expectations to the point where even a great quarter looks like a miss. With RIMM under the magic $70 price point I will be watching for signs of life to go long RIMM for a trade.
The weak existing home sales numbers on Friday sent homebuilders lower but they were already on the downward slide. The end of the summer selling season and the end of various homebuyer stimulus programs is pressuring the sector and the homebuilders by default. Builders were down strongly for the week. KB Homes (KBH) lost -17%, Hovnanian (HOV) lost -13%, DR Horton (DHI) -12% and Ryland (RYL) -12%.
PHLX Housing Index Chart
I thought last week must have been an early Halloween because of all the crazy people hogging the microphone at the UN. Muammar Gaddafi, spoke six times longer than his allotted time and his translator collapsed 20 min before the end of the speech because of the strain. Gaddafi rambled on about a single state solution to the Israel-Palestine problem and called it "Isratine." Gaddafi, the self proclaimed "king of kings" brought his tent from Libya and set it up on rented property owned by Donald Trump. Gaddafi was followed by Venezuelan socialist president Hugo Chavez who is normally very long winded in his own right. However, he praised Gaddafi, saying he was very loquacious and has said all there needs to be said.
Iran's president Mahmoud Ahmadinejad spoke in Iran before coming to the U.S. to speak at the UN. He spoke about the nations ability to punish aggressors with an air force flyby to punctuate his message. Unfortunately one of the planes in the flyby crashed and killed seven people on the ground. He repeated his claims the holocaust was a myth. He warned that Iran would cut off the hands of any aggressor. The UN speech did not come off any better.
On Friday President Obama, flanked by French President Sarkozy and British PM Gordon Brown, blasted Iran for running a secret nuclear program in addition to the one already in violation of UN resolutions. The secret nuclear plant being built is reportedly 100 miles from Tehran. It must not have been very secret in intelligence circles because scientists claim when completed it could produce enough enriched uranium to build a bomb a year. The sudden announcement stunned the G20 attendees and set the stage for a showdown with Iran later this year.
President Obama was set to begin engagement talks with Iran over the prior nuclear program later this year. A decision was expected before a December deadline for harsher UN sanctions. After the announcement Russian and Chinese officials were in rare agreement with the US, France and Britain that harsher steps may be necessary before year-end. Ahmadinejad immediately blasted Obama and demanded he take back the remarks saying the IAEA was in full knowledge of the secret site and Iran was in full compliance. The head of the IAEA disagreed. Personally I think it was perfect timing by Obama, Brown and Sarkozy and erased the stature increase Ahmadinejad got from speaking at the UN. This will be a very serious test for President Obama and the December deadline. Everyone knows Ahmadinejad is NOT going to negotiate openly and honestly and will attempt to delay and distract the talks as he has in the past. If the president allows him to succeed in avoiding any meaningful sanctions the president will lose face on the world stage.
Oil prices were especially volatile last week with a drop from $73.50 to $66. Crude futures expired on Tuesday and contributed to the volatility as well as an increase in inventories on Wednesday. The dollar index also rebounded sharply off a Wednesday low of 76.04 and a level not seen since August 13th 2008. The rebound in the dollar crushed the commodity stocks including oil prices. We are nearing the end of hurricane season without any major storms hitting the gulf and traders are closing their futures positions in favor of equities.
Natural gas futures hit $4 on Thr/Fri ahead of their expiration on Monday. This is a significant improvement over their $2.40 low on September 4th. The November contract is already trading near $5. The natural gas community is breathing a sigh of relief. Baker Hughes reported that 18 rigs went back to work with 7 in Oklahoma, 6 in LA, ND 2, CA, CO, NM and WY each gained one. Texas lost 6, Arkansas 2 and Alaska 2. This brings the total active rigs to 1017 with 710 exploring for natural gas.
The biggest natural gas ETF (UNG) with a market cap of $4 billion said it might have to shrink if the CFTC does not reach a decision on position limits soon. The CFTC has met twice to discuss the potential for position limits on passive index funds but no decision has been reached.
Jailed Texas Billionaire Sir Allen Stanford was in the hospital on Friday after being injured in a fight with another inmate. Reportedly the injuries are not life threatening and he will be moved to a private cell when he is returned to jail. Stanford is charged with bilking investors out of $7 billion, which he used to fund his previously lavish lifestyle. So Allen, how is that working for you now?
The Dow lost -155 points for the week or -1.6% but it is still on track to post a solid gain for the seventh consecutive month. It only has to remain above 9500 for three more days. The Dow has had a seven-month streak of gains only 15 times since 1928. On ten of those streaks it continued up for the eighth month. Overall this is the best quarter for the Dow since 1939. The +1223 point gain for the quarter so far is safe from all but the worst of declines over the next three days.
The markets have posted phenomenal gains since the March lows. The only thing fund managers have to do now is keep the markets from collapsing early next week and they can log some strong profits to advertise to their potential customers. This end of quarter window dressing was already underway according to some professional traders when commenting about the new highs on Wednesday. As a point of fact those fund managers don't even need to push the market higher. They only need to prop it up for three more days. Minor declines are ok and their quarterly returns will be locked in.
What happens after the quarter ends is a different story. As a fund manager who may be up 35% to 50% since March and only a few weeks away from locking in your yearly performance bonus the urge to be protective has got to be growing. Locking in returns after the quarter ends will probably be a serious trading strategy. They can do that with stop losses, protective puts, selling calls or just simply closing the positions. With the S&P at 1044 and 1100 an optimistic year-end target by most analysts there is little upside to risk and a lot of profit to protect.
The risk is missing out on the potential for a material rally over the five weeks. Most mutual fund year-ends are on Oct-31st. Is that really a risk? Do you really see a blowout rally in the cards over the next five weeks? I could easily see a decent rally in November but I am having trouble seeing fund managers chasing returns into late October. Instead they should be restructuring their portfolios. They have losers to sell and winners to sell to offset the losers. October is normally fund restructure month. If you were a fund manager today how would you restructure your fund? Don't forget this is a financial timing game as well. Funds need to reduce the bite from taxes.
Would you sell losers and throw more money at the winners? What if other funds were taking profits from those same winners? Chasing winners in October does not work for me. I doubt it will work for many people. I expect profit taking to be the name of the game in October.
Once we are past option expiration week in October I expect the market trend to turn higher. That does not mean we are going to have a correction over the next three weeks. That could happen if stops start getting hit but there are no signs today. More than likely we will see a range bound market with a slight downward tilt. I think the bloom is fading from the market and normal reality is about to appear.
That reality is a rebounding economy but not a vibrant economy. Earnings will improve in Q3 simply because it would be nearly impossible for them to be lower than Q3-2008. Employment in Q4 will be less bad. The outlook for 2010 will start improving dramatically as Q3 earnings guidance is released and that will energize buyers in Nov/Dec. Then we get to go through the year-end cycle again for those funds and private investors with a calendar year-end. January could see some strong volatility before improving earnings in 2010 sends us much higher.
What does that mean for next week? I think the final three days of September are a toss up. It simply depends on how active fund managers are going to be in holding up the market for quarter end. Starting on Thursday we could see a new round of weakness begin. The ISM report will cause a minor blip as will the Non-Farm Payrolls on Friday. However, I believe the main market motivation will be portfolio restructuring for the October year-end. I don't see that as pushing the markets higher. I could be completely off base and I will have plenty of egg on my face if we start making new highs. Been there, done that more than once. You can't write a market wrap 125 times a year and not have the market do the exact opposite once in a while.
I am not trying to predict the daily direction of the market over the next couple weeks but simply give readers an idea of the forces at work. For every analyst claiming there is a 10% correction in our future there are more analysts claiming a 2-4% decline is all we are going to get. I heard one person last week claiming that every 2-4% decline since March had been a vaccination against the market version of the swine flu. Every little setback had been cured with an aspirin and investors bought the dip and took the market back to new highs. Eventually that scenario is going to fail and October is the prime time for that to happen. I am leery after that perfect bull trap on Wednesday.
I warned a couple weeks ago to watch for a bull trap. I defined it as an intraday volume spike to new highs followed by a sharp drop below the prior days lows. On Wednesday the S&P opened at 1072, spiked to a new high at 1080 and then fell to close at 1060. The prior day's low was 1066. That began three days of declines. Wednesday and Thursday were decent volume of around 10.5 billion shares but Friday dropped off to only 8.5 billion. No surprise there despite declining volume 2:1 over advancing.
Another internal metric indicating caution was the new 52-week highs. They topped out at 638 on Sept-16th and despite a couple spikes over 500 since then they have declined to only 210 on Friday. That was the lowest level since before Labor Day. The leaders are no longer leading. The generals are being sold rather than chased.
The Dow only lost -155 points for the week but it closed -247 points off its high of 9917. That spike over 9900 was sold faster than cold beer at the Indy 500. Initial Dow support is now 9640 but it gets rather cloudy under that level. Every century mark has some support attached with 9300, 9100 and 9000 the critical levels. A 10% correction off the high close of 9841 is 8856. I doubt anyone is seriously considering that number as a possible target. You may get some analysts that are expecting a serious sell off but few would mention a target under 9300. Unfortunately the market is no respecter of persons and it exists to confound the most analysts possible at any point in time.
The S&P rallied to touch 1080 on Wednesday but like the Dow and 9900 the sellers were waiting in droves to take profits. Initial support at 1060 was quickly broken and Friday's intraday low of 1041 came very close to the next support level at 1035. A break under 1035 targets 990-995 and 978. A break below 978 could get ugly very quickly. The round number support at 1000 is likely to attract attention despite being only a number and not really a support level. If the S&P drops under 1035, I suspect we will see it range bound for sometime.
The Nasdaq slammed into overhead resistance at 2160 that dates back to March and July of 2008. This resistance (red line) has been a target for several weeks and that target was reached on Wednesday after two days of stalling at 2150. The next support level should be 2063 and the 50% retracement level of the March lows. However, it barely paid attention to that level on the move up. That is followed by downside support at 2050 and 2010. However, once below 2050 the Nasdaq could be in trouble. The Nasdaq spent over a month in a range between 1950-2015 and that range could be a magnet for an October low. Tech stocks saw limited selling on Friday but the Nasdaq was crushed by the -$14 drop in RIMM to push it below 2100. I would like to be positive about the Nasdaq hopes but the big cap techs are not leading. Without the big caps the Nasdaq is lost.
The Semiconductor Index is commonly referred to as the head of the snake or the leading indicator for the Nasdaq index. The SOX has declined to support at 320 and is valiantly trying to hold that level. Dragging the SOX down is Intel, which is resting on support at 19.25. If Intel fails the SOX will fail and the Nasdaq will follow.
The Dow transports came very close to resistance at 4065 with a touch of 4055 on the 17th. With that failed attempt the index started a decline that has taken it back to initial support at 3800. If the transports are declining the odds are good the Dow Industrials are not going to be rising. Next support on the transports is 3575.
Dow Transports Chart
If I had to net out everything I said above into a concise statement of market direction I would say the odds are good for a pullback over the next couple weeks. We could return to the range we saw in August and use that as a launching pad for an end of October rally.
I want to thank Todd and Linda for filling in for me last week. I was out of town all week dealing with a family medical emergency. Thanks to both for doing a great job.