With three days left in the quarter and the markets suddenly struggling to remain positive it appears the bulls could run out of money before we run out of month.
First I want to thank Todd for contributing to this commentary. I have been fighting the flu the last several days and he volunteered to share the load.
It was a tough week on the geopolitical front with Greece flaring up again, U.S. bond auctions not going well, China pushing back on its currency, some weak economics in the housing sector, some surprise announcements about the cost of the health care package on corporations and a South Korea patrol boat sunk on Friday under suspicious circumstances. I will get to all those items but first some economics from Friday.
The Greek tragedy in the form of another plea for money hit the markets on Wednesday when Greece said it would go to the IMF if the EU nations were not going to support Greece with money instead of words. By threatening to drag the IMF into the fray it raised the crisis to a new level because the EU wants to be recognized as standing on its own and being independent from outside help. If they lean on the IMF there is a blow to their prestige.
I would say that prestige is already pretty well dented with Greece playing the IMF card so soon after the last debt sale. Add in the downgrade on Portugal's debt by Fitch on Wednesday and the house of cards appears to be crumbling. The downgrade to AA- put Portugal at the same level as Ireland, Italy and Cyprus and that is just two notches above Greece. Fitch said the austerity measures Portugal had submitted for 2012-2013 could lead to "disappointment" and "underperformance."
When the Greek news hit the dollar spiked to a new 52-week high above 82.0 on the dollar index. The Euro and the Pound fell to 52-week lows and the equity markets stumbled on the news. Commodities were crushed and worries continued to circulate on which country would be next in the bulls-eye.
Before the week was out the EU in conjunction with the IMF agreed to give Greece $29.2 billion in guarantees to cover the next round of funding problems. One analyst put it this way. They were faced with two choices, both bad, and they took them both. He was referring to loaning Greece money from the EU and allowing the IMF to also put up money.
Of course, this is not the best of news for the Euro, which did gain a bit of strength of yesterday, but real strength can be seen in the U.S. Dollar. The greenback has gained nearly 1% against the Euro in the past week and is headed for a first-quarter gain of 6.8%. That would be the Dollar's best quarterly gain against the Euro since the third quarter of 2008. For all of the fiscal issues Uncle Sam faces and the soaring budget deficit and national debt we are witness to here in the States, the Dollar is still viewed as a safe-haven.
The greenback realized enough momentum this week to post its first weekly gain in March against the Australian and Canadian Dollars, two of the stronger currencies in the world.
Dollar Index chart
Despite the fact that Greece now has some kind of bailout package with which to work, the Greece theme will not dissipate as we move into next week. The Financial Times reported on Saturday that Greece is planning an auction of $6.7 billion in three- or seven-year Eurobonds before the end of March to test the strength of the aforementioned rescue plan. That auction will be followed by another of a similar size in April, the FT said. These auctions will certainly have forex traders and others watching the Euro carefully.
More important to me than the Greek debt crisis is our own debt crisis. This week the government auctioned off $118 billion in debt and it did not go well. The lukewarm auction with a bid to cover ratio of just over 2.5 and rates a lot higher than anybody expected. When there is weak demand the government has to accept a higher rate from reluctant investors. This was NOT a failed auction BUT we are headed in that direction. This was a shot across the bow for the government. These are bond investors saying we don't want the U.S. to follow Greece down the default road. We are not going to buy much more of U.S. debt unless there is a strong sign the government is going to do something to get its financial house in order. The government is planning on selling $1.2 trillion in treasuries in 2010.
The Office of Management and Budget (OMB) said back on February 1st that the administration was projecting a 10-year deficit total of $8.53 trillion. Congress has spent more money in the last year than during the terms of all the past presidents combined. On Friday the OMB said the initial estimate was too low and now the administration is expecting $9.75 trillion in deficits over the next decade. By 2020 the OMB is expecting the debt to rise to more than $20.3 trillion. That will equate to a debt to GDP ratio of 90%. To put this in perspective it would take a stack of $100 bills 690 miles high to make one trillion dollars. Unless bond investors continue buying treasuries at a record pace we will never get to 2020. We could see failed auctions soon and that will push interest rates up too fast for the economy to adjust. I had a 21% home mortgage in the early 1980s as a result of hyperinflation. Don't believe for a minute that it will be different this time.
Alan Greenspan spoke out on the weak auction and said the higher yield was the "canary in the coal mine." He said, "I am very concerned about the fiscal situation. An increase in rates will make the housing recovery difficult to implement and put a damper on capital spending." Also, "I am worried about the politics and what is happening. Historically there has been a large buffer between the level of federal debt and our capacity to borrow. That is narrowing at a time where we need it the most." He had previously said a Value Added Tax (VAT) could be used to produce revenue and reduce deficits BUT he says now, "I am not convinced now that we can succeed in stabilizing this long-term outlook strictly from a VAT." Gee, I can't wait for another new tax.
You have probably heard every day that China refuses to float its currency and about how unfair that is to everyone else around the world. U.S. lawmakers have given China until April 15th to make some changes or be officially labeled a currency manipulator. Officially applying that label requires the U.S. to take action against the country in an effort to force them to make a change. I believe part of the weakness in the treasury auctions could have been because China decided not to bid to show the U.S. just how important their monthly treasury purchases were. China has $1.2 trillion in dollar denominated reserves so they can't just sell dollar assets but they don't have to keep buying more. If lawmakers proceed in putting this label on China it could be a disaster for the U.S. debt sales. Be careful what enforcement action you take because there are always unintended consequences.
You may have heard in the news last week that major corporations are pre warning on lower profits as a result of the healthcare bill. Companies warning last week included 3M with a $90 million charge, AKS $31 million, Valero $20 million, Caterpillar $100 million, John Deere $150 million and AT&T announced a $1 billion charge to earnings. Honeywell said it would impact Q1 earnings by 5-cents per share or roughly $38 million. Companies are already announcing layoffs because they can't afford to continue paying worker insurance at the new rates.
This sudden surge of earnings warnings is just the initial trickle because every public company is going to be negatively impacted by the costs. These costs are coming at a time when American companies can't afford more expenses. This is a new tax on business and that is exactly what killed the country when it was rebounding from the Great Depression. Lawmakers upped the tax rate to try and recover the stimulus money. This caused the recovery to fail and the economy crashed for the next nine years.
The Heritage Foundation put out the table below in response to the earnings warnings. These are not the only taxes but simply a starting point. This does not include things like the 10% tax on tanning salons or the per person penalty for not having health insurance. Also the new tax on individual investment income like interest, dividends, rents, capital gains, etc and the higher Medicare tax rate is not listed. This is just a starting point. Expect for the airwaves to be clogged with earnings warnings over the coming weeks.
You may remember the constant speeches that nobody in America making less than $200,000 will be taxed. You probably also remember the claims last week that the healthcare bill was deficit neutral and would actually reduce the deficit. These claims were possible because the additional spending and taxes were pulled out to be included in the Reconciliation Act to "fix" the Senate version of the healthcare bill. Americans for Tax Reform said on Friday the Reconciliation Act raises taxes by $52.3 billion.
Heritage Tax Table
You probably also heard last week that new home sales in February fell to 308,000 "on an annualized rate" and the lowest level since records were started 47-years ago. Not only was it a record low but it was -6% below the prior record low set in January 2009. The high was 1.4 million in mid-2005. Months of new home inventory rose to 9.2. We are only 35 days away from the end of the homebuyer tax credit. We are only five days away from the end of the Fed's quantitative easing program where they bought $1.25 trillion in home mortgages to keep interest rates low. If the government does not extend the tax credit for another quarter the housing sector is going from bad to worse. Analyst Richard Bove said last week he expects home prices to decline another 15-20% before the end of 2010.
As if the week could not be any more complicated, news broke on Friday afternoon that a South Korean patrol boat had exploded and sank very close to the disputed border with North Korea. The announcement immediately caused a sell off in equities and a spike in the price of gold. The ship had a crew of more than 100 and 59 were reported rescued. South Korea initially expressed concern that the ship could have been torpedoed for straying near NK waters. They backed off that claim later in the interest of not causing a scene before the facts were known. South Korea had said the ship fired at an unidentified vessel farther north earlier on Friday. The two countries have had two major naval battles in the same area over the last decade. In November the navies exchanged fire and ships on both sides were damaged. The odds this ship exploded beneath the waterline without any help from North Korea are very slim. The news on Friday created yet another cloud over our struggling equity market.
South Korean naval ship Cheonan
The Greece theme, along with some "help" from Portugal, has resulted in some headwinds for U.S. equities, as highlighted by the evaporation of strong early session gains on Thursday and Friday, but the S&P 500 is in the midst of its best winning streak since August after notching its fourth consecutive weekly gain. There are some positive stock-specific stories if one knows where to look. In the past week, financials certainly fit that bill as Dow components Bank of America (BAC) and JPMorgan Chase (JPM), the two largest U.S. banks, have gained 8% and 4%, respectively.
Those are nice gains to be sure, but the new king of the big retail bank stocks, at least in terms of capital appreciation is Citigroup. Citigroup is still a member of the federal government's mutual fund of downtrodden financial stocks, but the shares have been anything but downtrodden as of late, gaining more than 10% in the past week alone. The stock is up about 26% in the past month, triple the returns offered by Bank of America and JPMorgan Chase. Citi is usually the most active NYSE issue and on Friday the stock traded more than 587 million shares compared to average daily volume of 480 million.
Another stock that offered some positive news on Friday was Brinker International (EAT), the operator of the Chili's, On The Border and Maggiano's restaurants. Brinker said it expects to earn 41 cents to 44 cents a share in its fiscal third quarter while analysts were expecting a profit of 40 cents a share. The company also it said it expects sales at restaurants open at least one year to fall between 1% and 2%. That's better than previous estimates that called for a decline of 2% to 4%.
While the casual dining space is not always on the receiving end of the type of fanfare that is normally reserved for financials, materials or technology names, it is a sector worth watching because it does offer a temperature check on the health of the U.S. consumer and perhaps Brinker's outlook indicates some consumers are willing to once again spend on dining out.
If nothing else, Brinker felt comfortable enough with its bullish guidance to raise its quarterly dividend 27% to 14 cents a share from 11 cents. The new dividend would give Brinker a yield of 2.8% based on Friday's closing price of $19.59. Brinker also said it will add $250 million to a currently existing repurchase plan that has $60 million remaining on it.
Brinker (EAT) chart
On the other hand, there is Oracle (ORCL), which traded down by 1.34% on Friday after issuing fiscal third-quarter results that were somewhat disappointing after the bell on Thursday. The software giant said it earned 38 cents a share on revenue of $6.4 billion. Analysts were expecting a profit of 37 cents a share on revenue of $6.3 billion and Oracle's inability to really impress the Street is one reason why the Nasdaq declined on Friday.
The company's acquisition of Sun Microsystems appears to be going well as Oracle said Sun added $596 million in sales in the quarter. That number was at the higher end of the range of $300 million to $700 million analysts had forecast. Oracle's earnings update was disappointing in comparison to the recent reports we have seen from other tech bellwethers such as Cisco Systems (CSCO) and Hewlett-Packard (HPQ).
It does pay to note that Oracle expects software sales for the current quarter to rise by 3% to 13%. That was the first time in over a year the company did not warn of a sales decline. The company said it would earn 52 cents to 56 cents a share for the current quarter while analysts are expecting a profit of 53 cents a share. Oracle shares are already trading close to a nine-year high, but Jefferies raised its price target on the stock to $31 from $30 and the stock was on the receiving end of a bullish write-up in Barron's today.
The economics on Friday did not provide any motivation for traders in either direction. The GDP revision for Q4 slipped slightly to 5.6% growth from 5.9% in the last version. This was expected and not a surprise. The consumer Sentiment revision showed a slight gain to 73.6 from the first March reading of 72.5. This split the consensus and whisper numbers and was not a market mover.
Next Friday the market is closed but the biggest economic report of the year will still be released. That is the Non-Farm Payrolls for March. The official estimate has climbed to 155,000 new jobs but the whisper numbers are well over that level. Morgan Stanley is expecting 300,000+ with 100K from the census hiring, 100K from the snapback in weather related declines in February and 100K from organic growth. The +300K estimate is about the middle of the road for the whisper numbers but there are estimates as high as +500,000 depending on the census hires. The census will hire 1.3 million over a four-month period and produce a monster jump in the employment sentiment. Odds are good that 99% of people who hear the headline number will not hear that x-thousand are only temporary due to the census.
Unfortunately all the whisper numbers are already priced into the market and anything on the low side could cause a serious dip in equities the following Monday. I am expecting a number near the middle at the 300K range because job postings have increased 18% year to date according to TrimTabs.com. That is a huge boost and it has nothing to do with the census.
The equity markets stalled last week after marking new 18-month highs. Of concern to me was the return of the afternoon sell programs. In Tuesday's commentary I warned that the end of day buying binges were an indicator of a continued reluctant meltup. "Once the end of day selling returns the buyers will become wary again." That is exactly what happened over the last three days. We got the gap and crap in the morning and sell programs into the close. The sentiment tide is turning.
I suspect fund managers have run out of ammo or maybe they are saving it for Tue/Wed to make sure the markets close at new highs. Time will tell. The advances came on weak volume and the declines came on increased volume. There were two billion shares of increased volume on Thursday compared to Tuesday's rally volume.
This has been a great run even though it came complete with its own lack of conviction. It was called the tortoise rally, a stealth rally and the rally only a mother could love. However, it was still a rally. The Dow has climbed for more than 35 days without a 1% decline. That has not happened in over a year. The big cap equity indexes are up about 5% in March, +10% over the last two months. The small cap Russell, S&P-400 and S&P-600 are up 8-14%. Unfortunately the fat lady may be getting ready to sing.
If the rally was a race for competitive returns by fund managers then crossing that end of quarter finish line could be the equivalent of a cold shower. Gains are not gains until they are sold and the cash is in the account. Volume next week is going to be horrible. Passover begins at sundown on Monday. Good Friday is Friday and Easter on Sunday. Volume will be very light and any remaining fund managers with money should be able to push the indexes in the desired direction. The following week should be back to business as usual and that could easily be the business of profit taking.
With dozens of companies expected to announce every day how much the healthcare plan will impact earnings the outlook for guidance is definitely down. Of course anyone with a brain realizes this is an exceptional event that paints everyone with the same broad brush but company after company whining about big writedowns is not going to boost sentiment. This is the year we may have an early "sell in May" event in April.
The Dow spiked to 10955 on Thursday and a +118 point spike before the selling began to push it back to only a single digit gain. On Friday the opening spike was more lethargic and only made it to 10909. That is a lower high but being only one day it is not entirely noteworthy. Resistance is still well above at just over 11000 and initial support is 10850 and exactly where it closed on Friday. The three failed rallies on the last three days of trading is definitely not a bullish indicator. While the fund manager window dressing scenario has the markets pinned to these levels or above through Wednesday's close, I have serious doubts they can pull it off even in the thin volume. The bears have been rather patient over the last month and the afternoon declines are a blue-light special calling them all to dinner. I could easily see a decline to additional support at 10700 over the next week.
The S&P-500 struggled with resistance at 1165 for four days and finally broke over that level on Tuesday. That level has now been tested every day as support and I believe it will eventually fail. A decline to 1150 will not be that traumatic but a break below 1150 would be a clear signal the bears are planning to stay for the summer. The 1165 and 1150 levels are clear signposts for next week. Resistance is well above at 1200 but I doubt it will be tested. There are simply too many negative influences in the current events.
The Nasdaq is a chart that says, "Sell me." The sharp rebuff from the uptrend resistance followed by a lower close on Friday is a clear sell signal at least for me. That does not mean it won't retry that resistance next week but I think the earnings warnings on healthcare costs are going to be a wet blanket for the big cap techs. Think of all the employees Microsoft, Intel and Oracle are going to have to cover at higher costs. They will have to warn and with earnings only about three-four weeks away they have to do it soon.
Initial support on the Nasdaq is 2385 followed by 2350. I would not hesitate to sell a break of that 2385 level. Resistance is well above at 2430 and I doubt it will be tested again.
The Russell has clearly defined support at 670 and a tempting target to short should it break. If the love affair with the small caps expires at the close on Wednesday then it could be an ugly breakup. The Russell has been performing weaker than the big caps for the last week and I think that is an indicator we should watch.
In summary, Thursday is going to be especially problematic with the jobs report on Friday when the markets are closed. Fund managers with profits to protect are not going to want to hold over Friday's report only to be met with a monster gap down the following Monday if the numbers are less than expected. The ADP report on Wednesday should be a clue to Friday's nonfarm payrolls. If the ADP report is seen as weak then there could be a rush to the exits.
I have told you over the last several weeks to buy the dips until we were proven wrong. At this point I don't want to be proven wrong with a loss of profits. I would let your conscience be your guide on holding or folding next week. I am thinking some June puts on the Russell ETF might be in order.