The ADP induced spike in expectations for the payroll report proved to be a downer for the market when the report failed to measure up.
When the ADP report on Wednesday forecasted a gain of 297,000 jobs in December that was 2.5 times the prevailing estimates at the time for a gain of +125,000 jobs. The ADP report upset the delicate balance of analyst estimates that ranged from gains of 75,000 to 160,000. Suddenly analysts and investors alike started to become giddy with hopes the ADP report was correct and we were going to see a serious spike in employment that signaled a true acceleration in the recovery process.
Unfortunately those hopes were dashed when the Non-Farm Payroll report showed a net gain of only 103,000 jobs. Private payrolls rose +113,000 jobs but government jobs declined by -10,000. If the ADP report had not muddied the water the +113,000 private jobs compared to expectations for 125,000 would have been right inline and not a problem for the market.
The busted headline expectations depressed the market but some of the report internals were definitely bullish. The unemployment rate declined by 0.4% to 9.4% and well below estimates. That headline got a lot of play in the news and helped to soften the market decline but in reality it was a bogus statistic. The unemployment rate declined because more people joined the ranks of discouraged workers and quit searching for a job. They fell off the unemployment rolls and although unemployed they are no longer counted as part of the workforce. Good headline but a bad reason.
The job gains from the prior two months were also revised higher. October was revised up to 210,000 from 172,000 and November was revised higher to 71,000 from 39,000. That was a total gain of 70,000 jobs from the prior periods. Those kinds of upward revisions never seem to matter to the market but they do count.
The Household Employment survey showed jobs there increased by +350,000. That is a strong gain but the household numbers never seem to move the market. This is a different survey than the Payroll Report. The data in the household survey is where we get the unemployment rate. The household survey showed 260,000 people left the workforce in December. That is why the unemployment rate declined.
Over all of 2010 the economy averaged job gains of 112,000 per month in the private sector. After subtracting government job losses the average drops to 94,000 jobs gained per month. State and local governments are facing serious budget shortfalls and the result is a steady stream of job cuts.
The economy needs to create a minimum of 150,000 jobs per month just to cover the increase in workers from legal immigration and students graduating into the workforce. Job creation needs to rise to a minimum of 350,000 per month before making any material dent in the 14.5 million unemployed and 8.9 million underemployed workers. Those underemployed are working part time for economic reasons or because they can't find a full time job. We will never have full employment but just to reduce that 23.4 million total by 50% would require 60 months of job creation at a pace greater than 350,000. The economy will have to be a lot better off than it is today. Some analysts believe we will never reach that goal. They believe we have lost the momentum and the retirement and downsizing of the baby boomers will further complicate the labor problem. Others believe the retirement of the baby boomers will be an employment boom as millions of workers leave the workforce making room for the unemployed. I believe that kind of analysis is way above my pay grade. I just want to get through 2011 with a trading profit and then I will worry about 2012.
Morgan Stanley believes we will see a gain of 200,000 jobs per month for all of 2011 and unemployment will be down to 8.5% by year-end. Morgan Stanley believes there was a blip in the data for December that will be revised higher next month.
Ben Bernanke told the House Banking Committee on Friday the employment rate could remain in the 8% range through 2013. He also said employment could take 4-5 years before a full recovery. Of course that is not factoring in a recession due to energy prices in 2012 but he can't be expected to know everything.
The economic calendar for next week only has one major event and that is the Fed Beige Book due out on Wednesday. This should be positive but like we saw in the payroll report too much optimism is a bad thing.
The PPI and CPI on Thr/Fri provide the monthly update on inflation and the consumer sentiment on Friday could be volatile. We have seen some swings in that survey recently and January could show some post holiday depression thanks to the blizzard.
The economic calendar will not be the primary focus next week. Alcoa will kickoff the Q4 earnings cycle with earnings on Monday. Also reporting on Monday will be Apollo Group, homebuilder Lennar, Meade Instruments and Steak & Shake. The earnings schedule grows cold on Tue/Wed but picks up again with Intel on Thursday and JP Morgan on Friday. The following week begins the real parade of reports and I will cover that next Sunday.
Earnings for the S&P are expected to have grown +27% over 2009Q4. That is according to S&P. Thompson Reuters is a little more optimistic with a 32% growth projection. This will be the fifth consecutive quarter of increased earnings after nine strait quarters of declines. According to S&P the financials will lead with a whopping +250% increase in profits, followed by energy at +118%, materials +70%, discretionary at +63%, information technology +52% and industrials at +26%. Rounding out the bottom is healthcare +11%, telecommunications +7%, utilities +7% and consumer staples +6%.
The 27% earnings growth sounds great until you compare it to the prior three quarters. Coming out of the recession in 2010-Q1 earnings rose +92%, Q2 +51% and Q3 +37%. Note the rapid deceleration as the year progressed. This will continue to be a challenge as the comparison quarters become harder to top.
S&P said the boost in earnings came from continued cost cutting, a decent increase in revenues in the low double digits and the increase in stock buybacks. When companies buy back shares there are fewer shares outstanding and that increases the earnings per share even without an increase in the dollar value of earnings. IBM is the all time pro at buying back enough shares in a quarter to meet analyst earnings targets.
As long as the earnings are inline with estimates with at least a small beat in many cases the rally could continue another week or two but I would not expect any material upside given our overbought conditions and the rising problems in Europe.
If the first few companies to confess earnings just report inline with estimates or miss estimates slightly then our overbought conditions could return to oversold very quickly. Investors are willing to bet on their favorite horses into earnings as long as the horses around them are not pulling up lame or collapsing on the track.
The gains in some of these early reporters could present a problem. Alcoa has risen +25% since December 1st and it will take some pretty strong earnings to keep the bulls in their camp. JP Morgan is up +16%.
Senior market strategist at Lind Waldock, Jeffrey Friedman, warned if results are inline or below the S&P could see an 8% pullback. Strong earnings could add another 4% for the S&P but only if earnings beat convincingly. He believes Friday's payroll disappointment has set the tone for next week with a greater chance of weakness. The negative payroll surprise removed some of the bullish sentiment from the market.
The key report for the week will be Intel on Thursday. Intel needs to say PC sales are strong and NOT say they are expecting normal seasonal weakness in Q1. That is a normal problem for this report. When they caution on seasonal weakness it seems to drag down the entire tech sector. The seasonality has to do with the drop off in PC sales after the holidays.
Goldman Sachs raised their 2011 target for the S&P to 1500 based on expected strong earnings. They are expecting record S&P earnings of $96, which tops the previous high of $91 in 2007. They believe the recovery will accelerate and the U.S. economy will be 5% larger at the end of 2011.
For those estimates to come to pass we have to get by the European debt crisis first. Next week will see Portugal, Italy and Spain attempt to auction debt. Portugal sold six-month bills on Wednesday at 3.686% and the high interest rate is causing some serious worries about what those countries will have to pay when they auction their long dated debt next week. Spreads on some European debt against the German bund were at or near record levels. This came after the EU suggested senior bond holders might have to share in the losses of distressed banks. This would be done by regulators writing down debt and converting it to equity in order to rescue the institution. For instance, if a bank had sold $500 million in debt and could not make the debt payments the regulators would write down that debt to something like $200 million and convert the $300 million loss into equity in the bank. If the bank recovered the bondholders might escape with a breakeven. This proposal did not set well with investors who just want to be secured lenders not unsecured stockholders.
There are increasing fears of a new round of problems requiring even more bailouts. China has been considering buying European debt in an effort to prevent a further contamination within the Euro nations. This week would be a good time to take the plunge.
Mark Zandi at Moody's thinks the European debt crisis will continue to pop up and cause trouble until the Eurozone expands their bailout fund and buys some more sovereign debt to force rates lower. "Clearly the first bank stress test did not work and it is time for Stress Test Two."
Another hurdle for the markets is the China trade data that will be reported on Monday. That will be an indication of the health of the global recovery. It will also give us a clue on their progress on stimulating consumer buying inside China. China claims it is trying to move from an export economy to a consumer economy but it continues to place regulations on consumption inside China. As the current driver for the world economy any economic number out of China is a cause for concern and a possible market-moving event.
Here at home we are starting to hear more about the impending muni crisis. States making headlines because of large deficits include Illinois, California, New Jersey, New York and Texas. The lone star state has a budget of $95 billion and a $25 billion deficit. You can't cut that kind of money out of a budget of that size. You can't fire enough people, cancel enough services and turn off enough lights. One proposal they are considering is dropping Medicare to save money. Obviously that would not sit well with Texans but desperate times call for desperate measures. These are the kinds of tough decisions that many states are facing in 2011. Reportedly states are facing a $200 billion deficit in 2011. How do you manage a recovery in jobs when they will be slashing payrolls to the bone?
The problems in Europe pushed the dollar to a +3.6% gain against the euro for the week. That was the biggest move for the dollar since August. The rise in the dollar crushed commodities with silver falling -7% for the week along with gold (-$54), copper and crude falling -3.7% each.
Another problem weighing on commodities is the pending rebalance of commodity index funds. The DJ-UBS Commodity Index and the S&P GSCI Index, with about $200 billion in commodity funds tracking those indexes will be rebalanced between Jan-7th and 13th. Basically the indexes try to maintain a specific ratio of commodities in the index. In a year where a commodity like copper has rallied +50% the indexes have to rebalance to bring copper representation back down to the correct ratio. This means the funds with $200 billion tied to these indexes will have to sell copper, oil, silver, etc in order to match the rebalanced index structure.
As if that was not enough pressure on commodities the CFTC will meet this week to vote on position limits on all commodities. Any funds holding large positions may want to avoid the rush to the exits if the vote passes.
On Friday the big news was a Massachusetts Supreme Court ruling against Bank of America and Wells Fargo. The court ruled against them in a foreclosure case saying they foreclosed illegally because they could not prove they held the mortgage at the time of the foreclosure. The mortgages in question were transferred into two mortgage-backed trusts without the recipients being named. During the mortgage bubble many mortgages were transferred around so much from lender to lender and then into multiple trusts depending on how the loan was sliced and diced the assignee names were left blank. Basically, paper trail was incomplete and the current holders were not the original lenders.
Because the decision was made by the Massachusetts Supreme Court the ruling can be used as a reference in hundreds of court cases already underway and dealing with the same proof of ownership mortgage problem. This ownership suit has proved effective in preventing many foreclosures.
Bank America was quick to point out they had no financial interest in the mortgages in question. BAC is solely as a trustee to a mortgage owned by a securitized trust and had no responsibility for transferring the loans. BAC recovered about half of its original drop in share price after the announcement. JPM lost -2%. Several analysts said this was a big deal because it called into question the entire securitization process of creating mortgage-backed securities. Most disagreed with that idea but worried this would put a cloud over the banks and delay foreclosures that had to occur before the housing sector could truly recover.
Liz Claiborne shares fell -13% after the company warned income would be significantly below prior forecasts. The company said profits from operations and divestitures would be in the neighborhood of $50 million compared to prior forecasts of $80 million. LIZ CEO said bad weather, competitive pricing and picking the wrong fashions all contributed to the drop in profits. Earnings are due out Feb-17th.
Dean Foods must have looked appetizing to billionaire David Tepper. His fund Appaloosa Management announced on Friday they had taken a 7.4% stake in the company. This is unusual because Dean Foods has been getting crushed every earnings day for a couple years now. Dean is the largest dairy producer and the worst performer on the S&P in 2010. Could it be that the company has hit bottom? At least one investor believes better times are ahead. Appaloosa bought 13.4 million Dean shares.
Dean Foods Chart
Homebuilder KB Homes (KBH) rallied +6% after posting a surprise profit for Q4. KBH posted profits of $17.4 million or 23-cents per share. The analyst consensus was for a loss of 18.5 cents. The CFO said the profits were due to an aggressive cost cutting program over the last two years and a switch to smaller and more efficient homes. KBH targets first time homebuyers. The company only closed on 1,918 homes, down from 3,042 in the comparison quarter. Net orders were down -25% to 1,085. The fact KBH managed to produce a strong profit on reduced sales prompted Raymond James to rate the stock a strong buy. Once new home sales begin to accelerate they expect even stronger profits from KBH.
KB Homes Chart
Apple recovered from the CES depression to close at a new high. Analysts failed to find an iPad killer among the dozens of new tablets introduced at the show and that provided new support for Apple's rally. With the iPad 2 scheduled to be announced soon most analysts believe the future is still bright for the tablet leader. However, while there was no iPad killer there were so many new models, styles and features that each will chips away at the Apple lead. There may not have been a single killer but Apple can still bleed market share from a thousand tiny cuts. For the time being Apple is still the king of the tablet mountain.
Verizon has scheduled a press conference for Tuesday with no hint of the topic to be discussed. However, a source told Reuters this weekend they will announce the new iPhone to run on the Verizon network with sales to begin in February. This is just one more reason why Apple is going to remain an investor favorite. However, this has been rumored for the last three months so you wonder how much of the excitement is already priced into Apple/VZ stock? AT&T is preparing for the competition by reducing the price of the iPhone 3GS to $49.
Atmel (ATML) closed at another new high after Wedbush initiated coverage with an outperform. The last three brokers to initiate coverage started them with a buy. The reason analysts like Atmel today is their heavy focus on the touch screen technology for smartphones and tablets. That technology is showing up on everything and will continue to spread into everything from autos to refrigerators. Atmel shares really need a cooling off period after more than doubling since August.
Murphy Oil (MUR) dropped -4% after disclosing a Q4 charge of $36 million for drilling three dry holes in the Congo. They do have producing wells in the same area. This proves just because you find oil in one well even with advanced seismic data there is still a risk every time you drill. These wells were not expensive as wells go today. Dry holes in deepwater can cost hundreds of millions each. This kind of news should not blunt the excitement in the energy sector but we are due for some profit taking.
Murphy Oil Chart
Chevron (CVX) will give its Q4 interim update after the close on Tuesday. Chevron earnings are Jan-28th. On Tuesday the company will update production volumes and give progress updates on recent projects. This update will be closely watched by energy investors.
Goldman Sachs was positive about the energy sector on Friday and especially the drillers. Goldman upgraded Diamond Offshore to buy from sell and said oil service companies with international exposure could see further gains despite their recent rally. Baker Hughes (BHI) was upgraded to buy from neutral.
Hess Corp (HES) said it planned to spend $5.6 billion in 2011 on capital projects. This was a +44% increase from 2010 levels. The company is going to spend that money in the Bakken shale in North Dakota and the Valhall project in Norway and Shenzi in the Gulf of Mexico.
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AK Steel (AKS) lost -7% after Goldman cut its rating to SELL based on rising imports of electrical steel. The company was the worst performer in the S&P on Friday. Electrical steel is used in high power electrical transformers. This downgrade was another blow to the sector after Schnitzer Steel (SCHN) reported earnings on Thursday of 64-cents that missed estimates of 71-cents. Schnitzer fell -7% on the news.
The markets struggled after the payroll report but they almost made it back to positive territory before the close. At one point the Dow was down -97 points and ended with only a -22 point loss. I think traders missed the point on the jobs report. The gain of +112,000 private jobs was just enough to confirm the recovery was still progressing but not enough for Bernanke to call off any further QE2.
In fact based on Bernanke's testimony we could see a QE3 or even a QE4 if job creation does not accelerate. He has to keep pouring fuel into the markets to stimulate housing by keeping rates low and rebuilding the wealth effect through the stock market. As investors see the value of their IRAs and 401K grow they become more positive about the future and less restrictive on how they spend their money. The housing sector accounts for about a quarter of our GDP and although it has improved it is still on life support. Continued payroll reports with less than 150,000 new jobs will keep the Fed on the side of investors. Just remember, once the pendulum swings back to the other side of robust growth the Fed is going to be very aggressive in removing all this excess accommodation. We need to make money on the long side in 2011 because 2012 could be very rocky.
After 33 weeks of outflows from equity mutual funds we have had two consecutive weeks of positive fund flows. Obviously that has a lot to do with year-end retirement contributions but sentiment has definitely changed. The major brokers are upgrading estimates and year-end targets for 2011 and investors on the sidelines are starting to feel like they missed the boat by not moving out of cash and bonds in the fall of 2010. Retail investors only account for 25% of the market but that is 25% of a $14 trillion market.
A total of $39 billion flowed out of equity funds in 2010 and whopping $271 billion flowed into bond funds. Investors were putting new cash into the safety of bonds as worries over a second recessionary dip caused unnecessary caution. We have seen in the last two months that some money has begun to flow out of bond funds and back into equities. It has only been a trickle but now we are past the year-end tax period and there is nothing holding that money in bonds. If it were not for the European debt crisis providing uncertainty today I suspect we would be seeing some major money flows back into equities.
Traders want the real recovery to begin but they have had their hand slapped more than once over the last year when they tried to venture into the market in anticipation of the recovery.
The key inflection point for those sitting on the sidelines will be the next market dip. I don't mean an intraday dip but a multi-day or even multi-week dip. When that dip is bought on decent volume it will be the signal to make the switch to equities. Despite the positive bullish sentiment, which declined from 61% to 55% last week there is still a mistrust of this market. The analysts whining about market manipulation by funds, high frequency trading or the Feds juicing the market have an audience but following those analysts is going to be bad for your financial health. A decent dip will give those analysts enough rope to hang themselves before the next leg higher begins.
We are facing a bull market in 2011. S&P earnings are going to be at new record highs. Cost cutting during the recession has made companies leaner and more cost efficient. As spending improves so will their profits. While we know there will be ups and downs in the market in 2011 the prevailing direction will be higher. This is going to be the year of buy the dip. I really wish we could see a dip next week because I get very impatient waiting for entry points. I assume I am not alone.
The S&P declined to 1261 on Friday and failed to hit that support at 1258 before rebounding strongly to close +10 points off the lows. Considering the negative payroll surprise I thought that was a good rebound. After all it was a Friday and traders probably wanted to take some profits before the weekend.
On three days last week the S&P tested the 1275-1278 resistance level and all three tries were rebuffed. Despite the failure at that level the index also failed to give up ground. Considering the profits built up in Q4 there are plenty of reasons to sell if money managers were worried about the future.
The key points to watch are support at 1258 and let's use 1280 on the upside. A break over 1280 would be sure to trigger some serious short covering. A break below 1258 would draw in the bears faster than a salmon run in spawning season.
The bearish view sees a topping process just under 1280 and the potential for a decline. I have no problem with that view as long as support at 1258 holds. It has been six weeks since the S&P visited the bottom of its broader uptrend channel so we are due for a retest any time. The difference between my view and the bears is that I believe the dip will be bought even if we have to retest as far down as 1180. When it is bought the resulting rally could be very strong. What is confusing the bears here is the consolidation back in November. That built a base for the current rally and discounts the need to take profits from the August to November rally. November was significant profit taking and should mean any dip in Q1 will be less intense.
The Dow is struggling with some serious resistance in the 11700-11750 range from August 2008. It is dealing with the uptrend resistance line (red) and the stronger horizontal resistance but still honoring the uptrend support (blue) from early December. The tone of the Dow changed in December with volatility shrinking. Even the -97 point intraday decline on Friday failed to really penetrate that uptrend support and the news was such a shock it should have had a bigger impact.
This is clearly an example of the bad news bulls climbing that wall of worry. They are hoping for more bad news to keep the Fed in the game and give them a dip to buy. Eventually this period of relative peace on the Dow will end but until it does the trend is your friend.
The dip to 11,600 on Friday was instantly bought and that is a good sign for future support tests.
The Nasdaq has an ace in the hole for Monday. That ace is the Verizon announcement scheduled for Tuesday. Since the topic has been leaked so thoroughly we can expect Apple to rally strongly on Monday and Tuesday. With Apple's weighting at 20% of the Nasdaq 100 index that will go a long way towards keeping the Nasdaq positive.
The Nasdaq is struggling with prior uptrend support, now resistance at 2700. A move over that level should trigger some short covering and some price chasing by frustrated fence sitters. Support is well back at 2650-2660 followed by 2625.
Nasdaq Chart - Daily
Nasdaq Chart -Weekly
The Russell continues to be our mine canary and it appears to be weakening at round number resistance of 800. However, the intraday dips were instantly bought so there is lingering support just under the bid. We did have a lower high on Thursday and a lower low on Friday. The RSI closed at 58.65 and that is a new six-week low. Those are normally key indicators of potential trouble ahead.
We had the same pattern back in mid October and it ended with a three-week consolidation and a blow-off move higher in early November. There is no guarantee it will happen this way again. We have seen consolidation around the 790 level since Dec-22nd but the volatility has picked up significantly over the last week. Beware a break under 780 as a change in trend. Support is still 760-765.
Russell Chart - Daily
Russell Chart - Weekly
To eliminate some of the noise in the smaller indexes like we will see from Apple in the Nasdaq next week we can use the Dow Total Market Index, formerly called the Wilshire 5000. This index has broken through key resistance at 13,275 and appears to be telegraphing a move higher. This represents market sentiment at its broadest.
Dow Total Market Index Chart - Weekly
In summary nobody is rushing to sell off the market and we successfully survived the first week of January. That is a good sign. Since 1950 there have been 60 first weeks of trading. 37 of those were positive. When there is a positive first week there is an 87% correlation to a positive gain for the entire year. When there is a decline in the first week there is only a 50% correlation to a decline for the rest of the year. Obviously you can twist statistics any way you want and past performance is no guarantee of future results. However, bullish markets create bullish sentiment and that sentiment creates further gains. It is a prime example of a circular feedback loop.
If you remember my January highs table I have shown several times over the last few weeks the average date for a high in January was the 12th. That would be Wednesday. With Intel reporting on Thursday that makes the 13th a likely target unless Intel really blows through estimates and raises guidance. There is no guarantee of a late month decline but the historical patterns are pretty strong.
January Highs Table
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