The Dow snapped an eight-week winning streak and suffered its worst one-day loss in more than two months. The Nasdaq lost -2.5% for the biggest daily loss in five months.
When markets want to go down they will find a reason. On Friday they had no trouble finding a reason with the three Es of Egypt, earnings and economics all providing an excuse to sell. The biggest blame was placed on Egypt and the civil unrest currently attempting to force changes in the government. The turnover in Tunisia a couple weeks ago was seen as a trigger for the riots in Egypt. Protestors seeking reform turned out in force and were greeted by police and military and the protests turned ugly.
Egypt has been an ally of the U.S. and helped to provide security for Israel for 30 years. It receives the second largest amount of foreign aid on an annual basis from the USA. The U.S has supplied F16s, tanks, personnel carriers, advanced missile systems and many other forms of military equipment. If the country was to fall under jihadist rule and it would be a very bad thing for Israel and for the U.S. since we have treaties with other Middle East countries. Egypt is the big dog on the block and should the country move in the wrong political direction it could be a serious challenge. If Egypt was forced into a government turnover like Tunisia, analysts fear it could lead to similar events in other Middle East countries and throw the entire area into a morass of instability that could ferment terrorist activity.
Egyptian leaders normally come out of the military and have the support of the military, which is strong and capable. A new leader to replace Mubarak would likely come from a military background and not result in too much change in administration. Late Friday Mubarak dismissed the entire Egyptian government and promised to rebuild with some changes wanted by demonstrators. Dismissing the government was not what the protestors wanted. They wanted Mubarak to step down and let someone else take over.
The Egyptian uprising had a serious impact on the market not specifically because of the possibility of a government turnover in Egypt but the possibility of the contagion spreading to other countries. Regardless of the outcome in Egypt there is the risk of another uprising elsewhere in the region. Saudi Arabia already has a lot of civilian unrest that is always bubbling just under the surface. If this kind of problem rose in Saudi Arabia the U.S. would be drawn into the picture in order to protect Saudi from outside influences, protect the royal family and protect the oil fields and facilities. This worry over Saudi being drawn into the fray is the real problem for the U.S. markets.
Egypt has 80 million people and more than 30% are illiterate. Inflation is over 11% and inflation in food is over 17%. The Egyptian markets had fallen -18% in the last week and -11% on Thursday alone as the unrest began to spread.
(Saturday afternoon update) Egyptian president Mubarak named 74-yr old Omar Suleiman as vice president, a position that has been vacant for 30 years. Analysts claim this is purely a figurative move given the man's age. Suleiman was planned to be successor for Mubarak and then pass the title to Mubarak's son Gamal as a method of keeping the presidency in the family. This was not received well when it was in the planning stages. The crisis appears to have interrupted those plans permanently. Gamal was seen as a continuation of policies associated with his father. Citizens believe the country has been looted by the ruling family and its inner circle while inflation rockets out of control and pushes them farther into poverty.
Mubarak also appointed Ahmed Shafiq as the new prime minister. Shafiq was in the air force and worked directly under Mubarak in the past. He was named head of civilian aviation in 2002 so his name is known to the public. He has been tasked with rebuilding the government.
According to Stratfor Mubarak is no longer in charge despite his title as president. Apparently the military has taken over and is choreographing the change in command so that it still looks like Mubarak is in control and ceding power gracefully according to the will of the people. The military has gone to great pains not to engage with the protestors but to show force and let the police handle the actual confrontations. The military does not want any negative publicity as their manipulation of the command structure is completed. The police force is severely hated because of its historical brutality. Eighteen police stations were burned on Friday.
Stratfor is also reporting the Egyptian Muslim Brotherhood (MB) appears to be working with Hamas to increase the level of violence in an attempt to seize control or manipulate the change in government to give the MB a greater say in the future. The Egyptian police are no longer patrolling the border with Gaza and large numbers of armed Hamas men have been crossing the border into Egypt. The MB has fully involved itself in the demonstrations and they are insisting on a new cabinet that does not include any members of the ruling National Democratic Party. Security forces in plainclothes are reportedly engaged in destroying public property in order to give the impression that many protestors represent a public menace. The MB is forming people's committees to protect public property and to coordinate demonstrators activities including supplying them with food, beverages and first aid.
The situation as of late Saturday appears to be worsening although demonstrations in Egypt have calmed. Protests flared up in Yemen and quickly turned violent. With Egypt on one side of Saudi Arabia and Yemen bordering on the south the odds are good some of this revolutionary feeling could blossom in Saudi. King Abdullah of Saudi Arabia strongly criticized the demonstrations in Egypt and Yemen and voiced support for Mubarak. I believe betting on a lame horse like Mubarak and making comments critical of the demonstrations is risky business. Saudi's stock market fell -6.4% on Saturday.
With the outbreak of violence in Yemen and the rapid influx of Hamas supporters from Gaza I fear this story has farther to run and the odds of a Saudi infection are growing. That would be VERY market negative in the USA.
Another event in this rapidly moving story was news China had blocked any searches for "Egypt" on its twitter-like service on Sina.com. Reportedly the news agencies have been told not to cover the protests and news of the event has been given only a couple paragraphs buried inside a few websites. China reportedly has a high level of unrest because of the rapidly rising inflation and citizen exposure with the free world thanks to the Internet and smartphones. If demonstrations begin to form in China our markets could be in a world of trouble.
Back home in the U.S. the GDP report for Q4 came in lower than expected and put a damper on trader spirits. The headline number showed growth of +3.2% compared to estimates of +3.6%. This was still an improvement over the +2.6% growth in Q3. The biggest drag on growth was a giant decline in inventories that removed -3.7% from the GDP number.
Without the drag from inventories the GDP number would have been a blowout. Ex-inventory or final sales of domestic products the GPD would have come in at 7.1%. This is the largest gain since 1984 when the economy was coming out of the early 80s economic distress. Personal consumption expenditures rose at a 4.4% rate after a 2.4% growth in Q3. Business investment rose +4.2% in Q4 compared to only a 1.5% gain in Q3. This was the sixth consecutive quarter of positive GDP growth.
Despite the lower than expected headline number this was a VERY strong GDP report. Unfortunately traders focus on the headlines rather than the internals. The internals in this report suggest we could see something in the low 4% range for Q1 and that would be much stronger than analysts previously thought. The payroll tax cut will stimulate additional spending and businesses are already ramping up capital spending because of the 100% depreciation available as a result of the tax deal. Corporations are going to be unable to keep up with the spike in business without hiring additional employees. Those new paychecks will be immediately spent and that will further stimulate the economy.
The final update for January Consumer Sentiment showed a +1.5 point increase to 74.2 from the preliminary reading of 72.7. This was still a -0.03 decline from December but was seen as a non-event by traders. Sentiment rebounded as consumers started seeing a smaller tax bite in their January paychecks.
Consumer Sentiment Chart
The economic calendar for next week is dominated by manufacturing reports and payroll news. There are four ISM reports with the national ISM for manufacturing on Tuesday. That is the most important of the ISM releases.
The payroll reports are led by the ADP report on Wednesday that will predict the jobs added in the Non-Farm Payroll report on Friday. The Non-Farm Payrolls is the biggest report of the week and estimates are for a gain of 146,000 jobs. Recent economic reports have shown an increase in the employment components so the whisper numbers are higher than the 146K. The spike in the jobless claims last week will not impact this report because the survey period ended before that layoff week. Could there be some limited impact? Yes, but analysts believe the broader trend in hiring will offset the temporary declines.
The earnings calendar slows significantly in frequency and importance next week as we begin the decline from last week's earnings peak. The ones I believe are the most important are Visa, MasterCard, UPS and YRCW. Visa and MC will give us a consumer update by releasing the latest delinquency numbers. UPS and YRC Worldwide will tell us how the shipping business is growing or declining. This is the last week for material earnings other than HPQ, Cisco and Dell.
Friday's decline was not all based on Egypt. Some high profile earnings misses were also creating havoc. Amazon reported earnings on Thursday night and declined 9% intraday to $166 before ending the day with a 7% loss. Amazon represents 2.1% of the Nasdaq 100 and while that is far less than Apple's 18% the big drop in Amazon was a major hit to sentiment for tech stocks.
Another highflying tech stock that crashed was SanDisk (SNDK). SanDisk reported earnings of $1.27 per share and analysts were only expecting $1.09. SanDisk raised guidance to $5.44 per share for the full year compared to estimates of $4.83. However, SNDK shares fell -9% to $46.79 on worries profit margins were shrinking as competition increases. SanDisk is benefiting from the rise in smartphones and tablets. The race to lower prices on the end user products is forcing manufacturers to pressure suppliers for lower prices.
Microsoft has a 4.5% weighting in the Nasdaq and the stock lost -4% on Friday after posting earnings that left many traders uninspired. The fall off in Windows Seven sales was a worry since a new release won't be coming down the chute until late 2012.
NetFlix was one of the few companies bucking the -68 point slide in the Nasdaq. NFLX shares rose strongly for the second day after earnings and posted a $7 gain. The worries over an early demise of NetFlix due to increased content costs seem to have been premature.
Commodities, especially gold, silver and oil, rallied strongly on the Egyptian violence. Gold and silver rallied on the safe haven play so common whenever a geopolitical event unfolds. Gold had declined to 1310 but rebounded +20 on Friday. Silver was a big winner with a +3.4% spike.
Crude oil had plunged to just over $85 on worsening supply fundamentals on Wednesday but rebounded +4.5% or +3.85 on Friday to close at $89.31. Egypt is an oil producer with daily production of 662,000 barrels but that was not the problem. Egypt is in control of the Suez Canal and 1.8 mbpd of oil flows through that canal. If the unrest grew and the crowds of protestors somehow halted the flow of ships through the canal it would be a major problem for world oil supplies. If ships cannot use the canal it adds 6,200 miles and several weeks to the journey by going around the coast of Africa. It would require more tankers and take significantly longer to deliver the same production. The cost would also be significantly higher.
I personally don't see the canal being blocked. The Egyptian military would not let it happen. They may be going easy on the hundreds of thousands of protestors in the streets but should they head for the canal I am sure they have orders to prevent that at all costs. It could escalate the violence significantly. Since unarmed protestors don't do well against troops with live ammunition I seriously doubt the canal is in danger.
Crude prices spiked so sharply because the short interest was very high going into Thursday's close. Prices were dipping to $85.15 and threatening to go lower when suddenly the news broke and triggered the rebound and massive short squeeze. Once the situation cools I believe we will see $85 again.
Crude Oil Chart
When I started writing this commentary on Friday afternoon I thought the Egypt story was something that would blow over and the markets would rebound after a follow through dip on Monday. I am far less certain of that on Saturday afternoon. There are some serious risks of other countries going down the same path and the consequences would be negative for the global economy. If it spreads to Saudi Arabia with production of 10 million barrels of oil per day there would be an opportunity for production to slow. Al Qaeda has been targeting Saudi oil facilities for years and a general uprising would give Al Qaeda cover to mount new attacks. Saudi Arabia's ruling family would not go down as passively as Tunisia or Egypt. There would be a much more hard line response against protestors. That may actually work in Saudi's favor because the people know the demonstrations would be dealt with harshly.
The entire Middle East region is on alert this weekend. There is no telling if, when or where this contagion will spread. For that reason I am cautious about the market for next week.
The S&P declined -23 points to secondary support at 1275. A break there threatens to retest 1265. Followed by the 50-day average at 1250. The S&P was due for a correction and the source of the event is immaterial in the long run. The market will always find an excuse when it is ready to decline.
The Dow declined to initial uptrend support at 11800 as the news flow became a constant stream of Egypt protest video late in the day. This was a reactionary decline that triggered stop losses all along the way. After two months in rally mode and eight consecutive weeks of Dow gains I am surprised the damage was not worse.
If the Dow breaks below 11800 the next logical target is 11600. This is where I would expect investors to step back and reconsider why they are selling. Does this really impact me? Do I really care if Mubarak steps down? Should I be buying this dip? The answers to those questions should be evident by late Monday morning and the reaction selling will morph into whatever follows, be it up or down.
Resistance remains 12000 but I seriously doubt we will be worrying about that again next week.
The Nasdaq was crushed by major declines in big name stocks including MSFT, AMZN, GOOG, PCLN, AAPL and ISRG. The -68 point decline was the biggest one-day drop in five months. The index came close to testing support at 2675. It also posted a lower high and a lower low since the mid January high. Obviously this was event driven by multiple events but it is still technically bearish. A break below 2675 targets 2640 and the 50-day average. If the events get out of hand in the Middle East we could easily see 2500 very quickly.
It is not that the Middle East is that material to tech stocks but those stocks are what investors just acquired to add risk to their portfolios. This may be more risk than they bargained for. If the violence continues or worse spreads then investors will be looking to shed risk rather than embrace it.
We should be encouraged the Russell did not fall any further than it did. The Russell stocks have more risk than the Nasdaq stock so the Russell could have easily declined significantly more. I believe the news caught fund managers off guard and most of them were still in buy the dip mode. We really did not have the full picture on Egypt until late in the day. By then many managers may have been hoping for an end of day rally to sell into.
The Russell has critical support at 773 and 765 and assuming we don't gap below that on Monday I think managers will be thinking twice about buying or selling a touch of those levels.
For three days last week the market tried to breakout to new highs without success. Each failed attempt increased the bears aggressiveness and conviction. The Amazon earnings miss and the Egypt event was what they had been waiting for over the last six weeks. They piled on the shorts and longs were getting blown out of positions as stop losses were hit.
Monday will be different. Traders and investors alike will have had the entire weekend to decide if the Egypt event is material to our markets and whether or not it might spread to Saudi Arabia or others. The market will open with an informed trading public rather than a Friday surprise.
Given a sudden market event there was a very strong urge to exit positions before the weekend simply because of the rising unknowns and the need to take profits in a suddenly volatile market. For those who were either not paying attention, away from the market or were in a state of massive confusion there will probably be another sell cycle at the open on Monday. It will be a knee jerk reaction to Friday's market loss and the events of the weekend.
Is that dip going to be a buying opportunity or a prelude to the next flash crash? Unfortunately I can't answer that today because we don't know what events will transpire before Monday's open. However, I do know the Fed's Plunge Protection Team (PPT) is alive and well and they could easily decide to enter the market on the dip to avoid having their carefully orchestrated rally since September destroyed like the crash of a Jinga tower.
Volume was heavy at 9.9 billion shares on Friday with down volume 6:1 over up volume. That is NOT a capitulation statistic. A capitulation day is typically 10:1 or higher. Yes, stocks sold off but the internals were not as bad as the talking heads would have you believe.
We never know in advance what event will pop up to cause a serious market decline. We do know that these declines are not permanent and a quick resolution in Egypt could fade from the headlines just as quickly.
Nothing has changed with QE2. The Fed is still going to pour additional hundreds of billions of dollars into the market over the next five months. The market will recover from any short-term event related decline. The only question is how long before that recovery begins?
As investors we should always be ready to take advantage of events in the market rather than run from them like our hair is on fire.
I believe we should take a careful look at the market about 10:AM on Monday and make a rational decision on whether we should be buying puts or buying the dip.
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An eye for eye only ends up making the whole world blind. - M.K. Gandhi