A rate hike by China and demonstrations at the Suez Canal knocked the markets lower at the open but the dip was bought once again. The bears were dumbfounded again.

Market Statistics

China started the morning off with a thud after it raised interest rates +25 basis points. The benchmark 1-year deposit rate rose to 3.0% and the 1-year lending rate rose to 6.06%. The increases are effective immediately. The last increase was on Christmas Day when those rates were also raised a quarter point.

With the "official" inflation rate at 5.1% but food inflation at 15% to 20% China has to keep applying the pressure. In China, where there is a very large underclass, the cost of food is 25% to 35% of income. China has to slow inflation or risk some serious civil unrest.

The knee jerk reaction to China's rate hike was a sudden drop in the futures and commodities. Crude oil in the U.S. declined sharply to $85.88 and Brent crude declined to $97.51. Later in the day both rebounded sharply on news from Egypt.

The news from China pushed the markets into negative territory at the open but the bulls were eager to rush into the dip. The dip lasted an entire 21 minutes before the S&P turned positive again on its way to a new closing high.

In the U.S. the Job Openings Labor Turnover Survey (JOLTS) showed a slight decline in the labor market. This survey straddles the period between the December and January nonfarm payroll reports. The number of job openings declined from 3.202 million in November to 3.063 million in December. New hires declined from 4.214 million to 4.184 million.

This minor decline was not unexpected after the weakness in the payroll reports. Hiring was still slightly higher than separations but the gain was slight at 22,000 jobs. Few companies hire in December and there is a wave of terminations of seasonal workers in the last week of December. This report was mostly ignored on a headline basis but there was a bright side. It is further confirmation the economy is still not ready to walk on its own and the Fed will continue to provide stimulus through QE2 at least through June.

The weekly chain store sales snapshot exploded higher at +2.2% as the blizzard shut-ins busted out of house and into the malls. Pent up buying translated into solid gains.

The only reports due out on Wednesday are the Mortgage Applications and Oil Inventories.

Economic Calendar

There were still a few earnings reports today and the picture was mixed. Teva Pharmaceuticals (TEVA) said profits more than doubled to $1.25 per share. Analysts were expecting $1.28. Teva projected full year profits of $4.90-$5.20 and analysts were looking for $5.28. Teva shares declined -5.4% on the news.

Avon Products (AVP) needs a makeover. The company reported earnings of 59-cents that missed estimates of 66-cents. Supply problems in Brazil, poor sales in Russia and rising costs for raw materials forced the decline in profits. About 80% of Avon's revenue comes from overseas. Shares of AVP lost -3%.

Avon Chart

Disney (DIS) reported earnings after the close of 68-cents compared to estimates of 56-cents. The results were due to higher advertising revenue at ESPN and ABC, stronger performance at its theme parks and cost cutting at its movie studio. Revenue grew +10% to $10.7 billion. Revenue at ABC and ESPN grew by +11% but operating profits surged +47% to $1.1 billion. Shares of DIS, already at a 52-week high surged after the close.

Disney Chart

McDonalds (MCD) reported same store sales that spiked +5.3% for January. In Europe sales rose +7% compared to estimates of +3.7%. U.S. sales rose +3.1% compared to estimates of +4.4%. Europe contributes more than 40% of McDonald's revenue. McDonalds said new products and longer hours helped to stimulate sales. McDonalds has been raising prices to offset the higher prices of food commodities. MCD shares were up +$2.

The price of oil in the U.S. declined under $86 on the news from China on fears of lower demand as China clamps down on inflation. The price quickly rebounded after news broke of a worker demonstration at the Suez Canal in Egypt. Around 3,000 workers in companies owned by the Canal authorities and based in Ismailia and Suez had gone on strike on Tuesday over pay and working conditions. Workers in Canal owned companies in Port Said will go on strike on Wednesday. A senior official said the canal traffic was operating normally and the sit down strikes over pay would not affect Suez Canal operations and ship movement.

WTI Crude Oil Chart

Brent Crude Futures

Note the difference in the two crude charts above. The price of Brent light crude rose to $103 last week and after a brief decline it closed over $100 again today. Triple digit oil prices are with us again despite the $86 price on U.S. WTI today. The difference in the prices is related to the lack of available storage in Cushing OK and no place to put new oil. It is even worse than it appears because light Bakken crude was selling for $81 last week. Prices for WTI should continued to be pressured until some new pipelines are built or demand accelerates to deplete inventories at Cushing. Get used to paying higher prices for gasoline despite the weakness in WTI. AAA predicted a $3.15 average price for gasoline for 2011. About one third of global oil sales are priced off the WTI contract and two-thirds indexed to the Brent contract.

The Fed inflation hawks Jeffrey Lacker and Richard Fisher were both talking down QE2 today. Richmond Fed President Lacker said the Fed should seriously review their commitment to the QE2 program. He believes the sudden acceleration of economic indicators suggests the Fed seriously needs to reconsider its actions. Lacker has been an inflation hawk for quite a while so his stance it not new. It is however growing in intensity although he still believes inflation is benign today. It is future inflation he is worried about. Lacker is not a voting member of the FOMC in 2011.

Richard Fisher, president of the Dallas Fed, is a voting member and he vowed on Tuesday to vote against any additional bond-buying programs once the QE2 program expires. Bernanke held out the hope for investors last week that a QE3 program was a possibility. Fisher said he expects to be at the forefront of the effort to push the Fed to cut back on its Treasury holdings and tighten economic policy at the "earliest sign" of inflation moving out of the commodity markets and into consumer prices.

Bernanke may want to keep interest rates low by buying treasuries but the market appears to be in disagreement. The current yield curve from the two-year to thirty-year is the steepest it has ever been. This suggests the market believes the economy is getting dramatically better and the Fed will have to end its QE programs sooner rather than later.

Interest rates are rising and rising quickly. The bull market in bonds is over. The constant rally in equities is sucking money out of bonds and forcing yields (rates) higher. On the chart below we saw the two months of consolidation while the Fed tried to talk the market lower but the positive economics of the last few days has ended that possibility. The only way Bernanke could lower rates now would be an even larger QE3 program announcement and that is not going to happen.

While some see this as a failure for Bernanke I see the opposite. Sure he would have liked for rates to stay low for the rest of the year to support the housing market but there is another view to consider. Rates are going up because the economy is improving. Rising rates is driving money out of the bond market and back into equities. The stock market is soaring and the wealth effect for 70 million U.S. investors is improving daily. This was a major goal of Bernanke all along. Push the equity markets higher by driving investors out of bonds. The rising wealth effect means more homebuyers, more consumer spending, more new businesses and higher employment. Some people are ridiculing Bernanke for being unable to restrain rates but they should be giving him credit for reflating the equity market and the economy.

Ten Year Treasury Yield Chart

Option Investor readers should be applauding Ben Bernanke and thanking him for the current bull market. His QE2 program has done what countless stimulus programs over the last three years have been unable to do. Of course they all helped and did set the stage for Bernanke's big move. He just seized the opportunity and made the play.

We will have mother of all hangovers when Bernanke takes the punchbowl away this summer but for the time being the party is in full swing.

The S&P-500 rallied to close at the high of the day and well over resistance at 1320. This is one more bullish signal that suggests the markets still want to go higher. The quick rebound out of the opening dip was frustrating for those who were hoping for something a little more dramatic in the way of a buying opportunity. Support is now in the 1290-1300 range and rising.

The S&P has risen for four consecutive days so we do need to start looking for a down day in the not too distant future. The Dow is up seven days. Any decent dip should take the S&P back to the blue uptrend line for support AND it would be a buying opportunity.

S&P-500 Chart

The chart of the Dow is amazing. After two months of minor moves in a stair step pattern of growth it has turned into a mean, green breakout machine. The converging resistance at 12,000 managed to hold it in check for two weeks but those chains are no longer holding the Dow back. It has broken free and in breakout mode.

While this is a great chart it is also a warning that things can't continue this way forever. Once unbridled enthusiasm takes hold we are only a day or two away before something rains on our parade. I would love to believe that trees grow to the sky and I do expect higher numbers on the Dow but I am now concerned there should be a temporary pullback in our immediate future.

Real support is 12,000 and that is way back in the rear view mirror today. That means some other number will likely appear and 12,150 is a good candidate.

Dow Chart

The Nasdaq continues to lag the Dow and S&P and remains below long-term resistance. Initial resistance at 2810 should be tested on the next decent move higher and that uptrend resistance was solid back on January 27th. After four days of gains we should expect a pullback possibly later this week. In theory 2780 and 2765 should be support.

As long as Apple keeps getting new price targets in the $500 range the Nasdaq should maintain its forward progress. Apple has seen five upgrades in the last two weeks with price targets between $425 and $550. The high one was from Ticonderoga. The other three were in the $450 range. Apple has gained $10 this week and with a 20% weighting in the Nasdaq that is powerful support for the index.

Nasdaq Chart

The Russell finally found some traction and broke out over 800 this week and did it with gusto to close at 813 today. That puts the Russell over the 807 resistance high from January and in breakout mode. Future resistance is at the 825 and 835 levels.

The blue chips were leading the charge last week and the Russell was lagging but it caught up today and appears to taking the lead again. I was starting to get worried small cap sentiment was fading but it looks like it was only temporary. The difference in the chart from Friday through today is amazing.

Russell Chart

The biggest problem is the volume at only 6.8 billion shares for the last two days. There is a serious lack of conviction suggesting the majority of retail traders and quite a few institutional firms are still not onboard with the rally. Every day that passes they see the additional gains and become more frustrated. The 21 minute dip at the open is a key indicator they are looking for any opportunity to come off the sidelines but they are refusing to buy the breakouts. At least they WERE refusing. The market action over the last two days suggests they may be ready to panic.

In summary I believe the markets were in breakout mode today but the angle of the trajectory suggests there will be a bout of profit taking in our near future. I still believe it will be another buying opportunity and we have several more weeks of decent gains before traders begin to really worry about the Fed taking away the punchbowl. The sell off in bonds means more money moving into the equity markets and despite the strong bond selling over the last week I think we are just getting started. Bonds are going to be dead money and equities are where the action will be.

Don't fight the Fed, buy the dips instead!

Jim Brown

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