An escalation of Middle East tensions, a bogus rumor and a comment about high oil prices by Bernanke in congressional testimony was a toxic witches brew for today's market.
The multiple news items from the Middle East, Northern Africa (MENA) countries was a rapid-fire barrage of negative events that sent oil prices soaring and stocks plunging. New allegations about insider trading information leaked by a Goldman Board member added to the sudden decline in sentiment. Sentiment plunged so quickly that near record improvements in various economic reports was unable to stop the bleeding.
The ISM Manufacturing Index spiked to 61.4 for February from 60.8 in January. This was the sixth month of gains and the highest level of activity since 2004. New orders at 68.0 were the highest since early 2004. The employment component was the fastest rising component and rose to 64.5 from 61.7. This is the highest level of hiring in this report since the 1970s. All the other components rose as well except for inventories, which fell to 48.8 from 52.4. The gap between new orders and inventories widened from 15.4 to 19.2 and the widest since January 2010. New orders and falling inventories suggest the manufacturing sector will have to increase production to keep up.
ISM Manufacturing Chart
On Monday the ISM Chicago rose to 71.2 from 68.6 and that was the highest level of activity since the late 1980s.
The ISM New York also surged by +13.7 points to a new high at 513.4 and the employment component spiked from 54.3 to 62.5. Current business conditions rose to 77.5 from 71.2 and this is the fourth highest reading since the report began in 1993.
Not only the U.S. but Germany, France, the United Kingdom and the broader Eurozone ALL posted solid PMI data this week.
Despite the market decline today the economic recovery is accelerating into high gear.
U.S. automobile sales exploded higher in February to 13.4 million units (annualized) from 12.6 million in January. Those numbers are seasonally adjusted but the unadjusted numbers showed a sales gain of +27%. This is a huge gain and most of it was thanks to a sales surge by GM and Toyota. Sales at GM rose by 49.1%, Toyota +41.8%, Chrysler +12.6% and Ford +13.8%. Rising gasoline prices have had little impact on sales with the share of light truck sales declining only slightly from 51.6% to 49.1%.
With economic indicators literally exploding higher the market decline could easily be related to worries by hedge funds the Fed will change their FOMC statement on March 15th. If the Fed believes the economy is beginning to rebound too fast they could actually slow QE2 or end it early and funds may be expressing that worry with profit taking.
I warned last week that this worry could end our rally as we approached that March 12th meeting. It is entirely possible hedge fund managers are reacting to the employment in the economic reports and suddenly expecting a blowout in the Non-Farm payrolls on Friday that could change the Fed position on QE2.
The economic calendar for the rest of the week is mostly payroll related with the ADP, Monster and Non-Farm Payroll reports. The Fed Beige Book on Wednesday afternoon should be bullish for the market if it upgrades the outlook for each Fed region as expected.
The big drag on the market today was oil prices OR probably more specifically the threat of higher oil prices. Early this morning there was a report of an estimated 30 tanks being moved into Bahrain from Saudi Arabia. You may remember last week when Saudi said they were "prepared to intervene" if the Bahrain government needed help with the demonstrators. The news prompted an immediate spike in crude prices and worries about an increase in violence in Bahrain. However, the report proved to be false and was made by a Syrian reporter on Iranian TV.
There is a mass protest scheduled for Wednesday in Bahrain and it will be the first since the arrival of controversial opposition leader Hassan Mosheima returned from self imposed exile. His first speech after his return called for national unity and for protestors to increase demands for the ouster of the current prime minister of 40 years, Sheikh Khalifa al Khalifa. Eighteen members of Bahrain's largest party officially submitted their resignations from the lower house of parliament.
Finding out the Bahrain tank news was bogus and just an attempt by Iran to stir up trouble did little to slow the price of oil. News of an Iranian crackdown on protestors produced worries that increasing civil unrest could result in attacks on the Iranian oil infrastructure in order to cripple government funding. Iran produces about 3.8 million barrels per day of oil. A halt in production there could be serious but not fatal. Saudi Arabia has about 4 mbpd of the same kind of sour crude Iran exports so it would be painful but not a global disaster.
We also learned that Saudi Arabia arrested a high profile Shiite cleric, Tawfiq al-Amir, after he made a high profile sermon calling for a conversion to a constitutional monarchy. Saudi has zero tolerance for political dissent. The arrest was likely preemptive ahead of the scheduled March 11th day of rage protest. Saudi is also reeling from an open letter by 119 high profile educators, economists and business people supporting the March 11th protest. Arresting the cleric could have serious implications. Some believe the cleric publicized his planned sermon so he would be arrested and therefore further inflame tensions. Sort of a martyr in prison for the cause. If citizens were to increase protests and Saudi relented and released him then Saudi officials would appear weak and demands for change would grow. If Saudi keeps him in jail despite the growing protests then he becomes even a bigger focal point for the demonstrations. Either way it is a winning play by the protestors.
Security forces in Oman injured several protestors in a clash and caused new worries the unrest there would escalate. Oman produces just under one million barrels per day.
Of course Libya is still a sore spot and Gadhafi forces reportedly took back a couple towns on Tuesday. That suggests the battle has a long way to go and full production will not be returning any time soon.
The bottom line here is that you can't conclude two centuries of unrest and a half a century of rule by dictators in a peaceful manner. The old leaders are not going to leave quietly and the new leaders are inheriting a basket of snakes because of the various tribes and factions all wanting a place at the table.
All the MENA tensions sent oil spiking higher on short covering and worries about further production outages. U.S. WTI rose to $100.64 and Brent crude hit $116.76. Since the majority of our gasoline is made from oil indexed to Brent prices this means our gasoline prices are going sharply higher. The average U.S. price today is $3.38 but it should be over $3.50 by the weekend. At $116 Brent we could see prices in some areas hit $4 if the spike in crude holds.
Brent Crude Chart
U.S. WTI Crude Chart
Analysts on TV were blaming oil prices for the decline in the markets. While there is some correlation between oil price spikes and declines in the stock market I don't think that was the reason for the decline. The stock market and the oil market have been getting along fine until last week. Oil has been rising steadily since November and so has the market. The spike over $100 may have produced a little more economic risk but nothing immediate. It takes many months for the impact of higher oil prices to weigh on the economy.
Comparison chart - Brent & S&P
Normally when oil prices spike the price of energy shares rally. There was no rally in energy stocks today. There was serious selling. Oil over $100 but energy stocks getting hammered? Something does not compute. These companies are going to be printing money in Q1 thanks to the high prices so it is not a fundamental reason for the decline.
Energy Stock Losers
Many of those stocks listed above are the momentum stocks in the sector. Those were getting hit the hardest and that suggests a concentrated bout of profit taking. I suspect there was at least one large hedge fund that found themselves wishing they had taken profits when oil was $100 last week. However, the market sell off caught them off guard. Energy stocks were in strong rally mode on Monday and when oil prices returned to $100 today they were ready to pull the trigger.
I think the TV reporters attach too much importance to the surface events making the news and don't dig down to the real story. Of course a hedge fund sell off would be off their radar anyway.
In a news related sell off there is normally a sharp drop at the open to a plateau where the market tries to consolidate for a couple hours and decide direction. Today's selling was dramatic and constant. There was barely any letup other than a weak buy the dip bounce at 10:30 that was immediately sold. This smells exactly like a portfolio allocation move where a big fund decides to exit winning sectors at the top and roll over into sectors expected to do well in the future.
Nobody expects $100 oil to last. There is simply too much oil in storage and these MENA countries need to export oil to survive. There may be a few blips along the way but it would take a long time for excess supplies in storage to decline to a point where $100 is permanent in 2011. Next year, yes, this year no.
Even Bernanke said in testimony that $100 oil is not an economic killer because it is expected to be temporary. He said only a prolonged move over $100 would be a problem because of the impact on the consumer.
I spent a lot of time today trying to make sense of the market and oil and the bottom line is it did not make sense. I really think this was a fund liquidation/rotation event and not specifically related to the fears $100 oil will tank the economy. On the flip side, if we did see prices remain at this level or higher, there would be a drag on the economy long term. This is consistent with my Energy Recession expectations for 2012.
The fund liquidation theory fits nicely with my comments in recent weeks about funds anticipating a change in the Fed bias soon and the potential for QE2 to end early. Funds began buying the market two months before QE2 was formerly announced and I expected them to begin selling the market two months before the end of QE2 in June. When the economic reports began accelerating over the last several weeks many analysts began predicting an early end to QE2. No less than seven Fed heads talked about QE2 in some manner last week and the potential for an early termination or ending it on schedule. That much Fed press is not lost on the people who make trading decisions at the big hedge funds.
You have to look at it from their perspective. If they were planning on holding their positions for a few more weeks before lightening the load and then suddenly the economic picture changed and Fed speak is all over the news, they have to be thinking, "what do we have to gain by remaining long?" The market is at its highs and beginning to show the increased volatility of a market that could be topping. "Why should we risk our millions in profits by sticking it out until April?" Take profits now and take the risk off the table.
Once the persistent selling began the nervous traders who bought the dip from last week are suddenly rethinking their positions. When the market began diving again after lunch and sell stops getting hit it pretty much guaranteed a negative close.
Now that brings us to an interesting point. Without any attempt at short covering at the close it suggests the decline will continue. The S&P futures closed dead on 1300 and they are below that level overnight. Technically speaking a break below 1295 on the futures is a lower low and a strong sell signal. Note the absolutely vertical decline on Tuesday. That is NOT normal market activity. This is a serious sell program(s) by funds.
S&P Futures Chart
Have you looked at the calendar lately? March 6th is the two-year anniversary of the market low in 2009 at 666.79 on the S&P. Markets love anniversaries of major market events. It reminds them of how long the trend has been in play and the odds of it continuing. Is this anniversary a factor this week? Who knows but you can bet more than a few fund managers are looking at those two years of gains and making decisions about the future.
Gold made a new high today at $1435 and silver at $34.72 on inflation worries and geopolitical risk. The prices paid components of the various ISM reports are spiking sharply and that is another reason analysts are speculating about the Fed ending QE2 early. However, Bernanke gave no indications of an early end in his congressional testimony today. Like Bullard said last week, the Fed has to tell the market what it is going to do long before it makes the change. That makes the March 15th FOMC meeting even more critical.
For Wednesday there is only one thing important for traders. That is watching to see if support holds at Dow 12,000, S&P 1,295-1,300, Nasdaq 2,700 and Russell 795. These were the support levels from last week. A break of those levels is sure to trigger some major sell programs and stop losses and the drop could be dramatic. Last week's decline was written off as minor profit taking and traders bought the dip and the good economics for two days. Those gains are now gone and traders will be looking for a double bottom to appear at support so they can buy again. If that support provides a bounce then I expect an even stronger rebound because it will be a confirmation retest of the earlier support. However, if that support fails the bulls better run for cover.
Tuesday's sell off produced a lower high on the indexes and a break below last week's support would be a lower low and invite even stronger selling.
The S&P declined to uptrend support today but I am not expecting it to hold. I think we are almost guaranteed a retest of last week's lows at 1295.
The Dow declined -168 points at the close but that was more than -210 points from its opening high at 12,261. I don't see any way the Dow will not test 12,000 again on Wednesday. The decline was too dramatic and margin selling at the open is sure to pressure support. A break of 12,000 would be psychologically bearish and while it would target 11,800 I think the eventual damage could be worse than that. A break below 12,000 will have traders expecting a full -10% correction and sometime those expectations become self-fulfilling because everyone is waiting for the correction to end before they will buy again.
The Nasdaq declined to close right on the support from the 50-day average and uptrend resistance. However, there was very little bounce at the close on the big cap techs. Big losses in GOOG -12, PCLN -8, CEDC -8, ISRG -8, FFIV -4, DECK -4, AAPL -4 suggested there was more to come when there was very little short covering in the final few minutes.
The Nasdaq led the charge on Friday and today's close is below Friday's lows. This is bearish. However, as long as support at 2700-2710 holds the bulls might come back reenergized.
The Russell declined by -2% for the biggest loss other than the Dow Transports at -2.5%. Obviously the transports declined on higher oil prices. The Russell closed at 808 and well above the support at 795 from last week. In theory the accelerating economics should be especially good for the small caps. However, they are the first to be impacted by rising fuel prices.
In summary bull market selling is normally short, sharp and scary and that is exactly what we got today. Each index has decent padding between today's close and the support from last week but another day like today would obliterate that safety zone. I explained last week that we should buy the dips and remain bullish as long as those key levels of Dow 12,000, S&P 1300, Nasdaq 2700 and Russell 800 were not broken. Several were penetrated but the rebound was quick. The same is true for this week. As long as those levels are not broken the drop would be considered a successful retest of support and the rebound could be even stronger. A break below those levels turns me into a cautious bear until the market finds a bottom. We have to trade the trend until the trend changes then reevaluate. Blindly sticking to a confirmed bias will make you frustrated and broke.
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