The S&P traded over key resistance most of the day but gave up ground at the close after the Fed minutes showed a divided FOMC and the possibility of rate hikes in 2011.
The market appeared confused after the ISM Services report for March came in lower than expected and the FOMC minutes showed a divided Fed on future policy changes. The indexes rallied on the TXN/NSM deal news at the open but then went dormant while traders waited for the FOMC minutes. After the minutes were published and the news disseminated traders appeared to lose interest.
Leading the economics today was the March ISM Nonmanufacturing Index commonly referred to as the ISM Services report. The index fell for the first time in seven months. The march reading was 57.3 and lower than the 59.0 reading in February. Anything over 50 is still considered to show an expanding economy. Analysts believe the rise in fuel prices and the earthquake in Japan were the cause of the slowing. New orders were flat at 64.1 but overall business activity declined from 66.9 to 59.7.
Analysts pointed out the trend had been accelerating higher at a rapid pace since August's 52.8 and we were due for a pause. Despite the slightly lower headline readings the order backlog rose by +4 points to 56.0 and a ten-month high. That was double the normal increase for March. Inventory sentiment jumped by +9.5 points to 67 and the highest since June 2009. Sixteen industries reported growth for the month and matched the high for this recovery cycle set last May. Only 13 industries reported growth in Jan/Feb.
ISM Nonmanufacturing chart
The big economic event for the day was the release of the March FOMC minutes at 2:PM. The minutes still showed a Fed consensus that the economy would continue to strengthen in the months ahead. They expressed concern that Q1 growth was weaker than expected but were glad the labor market was improving. They expect that trend to continue and accelerate as the economy gains more traction.
Despite the Japanese disaster and the political instability in the Middle East and North Africa they felt the impact to the U.S. would be minimal. However, the Japan earthquake was only four days old when the meeting was held and the severity of the damage was still unknown.
The fly in the soup was the discussion on continuing QE2 until its conclusion. Some members of the committee thought it should be terminated early or reduced in scope while others favored continuing it to the announced conclusion in June. Those in favor pointed out the uncertainty over the events overseas, the considerable slack in the labor market and the weaker than expected Q1 growth. Overall participants believed the risks to the economy were roughly balanced.
The inflation discussion was apparently heated although we can't tell that directly from the minutes. Some participants felt rising costs were filtering through the system and would be soon be passed on to consumers. Others believed the impact from rising energy would be transitory and moderate once the crisis in Libya had ended. They pointed out that even large increases in commodity costs had produced little long-term impact on consumer prices in the past. Productivity has been increasing significantly and allowed manufacturers to absorb some of the commodity costs.
Several members believed the "expectations of inflation" could cause the public to doubt the Fed's ability to adequately handle a sudden rise in prices. The Fed is trying to manage those expectations but the constant stream of Fed presidents speaking negatively about QE2 is not helping.
The division among participants was extremely evident in this one sentence. "A few participants indicated that economic conditions might warrant a move toward less-accommodative monetary policy this year; a few others noted that exceptional policy accommodation could be appropriate beyond 2011." Some feel rates should be hiked in some form in 2011 while others believe continued record low rates are warranted for an extended period past 2011.
The good news for the market is that everyone choked down their differences and voted for no change in the Fed policy. How much longer that will last is obviously the big question. The next meeting is April 26th and they will have the benefit of another six weeks of data from Japan, the resolution of some of the Middle East unrest and more history to review on current oil price trends. They will also be well into the Q1 earnings cycle and Intel and IBM will have reported earnings and given guidance for the rest of 2011. It should be interesting.
With unemployment still hovering around 9% the Fed can't afford to raise rates and that is going to be a long-term problem. QE2 may end on schedule but that is a long way from any bias change by the Fed.
Kevin Reinhart, former senior Fed official, said all the competing comments by Fed speakers was all hype and the Fed's way of managing inflation expectations by keeping analysts confused.
The calendar for the rest of the week is lacking in material events other than speeches by two Fed presidents. Lockhart spoke on Monday and said the U.S. was facing some economic headwinds and predicted only moderate inflation as a result of commodity prices. However, in Lacker's latest speech the suggested the Fed will have to raise rates in 2011 so traders will be watching his speech for further hawkish comments on Thursday.
Overnight we learned that Texas Instruments (TXN) was buying National Semi (NSM) for $6.5 billion and a 78% premium to Monday's close. Some analysts liked the deal and others didn't. Some believed the large sales team at TXN could quickly expand sales for NSM products. Those opposed claimed NSM sales had been declining for four years and there was better places for TXN to spend their money. Obviously TI thought this was an opportunity rather than a detraction. NSM gained +71% and TXN gained +2%.
National Semi Chart
Retailer Abercrombie & Fitch (ANF) told Wall Street analysts in a conference it expects earnings of $4.75 per share for the next fiscal year compared to analyst forecasts of $3.97 per share. ANF was very bullish about future sales gains and product cycles. The chain will open ten more stores this year and another ten in 2012. Same store sales rose +13% in Q4. ANF shares rose +11% on the news.
KB Home (KBH) reported a larger than expected loss of $1.49 compared to 71-cents in the year ago quarter. Analysts were expecting a loss of only 30 cents. The company said it did not expect to post a profit in 2011. Orders for the quarter dropped -32% to 1,302 home. Deliveries of new homes fell -28% to 949. KBH said the comparisons were fighting a period when there was a homebuyer tax credit in 2010.
The Nasdaq announced overnight it was rebalancing the Nasdaq-100 to better represent the changes in market caps over the last decade. Apple will be cut from 20.49% of the index to 12.33%. 18 companies will see their weighting rise while 82 companies will see their weightings cut. The change will occur on May 2nd. This is going to weigh on the Nasdaq as funds with more than $340 billion indexed to the Nasdaq 100 and $40 billion in exchange traded funds like the QQQ shift their portfolio allocations.
Hypothetically if a fund had $10 billion in the Nasdaq-100 that would mean $20.49 billion in Apple alone. On or before May 2nd they would need to reduce that holding to $12.33 billion. The $8.16 billion difference would need to be added to the 18 stocks that saw their weightings raised. Multiply that over the 82 stocks with lowered weightings and you can see why the Nasdaq could be under pressure towards month end. That does not men the selling will happen this week. Index funds normally transact these changes as close to the rebalance date as possible but speculators will be trying to game the change and front run the funds. Nasdaq expects 9.5 million shares to change hands for every $1 billion indexed to the Nasdaq-100.
Significant Weighting Changes
Most of the Nasdaq-100 stocks will report earnings before the switch so funds can hold their positions until after earnings and possibly capitalize on earnings volatility to swap positions. Apple is the biggest change in the index and using the $380 billion in indexed funds I quoted earlier that would mean nearly $78 billion in Apple shares will be affected. Apple has a market cap of $340 billion. The current $78 billion investment by funds in Apple shares would be reduced to $46 billion and a drop of nearly $32 billion. So basically 10% of Apple's shares would be sold. Add in the falling share price because of the expectational selling and Apple could have a rocky month.
Another problem for Apple is the growing rumors of a delay in the4 iPhone 5 from the traditional June launch to sometime in the September timeframe. Analysts believe Apple will try to upgrade the iPhone 5 to a 4G model and possibly add a streaming music service. There is also the problem of kinks in the supply chain due to the earthquake in Japan.
Despite the flurry of news today Apple shares held up relatively well with only a minor drop of $2. This was the fifth consecutive day of losses for Apple. That is only the third time this has happened in the last year.
Google (GOOG) had a bad day. The U.S. FTC is considering a broad antitrust investigation into Google's dominance of the Internet search industry. Reportedly the FTC is waiting to see if the Justice Detp will challenge Google's planned acquisition of ITA Software as a threat to competition in the travel information search business. Analysts believe a Google investigation could be equal to the landmark case against Microsoft in the 1990s. They believe Google could fight the FTC but it would be a very long and very expensive proposition.
FTC commissioner Thomas Roach said last month he supported a probe of the "dominant players" in the search industry but failed to give any names. Obviously there is only one dominant entity in search today despite the rising popularity of Bing. A Google spokesman said there was no antitrust concerns because anyone that did not like Google could instantly switch to another search engine. Officials in Texas and the EU have already launched probes of Google. The EU probe could be especially costly because it is expected to expand into online video and mobile phone concerns.
Google has dozens of product offerings, especially in the advertising area on the web and on mobile phones, where there have already been complaints of antitrust behavior. Any formal probe is likely to quickly expand to touch all the bases. Google shares lost -$18 today to $569 and support at $550 could easily be in danger.
Gold hit a new high at $1455 on global inflation concerns after China raised rates by another 25 basis points. Silver hit a new 31-year high at $39.33 on the same concerns. Silver is up more than $5 since mid March. Expectations are for a continued gain in both metals until the Fed quits printing money with QE2. Once it appears rates are going to rise the dollar will strengthen and metals will weaken.
Crude prices in the U.S. continue to hold at the $108 level and Brent is now well over $120. These prices are supported by the production halts in Libya and the "what if" factor surrounding various other Middle Eastern and North African countries. Syria, Algeria and others could still see an escalation of tensions that could lead to production declines.
Gasoline prices rose to $3.69 nationwide and the EIA report on Wednesday is expected to show demand has fallen -3.6% over the same period in 2010. As demand is destroyed by high prices the amount of oil needed by refiners will also decline.
Fadel Gheit, a long time energy analyst at Oppenheimer, projected the Middle East will get worse before it gets better and oil prices could rise another 10% to 15% when it does.
Personally I believe these concerns are already priced into the market and we will not see WTI move over $110 without some significant news. Inventories in the U.S. are literally bulging and there is little storage space left to hold additional oil. A tanker arrived at a Libyan port on Tuesday to load oil under control of the rebels. Qatar is going to sell the oil for them and supply food, emergency supplies and fuel in return. This could be the first of many but the volumes of oil available to the rebels is relatively small. Still, it is a start. I am lightening positions in energy this week in expectations for a decline. If I am wrong I will probably miss a couple dollars of extra profit but at least I will capture the profits from the last three months. You never go broke taking a profit.
U.S. Crude Chart
Brent Crude Chart
Trading volume in March was the lowest since December 1999 and we saw some significant volatility in March that actually spiked volume levels. Volume on Monday was only 5.7 billion shares and the second slowest day in 2011. Volume today was 6.8 billion shares and a little better but still not good. There is still no conviction in the market even on the side of the buyers. The buyers appear to be afraid the rally will fail at the current resistance highs and they could be right. Those fighting the recent trend higher are afraid of another painful short squeeze. I had a couple emails recently asking me not to call them bears so in the future I will refer to them as those fighting the market. Eventually they will find out it is much more profitable to trade the trend rather than fight it.
For three days now the S&P has traded over resistance at 1333 but failed to hold the gains at the close. This is the 100% rebound level from the March 2009 lows at 666. There seems to be nothing in the news to provide a reason to move higher and without any conviction the few buyers in the market are losing traction.
I am actually pleasantly surprised that we did not see any material window undressing. So far fund managers seem content to hold their quarter end positions as we wait for earnings to begin next week. Maybe we are seeing a situation where potential buyers were waiting for a post quarter end dip to buy and that dip has not yet materialized.
If you look at the chart since the March 16th low there have been several intraday declines that were strongly bought. Buyers could be simply waiting for another dip to buy.
The S&P closed at 1332 and oh so close to the 1333.78 resistance. Given the gains of the last three weeks the lack of profit taking is a bullish indicator in itself. Once we move and close over this critical resistance we could see a quick move to new highs on short covering. If you look at the S&P closes for the last three days you will see a market where buyers and sellers are very evenly matched. The closes starting with Friday were 1332.41, 1332.87 and 1332.63. Do you ever remember the S&P closing within a 0.46 point range for three consecutive days? I would say the spring is being compressed and we are likely to see a major move in the next couple days.
The Dow is stuck at resistance again at 12391 after a new high close at 12400 on Monday. Personally, I believe the lack of a material decline after that 12400 close is somewhat bullish. There are multiple converging lines of resistance at this level and while the Dow is honoring that resistance there is no indications it is weakening. Only two Dow stocks gained or lost more than $1 and that was CAT -$1.07 and CVX +1.10. Definitely no sellers.
The Nasdaq Composite once again failed at 2800. This level is turning into strong resistance despite trading over that level intraday on two of the last three days. Sellers are definitely sitting on this level and with the Nasdaq 100 rebalance now in the news it could be tough to cross. Even though the rebalance is not until May 2nd (April 29th is the last day under the current weightings) there will be a cloud over the tech sector. There will be traders taking short positions on every stock with a reduced weighting in hopes of catching a downdraft as the month closes. I was already concerned about the strength in the tech stocks and that concern has increased.
The Russell 2000 is showing no signs of weakness. The index set a new historic high intraday at 858.05 before pulling back slightly at the close. I would anticipate some difficulty in closing over that level and given the gains over the last week it is definitely over extended at least temporarily. However, it does suggest fund managers are NOT worried about future market weakness.
On Sunday I cautioned about buying a dip this week and I expressed concerns about possible window undressing by funds. The funds do not appear to be selling their end of quarter positions despite the indexes at new highs or strong resistance. This is bullish. However, while I am not cured of my worries over a potential short term sell cycle I am back in buy the dip mode thanks to a lack of selling by funds and the strength in the Russell. If it were not for the rebalancing cloud over the Nasdaq I would feel a lot better. Hopefully anticipation over the coming earnings cycle will over power those trying to setup shorts ahead of rebalance.
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