For whatever the reason the market fireworks last week were impressive. It may not have had the smoke and flame of a Grucci or Zambelli fireworks show but the rocket ride higher was definitely an unexpected surprise.
The S&P gained +5.6% for the week and the Nasdaq 100 +6.5%. The Dow raced higher to gain +645 points. The indexes posted their biggest weekly gain since the week ended July 9th 2010. The S&P is now up +6.5% for the year and 5.6% of that came last week. To say it was a good week would be an understatement.
So what caused this weeklong rocket ride? Some people blame Greece but there was more than one reason for the sudden gains. Greece was a definite positive as the conversations turned from imminent default the prior Friday to votes passing and the default threat evaporating. This will only be a temporary pause on Greece but enough to get traders focused on other factors. Greece will be back in the news next week as the EU/IMF begin discussing the next bailout of something between 85-110 billion euros that will need to be enacted before the end of August to avoid the next default conversation. This second package is supposed to support Greece through 2015 assuming they achieve certain austerity targets along the way.
The optimism over the Greek vote caused shorts to lose interest in adding to positions but they were still excessively short. After two months of market declines the markets were very oversold. However, the S&P tested the 200-day average twice and rebounded both times. This gave the dip buyers some confidence but they were content to wait for confirmation.
The end of quarter window dressers saw the Greek vote passing and they started to add to positions early in the week. This helped stimulate the shorts to cover and provided added confidence to the dip buyers.
This quickly became a decent rebound but it had not yet caught fire. The message boards were full of traders bragging about selling the bounce. Bullish sentiment was still absent.
What really kicked the markets into high gear was the sudden appearance of improved financial data across the board. Beginning on Tuesday the Richmond Fed Manufacturing Survey rebounded back into positive territory after a 31-point drop over the prior four months. Improvement in one report may not be earth shaking but suddenly the potential double dip is looking more like a soft patch in the rear view mirror. On Wednesday the pending Home Sales report showed a spike of more than six million homes (annualized) under contract. OK, the bears acknowledged the improvement but claimed it was seasonal and they are right but it was still a second plus for the bulls.
On Thursday the ISM Chicago (PMI) unexpectedly rebounded from the cycle low in May when the consensus estimates were for a continued decline. On the same day the Kansas Fed Manufacturing Survey rocketed out of near negative territory to erase a -13 point drop the prior month. Suddenly good news is breaking out all over and the short premise of a potential economic double dip was evaporating before the bears eyes.
Friday's national ISM Manufacturing report rose to 55.3 from 53.5 when the consensus was for a drop to something in the high 51, low 52 range. That 55.3 may be well below the 61.0 average since the high in February but it is definitely headed in the right direction.
Suddenly Positive Economics (Green = cycle highs, orange = lows)
Now the shorts have a real problem but so do the bulls. The market is running away from everyone because nobody expected this kind of rebound for any reason. The window dressers may have kicked it off with a few buys to try and get fully invested by quarter end but as the week went on and they still had money left, suddenly they were in a race to get it invested. The balanced funds were holding 10% more in bonds than they should be holding thanks to the bond rally and stock decline for the last two months. They were also selling bonds and putting money into equities to try and bring their ratios back into balance for quarter end.
With the shorts getting squeezed, window dressers in a panic to be fully invested in what was suddenly turning into a bull market and the funds trying to manage their asset allocations it was rapidly turning into a feeding frenzy.
While all this is happening the bulls that had been patiently waiting on the sidelines for some confirmation the selling was over so they could buy something suddenly realized the market was running away from them and they began chasing stocks. We all know the feeling. Your waiting for XYZ stock at $49 to move over resistance at $50 as a buy signal. Something happens and the market gaps open and XYZ gaps up to $53. Crap, I really wanted to buy it at just over $50. I will buy it when it drops back tomorrow. More news, gap open market and XYZ is now $55. More frustration for you because you are convinced it is going to $75 by year end but you don't want to buy it at this "short term over bought level" after a +10% gain in two days. When it opens higher the third day and shows no signs of retreat you throw caution to the wind and start placing orders on XYZ and several other stocks with the same trend. If you are like me you are probably placing limit orders just under the bid to buy it on a dip. The price keeps rising along with your orders and by Friday you and a million other closet bulls are throwing money at stocks because the trend has changed and you have to be long.
That is how the markets rally +6% in just a week. Retail traders are not the only people making those trades. Hedgefund managers and managed funds are doing the same thing. They did not expect a rally that strong either. When it began I am sure they looked at is skeptically but as the week progressed they went into crisis mode. Manager bonuses are paid on performance. They can't afford to sit on the sidelines with a high cash position because they think the market is going lower. If they miss a 5% move higher that could make the difference between getting a good bonus and getting fired. They have to chase moves. They can't afford to let other funds catch the wave while they are waiting on the beach.
Dozens of factors combined into the perfect storm for the bears and the result as they say is history. The soft patch may also be history. With the sudden turn in economics coupled with the surging stock market the sentiment in the business sector should improve significantly. Gasoline prices are lower and weekly same store sales were up +2.9% last week. There are so many green shoots suddenly cropping up we may have to mow soon.
Obviously I exaggerated somewhat in the prior paragraphs but you get the idea. Economics are improving and the Greek debt default is off the table for a couple months. It was an outstanding week in the markets BUT it was just a week. It does not make a trend. Volume was barely 6.0 billion shares on Friday BUT for a summer holiday Friday that is actually good.
The main motivation for Friday was of course the manufacturing ISM. Expectations were for a decline to 52.0 from 53.5 but it rebounded to 55.3. This was the first gain since February. There were quite a few concerns it could have fallen all the way to 50.0 and the borderline between contraction and expansion. The gain suggests the economy is retaining some momentum heading into Q3 and the soft patch caused by the supply chain breakage is behind us.
Manufacturing ISM Chart
Further good news came from the auto sector. Vehicle sales for June were still weighed down by parts shortages from Japan but it mostly impacted Japanese automakers. Chrysler led in sales with a +30.1% increase followed by Ford at +13.6% and GM at +10.5%. Honda's sales declined by -24% and Toyota -21.1%, both due to inventory shortages. Morgan Stanley expects auto sales in July to grow by +24% as the supply shortages are quickly erased.
We are still several weeks away from the first look at GDP for Q2 but estimates are flying fast. The consensus is holding in the +2% range although the inventory growth over the last several weeks has some analysts wondering if GDP could be a little higher. Once past Q2 Morgan Stanley is predicting a serious acceleration to +3.9% in Q3 and +4.0% in Q4.
The economic calendar next week is dominated by the payroll reports. The Non-Farm Payrolls on Friday have estimates from 25,000 to 125,000 new jobs for June. I have not heard anyone expecting job losses even though the weekly jobless claims have remained well over 420,000. The jobs report could be the one thing that puts a severe dent in sentiment if we get an unexpectedly low number. Conversely an unexpected high number could provide even more conviction the soft patch has passed.
The ADP report on Thursday is seen as the proxy for the Non-Farm payrolls even though the numbers rarely agree. That makes the Thursday morning report a market mover. Given the size of the rally last week I would not be surprised to see some profit taking ahead of the payroll numbers.
The ISM Services report on Wednesday is the bookend twin to the manufacturing report on Friday. The services report is expected to be flat but I am cautiously optimistic we could see a surprise there as well.
Another factor weighing on the markets late next week is the onset of Q2 earnings the following week. . For the entire S&P the Q2 earnings are now expected to show growth of 14.1%. Analysts are not united on their estimates and there is some worry that guidance could be weak. So far 65 companies have given negative guidance and 35 have upgraded guidance.
Secondly the debt ceiling argument will accelerate with the administration warning lawmakers they have to have an agreement signed by July 22nd to avoid a debt default on August 2nd. While nobody actually expects a debt default we can expect some last minute brinksmanship on both sides as they try to blame the other side for driving the car into the ditch. This brinksmanship could unsettle the markets but once a deal is announced I believe it will produce a rally assuming the compromises are something investors can live with.
In stock news web hosting company Go Daddy Group agreed to be bought by a consortium led by KKY and Silver Lake for $2.25 billion. Allowing themselves to be bought by some deep-pocketed investors will allow Go Daddy to expand through acquisitions and broaden its international presence according to founder Bob Parsons. Go Daddy is the world's largest domain registrar with 9.3 million customers and more than 48 million domain names. They have 3,000 employees with 500 dedicated to product development. Go Daddy filed to go public in 2006 but eventually pulled its registration statement due to unfavorable market conditions.
A consortium of buyers prevailed over Google in the bidding war over the 6,000 patents held by bankrupt Nortel Networks. The consortium included Apple, Research in Motion, Microsoft, EMC Corp, LM Ericsson and Sony. The group bid $4.5 billion and five times the $900 million opening bid by Google. The patents were derived from more than $40 billion in investments over the years by Nortel and through companies Nortel acquired. The companies bought those patents to protect themselves from patent litigation from others on their existing and future products. If somebody sues you for some obscure patent on your smart phone and you have a portfolio of 6,000 of your own patents there is a good possibility you can find something in your portfolio that they have not licensed for their equipment. Owning these patents is like putting your office in a bomb shelter. All the small arms fire is deflected and only a direct hit by a major patent attack is likely to get through.
Analysts wonder if Google was really bidding to win or just to pass time. Some of their bids were not based on the patents but were known numbers in the scientific and mathematical world. For instance for one bid they offered $1,902,160,540 or Brun's constant. Another bid of $2,614,972,128 was Meissel-Mertens constant. Once the bidding moved over $3 billion they bid "Pi" or $3.14159 billion. Intel had opened the final bidding round last week at $1.5 billion after Google's stalking horse bid of $900 billion in the bankruptcy court. After bidding became too steep for Intel alone they joined Google in forming vehicle called "Ranger" to continue bidding. The bid increment was $100 million and bidding was frantic until it moved over $4 billion and the consortium headed by Apple named "Rockstar" finally won the deal. Google called the results "disappointing." The company has $37 billion in cash. Maybe if they had been more focused in actually winning instead of playing number games they would have found Ranger's pain threshold and won. Of course the Rockstar group also had a monster cash hoard of something in the $100 billion range so it was not like Google was going to bluff their way through.
Google was named as one of the suitors for Hulu. The bidding between 10-12 prospective purchasers has begun and Google and Microsoft are rumored to be at the top of the list. Morgan Stanley is running the sale and expects to get $2 billion for the company, which is owned by Disney, Comcast and News Corp. Hulu has more than a million customers at $7.99 per month. This compares to 23 million for NetFlix with a value of $14 billion. Hulu will have $45 million in profits for 2011.
Google said it hired 12 lobbying firms to assist it in defending itself against an FTC review of its business practices. I could see hiring several legal firms to assist but 12 lobbying firms?
Zynga, the online game maker behind FarmVille, CityVille and Texas HoldEm Poker finally filed to go public. The company hopes to raise $1 billion in an IPO later this year. The company is expected to be valued at $20 billion and they are planning on doing a sliver offering much like Linkedin. That means they will offer very few shares in an effort to pump up the price. More than 230 million people play Zynga games online every month. This compares to only 105 million users on Linkedin. One of the cautions in the IPO was the dependence on Facebook. The company said a collapse of the co-dependent relationship with Facebook could cause a severe decline in the number of people playing its games. Zynga earned $90.6 million in 2010. Not bad for a company that started in 2007.
Some claim there is a major bubble in Internet IPOs but not all companies are feeling the love. For instance News Corp sold MySpace on Wednesday for $35 million. News Corp paid $580 million for it in 2005. Justin Timberlake announced on Saturday he is a partner in the effort to renovate MySpace.com.
Apple found a supporter in Ben Reitzes at Barclay's Capital. The analyst but a buy on Apple shares with a $465 price target. He said 2011 feels like 2006 when Apple shares were held back by the switch over to Intel chips from the Apple Power PC processors used at the time. He feels investors are worried that today's shift over to Qualcomm processors for the iPhone and the potential lag time to get to a 4G offering is holding the price back. He cut back his expectations for sales from 70 million iPhone units to 67.7 million for 2011. However, he raised his iPad estimate to 7 million units for Q2 from a prior 6.5 million. He said fewer investors were asking about Steve Jobs health now and were apparently comfortable with COO Tim Cook. They appear to be resigned that Steve's health is deteriorating but no longer a major factor.
BMO Capital said Apple will only produce one version of the iPhone 5 this fall and it would be a fully featured 4G model. The iPhone 3Gs could go to zero with a contract and the iPhone 4 could drop to $99. The iPhone 5 will be released about one week after you finally give up waiting and buy an iPhone 4. The iPad 3 is also expected to be available this fall.
Amazon continues to be the stealth story of the Internet. The news of their demise has been exaggerated dozens of times. The story last week was news Amazon is buying up web advertising inventory and then using what they know about their customers to serve them advertising they are more likely to read. If you bought camera equipment on Amazon then you would be more likely to read a camera ad while surfing AnyWebsite.com. While the privacy question of Amazon using your purchase habits against you by serving ads elsewhere has yet to be determined it appears they are stealthily putting the plan in progress.
Amazon announced that Triggit had been selected by Amazon to create real time bidding and advertising software that will enable Amazon to display the right ads to the right users across nine ad exchanges and more than four million websites. Basically Amazon is going to buy up generic web advertising slots on the cheap and then resell that advertising for more money because their ad targeting software will result in more product sales. Amazon software will follow you from site to site and continue to serve you ads for products you might buy. Never assume Amazon only sells books.
Crude prices declined slightly on Friday after China said its Purchasing managers Index for June declined to 50.9 from 52.0 in May. The index has been over 50 and in expansion territory for 26 consecutive months but inflation curbs are taking their toll. Analysts expect a fifth interest rate hike soon to counter surging inflation that is expected to have reached 6% in June. Slower manufacturing means lower oil demand but the decline will not be material since consumer demand is surging. WTI crude closed at $94.75 with a gain of +4% for the week.
U.S. WTI Crude Futures Chart
Brent Crude Chart
Gasoline prices nationwide are 24-cents cheaper than they were on Memorial Day. That is a $5 savings on every tank of gas you use heading out for your Fourth of July picnic and fireworks show. Despite the decline in prices AAA expects 1.1 million fewer families will drive this weekend than in 2010. Prices are still 79-cents more expensive than last Independence Day. Now you are talking $16 a tank more and that is enough to keep people at home.
The energy sector rebounded strongly last week with a +7.1% gain despite a lukewarm rebound in oil prices. The sector had been under pressure since the May 2nd crash in oil prices began. However, with investors looking for something to buy that was not already overbought the energy sector provided a perfect opportunity. Fundamentals in oil stocks have never been stronger.
Since the start of the second quarter the aggregate earnings estimates have risen +0.9% but the energy sector earnings estimates have increased +13.9% according to FactSet Research.
In retrospect it was an amazing week in the markets with a +6% move in the indexes. It was not because traders were smoking "hopium" but just a confluence of events that culminated in the perfect storm for the bears. We erased two months of declines in five days.
Ordinarily this is where I would say I doubt it will last and look for a pullback next week. Markets don't go up 6% in one week and not correct. Unfortunately they can and do make moves like that and sometimes they keep right on going. I admit it is rare but the same perfect storm that caused the rally may have been strong enough to snap traders out of their summer doldrums slumber. If investors suddenly start to believe the economy is really improving we could be off to the races.
One thing we should remember is that the gains were made possible by a monster short squeeze. When the market sentiment is so bearish the squeeze can go on for days longer than anyone expects. Another thing to remember is the market can stay irrational far longer than we can stay solvent if we are betting against it.
I once saw a roulette table in Mesquite Nevada hit red 21 times in a row. People were lined up four deep and throwing money on black in increasing amounts after every spin. With 18 red numbers, 18 black and 2 green the odds of a black number coming up after 6,10,12 or even 15 consecutive reds would seem to the casual bettor as almost 100%. Unfortunately for those bad in math the odds are exactly the same on every spin. 47.4% black, 47.4% red and 5.2% green. The roulette wheel has no memory.
The odds of a pause/decline next week are as close to 100% as you can get because traders do have a memory. They should be hesitant to go long simply because of the big gains. Those currently long should be tightening stops and looking to take profits. Those would be the logical moves. However, we know from experience that logic rarely applies to the stock market.
We are close enough to the May highs they could become price magnets. Funds will be putting quarter end retirement cash to work all week. If the volume of that cash is sufficient to overcome the weak holders who rode the market up then more short covering could occur.
We will know the real market once a decent dip appears. It won't have to be much. With the S&P at 1339 a dip back to 1320 would be enough to give reluctant buyer a chance and enough to suck the bears back into new shorts. If we can set a new relative high after the next dip then sentiment has changed to bullish. If we dip and then set a lower high the odds are good we will see a continued move lower. Historically the second week of July is weaker than the first.
If I were looking at the chart of the S&P without any news context to color my thought process I would be looking for a decent pullback to buy. The next material resistance is 1350 and that is just one day away if the current pace was maintained. That is where the internals will get really interesting once again. There were 322 new highs on Friday and advancing volume was 6:1 over declining volume. If those numbers went back to normal at 1350 I would bet on a resistance failure.
S&P Chart - Daily
The Dow rarely gains more than 600 points in a single week. That does not mean there are not big rallies that seem to go on far past a reasonable gain. You may remember the rebound from the March lows at 11,600. The Dow rallied to 12,450 in 14 trading days for a gain of +850 points. There were four negative days but none more than a couple dozen points.
On April 19th the Dow opened at 12,200 and ran for eight days to 12,810 for a 610-point gain with only one down day of -26 points. There was another 600-point gain that started on January 31st through February 18th with only three down days.
Last week was the fourth 600+ point gain this year. Lightning can strike more than once in the same place. The key here is what happens when the move finally ends. Each one ends in a significant bout of profit taking once the rocket fuel runs dry.
Dow Chart - Daily
The Dow is just over 200 points away from closing at a new three year high. That is an incredible aphrodisiac for investors. After two months of painful declines to be so close to those new highs once again could cause investors to lose track of reality and start sucking on that hopium again. I hope we go on to new highs but I am definitely not betting on it.
The closest resistance is 12,600 but it should be light and no real hindrance if real buyers emerge. That resistance at 12,800 should be stout. Support should be back at 12,400.
Dow Chart - Daily
The Nasdaq finally pushed through 2800 but is now fully extended with strong resistance just ahead at 2830. Apple and Google finally contributed on the same day with +22 points between them. Unfortunately Apple is at strong resistance and Google has added nearly $50 in five days. Both are due for a rest.
The Semiconductor Index broke over its 200-day average and despite the weak PC outlook it appears investors are speculating in chips once again. Given the prior sentiment this is probably just short covering.
Like the other indexes the Nasdaq is very extended with strong resistance just overhead. I would be very surprised to see it continue higher.
The Russell is only 15 points from its prior historic high in 2007 of 855 and only 25 points from its current closing high at 865. Like the other indexes it is definitely over extended and could easily pull back to the 100-day at 820 to rest.
The most bullish index is the Dow Transports, which closed at a new historic high on Friday at 5548. This is a bullish signal and suggests investors are becoming more positive about future economic expectations. A continued move higher by the transports would pull the other indexes higher.
Dow Transports Chart - Monthly
To recap it was a great week for anyone already long. Greece is off the headlines for the next couple of weeks before coming back to the forefront for their next 100 billion Euro bailout.
The economic double dip recession worries appear to be behind us. It appears to have been just a soft patch caused by Japan's supply chain breakage. That supply chain has healed and we are headed back to prior production levels.
The July 22nd debt-ceiling deadline should not be a big deal for the market next week but the week of the 11th the debate should begin hogging all the headlines until something is resolved. The political banter in press will be bruising to consumer sentiment because the average consumer can't separate fact from fiction when the opposing parties start spouting bullet points in rapid-fire sound bite mode.
Oil prices are down but not out. Nothing has changed in the fundamentals but temporary declines in gasoline prices are positive for the economy.
Going into last week the shorts were seriously overloaded. They were rewarded with an involuntary rocket ride higher. After a week of pain I doubt many went into the weekend short. Most likely covered and crawled home to lick their wounds while they prepare the weekend barbecue. The lack of shorts over the weekend means a potential lack of motive power on Tuesday. Europe and Asia should rally based on our Friday market unless weekend news distracts them.
Last week's rally was all reaction, no conviction. Five days don't make a trend. Expect a bump in the road and observe the market reaction to that bump to determine if the trend has changed. We got the quarter end window dressing I was expecting and a whole lot more. Traders will be confused until some semblance of normal returns.
The Non-Farm Payrolls will be the next challenge. A decent number over 75,000 should be market positive while a number under 50,000 could be market negative.
At the risk of seeing the market run even farther away from us I would probably not be going long on Tuesday. Call me old-fashioned but I need a dip to buy and I would be skeptical of a one-day wonder.
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