The Dow rebounded +864 points from the 10,605 low on Tuesday and still ended the week with a -175 point loss. Volatility for the week set records with the Dow moving over 400 points on four consecutive days.
You know the market had a bad week when a +864 point Dow rebound still leaves it with a -175 point loss. However, Friday's gain of +125 points was the second consecutive daily gain and we need to celebrate those wins whenever possible. There are still plenty of sellers around and Friday's gain was more about covering shorts ahead of the weekend than buying the dip. Monday starts a whole new week and I can't wait to see what is in store.
Economics on Friday were a mixed bag with Retail Sales for July coming in at +0.5% and well above the +0.1% in June. The surprise spending increase when corporations were telling us activity had dropped and the debt debacle was in full swing is another one of those anomalies that we often see in the market. Electronics and appliance sales rose +1.4%. Autos, home furnishings, furniture, food and beverages all rose more than +0.4%. Sporting goods was a major loser with a -1.5% decline thanks to the football lockout depressing interest in fan gear.
The retail sales were an unexpected bright spot in a period that was expected to be grim. However, there was plenty of grim to go around in the Consumer Sentiment survey. The headline number for the first reading of August sentiment fell to 54.9 and a 31-year low. That headline number was an -8.8 point drop from the 63.7 in July.
The present conditions component declined -6 points from 75.8 to 69.3 the lowest since Nov 2009 but the expectations component dropped over 10 points from 56.0 to 45.7 and the lowest level since May 1980. The headline number has declined -19.4 points in just the last three months and that has only happened twice in the history of the survey, once in 1990 and once in 2005.
I warned everyone we would see a dramatic drop. The consensus as late as Thursday was for a minor decline from 63.7 to 62.5. I have no clue why they could not see the freight train headed right towards them. I guess it is true you could lock up 1,000 economists in a conference room for a week and still not get an accurate answer.
Consumers were concerned about unemployment, the debt debacle, the $14 trillion deficit soon to be $20 trillion, the downgrade of the U.S. credit rating, the falling stock market and evaporating 401Ks and probably a very few are worried about Europe. With Porter Stansberry blanketing the airwaves with his end of America in 2012 warnings I am surprised sentiment was not lower.
The three weeks surrounding the survey period contained daily press conferences by Washington politicians predicting the end of the world as we know it if the other party did not give in on the debt talks. It only takes a few gloom and doom press conferences before consumers living blissfully ignorant of the situation suddenly start wondering if they should worry. Apparently quite a few decided it was time to worry.
On the bright side these sentiment numbers should be the low for the cycle. Europe may actually be planning some steps to control their crisis. The U.S. debt debacle is going to be out of the headlines for a couple months and the market should begin to stabilize as we head into the fall and gas prices are going down. The nonfarm payroll numbers were a positive surprise and kids going back to school is always a boost to sentiment as normal routines return.
Consumer Sentiment Chart
The market dipped on the sentiment data but only briefly. Even though analysts were clearly confused and estimates off the mark I think traders were expecting the worst given the events of the last three weeks.
Historically whenever sentiment dips to levels close to this range it is normally followed by a market rally of 10% to 20% in the 3-6 months following the report low.
To further confuse you there are other studies that suggest sentiment numbers this low have been associated with a new recession in 10 of the last 12 times. Personally I believe the low sentiment was a self-inflicted wound from the debt debacle and not specifically related to the current economy. Does that mean this time does not count? We will know by year-end.
The calendar for next week begins the regional economic reports with the NY Empire Survey on Monday and Philly Fed Survey on Thursday. Hopefully they will be an improvement over July. We will also get the inflation reports in the PPI and CPI but there is no inflation in sight. The Fed confirmed that on Tuesday when they said the risk of deflation was now larger than the risk of inflation.
A big geopolitical event is the meeting by Germany's Angela Merkel and Sarkozy from France to discuss a solution to the banking problems in the EU. That meeting could be a market mover.
The earnings cycle for Q2 is really winding down with only a few reports next week. Dell, Hewlett Packard and Wal-Mart are the big reports. Wal-Mart will be a read on the health of the consumer at the low end of the income scale.
Bloomberg recently released details of an internal Wal-Mart memo showing that same store sales declined -2.6% from February to June. Wal-Mart earnings should be interesting.
With the earnings cycle nearly over the focus will shift to the regional economic reports in hopes of seeing an uptick in economic activity. Analysts are split over whether the risk of a double dip recession is priced into the market or the recent correction was simply a reaction to the possibility of a debt default and the ratings downgrade.
Personally I think it was all of the above. I do think the market has factored in slow growth from a multitude of factors plus the turmoil over the debt. Now that the debt limit is on the back burner for a couple months and out of the headlines the market is free to focus on fundamentals.
Is the bottom behind us? Nobody knows. Bottoming is a process and can take many forms. S&P 1100-1120 is decent support but despite the +80 point bounce I would not be surprised to see it tested again.
However, the number of bargains in the market is unbelievable. With the S&P trading at a PE of 11 last week and many stocks more than 20% off their highs in just three weeks there are plenty of bargains to be bought. Value funds should be tripping all over themselves given the abundance of opportunities.
S&P may have accelerated the market decline with their downgrade but the Fed countered their downgrade with a promise of exceptionally low interest rates for the next two years. Basically by pledging to keep rates artificially low for two years it forces investors to look outside the bond market for returns. With inflation at 1.5% and short term bond yields at 2% or lower the option of just parking money for a couple years is not very attractive.
Investors can buy hundreds of dividend paying stocks at truly bargain prices today and achieve a lot better return than with fixed income investments. The Fed is driving investors out of the bond market and into equities, commodities and real estate among other things.
How long it takes for investors to become comfortable moving out of those risk free bonds and into some low risk equities is of course unknown.
What we do know is the volatility is back at highs reached only six times in the last 20 years and volume has spiked to more than double normal summer levels. Option volume over the last two weeks is 73% above normal, which should make the Nasdaq and CME a couple of good stocks to play into Q3 earnings because they are raking in the money.
Friday's market action was positively boring. After a +200 point opening bounce the Dow moved sideways the rest of the day with little volatility until the close. I was checking quotes on my smartphone at lunch and the numbers would not change. I thought there was a problem in the quote system but it turned out to be just a lack of movement and low volume intraday. When I checked the volume Friday night to create the table below I was shocked to see more than nine billion shares traded. The tape had been so lackluster after lunch I was expecting something in the 5-6 billion share range for a normal summer Friday.
Market Volume Table
I think Friday's gain was due to traders closing short positions early in order to avoid the weekend risk and then leaving for the beach with less than three weeks left in the summer. After the extreme volatility for the week the tame tape on Friday was boring.
Charles Biderman of TrimTabs.com said on Thursday that insider buying had risen to the second highest level month to date since June 2008 with only March 2009 higher. Biderman said insiders had bought more than $861 million so far in August. The CEO of Titanium Metals (TIE) bought 600,000 shares for $8.2 million. The Morgan Stanley CEO bought 100,000 shares for $2.1 million and co-president Paul Taubman spent $1 million for 50,000 shares. Ben Silverman at InsiderScore.com confirmed that corporate insiders were rushing to buy shares in their companies. Corporate buybacks were also booming. One large trading desk reported corporate buybacks were up over 100% in the last two weeks. Warren Buffet said he was thrilled with the decline saying, "The lower things go the more I buy. We are in the business of buying."
Ralph Acompora came back to haunt the markets again on Friday. Ralph was known in the trading community back in turn of the century as Ralph Make-Them-Poorer because of his many bullish forecasts that failed. He became a contrarian indicator. He has 45 years experience in technical analysis and I enjoy listening to him but I would be careful following his recommendations until his track record improves.
Ralph was calling for a new market high in the near future thanks to the spike in the VIX. The VIX has hit highs over 40 six times since 1995 and a high of 34 in 1997. In all but one of those events the spike lasted only a couple days. The 2008 Lehman high lasted for five months. Removing the Lehman event from the list and in four of the remaining six VIX highs the market set a new high within four months according to Ralph.
The VIX hit a 29-month high last week at exactly 48. You have to ask yourself "is this event a short term volatility bout or one that could last for months like the Lehman crash?" I believe the high at 48 was a short-term limited duration event but there are numerous factors in play that could keep the VIX elevated for some time. That would probably be levels in the low 30s since the panic has already begun to decline.
The VIX is a panic indicator. The VIX moves higher when investors are frantically buying puts to protect their long positions. I think the panic associated with the debt debacle and credit downgrade is over. The impact of those events will be with us for a long time but the panic has ended so the VIX should decline. I seriously doubt the markets will set new highs by year-end but stranger things have happened before.
The markets accomplished something last week that has only been done once before since 1940. There were four consecutive 90% trading days. A 90% day is normally seen as a reversal day for the current trend. A 90% day is when the advancing or declining volume is 90% of the total volume. This is typically seen as a capitulation event on the downside or a blow off top on the upside. According to Lowry's Technical Service there were four consecutive 90% days last week and each one was a reversal of the day before it. This is extreme uncertainty and extreme volatility.
Floyd Norris of the New York Times pointed out that there have only been three instances of four days of 4% swings in the S&P since the Great Depression. Last week was one of those three instances.
NYT Four Percent Move Chart
Morgan Stanley believes there is more pain ahead. While a GDP of 1% is now priced into the market after the 18.8% decline in S&P from the July 7th high to the August 9th low, they are expecting further declines.
Morgan Stanley has several potential scenarios they release to their clients and they range from a year-end S&P high of 1,425 to a low of 1,004. Their latest note to clients says "While there is 18% upside to the year-end bull case and 16% downside to the year-end bear case, we assign a higher probability to our bear case than bull case, preventing us from becoming increasingly optimistic."
The general consensus of opinions appears to be focused on the next crisis. The current state of economic and political dysfunction is priced into the market but there are serious concerns over the near future.
While it appears Germany and France are going to put another band-aid on the European financial crisis there is almost 100% agreement that more country downgrades are coming. Now that the U.S. has been downgraded it only makes sense that the ratings agencies would continue to downgrade other countries in Europe with weaker prospects than the USA. That is especially true with the larger and large amounts being discussed for potential bailout funds. Those countries with better economies will be forced to pay up for their weaker brethren. The talk of a Euro Bond is growing as a way to raise money and spread the risk among all EU countries. There was talk last week that the ECB itself could be downgraded. While all of these things do not directly impact the U.S. equity markets they are a psychological impact for investors because of the overall contagion factor. Greece could go under today and nobody would notice but as the contagion spreads and threatens to impact the financial health of the entire Eurozone it becomes a psychological cloud over the global markets.
In the U.S. the economic signals are also confusing. Recent reports of Business Inventories, Productivity, ISM, Trade Deficits, etc, suggest the economy is weakening and the Q2 GDP could be revised to nearly zero. However, the retail sales continue to improve and that suggests we are not going to return to a recession. However, the consumer sentiment is at levels that normally indicate a recession. In the chart below you can see how retail sales and consumer sentiment typically move in tandem but for some reason that decades old linkage is currently broken. Sentiment fell to a 30-year low last week but retail sales are at decade highs. What is wrong with this picture?
Obviously something has to change because the current move in opposing directions can't last. Sentiment must improve or retail sales will eventually crash and it could crash hard given the current spread between the indicators.
I personally believe sentiment was severely damaged by the two months of hysteria and negativity surrounding the debt limit debacle. Add in the S&P downgrade and market crash and you have a witch's brew of negative news weighing on the collective mindset. With the political news now in a dormant state until the end of August most consumers will be focused on back to school shopping rather than politicians predicting the end of our financial system. Hopefully the correction to the chart below will be a sudden improvement in sentiment rather than a massive decline in retail sales.
When Bernanke alluded to QE2 at Jackson Hole in August of 2010 the S&P-500 was 1050 and just over the 52-week low at 1010. This year's conference at Jackson Hole will again center around Bernanke's speech on the 26th. Bill Gross had predicted Bernanke would announce QE3 or a long term cap on rates in that speech but Bernanke capped rates at the FOMC meeting last Tuesday so analysts don't know what to expect in the conference speech. Pimco's El-Erian said, "The Fed knows there is a recession risk but I am not sure the Fed can act any faster given their available tools." This puts the pressure on Bernanke to say something in his speech that suggests how the Fed will continue to stimulate the economy.
The S&P was 1050 when the last Bernanke put was implemented. A year later the S&P hit 1101 after the second Bernanke put was announced with a cap on rates until 2013. Will that 1101 level hold could depend on how he backs up the FOMC decision with his comments on the 26th.
Last week the market reached the same oversold levels as we saw in the aftermath of the Flash Crash. Some are calling last week the "Flashback Crash." Despite what you call it the fact remains the markets are seriously oversold.
I look at hundreds of stock charts every week and I have been amazed by the devastation in such a short period of time. Most stocks have been crushed with some more than others depending on their prior momentum and earnings guidance.
Ingersoll Rand Chart
These severely oversold conditions are not justified by the current economic conditions. This should prompt value funds as well as retail investors to go bargain hunting but we need the news headlines to improve before this will happen.
August and September are normally tough months for the market with October a capitulation and rebound month where funds adjust their portfolios for year-end and Q1. The current oversold conditions could advance that buying since any fund planning on liquidating unwanted positions probably did so over the last couple weeks. I reported last week that many hedge funds had cash positions as high as 50%. There is plenty of dry powder around if the buying bug begins to bite.
The S&P traded in a wide range between 1120-1175 with brief attempts to move outside those levels. In order to stimulate buying the S&P would need to move over 1205. Conversely a new move under 1120 would likely target 1050 and support from August 2010. That would mean the entire QE2 rally had been erased.
S&P-500 Chart - Daily
The Dow completely ignored support from November at 11,000 with broad swings above and below that level. However, in a calmer market we should see that level provide a base for future buying. There is really nothing we can predict from four days of more than 400-point swings other than extreme investor indecision and heavy short interest.
Friday was an indecision day of a different sort. With events unfolding in Europe on a daily basis and triple digit gap opens now the norm it appears nobody wanted to go into the weekend short. However, the markets still managed nearly double the volume of an ordinary August Friday. That suggests there was some buying in progress. Dow 11,200 emerged as temporary support. That was resistance last November.
Dow Chart - Daily
The Nasdaq actually honored support at 2400 despite the multiple dips below it. Every dip was immediately bought. That suggests another dip in a calmer market should again find willing buyers at the 2400 level.
Nasdaq Chart - Daily
For those looking for bullish signals on Friday they did not find any in the Russell 2000. Where the Dow (blue chips) rallied +1.12% and +126 points the Russell only managed a +0.23% gain and +1.6 points. That suggests fund managers have no confidence in market direction and after last week I don't blame them.
The minor Russell gain was clear indecision on the part of investors. The blue chips gained because fund can store large amounts of cash there in order to benefit from a rally but still be able to extract that cash instantly if conditions change. They will not put money into the Russell until bullish sentiment improves.
Russell Chart - 15 Min
Russell Chart - Daily
I am neutral for next week. Despite the seriously oversold conditions we would still see support tested again. The abnormally high volume suggests the worst is over and the bottom may be behind us but it will take a couple days of positive gains to rebuild investor sentiment.
I would look to buy dips to the 10,800 range on the Dow, 1120 on the S&P and 2400 on the Nasdaq. I would buy breakouts over 11,500, 1215 and 2565. I would not be looking for new shorts because of the oversold conditions. We may see further dips but I would use them as buying opportunities because of the lack of negative headlines to push us lower. The S&P downgrade is history and Merkel and Sarkozy meeting on Tuesday (Monday night U.S. time) could produce positive headlines on Tuesday morning. I feel the bad news is priced in and without further unforeseen events we may chop around at these levels but the long-term outlook is currently higher.
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"Being wrong and losing money: that is part of the game. Being right and not making money: that is really annoying."