The first three weeks of September have produced four Dow moves of 700 points or more. The opening move was a drop of -7.5%, +5.8% rebound, -5.8% drop and now a +7% rally. Dizzy yet?
The various geopolitical events have provided a very volatile start to September and next week is not likely to change. The two day Fed meeting, United Nations General Session and more volatility out of Europe are sure to drive big market moves. This could easily be a September to remember.
The only economic report of note on Friday was Consumer Sentiment. The headline number for September rose slightly to 57.8 from 55.7. This was slightly better than expected and it was due completely to a sharp jump in the present conditions component. The present conditions number rose to 74.5 from 68.7. However, the expectations component declined slightly from 47.4 to 47.0 BUT that was a 31-year low. Obviously there was a relief rebound after the debt debacle faded from the headlines but consumers are still concerned about the long term problems in Europe, the new November debt deadline in the U.S. and the mudslinging as the election cycle ramps up.
Consumer sentiment averaged 89 in the five years prior to the recession. A bounce from 55.7 to 57.8 is nearly meaningless.
Consumer Sentiment Chart
The economic calendar for next week is short but there are several high profile events. The two day Fed meeting starts on Tuesday with the post meeting announcement on Wednesday. That could be a significantly volatile event if the Fed fails to implement some new stimulus strategy. The rally last week had a lot to do with traders betting on a Fed move.
On Friday the German parliament will vote on the changes to the EFSF euro zone rescue fund. That fund was proposed at â‚¬250 billion but they are trying to raise it to â‚¬440 billion and allow the fund to buy sovereign bonds in the secondary market to boost its lending capacity. EU leaders have endorsed the changes but the various countries have to approve them before the changes can take place. Several German lawmakers have said they would vote against it so Chancellor Merkel is going to have to make deals with some opponents to get the measure passed. Should it not pass it would be VERY negative to market sentiment.
The U.N. is in session this week and there will be dignitaries in attendance from hundreds of countries. This is going to be a giant security problem for New York. This will be especially true when president Obama visits with Israeli president Netanyahu, which I believe is on Wednesday although it is not confirmed. The president will speak to the full UN on Wednesday as well. Obama will meet with the leader of the Libyan transitional council on Tuesday. The president will also meet with UK Prime Minister David Cameron and French President Sarkozy. The vote on Palestine is on Friday, also not confirmed. Just be aware the markets will be hostage to any high profile events at the U.N. where security is an issue.
Treasury Secretary Geithner met with EU policy makers in Poland on Friday and pressed them to increase the size of the EFSF in order to better handle future problems. Unfortunately his visit was seen as interfering and several members made derogatory comments to the press. Austria's Finance Minister Maria Fekter said, "I found it peculiar that even though the Americans have significantly worse fundamental data than the euro zone, that they tell us what we should do and when we make a suggestion, they say no straight away."
Another member said America should put its own house in order before telling others what to do. Jean-Claude Juncker, the chairman of the Eurogroup, said he was not prepared to discuss EU problems with someone outside the EU. He told reporters, "We are not discussing the expansion or increase of the EFSF with a non-member of the euro area." They allowed Geithner only 30 min to state his case. Geithner stressed it was extremely important to act quickly, decisively and in unison in order to prevent the uncertainty from pushing the global economy back into a recession. He warned of "catastrophic risk" to financial markets if the problem is not resolved. Unfortunately getting 17 countries to act quickly and decisively on anything is impossible.
One point coming out of Europe on Friday was the delay in payment of the next â‚¬7 billion to Greece as part of their bailout. That payment has been delayed into mid-October after the EU, IMF and ECB team left Greece unexpectedly on Sept 2nd because Greece was not cooperating with them on their review of steps underway in the austerity agreement. I suspect the continued talk of a Greek default has made them leery of throwing good money after bad. They are going to want increased assurances that Greece is moving forward on the plan before they agree to loan the money. Many analysts believe they are secretly preparing for a default while going through the bailout motions.
Greece has missed nearly every target they agreed to initially and many revised targets as well. More anti-austerity riots and demonstrations are scheduled for Greece next week. Lawmakers announced new taxes and more layoffs of government workers last week. One sticking point is those layoffs of workers. Since the austerity began they have laid off 20,000 workers but they have hired 7,000 over the same period. The agreement calls for hiring no more than one worker for every ten they layoff. This is to prevent Greece from laying off workers to comply under the agreement then hiring them right back again. Instances like this are used by the EU inspectors to prove Greece is not really serious about adhering to the loan agreement.
Greece is insolvent. It can't pay its bills and without the next installment of the bailout loan it will default. Since the loan was delayed until October that could actually force them to default. Greece can't pay its bills now and adding more debt every quarter will only make it worse. John Mauldin claims it is mathematically impossible for Greece not to default. The play in progress on the European stage is just an elaborate game of crisis avoidance while they make preparations behind the scenes for the eventual default.
I am very surprised the U.S. markets rallied on the various news points last week. The fact Merkel, Sarkozy and Papandreou had a conference call is not a market moving event in my opinion but the Dow rallied triple digits. Having five banks announce they were going to provide dollar loans because bank to bank borrowing had dried up also produced a rally when it was actually a sign of increasing stress. Five central banks don't take this kind of joint action unless there is a serious problem. The action accidentally coincided with the three year anniversary of Lehman's failure. The ECB had to give emergency loans to two banks last week but withheld the names for obvious reasons. The liquidity event in Europe is due to individuals and businesses alike pulling all their funds out of banks in France, Portugal, Ireland, Italy, Spain, etc. They see the future based on the European mentality of governments, civil employees and forced austerity and they want hard cash (dollars) under their mattress not a check book.
Friday's rally on hopes Geithner could influence EU affairs was definitely not warranted. It is really very confusing but it would appear that U.S. investors are tiring of the Europe story and want to move on to the Fed meeting and Q3 earnings.
There is another rumor in the rally. David Rosenberg, chief economist at Gluskin Sheff, claims the last five days has been a relentless short covering rally because investors are betting on Bernanke. The consensus view is a Bernanke announcement of Operation Twist where the Fed goes farther out on the curve in its monthly purchase of treasuries.
Rosenberg believes Bernanke will shake up the market with a more dramatic strategy. He points to prior Bernanke speeches where he sees the stock market as a transmission mechanism from Fed policy to the rest of the economy. If the market does well, sentiment improves and the economy improves.
He believes Operation Twist is already baked into the market with this week's rally. That means Bernanke will have to come out with a shocking announcement to have any impact or the rally is going to implode.
As a qualification it should be noted that Rosenberg is a solid bear and believes we have a 99% chance of falling back into recession. As a firm believer in a coming recession he would expect the Fed to take aggressive action. His bias may be coloring his expectations for next week.
I have to admit I am surprised by the strength in the rally when the economics were terrible. Retail sales were bad, jobless claims rose to a two month high, regional manufacturing reports are still contracting, central banks are reacting to Lehman like potential in Europe, Geithner is using terms like "catastrophic risk" and JPM/GS cut their S&P estimates for year end to 1250 when we are just under 1220 today. Where is the bullishness in all that news? I know I have been predicting a rally ahead of the Fed but I am still surprised at its strength.
In stock news it was a fairly light day. The big rumor all day was a potential acquisition by United Technology (UTX) in the range of $16 billion. Various companies were suggested as the target such as Tyco (TYC), Goodrich (GR), Rockwell Collins (COL) and Textron (TXT). Call activity in all those companies was 5-6 times average while puts on UTX were very heavy. The rumor started when it was learned UTX had lined up billions in financing for an undisclosed acquisition. Late Friday evening Bloomberg said the target was Goodrich and the price could be in the $110-$125 range. Goodrich closed Thursday at $86.50 but it had rallied to $94 intraday on Friday as the rumors surged. After the bell it spiked to $115 in afterhours trading.
United Technology is heavily into aviation with its Sikorsky Aircraft and Pratt & Whitney brands. Goodrich is the world's biggest manufacturer of landing gear, nacelles that house jet engines and de-icing systems used on planes. UTX has a market cap of $69 billion and Goodrich was valued at the close at $17 billion. Takeovers in the sector have recently garnered about 12.3 times ebitda. Goodrich had $1.4 billion in ebitda over the last 12 months. UTX normally paid about an 18% premium in the last 30 deals where prices were reported. Goodrich exited the tire and chemical businesses in 1988 to focus on aerospace and industrial products.
Goldman Sachs (GS) finally caved into investor sentiment and announced it was closing the Global Alpha hedge fund. At one time this fund had $12 billion under management. Today that has fallen to $1.6 billion thanks to the market volatility and a race to the door by investors. Global was one of the world's premier quant funds using complex computer algorithms to find trading opportunities. It was founded in 1997 by Cliff Asness, the person who developed the computer models. He left Goldman when the company refused to pay him on performance of the fund. When he left the management staff was being paid discretionary bonuses rather than indexed to performance.
The fund began losing money in 2006 at -6%, the first decline in seven years, but really took a hit in 2007 when the quant bloodbath exploded on the scene. The fund lost -7.7% in July alone in 2007. In August losses accelerated to -22.7%. The problem was the proliferation of quant funds at the time all using the same strategies. Dozens of funds were closed and dozens more locked to prevent investors from withdrawing their money. As time passed those locks expired and the money flowed back to investors. The fund is down -13% this year while similar funds have been flat to positive. Goldman announced the fund will be closed and 85% of the money will be returned to investors. The remaining 15% will be retained to cover possible legal expenses.
Goldman Sachs Chart
In related news Goldman analyst David Kostin slashed his year-end target for the S&P from 1400 to 1250. He previously cut it from 1450 to 1400 on August 5th. He said, "The unstable macro environment is likely to persist for the foreseeable future because Europe currently lacks both the institutional structure and policy tools to solve the festering debt crisis." Goldman follows Wells Fargo, Barclay's and JP Morgan in cutting S&P targets last week. I wonder if they are regretting those calls after the week's 5% gain.
Amazon (AMZN) continues to power ahead with a $12 gain on Friday to another new high at $240. Amazon's tablet is generating a lot of positive rumors and they definitely have the clout to go head to head with anyone in the tablet wars. Amazon already has its cloud service so offering cloud functions on their tablet would be a slam dunk. Store your files, contacts, etc for retrieval from any other device. Plus an Amazon tablet becomes an Amazon shopping portal, video on demand device, book reader, etc right out of the box. No word yet on when they will actually announce the product. I can hear Jeff Bezos laughing now.
Research in Motion (RIMM) ended the day down -19% as a result of their poor earnings and poorer sales. They only sold 200,000 PlayBooks for the quarter compared to more than 500,000 in the prior quarter. Apple sells 200,000 iPads every two days. The RIMM party may not be over but the punchbowl definitely needs a refill.
Despite the RIMM earnings and NetFlix warnings it has been a relatively tame mid-quarter period. There are two weeks left in the period normally reserved for earnings warnings and we have had very few despite the lethargic economy. Goldman is still predicting $102 in earnings for the S&P over the next 12 months and many analysts see as much as $110. The next two weeks will be the key. If we can get through the sporadic earnings reports and avoid any serious earnings warnings then we could see a market rebound into the Q3 earnings cycle in early October. I know that is a stretch but it is a possibility. Enormous negativity is already priced into the market despite last week's rally. If positive sentiment began to emerge we could see a significant rally. Don't hold your breath but be aware it could happen.
Earnings next week:
Tue: Carnival, Oracle
Thr: Discover, FedEx
Fri: KB Home
Ebay was upgraded by Wedbush analyst Gil Luria to outperform from neutral. He raised the price target to $48 from $35. The call was related to the strong performance of PayPal. He believes the PayPal unit will continue growing 25-30% a year for several more years and turn into Ebay's largest business by 2014 and lead to significant multiple expansion. PayPal introduced a new mobile payments component to its brick and mortar strategy and he believes that will allow PayPal to extend its lead over competitors.
What goes around, comes around. Marc Andreessen, co-author of Mosaic, co-founder of Netscape, chairman of Opsware/Loudcloud when it was acquired by Hewlett Packard, co-founder of Ning and one of the six initial members of the World Wide Hall of Fame is reportedly sniffing around Yahoo. His venture capital firm Andreessen Horowitz may be interested in buying Yahoo. If anyone knows how to fix Yahoo it would be Marc. Their firm has the money, experience and guts necessary to actually make Yahoo succeed rather than chopping it up and selling off the parts like any other VC firm would do. Yahoo's board has hired three different investment banks to try and come up with a strategic direction. They are a target in search of an acquirer. The rumor caused a decent pop in YHOO shares on Thursday but there has been no further update. If Andreessen Horowitz starts talking up a deal I would be a quick buyer of Yahoo shares. The stock has already rallied sharply since Bartz was fired.
The S&P managed to extend its gains over 1205 and close near the high for the day despite the weekend event risk. I watched in disbelief as the time expired for trading and the market did not give back its gains.
I don't think it was a strong desire to be long ahead of the Fed that created the positive close because the weekend event risk would have surely over powered that urge. It appears the shorts were more scared about holding over the weekend than were the longs. I reported on Thursday rumors of a potential shock and awe event in Europe before Monday. It was just rumors and with the disorganization evident in every meeting and press release I would be shocked and awed if the EU was able to put together something that was actually important and complete.
Maybe those rumors and the solid stream of comments out of the European meetings all week was too much risk for the shorts. It was a quadruple witching Friday and volume was strong at 9.1 billion shares but the market action was lethargic. There was an early morning pop on expiration followed by an immediate decline back to negative territory but by 11:00 the market was positive and it traded perfectly flat the rest of the day.
Regardless of why the markets rose they are now up for five consecutive days for an average gain of 5%. The Nasdaq gained over 6% and Dow +4.7%. The markets are overbought ahead of what could be the mother of all sell the news events on Wednesday when the Fed releases its statement. That suggests Monday and Tuesday could be rocky even if Europe was perfectly quiet over the weekend. If we do see some profit taking I would look at 1204 as the initial support followed by 1190.
S&P Chart - 5 Min
S&P Chart - 90 Min
S&P Chart - Weekly
The Dow touched 11,700 twice at the end of August before crashing back to 10,825 on Sept 12th. That 875 point drop has been nearly erased but 10,650-10,700 remains solid resistance. With the Dow already overbought after five consecutive days of gains that could be a challenge to move over that resistance. It would take a major news event to extend this rally without pausing to rest.
One third of the Dow components were negative on Friday. IBM was the biggest winner with a +2.90 gain that added +24 Dow points. PG and BA both gained over a dollar and the rest were only up fractionally. It was far from a bullish day.
Short term support is about 11,250 followed by 11,100. Until the Dow moves over 11,700 the bears will remain in control. We could be setting up for a short term H&S pattern with the shoulders at 11,500 and the head at 11,700. Normally H&S patterns are not relative unless they form at the top of a market. After a big decline like we had in July this is more of a bear flag until we break back above 11,700.
I prefer to concentrate on the macro view rather than purely a technical outlook and that macro view has a major storm ahead with the FOMC meeting. That cloud will color my outlook until Wednesday's close.
Dow Chart - 90 Min
It was a big cap tech week and the charts below show just how powerful the big cap rally was. The big cap Nasdaq 100 broke over the 50 day, 100 day and 200 day averages and is only 123 points below the high close for the year at 2429. Apple, Google and Amazon overcame weakness in NetFlix and RIMM and it was a convincing win for the big caps.
However the broader Nasdaq Composite posted strong gains as well. The close over 2600 was bullish and that is a new six week high. The 2600 level was resistance from March and June. The Composite never posted lower lows like the other indexes. The lows on the 26th, 6th and 12th were progressively higher. The index has not yet tested the 100/200 day averages but it was still a strong week.
Nasdaq Composite Chart - 90 Min
Nasdaq Composite Chart - Daily
Nasdaq 100 Chart - Daily
The Russell 2000 remains the laggard of the major indexes. The index is still well below critical resistance. This suggests fund managers are still not convinced the rebound is for real. When the Russell begins to outperform the big cap indexes we will know manager sentiment has turned bullish. Right now they are buying the big caps so they can participate in the rally but also be able to exit immediately if trouble appears.
Weekend event risk could shape our open on Monday but by noon the focus will turn to the Fed meeting and it will blanket every airwave and TV station. Bernanke may want to produce a shock and awe event of his own but he may be held back by the three dissenters on the committee and be forced to offer only a token stimulus program. The rising jobless claims last week plus the continued contraction in the NY and Philly Fed reports could be the deciding factor. If Europe turns worse over the weekend that could actually force the Fed to take stronger action to avoid additional contagion.
I would be very cautious about buying any rallies early in the week. There will be plenty of chances to trade in the days ahead. Buying an overbought market ahead of a major event is a recipe for disaster.
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