Talking about approaching historic highs is the best way to jinx them. Market reporters were doing their best on Friday to do just that.
I have not read or heard so many comments about a new historic high since the first Dow 10,000 effort. You would think by talking about it they believe they can make it happen. In some cases that is true. The often repeated target eventually becomes an assumed event way before its time. Once the target has been hit the resulting profit taking can be ugly.
Personally I think it is far too early to be talking about new historic highs. That would be 1565 for the S&P and 14,164 on the Dow on a closing basis. That was achieved on Oct 9th, 2007. The S&P would have to gain +161 points and the Dow more than +900 points to close at a new high. I think we are better off worrying today about holding our gains through the Q1 earnings cycle than maybe hitting new highs.
Before we get to earnings let me cover the economic new first. The Consumer Price Index for February came in at +0.4% on the headline number and the largest rise in prices since April 2011. Nearly all of those price gains came from gasoline prices which rose +6%. Overall energy prices rose +3.2%. The core rate rose only +0.1% when you take out food and energy. Food prices were actually flat for the month.
The headline pace of inflation on a trailing 12-month basis was +2.9% and well below the high for the year at the 3.9% pace we saw in September. The core rate for the month at +0.1 is well within the Fed comfort zone but the 12 month rate at +2.2% is pressing the upper boundary. The Fed said last week they expected a temporary increase in inflation as a result of oil prices but they emphasized "temporary."
Industrial Production was flat for February and less than the +0.4% analysts expected. The decline came from a slowdown in mining activity (coal) and lower production from utility companies. Both of these were a result of the fourth warmest winter on record. That limited demand for electricity for heating and demand for coal to supply that electricity.
Consumer Sentiment for March dropped unexpectedly to 74.3 from 75.3. Analysts were expecting a rise to 77.0. The present conditions component rose to 84.2 from 83.0 but the expectations component declined to 68.0 from 70.3. The decline in expectations caused the decline in the headline number.
Analysts said the rise in gasoline prices were the reason for the decline in expectations. The constant headlines about $4 or even $5 gasoline this summer caused an increase in worry over fuel bills. It also caused the survey's one year inflation expectations to rise to 4% from 3.3%.
This was the first decline in sentiment in seven months. Respondents were also worried that high gasoline prices would slow the recovery and possibly push the U.S. back into recession. Gasoline prices rose to average $3.83 and a record high for this time of year. That is an 18% gain over the last three months. Prices are over $4 in Alaska, California, Connecticut, Hawaii, Illinois and New York.
Despite the small decline in the headline number the overall sentiment is still improving. Jobs are improving and that has a direct impact on sentiment. The warmer winter and early spring is also a plus that will continue to support rising sentiment levels.
The wild card is clearly gasoline prices. Being an election year you can bet there is a strategic petroleum reserve release in our future. Even though there is no shortage of oil the price of producing and shipping that oil is rising as excess capacity declines.
If the president does release some reserves it will be a bad idea. We are about to go to war in Iran in the Persian Gulf. We could see an actual prolonged shortage of supplies depending on the extent of the conflict. Releasing our strategic inventory today to lower gas prices by 25-cents for a couple weeks is not a "strategic" use. It is a political gambit. The release will be justified by saying it is to prevent high gasoline prices from pushing us back into recession. Unfortunately that won't work.
When oil is released from the SPR it is a lengthy process. The administration determines how much they will release, say 30 million barrels, which is how much they released last August. They will post a notice of grades available and schedule a bidding process. This is a 3-4 week process. The refiners bid for X amount at Y dollars per barrel for a particular grade. It is normally $2-$3 under current market value so no real benefit as a result of buying it from the SPR. Many refiners will not bid because the mechanics to bid, pay and arrange delivery are too cumbersome.
After the administration reviews the bids they will announce the winners and open the payment process. After the refiners pay they can schedule delivery. That requires taking delivery at a SPR location and having the oil piped to their refinery. Rarely do they actually take delivery of the actual SPR oil they bought. They will swap the oil in the pipeline for oil in some other location closer to their refinery. Everything costs money. Transporting it costs money and time. Trading it for oil in another location costs money. By the end of the process the oil from the SPR does not cost significantly less than the oil a refinery normally receives and it is a lot more trouble. SPR oil simply does not make sense for lowering gasoline prices. It only makes sense for making up shortages like we could have in a war with Iran.
It took over 60 days to release the 30 million barrels last August in response to the "shortage" from Libya. Once all the bidding, awarding, paying processes were complete the SPR was only able to release an average of 743,000 bpd into the delivery system. The mechanics required to actually push 30 million barrels into the pipeline system is complicated and lengthy for the reasons I listed above. That release was due to a shortage of 1.6 mbpd of oil from Libya. Today there is no shortage.
Oil supplies have risen in the U.S. for seven of the last eight weeks and will continue to rise for the next 6-8 weeks. There is no shortage.
The blue area is the five year range. Note that supplies in red are at the high end of that range today and will probably move above that range as we move through April and the refinery maintenance period. In case I did not make myself clear there is no oil shortage that requires a release from the SPR!
Crude Oil Inventory Chart
The benefit for gasoline prices is the publicity. The announcement that 30 million barrels of oil are going to be sold creates a temporary dip in WTI prices. Gasoline prices will decline for a week or two and then the political exercise drops out of the headlines and prices return to whatever level Brent is selling for that day. It is only temporary and would be a stupid political move with an Iranian war moving closer every day. Remember, it is a "strategic petroleum" reserve not a strategic "political" reserve.
While on the topic of war with Iran there was a significant move closer last week. The Society for Worldwide Interbank Financial Telecommunication (SWIFT) announced on Thursday it would disconnect Iranian financial institutions from its wire transfer system as of 4:PM on Saturday. More than 80% of international wire transfers go through the SWIFT system. More than $6 trillion of wire transfers are handled daily by SWIFT. In 2010 44 Iranian banks and institutions exchanged more than two million cross border transactions using SWIFT. The SWIFT announcement effectively isolates Iran from any electronic transfer of funds. The Society said it was reacting to the EU sanctions over any form of funds transfer for Iran.
This is a huge blow since billions of dollars flow into Iran weekly from transactions around the world. This not only impacts the banks, institutions and Iran's central bank but also citizens. A large number of citizens receive money every week from relatives around the world sending home support. This will escalate tensions inside Iran as well as rhetoric by Iran directed at the outside world. This will further decrease their ability to sell oil and by doing so severely restrict their inflows of money.
In other news Israel's Prime Minister Netanyahu received the green light for attacking Iran by 8 cabinet members supporting an attack. The remaining six members are either opposed or prefer to wait. This means the Cabinet could vote at any time to approve the attack. Netanyahu said president Obama asked him not to attack Iran before the November elections in the USA. A Netanyahu aide said the prime minister believed it would be best not to wait because he did not trust Obama to support Israel after the elections. (I am just reporting the news.)
Lastly Secretary Clinton asked the Russians to give Iran a "Last Chance Warning" that the upcoming six nation talks are the last chance Iran has before military action. Iran formerly requested a date and location to resume the six party nuclear talks that have been on hold for a year but at the same time warned the West they will not put up with demands to halt uranium enrichment or allow their sensitive sites to be inspected.
Remember my wild animal analogy from several weeks ago. When a wild animal is backed into a corner as the West/EU has done to Iran there is always the potential for a fierce reaction.
The U.S. Navy announced it was sending four additional minesweepers to the Persian Gulf. This will double the number of minesweepers in the gulf. Iran has warned it will mine the Strait of Hormuz to close it if its own oil sales are hindered. The U.S carriers Abraham Lincoln and Carl Vinson currently in the Persian Gulf area will be joined by the carrier Enterprise sometime in the next week or so. Three carrier groups in a very small piece of ocean at the same time is a definite show of force.
Brent and WTI crude rallied sharply into Friday's close with Brent gaining $3.56 to $126 and WTI adding $2.04 to $107.15. Expect gasoline prices to go higher.
Brent Oil Chart
WTI Oil Chart
The economic calendar for next week is light with the major reports all relating to the housing sector. New home starts on Tuesday, new home sales on Friday and existing home sales on Wednesday. I expect positive numbers from all three reports. This could further stimulate the market, which is already in celebration mode over the banking stress test results.
We are closing in on the end of the quarter and we have a real challenge brewing. Fund managers were caught off guard by the quick market rebound in early March and could be chasing stock prices into the end of the quarter in order to dress up their statements. No fund manager wants to show they are in fixed income investments or cash with the markets setting new multiyear highs.
On the downside the Q1 earnings are not shaping up well. S&P expects earnings for the S&P 500 to only grow at +0.52% for the quarter. That is down from the +7.5% in Q4 and nine quarters of double digit earnings growth prior to that. The odds are very good that will decline to a negative number in the weeks ahead. Since January 3rd S&P has downgraded estimates for nine of the ten sectors with technology the only sector currently expected to post a gain. Tech earnings are expected to increase by +2.6%. That is not exactly a rousing victory. The earnings estimates for the telecommunications sector have declined -15.3% and there has been a drop of -13.9% for the materials sector. Six sectors are expected to post a decline in earnings. Those are energy, materials, health care, financials, telecommunications and utilities.
S&P Earnings Estimate Revision Chart
Earnings growth estimates for the entire S&P for all of 2012 has declined to +6% with a rise of +13.5% in 2013. S&P expects U.S. GDP for all of 2012 at +2.1% and rising only to +2.3% in 2013. They claim problems that could derail their less than optimistic forecasts were:
A meltdown in Europe's debt situation. (Portugal, Spain, etc)
A spike in oil prices.
A geopolitical event.
Mounting tensions in the Middle East.
Gridlock in Washington leading to another ratings downgrade.
So what are the odds of any of those events coming to pass? I would say it was about 100% on several. That does not bode well for future quarters and we are not even out of Q1 yet.
How is the market going to react when nearly every company starts posting a decline in earnings if S&P is correct? I would bet it won't be new highs. However, we saw the market shake off the flood of earnings misses and guidance warnings for Q4. It is always possible the market overlooks Q1 as well but I am not holding my breath. Guidance for Q2 could be a serious challenge.
That brings me back to the quarter end scenario. Fund managers are not dummies. At least most are not dummies. They know earnings are going to be terrible. Do they still throw money into stocks to window dress for quarter end? Since funds live and die by their quarterly statements I don't think they have any choice. However, there are probably quite a few who have been invested for the last three months and they could go to cash now, sell the rally and guarantee their year end bonuses.
The retail investors are not nearly as educated and informed. They are finally coming back into the market thanks to the new highs working as an advertisement for equity investing. They don't realize earnings are going to be terrible. You can't pick up a newspaper every Saturday and really understand what is going on in the financial world. You get headlines designed to sell newspapers and rarely hardball warnings on the state of the market.
Using a line from the movie Cool Hand Luke, "What we have here is a failure to communicate." Retail traders rushing in to buy a market top is a time honored tradition. For years they have been sitting in the safety of fixed income investments and afraid of equities. Now that the markets are setting new highs they are afraid they are missing the boat and they are starting to abandon those fixed income funds. If earnings were going to be in double digits again I would say the switch to equities was timely and appropriate. Unfortunately they are going to make the switch at exactly the wrong time.
I believe we are setting up for a monster "Sell in May" event. We will get deep into April and the majority of the S&P will have posted a decline in earnings and probably a decline in guidance and the money flow will reverse and the summer doldrums begin.
Those last twenty paragraphs of analysis and $3 will buy you a bad cup of coffee at Starbucks. That is just my thoughts based on the earnings analysis of S&P and nearly 20 years of studying the market every day. Nothing is easy. Nothing is ever guaranteed. The market exists to make fools of as many analysts as possible every day. I would nominate myself as head fool but a couple of other guys have been using that title for about ten years now.
In theory the market should continue inching higher for the next couple of weeks as the move out of fixed income gains momentum and fund managers window dress the end of the quarter. The next chapter would be a bit of choppy trading as the first couple weeks of earnings are released then a decline into the summer doldrums. Theory never seems to work for me in practice. Maybe this time it will be different.
The rush out of bonds stalled on Friday but that was probably due to the desire for safety over the weekend just in case Israel and Iran started shooting. If nothing happens over the weekend the bond outflows should resume.
Ten Year Yield Chart
Thirty Year Yield Chart
The market is rising on a lot of positive news or at least negative news that failed to live up to expectations. We worried for months over a hard landing in China. Many believe that hard landing has arrived with estimates for +7.5% growth in 2012 but the damage has been minimal. (China's Hard Landing)
Greece caused severe market dislocation for the last year and they have now moved out of the headlines and into history without a disorderly default at least for the time being. Instead of being the "Lehman event" in Europe the result was far less destructive.
The fears of a double dip recession in the U.S. in the fall failed to appear despite a significant soft spot. The economics and sentiment declined sharply to bottom in late summer but stopped well short of a new recession. Look at the Consumer Sentiment chart reprinted below. The sentiment for August was only 55.7 and only .04 away from the 28-year low in 2008. That drop in sentiment and economics was sharp but the bounce was equally as strong.
The markets shook off the Japan earthquake and the Thailand floods, the civil war in Libya and unrest in Egypt, Yemen, Nigeria, Sudan, etc. The ongoing Syrian disaster today has been regulated to the inside pages with barely a mention in the network newscasts. The markets have climbed a serious wall of worry to get this far so maybe they will shake off what could be a negative earnings quarter and move higher. Stranger things have happened in the past.
In stock news the banking sector continued to outperform post stress test. Amazingly banks that failed the test were doing very well. SunTrust (STI) gained +8.8% for the week. Citi gained +7.1%. Banks that passed also did well with Bank of America gaining +21.4%, JPM +8.5% and WFC +7.1%. Even Goldman Sachs added +3% despite the ugly NYT article by outgoing employee Greg Smith. (Why I am Leaving Goldman)
I would bet that most of those stress test banks are being chased by funds eager to show winners on their quarterly statements. Banks were consistently overlooked in January and February but they have gone from sinners to winners over the last week.
KBW Bank Index Chart
Apple (AAPL) began delivering the new iPad on Friday. Lines were long but not as long as in the past because of the online preorders. Apple shares hit $600 on Thursday and came to a dead stop. Analysts are tripping all over each other to put ever higher price targets on the stock but the new iPad is now old news. How much longer will this rally last? I know there is every justification in the world for Apple at this price with a PE of 15 and massively growing sales and profits. One analyst expects their cash hoard to grow to $150 billion by the end of Q2. I have heard repeatedly that dividend funds are buying the stock in expectations for a monster dividend. Unless Apple decides to use that cash to buy IBM ($239 billion market cap) or Microsoft ($274B) they are going to have to make a major distribution soon. That would require a special dividend or a massive stock repurchase.
I think investors are tiring of the wait. The dead stop at $600.01 was clear evidence there were a lot of sell stops waiting. The intraday volatility over the last three days has increased and a break under $580 could begin a sharp decline. A return to the prior week's $520 level would be a buying opportunity for some. The stock has gone parabolic and eventually this rocket ship is going to run out of fuel. A return to the 200-day average would be a -$200 point drop.
Apple Chart - Daily
India doubled its tax on gold and platinum from 2% to 4% in an effort to slow down imports. The tax on silver was not changed. India is the world's biggest bullion buyer and the rising rate of imports increased its current account deficit. India imported 969 metric tons in 2011 as gold prices rose for the 11th consecutive year. Gold futures in India rose by 32% in 2011 and much higher than the 10% in the global markets. Gold imports into India rose by 50% over the last three quarters. The tax on gold jewelry also doubled to 3%. Demand for gold in India is expected to slow slightly as a result of the tax but one analyst said it would be brief. "When you are buying gold for a long term investment to hedge against inflation the additional 2% tax is nothing." That is an increase of only $33 on a $1650 ounce of gold. Gold has declined over the last two weeks on the stronger dollar.
The VIX dipped to a low of 13.66 just prior to the close. That level has not been seen since 2007. The sharp intraday dip is related to the options expiration and the impact on option prices. Volatility is so low at present that buying options outright are a bargain rather than doing spreads. To illustrate, a $60 April put on Wal-Mart is 52-cents with the price of WMT shares at $60.84. A 52-cent option 88-cents out of the money is a pretty cheap bet on a stock's direction. That is especially true given the price of gasoline and the odds Wal-Mart sales are going to suffer.
VIX Chart - Weekly
The S&P squeezed out a +1.57 point gain on Friday to stretch its string of weekly gains to six. The index closed over 1400 for the second day and the gain was never in doubt. Expiration of options and futures helped pin the index to 1400 level all day. Support is now well back at 1340 but there are no signs of a retreat.
Volume was strong on Friday thanks to the quadruple witching and some minor rebalancing of the indexes. Volume exceeded 7.0 billion shares for each of the last four days with 8.0 billion on Friday. Internals were evenly distributed with advancers and decliners almost dead even. The minimal 1.5 point gain was a result of the low volatility.
On the S&P the next resistance level is 1426 and the closing high from May 2008 just before the big recession drop began. Real support is 1340.
The Dow has broken out to multiyear highs and set a new closing high for three consecutive days before resting on Friday. UTX was the laggard at -1.41 followed by MMM, PG and WMT to drag the Dow down.
Bank of America was the hero with a +6% gain but unfortunately a $9 stock has no material impact on the price weighted index. IBM is the largest weighting at $200 followed by CVX and CAT.
Support is well back at 12,750 and resistance is the October 2007 high close at 14,093.
Dow Chart - Daily
Resistance on the Nasdaq Composite is about 3,075 and then it jumps to 3,500 and the October 2000 highs. I seriously doubt that decade old highs will have any impact on the Nasdaq. The bigger impact will be just one more round number at 3,500.
The Nasdaq is going to be controlled by Apple so we should really just show an Apple chart in place of the Nasdaq 100 chart. When the spike in Apple finally collapses it will take the entire market with it. The S&P is up +11.65% for the year and Apple alone is responsible for 2%.
The Russell 2000 small cap index continues to be the fly in the market soup. The Russell refuses to break resistance at 830 and it has been rock solid for over a month. This contradicts the "fund managers chasing performance" claims because fund manager sentiment appears to be lacking conviction. They may be throwing money at the big caps but the Russell is only getting pocket change.
Don't back up the truck to go long until the Russell breaks out on strong volume.
Russell 2000 Chart
Conventional wisdom seems to think the rally will continue through month end and possibly into early April. The stall in Apple shares is giving me second thoughts about that concept. I believe Apple will control our fate. Once the profit taking begins in Apple the rest of the market will follow. With the iPad news now old the levitating power of the Apple faithful may begin to fade.
Wait for the Russell to confirm any further market gains before drinking the Kool-Aid and loading up on longs.
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"If you fail to plan, you plan to fail."