Cyprus worries have disappeared with the Dow surging to a new high on positive economic numbers.
The Dow surged +112 points to close at 14,559 and exceeding the old closing record by +20 points. Monday's big decline on the Cypriot bank robbery was forgotten as fund managers dress up their statements for quarter end. The S&P came within two points of a closing record with a close at 1563.77. The record is 1565.15. This was the sixth day this month the S&P has moved to within five points of the record but failed to hit the goal. On Monday the S&P surged to 1464.91, only .24 points away on an intraday basis before falling back to 1546 intraday.
The morning surge was powered by some surprising economics. In true bullish fashion investors jumped on the good news and completely ignored the bad news. Traders have honed the art of selective hearing to perfection. Husbands around the world should take lessons.
The first piece of good news was the Durable Goods report. After a -3.8% drop in January the new orders surged by +5.7% in February. That is the biggest gain since September. However, if you dig down into the components the majority of the gain was due to large orders for Boeing planes. Boeing only sold 2 planes in January and that jumped to 179 in February. Transportation orders rose +21.7%. Ex-aircraft orders actually fell -0.5%. Core capital goods orders fell -2.7%.
It is clear if you subtract Boeing from the report the numbers were terrible. However, the orders for 179 planes will power a large part of the economy for years to come. Boeing supports a workforce of more than 400,000 workers. That means their orders should be counted but noted in the context of slowing orders across the rest of the country. This was a good news report with a large "*" for investors.
The second report generating buzz was the New Home Sales, which declined from 431,000 in January to 411,000 in February. That was a decline of -4.6% from January but sales are still up +12.3% over February 2012. Closed sales represent contracts initiated 60-90 days in the past. December was full of negative headlines about the fiscal cliff and higher tax rates so home buying decisions were probably postponed. Also, December is the holiday month and home shopping is not high on the priority list for most families. I believe home sales will improve in the months ahead now that some of the political issues have been resolved and Fiscal Cliff and Sequestration headlines have disappeared from the news.
New Home Sales Chart
Case Shiller Home Prices rose +8.1% in the three month period ending in January. For the first time in more than five years all metro areas were showing price appreciation. The number of houses on the market is now at a 12 year low. Distressed properties have declined from 34% of available homes to 25% and that is allowing the average sales price to rise. Institutional investors are buying up substantial amounts of inventory with as much as a third of all properties going to investors. There is a flood of newly released foreclosures coming to market this spring. The last round of legal battles over things like robo-signing and chain of ownership lapses have passed. Banks are now free to release the properties and the market is going to snap them right up. The outlook for housing remains strong as long as the economy does not fall back into recession.
On the negative side of the ledger the Richmond Fed manufacturing Survey declined from 6.0 in February to 3.0 in March. New orders dropped into contraction territory at -4.0 after being flat the prior month. The three month average is now -7.0. Backorders fell farther into contraction territory at -14 after -12 the prior month. The three month average is -15. Employment was flat at a surprisingly strong +9.0 and the second strong month. Capital expenditures expectations surged from 7.0 to 17.0, also a surprise. Activity is declining but hiring and capital expenditures are going up. Why? With sequestration cuts likely to be brutal in the Richmond area you would think the outlook would be declining as well. The long term trend for activity in the Richmond area is still down.
Richmond Fed Chart
Consumer Confidence declined a whopping -10 points from 69.6 to 59.7 in March. With the equity markets hitting new highs you would have expected a better result. Analyst estimates were for a minor drop to 68.0 as a result of the administration warnings over the impact of the sequestration. The index is only one point from a 12 month low and that does not bode well for the summer.
The current conditions component declined from 61.4 to 57.9 and that is the component that should have been most impacted by the negative headlines. However, the expectations component imploded from 72.4 to 60.9. Clearly something is weighing on consumers in the months ahead. That is the lowest level since October 2011.
Buying trends were mixed. Those expecting to buy an appliance like a flat screen TV or refrigerator declined from 49.6% to 45.2%. Those looking to buy a car declined one point to 10.1%. However, those looking to buy a home surged from 3.8% to 5.6%. This is a contradiction of sentiment. Overall confidence declined -10 points but home buyers rose +47% over the prior month? That does not compute. Also, more than 18% of respondents were expecting a decrease in pay.
The administration should think twice before dumping bad news on consumers in an effort to get legislation passed. The long term economic impact may not be worth the political risk.
Consumer Confidence Chart
The Economic Calendar for Wednesday is light. The pending home sales report is the highlight and it is rarely a market mover. The big day is Thursday with GDP, ISM Chicago and the Kansas Fed Survey. Coming on the last day of the week/quarter the reports will probably produce a very volatile morning and then volume will die before lunch and remain dormant for the rest of the day.
The bank robbery in Cyprus is about over. The banks are scheduled to reopen on Thursday after being closed for about two weeks. Large depositors will lose up to 40% of their cash. On Monday the new head of the EU Commission said the bank Stability Tax should be a template for the rest of the eurozone. The equity markets crashed and he tried vainly the rest of the day to take back that comment. Today another Finance Minister said the European parliament will push for a tax on depositors with balances over 100,000 euros when any banks need a bailout. Nobody blinked and the euro closed up for the day.
It is surprising how quickly these monumental policy changes can be ignored by the markets. You can bet depositors in Portugal, Ireland, Spain, Italy, Greece and even France are not ignoring the new rules. Deposits will be flowing out of banks in those countries. Spanish and Italian banks are particularly at risk. This European banking system problem has not gone away just because banks in Cyprus are going to reopen. It will simply return in a different country. Slovenia is thought to be the next country with a banking crisis.
Meanwhile the banking issues in Europe are going to be positive for U.S. banks and equity markets. European depositors looking for safety for their funds are not going to put them in another European bank. Some of that money is going to move to the U.S. and probably into the U.S. equity markets. It won't happen next week but over the next few months we should see an influx of European cash. Having our markets setting new highs makes an attractive beacon for foreign investments.
On a side note analysts are now expecting a -10 to -30 point drop in the GDP of Cyprus. Instant recession. Fitch put Cyprus on credit watch with negative implications. The only shock there is that it took them several days to make the move. The entire economy has been basically shut down for the last two weeks and their main export was financial services and that business is now dead.
In stock news Seagate Technology (STX) and Western Digital (WDC) both surged after RBC Capital initiated coverage on WDC with an outperform rating. The detailed update said the sector should be a lot more stable because many suppliers have disappeared. In the current environment RBC believes WDC can take market share from Seagate. However, both companies are expected to thrive.
The analyst pointed out that since 1997 the supplier of disk drive heads have shrunk from 14 to 1, suppliers of media from 12 to 2, suppliers of motors from 5 to 3 and suppliers of substrate from 22 to 6. The analyst said this would reduce margin volatility for WDC and the hard drive industry in general. Today only three companies make drives compared to ten in 1997. WDC recently said their new model for gross margins is 27-32% compared to the historical model of 18-23%. Both companies have significant capital allocation strategies with WDC pledging 50% return through dividends and buybacks and Seagate 70%.
Needham & Company also initiated coverage of WDC with a buy rating today. Shares of WDC rose +3% and STX +3.3%.
Shares of Boeing (BA) lifted the Dow after the monster order details in the Durable Goods orders and a successful test of the new batteries in the 787 Dreamliner. Shares of BA rose +2%. The 787 completed a successful two hour flight using the new battery structure. Two hours is far from a working model and I would not want to be the FAA official that allowed all the 787s to begin flying again on just a two hour test. Every journey begins with the first step and the successful test is Boeing's first step in getting all those planes back into the air again. Boeing will also have to manufacture the new battery configuration and ship them all over the world for installation once the FAA clears them for use.
Crude prices rallied +1.45 for the second day of big gains. The Durable Goods report was credited with the boost but Iran and Korea were also factors. Iran was the piÃ±ata of choice after President Obama's trip to Israel last week. Harsh words came out of Iran with threats to destroy Tel Aviv and Haifa and close the Strait of Hormuz if Iran is attacked. We have heard this before but the time is running out on Iran's "red line" capability to build a nuclear weapon.
Today North Korea said it put all of its artillery units, including long-range artillery and strategic rocket units on highest alert. The Supreme Command of the Korean People's Army said, the alert affects "All the field artillery units including strategic rocket units and long-range artillery units which are assigned to strike bases of the U.S. imperialist aggressor troops in the U.S. mainland and on Hawaii and Guam." It is the highest alert North Korea has ever issued. Earlier this month NK warned of preemptive nuclear attacks on the USA and South Korea and said the countries were in "a state of nuclear war." Tensions in the area have been very high since NK detonated its third nuclear weapon test in February in defiance of global sanctions.
The U.S. and South Korea are currently engaged in joint military exercises. Three times in March the U.S. has sent B-52 bombers on practice flights over South Korea. North Korea has more than 13,000 artillery guns, 4,000 tanks, 1,700 aircraft and 800 surface vessels. While NK does not have a missile that can reach the U.S. and has not demonstrated the capability of putting a nuclear weapon on a missile they have proven they have nuclear weapons capability. They could easily put one in a passenger plane and fly it to any country they choose disguised as a commercial flight and set it off. They don't have to use missiles.
The combination of Iran, Korea and what appears on the surface to be an improving U.S. economy sent crude prices to a five week high.
WTI Crude Oil Chart
The Dow and the S&P-100 made new historic highs today on relatively low volume. The rest of the indexes did not. At 5.1 billion shares it was the second lowest volume day of the year. The key point here is that the Dow and S&P-100 are the biggest of the blue chip stocks indexes. These are the highly liquid stocks that trade millions of shares per day. Fund managers can enter and exit these stocks in a hurry without making waves. This is a place of safety where they can temporarily park money at the end of the quarter.
The Russell 2000 small cap index actually traded negative for most of the day until a slight uptick appeared after 3:PM. The Nasdaq has closed with losses on five of the last seven trading sessions prior to today. There is nothing bullish about that.
I believe we are in the midst of quarter end window dressing and fund managers will try to get the S&P to a new high on Wednesday and then call the quarter done. Thursday could see some volatility given the three high profile economic reports and the potential for a down week next week. Aggressive traders will begin taking short positions on Thursday in anticipation for some window washing the first week in April.
The S&P closed at 1563.77, less than two points below the record high close at 1565.15. It is poised for a climax spike on Wednesday to record levels. We saw on Monday there was immediate selling right at that 1565 level. The high was 1564.91. If that new high trigger is still in effect we could see short covering if we blast through it or we could see another sell cycle if there is not enough volume to keep the spike alive. If we do see another flush when 1565 is hit I would not expect another attempt this week. I think the buyers will take a wait and see attitude and hope for a bigger dip next week.
The best of all worlds would be a blowout spike through 1565 and a big gain for the day. That would create significant short covering and attract new money to the market. After two weeks of consolidation at this level that is entirely possible.
Analyzing volatility around a specific market number is a fool's errand. There are thousands of market makers and fund managers all intent on pushing the numbers around either directly or indirectly on any given day. When a number like 1565 has been in the headlines so much over the last month we can expect a significant amount of game playing. For that reason I would hesitate to base my market direction decisions on the gains or losses the rest of this week. Once that number is surpassed even if by only a minor amount the importance attached to that number immediately evaporates. "Ok, we did that, what now?" Everybody can quit a winner and start wondering about what to do next. It also makes a high profile profit target for those long the rally over the last four months. "Ok, we had a good year, let's buy some bonds now."
I suggest that readers not apply any importance to that number this week. It makes no difference in the long term scheme of things. Instead of hoping for record highs on the S&P-500 I would rather be hoping for a decent dip to buy. I have my list of stocks I want to buy on a pullback but dips have been short and few since December. Give us a decent three day dip and let everyone reload and I will be happy.
I know a lot of analysts have been worrying about "sell in April" rather than "sell in May." I don't know which it will be but I do believe it will appear. We have gone more than 500 days without a -10% correction and that is not normal. If the Fed keeps filling the punchbowl, earnings don't turn out to be a disappointment and the economics continue to improve at least moderately we could continue the run. There will be dips like we saw in December and late February but they won't be dramatic. That was a trio of capital "IFs" so I am not betting my house on the outcome.
Earnings are expected to grow only 0.58% for Q1 so the bar is set VERY low. If we were to miss that target the impact on the market could be significant.
The Dow closed at 14,559 and +20 points over the prior historic high. The index is poised for a breakout after two weeks of consolidation and four support tests at 14,400. In theory this is where you would be positioning yourself for new long positions on the DIA as it breaks out of this consolidation pattern. Theory does not concern itself with things like end of quarter window dressing and simply focuses on the chart patterns. In real life we need to be cognizant of the macro factors. I would buy the breakout if it happens but I would be very watchful for volatility next week.
The Nasdaq has been pretty choppy over the last two weeks. However, there is a nice pattern of higher lows and clear resistance at 3260. If the Nasdaq could break over that resistance there would be significant short covering. The high volatility over the last two weeks has given the bears hope and you can bet the short interest has risen significantly. The weakest index seems to attract the most shorts. Don't count the Nasdaq out but I would not be a buyer of this index without a big dip.
The Russell 2000 has been very contained. The volatility has been minimal. If this is a market top as many expect you would expect the Russell to show more volatility. There does not seem to be any flight out of the small caps but buying has been weak for the last seven days. The Russell was negative most of the afternoon until a small uptick in the last hour. A breakdown below 938 would be bearish and indicate a potential test of 895.
Russell 2000 Chart - Daily
Russell 2000 Chart - 30 Min
Don't attach too much importance to S&P 1565. Plan your long term buys and wait for an entry point. April and May are historically volatile months. Over the last three years there was a significant decline after strong gains in the first quarter. Once these patterns are recognized they cease to exist so we can't count on the same thing this year. History is a guide, not gospel.
There is always a dip in our future. Only the timing is in doubt. Plan for it and capitalize on it.
Enter passively, exit aggressively!
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