Thanks to gains in Chevron and Boeing the Dow finished positive on Friday while other indexes were negative.
Friday started off negative after the GDP report came in weaker than expected but the bad news bulls nearly succeeded in pushing all the indexes into positive territory before the close. There is no fear in the markets despite an outflow of cash from mutual funds. Month end window dressing is supporting the markets but that clock is rapidly winding down.
The economic calendar was light on Friday but the one major report was a disappointment. The first estimate of GDP for the first quarter came in at +2.5% growth. That was below the consensus estimate of 3.2%. This was well above Q4 growth of +0.38% but mostly due to a higher rate of inventory accumulation. Here is the catch. More than 80% of the rise in inventories was farm related. Farmers were building up seed, fertilizer and equipment in hopes of a rebound in 2013 after the drought of 2012 nearly wiped them out. It was the biggest jump in farm inventory in 13 years. This inventory buildup is not really a factor in the consumer driven economy.
Growth was also lifted by a spike in consumer spending of +3.2%. This is most likely a result of the surge in dividends and accelerated bonuses late in Q4 that helped push the Q4 savings rate to 4.7%. That savings rate declined in Q1 to 2.6% and the lowest level since early 2007 as that Q4 cash was spent. The spike in consumer spending was also due to the record high fuel prices in February. That is not a reason we want to see for higher consumer spending.
Utility spending due to the abnormally cold weather also added to the GDP. Hopefully that won't be repeated in Q2. Also, a rise in imports helped push GDP higher but the rise in imports was due to higher prices for oil. I hope you see this thread. The spike in GDP was due to onetime events that will not repeat.
Government spending fell -4.4% in Q1 after a -7.0% decline in Q4. Defense spending fell -11.5% in Q1 after a -22.1% drop in Q4. That was the two biggest quarterly drops since the end of the Korean War and is not likely to continue.
Analysts believe the initial Q1 estimate could be revised down to 1.4% to 1.9% with the next two revisions. The consensus estimate for Q2 GDP is currently +1.5% but falling. As Q1 numbers are revised lower the estimate for Q2 will also decline.
The final reading for April Consumer Sentiment rebounded from 72.3 to 76.4. That is still a three month low. Analysts credited the decline in fuel prices over the last eight-weeks for the improvement in sentiment. The present conditions component declined from 90.7 to 89.9 and the expectations component fell from 70.8 to 67.8.
The uptick in the sentiment reading late in the month suggests worry over the mid month decline in the stock market faded as the rebound began. However, the daily Rasmussen index declined to 92.6 on Friday and the lowest reading of the month. The high was 103.4 on April 1st. In the Rasmussen survey only 16% of adult consumers rate the economy as good or better, while 42% rate it poorly.
Sentiment may not be in a sharp downtrend but with the equity markets within 1% of their recent highs you would expect sentiment to be improving not declining.
Consumer Sentiment Chart
The calendar for next week is extremely busy. There are three payroll reports, three ISM reports and the FOMC meeting. The ISM reports are not expected to improve but nobody is expecting a sharp decline either. Expectations are for business activity to be flat to down slightly. However, the farther we get into the summer the more impact we are going to see from the sequester.
The payroll reports are garnering estimates that vary widely. The ADP report on Wednesday is expected to show a gain of +170,000 jobs compared to 158,000 in March. This is highly optimistic. The Nonfarm Payrolls on Friday are expected to show a gain of +150,000 jobs compared to only 88,000 in March. I think investors are going to be very disappointed. Nearly every one of the regional Fed reports have shown declines in the employment component. However, the weekly jobless claims have not been that bad with a drop to only 339,000 this week from 355,000 the prior week. On March 30th they had spiked to 388,000.
April is the month we are expecting to see a bigger hit to employment from the sequester. The required 30 day notice period of a layoff has now expired and workers should be headed out the door.
The FOMC meeting is not likely to produce any fireworks. Over the last week we have seen several Fed heads actually claim the Fed may have to ramp up QE purchases to combat the growing economic weakness. That increase in worry by Fed members should soften the talk by others about shrinking purchases later this year. The FOMC statement should be neutral and claim "growth is continuing at a moderate pace" and restate the benchmarks for ending QE. Unemployment at 6.5% and inflation at 2.5% are not likely to happen in 2013 or even 2014 so any talk about slowing purchases in 2013 is wasted breath.
If I had to pick a turning point for the market it would be either the FOMC announcement or the Nonfarm Payrolls. The week ahead is typically the inflection point where market direction changes.
There are several overseas events that are sure to gain attention. Those are the Eurozone PMI, ECB announcement and China's PMI, both versions.
There were only a few stock stories on Friday. Chevron (CVX) reported earnings that declined -4.5% on lower prices received for oil and gas. Chevron said it earned $6.18 billion or $3.18 per share on revenue of $56.82 billion. Analysts were expecting $3.09. The company did raise output from 2.63 mbpd to 2.65 mbpd. However, the average price received for the oil fell from $102 to $94 in the USA and from $110 to $102 overseas.
Chevron expects to increase production by 25% to 3.3 mbpd by 2017. They have more than 50 projects underway that cost more than $250 million each and 16 that cost more than $1 billion. The LNG projects in Australia are more than $40 billion. Chevron rallied +$1.53 on the earnings report.
DR Horton (DHI) rallied +9% on Friday and +20% for the week after reporting profits of 32 cents on revenue of $1.39 billion. Profits beat estimates by 13 cents. The average selling price of a Horton home rose +13%. The company said "The first half of fiscal year 2013 was nothing short of phenomenal. We expect the second half to be even better." That energized buyers all across the homebuilding sector.
DR Horton has an inventory of 16,000 homes and is better positioned for the spring selling season than competitors according to analysts. DHI builds homes between $100,000 and $600,000. Orders in Q1 rose +34% to 7,879 homes with a value of more than $2 billion.
DR Horton Chart
Amazon (AMZN) fell -$20 on Friday and was a major drag on the Nasdaq. Amazon beat the street on earnings but lowered its outlook as a result of the recession in Europe. Earnings were 18 cents compared to estimates of 8 cents. Amazon guided for Q2 revenue in the range of $14.5-$16.2 billion and analysts were expecting $15.92 billion.
The company's gross profit margin rose from 24% to 26.6% but growth slowed slightly. Amazon is growing at roughly twice the rate of ecommerce in general. That is down from 3x a year ago. Amazon is benefitting from its ever increasing scale in reducing costs and improving margins. However, that rapidly rising scale is working against it in the multiples of growth. You can't keep growing at 25% a year. The bigger you get the harder it is to maintain that growth rate. Amazon is benefitting from its addition of regional shipping centers with freight costs declining from 5.1% to 4.7% of sales. Unit sales growth rose +30% in Q1 and that would be dynamite for anyone else. For Amazon that was a decline from the 49% growth in Q1-2012. The law of large numbers is going to haunt them from now on.
This earnings cycle has been better than expected on an earnings basis but significantly weaker than expected on a revenue basis. A month ago the expectations for Q1 earnings were from a loss of -1.9% to a slight gain of +1%. More than 50% of S&P-500 companies have reported and earnings are showing growth of +3.1%. Typically actual earnings beat the consensus estimate at the beginning of the reporting cycle. Analysts are cautious. They would rather be blamed for understating than being too optimistic.
As of Friday 56.9% of companies have beaten on earnings. That is slightly below the averages but not a disaster. However, the majority of earnings beats came on cost cutting rather than increasing sales. That is the LOWEST beat ratio since the recession.
Only 44.1% have beaten on revenue. That is well below the average of 62% and very close to a 13 year low. The recession quarters saw revenue beats in the 40% range. Are sales that weak that we are nearing recession levels of revenue growth? That is a very disturbing percentage.
For those companies giving guidance with their earnings the negative guidance is 14 times larger than those raising guidance. Since April 1st the consensus estimate for Q2 earnings growth has declined from 7.2% to 3.0% and still falling. This is NOT a bullish environment for stocks.
Bespoke Earnings Beat Chart
Bespoke Revenue Beat Chart
Birinyi and Associates reported the announced share repurchases in the first quarter were the largest since they began tracking the information in 1985. Share buyback announcements through March totaled $208 billion. There are multiple reasons a company does buybacks. One would be when they think the shares are cheap. That is clearly not the case today with most stocks at cyclical highs. Another is to buy back shares in lieu of a dividend. That could be the case today because buybacks are easier than dividends and they don't repeat.
If a company pays a 25 cent dividend today and they increase it to 35 cents because they have extra cash then it haunts them for every dividend cycle in the future. Most companies would rather leave their dividends at a manageable level for cash flow and use extra cash for random buybacks. Most buybacks are random. They are announced for a period of time, say over the next two years, but there is rarely a specific schedule. Companies can elect when they want to spend the money.
Another reason companies buy back stock is to cheat on earnings. If you have 10 million shares outstanding and you buyback a million then the earnings per share jumps sharply because there are fewer shares outstanding. IBM is the poster child for this method of earnings management but it failed them last quarter. They were missing so badly they could not buy back enough shares to compensate.
Lastly, companies buy back shares when they have no other use for the money. According to S&P Capital IQ the S&P-500 companies have more than $2 trillion in cash on their balance sheet. The economy is lagging, revenue is slowing and the outlook is for more of the same. If companies don't see an acquisition that makes sense they can throw some money at buybacks in an effort to appear shareholder friendly. They also benefit by bringing shares back in house to use for stock based compensation.
Company executives are often compensated based on the stock price. Buying back large amounts of stock will raise the stock price and improve their compensation packages even though they are not building the company in the process. Their millions in stock options will eventually vest in the money and they are rewarded for buying back stock using the company funds.
Since stocks are not bargain basement cheap today it suggests companies are announcing buybacks because there is no better use of their money. That is not a bullish conclusion. All investors would much rather see companies invest that money into something that would increase profits and raise the future stock price. Aggressive buybacks are an admission business is slow and the outlook is flat. This was a record quarter for buybacks so what message should we get from this trend? The outlook for business is not rosy. It may not be gloomy but it is not rosy.
Top Ten Share Buybacks in Q1
As if we did not have enough clouds over the market, China's Politburo Standing Committee warned last week the country needed to boost consumption and guard against financial risks amid signs the economic recovery is faltering. In a special session on the economy the committee warned the macro-economic policies should be stabilized and micro controls in some sectors should be loosened. The full context of the warning suggested the financial risks were to the point where the government was no longer going to be able to use stimulus to boost growth at the expense of structural reform. Translated this means no further stimulus from the new government and a push to boost internal consumption rather than massive building of roads, railroads, apartments and cities. China's consumer credit increased by more than $1 trillion in Q1 in an $8 trillion economy. Bubble anyone?
In response Nomura, JP Morgan and Goldman Sachs all cut their growth estimates for China in 2013. Nomura's China Stress index, which monitors the risk of a hard landing, recorded its highest reading ever, driven by credit and property market booms. Based on the index there is a 33% chance of that by 2014. Nomura is predicting a 7.2% GDP by Q4 and the weakest growth in more than 13 years.
Sell in May? We are at that time of year when investors have to decide if they want to take profits and move to cash for the summer or risk losing those profits in the next correction. The Stock Trader's Almanac has made the "Sell in May and go away" trade one of the most visible trends in the market. Because the markets normally decline in the summer they came up with the best six months trading system. If you had invested $10,000 in the Dow in 1950 and only kept the money in stocks from November through April you would have $684,073 as of the end of 2011. If you reversed the strategy and invested for the May-October period you would have lost -$1,024 over the same 61 year period. That is a pretty telling statistic and the cycle rarely fails to produce.
It is rare that the market does not set its lows for the year over the summer months. Go back and look at charts of the Dow or S&P and see how many times the summer doldrums push the indexes below the levels in the first quarter.
I seriously doubt very few people close all their positions for the summer. However, it never hurts to take profits in the high flyers and set stop losses on those you decide to keep. The high flyers are the stocks that will be hurt the worst when the correction comes.
A correction is coming. Like night follows day there is always a correction in our future. It could be next week or next month or several weeks in our future but it is coming. Corrections are necessary to force investors out of positions and allow new investors to take their place.
To compound the sell in May reasons for 2013 the first year of a presidential cycle is typically the weakest of the four year period. Add in the declining U.S. economics, European recession and slowing growth in China and there are a number of reasons to move to cash for the summer. That also frees you from worrying about the market while you are at the beach with your kids or enjoying a road trip with your wife. There is a lot to be said about not waking up every morning in the summer and checking to see what crisis has appeared in the market to cost you money.
Bonds up, equities up, what's up? The equity markets rallied last week to within 1% of their recent highs. At the same time treasuries rallied to five month highs. Treasuries and equities rarely trade in tandem and normally trade in opposite directions. This suggests the smart money is looking at the economic picture and heading to safety in treasuries ahead of the sell in May cycle. Treasuries have been strong for the last six-weeks and the weak GDP report on Friday strengthened that position. Treasury strength is just one more reason to worry about a summer decline in equities.
Ten Year Yield Chart
Signs of a top? When predictions seem to suddenly rocket to levels not previously considered it is sometimes seen as signs of a top in the market. Bullishness is seen to be off the scale and calmer heads begin to take profits. Price targets for Apple of $1000 or more back when Apple was trading for $700 would be an example. Having the NYSE bull appear on the cover of Newsweek with some lofty Dow target would be another. How about Barron's predicting Dow 16,000? Does that qualify?
On the other side of the coin the AAII Investor Sentiment Survey showed respondents were 28.3% bullish and 38.8% bearish last week. Another 32.9% were neutral. That would seem to indicate the bullishness has faded. Maybe it is simply reality taking hold as we near May.
However, margin debt is very close to exceeding the all time highs from 2007. That could happen in the next report.
A friend of mine works for Edward Jones. He claimed the EJ offices had their best month in years in March and April was going to beat that. Investors are coming out of the woodwork and putting cash into the market. He could not say enough positive things about the amount of business flooding into their offices. Obviously the conventional wisdom suggests when the retail investor goes all in the game is over.
The internals of the market suggest there is distribution in progress. The new 52-week highs have been less than half the number from just three weeks ago. On Friday there were 310 new highs compared to 942 on April 11th. Volume is declining almost daily with only 5.6 billion shares traded on Friday.
The S&P traded up to 1592.64 on Thursday. That was only 1 point below the historic closing high. That occurred at 2:PM just before the market rolled over. I am not going to claim that was a market top because nobody really knows until we can look back at it after a couple weeks of trading and then know for sure. It is still troubling for the bulls.
Trading on Friday failed at resistance at 1585 early in the day thanks to the weak GDP report. After drifting lower all morning the S&P rebounded from weak support at 1577 and again failed at 1585 just before the close.
I will be the first to tell you we can't make any market direction decisions based on any market action on a Friday. Counter trend moves are the norm. Profits are taken from a week of gains. Shorts are covered. Dips are bought after a week of declines. Traders are more cautious on Friday's because of potential news events over the weekend. Where existing trends are continued on a Friday we can predict those trends to continue the following week. Everything else is a guess.
I have been expecting window dressing from funds until month end but we are basically at month end now. Also, there was an outflow of cash from stock funds last week. That is the first outflow in a long time. That would also suggest cyclical investors are starting to implement the sell in May strategy. We are close enough to month end that sellers should begin to appear early next week. With the heavy economic calendar and the FOMC announcement on Wednesday the risk is to the bullish case and favors the bears.
S&P-500 Chart - 15 min
S&P-500 Chart - Daily
S&P-500 Chart - Monthly
Many Dow components reported last week and that created a lot of cross currents that prevented the Dow from capitalizing on the Tuesday gains. The Dow spiked up to 14720 on Tuesday and that is roughly where it closed on Friday. The intraday range on Friday was only 59 points and one of the lowest for the year.
The Thursday spike to 14760 failed in the morning and again in the afternoon with seller volume picking up in the afternoon. The weak GDP on Friday prevented the industrials from extending their gains but Boeing and Chevron managed to close the Dow in the green with gains over $1 each.
Critical support is now 14670 and the bottom of the range last week. Critical resistance is now 14760 and then 14865.
Dow Chart - 15 Min
Dow Chart - daily
The Nasdaq actually had the most bullish chart of the big three with a return to 3300 although that level was rock solid on Thursday. The return to the 12 year highs was bullish but the gains did not hold. The -21 point drop by Amazon and -8 by Google and Baidu was too much baggage to haul up the hill. Apple tried to help with an $8 gain but there were too many losers from disappointing earnings reports.
The volatility in the Nasdaq continues to be a problem. Every day is a gap open in some form that forces either bulls or bears to cover in a rush. There is little investing in progress with the action mostly from trading. Decliners outpaced advancers nearly 2:1 on Friday.
Winners and Sinners
Nasdaq Chart - 15 min
Nasdaq Chart - Daily
The Russell 2000 surprised traders with a strong bounce off the 900 level but the rebound failed with another lower high. The Dow was handicapped by the various earnings disappointments by the Dow components. Since there are only 30 stocks in the Dow a single stock can hold the index back. Meanwhile the Russell is 2000 stocks and it is more representative of the broader market.
I view the Russell rebound from short term oversold as short covering from strong support and possible window dressing by funds. They would love to see the Russell close at its highs next Tuesday.
The Russell has not made a new high since March 14th at 953.07 and the range of movement has been widening. The broader range translates as increased volatility and less conviction by either side. Watch 953 for a breakout and 895-900 for a breakdown.
Russell 2000 Chart - Daily
The Dow Transports rallied on Boeing ending its battery challenge, the vote on ending the FAA employee furloughs and some positive earnings by airlines. In reality I would have expected a little stronger bounce. The gains began to fade on Wednesday and Friday's narrow range suggested the bloom was gone off the rose.
Dow Transport Chart - Daily
I would be cautious of the market next week because of the calendar impact and the number of major economic events. If the bulls are going to climb a wall of worry they are going to need a truckload of Red Bull to keep their energy up. It could be a tough climb. However, as I stated earlier, when everyone is expecting a direction change it rarely appears. Once historical trends are clearly visible the contrarians bet against them. The path of least resistance may be down but I am sure the dip buyers are still looking for their entry point.
Friday was the 40th anniversary of the options market. On April 26th 1973 the CBOE began trading options on 16 stocks. A total of 911 contracts of calls were traded, no puts. Marty Kearny, Social Media editor for the CBOE, said more than four billion contracts traded in 2012 on 3,500 securities. The CBOE put out a video to celebrate the anniversary. CBOE Video
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"A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves largesse from the public treasury. From that moment on, the majority always votes for the candidates promising the most benefits from the public treasury with the result that a democracy always collapses over loose fiscal policy, always followed by a dictatorship. The average age of the worldâ€™s greatest civilizations has been 200 years."
Alexis de Toqueville