Investors don't appear to be afraid of May with three consecutive weeks of strong gains and no sellers in sight.
The Dow did spend most of Friday in negative territory but every dip was bought. The S&P dipped briefly into negative territory at lunch time but it was seen as a buying opportunity. The Nasdaq never traded down and ended with a strong +27 point gain to 3435 and a new 12-year high.
The equity gains were unusual with the dollar surging to six-week high and crushing commodities at the open. That selling also reversed with crude oil losing only 42 cents at the close after being down more than $3 intraday. Unfortunately for gold owners there was still pain thanks to the spike in the dollar. Gold was down over $50 intraday but recovered somewhat to lose only -$21 to close at $1447.
Gold Futures Chart
The dollar index posted its biggest two-day gain since December after the weekly jobless claims on Thursday fell to five-year lows. After the strong nonfarm payrolls last week the decline in weekly claims suggests the U.S. economy may be improving.
The dollar rose as high as 101.3 against the yen and the first time since April 2009 it has been over 100. The yen traded at 78 to the dollar as recently as October. The decline in the yen suggests the "Abenomics" QE program in Japan is working. The Japanese Nikkei spiked +2.9% to 14,607 and the highest close since January 2008. The "short the yen, buy equities" crowd is celebrating this weekend.
Dollar Index Chart
Japanese Yen Chart
The yield on the ten-year treasury rallied to a six week high at 1.9% and prompted Bill Gross to tweet the 30-year bull market in bonds ended on April 29th when prices hit their recent high. He said the amalgamation of treasuries, mortgages and corporate bonds peaked on the 29th. With the talk likely to increase about the Fed trimming QE purchases the effective interest rates in the bond market should begin to climb. Once the Fed starts down this road it will be irreversible and yields will eventually rebound to 4% or higher. If treasuries continue to sell off next week we could see the beginning of the Great Rotation as some are calling it.
Ten Year Treasury Yield Chart
The only economic report making news on Friday was the Treasury Budget for April. The budget posted a surplus of $112.9 billion. That was +$53 billion more than April 2012. The rise in income is related to the higher than expected tax receipts in April. While that sounds great that the deficit will be reduced by $112.9 billion you need to look at the bigger picture. The budget deficit in March was -$106.5 billion and -$203.5 billion in February. There was a surplus in April simply because April is tax month. The trend will revert back to monthly deficits once the late filers pay their taxes. The year to date deficit is -$488 billion. Interest payments on the federal debt rose +11.7% in April to $26.8 billion.
We had a very light economic calendar last week but next week the activity increases. The biggest report will be the Philly Fed Manufacturing Survey on Thursday. If the Philly report shows an increase in activity we could be off to the races. The weekly jobless claims will also be watched to see if they will set a new five-year low. That would also be very bullish.
The Empire Manufacturing Survey on Wednesday is not as important as the Philly Fed. However, it has only been positive for the last three months and a return to contraction territory could be market negative. The recent high was +10.0 in February and it declined to +3.1 in April.
The price indexes are not expected to show any inflation and could possible show signs of deflation. The Producer Price Index (PPI) was negative at -0.6 last month but it was due mostly to a decline in energy prices. The Consumer Price Index (CPI) also declined by -0.2% but that was also due to energy weakness.
New residential construction is expected to decline by -63,000 homes to 973,000. This is related to seasonal factors and weather. Last month the starts were 1,036,000 and the first time over one-million since mid-2008. They were +47% over the same period in 2012.
In the strange but true category the Bureau of Economic Analysis (BEA) has decided to change the way it calculates the GDP. Hey, $1 trillion a year in QE has not budged the needle so let's change the calculation. Currently when a company makes a contribution to a pension fund that contribution is counted as wages and is added to the GDP. In the future the BEA has decided to take the amount of contributions promised by corporations and call them wages even though they have not been paid and may never be paid.
For example XYZ Airlines (just an example) could have a pension fund that is under funded by $10 billion. They may have been paying $200 million a year because times are tough for the airline industry. They owe the $10 billion. That is a promise to the pension fund so the BEA suddenly decides to add that $10 billion into the wage kitty in the GDP calculation. XYZ Airlines may never pay it. If oil rockets to $125 next year and they begin hemorrhaging money again they could go out of business. Now take that example and multiply it by the thousands of corporations in the U.S. that have underfunded pension plans. We will suddenly have trillions of dollars in GDP calculated on the promises from companies who don't have the money to actually fund the pensions they owe. This is a bad idea and obviously just one more way to make it look like the economy is better off than it is.
Speaking of current economic conditions the Bloomberg Macro Index declined to its lowest level since October 2012. In the chart below the macro index is the red line. Note the solid decline starting in late March. The Macro Index measures the difference between the actual reported economic data and the consensus estimates for that data. For instance if the Philly Fed Index was expected to come in at 5 and actually came in at 3 then the difference would be subtracted from the Macro Index calculation. Over the last six weeks there have only been a handful of economic reports that have met estimates and there have been dozens that missed estimates. As you can tell by the green line that represents the S&P 500 the market has ignored the economic news.
S&P vs US Macro Index (Chart from ZeroHedge.com)
The stock news was dominated on Friday by the Carl Icahn offer to Dell's board. He took off the gloves in his fight against Michael Dell and he was not pulling any punches. He said Dell's $13.65 offer for Dell Inc was highway robbery and shareholders were "literally getting screwed." In the Icahn offer shareholders would get $12 as a dividend and retain their shares of Dell. The shares would not represent 100% of Dell but a stub amount. Icahn would take a portion of Dell private and the Dell shares would represent a fractional ownership. Basically investors would have $1.65 in their shares after the $12 dividend and Icahn thinks that would increase significantly. When Icahn did a similar deal with RJR Nabisco the $1 stub ownership went to $8 within three weeks. Personally I think it is a good deal. The difference between $12 and $13.65 in cash is minimal. I would much rather have that $1.65 share in a company Icahn is going to try and turn around. If he fails you did not lose much and if he succeeds then it could be a big win.
Icahn said the first thing he would do is replace Dell as CEO. He claims the company needs a new culture. It has been stuck behind Michael Dell's management style since inception and the business environment has changed. Icahn is going to nominate a slate of 12 directors to replace the entire board. Icahn has a 100 million share position (6%) in Dell. Hedge fund manager Jim Chanos said he reshorted Dell over the last several months because he does not believe the deal will get done. He pointed out that Dell's cash and receivables were roughly $8 billion but their liabilities were more than $13 billion. With PC prices plunging Dell's margins are shrinking. More than 18% of Dell shareholders have already said they would vote against the $13.65 offer.
Tesla Motors (TSLA) continued its rocket ride higher with another +11% gain on Friday. Tesla reported earnings of 12 cents compared to estimates of 4 cents earlier in the week and the reaction to the stock has been enormous. The stock closed at $55.71 on Wednesday before earnings and it closed at $76.78 on Friday for a gain of slightly more than $20. Revenue was $562 million and crushed estimates for $492 million. Gross margin was 17% and management expects that to rise to 25% by year end. They also raised production guidance to 21,000 vehicles for the year and the company believes end user demand will exceed 30,000 vehicles.
The earnings were great but it is the shorts driving the stock price. More than 55% of the shares are held by five entities and don't trade in the market. The latest numbers show 41% of the actual float is short. I suspect short interest declined a lot this week but you never know. TSLA shares are up more than 130% for the year. I am sure many traders are expecting this bounce to fade so they may be adding new shorts at this level. That has been dangerous in 2013 and with the new guidance I don't see any reason for the stock to go down other than just being overbought.
Rare earth miner Molycorp (MCP) rallied +31% on Friday after they reported a smaller than expected loss and higher than expected revenue. The company lost 15 cents compared to estimates for a loss of 31 cents. Revenue was $146.4 million compared to estimates for $135.6 million.
The company said they were seeing signs of returning demand after two years of contraction as the global economy declined. Over those two years the company has quadrupled production but because of falling prices they had to raise more cash with offerings and debt to fund the upgrades to the mine. Molycorp had become something of a joke in the market because they had to raise money so often. That trend appears to be over now that the higher production rates are producing more cash. Customers fearing an ever increasing price for rare earths had stockpiled inventories three years ago and then demand died. Those high inventories had depressed prices. Now that demand is returning those manufacturing customers are depleting inventories and are starting to return to normal purchasing cycles according to Molycorp. Actual rare earth demand is higher than annual production so once the inventories are depleted the high prices will return.
Molycorp had been heavily shorted as it declined from $80 in 2011 to less than $5 in April.
Priceline (PCLN) reported earnings on Thursday of $5.76 that beat estimates by 49 cents. That was a +35% increase in earnings. Revenue rose +26% to $1.3 billion that barely beat estimates of $1.28 billion. Those metrics would appear to be good but shares declined -$45 on Thursday night. Look out below for Friday if Thursday's after hours drop was any indication. We would have been wrong on that assumption. Despite warning that revenue growth would slow to 15%-22% and earnings per share to range from $8.87-$9.45 the stock soared. Analysts were looking for a +23.3% increase in revenue and EPS of $9.58. Priceline shares spiked +$28 on Friday. Brokers all jumped on the wagon in saying positive things about Priceline's international business, which some felt would rise up to 40%. RBC Capital reiterated their $900 price target. With $30-$50 swings you have to have nerves of steel to own PCLN but the long term outlook is still good. Buy the dip, not the spike.
The S&P-500 set a new high on Friday and it is the most overbought it has been since early 2011. There are 93.8% of the S&P stocks currently trading over their 200 day average. Bespoke claims the S&P is trading more than two standard deviations away from its 200-day and that is a level that almost always results in a correction. Apparently traders either don't know or don't care because the Fed QE put is in place. Until this changes the dips will be bought.
Percentage of S&P stocks over their 200 day average - 93.8%
The Bullish Percent for the S&P is an astronomical 86.2%. That means 86.2% of the S&P is showing a bullish signal. Historically anything over 70% is considered overbought and anything under 30% is considered oversold. Clearly the S&P is overbought and at a level that has produced sell offs in the past.
S&P-500 Bullish Percent Chart
At the same time the amount of margin debt has reached and possibly exceeded the record levels of July 2007 of $381.4 billion. The debt at the end of March 2013 was $379.5 billion. When we get the month end numbers for April I believe we will have a new record.
I have nothing against buying on margin but there is a bad historical precedent when margin debt hits the highs. When a market drop begins it tends to accelerate rapidly as stops are hit and margin calls delivered. Investors buying stocks on margin tend to be "weak holders" and that means an elevator market when a decent drop appears. They say bull markets climb the stairs up and take the elevator down.
Margin Debt Chart Courtesy of WSJ
The S&P managed to close at a new high on Friday at 1633. However that was below the intraday high on Thursday of 1635. Both of those numbers are right on uptrend resistance and in normal markets we should be expecting a decline soon. This has not been a normal market.
We are so far above support at 1580 it would take a major multiday reversal to reach it. That does not mean it is not possible but given the current investor sentiment it does not seem probable.
Just remember there is seldom a visible excuse for a market decline that can be seen ahead of time. Most declines are driven by a news headline that is unexpected. If it was expected it would already be priced into the market.
An example of what could crash our market would be news of an Israeli attack on Iran with assistance from the USA. A retaliation from Iran against oil producing nations in the Persian Gulf and the Strait of Hormuz could drive oil prices to $200 and our markets would implode.
Another possibility would be sending in 500 marines to Libya to evacuate U.S. citizens. That could happen on Monday after the riots this weekend. The marine force was put on standby on Friday along with a contingent of special operations forces in Germany. The U.S. and U.K. have already withdrawn some embassy personnel as violence is increasing.
Another headline would be an unexpected announcement from the Fed they were changing the QE program. This could come in the form of an authoritative comment from a Fed president that sounded like he had knowledge of a plan. Since a change is not expected until Q4 any near term announcement would be traumatic.
We can't plan for these events. We can only keep our stops in place and limit the damage when a headline occurs. Remember the margin issue. Everyone is expecting a short dip of 2% or so. If it is worse and sell stops are hit and margin calls delivered the decline can take on a life of its own. Be prepared.
S&P Chart - Daily
The Dow eased above 15,100 but it was a struggle. The close was lower than Thursday's high of 15,144 but still an uptrend. The Dow has plenty of room to run before reaching uptrend resistance but individual Dow stocks are starting to fade. This could be just exhaustion and the need to consolidate but it is more likely a need for profit rotation. Investors currently long need to take profits and let other investors with fresh money take their place.
Like the S&P the closest meaningful support is well back at 14,700. In today's market a -400 point decline to that support level would be traumatic. It will eventually come but it may require a headline to make it happen.
Dow Chart - Daily
The Nasdaq is clearly in breakout mode. After a couple days fighting uptrend resistance the battle was won and the Nasdaq is surging higher. That uptrend resistance should now be support at 3425 and we need a test and rebound to prove it. Tech stocks are being led by semiconductors and biotechs and there is no weakness like that evident in the Dow.
Nasdaq Winners & Sinners
The Russell 2000 posted a +2.17% gain for the week and was the best performing of the broader equity averages. The Transports manages +2.5% and the semiconductor index +3.3%. These moves are very bullish. When the small caps and transports are leading the rest of the markets will follow.
The Russell closed at a new high with a respectable +9 point gain on Friday. The Russell has plenty of room to run and it is starting to look like 1,000 is the next target. That could easily be reached this week without any major change in market sentiment.
Continue to watch the Russell 2000 for market sentiment and direction.
Russell 2000 Chart
The Transports are the first worry signal for next week. Note in the chart below the rally stalled at 6400 and both Thursday and Friday were lower highs. If the Transports were to dip below 6300 it would be an early warning signal that would likely carry over into the Russell and then the big cap indexes.
Dow Transports Chart
Thursday's rumored article on how the Fed plans to exit the QE program was published in the WSJ late Friday. The article was written by Jon Hilsenrath and he sounds a lot like Dallas Fed president Richard Fisher. He claims the Fed has mapped out a strategy to reduce the amount of bonds they buy in "careful and potentially halting steps, varying their purchases as their confidence in the job market and inflation evolves." Hilsenrath said, "The timing of this program is still being debated AND it might not be a clear and steady path the market expects." The Fed wants to avoid a clear and steady path in order to keep expectations uncertain. That prevents traders from front running the Fed. If purchases can go up or down at any time then speculators don't know which way to bet.
A WSJ survey showed that 55% of economists expect the first cut in purchases to come in Q4. However, 45% still expect the Fed to wait until 2014 or later. Despite no concrete data in the article this could disrupt markets on Monday. Any discussion in print of the QE termination plan always roils the market. Hilsenrath has had his share of insightful articles on the Fed in the past that tended to come true. The whispered release date for a termination plan is the September 18th FOMC meeting announcement. That is the first meeting after the Fed's Jackson Hole conference that Bernanke has decided to attend. He normally gives the keynote speech. Analysts believe that is a sign Bernanke is leaving the Fed when his term is up in January. I don't blame him. Unwinding this mess is going to be potentially catastrophic and he does not want to be in the hot seat when it happens.
Bernanke gave a speech on Friday where he said, "In light of the current low interest rate environment, we are watching particularly closely for instances of 'reaching for yield' and other forms of excessive risk-taking, which may affect asset prices and their relationships with fundamentals." That may have been the wink and nod warning that a change is coming. The term "bubble" has been used a lot lately on multiple markets. If enough FOMC voters start believing the bubble talk they could decide to pop it before it became too large.
The equity markets are addicted to stimulus and eventually there will be withdrawal pains.
The consensus this weekend is that there will be a short decline in our immediate future and that will be followed by a new leg higher to SP 1700. Be alert for the excuse the broadcasters will blame for the next market decline.
If you want to take your mother somewhere unusual for Mothers Day you could try Hooters. They are offering to give $10 in free food to any mother accompanied by a child. If you are even remotely considering this as an option you need serious psychological help.
Enter passively and exit aggressively!
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"The only function of economic forecasting is to make astrology look respectable."
John Kenneth Galbraith