The Dow lost -70 points at the open on the weak Nonfarm Payroll report but the dip buyers were waiting.
The biggest headline of the day was of course the Nonfarm Payrolls. The economy added +162,000 jobs in July compared to expectations for +185,000 to +200,000. The ADP report on Wednesday showed a gain of +200,000 and that increased expectations for the Nonfarm numbers.
The BLS revised May and June lower by a combined -26,000 jobs. May slipped from +195K to +176K and June declined from +195K to +188K. This was the first downward revision in several months.
The establishment survey was lackluster with the +162,000 jobs gain. The internals were terrible. Only 35% of the jobs created in 2013 have been full time jobs. The rest are part time thanks to the approaching cloud of Obamacare. I expect that trend to change over the next six months since the implementation has been pushed off until January 2015.
The economy has to create a minimum of 150,000 jobs per month to account for new entrants into the job market from graduations and immigration. July's gain of +162,000 is just treading water.
The separate household survey showed a gain of +227,000 jobs in July and the unemployment rate declined from 7.6% to 7.4% due to a lower labor force participation rate. More people quit looking for jobs and that lowers the unemployment rate. The larger U6 unemployment rate declined slightly from 14.3% to 14.0% as a result of that drop in labor force participation.
The payroll report was another Goldilocks report. It was just slow enough not to create fear the economy is rolling over and not strong enough for the Fed to relax. They are not going to change QE with jobs this weak, inflation falling at 1.3% and GDP at 1%.
The Intuit Small Business Employment Index is normally overlooked as the Nonfarm numbers get all the headlines. However, there is a trend in the employment and compensation for small businesses that took a sudden turn for the worst.
The index showed businesses with less than 20 employees cut about 10,000 jobs in July. However, compensation took a sharp turn lower. This is something the Fed watches. A decline in worker compensation can lead to a depression.
In the Moody's chart below note the compensation in orange since last August. It has been in a steady downtrend and it collapsed in July. The Fed is not going to change QE with compensation dropping.
Moody's ISBEI Chart
The Factory Orders report for June showed orders increased slower than expected at +1.5% compared to +3.0% in May and estimates of +2.5%. Previously released numbers for Durable Goods orders were revised down from 4.2% to 3.9%. Shipments were also revised lower to -0.2% rather than zero.
We have had some serious volatility in the various regional manufacturing reports. Some have fallen back into contraction. Some are still in expansion. However, the national ISM Manufacturing on Thursday was a blowout. The headline number rose from 50.9 and barely in expansion territory to 55.4 and the highest level since June 2011. Since the index was showing a contraction in May at 49.0 this sudden surge suggests everyone shook off the sequestration cloud and business activity is accelerating.
However, the majority of the gains came from a +6.4% rise in orders and a +11.6% rise in production. Those were the "seasonally adjusted" numbers. Unadjusted the respective increases were -1% and +2%. This suggests the ISM headline number could be a seasonal outlier and could be erased by another adjustment next month.
ISM Manufacturing Chart
Since I mentioned GDP earlier let me go over the government revisions that were released last week. They changed the accounting rules all the way back to 1929. I was expecting to see recessions revised away and recent numbers to be adjusted higher. Actually it was not as bad as I expected. In some years growth was revised higher and in some years it was revised lower.
I added up the newly revised GDP since Q1-2007 and the unrevised numbers for the same period. I averaged them by quarter and they were almost identical. The new revisions show a six-year average of 0.96% growth per quarter. The old numbers show quarterly growth of 0.92% over the same period.
That may sound really low and it is but that includes some seriously negative quarters during the Great Recession. In looking at the quarterly differences there are some big swings in individual quarters but overall the difference is minimal. Conspiracy theorists everywhere were disappointed.
A word of caution. Since World War II whenever the GDP for four consecutive quarters falls below 2% growth the economy has fallen into a recession. The four quarter rate through Q2 is +1.44%. (2.78, 0.14, 1.15, 1.67 = 1.44%)
Revised GDP Chart
Also worth mentioning, the MBA mortgage application index fell another 3.7% to a two-year low. This was the seventh consecutive weekly decline. This does not bode well for the housing sector. Home ownership is at an 18-year low.
Pimco's Mohamed El-Erian said the Fed statement was important for what it did not address. They did not discuss the taper and they abstained from evolving their forward policy guidance. They did stress the need for "highly accommodative stance of monetary policy" and the outlook remains uncertain, including the balance between inflation and deflation. When the central bank can't even decide which evil will appear out of the current economic uncertainty, they are not going to reduce QE. The next meeting is September 17th and this is going to be a critical meeting. The Fed will be forced to update their forecasts and Bernanke has another press conference. The market should be very cautious ahead of that event.
To say the economic calendar for next week is devoid of any material events would not be an exaggeration. The only event the market will care about is the ISM Nonmanufacturing on Monday and it is expected to surprise to the upside after the ISM Manufacturing blowout last Thursday. This report is normally ignored by the market because it is anti climatic. Since the U.S. has evolved into a service economy it should get more coverage but some things in life just are not fair.
The earnings calendar looks a lot like the economic calendar. This is the last week for major Q2 earnings activity although there will be some stragglers still to report in the weeks to come. Notables after this week are HPQ, CSCO and DELL. For some reason those three tech stocks can't or don't want to report early. I seriously doubt it takes them that long to put their earnings together so I suspect they just like being the big dogs in a week filled with kittens. They get noticed a lot more by delaying their report dates.
This week I had a hard time finding enough reporters to fill the graphic below. Those catching the most publicity will start with Disney on Tuesday and the $150 million loss they are going to take on the Lone Ranger movie. Up the next day are Green Mountain Coffee and the stock has gained +$10 over the last three weeks and near a 52-week high. They are always good for an earnings surprise and high volatility.
Also on Wednesday is Tesla Motors and they closed at a historic high on Friday at $138. That is roughly a $100 improvement from the $40 level where they were trading in April. Nearly everyone expects another earnings beat BUT when everyone already expects it the stock rarely does well afterwards even if they beat. The good news is already priced in.
Thursday has Priceline and Monster Beverage. Compared to those two the earnings from Progressive will be boring. On Friday the only two companies that routinely trade over one-million shares is biotech company Mankind and NRG Energy. All the other names not widely known.
Friday was a light day for earnings. Companies reporting included the CBOE (CBOE). Earnings rose +20% to 54 cents and revenue rose +14% to $150.8 million. Analysts were expecting 51 cents. The company said contract volume increased +3% to about 5 million per day.
Chevron (CVX) reported earnings of $2.77 compared to estimates of $2.97. CEO John Watson said the -25% decline in earnings was related to lower prices for oil and a heavy schedule of repair and maintenance work on U.S. refineries. The company still earned $5.37 billion so it was not like they have to cut back on food quality in the cafeteria.
Chevron's average price for oil was $92 per barrel in the U.S. and $94 overseas. That was more than $5 below their year ago levels. Watson said refined product prices had also fallen.
Global production declined -1.6% to 2.58 mbpd. The company said expanded projects in the U.S. and Angola could not overcome the decline from older fields. Chevron will not have any trouble increasing production when it's multiple natural gas projects come online over the next five years. They have multiple LNG products costing well more than $60 billion and they will have ten LNG trains operating by the end of the decade.
Exxon (XOM) said production fell -1.9% in Q2 for the ninth consecutive quarter of production declines. They simply cannot bring new fields on fast enough to offset the decline from older fields. Production averaged 4.074 mboepd in Q2. Liquids production declined -1.2% to 2.182 mbpd.
Exxon posted the biggest quarterly earnings miss since 1999. The company lost -$510 million on refining margins when oil prices rose faster than fuel prices. They also lost $370 million due to refineries undergoing maintenance. Net income fell -57% in Q2 but they still earned $6.86 billion, down from $15.9 billion in the comparison quarter. That quarter did have some special items from asset sales. Net income fell -19%. Revenue declined from $127.36 billion to $106.47 billion.
Exxon said part of the problem was the sluggish U.S. economy, the slowing economy in China and the two-year recession in Europe. This lowered the price they received for their overseas oil by $10 a barrel.
Shell (RDS.A) said it increased production +3.3% to 3.41 mboepd but has cancelled plans to raise production to 4.0 mbpd by 2018. The company said it was working on 30 major projects around the world and would spend $33 billion on capex in 2013. However, they face the same problems as Exxon and Chevron with older fields declining faster than they can develop new ones.
S&P earnings are going to finish with about +4% growth for Q2. More than 68% of S&P companies have beaten on earnings but only 53% have beaten on revenue. If the economy ever catches fire there is going to be a huge earnings explosion that takes S&P earnings well over the $120 expected in 2014. When that happens the markets are going into hyper drive with Dow 20,000 a distinct possibility over the next couple of years. Unfortunately that assumes the economy finds some traction and that has yet to happen.
The Great Rotation has yet to occur despite the slow transfer of some bond money into equities. Lipper said inflows into equity funds over the last week totaled +$6.6 billion while bonds saw outflows of -$1.6 billion. To put that into perspective since November equity funds have seen inflows of $206 billion. Over the prior five-years they saw outflows of $530 billion.
Since June 1st bonds have seen record outflows of $56 billion according to Lipper. Over the prior five years there were inflows of $1.4 trillion. So far the money coming out of bonds has been going mostly to money market funds. As of last week there was $2.604 trillion in money markets earning next to nothing.
Pimco's monster Total Return Fund (PTTRX) had outflows of $7.5 billion in July. That was the third consecutive month of outflows. The fund had assets of $262 billion at the end of July according to Morningstar. Jeffrey Gundlach's Double Line Total Return Bond Fund had $580 million in net redemptions in July. The fund had its first month of net withdrawals in history in June. The Great Rotation may not have arrived but bond funds are still bleeding cash.
The markets were volatile all week but the Volatility Index declined to a four-month low to close at 11.98. Nobody appears to be worried about a potential correction in the near future. They seem to have erased August and September from their calendars and they are skipping right to the normal Q4 rally. We will see how that works out for traders.
Volatility Index Chart
The various economic reports and the FOMC announcement whipped the yield on the ten-year treasury in better than ten point swings on Wednesday, Thursday and Friday. The trend is still higher and analysts believe fair value today is about 3.5% but that won't happen until the Fed exits QE. Anyone currently in bonds has been given fair warning that bond yields are going higher and probably a lot higher over the next two years. If the economy does find some traction the Fed could panic and start removing stimulus at a rapid rate and tank the bond market fast.
Ten-Year Treasury Yield Chart
The markets dipped at the open on Friday in reaction to the jobs report. Dip buyers arrived on schedule and the indexes began to slowly rebound around 11:AM. The Dow could not make it back to positive territory until James Bullard gave it the final push about 3:30.
St Louis Fed President Bullard said in a speech the Fed should wait for the expected second half rebound before tapering QE. "The committee needs to see more data on macroeconomic performance for the second half of 2013 before making a judgment on this matter." It appears if Bullard got his way it would be the middle of January before the decision would be made. You can't see "the data for the second half" until the half is over.
Bullard said inflation at the June rate of 1.3% is too far below the Fed's target of 2% and still declining. This poses risks to the economy. "The committee would not normally remove policy accommodation in an environment where inflation is below target and is projected to remain there." If accommodation is removed too early "inflation may be pushed even lower and the risk of deflation may increase."
These comments were all the incentive traders needed to cover shorts ahead of the weekend and the indexes rambled into positive territory and a new historic high for the Dow, S&P and Russell. The Nasdaq closed at a 13-year high.
Closing those shorts was probably a hard thing to do given the events in motion overseas. The administration announced it was closing more than 21 embassies and consulates in 18 countries in the Middle East and Northern Africa. The closure will begin on Sunday, a normal workday in those countries, and they will remain closed until further notice. Whether that is a day, week or month is unknown.
The closure of the embassies on August 4th, coincidentally President Obama's birthday, is due to what is seen as a credible terror threat in the region. Closing embassies over such a wide area suggests the threat was a coordinated attack on the facilities.
Al Qaeda was emboldened after the attack in Benghazi when no retaliation appeared. They were extremely successful in destroying the facility and killing the ambassador and even though the U.S. knew who did it within hours they never responded with an attack. There were no cruise missiles dropping into their headquarters unannounced. No drone strikes, no seal teams knocking down doors in the middle of the night. When Al Qaeda perceives weakness they go after it. You have to imagine they got the bright idea to replicate the attack in multiple countries at once and go for even bigger headlines.
The problem with combating this kind of terror is no timetable. If they call off the attack planned for Sunday they can wait days, weeks or even months and schedule it again and this time avoid the security leaks. Time is on the side of the terrorist. Eventually the U.S. will have to reopen the embassies to transact business and that makes them vulnerable.
General Martin Dempsey, chairman of the Joint Chiefs of Staff said the threat was "more specific" than previous threats and the "intent is to attack Western, not just U.S. interests."
Partial Map of Embassy Closures
The State Dept also issued a worldwide travel alert for U.S. citizens. The alert warned of "continued potential for terrorist attacks, particularly in the Middle East and Northern Africa, and possibly occurring in or emanating from the Arabian Peninsula." Also, "Current information suggests Al Qaeda and affiliated organizations continue to plan terrorist attacks both in the region and beyond, and that they may focus efforts to conduct attacks between now and the end of August." Citizens are urged to not travel to those areas and if they do to avoid normal tourist locations and infrastructure. That includes hotels, restaurants, transportation terminals, etc.
It sounds like a good weekend to be short the market but apparently the rally on the Bullard comments caused traders to abandon those plans and run for the exits.
The markets may have closed at new highs but the effort was definitely lackluster. Yes, there was a rebound from -69 on the Dow but every time the Dow and S&P hit a new high the sellers immediately appear. Thursday's opening short squeeze was the exception. So many people were short ahead of the Fed, ISM and Jobs that the blowout on the ISM was too much of a surprise.
The opening spike on the S&P took it from 1685 to nearly 1705 and it closed at 1706. The massive opening spike and slow grind higher the rest of the day was a typical short squeeze. On Friday the sellers appeared at the open but the dip buyers were alive and well. Thursday's high at 1707 was resistance until the Bullard comments.
S&P Chart - 4 min
Now the S&P has formed support at the 1701.50 level and that will give the dip buyers a frame of reference for the future. The next support level is 1685. Now that we are over 1700 the next resistance level is 1725 as a psychological level and 1735 as uptrend resistance. However, new highs tend to attract sideline money like ants to a picnic so it is hard to predict any material dip in the future.
We are so due for a dip it is ridiculous but markets like this tend to keep setting new highs. Bad news is good news because it keeps the Fed on hold. Good news is good news as long as it is a forecast and not an economic report. Predictions for 7% earnings growth in Q3 and 10% in Q4 with 2.5% GDP have investors almost giddy with excitement. Of course those numbers will be revised lower before we actually get there.
It is hard for anyone to predict a correction for this bull market since past predictions have failed and corrections normally arrive unexpectedly. If it was going to happen next week would be a perfect launch point with no economics of note and the end of Q2 earnings. Historically this is the week that typically declines.
Unfortunately you have to throw out all the adverbs like "typically" and "historically" as well as the adjective "seasonal" and similar words. Bull markets can last far longer than naysayers can remain credible. Eventually something will happen and the headline will be seized upon by investors as a reason to sell. Until that happens we can continue to party like its 1999. Unfortunately you know how that rally ended.
The Dow came back from a -69 point drop at the open to negative single digits before the Bullard comments. At 3:30 the short covering began and the Dow shot up to close at the high of the day at 15,655. The high on Thursday was 15,650 so there was no real surge to new highs. It was a small step and that 15,650 level was not surpassed until the last 5 minutes of trading.
With the Dow and S&P closing at new highs the financial newspapers and websites were able to report the new highs over the weekend and keep the positive sentiment alive. The market appears ready to move higher after three weeks of consolidation at the 15,500 level. Sometimes appearances can be deceiving.
You have to wonder what will propel the markets higher next week with limited economics and very few high profile earnings. At this point I don't think it will take a major headline since the uptrend is still in place. Fear of missing the rally will keep money coming into the market until a sufficiently negative headline reverses the trend.
Disney is the only Dow component reporting next week but Disney is not a volatile stock. Even if it drops a couple dollars after earnings it won't make a big impact on the Dow. Other companies like United Technology (UTX), 3M (MMM), Boeing (BA) and Wal-Mart (WMT) are pushing the index higher.
Resistance for the Dow is right where is closed at 15,650 and with the Dow in historic high territory the next target level could be 16,000. That would be some serious round number resistance. Support over the last week has been 15,500, followed by 15,400 and then the 30-day average at 15,240.
The Nasdaq blasted off from its base at 3600 and is now above all prior levels of resistance. The Nasdaq is leading the broader indexes and there is no weakness apparent. The Nasdaq rally is broad based and anchored by Apple (AAPL).
The only thing you can say about the Nasdaq chart is "breakout." A couple more days at this rate and overbought will again be a common adjective but the path is clearly higher as long as the overall market doesn't trip over some headline.
The Russell spiked to 1060 on Thursday and came to a dead stop. It was the only major index to post a loss on Friday when it could not move over that 1060 level. After two weeks of consolidation at 1040 I would have expected the Russell to breakout along the lines of the Nasdaq move. When it barely managed to move over the July 23rd high at 1057 that suggests sentiment is weakening.
We watch the Russell for fund manager sentiment. Because small caps are not liquid we see managers begin to unload these stocks before they do the big blue chips. The Russell is a leading indicator of sorts. I view Friday's lack of a positive close as a caution. Granted the S&P only managed to gain +2 points but it was a gain.
Intraday support was 1055 on Friday. That would be my first red warning line. The intraday low on the opening dip was 1053. A move under that low would be a signal there may be trouble ahead. A decline under strong support at 1040 would be a strong warning.
Uptrend resistance is 1065 so the initial upside may be limited without a broad market rally.
Russell 2000 Chart
The Dow Transports posted a huge move on Thursday after the ISM blowout. That move failed to continue on Friday with a loss of -18 points. That was a new high for the Transports but I am at a loss as to why they rallied. UPS and FDX both warned with earnings. Shipping volumes were falling and cheaper methods were being used. Railroads have been strong but when WTI prices rose to meet Brent last week the need for refiners to ship 780,000 bpd by rail dissipated to some extent. Home builders reported a decline in home sales and we are heading into the fall season where building material shipments decline. The airlines are the only sector left and they are doing well. Boeing is trying to set a new high and the same with Delta and United. The airlines are the only real strength in the Transports.
I think the ISM spike was more short covering than a sudden desire to own transports because the economy was improving. I doubt it will last unless the economic reports suddenly improve.
Dow Transports Chart
Next week is going to be crucial for the bulls if they want to maintain this rally. It should be a low headline environment and summer is running out. Investors will be faced with deciding whether to trade or take vacations before the kids go back to school. Typically this is the weakest part of the summer.
We have five weeks before lawmakers return from the August recess on September 9th. That is when the debt ceiling debate will shift into high gear and both sides have dug in for a hard fight. You can bet the president will not miss a chance to blame the future budget fight on republicans while lawmakers are on break and not in front of the microphones in Washington. Once they return on the 9th the competing headlines and warnings of government shutdowns will monopolize the headlines. The market tanked in 2011 when this fight was last held and S&P downgraded the U.S. credit rating. It is entirely possible this fight will be even more painful. It is even more likely the smart money will begin to take profits before the official battle begins in September.
I seriously doubt the Fed is going to taper QE on September 18th with the budget battle raging in Washington. If the markets weaken as I expect going into that battle the Fed will probably move their taper decision to the October 30th meeting. That won't keep traders from fearing the September meeting since the majority of analysts still believe there will be a taper announcement in September.
I am adding a post script tonight that I think everyone should read regarding EMP. It is not market related but it is important.
Enter passively and exit aggressively!
Send Jim an email
"I had a rose named after me and I was very flattered until I read the description in the catalogue: 'No good in bed, but fine against a wall.'"
Are you prepared for trouble?
According to three experts on EMP about two weeks ago the earth narrowly missed being knocked back into the 1850s technologically. According to Vincent Pry who served on the Congressional EMP Threat Commission from 2001-2008, former CIA Director James Woosley and Henry Cooper, a strategic arms negotiator under President Reagan, a Carrington class coronal mass ejection just missed the earth in July.
Let me define some terms before I continue. EMP means ElectroMagnetic Pulse. This pulse travels instantly through the atmosphere and depending on the strength can permanently destroy every electronic device with a microchip. Phones, TVs, satellites, radios, computer monitors, car and truck engines, water pumping stations, electrical substations, electric grids, etc. Anything with a chip, which is basically everything electrical in existence today.
An EMP can be caused by a nuclear weapon detonated high in the atmosphere. North Korea, China and Iran have published papers suggesting the first shot in a war with the USA would be an EMP blast high above the USA. That would eliminate any electrical device in the continental USA depending on the height of the blast. Iran and North Korea have already tested delivery systems for EMP weapons. Those tests are kind of an implied warning to the US.
An EMP can also be caused by a coronal mass ejection or CME from the sun. The sun is constantly exploding large fireballs into space and they travel at up to 4.5 million miles per hour. It takes 17.6 hours for one to reach earth. Normally the earth is protected by its magnetic sphere that dissipates the charged particles and the most we see of it is an increased Aurora Borealis or northern lights. A CME can cause the same damage as an EMP.
In 1859 an astronomer named Richard Carrington observed the largest solar flare on record at the time. This was so severe that the Aurora Borealis was seen as far south as Cuba and Hawaii. It was so bright over the Rocky Mountains that gold miners got out of bed and began making breakfast and heading off to work because they thought it was morning.
The geomagnetic storm was so strong it melted telegraph wires off the poles. Telegraph systems all over America and Europe failed. The telegraph systems were about the only electricity in use at the time.
There have been numerous smaller events that occur on a routine basis and knock out power to selected areas.
If that same event happened today every electronic device we have would be destroyed. Lloyds of London used the collected data on the Carrington event to try and estimate the cost of that event today. In June 2013 they estimated the cost to be $2.6 trillion.
The real cost would be in human lives. The presidents EMP commission and many scientists believe the loss of life in the developed economies could be as high as 90%. Think about that number. That would equate to roughly 280 million in the USA.
We live in a society where buying food is a 5 min trip to the local supermarket. After an EMP/CME that store would be empty in three days or less. There would not be any semis making 4-6 deliveries per day to keep it stocked because the trucks would not run. The crops would die in the fields because there would be no tractors to harvest them, no trucks to carry the produce to market and factories to process and package them. There would be no operating refineries because they depend on electricity. There would be no water in the pipes and no sewage treatment because everything depend on electricity. There would be no electricity for years because all the circuits would be fried. All the replacement circuits are made in China and replacing the millions of fried parts would depend on whether China was hit by the same EMP. If they were spared it would still take years for them to produce the parts and ship them to the USA.
The government would be ineffective in coming to our rescue because without electricity the government can't communicate and without electricity nothing moves. They could not ship relief supplies even if they had enough for 330 million people.
The point of this story is preparedness. There is some debate on whether the event actually occurred two weeks ago or not. Some say the event was generated by an article on a website and then repeated across the Internet, which is the largest echo chamber in the world. The three scientists I named earlier all believe it happened.
Reportedly the CME ejected across earth's orbit around the sun. If the ejection had been two weeks later in the same location civilization as we know it would be over.
Even if this particular event was just an example of Internet rumors gaining a life of their own it is a warning to everyone that it could happen at any time. According to scientists it is not a question of WILL this happen but WHEN it will happen. According to ice cores taken from the poles there has been a major event, significantly larger than the Carrington event about once every 500 years. Smaller events, still dangerous to the electrical life we have now, occurred on average every 100 years. That suggests we are overdue since the original Carrington event was in 1859.
With Iran, North Korea, China and Russia all capable of sending one lonely nuclear missile high into the atmosphere over the U.S. the potential for an adversary to bomb us back into the 1850s is also very high. North Korea has already put a "satellite" into polar orbit with the trajectory necessary to hit the U.S. and they have nuclear capability. If Iran gets a nuclear weapon they already have delivery systems.
One common thread in military circles is worry about a terrorist attack where they shoot a missile from a container ship off the coast of the U.S. and that can very easily be done. The CIA published pictures of "missiles in containers" where North Korea has already tested that launch capability.
Are you prepared? What would you do if you woke up on Monday to a world with no electricity and no transportation? Obviously very few people can prepare enough to outlive a Carrington class event. You can't store enough food or protect yourself from the mobs of starving people it will produce.
However, you can protect yourself from shorter term events that may be localized rather than global. Take a few minutes this week and think about what you would need for your family if electricity died and transportation stopped in your part of the world.
I am not selling anything. I have been aware of the dangers of EMP/CME for a long time. The story of the near miss two weeks ago awakened my fears again and I am committed to revising my disaster preparedness plans to account for a longer time horizon. While we can't prepare enough for the worst case we can prepare for a temporary disruption of weeks to months.
Thank you for reading my rant. I hope it stimulates you to action.