The best week for the Dow since January has pushed the index to a +575 point gain for the month.
September is historically the worst month of the year for the Dow but it did not start off that way. If the rally continues this could be a September to remember for its gains rather than its losses. The Dow is now only 2% from the historic highs and the S&P only slightly more than 1% below the highs. The Nasdaq has already set new 13 year highs this month and would be higher were it not for declines in Apple.
Given the Syrian headlines in late August and the budget headlines out of Washington that are starting to heat up, the gains are positively amazing. The AAII investor survey was showing that 43% of respondents were expecting a correction two weeks ago and that level of bearishness is very high. On a contrarian basis that is very bullish. If that many people are short and expecting a market drop then every move higher is forcing additional short covering and that can be self sustaining for a long time.
Not to beat the headline risk to death again but the budget battle is starting to heat up. There may still be a deal to postpone the budget battle until December but so far there is no deal and only two weeks left before the deadline.
The FOMC announcement on Wednesday is still a big event even though the market has already priced in a $10 billion QE cut. I think this is the risk event for the week. The Fed said it would not cut QE until there was stable and sustainable economic growth. That is far from the case today. Therefore if the Fed does not upgrade its economic forecast at 2:PM on Wednesday and cuts QE anyway the market could react negatively. Once the Fed begins cutting the weekly economic reports are going to take on a lot more importance.
Lastly there are numerous rumors that the White House will announce Larry Summers for Fed Chairman next week. A Japanese newspaper reported Summers would be named next week citing unnamed sources. They also said Lael Brainard would be appointed as Vice Chairman replacing Janet Yellen. The rumors were so strong the White House had to restate "No decisions has been made." That does not mean the announcement will not come the following week. If President Obama does nominate Summers even after numerous lawmakers have specifically said they would vote against him the market could take it badly.
Last week 400 economists sent a letter to the president asking for him to nominate Janet Yellen instead of Summers. This came after 20+ senators sent him a similar letter several weeks ago on Yellen. Nobody has asked for Summers. As I have written before Summers is considered a bull in every china shop he has ever entered. Summers is for OMF operations in times of stimulus. That means the Fed would buy securities directly from the Treasury and directly monetize the Federal debt. Currently the Fed buys the securities in the open market in order to put cash back into the hands of investors. The difference is dramatic. A Summers Fed would not be as stimulative as a Yellen Fed.
News broke over the weekend that Summers has terminated his relationship with Citigroup in anticipation of the nomination. That sounds pretty convincing to me.
Economics on Friday were lackluster and the market dipped into negative territory early in the day. Dip buyers appeared and the markets posted another gain.
Consumer Sentiment for September declined from 82.1 to 76.8 and the weakest reading since April. The present conditions component declined from 95.2 to 91.8 and the expectations component declined from 73.7 to 67.2. Worries over impending changes in economic policy, softening economic outlook and slowing job growth were cited for the declines. With the markets closing at two-month lows on August 30th the early month sentiment numbers were setup to fall even though estimates were for a gain. It was the biggest monthly drop in 14 months and the largest miss versus expectations (83.0) on record.
I ran across an interesting chart from Citigroup. Sentiment has almost repeated the same pattern three times over the last 18 years. It runs up, stalls then crashes to a new low. Let's hope this pattern does not complete.
18 year sentiment history (Source Citigroup)
Retail sales for August rose only +0.2% compared to estimates for a +0.5% gain. Overall retail sales were the weakest in four months. Excluding auto sales the gain was only +0.1%. Year over year sales slowed from +5.7% in July to +4.7% in August. Excluding autos YoY sales were only 3.3%. Building materials declined -0.9% from a +1.8% gain in July. If you need a clue to the health of the housing market this would be it. Clothing and accessories fell -0.8%, sporting goods -0.5% and general merchandise -0.2%. Furniture and electronics were the leaders with +0.9% and +0.8% respectively.
The Producer Price Index (PPI) headline number rose +0.3% in August compared to a zero gain in July. However, the core rate declined again to zero from a +0.1% gain in July. The year over year headline inflation rate for producers was +1.4% with the core rate at only +1.2%. The gain in the headline number was driven by gains in food and energy prices. Commodities declined thanks to a -15% drop in corn and soybeans and -8% drop in natural gas prices. There were some abnormal events in August that supported prices with oil spiking on Syria as an example. This means prices should be flat to down in September.
The economic calendar for next week is going to boil down to two events. The FOMC announcement and the Philly Fed Survey. The Philly Fed is a proxy for the national ISM manufacturing out two weeks later. The FOMC is the rubber meets the road meeting that will start an entirely new discussion process concerning Fed direction. With the amount of taper talk over the last three months it would be a shock if they did not taper.
The housing numbers on Tue/Wed/Thr will be important but we are moving out of the season for housing so they will have less impact on the market.
The German elections on the 22nd will be important. Angela Merkel will probably win but she has had a tough race. After the election the real news will begin. Merkel is considered the backbone of the Eurozone because Germany is the deciding voice in direction. Once the election is over the eurozone problems will come back to the forefront. Greece will need a third bailout and it will not be pretty. Problems in Spain, Italy and Portugal have not gone away. There is talk of a "smaller" eurozone with several countries eventually leaving the monetary union. Expect those headlines to appear later this year. If by chance Merkel were to lose the election it would be a shock to the system and the markets would take it badly.
In stock news Twitter shocked the market by filing for an IPO. The stock sale is expected to be large but not like Facebook. With Goldman Sachs as the lead underwriter the IPO should be priced reasonably to allow a first day pop but not be obscene as we saw with Facebook. There is a lot of speculation on what the ticker symbol will be. Since TWIT is already the symbol for a stock in Taiwan, T is the symbol for AT&T and TW the symbol for Towers Watson they will have to use something different. Speculation symbols include TWTR, BIRD, CHRP, TWEET, HSTG, HTAG and HASH. Some suggested just using the "#" but that does not work on U.S. exchanges. Whatever they choose you can bet the IPO will draw a lot of attention. You can also bet that some investors in other social networking stocks like FB and LNKD will be selling shares to buy into the Twitter IPO. This could mark a temporary top in the other social networking shares.
The easing of tensions with Syria and the prospect for permanent diplomatic negotiations in lieu of an attack sent gold prices plunging. Expectations for a QE taper and resulting improvement in dollar strength also weighed on the yellow metal. Gold fell -4.4% for the week or a loss of -$60 to $1308 at the close. However, in the afterhours session the contract spiked unexpectedly to $1327.
Silver dropped -6.6% to $21.78 at the close but then rallied +50 cents after the close to $22.29. If the Fed were to pass on QE cuts both metals would rebound sharply.
Apple shares continued their decline to close at $465 on Friday. The iPhone C was priced higher than analysts expected and is causing a rethink on projected sales volumes and margins. Apple declines 71% of the time after a product announcement so I would not get too excited. The new iPhones are scheduled to be delivered earlier than expected and that could impact Apple's sales estimates and earnings for this quarter. So far the potential for a small boost to earnings is not supporting the stock.
Disney (DIS) continued its gains after saying it could buy an additional $6 to $8 billion in shares in the next fiscal year. Shares spiked nearly $3 on Thursday when the announcement was made and then gained another $1.20 on Friday. Disney is no stranger to share buybacks. They have purchased between $1.5 and $3.8 billion in shares in each of the last three years. They are planning on borrowing money to fund this buyback and that always bothers me. It is one thing if you have the extra cash lying around but borrowing it means adding debt and negatively impacting fundamentals. The spike in shares last week brought Disney right back to strong downtrend resistance.
The Japanese won the summer Olympics for 2020. They are introducing a new sport called Yen carry. By the time the 2020 Olympics begin the Yen will be nearly worthless. The Japanese debt has officially passed the quadrillion mark. (1,000,000,000,000,000) That is one thousand trillion Yen and that equates to 247% of GDP. Since Japan will need even more debt to finance the Olympics we can expect the debt to be over 300% of GDP when the games begin. The athlete that can carry the most Yen for 100 yards will be the winner in this new sport. Instead of a gold medal they will give the athlete the 100 pounds of Yen he will need to buy a Big Mac at the Olympic McDonalds.
Early Saturday it was announced that Russia and the U.S. had reached an agreement on Syria. The country will have a week to produce an "all inclusive" list of its inventory. I sure wish I could bet on the accuracy of that list since Assad said he had no chemical weapons as recently as three weeks ago and I am sure he will want to hold back some inventory for future use. After he produces the list a chemical weapons team will move into Syria and attempt to locate and secure the inventory from Assad's control and safe from capture by rebels. The weapons will somehow be magically destroyed by mid-2014. That would probably mean they would have to be transported out of Syria in the middle of a civil war. If Syria fails to live up to this agreement they can be sanctioned by the U.N. The U.S. claims they still have the right to use force but Kerry has agreed to abide by U.N. decisions. Since Russia has a veto on the Security Council there will be no use of force. I am sure Assad is laughing his head off at the final solution. He gets to provide an inventory of the weapons he does not want and the U.S. can't attack him.
This will probably provide a boost to the market on Monday since the threat of a U.S. attack has completely evaporated.
Triskaidekaphobia had no impact on the market on Friday. That is fear of the number 13 as in Friday the 13th. The actual fear of Friday the 13th is called paraskevidekatriaphobia where Paraskevi is Greek for Friday.
The Dow had its second best week of the year and it appears the bulls are still in charge after a couple weeks off to rest. The Barron's cover for the first week in September was a play on that bullishness and in the past covers like this tended to signify a pending top in the market. Once everyone is bullish the trend reverses.
Barrons, Sept 2nd Cover
John Hussman, of Hussman Funds, sent the following chart to John Mauldin and I am reprinting it here. Hat tip to both of them.
The topping process in the market does not occur overnight. It can take weeks or even months. We could be working on a top now that was begun back in May when the Dow stalled at 15,542. One alternative view would be a long term head and shoulders pattern in progress. I hesitate to apply much credibility to it until the right shoulder forms but we are close.
The S&P has a similar pattern but it does not resemble the H&S. The S&P has a long term pattern of lower highs and a higher high in the next couple of weeks would be a continued confirmation of the rising trend.
On a short term basis the S&P broke through resistance at 1680 and is now using that level as support. The historic high close was 1709.62 on August 2nd and we are only about 22 points away from that high. With the Fed in taper mode, the budget battles about to break out in Washington and the impending nomination of Larry Summers as the new Fed chairman the stage is set for increasing uncertainty rather than bullish confidence.
The wild card here for Monday is the deal with Russia over Syria. That should lift the markets for another day but then the headline will be old news and worry over the FOMC meeting will begin.
One point of note is that even though the S&P gained +4 on Friday it stalled right at resistance from Wednesday. The Syrian agreement could break that resistance and give us another shot at the recent highs. If the 1690 level holds on Monday I would be very concerned the next move will be lower.
The Dow has really sprinted higher since the August 30th low. The 15,300 level was intraday support on Thursday and 15,380 was resistance on Friday. The Dow could be under some pressure towards the end of the week as index funds sell HPQ, AA and BAC. Those stocks leave the Dow index at the close on Friday. Fortunately HPQ and BAC have high float and high volume so the limited amount of selling may not be a material impact to the Dow. Just be aware this is happening.
Quite a few of the Dow stocks had really ugly charts just a week ago and I am sure they were heavily shorted ahead of the September headlines. The short squeeze has eliminated those positions and now the upward momentum will have to be from buyers rather than from short covering. Those buyers may be tough to find.
Resistance is now 15,425, 15,500 and 15,650. Support is 15,300.
The Nasdaq gapped up on Tuesday to 3729 and that was almost the high for the week. There was a brief intraday spike on Thursday to 3731 but the trend since the Tuesday open was downhill. Once the Nasdaq broke out to a new 13-year high the advance stalled. Much of that was due to the heavy selling in Apple.
If the Nasdaq dips back below support at 3700 it could be a long drop with the next material support at 3600.
The Russell 2000 rallied to 1055 on Tuesday and came to a dead stop. Three days later it closed at 1053. This is solid resistance with the prior closing high at 1057. This could easily be forming a double top depending on the headlines next week. Headlines always trump technicals so anything is possible. A breakout to a new high could run into heavy selling as fund managers contemplate their end of year positions for October. Quite a few small caps have had major rallies in 2013 and managers could be thinking about cashing out some profits to secure their bonuses.
The flip side of that is the lagging performance of funds. The average fund is up only +9% for 2013 when the indexes are up around 18% on average. How do you justify the lagging performance to investors? Likewise if the market imploded on Washington headlines over the next three weeks how would they feel going into the October year end with only a 5% gain for the year?
I would watch support at 1050 on the Russell for directional clues for the broader market. If that level breaks the next material support is 1040 then 1012.
Contrary to the bullishness we saw last week I still believe the markets are at risk for a large decline. Economics are slowing, sentiment is declining, wages are falling, health insurance costs are rising and the Fed is probably going to reduce QE. Lawmakers are going to battle until the deadline over the debt ceiling and budget and the eventual compromise will be economically negative. The market is assuming the best outcome in all these cases and that would be mathematically unlikely. Investors have become numb to the headlines on the assumption that everything will always work out. We know from experience that this is a risky assumption.
Q3 GDP is tracking at +1.4% according to Moody's and +1.6% according to BofA Merrill. The bank warned "When excess liquidity is removed, the market will get 'CRASHy'" as deleveraging ends and the era of normalization begins.
Sunday is the fifth anniversary of the Lehman Brothers bankruptcy and nearly the end of the financial system as we know it.
I would continue to keep a watchful eye on the market because it rarely telegraphs the next big decline. Stay long until the trend changes but be prepared for the unexpected.
Enter passively and exit aggressively!
Send Jim an email
"An economist is someone who sees something happen and then wonders if it would work in theory."