The market sank Friday as prospects of a government shutdown increased.
The headline war heated up last week but has not yet reached the fevered pitch we expect to see on Monday. After a week of parliamentary maneuvering in the Senate the short term budget bill that now includes funding for Obamacare was sent back to the House. If the two sides cannot agree on a compromise by midnight on Monday the government will shut down. Neither side wants to be left holding the bill at midnight. It has become the proverbial hot potato and the blame game is in full swing.
House Speaker John Boehner has already signaled he will not accept the Senate passed version of the bill. The president took the bully pulpit on Friday afternoon and warned the republicans not to go down the road that leads to a government shutdown. The president said, "Undoing Obamacare is not going to happen." Since the president would have to sign any bill passed by the House and the Senate any bill without Obamacare is going to be vetoed by the president.
Lawmakers have got to decide what they want compared to what they can actually accomplish. The president is VERY persuasive in his speeches and the majority of the public will believe whatever he says. He will pin a government shutdown on the republicans regardless of how much the Senate votes play in the process. The democrats have already begun a preemptive campaign to aggressively blame the republicans. During the debate over the budget bill the democrats displayed a countdown clock to the "Republican government shutdown."
The absurdity of the situation amazes me. The republicans want to defund Obamacare and the democrats don't. Why do the republicans get all the blame for a government shutdown when 50% of the blame is on each party? Because the democrats are better at pressing their case with the public and the tiebreaking vote is President Obama. He gets to point the finger and there is nobody on his level to point it back. He is "above the fray" so it appears to the public that he is right.
The republicans will lose the budget battle. With the heat of the democratic spotlight already blaming them for the shutdown the representatives with weak knees will cave in and a compromise will be reached. There will be a last minute bout of shouting and parliamentary gymnastics but it will probably be passed in time to stave off a government shutdown or the shutdown will be minimal.
The real headlines will come next week when both houses take up the debt ceiling debate. This also has more potential to rock the markets than the budget battle. The debt ceiling debate has a long history of hostility and legislative impasses. The House has already said it was going to put a one-year delay of Obamacare in the bill along with further spending cuts and the Senate has again said it will be dead on arrival. Cue the harsh headlines. The Treasury said it will run out of money between October 9th to 17th. If that happens the administration will be forced to begin closing certain areas of the government to save money until a deal is reached. The IRS will be among the first to close and that can't be all bad.
The president took to the podium Friday afternoon to deliver a 10 min monolog on why he was not going to negotiate with republican extremists over the debt ceiling and why it would cause the U.S. to default on its debts. Every knowledgeable person knows there is no risk of a government default but it always makes a good sound bite. The government takes in $225 billion a month and the debt service is only $38 billion a month. There is plenty of monthly revenue to pay oll the debts. This is just an administration scare tactic that has been used for decades.
I believe the republicans will be successful in getting the one year delay in Obamacare. If they don't the actual implementation could be a disaster and the consumer uproar could change the outcome of the 2014 elections.
For traders it means we have a very good chance of buying stocks cheaper over the next two weeks. The daily headlines shouting gloom and doom should push the markets lower. Buy the debt ceiling dip.
The economics on Friday were uneventful. The final reading on Consumer Sentiment for September rose nearly one point from the earlier reported number. The headline number rose from 76.8 to 77.5 but that was still down from 82.1 in August. Expectations were for a rebound to 82.0 so this was a major miss. In fact it was the biggest estimate miss of 2013 and the lowest point since April. The present conditions component declined from 95.2 to 92.6. The expectations component declined from 73.7 to 67.8. You can blame that on the rising headlines in Washington and the Syria debacle.
Personal Income growth for August accelerated to 0.4% and the fastest rate since February. However, gains were led by rental income and proprietor's income. Clearly that does not apply to 95% of consumers.
Consumer prices as measured by the PCE deflator rose +0.1% to +1.2% over the trailing 12 months. Clearly there is still no inflation. Energy prices actually fell -0.2%. This report was ignored.
The economic calendar for next week is very busy and there are a lot of important events. Starting the week off is the potential for a government shutdown if a budget bill is not passed by midnight.
The Institute for Supply Management or ISM Manufacturing for September will be released on Tuesday. Expectations are for a slight decline.
Wednesday is the first major employment report for the week with the ADP report. Last month this report showed a gain of +176,402 private jobs in August. With the weekly jobless claims hitting six-year lows we may begin to see a pickup in new jobs. Jobless claims at 305,000 on Thursday were the lowest since Sept 2007.
Bernanke speaks to the St Louis Federal Reserve conference on Wednesday at 3:00 so Wednesday's market close could be interesting.
Thursday has the Challenger Employment report but that is less followed than the other major reports. The ISM services report for September is also expected to post a minor decline.
The big report for the week is the Nonfarm Payrolls on Friday. The estimate is for a gain of +180,000 jobs compared to a gain of +169,000 in August. The Fed wants to see "sustained" job gains in the 200,000 range before they will consider changing policy. Bernanke said after the last meeting and Bullard repeated it the next day, they want to see the unemployment rate decline from rising employment not falling labor force participation. The Fed realizes the "reported" unemployment rate is fictitious because more people are giving up jobs in favor of unemployment, welfare and disability checks rather than their inability to find jobs. The true unemployment rate is around 11.4% but to report that in the major news outlets would cause turmoil in Washington. Instead they continue to massage how they report unemployment to present a positive picture.
Since we have no control over the numbers we have to play the hand we are dealt. That means reacting to the headline as though it was a correct representation of reality. Any number over 175,000 could produce worry about QE tapering in October. Any number under 150,000 should be market positive because it means QE will remain in place.
I have heard several analysts over the last week that believe the decision not to taper in September had more to do with Janet Yellen now being the assumed nominee to replace Bernanke. On a scale of 1-10 with 10 being the most dovish, Yellen is probably a 12. If Yellen is nominated some believe there will be no taper until Q1.
On that same subject since there are no potential nominees that are anywhere close to Yellen in the pool of nominees several political analysts believe the president is holding her nomination back as a hole card to play if something blows up on him during the debt/budget battles. The nomination would be a positive headline to offset a negative. Time will tell if that analysis is correct.
Stock news was relatively scarce on Friday with all the headlines focused on Washington. However, JC Penny (JCP) was again on the hot seat. On Wednesday Reuters reported JC Penny was going to offer $1 billion in stock to raise money. Also on Wednesday the CEO, Myron Ullman, had breakfast with the analyst community, was questioned about the story and was reported by two analysts to have said the company was comfortable with its cash position and had no reason to go back to the equity markets to raise cash. Shares rallied on the news.
On Thursday the board announced cash reserves were falling faster than expected and JCP was going to sell 84 million shares at $9.65 each to raise close to $1 billion. They lowered their yearend cash reserve estimates from $1.5 billion to $1.3 billion. This caused the stock to plunge to another decade low. The CEO now claims he did not make that statement on Wednesday. He did not rebut the statement on Thursday when the stock was rising. He only rebutted it after the investor community cried foul when the stock collapsed on the secondary offering news.
The company also reported the CFO left on September 20th. Normally these events are announced in advance so why are they just releasing the news? This is not good. Shares of JCP crashed to $9.05 and well under where the offering was priced at $9.65. Goldman Sachs is the sole book runner for the offering. It will be interesting to see how many shares they actually sell.
BlackBerry (BBRY) made news again when it officially reported earnings that were in line with the preannouncement made last week. That was not the big news. The big news was that CEO Thorsten Heins will receive a $56 million golden parachute if he loses his job after the company is sold. That package will include a "special performance bonus" tied to the launch of the Z10 series of phones. That is the phone that cost BlackBerry almost $1 billion in the recent quarter when the launch failed. That parachute was recently enhanced when the company was put up for sale. To make it even more bizarre Heins has only been the CEO for just one year. A year ago the stock was trading for $6.22 and it closed at $8 on Friday. More than 4,500 employees are being laid off without a parachute. Is that worth a $55 million bonus for the CEO?
Lumber Liquidators (LL) received an unwelcome guest on Friday. Federal officials including the Dept of Homeland Security and U.S. Fish and Wildlife Service executed a sealed court-issued search warrant at the Virginia headquarters and at a Richmond VA store. The company said it had no idea what the Feds were looking for. They confiscated documents relating to imports and they suspect it has to do with the century-old Lacey Act. This requires companies to obey other country's laws when trading animal parts. Wood was added to the law in 2008 to try and curb illegal logging.
Analysts say the scope is similar to the Gibson Guitar raid in 2011 where wood and guitars were confiscated when the rosewood was suspected of being imported illegally. Importers are famous for skirting the laws. If a company in the U.S. wants to import a certain type of wood, say rosewood, from a particular country where the harvesting of that wood is illegal the importers can sneak it out of that country to a third country and then export it to the U.S. from there. Buyers think they are getting rosewood from country B where it is legal instead of country A where it is illegal. Gibson ended up paying a fine of $610,000 and the forfeiture of guitars and wood inventory to settle the matter.
The Gibson raid was later thought to be politically motivated because they gave large amounts of money to republican and tea party candidates during the last election. Lumber Liquidators is a big sponsor of Rush Limbaugh on talk radio. If the IRS can target the Tea Party and conservatives it is not a big stretch to extend that kind of political harassment to Gibson and Lumber Liquidators by Fish and Game and Homeland Security. I am just reporting the news not making a statement.
Lumber Liquidators buys wood from all over the world and they have a staff of 60 just to monitor imports. They receive more than 250 container loads of wood from international sources every week. They have more than 300 stores nationwide. LL shares fell -5% on the news.
Nike (NKE) rallied +5% after posting earnings of 86 cents that beat estimates of 78 cents. Revenue rose +8% to $6.97 billion. Performance was robust in all geographic areas except for China. Gross profits rose +11% to a whopping $3.13 billion. Gross margin rose +120 basis points to $44.9%. That is a phenomenal margin and it came after a 12% increase in operating expenses. However, "demand creation" expenses fell -16%. I thought that used to be called advertising. The company ended the quarter with $5.6 billion in cash and investments. Future orders for the next four months were up +8%.
As a new component to the Dow the $3.30 spike in Nike added about 24 points to the Dow and the index really needed it on Friday.
Another new Dow component knocked -20 points off the index. Goldman Sachs (GS) loss -2.44 on Friday after the company was downgraded by three different analysts. Sanford Bernstein cut earnings estimates by 15% saying trading could be down as much as 15%. He also downgraded Morgan Stanley (MS) earnings by -20%. He said Q3 trading volumes are normally slow but this quarter turned into a "full-scale rout" with very low trading activity.
Marty Mosby, an analyst at Guggenheim Securities, cut Goldman and Bank of America from buy to neutral on worries that revenue from capital markets had declined sharply in September. He said fixed income trading revenue from the big banks probably fell -20% in Q3.
Richard Staite, an analyst at Atlantic Equities cut estimates for Goldman by -18% and Morgan Stanley by -25%.
Obviously it was not a good day for the banks. Goldman shares have been in a steady decline since being added to the Dow. They traded at $168.50 on Monday morning and closed at $159.73 on Friday. That is roughly the equivalent of 70 Dow points out of the -192 the Dow lost for the week. Thank you Goldman Sachs.
Several analysts have been pointing to the Baltic Dry Index, an index of shipping rates on normally traveled routes, as evidence of a global economic rebound. I have to admit the more than 100% surge in rates over the last six weeks has been spectacular. However, the spike was the result of Brazil suddenly dumping massive amounts of iron ore onto the market in July and August after shipments fell to a two-year low in June. They depleted the supply of available "Capesize" vessels and drove up the shipping rates. The Baltic index declined -3.2% on Friday and -4% over the last two days. There is a surplus of shipping capacity and the rates should decline sharply in the weeks ahead.
The Q3 earnings cycle will begin the week after the debt ceiling debate and earnings estimates are actually improving. S&P Capital IQ said Q3 earnings growth is now expected to be +3.5% and, drum roll please, revenue is now expected to grow +4.8%. Only two weeks ago they were expecting revenue to be flat to down. This is a major change in the outlook.
When you combine the improving economics overseas, improving earnings and dramatically declining jobless claims a picture of growth emerges. The key will be maintaining that growth spurt. The Fed has been projecting an acceleration of growth for a couple years now to no avail. Even a stopped clock is right twice a day and eventually the Fed will be right. I hope I am still alive to see it.
Something is supporting the market and for lack of a better reason we can call it earnings optimism. In reality investors are expecting the Washington headline war to eventually end and remove the barriers to a Q4 rally. All the prior speed bumps have proven to be minimal and that has spiked investor confidence.
The S&P dipped to 1687 on Friday and just above decent support at 1680-1685. The rebound was minimal but given the potential for weekend event risk out of Washington it was amazing we did not close nearer the 1680 level.
The S&P has declined almost daily since the post FOMC high on the 19th. However, the pace of the decline has slowed over the last week as investors pass time waiting for the Washington fireworks to be over.
Resistance is 1700-1705, support 1680-1685.
S&P Intraday Chart - 45 Min
S&P Chart - Daily
The Dow remains the weakest index with a drop to within 11 points of 15,200 on Friday. At the open the Dow fell -116 points but recovered to close down -70. That is still a three-week low with IBM and GS responsible for most of the drop.
When support at the 15,300 level broke it opened the index up for a drop to 14,880. The close just above the 100-day (15,231) was token technical support. The Dow is not normally reactive to moving averages because of the impact of single stocks like IBM or Goldman. Still, a break and close under the 100-day is a technical failure of support.
The Nasdaq is holding the high ground and wedging up to what could be a powerful breakout or breakdown. All we know for sure is that the successive pattern of higher lows is more pronounced than the lower highs. When you consider the recent headlines, the extreme event risk and the lack of a material decline this suggests the break will be to the upside.
Obviously any unexpected headline could trash the pattern and cause a significant drop but I would bet almost every professional investor and trader already understands the potential for a debacle next week. This potential should already be priced into the market.
Nasdaq Chart - 45 Min
Nasdaq - Daily
The Russell 2000 remains a bullish sentiment indicator. The Russell 2000 and the Nasdaq posted gains for the week while every other index posted declines. The Dow lost -193 points, NYSE Composite -85, S&P -18 and Transports -95. The Russell gained a point. Granted it was not a big gain but compared to the big cap losses it was very telling.
Fund managers simply do not appear to be afraid of the future. They are staying invested in small caps as we head into month end. It will be interesting to see if they rotate out once into October and just ahead of the October 31st fiscal year end for funds. There are some monster profits accumulated in hundreds of stocks and managers might want to capture those profits and secure their bonuses.
The Russell is moving slowly higher using uptrend support with solid resistance at 1080. If we break that to the upside we could see some significant price chasing.
Monday is the end of the month and the quarter. We should see some window dressing as long as the major papers are not running three-inch headlines proclaiming a government shutdown.
As I stated above I believe everything less than Armageddon is already priced into the market. Traders and investors are expecting the headlines and rather than be afraid they are hoping for a buying opportunity. We have seen this debt ceiling story before and we know how it ends. There have been 18 government shutdowns since 1976 and the country is still intact.
I think we should buy the debt ceiling dip. That is different from any budget dip we may see early in the week. The debt ceiling debate will follow closely to the budget battle but it is a separate event.
You are going to hear a lot about the debt ceiling over the next couple weeks. It is currently about $17.4 trillion. We routinely talk about millions, billions, trillions of dollars and even quadrillions of yen. I don't think many people can comprehend how big a trillion really is. I had someone explain it this way.
A million seconds is 11.57 days
A billion seconds is 11,574 days or 31.7 years.
A trillion seconds is 11,574,074 days or 31,709.8 years.
17.4 trillion seconds is 201,388,889 days or 551,750 years.
If we applied $1,000 a second to paying off the $17.4 trillion in debt it would take 201,389 days or 551.8 years. That is assuming no interest. Add the $450 billion a year in interest at the current rate and you add another 5,208 days of payments for every year of interest. In other words every year that passed you would become 14.3 years deeper in debt if we only paid $1,000 per second. When interest rates return to "normal" it would add 10,000 days of payments for every 365 days we paid.
We would have to pay $14,269 per second ($1.233 billion a day) just to pay the debt service each year with nothing going to principle.
There is no mathematical way we can pay down the debt so the entire Washington exercise is the equivalent of rearranging the deck chairs on the Titanic. Eventually the size of the debt will matter to foreign investors and when that happens it is going to be a very bad decade for the United States.
Enter passively and exit aggressively!
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"What beat me was not having brains enough to stick to my own game â€“ that is, to play the market only when I was satisfied that precedents favored my play. There is the plain fool, who does the wrong thing at all times everywhere, but there is also the Wall Street fool, who thinks he must trade all the time. No man can have adequate reasons for buying or selling stocks daily â€“ or sufficient knowledge to make his play an intelligent play."