The Dow, S&P and Nasdaq are all moving steadily towards round number resistance that could be hit on Monday.
The three major indexes are slowing approaching a series of what some would call critical milestones in their path higher. The Dow is 39 points below 16,000. The S&P is 2 points below 1,800 and the Nasdaq 14 points below 4,000. The potential for all three to hit their respective round number resistance on the same day is very high and that means the potential for a sell the news event is also high.
There is nothing magic about those numbers with the exception of the S&P. Many analysts have S&P targets in the range of 1,775-1,800 for year end and that means they either have to raise their targets or suggest taking some chips off the table. A JP Morgan analyst upgraded his S&P target on Friday from 1,750 to 1,800. Think about that. The S&P was 5 points below 1,800 at the time with 45 days left in the year. The odds of his target being hit are about 100% but then what will he do? With the current bullishness in the market it might have made sense to go to 1,825 or even 1,850 as some analysts have already done. Instead he picked a safe 1,800. When questioned he was neutral saying stocks are up strong for the year and there could be some volatility in December. He did not go out on a limb and he played it safe. That may be a lesson for equity investors in the weeks ahead.
The bulls are starting to pull in their horns and cautioning investors to be selective. That is a clue they are starting to worry. Need confirmation? The three major indexes made new highs again on Friday but the AAII Investor Sentiment survey saw bullish respondents fall -6.3 points to 39.2% and bearish respondents rise +5.7 points to 27.5%. The bullish high was 49.2% on Oct 24th and the bearish low was 17.57% on the same day. That means bullish sentiment has declined by -10 points (-20%) in the last three weeks even though the market is making new highs. That would seem to be a clue for astute investors.
We could continue to see a meltup in the weeks ahead but as I have reported several times in the last several weeks the market breadth is narrowing and funds appear to be going defensive by rotating out of small caps and into big caps. That may have started to reverse because the Russell 2000 showed new life last week.
The news was everywhere about Warren Buffett buying 40.1 million shares of Exxon Mobil. That is roughly $3.5 billion in stock. With 4.4 billion shares outstanding Buffet is not going to make a play for ownership of Exxon. He is not an activist investor like Carl Icahn so he is not going to demand a big dividend or try to force a spinoff of assets. Is Exxon a good company? Absolutely and they pay a nice dividend. I believe this was a defensive play for Buffett. Oil is at a five-month low so the odds of Exxon shares falling materially are near zero. Oil normally rises in the winter months. I believe Buffet was parking money in a dividend paying stock to wait out the next market dip. I could be wrong because he could have kept the money in cash but cash does not pay a dividend.
These events simply suggest that bullishness is no longer rampant and smart investors may be setting up for the next round of pin the blame on congress when the budget deadline of December 13th rolls around soon.
In theory investors should be even more bullish because the Janet Yellen confirmation hearing turned into a coronation event instead. Senators were overly nice and the confirmation is not in doubt. At the coronation Yellen blessed QE and said multiple times it would be dangerous to remove it too quickly. With the fiscal follies currently scheduled for Dec/Jan again the odds of a QE announcement at the January meeting are slipping again. March appears to be the month and that could slip even further into 2014 if there are any hiccups in the economic numbers over the next several months.
Investors should be bullish. Earnings were better than expected. Estimates for Q4 are rising. The S&P is still undervalued at 15 times 2014 estimates. Economics, although volatile, appear to be improving. Home prices are up and gasoline prices are down. Inflation is nonexistent with a continued miniscule threat of deflation so QE is here to stay. However, we know from history that all the market fundamentals can be in alignment and the market still sink. The market has a tidal cycle. It ebbs and flows and will find an excuse for any direction it chooses. The weakening market internals are like storm clouds gathering. Those clouds could coalesce into a thunderstorm or a tornado or they can blow quietly over and leave us with a sunny December. We never know what the next week will bring but the trend is our friend, until it ends.
The economics on Friday did not give investors any reason to increase their bullishness other than the Fed should be in no rush to taper QE as long as the numbers continue to be uncertain. The NY Empire State Manufacturing Survey fell from +1.5 to -2.2 compared to Moody's estimate for a rise to +4.5 and consensus estimates for +3.8. This was the lowest level since January and the fourth consecutive decline and expectations miss. All the major components declined sharply.
Note the trend on the chart since the initial 2010 recovery. New York manufacturing has been on a rocky path. I don't think this is translatable to the rest of the country. New York has its own set of manufacturing problems with wages, taxes and regulations that make it less desirable as a location and more likely for manufacturers to move elsewhere.
The drop in the Empire report pushed the dollar lower and gold and silver slightly higher. Any whiff of economic weakness suggests additional months of QE and a weaker dollar. The bounce in precious metals was minimal. We are likely to see another bounce as the fiscal follies in Washington begin in early December but that bounce will eventually be sold when a taper is finally announced. Tapering will push the dollar higher and commodities lower. Since QE is not permanent there will eventually be a taper.
U.S. Industrial Production for October declined -0.1% from a +0.7% gain in September. Expectations were for a slight gain of +0.2%. This is not a material event since the drag came from utilities and mining production. Those accounted for a -0.3% drag on the headline number. Auto production fell for the first time since July. Manufacturing ex-autos rose +0.4% so the overall report was neutral.
After barely rising over the prior three months import prices fell -0.7% for October. That wiped out the prior three month gain total of +0.4%. However, the majority of the decline was in petroleum prices with a -3.6% drop. Nobody should be complaining about that type of price drop. With plenty of excess manufacturing capacity overseas producers are cutting prices to try and gain market share in the USA. That excess global capacity is also impacting the prices U.S. manufacturers are getting on exports. Export prices declined -0.5% for the seventh monthly drop this year. Export prices are down -2.1% over the trailing 12 months.
The calendar for next week is headlined by the Philly Fed Manufacturing Survey and the FOMC minutes. Unlike the Empire State report the manufacturing conditions in Philadelphia are much closer to the rest of the nation. The Philly Fed Survey on Thursday is more closely watched as a proxy for the nation.
The FOMC minutes come up again on Wednesday and of course the conversations about QE will be of the most interest. However, since Yellen's coronation testimony stressing the need to avoid ending stimulus too early I doubt there could be anything in the minutes that would upset the market.
The CPI and PPI are this week but there is no inflation to report and expectations are for flat to declining prices. That is another reason for the Fed to continue QE until they can stoke the inflation fires.
The Housing Market Index and Existing Home Sales are probably going to tell us that sales declined in October but that is no surprise since it is a seasonal event rather than rapidly rising interest rates.
There is really nothing on the calendar that could rock the market but you never know when investors are going to seize on something as important just to have an excuse to sell.
The Fed speaker calendar is busy again with Bernanke leading the list on Tuesday. Monday is the heaviest day and we will get sound bites from four Fed heads.
Next week is retail sales week. The report for October comes out on Wednesday but there are numerous updates from individual retailers all week. Expectations will be the key. The National Retail Foundation (NRF) is expecting +3.9% sales growth over the holidays. That equates to $600 billion in spending despite there being six fewer days between Thanksgiving and Christmas this year because of the calendar shift. There are only 26 shopping days between Thanksgiving and Christmas. NRF member retailers are expected to hire 800,000 holiday workers. That means those same 800,000 will move back to unemployed in January.
After the bell on Friday JP Morgan (JPM) announced a deal to settle claims on mortgage backed securities for $4.5 billion. The settlement covers 21 institutional investors in 330 residential mortgage backed securities (MBS) issued by JPM and Bear Stearns. JPM took over Bear Stearns during the financial crisis. The two companies issued a combined $95 billion in MBS. This is separate from the $13 billion settlement with the government over mortgage issues. However, this does not cover claims from mortgages packaged by Washington Mutual, also acquired under duress by JPM during the crisis. JPM claims their acquisition documents leave the FDIC liable for any undisclosed liabilities when JPM agreed to assume the failing bank. CEO Jamie Dimon has vowed to quickly settle all outstanding issue that have been dragging on JPM shares. Shares of JPM were up fractionally in afterhours trading.
In stock news Zulily (ZU) began its first day of trading with a +71% gain of $15.70 over the IPO price to close at $37.70. The maker of kids clothes is only four years old and has never turned an annual profit. However, it has made money in the first nine months if 2013. The web retailer has 4,500 items and advertises them for flash-sale or limited-time events that advertise prices at least half off the regular retail price. They have carried more than 12,000 brands over their brief history. They tend to cater to small, emerging and boutique brands. Active customers jumped from 157,000 in 2010 to 1.58 million in 2012. Sales rose from $18 million to $331 million over the same period.
In the IPO documents the company noted many risks to its business model . It said the flash sales model was "dynamic and new" but that "growth may not be sustainable" if customers lose interest. Just ask Groupon how that sustainability factor played out. More than 300 Groupon like sites sprung up and then quickly withered away. Flash sale site Fab.com already moved away from the format calling it a "flawed" business model. Apparently investors did not care about the risks and powered shares to a monster gain on the first day.
The big IPO from the prior week, Twitter (TWTR), has had a rocky start. After soaring to $50 on the first day the stock declined to $39.40 on the third day. It has since stabilized at $44 although it has been hit with several less than optimistic analyst reports. UBS initiated coverage at neutral and S&P Capital IQ initiated coverage with a sell rating and price target of $30. Nearly everyone with a rating has a lower price target than the current price. Options began trading on TWTR on Friday and puts outnumbered calls by more than 2:1. Volatility was not extreme with at the money calls for December at $2.80 and puts for $2.50 on a $44 stock. Given the highly speculative nature of the stock I was expecting slightly higher prices.
The recent gains in IPO stocks had Art Cashin cautioning the markets are approaching conditions similar to the dot.com era. He said, "I just worry a little bit that we are edging back to the 'eyeball-and-click' thing we had in the year 2000. It is not quite frothy yet, but it won't take that much stirring to get there." He was referring to the websites that went public based on the number of clicks they were getting rather than profits. Some would say Amazon was still in that category but they are at least building a lot of hard assets from which to profit later.
The Fed has created an equity bubble by keeping interest rates so low the only way investors can beat inflation is with equities. Yellen said she is not seeing any bubbles but then Bernanke testified several times that the housing bubble was containable and would not get out of hand. Famous last words. As long as the Fed continues to support the market the bubble can continue to grow. Once taper begins many analysts believe we can see a 15% drop in the market even if the economy is accelerating. That is because cautious money will flee equities for the safety of higher yields in treasuries. One high profile analyst said something to the effect of "A bubble is not dangerous as long as you know it is not going away." Translated that means the rising equity bubble is not dangerous as long as the Fed does not cut QE.
Besides the 40.1 million share position Buffet accumulated in Exxon there were some other notable positions by funds in the Q3 SEC filings. Leon Cooperman of Omega Advisors put together a 2.8 million share position in Freeport McMoran (FCX). Joining him was David Tepper of Appaloosa Management with 737,800 shares. Gold miners seemed to be hot at the end of Q3 with numerous listings of large positions by funds. John Paulson still held 10.23 million shares of GLD at the end of Q3. That was down from 21.8 million at the end of Q1. George Soros accumulated another 1.1 million share stake in the Market Vectors Gold Miners ETF (GDX) after selling his entire 2.67 million shares in Q2.
Other positions disclosed in the Q3 filings was a 489,000 share stake in JCP by Jana Partners. Tepper's Appaloosa also added 737,000 JCP shares. Dan Loeb of Third Point has accumulated a 2.0 million share stake in FedEx but Perry Capital has him beat with a 4.2 million share purchase.
Obviously Buffet is the biggest whale of the bunch with that $3.5 billion stake in Exxon. In a business where size matters Buffet is the all around winner.
Crude oil prices began to fade after news broke that Iran and the six UN countries would meet again on November 20th and a "first step" agreement is likely to be reached. Details of the last meeting are starting to appear and the reasons why it failed. Apparently Iran and the six nations have tentatively approved a draft agreement but at the last minute U.S. negotiators changed the language in the document to appease the French objections. The disposition of the enriched 20% uranium and the status of the Arak reactor were the last minute changes. The original required Iran to not "activate" the Arak plutonium reactor. The text changed from "activate" to "suspend all work" on restarting the reactor and Iran objected. Lastly, the revised agreement required Iran to "render unusable most of its existing stockpile" of 20% enriched uranium by converting it into fuel rods for the Tehran Research Reactor. Iran immediately objected to that and President Hassan Rouhani tweeted "Iran's right to enrich was a red line that could not be crossed." John Kerry later alluded to the tweet in a speech in Abu Dhabi saying no nation has an "existing right to enrich."
Fast forward to Friday afternoon and the Nov 20th meeting is on and rumors claim a new draft agreement has been approved by all parties. That must be the case because there was a flurry of comments out of Israel on Saturday pleading with France not to weaken in its stance in the upcoming talks. President Obama and John Kerry were both pressing Congress not to pass any additional sanctions until after the Nov 20th meeting. Obama claims the draft agreement only slightly weakens the existing sanctions and they can be reinforced in a few months if Iran fails to follow through on its promises.
If the U.S. emerges from the Nov-20th meeting with an agreement that weakens sanctions regardless of how small, I would expect oil prices to decline further. Reportedly the oil sanctions are not involved in this first step deal. They are going to return some previously frozen funds and allow them to trade precious metals. It may not be much but it is the equivalent of the camel's nose under the tent. Just another small step could bring a much larger change in the existing sanctions. Iran has more than two million barrels per day of production offline because of the sanctions.
Refiners rallied intraday after the EPA proposed the first cut in the ethanol blending requirements since they were mandated in 2007. The original law required 18.15 billion gallons of ethanol to be blended with gasoline to cut our dependence on foreign oil and to stimulate the shift to "green" fuels in the USA. The refiners claim the amount of ethanol required to be used, which rises every year, was too much and required the amount of ethanol in fuel to rise past the point of safety in existing engines. Ethanol is corrosive and can damage engine parts in too high a concentration. With gasoline demand slowing and the requirement to add more ethanol each year the mix was reaching the point where ethanol would be too rich.
The EPA proposal is for a reduction in the ethanol requirement to 15.25 billion gallons in 2014. Producers complained it would set back investments in their plants, slow research into bio diesel and cellulosic products and put some producers out of business. The mandate to produce growing volumes of ethanol each year was forcing farmers to attempt to cultivate non-fertile soil and spend more on fertilizer to produce as much corn as possible. Some critics claim it was taking corn out of the food supply and running up prices on food and feed for livestock.
The proposal caused a -3.5% decline in Archer Daniels Midland (ADM) and -3% decline in Andersons (ANDE), both leading producers of ethanol.
Western Union (WU) fell -4.3% after the Wall Street Journal reported the CIA was monitoring money transfers into and out of the U.S. and building a database using powers granted under the Patriot Act. The CIA is barred from targeting Americans in its intelligence collection. You believe that, right? However, it can conduct domestic operations for foreign intelligence purposes. The CIA is trying to track terrorist financing both in the U.S. and abroad as well as transfers of drug money.
Since WU domestic transfers are limited to $2,999 with fees up to $191 per transfer I seriously doubt they are going to nab a major drug ring or terrorist cell locally. With appropriate ID and background check you can send up to $10,000 to "some" countries. Most are limited to much less than that. WU's website says the $10K limit can be raised under certain conditions but it must be an established account to a financial institution and be pre approved to prevent money laundering. That means give us all your contact info on both ends of the transfer and we will check you against all the databases to see if you are a criminal.
I am sure the news of the CIA overview is going to crimp WU transfers to some extent but I hardly see WU as the money pipeline of choice for terrorists. People with an ethnic background picking up $2,999 routinely at a WU office are probably already under suspicion. I am not profiling here but you can bet it is being done.
WU shares fell -25% on Oct 30th after they warned their compliance costs would rise from 2.5% of revenue to as much as 4.5% in 2014 as a result of increasing regulations on money transfers. That alone tells you the funds are already being tracked severely. I would avoid this stock. Nothing is going to improve in the near future.
The S&P has been up for six weeks in a row. The odds of adding a seventh week of gains are less than 5% according to Tom Bulkowski, author of Encyclopedia of Chart Patterns. It has happened only twice in the last ten years and once was Jan 2013. Can it happen twice in the same year? Sure it can but that does not mean it will. Markets, like dice, have no memory. It if the memory of the investors playing in the markets that provide the cycles. Investors understanding the rarity of the seven week string will probably take some cash off the table and the failure after six weeks becomes a self fulfilling event.
The S&P closed at 1,798 and only 2 points below 1,800. Large round numbers on the S&P tend to produce a backlash when they are hit. They are not an electric fence where the touch of the number creates an instant 5% drop but the rally that took us there tends to weaken over the next few days. The target is reached, time to take profits and pick new positions for the next leg higher.
Dow 16,000, S&P 1,800 and Nasdaq 4,000. What are the chances of a material pause when all three are hit on the same day? I would think there is a better than even chance of a temporary pause. It could be another rolling consolidation like we saw over the prior three weeks or a short dip to reload. Remember, the market breadth has been narrowing over the last month so investors are preparing for an eventual pause.
The S&P has gained roughly 40 points over the last three days since the dip to 1760 at the open on Wednesday. After a three week consolidation that is not unreasonable but it does put us right back into slightly overbought conditions. With strong support at that 1760 level that means a bout of profit taking could erase those 40 points and still retain the uptrend.
I don't really have to say much about the Dow. It has gone from very overbought to extremely overbought in the space of a week. Big caps are where it's at and the Dow is only 39 points from round number resistance at 16,000. Given the rebound off the October lows the Dow is due for another of those recent pauses. I would expect it in December when the fiscal follies begin again. We could see a temporary dip next week as the tension eases when the 16,000 target is hit.
The Nasdaq is only a handful of points away from round number resistance at 4,000 and Nasdaq sentiment is at a post recession high. As you can see from the sentiment chart there are broad swings in sentiment over the last three years with each top in sentiment reaching a higher point. To say the Nasdaq sentiment was at an extreme would be an understatement. To compound the problem there are troubles with tech earnings. Cisco was a huge disappointment. IBM has still not recovered from their earnings miss. While IBM is not on the Nasdaq it does impact tech sentiment. Just imagine where we would be now if Cisco had knocked the ball out of the park.
The Nasdaq sentiment is the biggest indicator of what I would call an imminent pause. There have been 201 IPOs year to date and the vast majority have been tech stocks or at least Nasdaq stocks. Twitter would be the exception of a tech stock on the NYSE but the response to the Twitter IPO was definitely a tech event.
Something has to dent the Nasdaq sentiment. It could be an event or simply the deflation of the current sentiment bubble. While nobody can predict when it will happen we do know it will happen and probably soon.
Support is 3,900 and resistance 4,000.
I was pleasantly surprised by the rebound in the Russell 2000 small caps. The Yellen testimony stressing QE was here to stay for several more months was the right prescription for a resumption of small cap buying. The index bounced off support at 1095 on Tuesday and closed at 1115 on Friday. That is only -6 points below a new high. While the market is short term overbought a breakout by the Russell could push all the indexes into overdrive and result in a strong close for November.
The Association of American Railroads (AAR) reported rail traffic for the week ended November 9th totaled 297,581 carloads. That is an increase of +4.9% over the same week in 2012. Intermodal volume was an additional 265,259 units, up +6.3% and the 19th consecutive week of increases. Petroleum and petroleum products totaled 14,400 carloads up a whopping +25% year over year. Grain accounted for 23,744 carloads, up +21.3% and motor vehicles and parts totaled 19,341, up +20.5%. Coal accounted for 114,084 carloads, down -0.6%. Total carloads year to date were 23,812,352 up +1.6% year over year.
Intermodal is the semi trailers and containers stacked on trains compared to typical boxcars and flat cars. Intermodal is how the majority of consumer goods travels across the country. To see that growth up +6.3% over 2012 and up 19 consecutive weeks suggests there is a recovery in progress. This is the early stages but it is comforting to know there are positive fundamentals underway in the economy. Maybe Yellen has the right idea. Keep pouring gasoline on the fire until it becomes so hot you have to back away.
Enter passively and exit aggressively!
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"In this age of instant information, investors can experience both fear and greed at the exact same moment."
Sam Stovall - S&P