The calm from Tuesday was erased by increasingly hostile threats and movements of military equipment towards the Ukraine. The markets noticed.
While no shots have been fired other than warning shots there are increasingly hostile events taking place in the Ukraine. The Crimean parliament voted to join Russia and cede from the Ukraine. They moved the previously announced referendum on ceding from the Ukraine forward two weeks to March 16th. The Ukraine government increased its claims there would be no referendum and any vote would have no legal effect.
President Obama announced sanctions against Russia, freezing of assets and a ban on travel for those involved in the Crimea takeover. Putin was not targeted individually but numerous high ranking government officials were the targets of the sanctions. At an emergency meeting in Brussels the EU passed a set of limited sanctions against Russia and warned they were prepared to increase the severity of the sanctions unless there was a swift end to the standoff. Russia responded saying "Russia will not accept the language of sanctions and threats and will retaliate if sanctions are imposed." Putin said any sanctions would backfire on the U.S. with Russia seizing U.S. and EU assets. Russian lawmakers are already drawing up a bill that would authorize the seizure of U.S. and EU assets.
After an hour long call with Obama, Putin said he was ready to use force to protect the people of Crimea. European reporters arriving by private helicopter to report on the events were promptly escorted out of the country by Russian attack helicopters.
The 37 member observation team requested by the Ukraine and sent by the Organization for Security and Cooperation in Europe, including people from 18 nations, arrived at the border but Russian troops would not let them into Crimea. AP reporters had their equipment confiscated and were prohibited from filing news stories because they were considered "spies."
Ukraine International Airlines said all flights in and out of Crimea have been cancelled due to the closure of airspace over Crimea. At the Ukrainian naval base in Novo-Ozerne a decommissioned Russian naval vessel was sunk by the Russians in the channel leading to the Black Sea preventing Ukrainian naval ships from leaving port.
Russia's Gazprom threatened to turn off the supply of natural gas to Ukraine if it does not immediately pay the $1.89 billion for previously delivered gas. This is a Putin tactic that has been threatened many times in the past. He threatens the shutdown of gas supplies in order to move his agenda forward. Ukrainian television channels were turned off in Crimea and replaced with Russian state TV channels.
More than 30,000 Russian troops are now in Crimea. All the Ukrainian military bases in Crimea have either been taken over by Russian troops or they have been surrounded with no Ukrainian troops allowed to leave.
The U.S. guided missile destroyer USS Truxtun arrived in the Black Sea on what was called a "routine" visit by Washington. The U.S. sent six F-15 jets and a KC-135 refueling tanker to join NATO patrols in the Baltics. Another twelve F-16 fighters will be deployed there next week. The increase in military forces came after a Russian surveillance plane flew over Turkey along its Black Sea coast. Turkey scrambled six F-16 fighters to repel the surveillance craft. That was the second time this week the Russian plane had threatened Turkish airspace. I am sure Russia has extended its surveillance umbrella as far as possible to try and prevent being caught off guard by an attacking force staging in another country.
Last but not least the former Ukrainian president who fled to Russia, Viktor Yanukovich, is now said to be in a Russian hospital in "grave condition" after suffering a suspected heart attack. Am I the only one that believes that heart attack may have not have been caused by natural forces? The Ukrainian government had issued a formal request for extradition back to the Ukraine so they could interrogate him about billions in missing funds and thousands of documents he tried to burn when he fled the presidential palace. Yanukovich is expected of taking Russian payoffs to pave the way for Russian businesses in the Ukraine and for passing or rejecting treaties as dictated by Putin. He was considered a Russian puppet. I guess a dead puppet can't be forced to talk.
Is it any wonder the U.S. equity markets were weak on Friday? With events surrounding Crimea apparently escalating as each day passes the potential for a negative surprise over the weekend is very strong. I am not surprised that early gains on the stronger than expected Nonfarm Payroll report quickly evaporated. I am surprised we did not end the week a lot lower as traders took profits ahead of the weekend.
The markets rallied on the stronger than expected payroll report with the Dow reaching 16,505 before the sell down began. The S&P hit 1,883 before giving back -13 points to trade at 1,870. The Nonfarm report for February showed a gain of +175,000 jobs in February. This was well over the estimates of 125,000-150,000. The estimates had been lowered significantly after the ADP Employment report on Wednesday showed a gain of only +139,000 jobs. Surprise, surprise!
Despite the severe winter weather the service industries tacked on big gains. The service sector added +153,000 jobs and manufacturing and construction +22,000. January was revised higher by +16,000 and to 129,000 and December rose +9,000 to 84,000.
The unemployment rate rose +0.1 to 6.7% as more people joined the workforce. The labor force increased for the second consecutive month with a gain of +264,000 after a +523,000 increase in January. If the economy begins to improve and more people begin looking for jobs that unemployment rate will continue to grow before the eventual decline when the economy finally returns to historical activity levels.
Interestingly hospital employment has declined by -10,000 over the last three months and insurance company employment rose +10,000 over the same period. I would suspect that to be a result of Obamacare. Lower reimbursements means less money to pay hospital employees while the massive switch from private healthcare to Obamacare means a lot more workers were needed to process the applications and handle the nearly 80% exception rate from the online applications.
The unemployment rate for adult men was 6.4%, adult women 5.9%, teenagers 21.4%, whites 5.8%, blacks 12.0%, Asian 6.0% and Hispanics 8.1%. More than 3.8 million people have been unemployed more than 27 weeks. Those account for 37% of the unemployed. The labor force participation rate was unchanged at 63.0% in February. There were 7.2 million people employed part time for economic reasons. Those want full time work but cannot find a job or their hours had been cut back from full time. There are currently 2.3 million people classified as "marginally" attached to the labor force. They want work and are available to work but are not counted as unemployed because they had not applied for a job in the last four weeks.
The report was a surprise because of the strength in the face of the severe weather. This suggests that once the weather warms we could see a sharp increase in hiring. However, this conflicts with the weak economic reports for the month of February. If those were also weak solely because of the weather then we could be looking at a strong economic bounce in April. March could show improvement but the weather is still a factor. Unless winter extends for another six weeks like it did in 2012 the April economics could be strong.
Obviously there are conflicting opinions about the strength and direction of the economy. The next 60 days are going to be critical for directional clues.
The economic calendar for next week has little in the way of material events. The NFIB Small Business Survey was neutral last month with a minor gain of +0.2 points to 94.1. It would be nice to see a pickup by small businesses in February.
The retail sales for February are expected to rise +0.2% but the weather will again be the major excuse for a weak report. When the weather does warm up I expect an explosion of pent up demand in the retail sector but that will be in March and April.
Lastly the Producer Price Index (PPI) on Friday is expected to rise +0.3% as commodity inflation works its way into the manufacturing sector. Once producers pass that inflation on to consumers the Fed will have a lot tougher task in keeping and accommodative monetary policy.
An economic indicator from overseas came in the form of a corporate debt default in China. The failure of Shanghai Chaori Solar Energy Science & Technology to make a $14.5 million interest payment on Friday was the first corporate debt default in 17 years. China has a long tradition of not letting weak companies fail. That has undermined the country's path to meaningful financial reform.
The fact that China allowed a company to default is a major event. In the past investors have been accustomed to these companies being bailed out either by the state or some large state owned bank. Defaulting was basically unacceptable to the greater good. Investors tended to gravitate to the highest bond yield they could find because there was no risk. If everyone gets bailed out then put your money where it earns the highest return. This default is just the tip of the iceberg. If China has really decided to shake up the financial community and let the weak companies fail then millions of investors are in for a roller coaster ride. Starting next week we could see investors dumping debt from Chinese companies if investors don't believe the companies can be successful.
Borrowing costs for Chinese companies are going to soar. No longer will they have the implied backing of the state. Standard & Poor's analysts in Hong Kong called the default a "transformative event." S&P said it will force more discipline among the companies and lenders and will lead to tighter loan conditions and more due diligence by lenders.
China's $14 trillion corporate debt market has thousands of companies that have benefitted from the implied government guarantee. When these companies are forced to pay market rates and jump through credit hoops just to get the money they may not survive. There are thousands of Chinese companies that should have already defaulted and gone out of business but the government has prevented this from happening to maintain the status quo and keep people employed. Fitch said "this will lead to a more efficient allocation of capital among corporate borrowers." That is the good news and the bad news. Quality companies will continue to get funding but lower tier and bottom tier companies are going to see credit disappear.
The number of publicly traded non-financial companies in China whose debt to equity ratios exceed 200% has jumped +57% since 2007 according to Bloomberg.
How this is going to impact China's economy in the future is unclear. We know there will be a lot more defaults and business failures. In a capitalistic society that creates opportunities for new companies to fill the void and prosper or for existing companies to expand and become stronger. It is likely to be a bumpy road for the first couple years as businesses adjust to the new paradigm.
A casualty of the default was copper prices. The price of copper fell -4.14% on Friday on worries the credit default in China is the first of many. That was the biggest one day drop since December 2011. Metals like copper, nickel and gold are used as collateral against letters of credit. The copper pledged to the letter of credit is then "sold" to a third party who uses it as leverage in a different paper transaction. Once the phony transaction is completed the copper is sold back to the original purchaser and the process is repeated. The copper in each transaction is the same as each prior transaction and is never moved from the bonded warehouse.
According to Goldman Sachs the same metal in question can be used as collateral for these transactions between 10-30 times a year without it ever being moved. The point to the process is to show the metal as an asset on various balance sheets at the same time to qualify for additional loans. The more metal imported into China the larger the number of loans. This is a shell game that will end badly. As banks and investors begin to require verification of the assets and proof of ownership the scheme will end badly with billions in fictitious loans ending in default. Goldman says this will extract tremendous leverage from the system and will have adverse impacts on China's ability to absorb inflation and grow its economy.
On Saturday we had further bad news from China. Exports declined -18.1% in February compared to the average estimate from 45 economists for a gain of +7.5%. Imports rose +10.1% leaving a trade deficit of $23 billion and the largest in two years. The decline in exports was the worst since the 2008 financial crisis. Analysts were quick to try and blame the Lunar New Year holiday and the weather in the U.S. for the decline. I find that hard to believe. I doubt wholesalers in the U.S. called up their suppliers in China telling them to hold off on those February shipments because it snowed in January. We all know that the products shipped in February were ordered months ago. Total exports for January and February declined -1.6% compared to a gain of +23.6% in the same period in 2012.
This suggests China is going to miss their 7.5% growth targets for Q1. UBS economist Wang Tao estimated the underlying growth rate so far in 2014 is 6.0%.
In stock news Alpha Natural Resources (ANR) fell -12% after Goldman Sachs cut its rating to sell and lowered the price target to $4. Goldman also cut their forecast for metallurgical coal from $150 a ton to $141 due to increased output from Australia, the expected slowdown in Chinese imports and "limited U.S. supply rationalization." They expect the current oversupply to increase in the coming years. This goes against what Peabody Energy has been saying about increasing demand and improving prices. Peabody pointed out that high cost production has been shuttered and that has reduced supply to the market.
The patent case between Juniper Networks (JNPR) and Palo Alto Networks (PANW) was declared a mistrial. Juniper had filed a lawsuit in December 2011 claiming PANW products infringed six Juniper patents. The jury was unable to reach a decision. If Juniper wants to pursue this claim they will have to file a new case and start over. Juniper indicated they would probably re-file. PANW shares rallied +11% because a new filing will take another couple of years to wind its way through the courts. FBR Capital Markets said the dismissal of the suit will provide a major sigh of relief for PANW investors. They claim the stock price has been under pressure for the last year on worries over the outcome of the suit. The chart does not show a lot of overhang with a near doubling of the price since November.
Big Lots (BIG) shares rose +23% after posting earnings of $1.45 that beat by a nickel. However, revenue of $1.57 billion missed estimates of $1.61 billion and same store sales declined -3%. They also guided to 40-45 cents for the current quarter and below the 50 cent estimate. The company said the quarter was a week shorter than the comparison quarter and the impact was about 5 cents. That would have them beating by a dime. They also announced a $125 million share buyback. Apparently a lot of traders were expecting the troubled retailer to miss earnings because even with the multiple negatives the shares still exploded higher.
After spending a couple years as a penny stock Plug Power (PLUG) finally hit on the right combination of news events to power it higher. Higher as in up +75% for the week with +30% on Friday alone. Plug Power is a fuel cell company. They manufacture power systems for major companies. PLUG announced a contract to supply power with six Wal-Mart distribution centers. The company said it expects additional contracts with new and existing customers. Ballard Power (BLDP) provides fuel cell components to PLUG for use in its power systems was up +4.5% on Friday. Fuel Cell Energy (FCEL) rose +18% after the U.S. Dept of Energy awarded them a $2.8 million contract to develop a fuel cell plant capable of delivering hydrogen as well as electricity and heat to industrial companies on their own sites. FCEL rose +81% for the week.
The fuel cell industry has apparently come of age and with new technology reducing the costs for hydrogen fuel cell plants the entire sector is on fire.
Coupons.com (COUP) went public on Friday by selling 10.5 million shares priced at $16. Shares surged to $33 intraday and closed at $30. The site began in 1998 but has been unprofitable until last quarter. The company made $1.5 million in Q4. Full year sales were $168 million. They survived on a $200 million investment from institutional investors in 2011. Coupons.com offers printable coupons and they get paid when a consumer prints a coupon. I checked as I was writing this paragraph and they have 282 coupons available today. They change all the time so coupon clippers can go crazy. The reason for the 100% spike was the low number of shares offered at 10.5 million. With almost no float any demand at all sends prices higher. Volume on Friday was 11.4 million so quite a few IPO winners unloaded their shares and those shares traded aggressively. Institutions probably held their shares, which meant the big blocks were not in the market.
The S&P has stalled at 1,875 for the last four days. The S&P spiked higher on Tuesday to close at 1,874 and it has not wandered far from that level for the rest of the week. Thursday closed at 1,877 and Friday closed at 1,878. Those are some very weak gains after a strong breakout on Tuesday and a stronger than expected payroll report. Clearly the Ukraine is weighing on the markets. At least that is what most commentators are blaming for the lackluster performance. I would agree the increasing hostility in the Ukraine headlines on Friday was a strong reason to take profits before the close. I am surprised we did not close a lot lower.
On Tuesday when Putin appeared to rethink his invasion plans after the Russian stock market imploded, the U.S. markets exploded higher. At the time the consensus opinion was that the Crimean invasion would be over quickly. That is no longer the consensus opinion. Now it seems to be consensus that we are only in the first act of a four act play. The Crimean vote to join Russia is scheduled for next Saturday and that is going to be a major challenge for Europe. No major country is going to recognize the outcome of this vote especially since it will be at the point of a Russian gun. Military positioning is increasing and we are only one trigger happy 20 year old soldier away from a major confrontation. So far all the shots fired have been warning shots. Once people start dying the confrontation will take on an entirely new intensity.
I think this will weigh on the markets next week. The lack of any material economics and a lack of earnings to distract investors will allow them to focus on the Ukrainian headlines and begin to question the wisdom of being long the market.
At the same time we are closing in on S&P 1,900 and that is the yearend target for numerous analysts. Reaching that target this early in the year could convince investors to take profits and move to the sidelines.
I personally think we have a good chance of moving higher if the Ukraine situation were to ease again. I have been looking for a market high in April and then a decline into summer. Midterm election years tend to peak in April and bottom in August. Given the strong gains in 2013 that have not yet been taken off the table we could see an active "Sell in May" cycle this year.
For next week we are looking at initial support at 1,872 followed by strong support at 1,840. Initial resistance appears to be 1,882 followed by 1,885 and 1,900.
The Dow is pulling ever closer to the prior high at 16,576 with the close on Friday at 16,450. The Dow managed to close higher on Friday when the Nasdaq and Russell 2000 ended in negative territory. Have we gone back to having fund managers store money in the big caps in fear of a negative market event instead of "investing" the money in small caps for a larger return? I am not ready to make that call yet since the Russell only lost -1 point on Friday and closed only -5 points off its historic high.
The leadership in the Dow was varied and did not seem to suggest any specific sector or trend was in control. It was Friday and I don't think we can apply too much logic to the moves.
The Dow Transports are finally confirming the Dow move and they closed at a new high on Friday by about 20 points. We really need a couple more daily gains to avoid the possibility of a double top. The airlines, shipping companies and railroads all began to rally at the same time so hopefully this trend will continue higher.
The Nasdaq Composite gave back -16 points but that was down from a 14 year high on Thursday. The Nasdaq has been leading the pack and it was time for a pause. The Ukraine headlines may have been part of the picture but the Nasdaq was right under resistance and due for a breather. In reality the decline was due in part to a sudden dip in the biotechs. The sector was up nearly 25% for the year and it gave back -4% last week. It is still up +21% and those negative headlines from Ukraine may have given those investors holding biotech stocks a reason to take profits.
On the Nasdaq chart we see a dead stop on uptrend resistance at exactly where you would have expected a pause. The rebound from the Feb 5th lows may be slowing but there is nothing to suggest it is dead. We would need to see a drop under support at 4,250 before writing the obituary on the rally.
The Russell is a carbon copy of the Nasdaq. Strong uptrend resistance created a solid ceiling for the Russell rally. If the Ukraine headlines disappeared I think a breakout would be in order. However, wishes don't work as a trading strategy. We could expect a decline to 1,182 without really starting to worry about a correction. Resistance is 1,208 and the historic high.
With the markets back at the prior highs and no real catalysts on the horizon to propel them higher we need to start worrying about a peak in April. If this occurs we could see a sharp downdraft for multiple reasons. Q1 earnings are going to be very weak. The weather excuse should cover almost everyone but eventually traders are going to become tired of hearing it.
Another worry is how we got to this point. The market has become a combination of baskets of stocks rather than a market of individual stocks. Futures and ETFs account for the majority of the market volume. Compared to the rally in 2000 there are very few single stock investors. There are now ETFs for everything. Every time a ETF or a futures contract is bought or sold in quantity it triggers hundreds of individual buys and sells to match that move in the ETF.
When we eventually hit a real correction this selling in ETFs and futures is going to produce violent market swings. Stop losses on these vehicles could create the kind of volatility we saw in 1987 when program trading flushed the market or similar to the flash crash where computer trading blew through stops and triggered monster sell orders.
On the positive side there is nothing that says it will happen soon. The market could continue to move higher but with more frequent interruptions on the hope the economy is improving. We have shaken off the taper process and some really negative guidance from Q4 earnings and so far the invasion of Crimea. Eventually something will become the excuse for a significant market decline but until it happens we won't know what it is. Unfortunately, not all declines need an excuse. Sometimes the markets just run out of buyers.
The situation in the Ukraine may have a lasting impact on the U.S. even though the Ukraine has no direct impact on our economy. In grade school if a bully decides to pick on a kid that was previously unmolested and that kid does not respond forcefully, the lesser bullies will see an easy target and begin picking on him as well. Everybody in grade school understands this. If a country lets itself be pushed around by an aggressive regime, others will take note and try to push that country around as well. If they see no credible response to the aggressive action they will begin to think they can get away with aggressive action of their own.
For this reason America must act forcefully to this aggression by Putin. I am not saying we should go to war. I just think we need to act forcefully and make sure Russia pays a price for the invasion. If we do not act then Iran, North Korea, Syria and who knows who else, will decide we are a paper tiger and try to get away with their own brand of bad behavior. For this reason I view the confrontational aspect of the Crimean invasion as having more risk than what may be priced into the market today.
In 1964 Art Cashin joined the NYSE and now, 50 years later, he is the unofficial godfather of the exchange. He is also a fan of Option Investor. Art celebrated a birthday last week. I am not going to give away his age but he is 6 years older than me. Happy birthday Art!
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