I am sure we all wish the rest of the year is as strong as the first week. The Dow gained +1.8% and it was the laggard of the group. The Nasdaq added +2.12% and S&P 2.68%. It was a perfect example of an index fund rally with the S&P leading the charge.
Friday's Non-Farm Payroll report was not even close to what analysts expected and all the markets gapped sharply lower on the news. Fortunately the sell the news event was short lived and bulls raced into the gap to buy stocks and all the indexes finished in the green.
The economy lost 85,000 jobs in December and that was much larger than the final consensus estimate for a loss of -23,000 jobs. This was a major shock to analysts who were flirting with the possibility of job gains in December. The household employment survey found that jobs declined by 589,000 following a gain of +139,000 in November. The total labor force declined by 661,000 due to unemployed workers giving up on looking for work. This drop in the number of available workers kept the unemployment rate at 10.0% even though the number of workers with jobs declined. The labor force participation rate fell to 64.6% and a 25-year low.
When these workers decide to start looking for a job again it will boost the overall workforce numbers and send the unemployment rate much higher. This suggests we could see the employment rise to 10.2% or higher over the coming months. Now that the holidays are over those discouraged workers will have no excuse for not job-hunting again.
The broadest measure of unemployment called U6, rose to 17.3% unemployed. More than 7.5 million workers have lost their jobs since 2007 and there are more than 15.3 million total unemployed. Over 4.164 million jobs were lost in all of 2009. Nearly 40% of unemployed workers have been out of a job more than half a year. The average duration of unemployment has risen to 20.5 weeks and by far the highest on record. In the early 1980s recession it peaked at 12 weeks.
The jobs report had a sliver of good news although it was only technical and definitely not meaningful. Jobs were revised higher for November to show an actual GAIN of +4,000 jobs, up from a loss of -11,000. That was the first increase in jobs since December 2007. Offsetting that gain was a revision to October from -111,000 to -127,000 jobs.
The January report could be really ugly given the sharp decline in December. The January report will show the number of seasonal workers terminated after the holidays and given the pace of declines in manufacturing in December the January numbers could easily be back into triple digit job losses.
Non-Farm Payrolls Chart
Consumer Credit took an enormous hit in November as credit card companies continued to restrict the amount of credit available to customers and consumers fearful of a job loss continue to pay down debt. Consumer credit fell -$17.5 billion or an 8.5% annualized drop. It was the sharpest monthly percentage decline since 1980 and the largest dollar decline since they began keeping records in the 1940s. $13.7 billion, or 17% annualized, was credit card credit declines. The decline prompted a warning from regulators to banks that they should not be restricting consumer credit ahead of an expected rise in interest rates.
Interest rates on car loans have been rising but the average term (63.4 months) and the average amount financed ($30,506) both declined in November. Consumer credit has declined nearly $100 billon dollars in 2009 alone.
Consumer Credit Chart
For next week there is only one really important economic release. That is the Fed Beige Book on Wednesday. This is the survey of the economic conditions in all 12 Fed regions. Last month eight districts reported a pickup in the economy while four reported conditions were mixed or unchanged. The real news next week is not in the economic realm but in corporate earnings.
The biggest event of the week will be the Intel earnings on Thursday. This could be a late Christmas present for the markets. Intel has made positive comments multiple times in the past couple quarters and the holiday sales should have been good for them. Intel is expected to report profits of 30-cents per share on revenue of $10.2 billion. That would be a dramatic rebound over the same quarter in 2008 where they posted 4-cents and $8.2 billion in revenue. Gross margins are expected to be in the rage of 62%.
The Microsoft Windows 7 operating system has been received very well and computer sales are improving. Corporate upgrades are beginning to occur and should ramp up as 2010 progresses. Since Intel processor sales occur well before the retail sale they should be seeing the benefit of this ramp already. The new tablet computers should add to the new wave of computer gadgets in 2010 as well as the growing acceptance of the Netbook. As always Intel's guidance is going to be more critical than their actual earnings.
Microsoft's Steve Ballmer said at CES last week that PC sales for 2009 were expected to fall -2% but actually rose by +3% due to a late surge at year-end. That equates to 300 million new PCs sold in 2009. Gartner Group is now expecting PC sales in 2010 to exceed +12% in new sales. That would be well over one billion new PCs worldwide. Intel will be the processor powering 85% of those PCs and Microsoft will be the operating system of choice for more than 80%.
Intel announced new processors at CES in Las Vegas that are produced on their new 32-nanometer process technology. With the new line of Core chips the printed circuit lines are so small their average width is only 32 nanometers. How small is that? It is 32 billionths of a meter. If you are like me you can't conceive of a billion, much less 32 billion of anything, especially something as small as 1/32-billionth. Let me put that in perspective for you.
I am sure you have heard the old joke about how many angels can dance on the head of a pin. Since nobody knows how big an angel is the question was a brainteaser. Well, tease your brain with this. How may transistors 1/32 billionth of a meter wide can you place on the head of a pin? I don't care what you guessed I would bet the real answer will surprise you. Over 60 million would fit on the head of a single pin. That is going to make keeping up with Moore's law in 2012 and beyond a very tough proposition.
Intel co-founder Gordon E Moore introduced the concept in a paper in 1965. Moore's law states that processor capabilities through decreasing the size of the transistors will double every two years. He wrote in 1965 that by 1975 he expected as many as 65,000 transistors to be built into a single chip. I wonder how he feels today knowing that the new generation of processors Intel just announced will have over one-billion per chip? In 2005 he projected that future improvements would reach a fundamental limit within the next 10-20 years where chips could have one-billion transistors. In only five years that threshold was been reached. Intel predicts that the end will come between 2013-2018 with 16 nanometer processes. However, Intel has been predicting for the last 30 years that Moore's law would not survive another decade. I guess you can tell I am a geek at heart. I just wish their earnings would double every two years.
Their earnings could set the tone for the entire earnings cycle for techs. If they say business is improving significantly we could be off to the races.
Earnings from JP Morgan on Friday could be a trouble spot. Citigroup analyst Keith Horowitz offered a bearish outlook for the major banks. Horowitz said fixed income trading revenues had ground to a halt in Q4. He downgraded estimates for Bank America, JP Morgan, Morgan Stanley and Goldman Sachs. He said there was a significant decline in Q4 and that decline in revenue could reach as high as 20% in 2010. Regulatory reform could knock off another 5-10%. He cut estimates on JP Morgan to 55-cents from 70-cents and chopped another 30-cents off the 2010 estimate of $3.20. He rates JPM as a hold. If JPM reports weaker than expected profits next Friday it could be bad for the entire banking sector.
JP Morgan Chart
He said Bank America could see fixed income revenues fall by 16% but he kept his profit estimate for 2010 intact at 84-cents. BAC reports on the 20th. He cut Goldman to $5.25 per share with consensus estimates at $5.39 but kept a buy rating. They report on Jan 21st. He cut Q4 estimates for Morgan Stanley nearly in half from 66-cents to 36-cents per share and he cut 2010 estimates by 50-cents. Analysts expect 49-cents for Q4.
This is a very skinny week for earnings and that makes Intel and JPM even more important because everyone will be watching.
Next week (Jan-18th) the pace will pickup with IBM, Citi, CSX, FRX, MMR and AMTD on Tuesday. On Wednesday (20th) we will get earnings from BAC, BK, EAT, EBAY, FFIV, STX, SLM, SBUX, STT, USB and WFC. On Thursday (21st) earnings are AXP, BNI, COF, CAL, FCX, GS, GOOG, MS, PCP, LUV, TCB, UNH and XRX. Friday will see GE, HOG, KMB, JCI, BBT, MCD and SLB. I will have a bigger list for you next weekend but these symbols should provide a starting point for some earnings play research.
Friday we saw strong December same store sales from Best Buy but traders were not happy. BBY reported a +8.2% rise in same store sales but they did not raise earnings estimates suggesting their margins had fallen even further. Domestic sales rose +9.3% and international sales +3.5%. BBY did not give Q4 guidance and instead gave full year 2010 guidance at $3.15 per share. If this is how all the Q4 earnings will go then we could be in big trouble but I really believe this is a BBY only problem.
Best Buy Chart
The UPS guidance on Friday is more of what I expect for Q4. UPS said earnings could be as high as 75-cents and that is a dime more than analysts expected. The rise in profits came from better than expected December shipments and further cost cutting. They are cutting another 1,800 management personnel. This is the double whammy for earnings. Better than expected shipments, business is picking up. That is what traders wanted to hear. To improve our profits we are cutting another 1,800 management personnel. That is also music to investor's ears because as business continues to improve so will profits without the additional overhead.
This is equivalent to walking a thin line with investors. UPS thought earnings were not improving fast enough so they dug a little deeper to find some more costs to cut. Hopefully future Q4 earnings reports will be heavier on the stronger business idea and lighter on the job losses.
If companies continue to cut workers as business improves then we could be in for a jobless recovery and that means a longer period before we are back to business as usual. The UPS CEO said he saw the economy gradually continuing to improve in 2010. It must be very gradual if he resorted to another 1,800 jobs cuts to please investors. If the recovery was really finding traction would he have still made the cuts? We will have to read between the lines on all the earnings reports to really understand what businesses are seeing.
The upgraded UPS guidance also helped FDX and powered the transportation index to a new high. Before anyone becomes too excited about the transports as a long play we need to see what is going to happen to $83 oil. Oil refuses to decline despite a potential disaster in the week ahead. A major inventory gain on Wednesday could burst this bubble. If it does not burst then I would be wary of investing in transports because gasoline and diesel prices are going higher. At Friday's close the transports are up +98% from the March lows and a tad bit over extended.
A number of analysts have come out in the past week with fund flow statistics claiming the rise in crude prices was related to year-end retirement money going into commodity funds. Eventually this money will run out. Also, crude is holding these levels on very light volume. For the first time I can remember the volume in gold futures was higher than the volume in crude futures. This should not happen and suggests there is a volatility event in oil's future.
Commodity Index Chart
Crude Oil Chart
Google probably wishes it had spent a few extra dollars in the Nexus announcement and a little less on their founder's fleet of jets. (1-767, 1-757, 2-Gulfstream V, 1-Dornier Alpha fighter jet) The Nexus announcement was botched if you compare it to the polished presentations from Steve Jobs. The poor presentation and less than incredible Nexus phone knocked Google's stock from just under $630 to just under $590 in only three days. Guys, take some lessons from Apple before you make your next presentation.
The Nexus phone may be decent but it is not an iPhone killer. The Motorola Droid is a better phone for most people than the Nexus according to reports. So, how do you recover from a public relations nightmare? Not the Tiger Woods kind but the kind where your new billion-dollar product is not jumping off the shelves and your stock is dropping. With so many prior Google announced products gathering dust on the "we will finish it when we get around to it" shelf they needed a quick plan to rescue their image.
Since there just happens to be the world's largest consumer electronics show underway in Vegas let's send our top engineer to CES with some announcement rumors. Sure enough Andy Rubin shows up at CES saying the next version of Nexus will be for "enterprise" users and "might" have a keyboard. Ah, yes, the "we are going to take on Blackberry" ploy. We missed on the iPhone killer play so let's abandon Nexus One and take on Blackberry instead. You know those people who would rather lose a hand than do without their Blackberry? I am sure they are going to run to a new videophone with a keyboard and toss their Blackberries in the trash on the way. Careful here guys, you are going to need a really strong phone and an even stronger presentation if you think you are going to have a chance in that market. Google has earnings on the 21st and they should be really interesting.
It is looking now like we are headed for scenario two. Several weeks ago I wrote that there were two scenarios for early 2010. The first involved a new false breakout in the first week of trading that would be followed by a sharp decline for 7-10 days before earnings. The second scenario suggested we could see funds keep the bullish pressure on until a couple weeks into the earnings cycle then a longer correction appear.
We got the breakout in the first week but there are no signs of a quick dip ahead of earnings and time is running out. I believe funds that are currently long will want to be long through the Intel earnings and probably the following week as well. Once all the majors report the market risk increases. Since Intel reports earnings next Thursday there is no time left for a meaningful dip per scenario one.
I have read/heard several analysts who have pointed out that year-end retirement fund inflows have been very strong not only into index funds and equities but also commodity funds. If you look at the two largest indexes with more than $4 trillion in index fund investments those two indexes led the markets higher. Of course I am talking about the Russell 2000 and the S&P-500. Those are the primary indexes for index fund investing. The Russell 2000 gained +3.07% and the S&P +2.68% compared to only +1.8% on the Dow and +2.12% on the Nasdaq.
Year-end retirement cash normally begins hitting the accounts of fund managers during Christmas week and tapers off around January 7th. If you look at the chart of the S&P the rally started on Monday of Christmas week and has not stopped except for the sell program on Dec-31st.
S&P Chart - 90 min
You can't tell me that every investor in the country suddenly decided to go long the S&P on Monday December 21st while the Dow only managed to add less than two hundred points over the same period. It probably would not have gained at all except that most of the Dow stocks are also in the S&P.
Dow Chart - 30 min
The volume was weaker than you would have expected for a melt-up of this size. That is another reason this rally lacks any dramatics. Friday's volume was the second lightest of the week. The only thing that really stands out in the internals table is the relatively level pace of advancers/decliners. There was very little selling. The volume all week was nicely bullish over the down volume but not specifically lopsided.
Personally I would be thrilled if the markets maintained this slow and steady pace all year but you know it won't last. Something is going to upset the applecart and knock us off this steady rate of climb.
For investors we actually have the best of all worlds right now. The jobs data was not a disaster despite it being worse than expected. The market recovered to close positive suggesting the bad news bulls are still lurking just under the surface and waiting for a dip to buy.
The job losses means the Fed will remain on hold for at least the next 3-6 months and some believe they will remain on hold all year. There is talk of a second stimulus package and of the Fed going back into the mortgage market to keep rates low.
Earnings for Q4 are expected to come in between +34% and +37% and most companies should give positive guidance for the rest of 2010. Obviously the strong earnings are due to a very bad comparison quarter in 2008 but they still count. Because so many companies have cut costs to the bone they should show increased profitability throughout 2010.
The second dip option for the recession has been taken off the table and some are actually calling it a V recovery. I am not in that camp but call it anything you want as long as it is not a VV recovery.
The retirement announcement by several high profile democrats suggests there will not be any major new programs passed in 2010 and the market likes a situation where major changes are not flowing through Congress.
The health care bill in its current form was not a poison pill for the private healthcare business so those companies are coming back from the dead.
2010 is going to be a blowout year for new PC sales, netbooks, tablets, superphones, etc so the tech sector led by the semiconductors should do well.
Solar and alternative energy companies just got a new multibillion tax credit so they should grow and prosper.
The remaining worries are the banks, oil prices, bonds and the dollar. The banks need to survive this earnings cycle without confessing to any of those potential earnings problems I wrote about earlier and guide higher for the rest of the year. If that happens financials plus tech, would put a solid floor under the market.
Oil prices need to weaken and move back under $75. Most economists believe that oil prices over $85 become a serious drag on the economy and much over $85 becomes recessionary. Demand has not returned, inventories are still plentiful, OPEC is pumping 2 mbpd under their maximum and there is no reason for the current price rally other than year-end cash moving into commodity funds. The current rally needs to end to allow the global economy to recover before the next round of high prices causes the next recession in 2012.
Bonds are going to struggle. With as much as $2.5 trillion in new U.S. debt to be auctioned in 2010 there is always the possibility of a failed auction. That would push interest rates significantly higher and the Fed would not be able to control the rate for home mortgages. With the interest rate spiking from a failed auction all future auctions would turn into a circus and the government and taxpayers would be forced to pay much higher rates on over $10 trillion in debt.
A failed auction would weigh on the dollar but higher interest rates would attract more buyers and support the dollar. I am not an economist but this contradiction of terms is confusing to me and probably to most investors. The Fed hiking rates to prevent inflation would come as the economy accelerated out of the recession. A Fed rate hike would produce a stronger dollar. An involuntary rate hike caused by a failed bond auction could have the reverse effect. If our ability to repay was called into question by a failed auction then rates would move higher from increased risk not stronger economy. That would cause the dollar to decline. Confused?
Hugo Chavez devalued the currency of Venezuela after the close on Friday. He established a two-tier system of rates. The dollar peg had been set at 2.15 bolivars to the dollar since 2005. After Friday the things he wants to pay for like food and medicine there is an exchange rate of 2.6 bolivars to the dollar. For those things he does not want to pay for the rate is 4.3 bolivars to the dollar. Items on that list include autos, computers, appliances, alcohol and tobacco. This will add 3-5% or more to the already high 25% inflation in Venezuela. In order to stifle dissent and save electricity he shortened the government workday to 8:am - 1:PM.
This is an example of where we don't want to go. The U.S. must retain its excellent credit rating and not be forced by circumstances into a hyperinflation environment of higher rates and weaker dollars. As long as the economy is growing we should not have to worry about countries buying our debt.
As for the markets I believe we are living on borrowed time. Since we made it through the first week of 2010 without a problem I feel the pressure for a correction has subsided for the next 2-3 weeks. Those long today believe earnings will be good and are likely to hold on at least until somewhere around the 22nd but after that day it could get dicey. There is a Fed meeting on the 26th and bullish earnings reports could push the Fed to change its plan on withdrawing stimulus. I don't believe it is going to happen but that fear should begin to creep into the market around Thursday the 21st.
The Dow struggled to break out of its six-week range and eased over resistance at 10600 only with the help of a late day buy program. The current support is 10500 and it appears pretty strong given the sharp rebound on Monday and the same strong rebound on Thursday. Dip buyers are alive and well.
Dow chart - 90 Min
The S&P appears to be leaving support at 1115 well behind as it surges higher on index fund buying. Eventually this breakout will pause even if only for a couple days. Note the declines in Aug, Sept, Oct. This is normal and we are overdue. The S&P has not posted a loss in 2010 but that is only 5 days.
Apple, Google, Qualcomm, Dell, Intel and Cisco all contributed to the Nasdaq rebound on Friday but Google was the biggest help with a +$8 rebound. The current rally looks unsupported and any real selling would find support at 2251. With Intel earnings expected to be strong the odds of any real selling this week are slim but Monday-Wednesday could see some profit taking.
The Russell shows the same pattern of year-end index buying from Dec-21st through Friday. The December 31st sell program is visible across all indexes. The Russell declined to support at 623 then exploded higher as index funds put year-end money to work. Next resistance is 660 but I would be really surprised to see that before enduring some profit taking.
In summary I think we will finish next week higher unless Intel says something to roil the markets or JPM misses their earnings estimates. I would not be surprised to see some weakness on Monday/Tuesday from profit taking but I think we have dodged the correction bullet until after the first three weeks of earnings.