EU finance ministers express doubts over the commitment by Greece to follow through on bailout agreements and traders took profits.
Reality returned to the markets Friday morning on worries the Greek Parliament will not vote to approve the conditions of the bailout required by the EU. Riots in Greece were the headline topic on all the news channels. Unions launched a 48 hour nationwide strike in protest of the new bailout deal. Six Greek cabinet ministers resigned over the severity of the cuts being required by the EU. The far right LAOS party has pledged to vote against the new austerity measures. Fortunately they only control 16 seats in Parliament. On top of all the problems over the bailout deal in Greece the EU finance ministers now claim the deal does not go far enough.
EU finance ministers gave Greece until Wednesday to find another 325 million euros to cut and then get those cuts passed through a divided congress, and get written guarantees that they will be implemented after the April elections even if the government leadership changes.
The Greek prime minister is planning on rushing the new austerity program and the additional cuts through parliament for a vote on Sunday night. Unfortunately the chances of getting the harsh new austerity measures passed by parliament in the current environment appear to be uncertain. Currently the governing coalition controls 252 of the 300 seats in Parliament but several coalition leaders are threatening to leave the coalition. Prime Minister Papademos told high cabinet ministers to either approve the austerity measures or quit and he would replace them with someone who would. Six cabinet ministers have resigned in protest over the last several days. The cabinet voted on Friday to approve the measures.
The parliament really has no other choice. The conditions set by the EU are no longer open for discussion and the EU, especially Germany, appears ready to allow Greece to fail rather than continue putting up with monthly agreements that are never implemented. Most analysts believe Greece will eventually default even if they do manage to get this bailout deal completed. The amount of debt at 350 billion euros will keep Greece in a hole for the next 20-30 years. If they default they could be back to growth mode in 2-3 years and not have the crushing debt load sucking the life out of the economy.
Most analysts believe it would be better for Greece to default now and suffer through the two years of severe pain rather than not defaulting and having to suffer through 10-12 years of moderate pain. Rip the band-aid off and get it over with. It would be ugly for Greece. The new drachma would go through daily valuation declines and there would be massive inflation. After the first year it would become a tourist meca because it would be extremely cheap to visit. The rest of Europe would see tourism decline but Greece would be sold out. Exports would be so cheap their industry would boom.
Even if the austerity measures are passed the EU does not believe they will be enforced. Many of the earlier austerity steps were passed but failed to get any traction. This is a country in a total state of dysfunction. They can't even collect taxes because of violent threats against the tax collectors. This is an election year and historically Greece does not enforce tax collection in election years in order for elected officials to get voted back into office.
As part of this new bailout they have promised to cut 15,000 government jobs. The last time they promised to cut 30,000 and they ended up only firing 1,000. They were supposed to privatize (sell) 50 billion euros of public facilities. They later talked about raising 15 billion but then failed to raise even one billion through sales. These types of failures to implement the agreed terms of the prior bailout is what is causing the EU to take a hard line on the currently proposed bailout. This is why some members of the EU want the bailout money to be put in escrow and the EU be in control of how it is spent. That is not settling well with Greece for obvious reasons.
Everyone claims Europe would be traumatized by a Greek default but this constant worry about the next tranche of bailout money and the financial drain on all the other countries is going to be the equivalent of a bad case of never ending flu for years to come. Cut Greece loose and deal with the financial problem once. In three months it will all be over. They are going to default anyway. Count on it. Earlier last week two prominent Citigroup economists, Willem Buiter and Ebrahim Rabhari raised their predictions of a Greek exit from the euro zone over the next 18 months from 25-30% to 50%. On Friday Fitch reiterated its view that Greece will default even if it gets the bailout package.
S&P added to the gloom by downgrading 34 of the 37 Italian banks it follows. S&P said, "Italy's vulnerability to external financing risks has increased, given its high external public debt, resulting in Italian banks' significantly diminished ability to roll over their wholesale debt. We anticipate persistently weak profitability for Italian banks over the next few years."
Not only did Greek and Italian concerns mess with market sentiment but U.S. economics also weakened investor conviction. Consumer Sentiment for February declined to 72.5 from 75.0 with the current conditions component leading the decline. Current conditions declined to 79.6 from 84.2 and ending a five month streak of gains. Expectations declined slightly to 68.0 from 69.1.
The decline in the headline number disappointed analysts, some of whom expected a breakout above the 75 level that has been resistance since late 2009. However, it should be noted that seasonal adjustments have caused a decline in February sentiment in 11 of the last 12 Februarys. I would not get too excited about the minor decline. Consumers are normally depressed in February and March because of holiday bills coming due and the pressure of filing and paying income taxes. We are also approaching the end of the temporary payroll tax cuts if Congress can't find a way to pass another extension. Consumers are only 1-2 paychecks away from seeing that tax bite return.
Consumers have been upbeat about the economy. The recent payroll reports have shown unexpected strength and the weekly jobless claims continue to decline. If those trends continue the sentiment numbers should improve. However, with five presidential candidates pounding the airwaves with alarmist comments on how bad the economy is today those consumers may continue to be somewhat depressed.
Consumer Sentiment Chart
The administration also announced the budget deficit is expected to top $1.3 trillion in 2012 and more than $900 billion in 2013. The White House confirmed a report that President Obama's budget would produce a $1.3 trillion deficit for the fiscal year that began on Oct 1st. That is the same as 2011 and it is $327 billion more than the president's last estimate. In 2009 the administration ran a $1.41 trillion deficit and that declined slightly in 2010 to $1.29 trillion. The 2012 deficit is actually lower than previously expected because of higher corporate tax receipts. Tax revenue rose to $790 billion from October through January. President Obama is scheduled to release his proposed budget on Monday.
The calendar for next week is a lot busier than the week just ended. The key points are the FOMC minutes on Wednesday and Philly Fed Manufacturing Survey on Thursday. The FOMC minutes are not likely to surprise since this was a Fed meeting followed by the Bernanke press conference and two days of congressional testimony.
The Philly Fed survey is the first major manufacturing report for February. This should give us an indication on whether the economy is still improving or the bounce was just temporary.
The price indexes CPI and PPI will tell us if the inflation monster is still asleep and the Fed is free to take additional action if needed. If you exempt rises in food and energy inflation should be tame.
In stock news it was a very quiet day. Earnings reports on Fridays are very slim and normally companies you never heard of. Linkedin (LNKD) continued its afterhours rally from Thursday night with a +18% gain on Friday to close at $90. The company posted better than expected earnings after the close on Thursday and brokers were racing each other on Friday to raise their price targets. Morgan Stanley raised their target to $105. Canaccord Genuity raised it to $95 from $85. JP Morgan went from $84 to $90. Citigroup added $10 to target $90. Since LNKD closed at $90 with a $13 gain some of those price targets need to be raised again but first the stock needs to conquer that resistance at $90-$93.
Cobalt Energy (CIE) rallied +32% after announcing test results for a new well off the coast of Angola. The Cameia-1 well produced "exceptional results" and will be able to produce 20,000 bpd. Since this was the first exploratory well in this area the company plans several more and they will be drilled even deeper to test other formations. This is like winning the lottery for a small company. Knowing they will have revenue from 20,000 bpd allows them to expand drilling programs in the same area. They said the well had a 1,180 foot "continuous oil column." Goldman Sachs is said to own 19% of Cobalt. Citigroup said the well results suggested Cobalt could have reserves in their contiguous blocks of up to two billion barrels, worth $6.60 per share.
Yahoo rallied again although it is hard to see on this chart because of the decline at the close. Positive chatter is starting to appear on the blogs suggesting the Internet company is moving ever closer to a deal. This is proceeding so slow it is like watching grass grow but the end result should be worth it with an eventual deal price estimated at $19 to $23. I would bet on the low side of that range simply because of all the complexity. The Japanese and Asian parts will be tricky to unload without a big tax bill.
Pharmacyclics (PCYC) reported earnings Thursday evening and the results were dramatic. Adjusted earnings were 82-cents compared to analyst estimates for a loss of 19 cents. The company is working with Johnson & Johnson (JNJ) to develop potential treatments for cancers like lymphoma and leukemia. JNJ paid PCYC $150 million up front and if the drugs are successful they could get more than $1 billion in follow on fees. Shares rallied +17% on the news.
After the close on Thursday the CME lowered margin requirements on numerous futures contracts. They lowered the margin requirements on Brent crude futures by -8.3%, Nymex crude (CL) by -8.9%, Comex silver (SI) by -13.5%, copper (HG) by -13%, gold (GC) -11.8% and platinum (PL) -22.2%. Margins for natural gas were raised by 8.5%. These rates will be effective after the close of business on Monday.
The CME also said the size of its board will shrink soon. As a result of past mergers the board had swelled to 32 members at an annual cost of $5.5 million in fees. Some of those positions as a result of mergers will sunset over the next 12-18 months and the board could shrink back to the 20 members it had before the last merger. The bylaws require a quorum of 17 to transact business. The current 32 member board is the largest of any U.S. company for the last decade according to GMI, a corporate governance research firm.
CME shares have exploded since they moved to limit fallout from the MF Global disaster. The firm said it would put in place a $100 million guarantee fund for farmers and ranchers. It also plans to provide $25,000 per account if customers suffer losses from the insolvency of a CME clearinghouse member. They also reported earnings of $11.25 per share compared to $2.93 per share in the year ago quarter. There was a $528 million noncash benefit from a tax adjustment. They also raised their quarterly dividend to $2.23 from $1.40. Plus they added an annual variable dividend of $3.00 per share this year and paid in the first quarter of each year based on profitability. Both dividends will be paid on March 26th to holders of record on March 9th.
Three vowels attacked the energy sector on Friday. The drop in oil prices was brought to you by A, E and I. Last week the Energy Information Administration (EIA) helped push oil prices higher by raising their demand expectations for 2012 and 2013. On Friday the International Energy Association (IEA) cut its oil demand growth forecast for a sixth consecutive month due to a weak global economy. The IEA cut their demand growth forecast by -250,000 bpd to 800,000 bpd for 2012. That was dramatically different than the EIA forecast earlier in the week which raised estimates for 2012 demand by 50,000 bpd to 1.32 mbpd. That was the first increase in demand for the EIA in four months. Now we have a real smack down in progress with the IEA and EIA publishing dramatically different numbers despite having the same real time data. I am putting my money on the EIA and I never thought I would write those words. I am an ardent critic of the EIA and the IEA for that matter but in this prediction battle I will side with the EIA.
When competing agencies post different predictions it is helpful to find a third, impartial, agency to moderate the debate. Unfortunately none exist so the obviously biased OPEC ends up being our arbiter. OPEC said on Thursday they expected oil demand growth to decline by -120,000 bpd from their prior estimate to +940,000 bpd.
The IEA said they were basing their estimates on a projection by the IMF that the global economy will only grow by 3.3% in 2012, down from their prior estimate of +4.0%. The IEA said oil demand in industrialized nations was expected to fall by -0.8% and account for more than 40% of the global decline. The U.S. has seen oil demand decline by -4.1% year over year despite an unexpected pickup in economic activity. The IEA believes this is due to a sharp decline in heating oil and LPG demand due to an unseasonably mild winter in the USA. They also expect European demand to post the largest decline in 2012 of -300,000 bpd. That is the key to the IEA demand scenario because they still expect emerging economies to increase demand by +1.2 mbpd.
Despite the predictions for slowing demand OPEC pumped a near record 30.9 mbpd in January and 900,000 bpd over their official quota. Global oil supply rose to 90.1 mbpd, also a record, and yet prices continue to climb. If the IEA is right about demand falling and production rising then why are prices rising? Maybe oil demand is not as weak as they are predicting. We know there is a security premium in the price due to Iran, Syria, Nigeria, Egypt and Sudan but in theory the eventual price should reflect actual demand. February is normally the seasonal low for oil prices. If $98 is going to be the seasonal low then summer is going to be a challenge when demand and prices increase sharply. Libya is no longer a problem with 1.3 mbpd of light crude now being produced. Saudi Arabia is also producing close to 11.0 mbpd and well over their stated target of 10.0 mbpd. China bought an "extra" 250,000 bpd from them in January because demand in China was increasing. India has been purchasing an "extra" 200,000 bpd from Saudi as well. Saudi claims it can produce up to 11.8 mbpd so that does not leave a lot of excess production for future demand increases.
Iran claims it will announce "big new" nuclear achievements later this week. The president also said Iran would never give up its nuclear ambitions so obviously the announcement is not going to be that they decided to quit enriching uranium and play nice with others. The IEA claims there are commitments to drop purchases of 1.0 mbpd of Iranian oil later this summer as sanctions increase. That number is likely to grow as sanctions against the Iranian central bank restrict the flow of funds to pay for oil.
There may be some extra oil sloshing around in the markets today but refiners are stocking up in case somebody drops a bomb on Iran. If covert operatives can kill four nuclear scientists with impunity you would think they could blow up some oil facilities just as easily. With the Iranian oil embargo scheduled to start in July just when summer demand is at its peak we should expect some pretty steep gasoline prices for that summer vacation driving.
WTI Crude Oil Chart
Brent Crude Oil Chart
The markets have not been racing higher the last couple weeks and Mark Hulbert believes it is because of a flood of insider selling. He claims insiders are now selling shares at the fastest rate since last July when selling peaked just as the market imploded. The Dow declined -2,000 points in August.
Argus research said the ratio of insider sales to purchases was 5.77 to 1 last week. For companies listed on the NYSE it was 8.2 to 1. In the last week of November with the S&P declining to 1160 the sell to buy ratio was only 0.81 to 1. The current ratio is ten times higher for the NYSE stocks.
While corporate insiders are selling shares at a record pace the American Association of Individual Investors (AAII) reported their recent poll showed bullish sentiment at 51.6% and bearish only 28.2%. AAII spokesman Charles Rotblut called the levels "unusually high but still not at an extraordinarily high level." He said that suggested the rally could still have some breadth.
While some analysts are calling a top, famed doom and gloom analyst Nouriel Roubini actually just made a bullish case for stocks. Who knew doctor death had a bullish bone in his body? Blackrock's Larry Fink suggested investors go 100% into equities. Warren Buffett and others are warning the long bond market could be nearing an end and that suggests stocks will continue higher.
I heard one analyst on Friday claiming this was the most hated bull market in history because funds were still selling the highs because of bad earnings, bad U.S. economics and bad global economics. Despite the selling the market kept moving higher because the majority of funds were still under invested and while some were selling the tops others were buying the dips.
Technicians are looking at the 1350 level as a double top and some are projecting a retest of 1100. Personally I hope I never see 1100 again but that is not my decision. There are some who believe we will see 800. Those are stories for another day.
Pretty much nearly every bull believes the market is due for a rest. The only difference in opinion is how much of a rest. Generally 3% to 5% appears to the consensus. Some are looking (hoping) for a 6% to 10% drop. I believe any decline is going to have a difficult time achieving more than a -3% decline which would take the S&P to 1310. If you remember we consolidated at that level for nine days in January. A decent bout of selling would find strong support there on a retest.
The S&P lost -9 points on Friday to close just over 1340 and that was the biggest daily loss for the S&P this year. That should give you a clue about the dip buyers. Every little decline is instantly bought but there is a steady flow of sellers at the highs.
Volume was slow again at 6.5 billion shares and decliners were 3:1 over advancers. That is actually a lot better than the 5:1 earlier in the day. The S&P rebounded +5 points in the closing minutes and the Dow rebounded about 60 points. Dip buyers were alive and well despite the potential for another Greek disaster on Sunday.
The best thing that could happen to the market would be a failure of the Greek vote on Sunday and the potential for a disorderly default. That could push a few more weak holders back to the sidelines on Monday and allow for a nice relief rally when the Greek parliament passed the vote on the second attempt. That is not likely to happen given the strong imbalance of 252 of 300 by the coalition in power. The austerity should pass on Sunday.
The politicians have no choice. It is either long term pain and having to suck up to the stern EU parent and play by the rules to get their quarterly allowance or serious short term pain with no handouts and be cursed by everyone you know when the Greek economy implodes. For a politician the path is clear. Moan and groan in public but vote for the long term pain and hope to keep kicking the can down the road until your pension kicks in.
For me that means we keep buying the dips. I was really skeptical about the market for Friday after the miniscule gains for the first four days but the lack of a real decline and the dip buying at the close suggests the rally is not over. I would be thrilled with a pullback to 1310 but I am not counting on it.
Conventional wisdom suggests we are due for a steep decline given the distance we have come but we could go broke betting on it to happen. A decline will eventually appear but that could be days or even weeks in the future. Sooner would be better than later but we don't get to pick the market direction. We just play the cards we are dealt.
Did anyone really expect us to just blast through that strong resistance at 1350 on the first attempt?
Initial support for the S&P is 1340 followed by 1310.
The Dow did punch through resistance at 12,750 after ten days of consolidation at that level and now that prior resistance has turned into support. This is the perfect scenario if it holds. The armchair technicians will see a rebound from that support and give it their blessing and we go higher. If there is no immediate rebound the next support level is only about 100 points lower at 12,650 to 12,600. We could easily test those levels on some ugly European news but I believe it would be a buying opportunity funds would not pass up.
Resistance 12,900, support 12,750, 12,650, 12,600.
The Nasdaq gave back -23 points but the damage was minimal. That loss put the Nasdaq Composite negative for the week by a whopping -1.78 points. Most of Thursday's gain was due to Apple's +17 point spike. Apple did not contribute on Friday and closed with only a fractional gain. That allowed big declines in stocks like TRLG -10, GOOG -6 and FSLR -5 to push the index lower. Declines were 3:1 over advancers on the Nasdaq with the average decline -1.03%. Considering the gains over the last two months that was negligible.
The biggest indicator for me was the 25-cent gain on Apple. That stock is up +$70 since earnings and closing in on $500 and there is zero weakness. The Apple faithful are betting on the new product announcement the first week in March and the potential for a big dividend as well. Somebody needs to remind those investors about the post announcement declines. Capture the rally now but be very sure you are flat or short on the day of the announcement. Apple has been a prime example of buy the rumor, sell the news. Until then, gains in Apple should equal gains on the Nasdaq.
Initial support appears to be 2900 followed by 2885 and then 2800. That last step down is a killer.
Nasdaq Chart - 15 Min
Nasdaq Chart - Daily
Is our canary sick? The Russell 2000 small cap index is our canary in the coal mine and it looks like Friday was a bad air day. The Russell declined -1.4% or -11 points and twice the percentage decline of the S&P. The chart pattern is very clear and I did not have to redraw any lines. Uptrend resistance held at 830 and the index is returning to test uptrend support at 810. This is healthy. However, since we are watching the Russell for signs of fund manager sentiment we need to make sure we are paying attention if 810 breaks.
It may not be a big break with next support at 800 but the uptrend from November will be in jeopardy if 800 breaks. That is going to be a critical level for market sentiment.
Russell 2000 Chart
The Dow Transports function as the backup canary. Unfortunately they have declined for four of the last five days and they are in danger of breaking below uptrend support.
The combination of weakness in the Russell and the Transports reinforces my market caution. The big cap indexes may be misrepresenting the health of the market because of their liquidity. Watch the Russell and Transports carefully for signs of weakness before adding to long positions.
Dow Transports Chart
We are still waiting for the EU to kick the Greek can far enough down the road to keep them out of the headlines for the next couple of months. Unfortunately that means we have to get past the Greek Parliament vote on Sunday, the EU Finance Ministers vote on Wednesday and then the final signing of the deal a couple weeks later and the disbursement of funds by mid-March. Until then there are any number of complications that can arrive and most likely will arrive. This is not going to be painless. For this week we just want to get past the Monday open and then past the Wednesday EU meeting then we will worry about the next set of crucial dates.
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"Capitalism without bankruptcy is like Christianity without hell."
Kyle Bass, Hayman Advisors