The markets rebounded from significant losses after the gang of four made a joint statement following their White House meeting with the president. Traders were obviously not paying attention.
The four leaders of the House and Senate were the picture of bipartisanship when they walked in front of the cameras Friday afternoon. John Boehner, Harry Reid, Mitch McConnell and Nancy Pelosi knew they had to say something positive and avoid divisive comments to prevent a market meltdown. What the market heard was double speak clearly scripted to pull the markets back from the brink on worries over a deadlock on the fiscal cliff. Basically they said they agreed on the need to cut spending and raise additional revenue and they would work on a bipartisan framework to get this done. Cue the applause and everybody quickly exits stage right as the Dow rebounds from a -71 point loss.
We have a failure to communicate. What traders did not hear were the qualifications. Harry Reid said they would work through the Thanksgiving recess and have some proposals in early December. Nancy Pelosi said they hoped to have something done before Christmas. For me that was some bad news. The markets are crashing on fears the cliff will not be resolved soon. Instead of getting together and coming to an agreement in the coming days they are talking about mid to late December for "something" to be done.
That means investors will not have any reduced uncertainty for weeks into the future rather than days. That means investors don't know if the tax rates are going to change and which rates will change so they can make decisions.
Even worse, despite the Kumbaya moment for the TV cameras, we know there will be disagreements and delays in the process. The president has already locked himself into an unbreakable position and we know there is no common ground between Harry Reid and John Boehner. Despite the positive comments there will be some hard line positions and some ugly headlines as the fiscal cliff approaches.
I expect we will eventually get a deal to agree on a deal. This is similar to what the EU Finance Ministers have been doing for the last three years. They agree to agree on some major plan and the markets breathe a sigh of relief. Unfortunately the devil is in the details and the plans never seem to have the impact they envisioned. The House and Senate may agree to agree on a plan and then pass some stop gap legislation to kick the can down the road and end the worry over the fiscal cliff. I simply don't see them actually coming together with a comprehensive plan that accomplishes any major goals.
I believe the market rebound today was more short covering ahead of the weekend than optimism over a soon to be announced fiscal cliff deal. The initial rebound was on the lack of outright hostility rather than a vision of a deal.
With Thanksgiving week normally bullish and the next headlines on the cliff not likely to start impacting sentiment until the week after Thanksgiving there was no reason to hold shorts over the weekend. This entire cliff conversation is now on hold until after the holiday. Black Friday shopping will quickly move to the forefront for consumers and investors alike. After the shopping weekend I would expect investors to come back to the markets in search of the next entry point.
The market will not have a lot of external input next week. On the economic front the only material reports are the housing sector reports on Monday and Tuesday. Those are important but we already know the sector is improving. However, I would expect some weakness there simply because the summer buying season is over and shoppers are more focused on holiday shopping than house shopping.
Friday's economics helped to push the market lower at the open after the Industrial Production for October declined -0.4% rather than the +0.3% gain analysts expected. The government said the decline was related to disruptions caused by Hurricane Sandy. Since Sandy did not approach the northeast until Oct 29th I fail to see how that would have had any material impact on production in October. The government said Sandy's impact to production was a full -1.0%. Manufacturing output fell by -0.9% while mining output rose +1.5%.
Treasury International Capital Flows fell from $90 billion to $3.3 billion in September. That means foreigners and central banks bought $86.7 billion less in U.S. treasuries in September. That is a MAJOR change and it could be a harbinger of some serious trouble on the horizon. Analysts always warn that America can continue on its path of annual trillion dollar deficits only as long as China and others continue buying our debt. The talk of the approaching fiscal cliff and our $16.4 trillion in debt may finally be hitting home for foreign investors. China only bought $300 million in treasuries in September to bring their total to $1.16 trillion. If the Fed was not buying treasuries every month in Operation Twist and $40 billion a month in mortgage backed securities the bond market could get very ugly.
Internet E-commerce sales totaled $57 billion in Q3 compared to $54.8 billion in Q2. This is the 15th consecutive quarterly increase and Q4 is likely to be a blockbuster. Online purchases were up +17.3% from Q3-2011. The fourth quarter could see a major increase with the trend towards store shopping and then online buying really accelerating. Q4-2011 only saw $51.6 billion in sales and Q3-2012 is already well above that.
The ECRI Weekly Leading Index declined for the third consecutive week with a reading of 125.4, down from 126.1 the prior week. The WLI attempts to predict the direction of the economy by consolidating the monthly economic reports. The short term decline in the WLI could be related to Sandy since the regular economic reports have been impacted by the storm. For instance the weekly Jobless Claims spiked to 439,000 last week from 361,000 the prior two weeks. This spike is factored into the WLI and a reason why the index would have declined. The WLI is not an index to watch week to week but to be followed month to month. If the decline continues it could be pointing to a slowing economy.
In stock news Sears Holding (SHLD) was crushed for a -$11 loss after reporting a loss of -$1.99 per share for Q3. Earnings were down -20% and revenue -6%. The biggest problem appears to be the Kmart division. They are getting beat up by the dollar stores and Wal-Mart. Kmart has been treated like the adopted stepchild and ignored by Sears and it is dragging them down. Apparel and appliance sales at Sears improved and the online business grew by 20% so the Sears division is doing better. The company is going to have to speed up the restructuring or the problem areas are going to continue to drag results lower.
Sears Holding Chart
Dell (DELL) lost -7% after they missed earnings and cut their revenue forecast for Q4. Adjusted earnings of 39 cents missed by a penny and revenue of $13.79 billion missed estimates of $13.89 billion. Neither miss was a big deal but they also cut revenue estimates for Q4 to $14.2 billion and slightly less than the $14.5 billion estimate. That is a -13% decline from Q4-2011. The problem with the PC sector is the shift to the tablet. The common PC is fading and Dell and Hewlett Packard are fighting for market share in a shrinking market. That means lower prices and tighter margins. This is not going to get better any time soon since tablets are only going to get faster and cheaper. Dell shares have been cut in half since February.
Dell Chart - Quarterly
Apple shares dipped to $505 intraday before rebounding +22 to close at $527. Analysts are tripping all over themselves claiming Apple to be a buy at this level. Historically Apple dips -30% when it corrects. That would $493. I doubt we will see that level since $500 is such a round number target.
The problem with Apple is the capital gains tax hike coming on January 1st. If you bought Apple in Nov 2011 at $360 you have a monster profit even at the current depressed level. Do you really want to give Uncle Sam an extra 15% in taxes if you sell it next year? No, so the answer is to sell now. The selling has been brutal but it may be over at least temporarily. Volume was nearly double on Friday at 45.24 million shares and the majority of it was positive volume. The sellers were overrun by the buyers when it dipped to $505.
I believe Apple is going to explode higher once this financial crisis ends. Even with Mapgate and the product shortages the fourth quarter is going to be a blowout in terms of revenue. Morgan Stanley is predicting sales of 50 million iPhones this quarter. The current record is 37 million for a Q4.
The Apple stores are the most popular on the planet. They make about $6,050 for every square foot of floor space. That is twice the Tiffany rate of $3,017 per foot. Apple hosted 94 million visitors in its stores in Q3 or a rough average of about 19,000 per week per store.
Buy Apple at $500 or as close as you can get.
Schiff Nutrition (SHF) rallied +29% to $43.75 after England based Reckitt Benckiser offered to buy the company for $42 a share. What makes this interesting is that Bayer AG (BAYAR) had already agreed to buy Schiff for $34 a share on Oct 30th. When the first offer was made SHF was trading at $23. Now they are at $43.75 in anticipation of yet another offer. Clearly they were underpriced at $23.
There really is an expiration date on Twinkies. Hostess Brands asked the bankruptcy court for permission to go out of business after failing to get wage and benefit cuts from thousands of striking bakery workers. The 82-year old company employed 18,500 employees. The company immediately suspended operations at all 33 plants and put plans in motion to sell its assets.
The company said the unions had been the death of the company. There were 12 unions and the company had been fighting since January to get concessions that would allow the company to stay in business. Hostess had started implementing an 8% pay cut and a 20% increase in the cost of health care on November 1st. Workers went on strike Nov 9th in protest. The company gave employees a deadline of Thursday to return to work but the unions refused.
Now 18,500 workers are unemployed and the 82 year old brand is going to disappear. Actually, I am sure the brand will be purchased in the liquidation auction but it may be a long time before Twinkies and Ding Dongs are for sale again. Hostess has 33 bakeries, 565 distribution centers and 570 bakery outlet stores. Other than Hostess its brands include Wonder Bread, Natures Pride, Dolly Madison, Home Pride, Merita, Drakes and Butternut.
That means the last Hostess Twinkie has been baked and consumers were racing from store to store trying to score as many packages of Twinkies, Ding Dongs, Zingers, and cupcakes as they could find. A box of 10 Twinkies was selling for as much as $45 on Ebay with 5,361 auctions listed.
Extinct Hostess Products
With the Q3 earnings cycle nearly over we have a pretty good idea how it is going to end. 460 S&P companies have reported. Revenues were down -3.6% and earnings declined -2.2%. 62.2% beat on earnings but only 38% beat on revenues. That is the worst quarter in three years. Energy was the biggest loser with earnings down -19.8%.
In the commodity sector the price of oil rebounded on news Israel had activated up to 75,000 troops in its reserve force for a possible ground attack into the Gaza Strip. The trigger for this increase in posture was the targeting of Jerusalem by Hamas. Several long range missiles fell in the Jerusalem area. This was the first time Jerusalem has been targeted since the 1967 war. Three Israeli's have died. Over 550 rockets have been fired into Israel over the last two days with 197 intercepted by the Iron Dome missile defense system. In response Israeli airstrikes have hit more than 600 targets in Gaza.
Egypt has vowed to protect Palestinian rights. Egypt's prime minister visited Gaza and called for an international effort to end the violence. If Israel sends in ground troops it might force Egypt to retaliate and that would escalate the conflict. The U.S. would be forced to support Israel.
A ground war in Gaza could unsettle the entire Middle East since the various new regimes might be compelled to take some action to show they are not afraid of Israel and the USA. This flare up is a liability for the U.S. in the Arab world especially post Arab Spring. This could cause civil unrest in the Arab countries and possibly lead to disruptions in oil production.
WTI Crude Oil Chart
UN inspectors working for the IAEA reported on Friday that Iran had jumped ahead in its nuclear capability. The report said Iran had installed all 2,800 centrifuges in the underground Fordow nuclear facility. This will allow them to accelerate the enrichment process. The IAEA also said Iran's inventory of uranium already enriched to 20% had increased by 50% in just the last three months. Uranium at this level of enrichment can quickly be further refined into bomb grade material. Iran claims it needs the highly enriched uranium for its medical reactor but the IAEA claims Iran has far more of the enriched uranium than they need for that purpose. The IAEA claims it can no longer verify that all enriched uranium is being used for peaceful purposes because of the rapidly growing size of the inventory and diverse locations. It would be easy for Iran to set aside enough uranium for a weapon and the inspectors would not be able to detect it.
If Israel was not already involved in the Gaza war these new revelations from the IAEA would be increasing worries over an attack on Iran.
There was an explosion at an oil production platform in the Gulf of Mexico that left four men critically injured, with 11 taken to local hospitals and two still missing. The platform was not in production at the time and there was no material spill. The fire was put out almost immediately. The platform was owned by Black Elk Energy. It is one of 854 oil wells and 155 platforms owned by Black Elk. This particular one is in 56 feet of water and is not a spill risk.
The news of the explosion came at 10:AM and coupled with the Israeli news helped push oil prices higher.
Black Elk Rig Fire
Once President Obama was reelected it took only a week before BP settled on the criminal portion of the Macondo spill liability for a record $4.5 billion. They still have the big case ahead of them. The remaining problem is the fines for polluting under the Clean Water Act. If the U.S. can find them guilty of gross negligence the fine could be close to $20 billion. If not gross negligent it would be closer to $5 billion.
The U.S. also announced the indictment of multiple BP employees in conjunction with the spill. Don Vidrine and Robert Kaluza were charged with 11 counts of "seamans manslaughter," 11 counts of involuntary manslaughter and one violation of the Clean Water Act. They could face up to 10 years in prison for each count. The charges stem from misinterpretation of safety tests and violations of standard procedures. David Rainey, BP's former head of Gulf exploration, was charged with obstruction of Congress and making false statements to law enforcement personnel about how much oil was being discharged into the gulf.
Kurt Mix, a former BP engineer, has been charged with destroying evidence in the probe.
Several BP employees have refused to testify and lawyers have asked the court for permission to declare them hostile witnesses and to assume their testimony would have been detrimental to BP's case. Basically the judge will assume the worst in regard to the questions they will not answer.
Since BP has no further reasons to drag out the case and going to trial has significant risks we should expect to see them settle this case in the weeks ahead. Both sides admit to settlement talks but no details. The government spokesman simply said, "We have not been offered a settlement price that is acceptable." Clearly this is going to be an expensive settlement for BP and they still have thousands of individual suits to fight.
Natural gas prices rallied more than 25 cents for the week to end at $3.79 and only a penny below the high close for the year. The incentive for the rally was the first draw down of gas from inventory for the 2012 heating season. The EIA reported an 18 BCF decline in storage. However, gas in storage is still at record levels so the rally may not have much farther to run unless a new ice age descends on the USA.
Natural Gas Chart
Gold prices continue to disappoint with a close just over $1700 and no material movement since mid October. The reason is the strong dollar, which closed at a three month high on Friday. Europe is in a recession. Germany's economy is nearing a recession and China's economy is struggling to turn the corner as the new leaders take over. Greece and Spain remain in the headlines and that is pushing the euro lower and supporting the dollar. A strong dollar pressures gold and silver. This is a temporary situation but frustrating for the gold bugs.
Dollar Index Chart
After two weeks of declines the markets have entered oversold territory. The reason for the declines has not changed and will be with us for the weeks ahead. However, oversold markets tend to stimulate bottom fishing even when the reason for selling still exists.
The markets can benefit from seller exhaustion. That means sellers either ran out of stock to sell or they no longer want to sell it at the current price. In the case of equity funds they will expect a rebound from a critical support area like S&P 1350 and so they temporarily stop selling in hopes of a decent bounce so they can resume selling at a higher level.
I believe that is what we will see next week. The normally bullish holiday week will benefit from the drop to 1350 on Thr/Fri and we could see a rebound to 1385 or even 1400 before the next wave of selling begins the week after Thanksgiving.
With Washington politicians leaving town for Thanksgiving the headlines on the fiscal cliff should be subdued. The news shows will replay the Friday statements from the gang of four and blather on about how the new bipartisan compromises will come up with a deal before the cliff arrives. The news or actually lack of news will be conducive to a trading bounce in the market. At least that is my theory and I am sticking with it until proven wrong.
The S&P dipped to 1348 on Thursday and 1343 on Friday but both days saw closes back above 1350. This double test of support should have the antsy money chomping at the bit to buy something on Monday.
Clearly this theory could fall apart depending on the headlines but Black Friday news stories should begin to blanket the news early next week. Hopefully that will keep everyone distracted.
The worst case scenario is targeting a dip to 1265 over the next 3-4 weeks. Maybe I should say the next to worst case since signs of a heated partisan argument rather than compromise could push us back to 1200 very easily in early December.
I would use any Thanksgiving bounce to add to bearish positions.
The Dow declined to its initial target at 12,500 and that support level held as the week ended. The intraday rebound on Friday from a -71 point loss still left the index down -177 for the week and more than -1000 points from the October 5th high close at 13,600. The damage is not over for the Dow but we could see a trading bounce next week. The next downside target would be a retest of 12,000.
The Nasdaq never had a chance last week. With Google and Apple both dropping like a rock, Dell crushing the PC sector and semiconductors hitting four month lows I am surprised we did not break below that soft support at 2800.
Next week could be an improvement. Apple is being talked up as a buy in nearly every chat room and on CNBC. At $500 I believe it but we simply don't know how much the pending capital gains tax hike is going to hurt stocks like Apple. Big gains mean big taxes and investors don't want that bite to be even worse.
I expect support at 2800 to eventually be broken and that could push the Nasdaq into a freefall with the next closest support at 2500. Let's hope that does not happen.
Just because I see the possibility of a trading bounce it does not mean it will happen. We need to remain focused on the longer term trend and until the fiscal cliff is much closer to being solved I believe that trend is down. The ratings agencies are just waiting for signs of a logjam between the House, Senate and the president as a signal to warn of another ratings downgrade. We also have the debt ceiling debate coming soon. Add in the recession in Europe, rising tensions in the Middle East and crummy earnings and there is no reason for the market to rally.
Definitely, enter passively and exit aggressively over the next few weeks!
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"A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves largesse from the public treasury. From that moment on, the majority always votes for the candidates promising the most benefits from the public treasury with the result that a democracy always collapses over loose fiscal policy, always followed by a dictatorship. The average age of the worldâ€™s greatest civilizations has been 200 years."
Alexis de Toqueville