The Dow tried valiantly to stretch its winning string to 11 days but was unable to complete the task.
The Dow streak ended at 10 days and the longest streak since 1996. It set a new closing high on seven consecutive days. The Dow has risen for ten consecutive days only 15 times in its history. The cards were stacked against the Dow making it 11 days because of the quadruple witching and the S&P rebalance.
S&P weightings on three major Dow components, XOM, T and PFE were being rebalanced at the close. Those companies had been especially active in their stock buyback programs and S&P cut their weighting in the S&P as of Friday's close. That means every equity fund indexed to the S&P had to sell shares of those companies before the close to adjust their holdings to match the new S&P weightings.
The option expiration also weighed on stocks after weeks of gains. Closing out long option positions can create selling as the writers of those options square positions as well.
Lastly, it was time for the Dow to rest. Thursday's strong gains were out of character with the minor moves we have seen over the last two weeks. Although this was probably expiration related it created the appearance of the climax spike that typically comes at the end of a long run of gains.
The markets plunged at the open after the Consumer Price Index (CPI) for February spiked +0.7% and stronger than expected. The total for the prior three months was +0.2% with two of those months showing zero gains. A sudden spike of +0.7% sent a shockwave through the market.
Rising inflation is one of the criteria the Fed is watching to trigger an end to its QE process. Fortunately the internals were weaker with the core rate only up +0.2%. The core rate does not include food or energy and that is the rub. Food was only up +0.1% but energy exploded higher with a +5.4% gain. This should not be a surprise since gasoline has been trading at record highs for this time of year.
The Fed watches the core rate but that does not mean they are not seeing the spike in energy. They simply believe energy prices are going to moderate in the year ahead and that is not a challenge for them today. As long as the dollar is rising the price of oil will decline. Eventually that spike in the dollar is going to fail and oil will rebound. That puts the Fed on notice once the dollar begins to weaken.
The 12-month rate on the core CPI is +2.0% and the Fed's tripwire for ending QE is 2.5%. Despite the spike in food and energy the core rate is not expected to climb to 2.5% in the next six months. However, it has risen +0.6% in just the last three months. Payrolls are expected to decline over the next six months and that will moderate the importance of the CPI on the Fed's decisions.
The NY Empire Manufacturing Survey for March declined slightly from 10.0 to 9.2. While that may seem slightly negative it is not. The Empire Survey had been in negative territory for the six months prior to February's return to positive territory. We should look at this as second consecutive month of expansion in the NY area.
New Orders declined slightly from 13.3 to 8.2 but still well into expansion territory. Backorders were flat at -2.2. Last month was -2.0 but those were the best readings in more than eight months.
Empire Manufacturing Chart
Traders were just getting over the CPI data when the Consumer Sentiment report at 10:AM pushed the markets to a new low. Sentiment for March fell to 71.8 and the lowest level since December 2011. This decline was a real shock since analysts were expecting a rise to 80.0 from February's 77.6.
The present conditions component declined slightly from 89.0 to 87.5 but the expectations component dropped sharply from 70.2 to 61.7. That is the lowest level for expectations since November 2011.
Analysts were claiming the decline was due to tax hikes and gasoline increases. However, those are current situation factors and the current situation number barely declined. I believe the decline in the expectations is related to the sequestration debate. The administration warned for a month how bad it was going to be if the presidents forced sequestration cuts were allowed to take place. The president warned of long waits at the airports, lack of vaccines for kids, a decline in food safety checks, closing of U.S. parks, delays in tax refunds, 750,000 job cuts and hundreds of other sequestration impacts. You can't appeal to consumer emotions to try and exert pressure on politicians without impacting consumer sentiment as a result of those emotions.
Consumer Sentiment Chart
On the positive side of the economic ledger the Industrial Production for February rose +0.7% compared to a decline of -0.1% in January and expectations for +0.4%. The biggest gain came from autos and parts rising +3.6%. Also adding to production was an increase in utility production of +1.6% thanks to the cold weather. Manufacturing rose +0.8% and business equipment rose +2.5%. Mining was the weakest with a -0.3% decline. This report is normally ignored by the market.
Industrial Production Chart
Next week's calendar has three critical events. The first one is the FOMC meeting and the announcement will be at 2:PM on Wednesday. No changes are expected but there is always a huge risk for a surprise. With the sequester intact I can't imagine the Fed would make any changes because they need to try and counteract the impact of those spending cuts on the economy. We know the various Fed heads are mixed in their views on QE and there have been dissentions to the policy. Never say never when predicting Fed actions or inactions.
The second event is the Bernanke press conference on Wednesday afternoon. These have turned into cheering sessions for the economy but given the better than expected payroll numbers the market does not really want Bernanke pounding the table on the economy because that would mean future changes to QE. The market will want him to continue to stress no changes to QE until inflation rises to 2.5% or unemployment falls to 6.5%. That unemployment number is not going to happen until 2015 according to the majority of analysts so inflation and economic growth should be the hot topics after the big CPI gains.
Lastly the Philly Fed Manufacturing number on Thursday will be a market hot spot. The Philly Fed has declined the last two months with a -12.5 reading in contraction territory in February. New orders were negative the last two months and backorders hit their lowest reading at -11.2 for the last six months.
We need to see improvement in the Philly Fed report. Any further declines sets up some serious soul searching on the direction of the economy. The Philly Fed report is the most closely correlated to the national ISM coming in two weeks. The ISM has been up the last two months so one of these reports is due for a course change very quickly.
There is a flurry of overseas economics as well. Chinese and Eurozone PMI and the German ZEW and IFO data. There should be no surprises here but anything is possible.
Stock news was fairly quiet on Friday. It was all about the economics and the 10-day Dow streak. Most of the stock news was centered on financials. The Fed released its approvals for the capital allocation plans submitted by the top 18 banks. Not all were approved.
The Fed approved 14 of the 18 plans with two rejected and two were conditional. Goldman Sachs (GS) and JP Morgan (JPM) had their plans approved but they were asked by the Fed to resubmit capital plans by September after analyzing the "weaknesses" the Fed saw in their capital planning process.
Ally Financial failed the stress test and the Fed rejected their capital plans. BB&T Corp (BBT) was also rejected for certain "qualitative" reasons the Fed did not disclose. There was a recent change in calculation of certain assets by BB&T that would result in lower capital ratios than those submitted in the stress test. BB&T said it would be resubmitting a plan shortly.
Bank of America (BAC) received approval to buy back $5.0 billion in common stock and $5.5 billion in preferred stock. Citigroup (Nyse:C) received approval to buyback $1.2 billion in stock through 2014-Q1. Wells Fargo (WFC), Bank of New York (BK) and U.S. Bank (USB) also received approvals to raise dividends and/or buy back shares.
Goldman Sachs shares declined on the news but rebounded by the close to an 82 cent gain. JP Morgan shares fell -$1 but it was due to headlines about the whale trade and not the capital program. JP Morgan officers were beaten up severely in Washington as senators went through the dog and pony show of "investigating" the whale trade. You know the process. A senator spends 5 minutes berating the person testifying and finally ends with a question where only a negative answer is possible. The senators get their face time on camera and the bank employees, some of them ex-employees, are tortured on camera. Given the stock's gains over the last four months the decline was minimal.
Carnival Corp (CCL) declined only slightly after acknowledging they have two more crippled cruise ships in the Caribbean. The Carnival Legend reported engine trouble and elected to cancel a stop on Grand Cayman on Friday. The ships speed has been reduced and they are heading directly to port in Tampa rather than making its last stop and arriving in Tampa a day late. Carnival said it would give each passenger a $100 credit and 50% off a future cruise.
On Thursday the Carnival Dream was idled in St Maarten after its emergency diesel generator malfunctioned during testing. Passengers were flown home on planes chartered by Carnival. Last week the Carnival Elation had to be escorted down the Mississippi River by tugboats after a mechanical problem.
None of these events were as bad as the Carnival Triumph disaster last month when the ship lost power due to a fire in the engine room and had to be towed back to port in a week long process.
Carnival reported earnings on Friday and made a profit for the quarter. However, they cut the forecast for Q1 to $1.80-$2.10 from $2.20-$2.40 per share. The company said it was experiencing booking challenges and the cost per cabin was declining as a result of lower pricing and extra promotions. Bookings for the rest of the year are below 2012 levels. I would think you can book a carnival cruise really cheap today.
Freeport McMoran (FCX) was upgraded by Goldman to a buy from hold saying the fundamentals for copper were strong. Their price target is $42 and 33% over the current price. Goldman said miners in general should improve because of the expected increase in demand for metals as the global economy improves. FCX closed at a four-week high.
Other upgrades included:
ARMH from hold to buy at Jefferies
BBY from sector perform to outperform at RBC Capital
CPST from neutral to buy at Roth Capital
INFY from hold to buy at Jefferies
NDAQ from market perform to outperform at Wells Fargo
NVS from neutral to overweight at JP Morgan
SEE from neutral to outperform at Credit Suisse
VMW from hold to buy at S&P Capital IQ.
What's up with Apple? Shares of the iPhone maker rallied +2.6% to a two-week high at $444 the day after Samsung released its new iPhone clone the Galaxy S4. Apple faithful must have thought the S4 lacked the capability to steal meaningful share from Apple. Samsung said it was launching the phone in 150 countries by mid April. The phone has a five-inch touchscreen compared to the four-inch on the iPhone 5. This is one of three major Samsung competitors to be announced this year and Apple should not announce a replacement for the iPhone 5 until after June. Typically they wait until after the developers conference in June. Analysts reviewing the S4 said it was "evolutionary not revolutionary" and apparently investors are expecting revolutionary from the next iPhone. Piper Jaffray expects Apple to sell 177.5 million iPhones in 2013 and announce a cheaper model in Q3.
Quite a few analysts are starting to call a bottom in Apple shares and that is probably one of the reasons for the bounce. The S4 was not a Goliath killing cruise missile as some had expected and that helped Apple shares.
The +$11 gain on Apple was not enough to lift the Nasdaq into the green because ISRG (-$30), ULTA (-$14.57) and GOOG (-$8) were weighing it down along with EQIX, AMZN, NFLX and PNRA.
Intuitive Surgical (ISRG) fell -$30 after the president of the American College of Obstetricians and Gynecologists discouraged the use of robotic systems in hysterectomies. The president said other techniques allowed women to leave the hospital sooner and with a smaller bill. Robotic procedures added $2,000 to the bill. The Da Vinci system performed more than 450,000 procedures in 2012, an increase of 25%, and the number should continue to grow. Cantor Fitzgerald said this was old news and shares should rise in the months ahead. Shares of ISRG dropped sharply in early March after the FDA announced a probe into the Da Vinci system.
Don't look now but the AAII Investor Sentiment Survey has recovered the majority of its losses from the prior weeks. The bullish component rose +14.4% to 45.4%. The bearish component declined -6.5% to 32.0%. Those in the neutral camp declined -7.9% to 22.5%. Just two weeks ago bullish sentiment was at a multi-month low at 28.39%. Four weeks before that it was at a multi-month high of 52.34%. Clearly the sequester worries weighed on investors but when the world did not end on March 1st they came roaring back. Having the Dow make eight consecutive new highs did not hurt either. The bullish component is over its average of 39% but still below its highs. A short dip in the market followed by a decent rebound could send these survey results into the stratosphere because a worry over a correction would disappear. Time to launch short positions when that fear goes away.
The market sold off slightly on Friday but there was no fear. The VIX closed at 11.30 for the second consecutive day. That is a six-year low and the Dow was down -66 points at the open. There is no fear. When it finally arrives it could be really ugly since everyone has forgotten about the boogeyman.
The table below shows the year end estimates by the top banks and brokers. The change and percentage columns are based on the Dec-2012 close at 1426. If the majority are right we have a ways left to go in the bull market.
2013 Predictions from 1426 at year-end 2012.
The Dow winning streak brought the statisticians out of hiding and there are all kinds of comparisons making the rounds. The graphic below represents the 12 years since 1950 the Dow gained more than 8% in the first quarter. Several people have used the quote "Every time the Dow gained more than 8% in Q1 the markets finished higher for the year." While that may be true I am sure you see the problem highlighted below. For instance in 2012 the Dow gained +8.14% in Q1 but only gained +7.26% for the year. That means is lost ground the rest of the year. In reality if it were not for the big Q3 gains and the November rebound the outcome would have been a lot different.
Take 1987 where the Dow gained +21% in Q1. That was where the Dow set its longest winning streak of 14 consecutive days in January. Of course we all know what happened in 1987 when the market crashed in October. The Dow declined from 2746 in late August to 1616 in October. That was roughly a -41% decline in two months. But you can still say the Dow closed positive for the year despite the -19% decline from the April 1st levels.
While I would love to say "100% of the time since 1950 the Dow has posted gains in any year where Q1 started with 8% or better" I don't think that is the right claim. However, in 10 of 12 years it did finish higher than Q1. That is a pretty good record.
Unfortunately in nearly all of those years there were negative quarters. That means it dropped below the Q1 ending point but recovered by year-end. I went back and did a quick scan of the last 20 years. Only three years, 1993, 1995 and 2003 did not have losing quarters after Q1. Hence the claim you hear a lot about not fretting over lost Q1 profits because you will get to buy stocks cheaper later in the year.
Q1 Gain, Year Gain Table
I have no doubt we could have a great year if the global economy along with the U.S. began to accelerate slowly higher. We would have the obligatory angst over when the Fed was going to end QE and its impact on the market but like night after day that problem is going to be with us regardless of the market.
In reality we have had a great year already. The majority of years don't have gains this good. The Dow is up +10.7% and the S&P 9.43%. The Nasdaq is lagging thanks to Apple with only a +7.6% gain. Transports are up +18% and the Russell 2000 +12%. We should break out the champagne and party hats and take the rest of the year off.
However, I believe there are better things ahead. The Fed is driving the herd like Rowdy Yates and the gang in Rawhide and there has been no stampede. The 2013 portion of this rally has been uneventful. I can almost hear Bernanke finishing his press conference next week with the phrase "Head 'em up! Move 'em out!" as he pushes the herd and the market farther along the bull market highway. In the Rawhide saga there was always an unexpected problem cropping up. A flooded river, a town with an unexplained sickness or a bunch of rustlers to disrupt the drive and keep the story interesting. This market will have plenty of those plot points as we move ahead.
There is really nothing in front of us that is an obvious pitfall. Europe is not falling off a cliff. China is flat lining at 7.5% growth and Latin America is booming. We just need to let some time pass and Europe will pull out of its recession and that will be the spark that lifts China and Asia and the rest of the world.
If only everything would work out that simple. It is never that simple in real life and that scares me. If we can look out 6-9 months and not see any pending disasters there is something wrong. There needs to be a wall of worry for us to climb. The biggest worry we have today is the future of QE and that is many months down the road.
The House and Senate are close on approving an extension to the continuing resolution that expires on March 27th so no government shutdown there. There has been "cooperative" movement on the debt ceiling and there may not be a crisis when it reappears in May.
I expect the markets to finish Q1 higher than we are today. The average hedge fund is up +4.9% for the year and the Dow is up +10.7%. That means the hedge funds are going to have to chase performance to justify their fees. Most were either not long enough early in the quarter and hoping for a dip to buy or they were shorting the early rallies and fell behind the curve when the shorts did not work. Now they are facing statement deadlines in two weeks. That suggests they will try to buy performance by chasing the high beta stocks into the quarter end.
Once the quarter is over and the new retirement funds dry up we will be in the Q1 earnings cycle. The hedgies will probably stick around for the first couple weeks of the cycle and then head for the sidelines.
Beware the Ides of March! The Stock Trader's Almanac has tracked triple witching performance since 1983. The March expiration cycle normally produces gains prior to expiration but losses the week after expiration. Link to Traders Almanac story
Table of March Triple Witch Losses
Remember 2012? The Dow rallied +2,065 points from Thanksgiving weekend in 2011 to top at 13,197 on April 2nd for an 18% gain. On April 3rd a decline began of roughly -587 points. Earnings produced a rebound to a higher high at 13,338 on May 1st. On May 2nd the "Sell in May" crowd took over and the Dow declined -1,303 points by June 4th.
2012-Q1 was not a one-time event. The S&P started 2010 with a +9.2% gain only to be followed by a -15.6% correction. 2011 started with an 8.4% gain and then saw a -19.4% correction. Just because the markets are off to a running start it does not mean there is no risk of correction.
The Dow only gained +2.85% over the last nine record setting days. That is the smallest gain since 1964 suggesting the rally is slowing.
Dow Early 2012 Chart
Dow Early 2013 Chart
History is a guide not a gospel. We are clearly setting up for what could be a repeat of Q1-2012 but we can't count on it. The geopolitical landscape was littered with potholes in early 2012 with Europe threatening to fall apart and China still in decline. Those problems don't exist today.
The problems that could disrupt the rest of 2013 are not on our radar. As long as the horizon remains clear we could see Bernanke slowly move the markets higher step by step until we eventually step off a cliff at some point in the future. Strong rallies never end well. To use boxer Robert Fitzsimmons phrase, "The bigger they are the harder they fall."
You can make this as complicated as you want to or you can make it simple. The trend is our friend until it ends. I am going to be looking for the trend to end around May 1st but that does not mean we are going to continue moving straight up. Once into April we should see the volatility pick up. Once into May we should see a decent pause. Remember, only three of the last 20 years did not have losing quarters after Q1. That is a pretty strong record.
Have you ever watched marathon runners crossing the finish line? Lots of runners stumble forward after crossing the tape. Many collapse or quickly find someplace to rest. The market velocity over the last three months is similar to a marathon. Very few sprints but nearly every day is another mile farther. Eventually the runners will need to rest. If the race turns into a sprint over the next couple of weeks it will only increase the severity of the decline. Slow and steady wins this race and keeps it going longer.
The S&P came within two points of touching the 1565 historic close on Thursday and Friday. The economics and S&P rebalancing stole some of the momentum from the buyers but the index still closed at 1560 and within easy range of the high.
I was glad to see the pause. Breaking the streak takes the pressure off. Traders are reminded the markets go both ways. Now they can take a breath ahead of the FOMC meeting and make a conscious buying decision rather than trying to chase prices higher. I would be thrilled if the Dow dropped -100 points on Monday and Tuesday. That would force profit taking and allow the hedgies to buy the dip and push us back to the new high before month end.
I seriously doubt we will get that kind of dip ahead of the Fed meeting. There is too much pent up buying. Everyone looking for a dip to enter will be thinking this is their last chance to buy. It is crazy that everyone is anguishing over a -3 point loss on the S&P. What are they going to do when a 20-point drop occurs?
We finally broke away from the 1550 resistance on Wednesday and now that should be support followed by 1540. That should keep us from any material declines.
Jeff Kleintop from LPL Financial, noted the +125% rally since the March 2009 lows makes this the second best bull market of all time for the S&P. It is also one of the longest and duration will become a problem soon. As duration records are broken the market stress will begin to build.
Note in the chart below the reversion to the uptrend support in November, December and February. Nobody died. It was temporary and followed by a decent rebound. Just plan for that to happen again in the next few weeks and you will be fine. It is the traders that don't plan for a speed bump that get hurt.
This was the first Friday in 2013 that the Dow ended with a loss. Even though the Dow ended its streak of gains the individual losses were minimal. Only two Dow stocks lost more than $1 and Boeing almost made up for both with a $1.81 gain. This was not a sell off. This was simply a combination of factors that ended without a Dow gain. The Dow is in blue sky territory and short term resistance would be in the range of 14,650. Initial support is 14,425. There is nothing to get excited about on the Dow chart.
Dow Chart - Daily
The Nasdaq was overpowered by losses in Google and Amazon, the big caps on the list, with help from the supporting cast of ISRG, ULTA, etc. Apple's +12 helped keep the tech index from posting a double digit loss and like the other indexes this decline was just noise. We need to ignore it and hope for a bigger dip to 3220 or so to wake the animal spirits again. Resistance is 3260 and 3275.
Top 20 Winners and Sinners
Nasdaq Chart - Daily
If you need evidence the selling was lackluster look only to the Russell 2000 with its -0.58 decline. If small cap holders were not concerned about the red ink on the big cap indexes we should not be concerned either.
Russell 2000 Chart
The transports look like a three stage rocket in flight with the first two stages separating at the end of December and end of February. I have never heard of a four stage rocket so we should reach terminal velocity here soon and gravity should reassert itself. Of course I have been saying that for the last 400 points. Never forget the market can stay irrational longer than we can stay liquid.
As long as the Russell and the Transports are going up in tandem the party is still in progress.
Dow Transport Chart
North Korea has not declared war on anyone but the U.S. is beefing up its missile defenses on the West Coast. Did you notice the market had no reaction to the news? Washington is going to put 14 more missile interceptors on the West Coast and bring the total to 44 by 2017.
All of the economic numbers to date have not reflected the impact of sequestration. It will take another 60-90 days before the impact is really felt.
The new highs and lack of a meaningful dip may have lured the few remaining retail investors back into the market to join the herd. The herd is normally wrong.
Friday's volume of 8.3 billion shares was the highest since December 21st. This was related to option expiration and S&P rebalancing but you should always be cautious when volume spikes significantly on a down day regardless of reason.
Remember my musical chairs analogy. The music is still playing and funds have to keep dancing until it stops. Markets are being powered by the fear of missing opportunity more than the fear of losing money.
Gold put in a short term bottom in late March on 9 out of the last 11 years. Trade accordingly.
Enter passively and exit aggressively!
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"Women will forgive anything. Otherwise, the race would have died out long ago."
Robert A. Heinlein
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