If you were at the beach on Friday you missed it. Some believe we just witnessed a serious change in investor sentiment.
At 8:30 the government announced a higher than expected Nonfarm Payroll number and the Dow rallied +116 points at the open. Within 30 minutes the opening spike was sold hard after it became clear that the Fed would be cutting QE sooner rather than later. The Dow returned to negative territory for the next two hours. At exactly noon a buy program hit the tape that added +85 points and that triggered follow on buying and short covering and the Dow ended at the high of the day with a +147 point gain. The Dow had a 166 point range with a triple digit intraday decline before closing at the high of the day. That is remarkable considering the implications of the payroll report. What changed investor sentiment or did it really change?
The headline number on the June payroll report showed a gain of +195,000 jobs compared to expectations for a gain of +165,000 with some whisper numbers a lot lower. While the headline number was a big beat there was more good news. May jobs were revised higher from 175,000 to 195,000. April jobs were revised up from 149,000 to 195,000. The Fed heads have said they wanted to see "several months of job gains of 200,000 or higher." Don't look now but suddenly the last three months have averaged 196,333 jobs and Q1 averaged +207,000 pushing the average to +198,600 for the first six months and that is enough for the Fed to act. This realization is why the market sold off after the open.
I understand the sell off but why the rebound? First it was a low volume day with only 4.7 billion shares traded. Most of that traded in the first hour when the Dow spiked +116 then dove -125. The tape went quiet for a couple hours before the buy program hit at noon. That low volume, low volatility period was what I expected for the rest of the day. The buy program at noon overwhelmed the shorts from the morning. Clearly the conventional wisdom trade was to short the opening spike on expectations for the Fed to taper. When the buy program triggered the stops on those short trades it forced prices higher and suddenly traders were faced with a runaway market. When the S&P and Dow broke through the resistance of the 50-day averages the race was on to cover shorts. Traders had been shorting the 50-day for the prior five-days. Suddenly that trade was broken and buy stops were getting hit to the upside.
This was a low volume day and the buy program took advantage of that low volume to trigger stops and push the market higher. Were Bernanke and crew buying S&P futures on Friday? If not they should thank whoever launched that buy program.
The real question will obviously be "Will there be any follow through on Monday?" If there is any follow through there will be more short covering and probably a push to retest resistance at 1650. More on this later.
Going back to the Nonfarm Payrolls for a minute there were challenges under the headlines. There were +360,000 new part time jobs created but -240,000 full time jobs lost. More than 52,000 of those part-time jobs were in food service and we know how much waitresses make. Retail sales added 37,000 and those are not high paying jobs either just ask anyone working at Wal-Mart. The labor force increased by +177,000 and that held the unemployment rate at 7.6%. Manufacturers lost jobs for the fourth consecutive month. Overall manufacturers have lost more jobs than created for more than a year.
The number of people forced to work part-time involuntary and the number of discouraged workers rose significantly. Involuntary part-timers rose by +352,000 to just over eight million and discouraged workers rose +247,000 to 1.027 million. Those are huge increases and contain "seasonal adjustments." The unadjusted number for involuntary part-timers rose by more than 800,000. That is a heck of an adjustment. More than 37 million people now work 34 hours or less. Only 47% of adults have a full time job.
The broader U6 unemployment rate spiked from 13.8% to 14.3% or 22.3 million people.
The economy lost -9.1 million jobs in the financial crisis. Since the recession it has added +6.1 million jobs. However, the working age population has grown by roughly +7.1 million people in the last four years. Do the math on that and suddenly a +195,000 job gain is not so good. Those not working are increasing as fast as those working so we are winning the monthly battles but losing the overall employment war.
On the bright side the White House has cancelled implementation of Obamacare for corporations until January 2015 and after the 2014 elections. Apparently the feedback about the impending changes was so negative they had to push it back or risk losing all the elections in 2014. They are blaming it on "still undefined regulations" and the lack of manpower to implement the new law. Corporations are breathing a sigh of relief because that means they can hire full time workers now and not worry about the healthcare requirement until January 2015. If the workers turn out to be good employees then they get healthcare. If they turn out to be mediocre they will see their hours cut back to part time and join the ranks of the U6 involuntary workers. It is a win-win for everybody today but the selection and refining process will restart in 2014-Q4.
On the surface it would appear that traders applauded the higher jobs numbers and the near confirmation the Fed would announce a taper for QE at the September meeting. I believe we would be wrong making that assumption. I think volume was so low and the morning announcement so heavily shorted that the afternoon buy program simply forced the shorts to cover while other retail traders with just enough technical knowledge to be dangerous bought the breakout over the 50-day average. I don't believe the prospect for tapering QE has changed that much for investors since the middle of June.
Obviously if the economy was suddenly accelerating and jobs growth was moving well over 200,000 we would have a reason to buy stocks. However, the market rarely moves higher when the Fed is moving "into" tightening mode. Once the tightening trend is established the markets will recover on expectations for stronger earnings and economic growth. We are not seeing that growth today.
This will probably require an entirely new round of spin control by the Fed heads to convince us the Fed is still on the fence about cutting back on QE. I expect a flurry of headlines next week from Fed presidents telling us the sudden improvement in jobs is gratifying but not yet conclusive.
CNBC did a snap poll of 45 analysts after 10:AM on Friday. They found the consensus estimate for the first cut in QE was October. The September FOMC meeting is September 18th so that makes sense the first cut would be in purchases for the following month. The survey also showed analysts expect the cuts to be in roughly $20 billion increments with QE ending in July 2014. That means a cut in QE roughly every other month of $20 billion with no purchases in July.
The Fed will tell us that slowing down on purchases is not the same as tightening but they are wrong. Slowing the pace of stimulus is the same as tightening monetary policy.
Personally I will be glad when this QE program is over. We will still be a year away from any tightening of rates if it ends in July. Raising rates IS tightening policy and that means the economy should be accelerating if that is to happen.
We will have our first look at the economy through the prism of corporate earnings beginning next week. Estimates are for a meager +3.3% earnings growth and +0.5% revenue growth. The revenue growth is the key. If sales are not increasing the economy is not growing. That may be a simplistic view but I think you will find it is true. Companies can only cut costs so far before they run out of ways to increase earnings if revenue is not increasing.
The big earnings news for the week will be YUM on Wednesday and JPM and WFC on Friday. Alcoa is normally portrayed as the start of the earnings season on Monday but their earnings are only relative for the forecast for Asia. They are also somewhat of a barometer for manufacturing. With the stock under $8 the expectations are for another weak report. Falling commodity prices are a significant weight on their earnings.
The FOMC minutes on Wednesday are going to be critical since they will give us a better understanding of the politics in the meeting prior to Bernanke's press conference where he spelled out the taper expectations. He said he was "deputized" to give the bad news but that may not play out in the minutes.
The Producer Price Index (PPI) on Friday will address the deflation fears but it will be overshadowed by the JPM and WFC earnings.
The jobs report did a number on interest rates. The yield on the ten-year treasury rocketed +8% higher to close at 2.715% and a two year high. If the bond rotation was not fully underway with -$80 billion withdrawn from bond funds in June, it is definitely underway now. An 8% move in the yield (21 bps) is huge. Anyone still in fixed income investments is going to be running for the exits next week.
Ten-Year Yield Chart
The Dollar Index spiked +1.46% to a new three-year high on the assumption the jobs numbers meant the economy was recovering. Apparently the sequester has not been as damaging as analysts thought and the dollar is surging as a result. A stronger economy with less stimulus means a stronger dollar.
Dollar Index Chart
The ECB and BOE both announced last week they were going to keep rates low and that was good for the European markets but bad for the currencies. The pound fell to an eight-month low and the euro fell to a two-month low. These declines coupled with the strong dollar are going to cause earnings problems at multinational corporations.
Gold gave back -$29 of its early week gains to close at $1213. Stronger dollars and jobs means the fear trade is easing and money is shifting from commodities to equities. Copper gave back -3% to close at $3.07 and very close to collapse after German economics came in weak with a sharp drop in new manufacturing orders.
Oil did not drop and actually exploded to a new 52-week high on the unrest in Egypt. Past president Morsi and 12 aides were being kept under house arrest in a Cairo suburb but thousands of Morsi supporters rioted in the streets and attacked police and Morsi opponents with rocks, bottles, fireworks and Molotov cocktails. Reportedly 17 people have died and hundreds injured. The military moved tanks and armored personnel carriers to strategic points and launched clouds of teargas to dissipate the crowds with little to show for their efforts.
Morsi supporters vowed to turn themselves into suicide bombers and destroy Egypt from the inside if Morsi was not returned to the presidency. Video: Supporters vowing suicide (english)
There were quite a few signs in the crowds blaming Obama for the current situation because he backed Morsi as the democratically elected candidate and then Morsi turned into an Islamist dictator instead. President Obama called on Egyptians and the military to not target the Muslim Brotherhood or its supporters.
The military put out a wanted list of 100 top Muslim Brotherhood leaders. The new Islamist leaning constitution was suspended and the Islamist dominated legislative Shura Council was dissolved as well. The courts dissolved the lower house of parliament last summer after it was ruled invalid. The Council had managed most of the legislative duties since then.
The African Union has suspended Egypt for the "unconstitutional" ouster of Morsi.
Oil company, BP, said it was pulling staff from Egypt as a "precautionary measure" and that suggests the civil unrest is spreading. The military announced a state of emergency for the Sinai and the Suez Canal. More than four million barrels of oil move through the canal every day. Spokesmen claimed everything was operating normally and there was a very large troop presence to insure operations remained calm.
However, BDP International, a partner for Egypt Sea & Air Intl Shipping and Forwarding, said international cargo activity has been curtailed in Egypt since June 20th. Cargo operations at seaports and airports along with offices of transportation authorities and government ministries have been closed since July 3rd. Commerce in Egypt is slowing to a halt because of the riots. Tourism is nonexistent.
With riots in Egypt, civil war in Syria, protests in Turkey and surrounding countries taking firm defensive postures there is a strong potential for oil shipments to be interrupted. This powered crude oil to $103.63 on Friday and a gain of +$2.39. Nobody wanted to be short oil over the weekend. Once the Egyptian riots begin to fade I expect those prices to fade as well. Brent crude rallied +$2 to $107.58 and narrowing the spread between WTI and Brent to roughly $4 and the lowest level since the recession.
WTI Crude Oil Chart
I have written about the potential for fraud in the Chinese economic reports several times over the last couple years. Reputable analysts rely only on reports put out by companies like HSBC rather than the official government data. After Friday they have yet another reason to believe the government reports are fictitious.
China suspended the release of industry-specific data from the monthly survey of manufacturing purchasing managers or PMI. The Chinese official said there was simply not enough time to analyze the large volume of responses from more than 3,000 companies in the monthly survey. The details of the PMI reports were previously made available to analysts but even then there were claims of fraud. Previously companies created phony invoices for raw materials and product sales. This practice was reportedly demanded by the government in order to show continuously improving economic data. When private companies began surveying the companies outside the government channel the discrepancies were discovered. Analysts started surveying electricity generated (demand) as a track on economic activity. The government told the power plants not to report any drop in demand below a certain threshold to keep up the illusion of a strong economy. That voided the electricity surveys as a valid research tool.
The new practice of hiding the details behind the PMI headline number means China can claim any number it wants and nobody will be able to prove anything different. Without knowing which companies were "supposedly" surveyed by the government there is no way to try and validate the number. The PMI number has been dropping like a rock with the private HSBC number well into contraction territory while the government number continues to hold in expansion territory above 50. Earlier last week the PMI report for the steel industry was suspended after a person involved said the government wanted to change the way the number was calculated to be more favorable. Previously the steel PMI for May was quoted at 46.8, up from 45.1 in April. Those represent strong contraction in the steel industry. China accounted for 49.18% of worldwide steel production in May.
China's economic numbers have been a source of confusion for years. Now that the Chinese economy is rapidly declining I can understand why China does not want to let the world know the true state of the economy. Recently Bloomberg surveyed several dozen analysts regarding the January-April export growth numbers. The economists felt the official numbers were overstated by 4 to 13 percentage points. Bank of America estimated the actual trade surplus for that period was only one-tenth the official figures.
Hiding the supporting detail behind the PMI numbers only causes analysts to project an even lower number. For China to be so openly dishonest in their economic reporting suggests conditions are far worse than they appear.
There was very little stock news on Friday because of the holiday weekend. World Acceptance (WRLD) took the opportunity to issue a press release at 6:15 Wednesday evening saying they had not been able to file their annual report for the fiscal year ended on March 31st but they hoped to do so by the end of July. They also said they "may" report a material weakness in its internal control over financial reporting related to the allowance for loan losses. To put this in English, they have loan losses, probably a lot, and they have inadequate controls to monitor and report those losses. Sometimes filing a confession after hours on a holiday can help you avoid some of the pain but shares declined -12% on Friday because not everyone was at the beach.
World Acceptance Chart
Priceline (PCLN) and Google (GOOG) have something in common. They are both trying to be the first to see their shares hit $1000. I guess they think it is a status symbol to have a high dollar stock but surely they know more investors would buy shares if they announced a reasonable stock split. With shares in the mid $800s they could do a 10:1 split and still have a $100 stock by the time the split occurred. At this point I would bet on Priceline to win the race but Google has a market cap six times that of Priceline. Both have a PE around 27.
The index charts are really tough this weekend. After five days of failure the S&P finally broke through the 50-day average on low volume short covering. Technically a breakout is a breakout but there are other factors in play. The downtrend resistance from May 22nd is 1632 and the S&P closed at 1631.89. Uptrend resistance from November is 1640. Resistance from mid June is 1650. Support is 1605-1610. The chart looks like a road map and every direction has a potential detour.
If Egypt does not meltdown over the weekend and the U.S. markets open higher, the SP should see some additional short covering. If something happens to knock the S&P back below the 50-day at 1626 the shorts would gain confidence and lead to another test of initial support.
About the only thing for certain for next week is that volatility will reign. There are too many cross currents and volume should be light. The month end and quarter end fund flows will end on Monday when funds open their holiday mail.
In theory the S&P should be weak with QE tapering ahead but investor sentiment could begin to improve because of the rise in jobs.
We simply have to play the hand we are dealt and try not to fall into the bias trap. If we are convinced the market is headed in a single direction and we are wrong the normal thing to do is come up with reasons why the market is wrong and why it will reverse. Unfortunately the market never listens and we just cause ourselves pain while we wait to be proven right.
We need to trade in the direction of the trend. As of Friday's close the short term trend (8-days) was up and the intermediate term trend (6-weeks) is down. It could change at a moment's notice but until it does we follow the trend.
S&P Chart - Daily
The Dow has a similar chart with resistance at 15,150, 15,300 and support at 14,900. The Dow also broke through the 50-day but until last week that was not really a factor in the Dow's trajectory. The 50-day was 15,072 on Friday and the Dow closed at 15,135.
Overhead resistance is crowded but not impossible to overcome. The right headlines could cause further short covering and we could be looking at new highs before the week is out. Likewise new tapering headlines could have us retesting the lows by next weekend. There is no consensus opinion.
Pent up buying was released after the dip to 14,550 the prior week and it may not have been completely satisfied.
Remember the historical pattern I discussed the last two weeks. The first week of July is normally positive and then the markets tend to fall off in late July and August. Just because we break through a couple resistance bands does not mean we are going to stay there.
The Nasdaq is no longer lagging the big caps. The Nasdaq has been leading or at least following closely to the Russell 2000. The resistance at 3485 is likely to be broken at the open on Monday with any kind of a positive market. The Nasdaq has been up 7 of the last 8 days. It is only about 135 points from the 12 year closing high at 3512. Apple has not been contributing so the gains have been broad based.
The Russell 2000 was the star last week with a gain of almost +3%. Much of this was related to the Russell index rebalance. Fund managers late to the rebalance exercise spent much of the week squaring up positions. Every stock added to the index on the prior Friday helped to push the index higher as fund managers added to their positions in those stocks.
The Russell 2000 broke out to a historic high at 1005 on Friday. It has traded over 1000 several times intraday but never closed there. If it were not for the influence of the index rebalance I would be pounding the table on this breakout. However, it is not what it seems. This was an artificial rally powered by the index rebalance. Regardless we have to stick with the trend until it ends.
Russell 2000 Chart
I am conflicted this weekend. My head sees the technical overhead resistance and the potential for failure on the Dow and S&P ahead of new QE headlines. My gut tells me to stick with the trend because "this time it is different." At some point in the future investor sentiment is going to change from bad news is good news to good news is actually good news. Things like the payroll report will be seen in a positive light. Are we there yet? I don't think so but the market will tell us.
I would like to sit back all knowing and tell you to wait for a lower low in August/September to go long but I can't because I am not all knowing. Nobody is. I can tell you that 83% of the time the market sets lows in the late-summer period but every year is different in thousands of ways as we are seeing in headlines from Europe, Asia and the Middle East today. This year may be part of the 17% that moves higher over the late summer. Only time will tell but if we trade with the trend we should have a better result than trying to anticipate a trend change.
Enter passively and exit aggressively!
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"Our greatest weakness lies in giving up. The most certain way to succeed is always to try just one more time."
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