There may be light at the end of the tunnel in the Washington standoff.
The market rebounded slightly for multiple reasons on Wednesday but it was more on wishful thinking than material changes in the Washington shutdown. The market rebounded slightly at the open on news that Janet Yellen would be nominated to replace Ben Bernanke as chairman of the Federal Reserve. It will be the first time in history that a woman has chaired the Fed. She is seen as more dovish than Bernanke so overseas markets rallied overnight on expectations for continued QE until well into 2014.
After lunch the market rebounded again after the Republican Study Committee, the most conservative bloc in the House, told Fox News they are looking at the possibility of a short-term debt ceiling increase after the president said he would consider that option.
The president has said repeatedly he will not negotiate with republicans until they end the shutdown and raise the debt ceiling. In politics that has become a significant hurdle to resolving the crisis. If he negotiates he will be seen as the loser and weaker in the eyes of the public. However, if the House passes a temporary solution solving those problems for 30 days then the president can say he did not negotiate. He is then free to negotiate the budget in a "new" era of willingness to come up with a longer term bipartisan solution. Everything in Washington is about appearances. It would appear the republicans gave in to the president and he was the winner of the battle. The concessions the republicans would get during the short term extension of the deadline would not be perceived the same way as a concession before Oct 17th but they will have to settle for what they can get.
The important thing is that the immediate shutdown would end and the debt ceiling deadline would be kicked farther down the road. The markets would rally and the news services would have to find something else to talk about 24 hours a day.
The timeline for this is relatively short. The democratic leaders met with the president at the White House today. The republicans are meeting with the president on Thursday. This is a concession the republicans demanded so they can check that off their list. It does not make any difference if the president walks in, says I am not negotiating and leaves the room. The republicans can still say they met with the president and that box on the list of demands is checked.
You may remember last week when I said a lot of crisis situations tend to get resolved prior to congressional breaks. I pointed out that congress is scheduled to go on recess for the week of Oct 12th. That suggests we could have a resolution over this weekend. All the republicans have to do is come out of the meeting with the president and say they have decided to submit a clean short term budget deal and the markets would be off to the races.
The rebound was listless today because there are still a lot of moving parts in the Washington picture and nothing has yet changed.
We are still running under a shortened economic calendar since the majority of the government reports are not being produced. The FOMC minutes were the most important report for the day. The minutes showed the FOMC spent a lot of time discussing QE and the timing of cuts in those purchases. In the end only one person, Esther George, voted against continuing QE at the current rate.
The FOMC members thought they needed to improve on the communication policy. They felt the markets misinterpreted the Fed QE guidance since yields on Treasuries spiked to nearly 3% over the last several months. The Fed also felt they bungled the guidance over the taper since there was almost unanimous expectations for a taper in October.
During the meeting there was a significant amount of conversation about setting QE taper targets based explicitly on the unemployment rate. Those arguing against setting specific targets pointed out the unemployment rate was declining for the wrong reasons as more people gave up looking for work.
There was discussion about setting GDP targets but those numbers vary wildly from quarter to quarter. In the end the committee agreed the economy was slowing and decided to wait for additional economic numbers before making a QE decision. The possibility of an economic blip caused by the current fiscal disruption in Washington was also discussed.
Since the FOMC meeting the tone of the Fed speakers has been increasingly dovish. Most analysts now believe the soonest the Fed could announce a QE cut would be December but that expectation is being pushed into 2014 as a result of the government shutdown and the impact on the economy. With Yellen now the assumed Fed chairwoman there are some estimates the first cut could be announced at the March meeting. What everyone should remember is that the eventual announcement will be data dependent and the data is going to be flawed for the next 45 days or more. Government surveys are not being done and the when it occurs the restart will probably cross data collection date boundaries. Surveys are done in the month before the actual reports and that means the survey samples for October and part of November will be smaller than normal.
With Yellen in control the FOMC will be more dovish. The official Fed estimate today for the first hike in the Fed Funds rate is December 2015. Yellen has published her own data sets that target Dec 2016 as the first rate hike. Analysts assume similar views exist on the tapering of QE and Yellen could push the date farther into the future.
The FOMC minutes also showed the members were worried that further delaying the taper would make its job even harder down the road as the markets became further addicted to the QE drug. There is no silver bullet and extracting $3 trillion in monetary stimulus is going to be a daunting task for Yellen regardless of when it starts.
The last oil inventory update until the shutdown is over was released today. The EIA said a massive 6.8 million barrels were added to inventories last week. That came after a +5.5 million barrel gain in the prior week and a 2.6 million gain the week earlier. Crude inventories are expected to climb in the fall but the rate of increase has surprised everyone. Imports fell by -320,000 bpd but refinery demand for crude fell -550,000 bpd. Refinery utilization fell sharply from 89.0% to 86.0%. The sharp climb in inventory levels knocked $2 off WTI prices and threatened to push prices to a three-month low.
Inventory levels are now above the five-year range and rising. This should continue to weigh on prices in the days ahead.
The economic calendar is still questionable since any government reports are likely to be delayed. The hit or miss reporting over the last week makes it difficult to know which reports will appear on schedule.
The economic news for Thursday will come from the republican meeting at the White House instead of a regularly scheduled report.
The earnings from The Gap, Safeway and Micron will also be important.
Fidelity Investments was worried enough about the debt ceiling and the potential for a government default that they sold off all their government debt maturing in October and November. Fidelity manages $430 billion in money market funds. The company said they expect the debt ceiling to be resolved but they were concerned enough to close all their open positions on short term debt. They did the same thing in August 2011 when the debt ceiling battle was underway. They called this "precautionary measures." The restructured to debt expiring in 2014 and converted a substantial amount to cash. The company did not give any numbers for debt liquidated or cash raised.
I don't care how conservative you are as an investor but when a giant like Fidelity starts hedging against a government default it has to make you think twice about the future.
In stock news Citrix Systems (CTXS) was crushed after the bell when they warned that Q3 profits will fall below expectations. The company said it now expects report earnings of 69 cents for the quarter compared to analyst expectations of 73 cents. Revenue guidance dropped to $711 million and well below expectations for $737 million. Shares of CTXS fell -$9.31 after the bell.
Hewlett Packard (HPQ) was a market leader today with a +9% gain after CEO Meg Whitman told analysts the company expects to see "pockets of growth" in 2014 and revenue will "stabilize." She said 2014 will be a pivotal year with revenue accelerating into 2015. The company also guided for earnings of $3.55-$3.75 and slightly above the street's estimates. Analysts were expecting $3.62. The guidance upgrade came only two months after Whitman warned in August that she did not see revenue growth in 2014 because of the decline in the PC sector. The unexpected news at 11:30 caught the shorts off guard and HP shares soared after nearly a two-month decline.
Ariad Pharmaceuticals (ARIA) shares fell -66% after patient tests of a leukemia drug showed serious circulatory blockages within two years after taking the medicine. For those patients in long term tests over two-years more than 11.8% suffered serious arterial thrombosis, or blood clots. Of those 6.2% suffered heart attacks, 4% strokes and 3.6% peripheral vascular trouble. The company said tests would continue on patients already in trials but they were no longer accepting enrollment of new patients. Investors in ARIA are going to need some stress medicine when they see this chart.
The previously high-flying biotech sector saw a serious sell off over the last three days and that was before the ARIA announcement. Individual stocks have been hammered and most on no news. For example Aegerion Pharma (AEGR) lost another -10% today and is down -20% for the week on no news.
These types of declines are typical when fund manager sentiment changes. They take profits in the prior fast movers and run to the sideline with their cash. AEGR was up +400% for the last 12 months. This is a symptom of a market undergoing a change. Biotechs have been hot in 2013 and the fiscal year end for mutual funds is October 31st. They need to capture this profit and secure their bonuses.
The same is true with other momentum stocks. NetFlix (NFLX) shares have declined nearly $50 since the $334 high last week. Shares have declined to the 30-day average that has been support since April. Netflix was up +200% for the year.
Tesla (TSLA) shares dipped from $194 to $164 over the last week. They are the dictionary definition of a momentum stock with a +400% gain for the year.
LinkedIn (LNKD) declined -$40 to $215. Priceline (PCLN) has fallen from $1,027 to $972.
These high profile, high dollar momentum stocks had been stores for cash ahead of the mutual fund year end. They trade large volumes of shares. They are day trader favorites and managers could exit in large volume without causing a dramatic dip in the stock prices. At least that was true until this week when every manager got the same idea at the same time.
The high profile momentum stocks I listed above have been leading the charge higher. The sudden race to raise cash has knocked them all back about a month in time. The recent gains were erased and investors are getting nervous.
They have good reason to be nervous. The Investment Company Institute (ICI) said $56 billion flowed into money market funds in September. Yes, September, when the Dow, S&P and Nasdaq were setting new highs. Cautious investors were taking profits on the rally and moving cash to money markets.
Funds and money managers are now doing the same thing. Cumberland Advisors said they normally keep about 10% in cash in client accounts but they raised that to 20% over the last three days. Investors and managers are afraid the battle in Washington could end badly and that is being reflected in stock prices.
Chart from CNNMoney
Is the worst behind us? Tuesday was very close to a capitulation day for sellers. Up volume was only 861 million shares compared to down volume of 6.0 billion shares or roughly 70%. A capitulation day is typically a 90% down day. Today the A/D volume was roughly equal. Volume on Tuesday was only 6.9 billion shares and the highest in two weeks but still just barely over normal. Capitulation days are normally high volume declines.
The internals on Tuesday were also neutral. New highs were only 113 compared to new lows at 97. That is hardly a capitulation day. Actually the internals were worse today with only 68 new highs compared to 128 new lows but the Dow and S&P closed in positive territory.
The Volatility Index ($VIX) has risen to a level consistent with market bottoms. Nothing will prevent it from moving higher if Washington continues its shutdown and move closer to the debt ceiling but with the expectations for something to break by this weekend I would be looking for a market rebound soon.
However, the offset to the possible market rebound is the potential for fund managers to continue restructuring their portfolios ahead of the October 31st year end. It is entirely possible that managers have used the volatility of the last week to begin their portfolio rotation. Time will tell.
The S&P declined to break through strong support at 1680 on Tuesday and dipped to 1646 today before rebounding. The 100-day average at 1662 became resistance on the rebound today. The S&P has declined to a critical level at 1650 and a level that could produce a rebound if conditions in Washington changed.
The next material support is 1630 and one more round of scare tactic headlines could see this level tested. I would definitely be a buyer for at least a short term trade at 1630.
Resistance is now 1662 and prior support at 1680.
The Dow has been down 11 of the last 14 days for -6% loss. The Dow declined below strong support at 14,880 on Tuesday to hit 14,719 intraday today. The rebound back above 14,800 was important and that is where the index closed. This is a definite launch point on any decent news from Washington.
The 200-day average is 14,728 and that could be weak support. The Dow is not normally reactive to moving averages since it is only 30 stocks and any one stock can push the Dow by double digits.
While there is no guarantee that prior support will be future support I do like the way the Dow hit critical support just ahead of potentially positive news out of Washington.
On the negative side the 50-day average crossed below the 100-day in a bearish signal.
The Nasdaq was hammered by huge drops in biotechs and momentum stocks and declined exactly to support at 3650 intraday. That produced a decent rebound to 3690 and a close just below 3680. This has been a -4% decline since the short covering close at 3807 on Friday.
With the major momentum stocks off from 10% to 20% in some cases I could easily see a tech rebound from here. While the headlines from Washington will rule the market I believe investors are looking for an opportunity to buy the dip. Once there is a proposal in Washington to solve the problem investors will begin moving that $56 billion of money market funds back into equities. Techs and small caps will benefit the most.
Support 3650, 3575, resistance 3700, 3730.
Like the Nasdaq the Russell 2000 declined to strong support at 1040 but the rebound was lackluster. The Russell closed at 1044 and only slightly above support. The small caps have declined -3.6% and that is about half of their gains since the August low. The 1040 level is strong support both horizontally and on an uptrend basis. A breakdown here would target even stronger support at 1012.
If fund managers are going to rotate out of winners by month end there is a good chance we could see that 1012 level. Given the big declines in the large cap momentum stocks it appears they are still favoring small caps. Eventually that favoritism will come to an end but at some point they will need to start putting that momentum cash back into stocks for the 2014 market cycle. That is typically done before month end. Out with the old in with the new and a new vision in the year end statements for the next year.
Support 1040, 1012, resistance 1050, 1065.
I think you can tell by my comments above I am turning bullish for at least a trading bounce. The key will be the president's meeting with 18 republicans at the White House on Thursday. If they are successful in plotting a short term solution the market will rally and then we get to repeat all this aggravation several weeks from now when the next deadline returns.
I would buy a bounce from these levels but I would remain cautious until the House submits a budget bill the president is expected to sign.
Enter passively, exit aggressively!
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