Fear of an early taper crushed markets on Thursday but positive data reversed those fears on Friday.
The markets sold off on Thursday with the biggest drop in two months after two weeks of lackluster consolidation. The Dow gave back -152 points to close at 15,593. The reason given for the sell off was a fear of an earlier than expected QE taper announcement.
On Friday there was a blowout payroll report that almost guarantees there will be a taper announcement sooner rather than later and the markets rallied with the Dow gaining +167 points to a new closing high at 15,761.
Why was the market so bipolar in its views for QE? The comparison is easy. If the economy is just muddling through with tepid growth and the Fed cuts QE just because they feel the need to slow down the biggest stimulus program in history then equities will be sold and the money would move into higher yielding treasuries. However, if the QE taper is because of a rapidly accelerating economy then money flows into equities on expectations for higher earnings from higher sales.
Friday's Nonfarm Payroll report was the exclamation point on two weeks of economic surprises. We went from random economic events with positive surprises to a string of strong reports covering October. In case you have a case of dementia and forgot, October was government shutdown month and all the reports were expected to be bad. Instead we saw better than expected numbers in the ISM Manufacturing, ISM New York, ISM Nonmanufacturing, Challenger Employment, GDP and now Nonfarm Payrolls.
Thursday's GDP was seen as the nail in the economic downturn coffin. The expectations for Q3 GDP were for +1.25% to +1.9% growth and a decline from the +2.48% in Q2. Instead the headline number showed growth of +2.85% and if you strip out the government declines the private sector GDP was +3.5%. However, the majority of the gains came from the largest increase in inventories since Q1-2012 not from consumer spending, which rose only +1.5% and the slowest rate in 3 years. Did inventories rise on expectations for a strong holiday season or because consumer spending was so weak inventory rose unexpectedly? Business spending declined for only the second time since the recovery began. Despite the conflicting data analysts had to rethink their assumptions and expectations for QE tapering were pulled rapidly forward from the June date analysts had been gravitating towards. The market choked and had the worst day in two months.
On Friday the Nonfarm Payroll number showed a gain of +204,000 compared to consensus estimates at +125,000 and whisper numbers well under 100,000. The number for August was revised up +45,000 to a gain of +238,000. The initial print was +169,000 and it has now been revised higher twice. September was also revised higher from 148,000 to 163,000. The two revisions added another 60,000 jobs and brought the three month average to +201,667 and right at the level where the Fed wanted to see job gains in order to taper QE. The odds are good we will see September and October revised higher in the December report.
Private payrolls added +212,000 jobs, the highest number since February. Estimates were for a gain of only +110,000 private jobs. More than 44,000 jobs were added in Retail as employers started hiring for the holidays.
The Labor Dept found "no discernible impact" on payrolls from the 16-day government shutdown. However, the unemployment rate rose for the first time in months from last month's five-year low of 7.2% to 7.3%. The labor force participation rate fell to 62.8% and the lowest level since March 1978. The -0.4% drop was the most since December 2009 and the third largest in history. The number of people NOT in the labor force rose by +932,000. That was the third highest increase in history. Also, the Household survey showed a loss of -623,000 jobs in October. Even the BLS was confused by the difference in numbers between the Nonfarm Survey and the Household Survey. At this rate there will be more people out of work than people working in less than 4 years.
St Louis Fed Labor Force Participation Rate Chart
UBS disagreed with the numbers saying without the shutdown the participation rate would have remained flat and the unemployment rate drop to 7.0%. The bank said the Nonfarm Payrolls did not show any corporate impact but the separate Household Survey showed a dramatic impact. In the survey of 60,000 households anyone of the 800,000 furloughed workers was considered unemployed if they were home even though they were getting paid during their time off. This distorted the unemployment rate and the labor force participation rate according to UBS.
Analysts were split on the impact to the Fed. Many brought their expected announcement date into December assuming the economic data continued to improve in November. Others rolled back from a June estimate to March and a few were targeting January.
I don't believe we will see a December or January move because of the impending budget battle. The short term resolution of the recent debt ceiling battle required the House and Senate to come up with a bipartisan budget solution by December 15th. I don't believe that will happen. The divide is too great between the desire to spend and tax on one side and spending and tax cuts on the other. Every conference over the last two years has ended with a deadlock. That puts us back to a new debt ceiling battle on January 15th with "special operations" extensions for another month or so.
The Fed would be crazy to announce a taper before the budget battles are over. Washington has a history of cratering the stock market with their headline wars. The Fed will not want to ease the market off its sugar high until those concerns are behind them. I am voting for a March announcement. Yellen will be in charge, it is a quarterly meeting with her first press conference, there will be four more months of economic data and hopefully the budget battle smoke will have cleared.
Also, with the ECB announcing a rate cut last week the dollar soared. The Fed can't afford to cut QE right now because that would push the dollar higher and depress earnings for U.S. corporations. If anything they might be forced to continue QE even longer.
On the negative side the Consumer Sentiment for November declined from 73.2 to 72.0 compared to estimates for a rise to 75.0. Analysts believed the end of the government shutdown would have raised sentiment but apparently the consumer impact was longer lasting and probably indicates frustration with Washington. The headline number was the lowest in nearly two-years.
The actual economic data for next week is light. The Fed speaking calendar is not. We will get a chance to hear from multiple Fed officials about what they think of the stronger data and the need for continued QE. I tried to determine the latest positions of each speaker and the hawks (those wanting to cut QE) outnumber the rest next week. I put Bernanke and Lockhart at neutral because both have been stressing the "data dependent" claim rather than laying out a case for a move in either direction.
Richard Fisher 3:AM (Hawk)
Narayana Kocherlakota 1:PM (Dove)
Dennis Lockhart 1:30 (Neutral)
Sandra Pianalto 8:45 (Hawk)
Dennis Lockhart 6:PM (Neutral)
Ben Bernanke 7:PM (Neutral)
Charles Plosser U/A (Hawk)
While I highlighted the Bernanke speech on Wednesday night I would be very surprised if he said anything to rock the boat ahead of Yellen's nomination hearing on Thursday.
Yellen is expected to sail through the nomination hearing but there are some political hurdles ahead of the vote. Rand Paul has threatened to hold up the nomination unless he can get a vote on his "Audit the Fed" bill officially titled the "Federal Reserve Transparency Act of 2011." The title of the bill should give you a clue on how long it has been lingering without a vote.
The other economic reports are of minor interest compared to the reports of the past week. It would take a major surprise in any single one to move the market.
Financial stocks rallied on the strong employment report for two reasons. A stronger economy means more business for the banks and higher interest rates. The higher rates mean the banks will finally be able to make some money on their deposits. With short term interest rates under 1% and the ten-year yield under 2% until recently the banks have been hard pressed to increase the spread between their cost of money and the interest they charge to lend it out. A rising interest rate will allow banks like Bank of America with more than a trillion in deposits to start profiting from those deposits.
You may remember a couple years ago just after the recession banks were thinking about charging for deposits because the spreads were so low. The rebound in the yields over 2.5% has been a breath of fresh air for the banks.
The yield on the ten-year treasury rose +5% on Friday to close at 2.75% and any further good news on economic data could easily push it over 3%. That will be a challenge for the Fed since they want to keep rates low for as long as possible to benefit the mortgage market and keep upward pressure on stocks. Eventually they will have to accept the reality they can't control rates forever.
Twitter (TWTR) shares fell -7% to $41.65 on their second day of trading to lose -$2.3 billion in market cap to $24.457 billion. This was to be expected after the monster spike on Thursday. Twitter's IPO price was $26 and it opened at $45. It is common to see high flying IPOs lose ground in the week after the event. Facebook (FB) declined -16% in the week that followed. Zynga (ZNGA) fell -6%. Exceptions were Groupon (GRPN) gaining +21% in the first week and Linkedin (LNKD) up +91%.
Hudson Square Research created headlines when it initiated coverage of twitter with a "sell" rating and a $37 price target. Pivotal Research downgraded Twitter from buy to sell with a $30 price target. Cantor Fitzgerald put a buy rating on the stock but their price target was $32, nearly $10 below Friday's close. Analysts at Wedbush initiated coverage with a neutral rating and $37 price target.
Social media stock Facebook (FB) is losing traction after more than doubling in price since July. Shares of FB are threatening to break below critical support and could be in for a dramatic drop. Now that Twitter has gone public the social media space should fall out of the headlines and investors may begin to look for stocks that have a more fundamental background like defense or manufacturing. Social media stocks will have their place but as the buzz dies down so will the investor interest.
Earnings are still trickling in with Groupon (GRPN) reporting a 100% estimate beat. Ok, they reported earnings of 2 cents compared to estimates of 1 cent. Shares rallied +6% on the news. I thought Groupon was in danger for quite a while as the email coupon fad crashed and burned. Now that dozens of their competitors have crashed and burned their business model may actually improve and they can make a real profit. I am not holding my breath but the trend seems to have turned positive.
Priceline (PCLN) reported earnings of $17.30 compared to estimates of $16.15 and shares rallied +5%. In Priceline terms that meant a $50 gain to close at $1,072. Priceline is finding it difficult to gain ground over $1,000 and shares have been making lower highs since the first big close at $1,087. Shares traded down to $1,020 on Thursday. Shares have not touched the 50-day average since May.
Disney (DIS) lost $2 on Thursday ahead of earnings but they regained half on Friday when they beat estimates by a penny with earnings at 77 cents. It was a lackluster performance and shares of DIS may lag in the week ahead.
Competitor Lions Gate Films (LGF) posted earnings of zero but that beat estimates for a loss of -8 cents. Shares of LGF lost -$3 in the prior two days ahead of earnings and closed flat on Friday after some serious intraday volatility. Hurting LGF is the disappointing performance of the movie Enders Game which debuted last week. The opening week proceeds were $27 million but reviews were mixed. Those viewers that had not read the phenomenally popular book really liked it because they had no preconceived expectations. Those who had read the book were seriously disappointed. I read the book a couple months ago on the recommendations of a couple of my kids. I loved it but the sequel to the book, "Speaker for the Dead" was a loser in my opinion. I could not even finish it. However, the parallel book to Enders Game written from another participants view, "Enders Shadow," was also excellent.
Lions Gate said the "as expected" performance of Enders Game meant the possibility of a movie sequel was unknown. The company said it would wait a few weeks before making the decision.
LGF has another winner coming out on Nov 22nd with the sequel to the Hunger Games called "Catching Fire." That is expected to be a big winner like Hunger Games. The final book, "Mocking Jay," has been broken into two parts and is already in production and nearly complete. It will be released in Nov-2014 and Nov-2015. Two different territories have approached LGF about making the Hunger Games into a theme park and they are pursuing that opportunity.
I like the potential for LGF shares. I would be a buyer of this dip. Shares have declined from $37 to $32 on the Enders Game disappointment but Catching Fire already has a strong following and the Thursday night shows are already sold out in many theaters.
Nvidia (NVDA) reported earnings of 26 cents compared to estimates of 19 cents and raised its quarterly dividend by 13%. Going from 7.5 cents to 8.5 cents on the dividend is not very exciting in dollar terms but 13% sounds like a lot. The company also said it was going to return $1 billion to shareholders through buybacks and dividends in fiscal 2015. The board approved another $1 billion to be added to the existing repurchase plan bringing the total unspent to $1.29 billion through Jan 2016. Shares rallied +7%. Nvidia's next major release will be the quad-core Tegra 4i in early 2014 with shipments of high end products in Q2. The chip will be a processor and LTE modem all in one chip.
So far 423 S&P-500 companies have reported earnings. So far 286 companies have beaten estimates with 95 missing and 42 reporting in line with estimates. Earnings growth for Q3 has risen to 5.35% and revenue is up roughly +4%. These numbers are vastly superior to the 1% to 2% growth estimates at the beginning of the cycle.
More than 80 companies have given Q4 guidance. Of those 63 were negative, 10 positive and 7 were in line according to S&P Capital IQ. The ratio of negative to positive is 6.3 and higher than the 15 year average. Q4 revenues are seen growing at +3%. Analysts are rapidly reviewing their estimates given the surprising improvement in economics. Q4 could end up being a banner quarter.
People in the Philippines and Vietnam are not worried about Q3 earnings. They are more worried about finding a cave to hide in to escape the winds of Super Typhoon Haiyan. The storm may be the strongest on record with sustained winds around 200 mph and gusts up to 235 mph. A storm surge of 20 feet with waves of 30 feet could cause massive damage because nothing in the coastal areas is built to survive that kind of storm. Previously Super Typhoon Nancy in 1961 had the highest winds on record at 215 mph. Hurricane Camille was the strongest storm to make landfall in the U.S. going ashore in Mississippi in 1969 with winds of 195 mph. Many believe the winds were actually stronger than that but the wind instruments were destroyed by the storm.
I doubt we will see a typhoon in the U.S. equity markets next week but anything is possible. Just because the Dow closed at a minor new high only 15 points over the prior high it does not mean we are in take off mode. The Dow gain was powered by the financials with GS rising +3.53, JPM +2.31 and Visa +2.19. It was also powered by yet another round of short covering after the markets closed at two-week lows on Thursday. The shorts were piling on at the close on Thursday and they had their worst nightmares come true on Friday morning.
Short squeezes are not bad but they are not rally perpetuating. Long term rallies run on improving fundamentals not sporadic short squeezes. Those are useful for pushing indexes over critical resistance but they are very short term.
The S&P has been in a narrow range for two weeks with the recent highs at 1774 the critical resistance. The +23 point gain on Friday completely erased Thursday's loss but the rebound stopped at exactly the closing resistance from Wednesday.
The glass half full crowd will see this as a potential setup for a breakout. The glass half empty crowd will see it as one more chance to sell the top and get ready for a new move lower. Both could be correct.
However, we are facing something we have not seen in several years and that is a dramatic improvement in the economy. With QE likely to remain unchanged until March investors have a green light to buy stocks. There is never any guarantee but the setup looks pretty good. The only qualification in the premise is that is a longer term view. The short term view still has numerous analysts calling for a correction in November. Actually the more analysts expecting a correction the better chance we have for a rally. Those with a negative view will setup their trades to profit from a decline and eventually a news event like the payroll report will produce another short squeeze.
I heard several reporters claiming investors bought the dip on Friday. I think that is a misnomer. I doubt investors were just sitting around waiting for a +200,000 jobs number to put millions of dollars to work. The gap open is a clue it was a short squeeze. Volume was decent at nearly 7.0 billion shares but the internals were lackluster. New 52-week highs at 270 were higher than new lows at 101 BUT that was the second highest number of new lows since October 9th. That was the second lowest number of new highs since October 10th. Market breadth is still narrowing.
There is no negative trend. Despite Thursday's dip the trend is sideways not negative. This suggests we are consolidating from the rally rather than setting up for a decline.
The S&P has returned to the 100-day average three times since January. The latest rally put it above the trendline for the prior highs and it is now using that trendline as support. In a perfect world we would see another return to the 100-day followed by another rebound. This is what many analysts are expecting with a buy target at 1700. Unfortunately, this is not a perfect world and markets can remain irrational far longer than we can remain invested.
"IF" the S&P were to break above 1,775 it could begin a new leg high and the price chasing would begin in earnest. Funds that are not 100% invested would begin throwing money at the market in order to keep up with the market.
I am not going to tell you the S&P will do X or Y because I don't know. This is a crazy environment and anything is possible. I do know the longer we remain in this consolidation pattern the better chance we have of breakout to the upside. I would be a buyer over 1,775.
S&P Chart - 30 Min
S&P Chart - Daily
However, we need to see volume and breadth increase. Market breadth has been narrowing over the last two weeks. The first chart is the number of S&P-500 stocks over their 50-day average. Note that since Oct 23rd breadth has been decreasing. This is a shorter term average so it tends to be violated the most.
On the longer term 200-day average the participation trend is very clear. The number of S&P-500 stocks participating in the rally has been declining since July. If stocks are not over their 200-day they are not leading the rally.
Same 200-day chart with a multi-year view. Note the weakening of the pattern in the last five months.
I have been actively writing about the markets for the last 15 years. I don't remember seeing an index chart like the Dow in that period. In the last six months we have seen six swings of roughly 900-1000 points each. The upper end of the range since May has only seen a +200 point increase since the 15,542 high on May 22nd. Most people would say the Dow was in rally mode but only gaining +200 points since May is hardly a rally.
On the positive side the volatility has given traders plenty of chances to take profits and establish new positions. On the negative side everyone can easily see the pattern and the obvious target would be a retest of the base line at 15,000. This is keeping traders from eagerly embracing the new high potential. Professional traders know that once a pattern become crystal clear to the general public it seldom repeats.
It is a confusing set of events that could keep traders on hold for another week.
Dow Chart - Daily
You may remember back on Tuesday I said the Nasdaq was slightly more bullish than the rest of the indexes because it closed at the top of its range. That was the kiss of death since it was the high close for the week. The Nasdaq declined to close at a three-week low on Thursday at 3,857. The monster +62 point rebound on Friday was due mostly to PCLN +50, ISRG +9, AAPL +8, GOOG +8, NFLX +8 and AMZN +7. It was another big cap rebound as money flows sought the safety of the big names. This is troubling since it suggests fund managers are favoring high liquidity rather than high growth.
After Thursday's decline the Nasdaq chart is actually the least bullish of the big three but it would be an error to say it was bearish. The Nasdaq simply closed at a lower high even with the +1.6% rebound. A bearish event would be a lower low than Thursday's close at 3,857. It would take another +35 point gain to put the Nasdaq back into new high territory.
The Russell 2000 is now the weakest index. The Russell set a three week low on Thursday and then failed to rebound back recent resistance at 1108. With the Russell weak and the Dow strong it is a clear signal that fund managers are rotating out of high risk small caps into high liquidity large caps. They are afraid a correction is coming. Another new low for the Russell would be a strong sell signal.
Sasha Cekerevac noted that margin debt hit a record high at $401 billion last week. That is a definite warning sign of overly optimistic investors. When a correction eventually appears it could be very ugly as that margin debt tends to unwind very quickly. This corresponds to the highest level of equity investment since 2007. The AAII said equity allocations reached a six-year high at 66.3%. This is the highest level since the 68.1% peak in September 2007. Cash allocations fell -2.7% to 16.9% compared to the historical allocation at 24%. Equity inflows into ETFs and equity funds in October were the strongest since the height of the tech bubble. We know how that ended. The "everything will work out" mentality is pervasive. This should be a warning signal for 2014.
I would remain neutral at this level unless the S&P breaks out to a new high. I would watch the Russell 2000 for continued signs of selling and act accordingly. Bullish animal spirits are running high but breadth is shrinking and fewer generals are leading the charge higher. Be cautious and reduce any positions bought on margin.
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"I never try to predict or anticipate. I only try to react to what the market is telling me by its