Despite the lackluster week for the markets it was still the best performance for September in seventy years.
Last month may have turned out to be a September to remember but will October be a month we will want to forget? The first day of the fourth quarter started out slow but eventually ended with a minor gain.
The morning futures moved higher when the Personal Income report for August came in at a seven month high. The headline number of +0.5% was nearly double the consensus and more than double the +0.2% rise in July. Spending rose +0.4% and at the same pace as July. On an annual basis the rate of spending has risen to +5.8% and that is a good sign in a weak economy.
There was a catch but you had to dig deeper than the headline number. Income growth rose because of the resumption of extended and emergency unemployment insurance in August. This added $20.6 billion in personal income. This offset a -$17.7 billion decline in July when payments were on hold.
Prices rose slightly by +0.2% to give the Fed a little breathing room in its worry over deflation. There is still no inflation but prices are no longer going down.
Economists are fond of pointing out the 10% unemployment (-16% U6 unemployment) as a worry about the strength of the rebound. If you reverse that you have 90% employed and they appear to be spending at an increasing rate. This was a bit of good news for the market.
Construction spending rose +0.4% in August and well over the consensus estimates for a decline of -0.4%. However, this was another example of a headline number not showing the entire picture. Private spending fell -0.9% to the lowest level in 12 years while public spending spiked +2.5% to push the headline number higher. Spending is still spending but we would rather have private entities building things rather than the government.
Consumer Sentiment ended September at 68.2 and that was a significant improvement over the mid month reading at 66.6. That suggests sentiment improved as the month progressed. The present conditions component actually moved higher to 79.6 from August's 78.3. The drag on the headline number came from the expectations component that ended the month at 60.9 and down -2 points from August.
Consumer Sentiment Chart
The big report for Friday was the national ISM or Purchasing Managers Index. The ISM declined to 54.4 in September from 56.3 in August. This is still in expansion territory but it was the fourth decline in five months and the lowest level since November. The internal components also suggest that activity will continue to decline. The new orders declined to 51.1 from 53.1 and very close to contraction territory under 50. This is the lowest level since June 2009. Backorders fell into contraction territory at 46.5 from 51.5. Inventory levels shot up to 55.6 from 51.4 suggesting there is no need to increase manufacturing to produce more inventory. Falling orders and rising inventory levels are a recipe for a slowdown in overall manufacturing.
An interesting highlight of the ISM was the sharp rise in the prices paid component from 61.5 to 70.5. This is the highest level since May and suggests the rising cost of commodities is starting to show up at the producer level. This could be an early warning sign of future inflation.
The decline in the ISM weighed on the markets but it was tame compared to what next Friday's payroll report is likely to do if the numbers disappoint. Yes, it is that time of the month again when the NonFarm Payroll report for September confuses analysts and investors alike with speculation on hiring.
The current estimates from Moody's is for total employment to have risen by 5,000 jobs in September. They believe private employment has risen by 90,000 but government terminations will approach 85,000 jobs. Census employment declined by an estimated 77,917 in the September period.
The census has complicated job prediction for the last six months but we should be at the end of that cycle. It forced analysts to emphasize "private employment" rather than concentrate on the overall number. Unfortunately the retail investor sees the headline number with a loss of jobs and immediately draws a conclusion.
Most people believe the jobs numbers are a government game anyway. Most revisions increase the jobs lost making it appear the government produces favorable estimates and then corrects their "mistakes" a month or two later after the politicians have finished using the numbers and investors have forgotten about them.
In reality the numbers are simply the result of a scientific wild ass guess, which we all know as the SWAG method. They take historical trends from decades of number crunching and apply the formulas to the small amount of valid data they do have. After all, does anyone actually believe that with a labor force of 154 million that the government knows if 5,000 more people were hired than fired in September?
Obviously they don't and could actually be off by hundreds of thousands every month but the key is the trend more than the details. The trend shows that the economy lost government jobs starting in June but private hiring offset a significant number of those job losses. Despite the negative headline numbers there were job gains in the private sector.
If the headline number is positive for September despite the -85,000 government jobs then it will be a good sign the economy is growing. The October report should not have a significant impact from terminated census workers so we could be back to a +100,000 rate when that report is released in November. This week we just want to see a positive headline number. Anything else is a bonus.
The only other number of any significance next week is the ISM Nonmanufacturing Index on Tuesday. It is expected to be flat with August at 51.5 and just over contraction territory. Any improvement there would be well received by the market.
More important to the market next week is the beginning of the Q3 earnings cycle. Something that was not well reported in the media is the growth of earnings warnings. We have seen more than double the earnings warnings for the coming Q3 earnings than we saw for the Q2 cycle. This is not a good sign that earnings will be strong. For every company that warned there are several that were still hoping to squeak by and not make waves.
The quarter is now over and the wishing and hoping period has passed. They either made their quarter or they didn't and now they have to face reality. That reality may mean another flurry of warnings next week.
There are a few companies you would recognize reporting next week and the most visible will be MOS, YUM, MAR, MON, PEP and AA. Alcoa is the first Dow component to report and they will be on Thursday.
I think Marriot and Costco on Wednesday are more important because they will give us input on business and retail spending.
The tepid economic data and the potential for another round of quantitative easing continues to push the dollar lower against other world currencies. The dollar index has fallen -6.2% since September 1st and still has farther to go according to Bank of America.
This pushed gold to a new intraday high at $1,322 and traders expect a move over $1,325 next week and $1,350 by month end.
Dollar Index Chart
The falling dollar is also powering crude prices to a new six-week high. Crude was also helped by political unrest in Ecuador, a major oil exporter to the U.S. and by quarter end window dressing by commodity funds. With the dollar quickly getting cheaper it takes more dollars to buy hard commodities like gold and oil. Add in some unrest in Nigeria and Ecuador and a couple tropical storms and it was another short squeeze for the bears. With product inventories at 20-year highs it was definitely not a demand driven rally.
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Crude Oil Chart
In stock news Microsoft sued Motorola for patent infringement over the Android phone. Microsoft claims the Android violates Microsoft patents for synchronizing email, calendars and contacts. Motorola vowed to defend itself aggressively. Microsoft said Motorola licensed this technology from 2003 to 2007 but did not renew the license even though it continued to use the technology. Both stocks finished the day flat.
Computer research firm NPD Group threw some cold water on the idea the iPad was hurting PC sales. According to a survey only 13% of iPad owners bought an iPad instead of a PC. However, 24% bought an iPad instead of an e-reader like the Kindle. According to the survey the iPad is more of a challenge to Amazon than Hewlett Packard or Dell. Amazon shares reflected the results of the survey.
This should come as no surprise since the iPad was targeting the Kindle market as well as the smart phone market. The survey also found that iPad owners were significantly more likely to own other Apple products. I don't think they actually needed a survey to figure that out. More than 48% of iPad owners also own a Mac desktop or an Apple notebook computer. That compares to only 11% of computer owners who owned a Mac a year ago. 53% of iPad owners have a Windows based PC. 38% of iPad owners also have an iPhone.
Apple shares gave up $10 for the week to close at $282.55.
A Bernstein Research semiconductor analyst cut his estimates again for Intel and AMD saying the Q3 notebook environment was below their already reduced expectations. He said early signs for Q4 suggest demand will be below seasonal norms. He claimed notebook shipments from Taiwanese manufacturers show "a significant deceleration" from recent quarters and typical historical trends. He said Taiwan notebook makers are now guiding to flat to lower shipments with as much as a -7% decline. Historical norms for Q4 are +20% increases. He also noted the loss of shelf space at stores like Best Buy in favor of more space for tablets and smart phones. It is not shaping up for a good quarter for chip stocks.
What's up with Goldman? The bank appears to be on everybody's short list and brokers are downgrading it almost daily. Since September 22nd there have been downgrades from Deutsche Bank, Rochdale, William Blair, Bernstein and on Friday a pair of dueling downgrades from Wells Fargo and Credit Suisse. It should be a clear case of all the bad news priced in after the string of downgrades but the banking sector is struggling under the uncertainty of the new banking regulations. If the dog pile on Goldman continues I would probably be a buyer in the $140 range.
Banking Sector Chart
Doug Kass used the current weakness in the banking sector as one of the reasons October could be ugly. Calling it a toxic combination of low volume, declining breadth and weak financials he thinks the markets are setting up for a pullback. He claims these are classic bearish signals. He believes the September rally was built on a false hope further Fed easing would stimulate the market. Kass is normally seen as a bear so it is not surprising he is expecting the September rally to fail.
On this occasion I am on his side. I believe the September rally was a combination of funds chasing performance, shorts covering and just plain old momentum trading. However, we did have positive words out of the Fed and a very slight improvement in economics. It was just enough to stimulate the markets and begin the cycle we have seen so many times before.
The majority of traders were lining up on the bearish side going into September and once the short squeezes started they were caught off guard. They entered the denial phase and continued to short each new high and continued to get crushed. Once that momentum ball starts rolling it is hard to stop but last week we may have seen the pull of gravity returning.
Quarter end window dressing was credited with keeping the indexes pinned at their September highs until month end but every attempt to push through those highs was immediately snuffed. The spike on the S&P to 1157 at Thursday's open managed a hang time of about 15 minutes before the bears piled on to push the S&P to the low of the day at 1136 about an hour later. Resistance at 1150 is very strong and moving into a normally volatile October only strengthens the resolve of the bears.
We saw some decent volume last week with about 7.5 billion shares on average. However, Thursday's opening spike pumped that volume to 8.7 billion shares and two-thirds of it was down volume. That tells me there were plenty of bears waiting at 1150.
For next week I expect the markets to be flat to down. The quarter end retirement fund flows will help support prices the first few days but with the payroll report on Friday there will be some serious hesitancy about adding to long positions.
The window dressing is over and now the funds have to make those hard decisions about what to keep for their fiscal year end on October 31st and what to sell. Those decisions will start executing soon and I doubt we are going much higher without first seeing some profit taking. Option expiration is early this month, only ten trading days away. That means any positions including options will have to be closed quickly and that increases the likelihood of higher volatility over the next week.
The S&P first tested resistance at 1150 on August 21st and has failed on every attempt. This will be our line in the sand for October. A close over 1150 signifies a win by the bulls and shorts on the run. Critical support is 1120 and below that level the bulls turn into bears.
On the Dow we have resistance at 10,875 and initial support at 10,750. Critical support is 10,550. The Dow has been moving sideways in about a 75-point range since 10:AM the prior Friday and unable to put together back-to-back gains. The Dow lost -30 points for the week and it would have been a lot worse except for Friday's 41 point gain.
The Dow is going to be hostage to earnings with Alcoa reporting on Thursday. Big caps could be weak until we get some idea how the earnings are going to play out. They have been savings accounts for funds looking for liquidity for the last month and eventually funds will want that cash back to put into small caps for the year-end rally.
The Nasdaq 100 (NDX) led the rally in September. The index lost 27 points last week as the momentum in Apple, Amazon and Priceline slowed. The NDX lost traction when fund managers quit throwing money into those big cap tech stocks. After a four-week rally we could easily see a decent decline in October. Semiconductor analysts continue to dump on the sector and the tone of the research reports is growing increasingly negative. Eventually traders are going to start taking them seriously. Support on the NDX is 1985 with nothing even close for backup. If 1985 breaks it could be a long drop.
The Nasdaq Composite actually hit 2400 at the open on Thursday but was knocked down faster than a dog with his paws on the dinner table. Friday's spike to 2389 was just as quickly rebuffed for a lower high. The composite index is holding at the highs a little better than the NDX simply because it has more stocks and is not quite so reactive to the declines in a few big caps. Still the daily whipping of the semiconductor and PC stocks is eventually going to force some profit taking. Initial support is 2350 followed by 2325.
Nasdaq 100 Chart
Nasdaq Composite Chart
There was a slight change in the Russell last week. It had lagged the other indexes in moving to a new multi-month high but finally succeeded. The Russell actually posted the best gains for any broad index last week with a +1.2% gain when most of the others were posting losses.
I struggled to understand why the Russell suddenly outperformed when the big cap indexes were stalling. I believe it was "because" the big caps were stalling that some money found its way into the small caps. I would not have bought Amazon or Apple last week on a bet and I believe some fund managers probably felt the same way going into quarter end. It does not take a lot of money to move a small cap stock so the amount of actual cash spent may have been minor. The real key here is going to be the Russell direction in October. The first two weeks would normally be negative followed by a rebound in the last two weeks. I will be watching the Russell closely to see if we can get an early read on sentiment as the month progresses.
Last weekend I said I expected limited gains for the week and a decline in October. That is my same expectation for this week. I believe end of quarter retirement cash could keep the market afloat until Friday's payroll report but the following week could be ugly. I would love to see a decent bout of profit taking as funds shuffle their portfolios and I would view that decline as a buying opportunity.
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