The Fed gave the green light to major banks to raise their dividends and the flood of announcements helped push the Dow into the green. Techs stocks were not so lucky with the NDX closing in the red.
It was a tale of two markets on Friday with the financial sector lifting the Dow and S&P but large cap tech stocks were not finding any love. The Nasdaq 100 lost -4 points for the day with FFIV, NFLX, FSLR, ISRG, AAPL and PCLN all closing in the red. The rally started overnight with a strong bounce in the futures thanks to a coordinated currency intervention by the G7 nations and a UN resolution to impose a no-fly/no-drive zone on Libya. The opening bounce faded again just like on Thursday as traders seized the chance to take profits and avoid the weekend event risk.
There were not any major economic reports to provide an incentive to buy stocks. The Risk of Recession over the next six months fell to 19% in February from 21% in January. The Weekly Leading Index was flat at 130.4 and in the same range now for the last six weeks. Both reports were completely ignored.
The economic calendar for next week is headlined by the home sales reports for February and the Richmond Fed Manufacturing Survey. These are not normally market movers. Existing home sales are expected to decline thanks to the winter weather in Jan/Feb and new home sales are expected to see a minor increase.
The big news for Friday was the approval by the Fed to allow some banks to raise their dividends. The Fed said it was generally restricting payouts to 30% or less of the company's expected 2011 earnings. This is still lower than the 50% ratio some banks paid in a better economy. The Fed said common equity had increased +$300 billion across the 19 banks in the stress test group.
Suntrust Banks (STI) and Keycorp (KEY) have to pay off their remaining TARP loans before they can pay larger dividends. Both announced a secondary offering on Friday with plans to pay off those loans. STI said it was selling $1.04 billion in shares to finish out its payment plan on $4.85 billion in TARP loans. KEY sold $625 million in a secondary to finish paying its $2.5 billion in TARP loans. KEY was approved to raise their dividend from 1-cent to 3-cents after the TARP payment and the bank said it was considering the dividend. KEY and STI both closed in positive territory despite the share offerings.
Regions Financial (RF) is the last bank with a remaining TARP liability and the bank did not propose any capital raise to pay off the loan. The bank said it would repay its $3.5 billion TARP loan in a "prudent manner, on shareholder friendly terms."
Most of the major banks making announcements on Friday were announcing larger dividends. However, some were just making an announcement to avoid being left out of the rally. The dividend increases totaled $22 billion annually. There were $16.2 billion in buybacks and $5.4 billion in dividends.
JP Morgan (JPM) raised its dividend from 5-cents to 25-cents and announced a $15 billion stock buyback with $8 billion to be spent in 2011. Prior to the recession JPM had a 38-cent dividend.
Goldman Sachs (GS) said it was buying back the $5 billion in preferred stock owned by Warren Buffet as security for a loan he made Goldman during the crisis. The buyback includes $1.65 billion in dividends and will incur a $2.84 charge to earnings in Q1. Warren said he hated to see them buyback the stock because the dividend equated to $16 per second to Berkshire. Don't feel sorry for him because Berkshire still has warrants to purchase 43.5 million shares at $115 per share any time before Q4 in 2013. Goldman shares closed at $160 on Friday and I would expect them to be well over $200 before Berkshire exercises those warrants. Assuming a $215 stock price that would be a $4.35 billion profit.
Wells Fargo declared a special one-time dividend of 7-cents in addition to its regular 5-cent dividend. The dividends are payable on March 31st to holders on March 28th. The bank will also buy back $200 million in shares.
State Street (STT) will raise its dividend from 1-cent to 18-cents payable on April 15th to holders on April 1st. They also authorized a $675 million stock buyback.
US Bank (USB) raised its quarterly dividend from 5-cents to 12.5 cents and authorized repurchase of $50 million in shares by year-end. However, they said they would wait on the Fed to provide long-term capital guidance later this year before launching the share buyback. The dividend will be payable on April 15th.
BB&T (BBT) said it would pay a special 1-cent dividend in addition to its regular 15-cent dividend on May 2nd.
American Express (AXP) said it planned to buyback $5 billion in shares and return 50% of its capital to shareholders but not until after the Q1 results are released.
PNC Financial (PNC) said it was "considering" a Q2 dividend.
Bank of New York Mellon (BK) said it was planning a Q2 dividend increase and share buyback.
Bank of America, Citigroup, Fifth Third and Capital One did not raise dividends. I believe all said they were planning on changes to dividends in the second half of 2011. BAC did say it was planning on 30% payback to investors in 2012.
The banks all survived the stress test but they can't tell anyone about the results. The Fed issued a gag order that prevents them from disclosing the results without prior Fed approval. Evidently the Fed does not want news surfacing that a bank like Goldman may have received an A+ score while some other bank may have just scraped by with a D-. As long as nobody knows the results and all "passed" then all are on equal footing with investors and depositors. There will be no rush to pull funds out of those banks on the bottom of the grading scale. However, I think investors are smart enough to look at all the dividend announcements and decide pretty easily which banks are strongest and which are weakest.
Going forward the banks will have to submit a two-year capital plan each year and submit to an annual stress test.
Cisco (CSCO) also announced its first ever dividend of 6-cents to be paid on April 20th. Cisco shares hit a new 52-week low on Thursday at $16.97 and the Friday announcement only resulted in a 14-cent gain. Cisco has more than $40 billion in cash and the dividend will cost them less than $350 million. Cisco has 5.53 billion shares outstanding. The 6-cent dividend does not seem to represent a vote of confidence by the board on the company's future.
The UN passage of the no-fly, no-drive resolution against Libya's armed forces late Thursday also provided the market with support but the real help came from an early morning announcement from Libya. The Libyan defense minister said Libya had declared an immediate ceasefire and was complying with the resolution. The market spiked and oil prices plunged nearly $3. Unfortunately that was the Gaddafi version of the rope-a-dope. Fighting did not stop and government forces actually stepped up attacks on cities held by the opposition. That bit of news did not seem to trickle out into the market until late in the day. Crude prices immediately spiked again to close at just over $101.
The president gave a speech on Libya and warned against a fierce response from coalition forces if Gaddafi did not honor the ceasefire. However, he later briefed congressional leaders and told them the U.S. would only be there in a supporting role and U.S. planes would not be involved in policing the no-fly zone. He also told them there would be some hectic activity for only a couple weeks and then the U.S. would pull back to a remote support role.
We found out on Saturday that French and British planes had begun patrolling Libyan skies early Saturday morning and had destroyed four tanks advancing on Benghazi. Late Saturday evening Libyan time the U.S. and Britain launched 110 Tomahawk missiles at $500,000 each against Libyan air defense targets and Libyan air force bases.
Another event helping push stocks higher on Friday was the G7 currency intervention to weaken the Yen. In theory the G7 nations followed Japan's lead in selling Yen and buying other currencies in order to weaken the Yen rally over the last week. Japan sold two trillion Yen ($85 billion) to start and other countries followed suit. The dollar initially rose about 4% against the Yen to Y82.00 to the dollar. However, the spike faded and the Yen closed at Y80.58, up +2.4%. Analysts expect Japanese companies and corporate investors will be bringing cash and investments back from overseas and converting into Yen for rebuilding and investments into local projects. This raises the value of the Yen against other currencies. The dollar collapsed to a new 15-month low on the dollar index. The falling dollar supported stocks and commodities. The Euro rallied to a new five month high so that is a real clue about which currency the G7 banks were buying with their Yen. Seems nobody wanted to buy the dollar when the Fed is printing money at the rate of $135 billion a month.
Note the exact inverse correlation between the dollar and euro in these charts.
Dollar Index Chart
While on the subject of Japan the engineers working on the stricken plants have connected reactor one and two to an auxiliary power line and hope to have "some" cooling pumps running by Sunday. The other two reactors are scheduled to be connected to power by Monday. However, they caution the cooling pumps may be too damaged to be of use. They won't know until they get the power connected to the subsystems. Just having power to the plant does not mean they can flip a switch and everything will work. Because of all the misleading information being constantly disseminated on the Internet we won't really know what is happening until Tepco tells us the problems have been solved.
However, the U.S. public is starting to become immune to the news. Not only has the frequency of nuclear stories been declining but the quake stories are also slowing. This is good news on both counts for our markets next week. The bad news on both counts has now been factored into stock prices with the exception of a few tech stocks.
The new headlines concern problems with the supply chain of parts from Japan that are necessary for building cars, computers and electronics in the USA. Market research group iSupply predicted a shortage of iPad 2 tablets due to the quake. They identified at least five parts that come from Japan including memory, screens and other components. iSupply said some of the vendors have said their facilities were not damaged but they may be impacted by the resulting logistic problems including lack of electricity and lack of shipping. Aftershocks are still keeping semiconductor facilities offline because tolerances on the chip fabricators are extremely delicate and they have to be recalibrated after each shock. Apple is already sold out and there is a 4-5 week wait for online orders.
There are similar stories circulating for many other products and it is hard to tell what is real and what is a rumor but the tech sector is not recovering like we have seen in the Dow. The Nasdaq 100 actually lost -4 points on Friday.
Sony alone makes 10% of the world's laptop batteries. Japan is responsible for 30% of global flash memory, 20% of semi-conductors, and 40% of electronic components.
The Japan supply line damage is not limited to electronics. Deere (DE) warned on Friday it expects delivery delays for excavators and mining equipment due to a parts shortage. Deere said some manufacturers are recovering but overall conditions remain too uncertain to estimate the full effects on the movement of supplies.
GM will halt production at its pickup plant in Louisiana next week because of a shortage of parts from Japan. The company imports transmissions from Japan for two versions of pickups. The plant employs 900 workers and GM had no idea when it would be able to reopen.
Toyota, Honda, Suzuki and Nissan have shut down most of their facilities in Japan at least through next week and have warned the closures could be extended. Goldman says the shutdown is costing Toyota more than $73 million a day with another $25 million each for Honda, Nissan and Suzuki. A 30-day shutdown for Toyota would set them back about $2 billion. Honda said it took a week just to make contact with its more than 100 suppliers and they are shutting down some production for up to a month.
Toshiba, which makes the liquid crystal display screens for many models of autos, has
closed its plant for at least a month. That will impact nearly every automaker with navigation screens and LCD instruments.
Japan is expected to suffer from rolling blackouts for at least the next six months. Every blackout halts automated production lines and requires a lengthy restart procedure. Car frames being painted when power drops have to be scrapped and molten steel used for doors and other parts has to be scrapped if it starts to cool.
These supply line shortages could lead to layoffs in the U.S. just as the recovery was beginning to accelerate.
I reported in the OilSlick newsletter on Thursday that the refineries in Japan were coming back online sooner than expected. The Petroleum Association of Japan (PAJ) said it expects 780,000 bpd of refining capacity to be restored next week. An Exxon refinery with 335,000 bpd capacity and a Kyokuto refinery at 175,000 bpd are already back online. The PAJ said it had canceled exports of 4.09 million barrels of refined products through the end of March and had acquired an extra 2.83 million barrels of crude to feed the refiners through month end. I reported last week the fears over a drop in demand from Japan were misplaced. It appears demand is actually going to rise by 500,000 bpd with 200,000 bpd going to additional electricity generation and 300,000 bpd going into refined products to support the relief and rebuilding effort.
The problem is where to get those barrels since Japan uses light sweet crude. We have already seen a shortage of light crude since the Libyan problem began. Seeing demand increase another 500,000 bpd is only going to push prices higher.
Gasoline prices in the U.S. rose to $3.54 to $3.62 depending on which survey you use. Colorado and Wyoming were the cheapest at $3.30 per gallon thinks to their access to the cheaper $90 oil out of the Bakken. Diesel prices now average $3.91 per gallon nationwide with prices well over $4 on the coasts. We are already seeing the high prices crimp demand in the USA. The EIA reported gasoline demand declined to 8.83 mbpd for the week ended March 11th from 9.19 mbpd the prior week. That is a 360,000 bpd decline when spring weather should be pushing demand higher.
As long as WTI crude prices remain in the $100 range the damage to demand will be limited. If Libya were to be resolved quickly, an outcome I don't expect, I believe we would see oil decline to the upper $80s again. I don't see that happening any time soon without some expiration volatility on the futures contracts. The current WTI contract expires at Tuesday's close.
However, I believe the economy has reached escape velocity and baring another high profile news event we should continue growing. This should translate into a higher market in the weeks ahead. You have to admit the market was inundated by a tsunami of negative news for a couple weeks now and it has held up relatively well with only a -6% decline. It was due for a correction and the multiple news events gave it plenty of reasons to take that needed break.
The overriding theme I kept hearing this week was the fundamental analysis about the longer-term outlook. Valuations are reasonable with earnings expected to grow +15% for the full year. The economy is expanding and accelerating as evidenced by reports like the Philly Fed Survey on Thursday hitting highs not seen since 1984. Corporations have nearly $2 trillion in cash on their balance sheets and they are starting to put it to work.
The Fed is pouring a massive amount of stimulus into the market in the form of QE2 and extremely low interest rates that are likely to be with us into 2012.
Bonds are extremely over valued and knowledgeable investors like Bill Gross at Pimco has exited all his U.S. Treasury positions in the Total Return Fund. This is prompting investors to avoid bonds and put cash into other investments like commodities and equities.
Even after the six-month rally most investors are still under invested because of the lingering worries from the 2008 bear market and events like the flash crash. Now, thanks to the recent news events the overbought conditions from the last six months have been neutralized.
As the news stories start to improve we could see a decent ramp into Q1 earnings. If the economic conditions overcome rising fuel prices and continue accelerating into Q2 we could see another move higher ahead of QE2 termination at the end of June. If gasoline prices remain high and geopolitical conditions remain a problem I am starting to believe there could be an extension of QE2 on a smaller scale. The Fed can't allow the economy to slip back into recession on high fuel prices just as the QE2 ends.
Everyone knows gasoline prices are higher in the summer and the EIA is already predicting a $3.75 average this summer and more than $4.00 in the fall. That is a strong headwind for the Fed and I can't believe they will just pack up their bag of tricks and start raising rates. That would be the effect of halting QE2 in June. Without the Fed buying treasuries the bond market would decline and rates would rocket higher even without the Fed actually raising the Fed Funds rate. Bernanke has a problem. He has a tiger by the tail and he can't afford to turn lose or it will turn on him and the result will not be pretty. He has to find a way to transition from QE2 to some form of lower intensity stimulus.
All of this will be positive for the stock market until he turns loose of that tiger. When that happens the economy better be exploding along with earnings or we are going right back to another bear market. Don't fight the Fed in EITHER direction.
Bill Gross produced this graphic last week to illustrate the absurdity of the current QE2 program. The first chart shows the normal breakdown of treasury buyers. The second shows the current ratios. Note foreign central banks dropped from 50% to 30% and the Fed bought 70%. What happens when the Fed quits buying in June and 70% of the debt needs to be sold?
Who will buy Treasuries when the Fed doesnâ€™t?
That instant void in the debt market could be a major challenge for the U.S. and that is why I suspect there will be an extension of QE2 in some form. Regardless of what happens at the end of June I believe we have another 4-6 weeks before funds start boarding up the windows and stockpiling cash ahead of the June end to QE2.
If you recall I suggested several times over the last few months that the end of April was my target for a change in the trend. After the strong economics accelerated at the end of February and the Fed heads all started taking sides in public speeches on the merits of continuing QE2 I warned we could see some weakness ahead of last week's FOMC meeting. To be fair I did not expect that much weakness and the post meeting declines were news related not Fed related.
If you print these pages my opinion will make a good fire starter for your next barbecue. Opinions are like noses, everybody has one. I believe you should know where I stand on more than a day-to-day basis. I trust more in the longer term underlying fundamentals then in strict technical analysis. I believe they both have merit but you should not rely on just one. Pure technical analysis of the charts will always get run over by current events. However, believing solely in the underlying fundamentals will also get you killed because the market is cyclical between short-term bullish and bearish cycles inside the longer trend.
It is my opinion that baring an unforeseen news event we have seen the lows for this mini-correction at S&P 1250. A full -10% correction would take us to 1209. I will be the first to admit the chart is bearish and the total lack of conviction the last two days is also bearish. However, I wrote on Thursday I doubted very many traders would want to remain long over the weekend given the recent event risk. That was probably a major reason for the daylong decline off the opening highs. On the positive side resistance at 1275 was broken and became light support late in the afternoon. It may not hold past the opening tick on Monday but that is the way the day played out.
"IF" there are no negative news events over the weekend the market should open higher. If it follows the same pattern of gap and crap as it did the last two days I would expect a retest of 1250 before the week is out. If it can close over 1290 on Monday then I think the low really is behind us. It is going to be very difficult for that to happen if the big cap tech stocks remain weak. Investors are pricing in a series of announcements from companies like Apple on how sales will be impacted by the broken supply chain. If those companies were to make a positive announcement claiming no material disruption it would go a long way towards healing the market. Right now investors are grasping at straws and trying to guess which companies may be impacted. This weakness in techs has me cautious on the S&P for next week.
The Dow rebounded over prior support at 11800 and that could return as support but my confidence in that level is weak since it has already broken once. I do believe 11600 should hold if retested but I would rather not go there again. Energy stocks and financials should provide support for the Dow but that leaves about 24 other stocks to cause trouble.
In order for any rally to gain conviction we need to see the Dow move over 12,000 on decent volume. Volume on Friday was 9.6 billion shares but it was a quadruple witching option expiration so volume should have been high. Thursday's rebound volume was only 7.8 billion. We need volume to confirm any further moves higher or sellers will gain confidence and wait at 12,000 for a shorting opportunity. Sellers have lost the "overbought conditions" as a valid reason for shorting. Now the risk has leveled for both the buyers and sellers.
The Nasdaq Composite rebounded to a dead stop at the resistance from the 100-day average at 2663. That resistance has held the intraday bounces for three consecutive days. Support at 2610 is still within reach and the big cap techs are suggesting a further decline. The composite has to move over 2675 for confirmation of a rally and hold over 2610 to prevent a larger correction.
Nasdaq Composite Chart
The Nasdaq 100 big cap index is bearish. The NDX has failed at the 100-day average for three consecutive days at 2249. This repeated failure and the -28 point close off the highs on Friday is very bearish. This could be due to the chip problems in Japan and the broken supply chain or it could be just the need for further profit taking in the big caps that have performed so well since year-end. Whatever the reason we have a clear resistance level at 2250 and clear support at 2200. A break past either one will give us the new market direction.
Nasdaq 100 Chart
The Russell was the best looking index on Friday. Support at 780 appears to have held and Friday was the highest close in four days. This is far from bullish but it was the biggest percentage gainer for the day at +1.16% and the smallest loser for the week at -1.02%. This appears to be a glimmer of evidence suggesting fund managers are starting to nibble at small caps again. They are definitely not selling them and we can take a lack of sales as a positive indicator.
The Oil Service Index ($OSX) put in what appears to be a tradable bottom at 270 and multiple levels of converging support. High oil prices provide additional free cash flow to developers that they can use to pay for additional services and expand drilling programs. Investing in service companies at this level should result in future gains. The OIH ETF is one way to play this sector.
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Oil Service Index
Fundamentally I am bullish for next week but that is a long-term view. Technically I think the weakness in the Nasdaq big caps is going to be the controlling factor, assuming there is not another tsunami of bad news. The weakness in the NDX can significantly influence the S&P so we need to watch the NDX for market direction.
On Friday evening I had written several paragraphs about the possibly improvement in the nuclear crisis and its potential impact on our markets on Monday. On Saturday that changed for me when news broke that milk produced 20 miles away and spinach from six farms 60+ miles away had tested positive for elevated levels of radioactivity. Water in Tokyo had tested positive for radioactive iodine. This is not good news and I am sure the media is going to blow it out of proportion again.
Scientists said drinking a liter of the radioactive water would be the equivalent of one eighty-eighth of a chest x-ray. The levels in the spinach would require eating a kilo per day for a year to get the radiation equivalent of a CT-scan. Despite these infinitesimal levels of radiation it still represents contamination not previously expected.
I think we are closer to the end than the beginning of the correction because the news from Japan will improve. Japan's Nuclear and Industrial Safety Agency (NISA) is reporting power has been reconnected to reactor 1 & 2 and 3 & 4 should be connected by Monday. "IF" there is no significant damage to the cooling pumps we could see dramatic change in the situation by Monday. There are still a lot of unknowns about this process but they can't just throw up their hands and quit. They have to eventually fix the problem and no expense is being spared to solve it. That means eventually there will be a resolution and the hysterical news reporting will end. This is NOT a Chernobyl and there is a containment vessel around the reactors. It will take years to completely resolve but the crisis should end soon. Once this crisis passes the global markets should breathe easier.
Other challenges this weekend included a televised speech by Saudi king Abdullah, which promised $93 billion more in stimulus but failed to deliver any of the political reforms everyone had been led to expect. He said the government was hiring 60,000 additional security personnel. That should give you a clue as to their worries about future unrest.
In Bahrain the government demolished the 300-foot high Pearl Square monument that had become a backdrop to the protest movement after demonstrators setup camp in the square.
A weekend protest in Yemen attended by tens of thousands was attacked by police firing into the crowd from rooftops and 52 demonstrators were killed and hundreds more injured. Demonstrators were calling for the end to president Saleh's three-decade rule. Saleh declared martial law and said further gatherings would be illegal. The government began expelling journalists claiming they were acting improperly in their reporting.
In Iran thousands of demonstrators took to the streets protesting against the crackdown on demonstrators in Bahrain and Yemen. They also complained about Saudi troops in Bahrain and the Saudi government stopping protests inside Saudi Arabia. A prominent Iranian cleric urged Bahrain's majority Shiites to keep up their protests until death or victory. Obviously there is some country politics in play here as well.
The bigger problem with these various events is the rise of civil unrest all across the Middle East and Northern Africa. This genie is not going back into the bottle and if it continues to grow it may eventually envelope Saudi Arabia and slow oil production. Responding with indiscriminate force against a majority of the population only increases the hostility towards the ruling government. When residents of one country see positive results in another you get eventual contagion. I believe these uprisings have a long way to go before they are over and there could be significant unintended consequences along the way.
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