The markets soared on short covering after the final cliff deal and surprisingly held those gains for the rest of the week.
The graphic above shows just how big the gains were for the week. Four percent was the norm with gains of +6% in numerous sectors. Not only did the markets hold their gains from Wednesday's spike but they added to those gains. The small cap Russell 2000 sprinted to an all time historic high at 880. The Dow Transports are only 84 points below a historic closing high at 5618. The S&P ended Friday at a new five-year closing high of 1466.47.
It would appear the bulls are in stampede mode but the Dow and Nasdaq are still well below their new high levels. There is still some hesitation in the market ahead of the coming debt threat.
Yes, a new term has been coined. The "debt threat" refers to the coming battle over the debt ceiling in late February. I was going to call it the debt canyon because of the potential for a major market decline but I confess I like the debt threat name better.
The chief market analyst at Bank of America is predicting a 10% to 15% and possibly as much as 20% sell off in February. That would definitely be a canyon in the market. She is not alone in expecting a significant decline but those voices are well out of the mainstream today.
With the S&P at a new multiyear high and the Russell at a historic high anyone short has got to be feeling the pain. Those in cash on the sidelines are also reaching for the antacids. What if the expected sell off never comes? That question may be convincing them to put some cash to work just in case.
The market always seems to find a way to upset the most investors possible at any time. The one point worth repeating here is that new highs tend to turn into higher highs. If the Dow and Nasdaq continue easing towards new high levels we could see investors piling into the market.
With the fiscal cliff behind us and the change in the FOMC minutes, we have seen rising sales volume in the treasury market. The yield on the ten-year treasury rose over 1.95% intraday on Friday and a new eight-month high. If the treasury bubble is beginning to burst that cash is going to find its way into equities. New highs in the equity markets are a cash magnet.
Ten-Year Treasury Yield Chart
The U.S. economics are improving but at a very slow rate. Conventional wisdom suggests the economy will now improve more quickly since the fiscal cliff has passed. Unfortunately the debt threat is likely to have a bigger impact on the market than the cliff. Fortunately that is not until late February and after the January earnings cycle.
For those readers who have not heard about the new proposal to avoid the debt ceiling debate I will recap it here. President Obama has flat out said he will not debate the ceiling with congress as he did in 2011. That debate produced negative results in the market. Some believe he will raise the debt ceiling by executive order using the 14th amendment as cover. The amendment basically says the debts of the U.S. should always be paid. There are strong beliefs that using an executive order would be unconstitutional and would result in multiple suits over that constitutionality. Those suits could take years to work their way through the courts but the government would continue borrowing money every month to pay its bills. Life would go on.
A second alternative being discussed is the trillion dollar platinum coin. The Treasury can mint platinum coins in any denomination. Since there are no actual reserves behind our currency there is no need to have a trillion dollars of anything backing it up. The U.S. currency is backed only by "the full faith and credit" of the USA. It is the equivalent of Monopoly money regardless of whether it is paper or coin.
This is how it would work. The Treasury stamps out a handful of trillion dollar platinum coins. They deposit those coins into the general fund at the Federal Reserve just like you and I deposit paychecks into our checking account. Instantly the government would have trillions of dollars in its account to pay bills. Using this approach the president would not have to ask Congress to raise the debt ceiling because the future monthly expenses would be paid out of the deposited funds.
If you are hearing about the platinum coin for the first time I hope your immediate response was the same as mine. That is one of the dumbest ideas I have ever heard just to get around facing up to our debt problem. I have read several commentaries claiming it would not devalue the dollar (wrong!) and it would have no impact on inflation. Unfortunately, what it would impact is the "full faith and credit" of the USA. How would that appear to the rest of the world if we solved our debt problems by just printing more money? I have to think the bright light of the USA would be dimmed significantly by resorting to this legal trick to get around negotiating with Congress on future spending cuts. How would the ratings agencies view this coin trick? I suspect it would not go over well at S&P.
There is a petition on the White House website asking the president to use this option rather than work with Congress. White House Petition
Heck, why stop at $1 trillion dollar coins? Inflation in Zimbabwe rose to more than 100,000% in 2008 and they printed $10 trillion, $50 trillion and $100 trillion dollar paper currency. Or course we know that did not end well. On Ebay today you can buy a bundle of (10) uncirculated $50 trillion dollar notes ($500 trillion face value) for $10.
$100,000,000,000,000 Trillion Dollar Bill
Back in the real world the Nonfarm Payroll report for December showed a gain of +155,000 jobs compared to consensus estimates for a +150,000 job gain. The +146,000 job gain from November was revised up to +161,000 jobs. The monthly average for the year was +153,000 jobs per month so December's gains were right in line with the trend. The economy added +1.8 million jobs for the year and that is almost exactly the same pace as 2011. Private employment rose +168,000 jobs while government employment declined -13,000. The construction sector saw a gain of +30,000 jobs thanks to the recovering housing sector and the rebuilding in the aftermath of Hurricane Sandy.
However, in the separate Household Employment Survey jobs declined by -28,000 but you probably did not see that in the news. On the positive side the decline in the labor force of -257,000 in November was substantially reversed with a gain of +192,000. The labor force participation rate remained flat at 63.6%. Unemployment also remained flat at 7.8%.
Employment in 2013 is expected to continue to slowly improve with the monthly average projected to be +158,000 jobs. Unemployment is only expected to decline to 7.6% by the end of 2013. Should the pace of employment suddenly increase the outlook for the economy would ramp up significantly.
Nonfarm Payroll Chart
The December headline number on the ISM Nonmanufacturing Index rose to 56.1 from 54.7 in November. After two months of weakness the index has resumed its uptrend and is now at a ten-month high. New orders rose slightly from 58.1 to 59.3 and employment rose from 50.3 to 56.3. That was the highest level for employment since March. However, order backlogs fell from 53.5 to 49.5.
The report was marginally positive. Of the 18 industries surveyed only 13 reported that business improved. That was up from eleven in November.
The inventory component on the ISM suggests the GDP will struggle and decline to only +2.0% growth in Q4.
The EIA oil inventory report was delayed until Friday and it was a major surprise to the average trader. Crude inventories declined -11.1 million barrels for the week ended on Dec-28th. This compares to expectations for a -1.1 million barrel decline.
The problem here is the timing. Refiners have to pay property taxes on oil in storage on Dec-31st. With inventories currently +9.2% over year ago levels that represents a lot of money in taxes. Normally we expect to see a major decline in inventories in the entire month of December because of the tax deadline. However, the prior three weeks only saw a total decline of -800,000 barrels. That is about 20 million less than normal.
With no material decline in inventory levels you would expect to see imports halted in the last week. Refiners would not have wanted to take delivery of million barrel cargos only a week before the tax cutoff. It appears that is exactly what happened. Imports declined by -931,000 bpd for the week or roughly 6.5 million barrels in total. Since imports are normally 7.09 mbpd that represented a significant drop.
Here is the key point. If they simply told the tankers to put on the brakes and loiter offshore to avoid the deadline then we should see a similar spike in inventories over the next two weeks. That will negatively impact crude prices when it happens because most investors don't understand this year end scenario.
In the chart below the blue area is the historical five-year range. Note the trend for inventories to be at the lowest point of the year in late December. The red line is the current inventory level at 9.2% above year ago levels.
Crude Inventory Chart
Crude prices rose to $93 on Wednesday and held that level the rest of the week thanks to the inventory draw and the minor improvements in the ISM and Payrolls. Prices will remain at those levels only if there is further instability in the Middle East or continued improvement in China's economics. There is more oil being produced today than is being consumed and that is eventually going to weigh on prices.
WTI Crude Chart
The economic calendar next week is busy but there are no reports of any significance to the market. The Wholesale Trade and Factory Orders are the only ones with any following and those are lagging reports for the November period. They will be ignored.
The big news is the earnings on Tuesday from Alcoa and Monsanto as the first major reporters in the Q4 cycle. The week closes with earnings from Wells Fargo and the first major bank to report. Bank earnings are expected to be strong for Q4 and Wells will be the canary in the coal mine for that sector.
Fertilizer producer Mosaic (MOS) reported adjusted earnings on Friday of $1.02 per share that beat the consensus estimates of 88 cents per share. Sales declined -16% to $2.54 billion. Sales declined as a result of lower exports to Asia. That ended last week when major U.S. producers announced first half 2013 sales to China of more than one million tons. That one deal suggests the demand for potash in 2013 could be surging. Potash is a form of fertilizer that helps plants better resist drought. After the major drought in 2012 we may see farmers increase purchases in case of a repeat drought in 2013.
Mosaic said there was a longer and stronger tail on the 2012 fall application season that gave farmers more time to add fertilizer to fields. The deal with China for $400 a ton means the coming deal with India will also be in that range. India typically lets China negotiate the price for the season and then India rides in on their coattails for a similar price. Mosaic predicted current quarter phosphate sales to be in the range of 2.5 to 2.8 million tons at an average price of $485 to $515 per ton. The past quarter saw sales of 3.0 million tons at an average price of $544 a ton.
Mosaic shares rallied on the guidance more than the actual earnings.
Lululemon (LULU) declined after a Credit Suisse analyst cut his rating from outperform to neutral. Christian Buss also cut the price target from $86 to $80. Shares declined -5% on the news. Buss said rising competition and heavy discounting was impacting sales growth at the company's stores. He said "we see long term risks to competitive positioning and pricing power as active wear in general gains shelf space." There are a growing number of competitors offering similar products often at lower prices. In Q4-2011 same store sales were in the low teens in percentage terms. In Q3-2012 those sales declined to low single digits. LULU does not give out precise figures.
Family Dollar (FDO) rebounded slightly from the -$8 drop on Thursday but it was still an ugly week for FDO. The company reported earnings of 69 cents compared to estimates of 75 cents and lowered guidance. FDO now expects to earn $3.95 to $4.20 for the full year compared to prior estimates of $4.10 to $4.40. Consensus estimates were $4.24. The CEO said the addition of everyday items like cigarettes and soda increased customer traffic and it also lowered margins and that impacted earnings.
Transocean Offshore (RIG) continued its rally with another $2.62 gain (+5%) after news broke on Thursday they had settled their civil and criminal liability case with the government. The settlement included $400 million as a criminal penalty and $1 billion plus interest as a civil penalty. Out of the $400 million, $150 million will be allocated towards protecting the Gulf of Mexico and another $150 million allocated for preventing oil spillage. Transocean had previously set aside $1.5 billion for potential exposure. The company plans to pay the fine over a five-year period. There are still outstanding claims against Transocean and the total bill could be closer to $4 billion when the final dust settles years from now.
The Deepwater Horizon sank after exploding on April 20th 2010 with 11 workers killed and 4.9 million barrels of oil released into the Gulf. BP was operating the rig at the time. BP has not yet settled with the government and the liability trial will begin on Feb 25th. A BP settlement is expected to be in the range of $15 to $21 billion. They are expected to settle rather than risk a trial.
The settlement of the government claims frees Transocean from the liability cloud. Transocean shares rallied +$8 for the week.
Citigroup (NYSE:C) rallied after Goldman Sachs added the bank to its conviction buy list and Deutsche Bank reiterated a long term buy rating. DB said Citigroup was the best positioned bank stock because of its international exposure. DB expects $4.60 in earnings for 2013, $5.14 in 2014 and $6.01 in 2015. Goldman added Citigroup to the conviction list and kicked JP Morgan (JPM) out with a downgrade to a simple "buy" rating. Goldman said Citigroup's shares were mispriced given its core earnings power. Under the new CEO the new restructuring plan announced in December would result in $1.1 billion in cost savings and add 4% to earnings. Citi shares were up +$3.50 for the week.
Google shares rallied nearly $40 for the week after Google escaped the filing of an antitrust case by the FTC. The FTC staff decided there was no concrete evidence of anti competitive actions by Google against its competitors. The commission had been researching whether Google prioritized search results to hinder competitors. The FTC staff felt Google engaged in questionable behavior but could not come up with a convincing theory on how consumers and competitors were harmed. They said the questionable tactics did not necessarily violate antitrust law.
Herbalife (HLF) is holding an analyst meeting on the 10th to rebut Bill Ackman's short attack. Shares of the company were crushed after Ackman went public with a well documented attack saying the share price should go to zero. Since hitting a low under $25 on Christmas Eve the stock has rallied +44% and gained quite a few supporters along the way. Numerous hedge fund managers and analysts have come out in support of HLF saying the three million distributors are a major factor in the company's success. Herbalife routinely buys back shares and pays a decent dividend. That is not something a pyramid scheme would attempt to do.
Ackman went on CNBC late in the week and said he had not covered a single share of his 20 million share short. Davidson and Company analyst Timothy Ramey just did an in depth analysis of the Ackman attack and said he was wrong on numerous counts. Also, he said Herbalife could end the short by doing a Dutch auction on the outstanding shares. This would cause anyone holding HLF shares to pull them out of street name in order to be eligible for the auction. This would cause the "mother of all short squeezes" according to Ramey. HLF shares traded nearly 2.5 times its normal volume on Friday.
With that large of a short position Herbalife could simply ask shareholders to remove their shares from street name and that would cause a monster squeeze and benefit shareholders immensely.
Apple shares declined nearly -3% on Friday after Deutsche Bank of Japan cautioned that end of year sales had not been as strong as expected and production of components and materials for its mobile products was exposed to adjustment risk. DB said although component makers performed in line with guidance in Q4, we see a strong likelihood of major shortfalls from guidance except for the iPad mini.
Apple shares were also under pressure again because of the year long congressional investigation on its corporate finance structure. Apple uses subsidiaries to keep most of its profits overseas and safe from the high corporate tax structure in the USA. This is not illegal but considering how much profit Apple is hiding we could see Congress make an exception in the tax laws to drag some of that money back so it can be taxed.
Lastly Samsung is expected to increase its smartphone lead over Apple and extend its market share to 35% in 2013. Apple would have to significantly lower prices to combat the market share gains by Samsung. Apple remains the highest priced mass market product in the smartphone and tablet arena. With competitor phones evolving rapidly with dozens of models each year the single iPhone upgrade a year is not keeping the product line fresh.
The dollar continued to rally and the Dollar Index hit a six week high intraday. This strength in the dollar weighed on commodities with gold losing -$16 to $1652 but well off the lows at $1626. That loss punctuated the longest losing streak in eight years. However, of the 27 analysts surveyed by Bloomberg 20 were bullish for next week, five bearish and two neutral. Another Bloomberg survey of 49 analysts said that gold would reach $2000 in 2013 as multiple countries continue to debase their currencies through various QE programs. However, many analysts are beginning to believe that gold will peak in late 2013 as a result of improving global economics. If the global economy surges the need to protect wealth with gold will decline.
Silver demand would increase in that same situation because 63% of silver is used in manufacturing things like smartphones, tablets, computer circuit boards, flat screen TVs, etc.
The dollar surged when the FOMC minutes were released. A sentence on page 9 of the 25 page minutes said there was disagreement on how long the current QE programs would last. Some members would like to slow or halt the QE programs by the end of 2013. That was contrary to the outlook portrayed by Ben Bernanke in his press conference suggesting it could be 2015 before the QE was halted. The parameters outlined by the Fed statement said the QE would continue until inflation reached 2.5% or unemployment fell below 6.5%. Neither of those events are going to happen in 2013 and therefore the hawkish minutes seemed to contradict the official outlook. This sentence in the minutes caused the dollar to spike and treasury yields to rise to an eight month high.
Dollar Index Chart - Daily
Gold Chart - Weekly
If consensus begins to build that the economy is going to accelerate in the second half of 2013 the bond market is going to implode. Investors holding treasuries at a 2% yield are going to flee the fixed income market and rush back into stocks.
We have seen several positive signs of improving economics in China but the Eurozone is still in recession and the U.S. is barely avoiding a recession. GDP growth in Q4 is estimated to be +2% and that is expected to decline in Q1 as a result of the fiscal cliff uncertainty, the resulting tax hikes and the start of the various Obamacare taxes on January 1st. GDP estimates for Q1 vary from +1.0% to +2.0%. That is far from bullish.
The Q4 earnings cycle could go a long way towards improving investor sentiment. If the wave of warnings we saw with Q3 earnings don't show up as dramatic earnings declines in the Q4 cycle then investors could be encouraged. As in every earnings cycle the guidance will be the key. If the negative guidance trend from the Q3 cycle continues then it could be a tough spring. If the guidance turns positive the market should move higher.
I hate to bring up the subject but the battle over the February debt threat is already underway. President Obama used his weekend radio address to blast republicans and warn about the "catastrophic" debt fight ahead. He warned that any spending cuts would have to be offset by an equal amount of new revenue from higher taxes on individuals and corporations. Since the U.S. corporate tax rate is already the second highest in the developed world the addition of more taxes would simply send more businesses overseas. Of course the republicans point out the $16.4 trillion in debt and $26 billion in interest each month as unsustainable and vow spending must be significantly reduced.
As in the manufactured crisis that was the fiscal cliff the war of words and posturing consumed the two months prior to the deadline and the real negotiations did not take place until the last week. I suspect this will be the case on the debt threat. Nothing material will happen, other than sparring with sound bites, until after the inauguration on January 21st. The president will be sworn in privately on Sunday January 20th and then publicly on the 21st at the National Mall. That is also Martin Luther King Day and the market is closed. More than 1.9 million people attended the first inauguration but turnout this time is expected to be a lot lower. Donations for the $50 million party have been slow to arrive. Less than a dozen corporations have donated to the Presidential Inaugural Committee and only 400+ individuals have given more than $200 based on the required disclosures released last week.
AT&T is installing nine additional cell towers around the National Mall and others on the parade route to handle the heavy use of texting and tweeting during the inauguration. AT&T is also a corporate sponsor.
Sometime after the inauguration the gloves will come off and the two sides will increase their posturing for the debt fight in late February. Nearly everyone expects this to have a much greater impact on the market than the fiscal cliff. Most of the Q4 earnings will be over and there will be nothing to distract investors from the battle in Washington.
Fortunately we have a good four to six weeks ahead of us where the market should not be distracted by politics. The earnings cycle begins next week and the indexes are either at or close to new multiyear highs. It would appear the setup is bullish.
The S&P rallied +65 points for the week to close at 1466.47 and a five year high. That is only a few tenths over the September high close at 1465.77 but it is still bullish. The key will be holding that level and moving higher. That is clear resistance and ANY further gains should produce additional short covering. A move over 1470 should attract new buyers as the breakout becomes obvious.
The post cliff short squeeze on Wednesday was an invitation for anyone with a bearish attitude to climb aboard and there were two credible attempts to sell the rally. Both failed and shorts were forced to throw in the towel at the close on Friday to avoid another potential surprise at the open on Monday.
Support for next week should be 1450 with no near term resistance once we are clearly over that 1465 level. We are definitely in buy the dip mode until proven wrong.
S&P Chart - Daily
The Dow may not have broken out to a new high like the S&P and Russell 2000 but it did close at an 11-week high after passing through resistance at 13,279. The Dow has no real resistance now until it reaches the September highs at 13,625. That will be a major hurdle. However, for the Dow to reach that level the S&P and Russell 2000 will have to be much higher than they are now and in serious breakout mode. That should help pull the Dow higher if they can sustain their rallies.
The problem of course is the earnings. With only 30 components any single hiccup in an earnings report can kill the Dow advance. Likewise a couple of better than expected reports could easily power it over that 13,625 level. Many of the Dow components are surging higher but the tech contingent is holding it back. Even IBM, normally a strong mover ahead of earnings, is lagging the rest of the pack. Hewlett Packard, Microsoft and Intel are at six month lows. McDonalds and Coke are also weak on a slowdown in global sales.
The banks are leading the charge but they can't lift the Dow by themselves.
The Dow Transports have exploded through resistance at 5200 and 5400 and are on the verge of breaking out to a new historic high over 5618. This is a very bullish signal because it means investors are buying the concept of future economic recovery. The Dow Transports typically see buying about six-months before the economy accelerates.
Dow Transport Chart - Daily
Dow Transport Chart - Monthly
The Nasdaq gained nearly 5% for the week but Apple's -$15 decline on Friday kept the Nasdaq from finishing the week with a bang. Tech stocks were heavily shorted going into year end and the Wednesday/Thursday squeeze was very strong. However, the fundamentals remain weak for the computer sector. The tablet revolution and smart phones with giant screens are reducing the sales of PCs of all types. The PC sector is struggling and that is a drag on the index.
The semiconductor sector rallied to a three month high but that is still well below the levels seen in the first quarter. The semi bounce was pure short squeeze and there was no follow through on Thr/Fri.
IF the Nasdaq can push through 3125 we could see some short covering and additional excitement begin to build. However, that is a big IF.
Semiconductor Index Chart
The most bullish chart of the day is the small cap Russell 2000. The Russell closed at a new all time historic high on Friday at 879 and the outlook is for further gains. January is normally small cap month and we are off to a good start. Support is 870 and I would continue to buy the dips.
Russell 2000 Chart - Weekly
The Wednesday short squeeze may have been supported on Thr/Fri by the year end fund flows and not real investor interest. However, volume was over six billion shares both days. That would be an excessive amount of fund flow buying. I suspect there were still some shorts left over from the cliff that needed to cover and that helped the volume.
However, there was no material dip on either day. Thursday's afternoon dip was the result of the FOMC minutes but the buying picked up again on Friday morning as though nothing had happened.
I believe we are still in dip buying mode. If the first few earnings reports are positive we could be off to the races. A series of new highs in January will set us up for a strong bout of profit taking before the debt debate begins to weigh on investors once again. We will cross that bridge when we get to February.
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