InvestmentHouse Weekend Update:
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- Further selling in commodity and industrial stocks takes SP500, SP600 below their 50 day EMA as well.
- Nigerian pipeline explosion can’t compete when oil demand fades.
- Michigan sentiment monthly drop the worst in 12 years.
- Everyone suddenly scared of inflation.
- Market sentiment moving in two directions.
- Correction versus the end of the post-crash run.
- The leaders left standing trying to set up for a rebound as market getting oversold, but the selling has yet to show signs of letting up.
Everything getting sold off. Fast sell off, fast turn?
Stocks got off on the wrong foot Friday on news of a Nigerian pipeline explosion killing almost 200. Futures were lower, following through on the Thursday plunge lower. Aside from the human tragedy, the initial concern was the rebels were stepping up their intensity. As it turns out, that was not the case. Indeed, there was some good news in that the workers that were captured the day before were released. Back at home, the US trade deficit was smaller than expected, helping appease those claiming the trade gap will ultimately bring higher interest rates and Egyptian-like plagues upon our economy.
No blood red waters, no fire raining from the sky. No, no biblical plagues, but the action to end the week had the feel of it. Stocks started lower and went even lower in a hurry. Mid-morning stocks bounced, recovering lost ground for just over an hour. We expected some short covering ahead of the weekend and after that initial surge lower the market bounced into lunch. An early afternoon fade and then another short covering bounce. That did not hold either, and stocks faded once more, closing at session lows.
Internals massively weak again.
Volume jumped on NYSE as the recent leading commodities, materials, machinery, and industrial stocks sold. NASDAQ was lower, another indication the tech selling is getting a bit washed out. Breadth was again sharply negative on both NYSE and NASDAQ. SP500 and SP600 blew through their 50 day EMA while NASDAQ plowed lower again. NASDAQ tried to show some relative strength and SOX was even positive into early afternoon. Some of the big name techs that sold hard of late actually managed a positive close. That suggests the techs are getting a bit sold out, having avoided the Memorial Day rush and selling early. Overall, however, the techs folded up the tent as well, and by the close they were at session lows.
The increase in NYSE volume shows distribution, i.e. institutional selling, as the large caps and small caps dove through the 50 day EMA. The institutions were selling the positions they had pushed higher and higher, now running for the door for fear of a blow off top. Yes, the financial stations started talking about that Friday as well. The stocks associated with commodities and the like were knocked back hard and on volume, though many gold stocks rebounded intraday to hold near support. Nonetheless, there was some bloodletting in the stocks that had surged higher at breakneck pace.
Lots of fear ramping up.
Two days of selling in the stocks that had surged for weeks and there was talk of this pullback being ‘the big one.’ Watching too much History Channel about the 1906 San Francisco earthquake I guess. Sure the selling was sharp and ugly; we wrote about the potential blow off top in commodities the past week. They were primed to roll over after the insane run higher the past three weeks. Demand? Demand didn’t ramp up in the past three weeks. Indeed, economies are expected to cool a bit just down the road. It was way too much excitement and money chasing that performance.
Whatever the truth, fear jumped as fast as the selling. All the way up the action was choppy and grinding, almost whipsaw, yet if you listened to the financial stations it was just one easy ride higher. In reality there were more direction changes than a Vince Young scramble. Now with two days of selling, sentiment has pulled a 180 and surely the market has hit its cyclical peak. Certainly the low volume rise on NASDAQ was a problem, and DJ30 had run well to within 1% of its old high; a test was coming.
The problem is the rise in the commodities, materials, and related stocks was meteoric what with all the money chasing performance. When the Fed came out with its ‘yet’ statement that followed the Bernanke ‘pause’ speech, the growth stocks sold off further in disappointment, and then the industrial economy stocks sold off fearing the Fed was not tough enough on inflation. In short, no side of the economy found what it wanted from the Fed, and that was a bad combination for the market on top of the high energy prices.
THE ECONOMY
Oil demand drops, trumps news out of Nigeria.
The Nigerian news was potentially the kind of news that could really spike the market. Oil barely budged on the news. It had rebounded after dropping below $70 earlier in the week, coming back on stronger gasoline demand reported mid-week with the inventory numbers. It was fading Friday, however, even with the Nigerian news (closed at $72.04 -1.28/bbl).
It seems demand trumps all. Oil demand fell to 1.25M bbl/day last week from 1.47M bbl. Even with gasoline demand rebounding after prices fell back from $3/gallon and oil coming back from below $70, when oil approached $75 again demand has tailed off. That level remains a barrier for demand. On Friday, even a scare out of Nigeria could not budge oil past that level. Now that was not a gut-wrenching event, but oil was down even as the first news reports came in.
Michigan sentiment posts a strong drop.
It was the preliminary report, and that means all of 200 respondents, but it was surprisingly low. Early May sentiment reading was 79.0, down from 87.4 in April and well off the 86.0 expected. This was the weakest reading since October 2005 immediately after the Gulf storms when sentiment hit a 12 year low.
The commercial talks of the power of cheese. Well, the power of rising gasoline prices on consumers is at least as strong. $3 gasoline stalled demand in the fall of 2005 and it stalled demand again in April, at least gasoline demand. Survey respondents were comfortable with their jobs, but were concerned what affect higher gasoline prices would have on their discretionary spending and on jobs down the road. Indeed, expectations for the future fell to 68.0 from 73.4.
And suddenly . . . inflation?
Last week we discussed how the spike in commodities the past three weeks after a strong run was already in place got everyone talking about inflation. While strong gold, silver and platinum are indications of potential inflation (hedges of value as a currency devalues when there is inflation), we pointed out how other factors are at work as well, for one, the tremendous amount of liquidity chasing performance. That money is surging prices higher as it seeks a home.
Friday the financial stations were very much abuzz with talk of inflation and how commodities were signaling this. Even the hold outs were starting to say inflation was ready to get out of control. Bernanke was labeled a weak Fed chairman. Hell, he seems very level headed and has a real understanding, even yet, of the forces at work in the economy. Much more so than his predecessor who was rather one-dimensional in his discussions of the economy. That is probably what has the market on edge; Bernanke is definitely a different breed, at least from the early readings.
In any event, after the selling the pundits were looking for a scapegoat as to why the market sold, and inflation and a weak Bernanke were blamed. We even heard calls that the Fed, after 16 consecutive rate hikes and raising the Fed Funds rate fivefold, should finally get tough and throw in a 50 BP rate hike.
Wow. What a role reversal. As we discussed when this rate hiking campaign started, the Fed talks a good game, but typically ends up getting too wound up in its fight, losing sight of its goal and focusing only on stalling the economy. Usually it is the Fed calling for more and more hikes and everyone else cringing as it does so. Now we have a Fed taking a reasonable approach, saying after 22 months of hikes that it can pause if it sees conflicting undercurrents that need some time to show their intentions. The private sector, however, is starting to call for more aggressive action.
Who do you trust? Usually it is the private investor side that is more in touch with reality, and that would suggest inflation is indeed getting out of hand. Indeed, the TIPS and bond yield spreads are the widest they have ever been, meaning that the inflation protected securities are being bought (a hedge against inflation) while bonds are being sold (their value drops if there is inflation). That is the market of investors saying there is some inflation issues as opposed to gold shooting higher in a liquidity rush.
Outside of that, however, what we heard Friday was mostly a lot of fear about the sell off in stocks accompanied by the start of selling in the commodities and related stocks. Those banging the table in the past about the price rises in gold, etc. being demand driven (and thus not inflationary) were suddenly inflation hawks.
They are forgetting about the destructive force of high energy prices on the economy. Those pundits said the economy would survive even with oil at $80 or above. We have already seen how high gasoline prices squelch demand back in the fall and again on this last spike. High gasoline and cooling costs siphon off discretionary income from other areas; it goes into the gasoline tank. It is a double whammy: higher prices divert more money from other areas while the other products become more expensive, creating less demand for them as well.
They are also forgetting that the Fed has paused during rate hiking campaigns in the past when it wanted to see how the rate hikes and other forces were impacting economic growth. Of course, it still often got it wrong, but if the market is looking for more certainty in actions with Bernanke at the helm, this should give it some comfort in some perverse way. In reality, a pause heading into the summer driving season with gasoline near $3/gallon is not a bad plan of action. With the selling to end the week and the near panic that brought out, however, reason was not on the front burner.
THE MARKET
MARKET SENTIMENT
We discussed the conversion of many pundits after the Thursday and Friday selling, how even the strongest ‘demand growth’ advocates suddenly became inflation fearing after a two day drop in the industrial stocks. The put/call ratio spiked and the volatility indices finally got off their butts and jumped higher. On the other side of the ledger, the Wall Street Journal finally acknowledged the strength of the expansion after 3.5 years of growth. When the papers and magazines start covering a story that is typically very late in the game.
VIX: 14.19; +1.7. Highest level since January when SP500 endured a pretty nasty but short drop to the 50 day EMA. Volatility is used as another method to determine when fear reaches extreme levels. It is not near a level how that would indicate any major reversal, but volatility has declined on this entire move. As we have discussed before, volatility can remain low as a market rallies. It will eventually start to rise even as the market advances, as the move gets longer in the tooth. It was at current levels in 1995 just as the market resumed a strong bull run. VIX rose with the market, hitting a plateau from 25 to 30 with occasional spikes higher (and some huge spikes as in the 1998 bear market). Then in early 2000 volatility jumped further as the market topped. In sum, we would expect to see more volatility at the peak of this rally.
VXN: 17.1; +1.38
VXO: 13.52; +1.32
Put/Call Ratio (CBOE): 1.27; +0.31. First move above 1.0 for this indicator. The composite of all options exchanges moved to 1.12. That is a strong indication of downside speculation as puts are bought for the downside gain and puts that were sold for premium as stocks moved higher are now being feverishly bought as stocks tank. Either way it is a sign that many think the market is heading lower, a sign of that quick build in panic we are talking about. That is a contrary indicator, i.e. if it gets high enough the market gets sold out and can then rebound.
Bulls versus Bears:
Bulls: 44.3%. A rebound in bulls from 43.9% after a slide from 53.2% at the April peak. We can anticipate a decline next week given the dive lower in stocks Thursday and Friday. Overall still in a nice decline. After a month climbing from 42.3% back close to the 55% level considered bearish, the recent slide is a much needed decline. It rose from 42.3% on the low this cycle, a level below the prior lows in May and October 2005.
Bears: 26.8%. Bears declined as bulls 28.6%. The NASDAQ decline and overall market chop and volatility had its effect on bears as well, rising from 25.8%. Not as dramatic a move as the Bulls as they are still well off their high at 33% on the last cycle. Up from 24.5% on the low this time around. The 33% high hit last cycle topped the prior two highs (30% in May 2005, 29.2% in October 2005) that gave way to strong rallies. The 20% level and below is considered bearish. It started this move just above 20%, the threshold level.
NASDAQ
Stats: -28.92 points (-1.27%) to close at 2243.78
Volume: 2.342B (-7.38%). Well now. After spiking higher Thursday as NASDAQ dove lower, volume faded Friday as it continued toward the 200 day SMA. That may indicate it is getting sold out (technically not distribution Friday), but still strong, above average volume as NASDAQ sold. In short, it was not as severe but it was not sold out as of Friday.
Up Volume: 427M (+135M)
Down Volume: 1.898B (+1.898B)
A/D and Hi/Lo: Decliners led 3.1 to 1. Pretty ugly still though better than Thursday. That is similar to saying the bear only bit off one arm in the attack as opposed to both of them.
Previous Session: Decliners led 3.9 to 1
New Highs: 72 (-61)
New Lows: 129 (+32)
The Chart: (Click to view the chart)
Another gap lower, and three rebound attempts intraday failed. NASDAQ closed the session at the low. The selling has not let up yet as NASDAQ dives toward the 200 day SMA (2229). NASDAQ is close to making a full test of the breakout from its 2 year ascending triangle at 2218. The 200 day is above that level and NASDAQ looks ready to fully test that support.
SOX (-0.78%) was the relative strength leader Friday. It was even positive in the early afternoon but it gave up the goods into the close as well, managing a close right at the 200 day SMA (491.72). SOX acted a bit sold out Friday after 5 consecutive down sessions, but it has to prove it is ready to put in a bottom here at this key support.
SP500/NYSE
Stats: -14.68 points (-1.12%) to close at 1291.24
NYSE Volume: 1.849B (+2.13%). Volume was strong for the second straight session, increasing as SP500 and SP600 dove through the 50 day EMA. Breach of a key level in a hurry as institutions piled out the door to end the week.
A/D and Hi/Lo: Decliners led 3.9 to 1. Breadth got even worse as the dive continued. It is close to levels that indicate an extreme. That typically occurs near -5:1.
Previous Session: Decliners led 3.69 to 1
New Highs: 35 (-157)
New Lows: 199 (+58)
The Chart: (Click to view the chart)
SP500 dove lower once more, this time blowing out the 50 day EMA (1301) with authority, closing just off the session low. After this break it is heading toward next price support at roughly 1286 to 1280. Not much to say about it at this point other than it has to find support after crashing its major near term support. Indices tend to accelerate on breaks through key support and then rebound to test.
SP600 (-1.89%) broke lower as well, falling through its 50 day EMA (390.50) and its up trendline (391). First serious breach of this trendline in, well, ever. It has not crashed through this trendline with such authority during the 7.5 month uptrend. Significant move through key support, accelerating as it made the move. It is likely to rebound to test the breach of key support early this week.
DJ30
The blue chips came under pressure after leading the market higher in the latest run. Thursday and Friday it tanked on above average volume, though trade was not at the levels of early May. Fell through the 18 day EMA (11,426) and is looking to test the March high (11,317), possibly the 50 day EMA (11,272). Big run, sharp fall, panic running high.
Stats: -119.74 points (-1.04%) to close at 11380.99
Volume: 321M shares Friday versus 322M shares Thursday. Volume remained above average as DJ30 sold for a second day. Not major volume, indicating DJ30 is likely to find support at the above levels.
The Chart: (Click to view the chart)
THE WEEK AHEAD
Not just a pullback, but not the ‘big one.’
After Thursday and Friday the market is left in a defensive position, having to pick up the pieces in order to salvage the rally. DJ30 suffered a 376 point loss in a week in January, undercutting the 50 day EMA in the process and looking ready to really cave. It found footing and rebounded. SP500 and SP600 will have to show that kind of action this time around, as both crashed the 50 day EMA Friday. NASDAQ, well, has to find something at the 200 day SMA; its fade has been far more significant.
That is the difference this time: more breakdowns through support by the indices as many more stocks head lower as the breadth shows. Choppy is the best description of the action this year even though the indices have held their uptrends. When the Dow came within 80 points of its all-time high there were not enough followers. The new highs did not surge as SP600 and SP500 broke out, and NASDAQ could not attract buyers in any numbers. The Dow was leading, but as we often say, it is just 30 stocks. It made its run, came within spitting distance of a new high, and now is testing that move.
The other indices are engaged in something more. It has been a while since the indices corrected, and the bump and grind to get the last breakouts took its toll. There was distribution to go along with the leadership. The ratio of hew highs improved, but new highs overall did not surge. The move started to bifurcate when MSFT gave lousy guidance and technology lost its bid. That market divided was unable to hold the line.
So the market is correcting, and the initial ferocity led to those calls of the ‘big one,’ i.e. the end of the rally on the economic expansion. It could always be that; in the initial stages it is difficult to gauge. What would be the cause of an economic slump (that is what gives rise to the market selling off)? It would have to be energy prices, really devastating inflation, or a combination of the two. The Fed has not gone too far with rate hikes yet; if it continues much more it will given the high gasoline prices, but at this stage it is not browbeating the economy. No, the high energy prices are a main ingredient, the one (along with the Fed) concerning us the past year. After all, thus far demand has dropped the two times oil approached $75 and gasoline hit $3.
Many corrections in this ongoing advance.
But does that necessarily mean that the expansion has ended and that is what the market is signaling? Of course not. Several corrections dot this expansion. January through April 2005. August to October that same year. Significant corrections that led to further advances in this same expansion. All of the hype on the financial stations about new highs even as the market showed that nasty choppiness and distribution we discussed clouded the fact that the Q4 rally and the choppy extension of that rally in Q1 needed a consolidation. When DJ30 reached close to the old high no one was ready to follow. Indeed, the techs had already turned tail.
Thus the current correction, but we doubt it is the ‘big one’ that was hashed out on Friday and then rehashed Saturday morning is underway. Liquidity is still rampant across the globe. The central banks have not tried to drain the pool, and earnings growth projections are still double digit (outside of MSFT). Business investment, the key to the last recession, remains very strong as corporations are indeed flush with cash and are spending it. That works as an offset to the consumer beleaguered with $3/gallon gasoline. Oil and gasoline prices could still put an end to it, but thus far businesses are still spending.
From the market standpoint, the drop to end the week was sharp, but most corrections in ongoing uptrends are. One thing we note: despite the choppy trade in Q1, the VIX did not jump higher as is typically the case when a long market expansion is over. VIX has trended lower for years and is still in a historically low range. When the market has made its run, you typically see volatility as measured by the VIX jump to higher levels and hold those levels as the market distributes. You can argue that was occurring in Q1, but as we said at the time, it was not the same as a topping type of volatility.
So what about this correction?
That all leads us back to the Friday close and where this correction takes us. We have to acknowledge the possibility of a big meltdown that marks the end of the economic advance. As long term readers know, we always factor that in and discussed it above.
Given we are viewing this, for now, as a correction in an ongoing expansion, we were willing to let stocks test back some last week as long as they more or less maintained their support levels. We took gain on many positions as they moved higher, and we closed some positions as the market started to test back. Energy stocks are typically quite volatile so we give them a bit more room along with other more volatile areas.
Even with this pullback, however, we see many quality stocks holding near support or testing the 50 day EMA. That is what quality stocks do in a pullback: they hold up better. Not always, but more than the also-rans that ultimately get some money thrown their way if an expansion continues long enough.
What we are going to do is let this correction run its course and see what opportunities come into play as the strong survive and set up to move again. Typically a breach of key support leads to immediate stronger selling and then you get a rebound to test the move. Friday NASDAQ and SOX tried to hold up after lagging the upside move and starting to sell earlier than the NYSE. They showed some relative strength early, but of course that did not last. Still, they are indicating they are a bit sold out and ready to bounce.
That bounce is likely not the end of this correction unless it was just an FOMC induced blip lower that caused some sharp profit taking that gives way to a wave of new buying. That remains to be seen, but we note that the selling was preceded by choppy trade and some distribution (mainly in tech), and that tends to erode the market, requiring more rebuild time.
Though the bounce may not be the end of the correction, we are going to keep an eye on the stocks that have either completely ignored the selling or used it to consolidate their upside moves by easing back to support. Those that keep their big money support during the selling are the leaders on the rebound. Of course if the sell off is more nefarious than just a correction, everything will be sold off. Thus while we let positions test support while the market makes this correction, we won’t let them start closing below the 50 day EMA. As we play leaders, when they start closing below that key support en masse that is not a good sign for the market. For now many are holding up just fine so we exercise a bit of patience in letting it test.
Support and Resistance
NASDAQ: Closed at 2243.78
Resistance:
2273 is December 2005 closing high.
2278 is December 2005 intraday high.
2288 from December 2000 low.
2300 from the April intraday lows.
The 50 day EMA at 2313
The 18 day EMA at 2315
The late January highs at 2325
2328 from the May 2001 peak
The January high at 2333
The February closing high at 2361
Support:
2240 is closing low in February range.
The 200 day SMA at 2229
2218 is the August 2005 peak before the sell off through October 2005.
2205 is the December 2005 closing low.
2182 is the September 2005 peak and interim high from November 2005.
S&P 500: Closed at 1291.24
Resistance:
1297.57 is the recent February high.
The 50 day EMA at 1301.40
The January high at 1303
1311 is the March intraday resistance on this move.
The 18 day EMA at 1310
1315 is the May and May 2001 peaks
1317, the recent intraday highs from April.
1324 to 1329 from the October 2000 lows.
Support:
The late January peak at 1285
1280 from prior price points
1272 is the December 2005 closing high and March 2006 closing low
1250 to 1248 from the November and December 2005 lows.
Dow: Closed at 11,380.99
Resistance:
11,401 from the September 2000 peak and April 2001 highs
11,417 from the recent April highs.
11,425 from April 2000 peak
The 18 day EMA at 11,426
11,452 from December 1999 peak
The 10 day EMA at 11,480
11561 is the DJ30 closing high
11,638 from January 2000
11,723 is the January 2000 closing high
11,750 is the January 2000 intraday and all-time high.
Support:
11,350 from the May 2001 peak
The March 2005 highs at 11,329 to 11,335
The 50 day EMA at 11,272
11,250 is the October/January/February up trendline.
11,159 is the February high.
Economic Calendar
These are consensus expectations. Our expectations will vary and are discussed in the ‘Economy’ section.
May 15
- NY Empire State Index, May (8:30): 15.0 expected, 15.8 prior
- Net foreign purchases, March (9:00): $86.91B
May 16
- PPI, April (8:30): 0.7% expected, 0.5% prior.
- Core PPI, April (8:30): 0.2% expected, 0.1% prior
- Housing starts, April (8:30): 1.95M expected, 1.96M prior
- Building permits, April (8:30): 2.045M expected, 2.094M prior
- Industrial production, April (9:15): 0.4% expected, 0.6% prior
- Capacity utilization, April (9:15): 81.5% expected, 81.3% prior
May 17
- CPI, April (8:30): 0.5% expected, 0.4% prior
- Core CPI, April (8:30): 0.2% expected, 0.3% prior
- Crude inventories: +272K prior; gasoline +2.1M prior
May 18
- Initial jobless claims (8:30): 324K prior
- Leading economic indicators, April (10:00): 0.2% expected, -0.1% prior
- Philly Fed, May (12:00): 12.0 expected, 13.2 prior |
