Some food for thought?
Market Commentary for Tuesday, January 30, 2001
Yesterday was an historic day on the NYSE as more than 3,500 stocks began to trade on the new decimal system. NASDAQ is due to convert trading of 5,200 stocks at the beginning of April.
The big item this week is the two-day FOMC meeting, which begins today. It’s a given that the Fed will announce a second rate reduction on Wednesday, this one between ¼ and ½ point. It seems well factored into the market, from the tone of the press:
From WSJ:
“A rate cut also could attract investors back into stocks, analysts said.”
"If the Fed does what the market thinks it will, we're going to see psychology shift away from bonds and back toward equities," said Jim Caron, fixed-income strategist at Merrill Lynch in New York.”
“Reports scheduled for release this week include the consumer confidence index for January, due Tuesday. In last week's appearance before the Senate Budget Committee, Mr. Greenspan said what is crucial for the Fed is whether the country's economic slowdown "reaches consumer confidence."
The initial report on fourth-quarter gross domestic product is due Wednesday, the first indicator of the health of the overall economy following Mr. Greenspan's dour assessment of economic growth last week.
The National Association of Purchasing Management reports its widely followed manufacturing barometer on Thursday. Manufacturing has been among the weakest sectors of the U.S. economy. The NAPM reading for December marked the lowest level in a decade and the report was released just one day before the Fed cut rates on Jan. 3. On Friday, the Labor Department reports on the unemployment rate for January, as the financial markets look for some signs that the weakening economy has dented the tight labor market.”
U.S. Economic Calendar for This Week:
Tuesday, January 30
9:00 a.m. BTM-UBS Warburg Chain-Store Sales Index: For week of for Jan. 27. Consensus Estimate: n/a. Previous: -0.7%
10:00 a.m. Consumer Confidence Index: December report. Consensus Estimate: 125.0. Previous: 128.3
10:00 a.m. University of Michigan Consumer Sentiment: January report. Consensus Estimate: n/a. Previous: 98.4
10:30 a.m. Redbook Retail Sales Index: For week of Jan. 27. Consensus Estimate: n/a. Previous: 2.4%
Wednesday, January 31
8:30 a.m. Preliminary GDP: Third quarter. Consensus Estimate: 2.2%. Previous: 2.2%
10:00 a.m. New Home Sales: December report. Consensus Estimate: 891k Previous: 909k (or -2.2%)
Thursday, February 1
8:30 a.m. Initial Jobless Claims: For week of Jan. 27. Consensus Estimate: 230k. Previous: 12k
10:00 a.m. Construction Spending: December report. Consensus Estimate: -0.5%. Previous: -0.6%
10:00 a.m. Personal Income: December report. Consensus Estimate: 0.2%. Previous: 0.4%
10:00 a.m. NAPM Business Index: January report. Consensus Estimate: 43.8. Previous: 43.7
Friday, February 2
8:30 a.m. Non-Farm Payrolls: January report. Consensus Estimate: 75k. Previous: 105k
8:30 a.m. Unemployment Rate: January report. Consensus Estimate: 4.1%. Previous: 4.0%
10:00 a.m. Factory Orders: December report. Consensus Estimate: 1.0%. Previous: 1.7%
10:00 a.m. University of Michigan Consumer Sentiment: January report. Consensus Estimate: 94.0. Previous: 93.6
Speaking of the non-farm payroll numbers, the headlines are starting to get grim:
From WSJ:
“DaimlerChrysler will cut 26,000 jobs and idle six factories at Chrysler, as the company tries to pull its loss-making U.S. unit back to profitability.”
“Walt Disney said it will shut down its Go.com entertainment portal and convert the tracking stock for its Internet operations into Disney common stock.”
“OfficeMax warned that it expects to post a quarterly loss of more than five cents a share and said it will shut down 50 stores as consumer spending slows.”
“Venture-capital investing in start-ups fell 31% in the fourth quarter from the previous period, for the first quarterly decline since the first three months of 1998.”
Seems the pink slips are being handed out fast and furious in all sectors of the economy, as consumers stop consuming, presumably due to a reversal of the wealth effect that they have enjoyed for years. Unfortunately, consumers may not have paid for their enjoyment in cash, as personal debt levels continue at all time highs. With stock portfolios in tatters, one wonders. They could sure use a rally here…
Let’s have a look out there and see what the psychology is like at the moment. Early last week, we found a fist-pounding consensus amongst economists advocating various “soft landing” scenarios. This is in contrast to what FOMC Chairman Greenspan’s comments before the Senate Banking Committee on Friday.
From BARRON’S:
“Chuck Hill, director of research at First Call, worries about both the fourth-quarter numbers and beyond. The fact that technology earnings growth dropped from 42% about three months ago to 2% in the most recent quarter raises the possibility that there is something else amiss besides a slowing economy, he says. Estimates for 2001 are withering away by the day. Earnings growth for the S&P 500 is expected to be just 6.8% in 2001, which is down from 15.5% on July 1. The growth estimate is less than half of last year's. Earnings growth is expected to pop up to 14.7% in 2002.
Hill sees estimates for the third quarter as the key bellwether for 2001, particularly in the technology sector. "Technology numbers have been dropping at an unreasonable rate," Hill says. "It's certainly worrisome when we see earnings expectations drop from 11% on January 1 to 3% now."
Byron Wien, Morgan Stanley Dean Witter's U.S. strategist, echoes some of Hill's concerns. He sees a business expansion that lasted more than 100 months and built up excesses in inventory and capital spending. "To assume the excesses built up in that period [have already been] unwound may be too optimistic." Wien says there has been tremendous accumulation of corporate and consumer debt, and heavy spending on capital equipment, which leads to high fixed costs. Companies also have a limited amount of pricing power, which hurts revenue growth. All of these factors put a squeeze on profit margins.
Unlike the bearish Wien, most analysts on Wall Street expect a lean first and second quarter, followed by a resurgence in the second half of the year. Hill is unconvinced. "I don't think that's a given by any means," he says. "If cutting technology and consumer cyclical [earnings] were to continue, or worse yet, accelerate, then I think we will have a problem."
Thomas Galvin, head U.S. strategist at Credit Suisse First Boston, avers that this and the next few quarters' earnings might be sour, but help is on the way. "Fourth-quarter numbers are telling us what we already know: that the economy stinks and it needs help," he says. Galvin says the poor numbers rolling in now are telling of a sharp slowdown in the economy last year, but he believes the Fed's rate cut earlier this month and further rate cuts this year, combined with a possible tax cut brokered by the Bush Administration, should get earnings back up in the second half of the year.
But share prices often move up ahead of earnings estimates, which means stocks should soon take off on good news about the second half of 2001 and expected strength in 2002, Galvin contends. "The recovery of the Nasdaq is an anticipation of the fact that we're in the fifth or sixth inning of a nine-inning inventory correction process." In about six-to-nine months, lower energy costs, less excess inventory in companies, better consumer confidence and lower interest rates all should kick in, Galvin says. "But I think stocks will move ahead of that."”
So it seems this week, the press is now brave enough to report on some voices of alarm here amidst the continued consensus opinion that everything will be OK. However, we note that the “bearish” article is wrapped up in two or three sentences in the last paragraph with an assurance that “stocks are going to go up soon”.
One of the people that I have been eternally fascinated with is Felix Zulauf, of Zulauf Asset Management. Almost without exception, he has been part of the Barron’s round table each year. I my former employment, I had the luck of meeting people who worked with him, and they all respect him for his balanced macroeconomic analysis, which shall we say, is in concert with that of my mentor, Ian Notley. Today, I happened upon the January 2001 Barron’s Roundtable, and hopefully, we can lift a few paragraphs from it without dire consequences:
Barron's: At last year's gathering many of you were worried about the market and the economy. We were tempted but it's a good thing we didn't take it as a contrary indicator. John, you even shorted the Nasdaq 100, which was an excellent call. What do you think about the economy now?
Q: Felix, what do you think?
Zulauf: It looks to me like we're already in a recession in the U.S. and that the 10-year expansion is about over. The basic problem is overconsumption and overinvestment, and undersaving. It's probably very similar to the situation we saw in the late 1980s in Japan and the mid-1990s in Southeast Asia. It will take a few years to work off the excesses that have built up over the past 10 years. It's been about 25 years since the last globally synchronized recession, and wherever I look outside the U.S., economies are decelerating. It doesn't look like an outright recession in Europe, certainly not yet, but that could come in the next year or so. Japan looks like it is rolling over again. For investors, then, this will be a year of economic disappointments and major reflationary attempts by the authorities, monetary as well as fiscal. We might have only one or two down quarters, and then bump up for a quarter or two before the economy decelerates again. I do not see a major meltdown right away, but a long, drawn-out working off of prior excesses.
Zulauf: You can see already that we've gone from an inverse yield curve [denoting that short-term interest rates atypically are higher than long-term rates] to a slightly normalized yield curve. The yield curve throughout the U.S. and Europe will steepen, of course. There will be a major attempt at monetary reflation, and in some countries in Europe expectations for tax cuts already have been built in. We'll probably get a tax cut in the U.S., too. That's why the economy won't just fall apart. But it will be hard to rekindle the sort of growth we've seen, because the consumer is pretty extended. Another key problem is that we've overinvested in high-technology equipment, and that has been the driving force behind the expansion of the past few years.
Zulauf: That's what I am saying. The current weakness will draw a response from the authorities on both the monetary and fiscal sides.
Q: What you're saying is the economy will have five down quarters, but they won't be consecutive. That's the difference.
Zulauf: Yes. Since the early 1990s the U.S. savings rate has declined to below zero from 8%. One percentage point in the savings rate equals about $100 billion. When you look at the formula, corporate profits equal investments minus savings. Total corporate profits are $600 billion. If the savings rate were to go up a few percentage points, that would really eat into corporate profits. So corporate profits are going to be a major casualty this year.
Q: We believe you. Now, Felix, tell us about the rest of the world.
Zulauf: The current market environment is more suitable for trading than investing. We are looking for rallies in stock markets around the world. I think all the markets are preparing for rallies soon, starting this month into the second quarter. We are looking for stocks to play that theme, that are sensitive to changes in the yield curve. So we'd buy British bank stocks such as Barclays and HSBC Holdings. We would buy construction stocks like Italcementi, an Italian cement manufacturer, which is very cheap. John would love it at one times book value and 6.5 times earnings. The stock was down about 30% over the past 12 months.
In addition, we think the Nasdaq will finally start to rally, though it will be a bear-market rally. We'd use semiconductor stocks for that rally, and expect to gain 25%-30%, or more, within the next three to four months.
Q: Which semiconductor stocks are you recommending?
Zulauf: I'm talking about Philips Electronics or STMicroelectronics or Infineon Technologies. On the other hand, a lot of perceived defensive issues -- noncyclical growth stocks such as pharmaceuticals -- have benefited a lot from the bear market in technology. They've gone to unbelievable valuations. The European companies have benefited from a rising dollar for a long time. Now that's changing. One stock we're selling short is Aventis, created from the merger of France's Rhone-Poulene and Hoechst. The stock is now selling at 40 times earnings, with earnings growing at roughly 10%.
Q: Do you have other short-sale recommendations?
Zulauf: In foods it's the same story. Nestle is trading at 25 times earnings and has unit growth of maybe 2%-3%, at most. The company benefited from a restructuring program two years ago, but I do not believe that 10% earnings growth is sustainable. And with more than 50% of sales in U.S. dollars, the stock is vulnerable to currency swings.
These are trading ideas for the next three to four months. We would certainly not hold these positions for the whole year. After the Nasdaq rallies, I believe it will come down and go to new lows -- probably much lower lows than most people believe.”
So on that happy note, we come back to our commentary and analysis. Since the January 3 surprise attack from the Fed, stocks have indeed gone up, and as we have said, the consolidation patterns are evident in all the major averages.
The Dow Industrials is trading inside some sort of terminal chop:
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The S&P 500 Index has been consolidating as well, but is now looking like it has confirmed support of the topside of the upper boundary of the descending wedge formation seen on the daily chart, above the 30-day WMA. This is bullish:
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Last but not least, we go back to the NASDAQ 100 Index, which most people are interested in. For the past few weeks, we have been watching the wedge work itself up to the apex. Last week, it gave a buy signal, which we caught for a couple of bucks with the QQQ, before it failed to thrust up. Over the past few days, it has broken to the downside of the pattern as it pulled back again, but remains above the 30-day WMA, as well as the downtrend line extending from the August 2000 highs. As we said, the rising wedge here is bearish, but so long as it trades above the 30-day WMA and the downtrend line, we are still giving buyers the benefit of the doubt:
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There is always the possibility of pattern failure (meaning a move to the upside on a “failed” rising wedge), and now a pending catalyst with the Fed meeting, we keep two things in mind. First of all, I personally never trade in front of any kind of news that is a potential catalyst that can move a market from a consolidation to a trend in a single instant. Second, I know so many of you just want to buy, that I feel compelled to address this issue. We won’t go over the logic of this, because I think more rate cuts, especially a ½ point reduction after the meeting, will naturally lead to confirmation that recession is indeed here, and it may well have the complete opposite effect that most people imagine. But then again, it might not.
The job of a trader is to take shots that are controlled, in terms of potential damage to his capital. Right or wrong on any one trade is immaterial and inconsequential, so long as the account is not wiped out due to lack of risk and money management. Most of the damage is done when pride of being right causes a trader to hold onto a losing position. I wrote an article a while ago about the psychology of trading:
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That said, if you feel bullish, then just buy some QQQ – BUT WITH A PROTECTIVE STOP LOSS ORDER IN PLACE. In any event, a long position in the QQQ should have a stop loss at no lower than the swing low of January 26, 2001 of around $62.50:
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If you wish to short it, sell it on break of yesterday’s low of $64.25 with an initial stop loss order of no more than today’s high of $67.25. Note these are swing/position trades taken from setups on the daily chart, and therefore, there is risk of overnight exposure, and all traders should ensure that they have implemented disciplined risk and money management techniques to protect their capital.
For more information on risk and money management, please see:
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For more information on how to interpret our proprietary swing charts, please see:
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The trajectory on rising wedge pattern failure that buyers want to see is this, with two targets overhead. The first is a test of the January 24 high. The second is the December 11, 2000 high. Should the market break to the upside following the Fed meeting, traders are advised to tighten up protective stops as each target is approached, in case of failure on test:
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Traders have asked me about JSDU quite a bit of late. Here is the swing chart:
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Presently, it is in a DownSwing, but still trading above the 30-day WMA. We note that Japanese candlestick analysis yields a bullish engulfing pattern made by last Thursday and Friday’s pair of candlesticks, and this is a bullish reversal pattern. Monday's market action produced a very, very small range bar, and inside bar. ADX has dropped for two months, confirming this consolidation/congestion phase and so the stage is set for a move. Typically, you will see the high and the low of such an inside day tested quickly in the morning. Those who are position trading need to decide which way they want to go. The basic strategy is to buy on break of Monday’s high, with a stop at today’s low for aggressive traders with tight stops. Those who want to give it some room should have a stop no lower than the swing low of last Friday, which is at $54. Targets to the upside correspond with that of the QQQ in terms of date, and you can see that they are at $67 and $74, respectively.
One note of caution, amongst all these bullish scenarios. Last week saw the lowest VIX in almost four months, showing us considerable complacency. Also, the 5-day RSI ticked up, indicating that a short term top is here, but of course, at the end of a consolidation zone, we take it with a grain of salt, since this works much better in a trending market:
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NASDAQ new 52-week highs number 102 vs. 15 new lows. NYSE new highs number 194 vs. 6 new lows. The internals look decent still, and the 10-day MA of the net differential is still moving up, however slowly.
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I will be updating comments intraday for most of this week. Good luck and take care.
Teresa |
