It was too good to be true.
investmenthouse.com
In the pre-market alert we noted that the market was set up in a potentially dangerous situation: after an extended run a strong gap was coming on relief that economic data was not worse. With the increasing Nasdaq volatility and the extended, the modest employment report was not enough to establish a new solid foundation for another surge. The action was primed for big money to use the gap higher to exit positions, and that is what happened.
Nasdaq surged 38 points, DJ30 175, SP500 18 on the highs. SP500 cleared 1000 and Nasdaq threatened 1700. That was in the first hour. A long slide started at that point with Nasdaq swinging 60 points high to low, the Dow 153 points. Volume surged to year highs on the reversal. Strong run, exuberant gap higher on questionable news, high early volume, then a bearish intraday head and shoulders. These are some classic signals of an exhaustion move after a strong run.
This does not mean collapse is coming. It just means that this leg has in all probability run its course and needs to consolidate the strong gains. We recognized the characteristics early and started taking gains on many positions that were at the target and we had not banked any profit. That was about all there was to do other than take some downside positions as some stocks broke down through support on volume. It remains to be seen how vigorous this pullback will be, but back to the mid-May highs seems about right.
THE ECONOMY
May unemployment report offers mixed promise.
Unemployment rose to 6.1%, in line with expectations. The real news is always below the headlines. Non-farm payrolls fell 17K, much less than the 31K expected. The most surprising point was the April revision to unchanged from -48K. Upward revisions are something you should always watch. That is where the change typically first shows itself. This was a substantial revision.
Moreover, the mix of jobs lost and gained was key. Private sector jobs rose 10K while government jobs fell 50K during the period. This is an important swing. The private sector has languished with net job losses while government jobs have climbed. As seen, that does not stop overall unemployment rates because the government is not the economy. Moreover, government jobs are paid with taxes; you take from Peter to pay Paul. Some of the money re-enters the economy, but it is not the market putting it where it needs to go. Thus the data from May is promising on two fronts: private job creation is potentially increasing, a sign of real economic gains; government is downsizing , putting more dollars to work in growing the economy where the dollars are needed. It would be great if federal, state, and local governments would answer the budget deficits with elimination of redundant positions and wasteful spending and then not reverse course again when the economy improves. We would all benefit from that in many ways.
There are downsides to the data. No real increase in the work week and modest gains in overtime. At least they were gains. Much of the data has to be taken with a large salt grain, however, because of the new seasonal adjustment standards and changed benchmarks that have been made to more accurately reflect the economy today. The change is good, but that makes the data questionable until a few months are logged to see just what the trend is.
Is the Fed doing it all over again?
During the 1998 Russian economic crisis the Fed and other central banks met and slashed rates. That turned the 1998 bear market into a strong rally. That rally was goosed in 1999 with fears of Y2K runs on banks. The money supply was again stoked, and when the money was not used, it was put into the market. The market surged higher and higher on the speculation, and in the end it collapsed when the Fed, fearing the genie it may have released tried to engineer a �soft landing� buy calling in all of that money in March 2000 and continuing its rate hiking at an increased pace. The result was the crash and 3-year bear market and recession. That fear of too much air in the bubble has turned to fear of following Japan after it when through a similar episode 10 years earlier in the late 1980�s.
The spigot is now open after the Fed has finally caught up to the market. The Fed has made no secret it is going to do whatever it can to prevent deflation, basically daring other central banks to cut rates. The ECB responded with a 50 basis point cut last week. The Fed is on hold for rate hikes until the unemployment picture shows a few months of steady gains; in the interim it is going to cut rates. It is buying treasuries. Money supply is growing by $20B per week. The Fed is going all out and there is a tax package on top of that. Greenspan even said this week that the tax package is coming at a �very opportune� time. The tax package is a positive structural change in itself and thus has other virtues. Nonetheless, there is a make or break attempt at recharging the economy and recharging it fast.
No problem with that, but the fear is that if things get too hot too fast again (as this market has started to shift into high gear of late), the Fed will once again feel compelled to take away the punch bowl by raising rates and drying up the money supply. It always overshoots both ways whether raising or cutting rates, and unless there is the kind of real growth seen in the 1980�s coming out of this recession in order to give real substance to stock prices, there is the potential to simply re-inflate the bubble without substance behind it. That is a recipe for a true disaster of biblical proportions. Kind of like a relapse from the flu; the second time around can kill you.
That is where the tax cuts help. They are similar to those in the 1960�s and 1980�s that sparked real economic investment that led to putting a man on the moon and the U.S. economic and technological edge that put the USSR in the scrap heap of failed social experiments. There needs to be real investment in the US, not just buying DVD players and movie tickets. Real investment creates new industry and new technologies that drive real growth and real jobs. That is what is behind the tax cuts and, unwittingly as far as the Fed is concerned, the rate cuts as the two do play hand in hand: low rates allow lower cost investment in business along with the lower tax burdens. It will either work or it won�t. At least the administration is on the right track.
THE MARKET
For the second time in the week Nasdaq showed a high volume reversal after a gap higher. It started the week with one and ended the week with one. The first one had us concerned but not too worried. This second one on the highest volume of the year points to a consolidation coming.
We have talked of the added volatility coming into the market. Not necessarily as measured by the VIX and VXN but the kind of jerky intraday action and day to day action seen even as the market moves higher. One day the market surges and then reverses on volume. Then it surges on strong volume and holds the gains. This action has even started to show up on the volatility indexes now with the VXN breaking over its 50 day MVA. Volatility as rising as the market rises? Doesn�t volatility rise as the market sells and falls as the market rises? Yes, but volatility, as with all secondary indicators, is a measure of extremes. It tends to rise at extremes either at lows or at highs. Just look at late 1999 and early 2000 when volume climbed higher and higher as the market jerked back and forth on high volume; volatility was rising with it. The bear market started with a huge volatility surge.
This volatility surge is not in that league, but it is there. Volatility as we have seen where the market jumps one way then the next is an indication of season change. It has been indicating that a pullback was coming and with the two high volume gaps and reversals last week, the Friday one as the indexes moved through important levels, it looks like it is time. Unlike 2000 we don�t see this as the collapse that pushes the indexes to new lows. It looks like the start of a necessary consolidation.
Market Sentiment
One comment other than the volatility discussion above. Larry Kudlow on Kudlow & Cramer described the market as �white hot.� How we hate that phrase. That is the phrase used to describe the economy as late as summer 2000 when the market was in a nose-dive. That phrase often means that it is so hot it has started to melt.
VIX: 23.43; +0.31
VXN: 36.13; +1.6
Put/Call Ratio (CBOE): 0.78; +0.14
Nasdaq
Nasdaq gapped lower Thursday and rallied to the close on strong volume. Friday Nasdaq gapped higher and fell to the close on strong volume in a 60+ point swing. Now that is volatility.
Stats: -18.59 points (-1.13%) to close at 1627.42
Volume: 2.978B (+20.27%). Strong volume surge to the highest volume of the year. Not the kind of volume you like to see on a gap reversal.
Up Volume: 1.126B (-353M)
Down Volume: 1.826B (+860M)
A/D and Hi/Lo: Decliners led 1.18 to 1. Modest downside breadth, but it had to overcome the early upside breadth. As with the point swing, the breadth swing was wide as well.
Previous Session: Advancers led 1.58 to 1
New Highs: 446 (+119)
New Lows: 5 (0)
The Chart: (Click to view the chart)
Surged to 1684 on the high, threatening 1700. On the high it was 23% over its 200 day MVA (1370). It has definitely been getting top heavy, and after a 333 point run up off the mid-April low it is ready for a break. Typically there is a May and June pullback before a late summer rise through August. The rebound from the 3 years of selling has thus far kept things running longer than normal. It now looks ready for a bit of a breather to finally consolidate those gains. We keep looking at the May highs (1550) as a very logical point to hold, though it may drop to the 50 day MVA near 1500. We don�t want a straight drop but an overall orderly pullback over a few weeks or so to consolidate the gains. That allows the sellers to get out of their positions and then the buyers can reassert themselves.
S&P 500/NYSE
Big tombstone doji after the strong move higher over the psychological barrier at 1000 indicates a pullback is ahead.
Stats: -2.38 points (-0.2%) to close at 987.76
NYSE Volume: 1.816B (+8.24%). Volume surged as large caps turned and reversed after breaking over 1000 and then giving it back.
Up Volume: 812M (-334M)
Down Volume: 1.013B (+480M)
A/D and Hi/Lo: Decliners led 1.01 to 1. Narrow drop, but with the reversal it is harder to quantify. Advancers were well in excess of decliners, but it slid as the session gave back the gains.
Previous Session: Advancers led 1.65 to 1
New Highs: 577 (+49)
New Lows: 2 (+1)
The Chart: (Click to view the chart)
The large caps ran to 1007 in a terrific one-hour surge. Then it was all downhill. Volume was strong early and it was strong late as the large caps showed a reversal doji know as a tombstone doji. The name says it all, and it is not talking about pizza. It showed the same action Monday; not the same as the Nasdaq gap and reversal, but in its own way showing that volatility and topping action. We are not writing the obituary; every time it looks rocky it rallies right back. It is extended, however, and it needs a pullback. As with Nasdaq, the mid-May high (948) is a good target on an orderly pullback.
DJ30:
A reflection of SP500, the blue chips rallied to 9215 and reversed. They did post a gain though the reversal was clear and on the highest DJ30 volume of the year. Notably it closed the week below the August intraday high (9077), the point that would have broken the string of lower highs in the long downtrend. DJ30 is the last major index that has not broken through, and closing the week below that level after a 175 point rally says a lot as it was pushed back down by the sellers below that resistance. 8750 is the mid-May high that offers the nearest and very convenient level to hold.
Stats: +21.49 points (+0.24%) to close at 9062.79
Volume: 1.816B (+8.24%)
The Chart: (Click to view the chart)
THIS WEEK
Another week filled with economic news (inventories, retail sales, PPI, Michigan sentiment). The question is whether it will make a difference. The market received a load of decent news the past two weeks and the employment report Friday was viewed mostly in a decent light. Even with that employment report (maybe because of it as the market reversed after the early surge) the market fell back. It may have finally priced in all the good news. After a time the market gets used to the news, or at least it fails to give it an excuse to continue the current move.
Two reversals in one week, one to start it and one to finish it, are a pretty clear indication of increased volatility ahead of a needed pullback. The is a theme in the market that runs through all moves. We talk about how stocks run up the short term MVA 4 to 5 times after a breakout before a test lower toward the 50 day MVA. On the last two bounces the stock starts to show more volatility. Many stocks have made 4 or so runs up the short term MVA and are starting to get a bit more volatile. It is a theme that runs through the market.
This week we anticipate a pullback. Not all at once, at least if it is going to be orderly and meaningful. May be a session or so of distribution before things settle out to a more orderly pullback. In this environment we are going to use discretion as to what stocks we want to ride lower to a 50 day MVA test and which ones we will take the rest of the gains. All stocks that have hit targets we have taken some gain on with the idea of letting them ride for a test. We will watch those that hold up the best and let them do so. We will also look at selling some covered calls on those stocks we want to ride lower on the test (e.g., BRCM, QLGC), picking up some money for renting out our stock on the pullback. When they hit support and hold we buy them back for the move back up. For plays that have not hit the target we will enforce the stop points.
We also are looking for continued strong upside moves; they will continue even in the correction as leaders show their mettle and new leaders emerge. We will also look for the breakdowns as they have struggled to hold up during the rally and then really show their weakness as the market pulls back to consolidate its gains. Those have to be faster plays; even though the market needs a more prolonged pullback it may not take a long one.
Support and Resistance
Nasdaq: Closed at 1627.42
- Resistance: 1640 (20% over the 200 day MVA). 1700 (Feb 2002 low).
- Support: 1595 (June 2002 closing high). The 10 day MVA at 1596. 1573 (May 2002 closing low). 1567, the mid-June intraday high and the 18 day MVA (1567). The May high (1554) is what we are watching as a primary support level. The December intraday high (1522). The exponential 50 day MVA (1496) is the next primary support point. The January high (1467).
S&P 500: Closed at 987.76
- Resistance: 990 to 1000. Then 1050.
- Support: 975 (December 1997 peak). 965 (August 2002 peak). The 10 day MVA (967). The 18 day MVA (956). The mid-May high (948). 935 (November and January peaks). The 50 day MVA (924).
Dow: Closed at 9062.79
- Resistance: December high (9044) is not totally broken. The August high (9077). 9500 (June 2002 lows).
- Support: January high (8870). The 10 day MVA (8894). November high (8800). May high at 8743. The 18 day MVA (8793). 8522 and 8520, the March and April twin peaks. The 50 day MVA (8562). The 200 day MVA (8337).
Economic Calendar
6-09-03
- Wholesale inventories, April (10:00): 0.2% expected, 0.5% prior.
6-11-03
- Federal Reserve Beige Book (2:00)
6-12-03
- Business inventories, April (8:30): 0.3% expected, 0.4% March.
- Retail sales, May (8:30): 0.2% expected, -0.1% April.
- Sales ex autos (8:30): 0.3% expected, -0.9% April.
- Initial jobless claims (8:30):
6-13-03
- Trade balance, April (8:30): -$41.9B expected, -$43.5B March.
- PPI, May (8:30): -0.1% expected, -1.9% April.
- Core PPI (8:30): 0.0% expected, -0.9% April.
- Michigan sentiment, June (9:45): 94.0 expected, 92.1 May.
SUBSCRIBERS QUESTION
Q: I noticed that GNTA has a short ratio of 23. That�s 30% of the float and would take 23 days for the shorts to cover on average daily volume. Doesn't that make this stock much more volatile? Probably the shorts pushed the price down [Tuesday] as it hit a low of 10.30. Does this high short interest figure into your selection methodology? And if so, how do you use the information? Thanks again for a great investment letter.
A: We view short interest on a stock much the same way as we view it on the market as a whole, i.e., a contrary indicator. When short interest is high as it was during September and October before that bottom and then again in January, we view this as setting up the next move higher, particularly when the overall price/volume action is solid and leading stocks are still holding up well.
Thus when an individual stock has a high short interest in addition to a solid pattern and good overall accumulation, it is icing on the cake to have a higher short interest. Why? Because if all of the nuts and bolts of the primary indicators are solid it is still setting up for a move, and when it makes that move, i.e., breaking resistance, the shorts will start to cover and give the stock even more upside strength. Remember, when a stock or index clears resistance in a downtrend, the shorts start to cover. That is what happened in the move off the October low; as Nasdaq took out resistance level after resistance level, the shorts covered. That was fuel for the rally. Rallies often start on short covering. If it is to survive real buyers will have to come in along with the shorts.
Thus, if a stock has good accumulation and a nice pattern despite the short interest, then it has a potential extra fuel cell on it to drive it higher. On the lower volume test of the 18 day MVA on the Tuesday intraday low, GNTA shook out some of the sellers that were holding the stock for the upside move. When it started back up there was some short covering. Friday there was buying and short coverign as GNTA shot higher on huge volume. The shorts tried to take it down as it sold back to the 10 day MVA intraday, but it turned and closed at the high as the good accumulation and pattern won out over those shorts trying to drive it back down.
Stocks with higher short interest can be more volatile as the bulls and bears are going toe to toe, but if it has good credentials we view that higher short interest as a positive. Remember we typically do not take a position until there is resistance broken. When resistance is broken, shorts tend to cover. That just provides more juice to the move.
Don if 378 fails on the SOX then 359 may be a better level of support. We go all the way down to around 332 after that! Thanks for putting the earnings into perspective with me.
RtS |
