InvestmentHouse Weekend Update:
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- End of month brings back buying, and yes, on higher volume.
- Michigan sentiment lower while regional manufacturing remains strong.
- PCE remains low, Employment Cost Index low suggest lower inflation to some.
- Personal spending and income remain solid thanks to rising prices.
- Yield curve flattens further as talk of just one more rate cut spreads.
- SP500 holds recent lows for small double bottom & oil closes below $50/bbl, sending shorts running to cover, but not enough to turn the character yet.
- FOMC meeting is focus this week as stocks try to provide a follow through.
Several factors lead to rally to close week.
Another day, another higher volume session that reversed the prior action. The last four sessions of the week flip-flopped in price and volume, each session posting higher volume. As noted earlier in the week, this action is more common at the end of a selling round than the middle. Once more stocks showed signs of recovering, but they were just signs; the downtrends remain in place and stocks will have to show next week they are interested in a serious rally with a strong follow through session.
Stocks showed the Dr. Jekyll and Hyde routine again with futures running higher pre-market. Economic data was looking better with consumer income and spending higher than anticipated, MSFT providing a surprisingly upbeat view of 2005 and 2006, and other earnings looking decent. As usual, however, the stronger open led to selling. Sellers used the early bounce to sell into. The move was fueled by Michigan sentiment coming lower than expected and oil prices that started higher. Chicago manufacturing was solid, but it was overlooked in the early going. Stocks looked weak again, giving back all of the early gain and turning negative mid-morning.
NASDAQ undercut the recent lows at 1904 and 1900, and techs were looking grim. Then several events merged and stocks turned. SP500 tested the recent lows and held them as well as the August 2003/August 2004 trendline. Oil started to reverse its gains, and it picked up speed as the afternoon wore on. Indeed, after a test of the initial bounce off the session lows, oil started to drop. The market started to rise again. When oil closed below $50/bbl stocks really started to rally higher as shorts were covering. They kept the pace into the close, finishing at session highs.
Along with oil falling below $50/bbl the market received a boost from a rumor or notion bandied about that the Fed was going to raise one more time and then stop. The idea of a Fed that is quickly responsive to economic data has sex appeal, but it is more based in hope than in substance. With a market grasping at straws to hold on and with oil falling, however, it was some more sauce to add to the rally.
It also did not hurt that it was the last trading session of the month and there was some related portfolio shuffling. That helped boost volume once more and breadth was decent as SP500 put in a small double bottom on the recent lows. Will this be the bottom? Not likely given the short duration of the pattern, but it could well set the stage for the bounce that sets up the test that sets the bottom. Clear enough? In any event, the market closed lower for the week even with the upside volume session to end the week. The downtrends remain in place. The action was a good way to end the week, and it once more sets up the potential for a follow through in the week to come. As has been the case all week, the upside is good to see, but the market will still have to show a strong move in the second half of next week by more than just one index to put together a more sustained move higher.
THE ECONOMY
A still decent economy getting much maligned.
Not every economic report is coming in with gains the past few months unlike 2003 and 2004. After growing sharply with the fiscal incentives it is normal for the economy to slow some. We saw these issues arising a few months back because we were focused on oil prices and the Fed. At the beginning of the year we said those were the two issues that would dominate the market’s action, and that is how it has played out. Add onto those two some economic that has started to soften and you now have a lot of pundits jumping on the bandwagon of a slowing economy, stagflation, recession, etc.
That is all possible of course, though you almost have to chuckle a la Greenspan at the suggestion that low single digit inflation and 5% unemployment is somehow comparable to the 13% inflation and 10+% unemployment of the 1970’s and early 1980’s. It was just two years ago everyone was worried about deflation. Some normal ‘re-flation’ has everyone nuts.
The economy slowed late Q1. Slowdowns within expansions are not unusual, however. Economic expansions trend higher and there can be down cycles within the ongoing up cycle. The key issues this time are the same ones: the Fed and oil prices. Oil is going to test lower now toward the mid to low forties. The Fed funds futures are showing just a few more rate hikes. Perhaps that will be enough to stave off turning a slow cycle in the expansion into a sharp slowdown. If it is, however, we will see the market start to recover before the data verifies that the economy has recovered. Perhaps the ‘double bottom’ the past two weeks on several indices is the start of the bottom. As noted above, it will have to show it.
Friday’s weak economic data.
Michigan sentiment weakens.
Friday revealed additional weakening economic data, but it was more psychological than substantive. The final Michigan sentiment survey for April came in at 87.7, less than the 89.7 preliminary report and the 88.9 expected. As with the Conference Board’s confidence poll earlier in the week, these levels still indicate confidence at sufficient levels to drive consumption.
Most articles you read about confidence these days note that what the consumer says and what the consumer does are two separate things. In other words they proffer the proposition that sentiment and consumption have become disconnected. In reality there is no change. It is the level of consumption that makes the difference. Fluctuations in sentiment from the seventies to 100 or more show little change in consumption. Only when sentiment levels drop into the low seventies and really into the sixties does consumption alter significantly enough to impact the economy.
Thus while the there is worry about flagging sentiment, at these levels it is not an issue. The issue is whether this is setting up a trend of lower confidence that will eventually end up in the sixties. It definitely hurts confidence to see the gasoline bill $10 higher per tank, airlines charging fuel surcharges, service providers tacking on additional fuel charges. That saps enthusiasm and it also actually diverts dollars from the productive economy.
Personal spending increases, but it is all in the price.
Spending rose 0.6% in March, more than the 0.4% expected. It was less than February’s 0.7% gain, but that was revised higher. Now typically you would think spending was up so the consumer must still be hot to trot. Well, the consumer is at least spending. The problem is the consumer is having to shell out more for less. Adjust the spending figures for inflation and spending rose just 0.1%. In February the inflation adjusted spending rose 0.4%.
Seems that the higher prices are biting into actual spending. Overall dollars are higher, but it is buying less meaning less production needed to replace the goods sold. Also there is that problem with money diverted to higher gasoline prices that is not going back into the economy to buy more goods that have to be replaced. Thus the rise in spending is not what it was back in 2003 when the Fed was worried about deflation or even in 2004. We are spending more because prices are higher, and yet we are not slowing our spending in total dollars. That tends to create a vicious cycle: more money chasing the same amount of goods keeps the inflation rise feeding on itself.
Friday’s positive economic data.
The Chicago PMI measure of Midwest manufacturing activity fell to 65.6 from 69.2, but when you consider March was a record and expectations were for 63.9, it wasn’t chopped liver. The sub-indices were down across the board, but they all remained strong. Employment fell to 62.3 from 66.0; new orders were 71.0 (76.7 prior); even more positive, prices paid fell to 66.1 from 68.2. Lower but solid readings.
This report dovetails with the Philly Fed from last week and leaves the New York report looking like the odd man out. Chicago and Philly are harbingers for the national ISM to be released Monday, so we do not anticipate much of a drop nationwide.
One of the Fed’s inflation gauges, the Employment Cost Index, slowed slightly in Q1 to 0.7% (1% expected) after a 0.8% gain in Q4. Year over year costs rose 3.4%, the lowest in 6 years. As for the components, salaries and wages rose 0.6%, a 2.4% annual rise, holding steady from Q4 and Q3. That is the smallest advance since the records were first kept back in the early 1980’s. Benefits rose 1.2% versus Q4, the smallest gain in 3 years. That puts the year over year gain at 5.9%, the smallest cost advance in two years. Of course, health benefits rose the most.
The Fed looks hard at this data because the Fed believes that wages can lead to inflation. If people are paid more they must be spending more, thus driving up prices. This assumes that supply is steady. This is hogwash. In a healthy economy supply will meet demand. If employees are getting more money they are being more productive (particularly in this current economy). In other words they are making more of the goods and services that are being consumed and doing so more efficiently. There is no ‘wage-led’ inflation unless regulations really hinder supply in meeting demand. This is the old Phillips Curve mentality where prosperity is viewed with fear. It is so strange; politicians campaign with promises to deliver prosperity, and when we actually get it the Fed tries to stall it out. Does the Fed believe we have a death wish because we strive to prosper? Seems to be that way.
Bond Yield Curve continues to Flatten as Fed prepares to meet, China rumored ready to float yuan.
Back at the end of 2004 (just four months ago), the difference in yield between the 2 year Treasury and the 10 year Treasury was 116 basis points. Two weeks back it was 63 BP. Friday it was 55 BP, a four year low. It is not inverted, but it is not far from it.
Inverted curves mean that near term money is valued more than longer term money. In other words there is the perception of less demand for money down the road than there is for that money at the present time. That is prompted by the belief that the economy will be slow and money in less demand because of less building and other projects. Inverted curves almost invariably mean recession is coming.
Some say this is just a response to the Fed raising short term rates and the long end not yet starting its commensurate rise. The closer the curve comes to inverted, this argument loses weight. Thus the Fed meets Tuesday with this ‘conundrum’ to deal with. Once again reality is not fitting in neatly with the Fed’s view. If the economy is expanding as sharply as the Fed suggests, then the bond curve should be responding. Instead it is flattening as oil prices, though softening some, remain strong (indeed, until the Friday close pushed prices below $50/bbl it had been February 18 since oil prices closed below $50).
This led to the conclusion of some Friday that the Fed is going to raise rates 25 BP next week but then stop or pause to see what happens. As noted above, that is based more in hope than what history indicates the Fed will do. The Fed is indeed looking at the data, but it rarely, rarely changes course in mid-hike. Even the Fed funds futures are showing three more hikes this year before the Fed stops. It would take a major shift in Fed dynamics to stop after one more 25 BP hike.
Even if the Fed was inclined (and we know some on the Fed definitely are as the Dallas Fed wanted no hike at the last meeting), it has another huge issue to deal with. The administration has been harping at China to do some sort of float of the yuan re the dollar. That will supposedly rectify the trade imbalanced and current account and maybe cure the flesh eating virus as well. The problem if China does float the yuan, however, is an instant surge in US inflation as the yuan rises 30% overnight versus the dollar. Chinese import costs shoot higher. We either curtail our spending on them or pay more. China loses a big part of its market; its citizens may have to start consuming those goods. Their standard of living jumps as we struggle to maintain ours.
It is a real pickle for the Fed, and when in doubt the Fed will continue to raise rates in a ‘measured’ pace. After all, it sees some inflation even if Greenspan thinks the trade deficit will take care of itself (was he hinting at the China float last month when he said this). The Fed feels it is not in position to stop hiking rates at 3%. Maybe 3.5%, and that is exactly what the fed funds futures contract is pricing. If there is a big upheaval the Fed wants a few more arrows in its quiver. We would be shocked if the Fed said it was going to pause after another hike. It is the kind of shock we could live with, but we are not banking on it.
THE MARKET
The slugfest continued Friday, but it was no clear, one-sided move. Kind of fitting given the back and forth action day to day. Stocks started stronger, turned negative, then rallied back to close at session highs. The intraday and day to day action shows the same volatility.
When all was said and done there was really no change in the market’s situation: the indices are still in downtrends, they are still bouncing back and forth and showing some signs of a backbone developing, and leaders are still mixed in their action with some breaking down and some breaking out.
The action of oil, the speculation about just one more rate hike, the Chinese announcement that it could float the yuan at “any time,” and yet another turn around on volume was very interesting. The new twist in the technical action was the action around the recent lows. NASDAQ undercut its recent lows and rebounded for a gain. SP600 and SOX did the same thing: undercut and rebound. SP500 did not undercut, but instead held above its recent lows and the August 2003/August 2004 up trendline and surged back for a strong gain on very strong volume. The mid-cap SP400 slightly undercut, but it held its 200 day SMA on the intraday low and surged back up. The action in both of these indices formed a short, two week double bottom that could initiate a more sustained move off of this test.
How sustained? It can produce a significant rise. Back in Q1 2001 after the market had sold hard from the double top that formed with the September 2000 peak, SP500 formed a similar 2 week double bottom and rebounded for a 200 point gain. That move ultimately failed to deliver an end to the downtrend; too short to do that, but it did give rise to a solid rally. In February 2002 as the market tried to recover it tested the move off of the 2001 low with another 2 week double bottom. That short pattern delivered a 100 point move, but it too failed to turn the tide. It was not until the larger 2.5 month double bottom spanning July to October 2002 did the market bottom. That type of more sustained bottom is what we want to see from this move as it sets up a longer term rise. It is not always the case, but it does provide a better foundation to support a longer upside move.
In any event SP500 and SP400 showed some good technical action, both holding key support levels and rallying sharply on the best volume in two weeks. With the sentiment indicators moving higher they may have bottomed near term. The sentiment indicators did not reach much higher, and we really wanted a strong blowout session. Now we anticipate a rebound but will need to see a follow through next week. Whether this ends the selling is dubious; a more sustained rally and then a further test is likely.
MARKET SENTIMENT
The sentiment indicators continue to line up together, and that is what you want to see in order for them to have meaning. With sentiment there are two factors: first they have to get to extreme levels to have any real meaning. Second, the majority of the sentiment indicators need to ‘line up’ together. In other words, they need to all start showing more extreme indications. For example, the put/call ratio has remained very high for a few months, and has shown almost 10 closes above 1.0. That indicates there is excess downside speculation. At the same time, however, bulls/bears remained too high and low respectively, and volatility was hugging the flat line. Now that they are all starting to move we may see some movement in the market as well. Back in August 2004 they came together as well when volatility jumped to 20 from near 13, the bulls and bears closed the gap to the lowest since 2002, and the put/call ratio spikes. That immediately preceded the August to December run in the market.
Bulls versus Bears:
Big drop in bulls the past week, coming in at 44% and down from 48.4%. The low on this recent drop before last week was 46.2%. In August 2004 when NASDAQ bottomed Bullish sentiment hit 40%. Bullishness was falling and heading back toward that level, but as with volatility and the other sentiment indicators it was cut short by the rally attempt. Now bullishness is heading back down with the quick failure of that bounce.
Bears rose to 29.7%, up from 26.9% and just edging out the prior week’s 29% reading. Back in August 2004 bears rose to 30%; the bears are right there and the bulls may have been close enough last week to do the trick. Would have preferred to see them slice through those levels to really show some heightened anxiety even below 2004, but nothing is every perfect in the market.
Volatility could not make it above 17 intraday, barely clipping the Thursday level. Hardly extreme and nowhere near the 25 to 30 level we would have really liked to see.
VIX: 15.31; -1.55
VXN: 18.54; -1.59
VXO: 15.18; -1.38
Put/Call Ratio (CBOE): 1.01; -0.12
Again, it is important to keep these indicators in perspective. We like to talk of getting to a level to turn the market. These are secondary indicators, meaning they show us possibilities to turns, alerting us to potential change. The nuts and bolds of the market, e.g. price and volume, leadership, have to show the move is underway.
NASDAQ
Undercut the recent lows and then rebounded on strong volume to post a nice gain. Good reversal and actually a better double bottom than SP500 given the undercut and reversal. The idea of a double bottom is to scare them out, and the undercut of the recent lows is the type of action that does that.
Stats: +17.47 points (+0.92%) to close at 1921.65
Volume: 2.119B (+10.08%). Volume surged to the best level since the April 15 sell off. Didn’t make much of it at the time, but a tax day sell off seems appropriate. In any event this was a high volume breach and recovery. After back and forth accumulation and distribution this could have been the near term flushing of the system to allow NASDAQ an attempt to rally a bit further.
Up Volume: 1.413B (+1.032B)
Down Volume: 648M (-879M)
A/D and Hi/Lo: Advancers led 1.5 to 1. Pretty meek breadth, but it was fighting to recover all session.
Previous Session: Decliners led 2.93 to 1
New Highs: 26 (-3)
New Lows: 224 (+7)
The Chart: (Click to view the chart)
NASDAQ looked bleak early with another reversal from gains to a sell off, this one undercutting the earlier April low at 1904, hitting 1889 on the low. As is often the case with breaks below support all are watching, when it occurs the shorts cover and send it right back up. With this strong volume reversal that led to a nice gain, this time we see if there are some legs. Step one is moving past the 18 day EMA (1947) where it stalled just over a week back; it has to take out that point to show the downtrend is weakening. Then it can work on 1973 (bottom of recent trading range that failed in early April), the 200 day SMA (1990), and the other stiff overhead resistance it has built for itself.
Very similar action on NASDAQ 100 with the undercut of the recent low, moving below 1400 and then rebounding furiously for a nice gain.
SOX showed similar action, undercutting the lows of its 5 month trading range at 380 but then reversing. Lagged all session, and its final gain was modest (1.31 points), but its action mirrored the moves by the stronger indices. Maybe this is the move that sends it back up toward the top of its trading range at 450. That would be a sweet trade. Indeed, a move up to the 200 day SMA (407) would not be bad.
SP500/NYSE
This was the focal point as it held above the recent low and up trendline and blasted higher on strong volume.
Stats: +13.63 points (+1.19%) to close at 1156.85
NYSE Volume: 1.879B (+7.37%). As with NASDAQ, the best volume since the April 15 tax day sell off. Good to see the best volume in two weeks on a test and recovery. That shows strong covering and perhaps some buying. After the back and forth sessions this solid showing tells us to get ready for a rebound. Will have to show a follow through next week, but it is a good start.
Up Volume: 1.61B (+1.225B)
Down Volume: 716M (-1.058B)
A/D and Hi/Lo: Advancers led 1.99 to 1. Pretty decent breadth with the small caps lagging.
Previous Session: Decliners led 2.2 to 1
New Highs: 44 (+12)
New Lows: 137 (-7)
The Chart: (Click to view the chart)
We have pretty much hashed this one out thoroughly, but to recap, a hold above the recent low (1136) and the August 2003/August 2004 up trendline (1138) and then a strong, high volume recovery. Closed at the session high and took out the 200 day SMA (1155), though the latter means little in the recent action. The move sets up a challenge of the head and shoulders neckline (1164) and then the 50 day EMA (1174). Needs to clear the 50 day EMA to really start breaking up the recent downtrend.
SP600 undercut 300, continuing the Thursday breach of the early April low. It recovered along with the market but was lagging. Next key test is at 310. The small caps are really laboring, lagging behind the large caps. In a recovering economy the small caps lead. With the current concerns about a slowing economy now and into the future the small caps have come under considerable pressure.
The mid-cap SP400 actually looks similar to SP500. it tested lower Friday with the intraday low just barely undercutting the early April low on that burst of selling that took the entire market lower. It tapped the 200 day SMA (663) on the low and rebounded for a nice gain.
DJ30
DJ30 held above 10,000 on this test, turning higher Friday on rising, above average volume. Just a start at this point as it moves to test the 18 day EMA (10,247) and then the 200 day SMA (10,374) that is coincident with the neckline of the head and shoulders pattern it broke down from three weeks back. As with SP500, a solid start to a recovery.
Stats: +122.14 points (+1.21%) to close at 10192.51
Volume: 303 million shares Friday versus 279 million shares Thursday.
The Chart: (Click to view the chart)
MONDAY
Earnings continue, but the big event of the week is the FOMC meeting as investors look to see whether ‘measured pace’, eviscerated in the last statement, is removed altogether. We anticipate it will be taken out, and that is not necessarily because we think the Fed wants it out so it can raise rates. A couple of Fed governors have made it clear that it will need to come out in the event the Fed needs to lower rates. No one thinks the Fed will lower, but there is a cadre hoping (cannot call it anything else) that it will indicate that after this week’s hike the Fed will go on sabbatical. Despite its protests to the contrary, the Fed has a pretty good idea what it is going to do heading into the meeting; why else would it carefully construct its statements, setting up the next step as it did in the last rate hike statement? The Fed is very conscious of giving direction to those watching, and its actions and statements construct a path to follow and even look ahead on.
In addition the employment report is out on Friday, and while losing significance after the election, it is still closely watched as an indication of economic health. It is not, at least no a leading one. The economy recovers long before employment does, and it turns down long before the jobs data indicate anything amiss. It is thus a much watched lagging indicator, but since it is closely watched it has market impact.
The Fed and what it says Tuesday as well as the action in oil prices will help guide the move that tried to get underway Friday. After a week of tennis volleys Friday had the look of some real traction after some support was undercut and a solid recovery ensued. The indices are still in downtrends, and in order to change the character and show the bigger money is back in and buying they need to produce a follow through session Wednesday or later to show the buyers are picking up where the short covering left off. Of course we also need to see the leaders taking off; there are still hold outs that have refused to crack in the selling, though many have broken down with the market. Any rally is only as good as the stronger stocks that are in good patterns and sport strong earnings.
We also need to remember about timing of events. There is a lot of talk now about a March slowdown and a continuing slowdown. There are recommendations to move out of cyclical stocks because the growth phase of the expansion is over. That presupposes a continued economic slowing. With the Fed raising rates still and oil still near $50/bbl that is not necessarily an outrageous supposition. The market looks well ahead of the present conditions, however, at least 6 months down the road and more like 9 months or more. Thus the market will turn before things look as if they are getting better, before this ‘soft patch’ shows that it is ending. That is why it is critical to watch the action of the market and the strong stocks to get the queue as to when it is really safe to start buying on the upside. If you wait until your fears are allayed then you have waited too long.
That is why we are looking for a follow through next week starting Wednesday to give us an indication that there is some upside ahead. The downtrend continues so we are not counting on it, but just watching for it. Unlike the last follow through where just SP600 made the move, we want to see SP500, NASDAQ, SP400, and any other index that can, show us a strong upside move on strong volume and great breadth Wednesday or later. That sets the stage for a further rally. It may not be the one that turns stocks back up to challenge the former highs at the start of the year, but would likely be a move we can make good money off of before it comes back to test the recent lows and set up a more sustainable bottom.
Support and Resistance
NASDAQ: Closed at 1921.65
Resistance:
The 10 day EMA at 1933
The 18 day EMA at 1947 stalled the last rebound attempt.
1950 (top of October to December 2003 consolidation)
Late 2003 highs from 1960 to 1970 and the March/April consolidation low at 1974
Early October high at 1971 and the March low at 1973.
The 200 day SMA at 1990
The 50 day EMA at 1990 and the 50 day SMA at 2002.
Support:
1904 is the April low.
1900 from October 2004, March 2004, October to December 2003 (consolidation range bottom) held on this last test.
1876 from the May 2004 low and November 2003 low.
1860 from the late September 2004 low.
S&P 500: Closed at 1156.85
Resistance:
The 18 day EMA at 1161
1164 is the January/March neckline to the head and shoulders pattern.
1175 second high in that double top that spanned late 2001 and early 2002 is trying to hold
The 50 day EMA at 1174
The 50 day SMA at 1183
March 2003 up trendline at 1195
1196, the mid-January high and the early December peak in the left shoulder.
1200
Support:
The 200 day SMA at 1155
1137 the recent April low.
1138 the August 2003/August 2004 up trendline
1129 to 1125
1100 to 1095
Dow: Closed at 10,070.37
Resistance:
The 18 day EMA at 10,247
Some price resistance at 10,250
The 200 day SMA at 10,374
10,400, the bottom of the November/December range
The 50 day EMA at 10,420
Price consolidation at 10,600
10,754 is the February high
Support:
10,065 from March 2004 lows.
10,000 the recent lows.
9988 from September 2004.
9933 to 9900
Economic Calendar
These are consensus expectations. Our expectations will vary and are discussed in the ‘Economy’ section.
May 02
- Construction Spending, March (10:00): 0.3% expected and 0.4% prior
- ISM Index, April (10:00): 55.0 expected and 55.2 prior
May 03
- Auto Sales, April (00:00): 5.4M expected and 5.5M prior
- Truck Sales, April (00:00): 7.9M expected and 7.9M prior
- Factory Orders, March (10:00): -1.2% expected and 0.2% prior
- FOMC policy announce (14:15): Expecting a 25BP hike and dropping the ‘measured pace’ language or keeping the same language where it basically eliminated the phrase already. No mention of stopping the rate hiking.
May 04
- ISM Services, April (10:00): 61.0 expected and 63.1 prior
May 05
- Initial Jobless Claims, 04/30 (08:30): 323K expected and 320K prior
- Productivity-Prelim., Q1 (08:30): 1.8% expected and 2.1% prior
May 06
- Non-farm Payrolls, April (08:30): 173K expected and 110K prior
- Unemployment Rate, April (08:30): 5.2% expected and 5.2% prior
- Hourly Earnings, April (08:30): 0.2% expected and 0.3% prior
- Average Workweek, April (08:30): 33.7 expected and 33.7 prior
- Consumer Credit, March (15:00): $6.0B expected and $5.6B prior |
