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money investment, investment help
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01/22/05 Investment House Daily
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MARKET ALERTS:
Target hit alerts issued Friday: None issued
Buy alerts issued: CTIC (bonus); ABFS
Trailing stop alerts: None issued
Stop alerts: DUSA; NXTL
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SUMMARY:
- Morning relief bounce sold under.
- What has changed from late 2004 to early 2005?
- Volume lightens Friday on expiration, but SP500 joins the NASDAQ breakdown.
- Indices still have more to give back but will likely try to test this breakdown before heading much lower.
Stocks bounce on some better earnings, but earnings were not enough.
After the Thursday drubbing stocks perked up Friday morning, spurred by GE's stellar quarter (18% profit growth) and positive outlook for 2005 (10% - 15%). UTX, AT, FO, KEY and others threw in some solid earnings reports as well. Oil was markedly lower as well. A good salve for the EBAY and QCOM fiasco the day before.
Stocks started higher and then rallied decently. SP500 rallied toward the 50 day EMA and NASDAQ reclaimed some resistance at 2050. Volume was running lighter, particularly for an expiration session. That first run took about an hour. That was the extent of the rally.
The indices did not immediately reverse, but backed off slowly and made another run at resistance. They continued to move laterally and slightly lower, trying to set up for another move. As was the case before the rebound attempt that started two Wednesdays back, however, that lateral move turned into an afternoon sell off. The gains were given up and stocks turned red across the board. Stocks trended lower all afternoon and close at or near session lows.
This is the same pattern reasserting itself after the attempted rebound and follow through clearly failed. Stocks are in the second down leg of the new year. Some indices (e.g. NASDAQ) have already sold back into the 2004 base, others are heading that way. All but the small cap SP600 are breaking key support, and even the SP600 is not a picture of health. Three down weeks to start 2005 and close to a complete reversal of the nice breakout to end 2004 is trying to tell us something.
THE ECONOMY and THE MARKET
Late 2004 breakout versus 2005 selling.
A combination of good news results in the November breakout.
The breakout from the long 2004 base in November was an important move similar to others in history. We have previously discussed the Fed rate hiking in 1984 and 1994 and how the market in those years moved laterally while the Fed raised rates, only to breakout and rally once the Fed was mostly done with its rate hiking campaign. The market rallied well in the follow year (and more). As the end of 2004 approached, it appeared as if the Fed was going to be wrapping up its rate hiking in relatively short order. Yes there were still more rate hikes ahead, but the Fed seemed to indicate it was much closer to the end than the middle. The market broke out and started to rally.
In addition, oil had been rallying sharply but faltered and broke its uptrend. It fell sharply from the $56/bbl range, almost breaking below $40. A year of rising energy prices was another factor weighing down the market. Much was discussed on the airwaves about sustained higher oil prices leading to economic slowdown and even recession. We wrote several times regarding the problem if oil prices did not start to abate. When oil broke its sharp uptrend and collapsed rather spectacularly and looked to have more downside ahead of it, investors found another reason to take heart and move into stocks.
The economic news was not bad either. It looked as if the economy was heading into another 'slow patch' in early summer. Stocks continued to struggle as the economic data weakened a bit. The data started to turn in late summer, however, and improved since. Even now the economic data looks quite positive. This turn in the economic outlook emboldened investors as well.
Then there was the Presidential election. Stocks came off a test just before the election and started to rally. When the results were clear cut, stocks continued to rally. When Bush steadfastly talked of reforming the tax code and social security and had some positive response from Congress, that just added to the enthusiasm.
With this combination of positives, stocks broke out and rallied into the end of the year. Even with some dollar concerns and trade gap issues stocks managed to rally. There was some choppiness moving into year end, something that showed up particularly in the small cap index. That was something we noted at the time along with the excessive bullishness as being a warning flag, but stocks continued to move higher into the year end.
2005 brings a change in the circumstances.
As the year passed the selling started immediately. That initial selling was no doubt part of some tax strategies by big money mutual funds. The gains in the indices occurred in the last two months of the year. By waiting to take some profit until 2005 investors could put off paying the tax man for over a year.
The quick drop did not give way to a quick resumption in the rally. In other words, after the quick profit taking buyers did not return right away and continue acquiring stock. The selling pressure backed off and the indices tried to consolidate on lower volume. They even tried a rebound as seen the past two weeks, but the selling has resumed. From a solid rally to choppy December, then hard selling, a consolidation and rebound attempt, followed by further sharp selling.
One commentator on CNBC Friday said he was confused as to why the market is still selling after that initial drop. The market is clearly showing it is not through with the selling as it turned lower this week on a resumption of high volume. It is not confused, and when we look at the factors as to why the market broke out and look at where they are today, we gain an understanding as to why the market has given back its breakout.
First, the Fed has come out quite hawkish this year with respect to rate hikes. There are those that ague the Fed has said nothing differently this year from last. Maybe it has not said anything different in formal statements, but there has been a notable change, one that we have chronicled. Greenspan started late November at his speech to the world's central bankers regarding the need for investors to be fully hedged against further higher interest rates. It was basically ignored but the market did hiccup that day hard. This year he has talked of the need to narrow the trade gap or inflation would rise as would interest rates. He is trying to get Congress to cut spending and encourage foreign investment, but if it does not he is hinting he will use interest rate hikes to raise interest rates to a level that will keep foreign investors buying US Treasuries. A nightmarish scenario to say the least, primarily because it won't work. It is like burning down the house to save the barn.
Moreover, the henchmen vying for Greenspan's job when he retires in the fall are all out trying to show everyone how big their stones are. They are floating ideas not in line with Greenspan, e.g. having a target for inflation and growth (a horrible idea) or suggesting that the 'measured pace' of interest rate hikes would be dumped in favor of more aggressive moves. As much angst as Greenspan has caused with respect to the crash, he is a known quantity and the market has a love/hate relationship with him. The others just seem out there with their crinkled copies of the Phillips Curve in their breast pockets. The irony of this posturing is that none of the FOMC members are going to get the chairmanship. Bush will appoint someone from outside that believes in free markets and limited interventions, kind of in the vein Greenspan likes to think of himself as.
That may be an irony, but the market has to suffer through it and a clear indication that the Fed feels it cannot sit idly by while Congress continues in its spendthrift ways. Kind of a tough love approach, but the results are typically disastrous when the Fed gets off the path of just worrying about the money supply and inflation (though it can say it is worried about inflation as in 1999 and 2000 and be after something else).
Second, oil, after being on the verge of a real breakdown from a head and shoulders pattern, found new life when Saudi Arabia cut its production to start the year. That combined with some severe weather and reports that China's oil usage to end 2004 had jumped right back up to summertime levels propped up the price at that key juncture. It has used continuing questions about weather and demand to rally back close to $50/bbl, much too high for the economy to continue robust growth. That means slower earnings on top of what was already expected to be a slower earnings year. Even Thursday and Friday with reports that oil inventories were higher oil shook off some dips and closed higher. It is showing resilience that belies any near term breakdown.
Third, the euphoria over the idea of getting rid of that $11T overhang on the economy in the form of social security shortfalls in the near future has run into harsh reality. What was being viewed as a lock has been labeled by some weak-kneed republicans (and unfortunately strategically placed republicans such as Congressman Thomas, chairman of the Ways and Means Committee) as dead on arrival. Of course everyone underestimated Bush's ability to push through three tax cuts just as they are underestimating him now before the fight even starts. It will be a tough fight, and the market knew that in 2004. Still, in the market it is emotion that drives investors, and that causes it to overshoot the mark in the short term. And in the short term, emotions on this matter have soured.
The fourth factor, the economy, is still showing solid signs of expansion. Of course, it was still expanding in 2000 but was starting to show signs of slowing that we reported on regularly even as the Fed kept up its rate hiking, even after the market rolled over in March. This time around the economy is still solid, but unlike 2000 there is a real inflation problem in the future, and with oil prices closer to $50/bbl than even $40/bbl, the continued 'tax' or drag continues.
Moreover, the bond market continues to act strangely for an expanding economy. The 10 year and particularly the 30 year bonds continue to rally (i.e. yields are falling) despite Fed-speak of more intense rate hikes and economic numbers that on the whole appear to suggest continued economic improvement. Bond yields should rise or at least the yield curve remain steep in an expanding economy.
Why wouldn't bonds rise if the economy is expanding and the Fed is raising rates? First we need to point out that there is nothing that says (though the Phillips curve believers would say otherwise) an economy cannot grow without inflation, something we saw in the 1980's and again in the 1990's. The key is whether the yield curve remains steep, meaning that demand for money down the road is seen as stronger as in a strong economy. Right now the long yields are falling faster than the short end, flattening out the curve a bit. Even the housing market defies the conventional wisdom that interest rates are heading higher. If rates were going to seriously rise, the housing stocks would start showing weakness. They are far from doing that. As to why the curve is flattening, perhaps as in 2000 the economy today is not quite as strong as it is commonly believed and the bond market is looking at that, the return in higher prices, and the Fed's propensity to keep jacking up rates amid signs that it should back off.
Market set to continue regrouping in near term ahead of Iraq election.
Given the these factors that led to the breakout and rally in late 2004 are now being taken back or the perception is that they are being taken back, the market is giving back the breakout. NASDAQ is already back inside its 2004 base as is DJ30. It may be an overreaction; as noted above, the market always overshoots in the near term but gets it right after the knee jerk reactions die down. Whatever the causation, however, the market has turned back to selling and back toward the base in 2004. It is going to have to regroup, rebuild, and then try to breakout again. That, of course, presupposes that the factors that led to this selling will dissipate or correct and the market can resume building in future gains.
There is also the Iraq election on 1-30-05 that may act as a catalyst to the market direction. If successful it will be a positive that can impact oil prices and Bush political capital, both of which would likely be read as positives by the market as they would help return some of the positive catalysts to the market. Again, for now the market is in the process of taking out those gains and sizing up what lies ahead. When it does the latter it is in no mood to rally significantly.
THE MARKET
The Thursday breakdown continued Friday after a modest morning relief bounce. Volume was lower, surprising for a Friday expiration. That shows no stronger dumping, but the volume was still very strong on NYSE, indicating the sellers did not let up much. NASDAQ volume was back to average as it continued the fall, showing no further distribution. Small consolation, however, as it continued the breakdown following the Thursday gap down.
There were two key moves in the indices. SP500 broke below a key level that marked the neckline of a head and shoulders pattern, cracking through the November to early December consolidation range. It is still above the breakout point from its 2004 base, but the break through the neckline on continued strong volume points to further downside. It will try to test that break lower before it goes much lower, but the breakdown was clear and sharp.
The second move was SP600. The small caps finished lower for the session as well, but again showed relative strength. It also has not given up its next support level as have the other indices. It is still in a toppish pattern (head and shoulders) but it has put up a fight to hold its ground even after taking the worst as the selling started. The likelihood of it holding up is less than it folding up from here, but it is definitely an index to keep an eye on to give us a heads up for the rest of the market.
Market Sentiment
Volatility is rising on S&P 100, but it is still below the 200 day SMA (15) and well below the 16 to 17 level where we can look for a turn based on this indicator. Historically, volatility is below even the 'low' level that typically indicates complacency (20). In August when NASDAQ made the final bottom in its 2004 base before it started its breakout run, volatility reached 20.
VIX: 14.36; +0.53
VXN: 19.37; -0.13
VXO: 14.55; +0.21
Put/Call Ratio (CBOE): 0.87; -0.11. The ration fell back on a down day. Options expiration had something to do with this, but would have preferred to see the ratio hold strong as the market continued to sell.
NASDAQ
Continued its dive back into the 2004 base and the second leg down in this 2005 selling.
Stats: -11.61 points (-0.57%) to close at 2034.27
Volume: 2.06B (-8.28%). Volume fell back to just above average. No technical distribution but the kickoff it got Wednesday and Thursday was enough.
Up Volume: 738M (+147M)
Down Volume: 1.281B (-353M)
A/D and Hi/Lo: Decliners led 1.29 to 1. Not nearly as nasty as the prior two sessions, but again, with the sendoff earlier in the week this was not that big of an indication.
Previous Session: Decliners led 2.28 to 1
New Highs: 49 (+3)
New Lows: 46 (-4)
The Chart: http://www.investmenthouse.com/cd/^ixq.html
After gapping down to start the second selling leg of this run NASDAQ added some more downside Friday. It finished off any support at 2050 and the June high (2047), heading toward some price support at 2000 and possible the 200 day SMA (1976). It will most likely rebound to test the move just as will the other indexes before it falls too much further, but these moves show it has much more work to do.
NASDAQ 100 fell in step with overall NASDAQ, showing Friday was a much more equal opportunity drop than Thursday when the large cap techs led the selling.
SOX tried to buck the trend again, showing some relative strength but then gave it up late. It managed to close at the session low as it seeks some support at 375.
SP500/NYSE
The large caps have broken below the neckline of the head and shoulders pattern, continuing the high volume selling and opening the door for at least a full test of the breakout from the 2004 base.
Stats: -7.54 points (-0.64%) to close at 1167.87
NYSE Volume: 1.657B (-1.94%). Volume backed of some Friday, but it was still quite strong, right on the heels of the Thursday high volume distribution.
Up Volume: 567M (+129M)
Down Volume: 1.03B (-212M)
A/D and Hi/Lo: Decliners led 1.09 to 1. The relative strength in the small caps helped keep breadth in a decent range. Of course, breadth was atrocious the prior two sessions.
Previous Session: Decliners led 2.15 to 1
New Highs: 83 (+17)
New Lows: 25 (-7)
The Chart: http://www.investmenthouse.com/cd/^spx.html
SP500 broke below the support that marked the neckline of the 9 week head and shoulders pattern that had developed. Next stop, at least next support to be tested, looks to be the top of the 2004 base at 1157. It is never a straight line to the downside, and it will test this move, but the breakdown is going to lead to that test.
The small cap SP600 tried the 50 day EMA (314.88), clearing it on the high, but then folding up with the rest of the market in the afternoon. It still showed relative strength with just a 0.2% loss, and it is still above its neckline in its 9 week head and shoulders (310). Interesting show of some strength, but it is more on the verge of a breakdown than a breakout. Of course, that is what we felt about oil when it was ready to make the breakdown through its neckline.
DJ30
The blue chips broke lower to the bottom of the November to early December consolidation range at 10,400. Already deep back in the 2004 base, a breakdown hear consummates its own 9 week head and shoulders top. Volume was up and above average on the move, distribution indicating there is further downside toward the September high (10,342) and the 200 day SMA (10,279). Despite some outstanding GE earnings and solid UTX results, DJ30 could not post a gain.
Stats: -78.48 points (-0.75%) to close at 10392.99
Volume: 275 million shares Friday versus 242 million shares Thursday.
The chart: http://www.investmenthouse.com/cd/^dji.html
THIS WEEK
Earnings, regardless of their stripes, are getting predominantly rude treatment. Sure there are the scattered success stories that are handsomely rewarded, but the market is in a selling mode and that keeps most stocks under pressure.
After three harsh selling sessions there will be some more downside but there will be an upside attempt in the mix as well. The rebound attempt will in all likelihood not succeed; the market has to do more consolidation work before it can rebound. Remember, it just tried to reverse the tide as recently as Tuesday when it tried to follow through on the prior Wednesday reversal. It did not work and here we are, moving lower in the second leg down in January 2005.
That puts three down weeks under the belt to start the year. Last time that happened was in 1982 when Reagan was President. 1982 turned out to be a good year, but it took 8 months to bottom and then rally. Of course, the market was trending lower all of 1981 so it had a running start into the selling. In other words, that was a continuing downtrend; now the market is still trending higher, more like 1984 than 1981. It still has those inner demons discussed above to conquer, however, and that has it still searching for a bottom on this selling.
Again, the breakdown was about as clear as it gets: a follow through attempt slapped down hard. Again, it will try to test the move, but it is still going to go lower before it goes higher. The strong stocks will survive this dip, most will not. Right now there are still several pockets of strength, but groups that are strong overall are waning. We noted two weeks back that medical and healthcare stocks were showing relative strength as the money taken out of other areas was seeking more defensive areas. These are still some of the best looking sectors overall and we will continue to look toward those for some solid entry points.
We have to be judicious with upside at this stage as the market is still under distribution, and three out of four stocks will follow the market. As for downside the market will be looking to rebound in a test at some point over the next few sessions, so we don't want to chase stocks that have already put in a few downside sessions. There are still stocks that are just starting the break lower, however, and those can provide us some good downside opportunity still.
In sum, after the market showed a hint of trouble to end the year (the leading small cap index struggled) it sold harder than expected to start 2005. It has not been able to recover and indeed failed in one attempt at doing so. It reversed that move and started the next leg lower. It is still in the decline stage in this pullback with new leadership yet to really emerge and no bottom found as yet. A rebound that lacks real power (volume, breadth) will be time to unload mediocre performers and to let additional downside set up. In this market (and indeed as we always should), we take what the market gives just as the song in 'Tin Cup' says (a little bit is better than nada). See the move, take some gain and move on, all the while keeping an eye on signs of the next change.
Support and Resistance
NASDAQ: Closed at 2034.27
Resistance:
2047, the June high.
2050-54, prior resistance and the June high.
2066 to 2070, the bottom of the January lateral move.
The 50 day EMA at 2087
2110 - 2112, the top of the November consolidation.
January high at 2154 (early 2004 high)
2250 - 2260 from January/February 2001 highs and lows.
2282 from 5-2001 high.
Support:
2023 from the early June 2004 high.
2000
The 200 day SMA at 1976
S&P 500: Closed at 1167.87
Resistance:
1175 second high in that double top that spanned late 2001.
The 50 day EMA at 1181
1185, the top of the November consolidation range.
The 18 day EMA at 1187
1200 acted as resistance on the last trip higher
Q1 1999 lows at 1215
October 1999 low at 1233
Q2 2001 peak at 1310.
Support:
1166 is some support.
1157 is solid support from January through March consolidation tops.
The 200 day SMA at 1133
Dow: Closed at 10, 392.89
Resistance:
The late April, June peaks at 10,478 to 10,512
The 50 day EMA at 10,542
The 18 day EMA at 10,583 turned the index back Wednesday.
Price consolidation at 10,600 level
10,754 is the February high
10,975 - 11,000 from Q4 2000, Q1 2001
11,350 from the May 2001 highs
Support:
10,400, the bottom of the November/December range is cracking.
10342 the early September peak.
The 200 day SMA at 10,279
Economic Calendar
These are consensus expectations. Our expectations will vary and are discussed in the 'Economy' section.
January 25
Existing Home Sales, December (10:00): 6.80M expected and 6.94M prior
Consumer Confidence, January (10:00): 102.0 expected and 102.3 prior
January 27
Durable Goods Orders, December (08:30): 0.8% expected and 1.4% prior
Initial Jobless Claims, 01/22 (08:30): 330K expected and 319K prior
Help-Wanted Index, December (10:00): 37 expected and 36 prior
January 28
GDP-Advance, Q4 (08:30): 3.5% expected and 4.0% prior
Chain Deflator-Advance, Q4 (08:30): 2.1% expected and 1.4% prior
Employment Cost Index, Q4 (08:30): 0.8% expected and 0.9% prior
End part 1 of 3
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