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us stock market, understanding the stock market
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7/30/05 Technical Traders Report
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SUMMARY:
- GDP sets early negative bias that market cannot shake.
- Preliminary GDP disappoints market but has positive undertones as well as problems.
- Chicago PMI surges past expectations.
- Bulk of earnings over, results strong. What propels stocks now?
GDP disappointment prompts sellers to enter from the get-go.
After a Tuesday through Thursday move higher that saw NASDAQ join SP500 with a breakout over 2005 resistance we expected some profit taking on Friday. The market had some momentum from the Thursday close and so we were looking for an afternoon fade. Futures were solid but then the preliminary Q2 GDP number was released, and despite some good news deeper in the report, the headline number was below expectations. The futures faded, the market opened soft, and it could never get on track for the session.
In short, those ready to take some profits got a reason before the open to do so. After three days of rallying on top of the overall strong July move the buyers were exhausted. There was no one to come in to push stocks back up after the profit takers took their shot. NASDAQ gave up its breakout over the January high, but volume was lower and all of the indices remained above the 10 day EMA and in their uptrends.
The market eased out of the week pretty much as expected though it got an earlier start on the profit taking on the day. As noted, the indices have maintained their uptrends to the weekend. With the bulk of earnings now in the book, however, stocks are going to have to find a catalyst to push them further in the summer rally and overcome the continuing strain of Fed rate hikes and rising oil prices. In 2004 stocks sold through the July earnings season, bottoming in early August and then rallying to year end. The rally came earlier this time around and now the market heads into a traditionally weaker time period having a good run under its belt. So far it remains in solid shape, but it is smart to be aware of where the market is in its rally history. Strong move to this point and still showing good action, but earnings are winding down and the market is entering a period with some pitfalls, particularly after a summer rally.
THE ECONOMY
Shrinking inventories shrink and otherwise strong GDP report.
After 3.8% final growth in Q1, the 3.4% (3.5% expected) preliminary report for Q2 was a disappointment. As noted earlier, when the number hit the market started to struggle, and that was still before the open. With all of the strengthening economic data that 0.1% made a difference to those that were around Friday to participate in the market.
All in all the report was quite solid. For starters, the 3.4% is still above the growth trend. We have become so used to really strong growth that a bit slower gains, even if above what the Fed considers the long term trend, are disappointing. Moreover, this is just the first iteration of the Q2 GDP; two more revisions are to come. We recall the first run at Q1 GDP was pretty anemic, and the second not much better. It was not until the final revision that the 3.8% popped onto the screen. Thus the first go round is something like the Michigan sentiment reading: the preliminary reading is typically way off the mark.
More than that, however, you have to look at what exactly led to the drop; something indicating a negative for the economy or something that was not really that bad and maybe even something good.
In this case it was inventories. Inventories are one of those 'is it good news or bad news?' indicators. If they run too high it can mean that demand is too low and inventories are piling up. Or high inventories can mean manufacturers see good demand building and want to push up their supply to meet that demand. If they run too low it can be a sign that businesses see no reason to build up inventories due to weak consumption. On the other hand they can mean that consumption is running higher than expected and thus lower amounts of product on the shelves.
Bloated inventories in the auto industry in Q1 pushed GDP higher and now leaner inventories in Q2 pushed it lower as manufacturers used promotions and the like to move their stock. It worked and inventories dropped. They dropped so much that they accounted for a 2.3% decline in Q2 GDP. In other words, take out the decline in inventories (something that the auto manufacturers wanted), and GDP rose almost 5.8%. Manufacturers got rid of excess inventories and are now in position to manufacture again and better meet the demands of consumers. That is not a bad thing at all from the perspective of output to come later, and that points out how rather ludicrous inventories are in measuring output; high or low inventories can both be cause by something good or bad. In either case they often distort the quarter just as they did in Q2.
Inventories fall as sales and spending surge again.
That inventory reduction pushed a big surge in final sales. The 5.8% rise in sales was more than twice year over year numbers. Consumer spending rose a solid 3.3%, just off the 3.5% gain in Q1. Both are strong indications of a robust consumer the first half of 2005. Oil prices were no slouches during that period either, so the numbers indicate any drag from energy has not really hit. More accurately, it has not reduced overall sales or spending, but as we have discussed over the past few weeks, consumer spending habits are changing as more are returning to WMT and other discounters to better stretch the remaining disposable income after paying more for gasoline and energy. Also, from the looks of some of the casual dining establishments' results, they are also altering some of the eating out habits (PF Chang's).
Data indicate demand still outrunning supply.
The sales and inventory data is good news, but the data revealed that inflation is running hotter once more as demand is surpassing supply once more. Reduced inventories are great for businesses, but they result in pricing pressure as well. Indeed, core inflation rose 1.7%, and while that is below the hotter 2.4% in Q1, overall inflation is running near the 2% limit the Fed has set as its de facto limit. That keeps the Fed in the rate hiking and money supply shrinking game indefinitely. Indeed, the Fed Funds Futures indications are well beyond 3.75% as the end game for the rate hikes. They are now pricing in a 4.25% level by year-end. That is likely not even to be the end, however.
Friday bonds sold off with the 2 year treasury surging to 4.01%. The 10 year rose as well, but it is just at 4.28%; a three month high but the yield curve is still the flattest it's been in 4.5 years. Thank goodness Greenspan has told us a flat yield curve doesn't mean what it used to mean. How does that go? Oh yea . . . it is different this time. Different for one of the most reliable indicators since WWII.
So we have signs of inflation picking up again as demand outpaces supply, yet signs of slowing ahead as well given the yield curve. Not our father's stagflation of the 1970's but it makes things interesting in a sick sort of way. We know the Fed's answer will be to raise interest rates and lower money supply. That is how it responds to all threats, real or imagined.
Early in the year we wrote about how demand had led supply throughout the recovery and that is why we were seeing inflation pick up. Signs of inflation are at best mixed if you believe the government's figures. Many show growth without price pressure (gold continues to founder, the traditional inflation hedge; is this indicator different this time as well? Probably not) while others such as those reported in the Q2 preliminary GDP report show continued pricing pressure.
As noted, the Fed will respond by raising rates in an attempt to slow demand (it prefers the stick over the carrot). To really rectify the imbalance, however, supply needs to be encouraged. Use the carrot not the stick. We need more capital investment, investment in equipment and R&D to get supply caught up. Indeed, when business has incentives to invest and invent our economy really makes progress with low inflation. Business then can meet demand, and all of that investment and research starts yielding new technologies that start creating new products that make their own demand. After the big bust companies are loath to get stretched out with too much overhead. Thus less investment in their businesses and also bare minimum hiring.
In sum, the best way to avoid inflation is not slow the economy to the point where demand is so anemic it no longer creates inflationary pressures (the 'burn it to save it' method), but provide incentives to grow supply in order to meet demand and thus offset demand-led inflation pressures. Not only does that alleviate inflation, but it creates new technologies, then new jobs, and thus higher a higher standard of living. Given that the perception in Washington is that the economy is decent and the belief by many that taxes are too low, however, the likelihood of meaningful stimulus and incentives is remote. Thus instead of enlightened policies that promote investment in America they take the politically safe route and default to Greenspan and his 'burn it to save it' approach. At the same time they pass a highway bill and an energy bill that are double the size they should be because they are loaded with pork. Then they come to us and say they cannot provide any more capital investment incentives to smaller businesses because the budget cannot afford it. Call your Congressmen.
Chicago PMI surges on autos.
After a couple of stagnant months the Midwest region surged back to life with a 63.5 showing versus the 53.6 in June and the 55.0 expected. Employment rallied to 56.1 from 48.9. New orders surged back up to the highest reading since March at 69.6.
Does this mean anything? The Midwest region is auto land, and it has been strong with the Big 3's 'me too' pricing programs. Thus the reading was skewed and we doubt the rest of the country is going to show this kind of strength. Nonetheless it was not all attributable to the autos and is an indication that the solid growth from the first half of 2005 is continuing in the current quarter.
THE MARKET
MARKET SENTIMENT
VIX: 11.57; +1.05
VXN: 13.87; +1.26
VXO: 11.07; +1.33
Put/Call Ratio (CBOE): 0.99; +0.21
Bulls versus Bears:
Bulls ran right back up after a dip last week. Bears edged lower. Both are showing a lot of bullishness in terms of investment advisors, and that is historically a problem for the market. If everyone is a bull then where does the new money come from?
Countering that is still an underlying revulsion for the market by a lot of investors that still have money tucked in money market accounts. Indeed last week equity mutual funds showed an outflow of cash. The market is in a 12 week rally and money continues to leave. That is a contrary indicator as well, but it is more bullish.
In short, the sentiment indicators are pointing in different directions. They are usually the most powerful when they all line up in one direction. And of course they always take a back seat to the actual price and volume action as well as leadership. They give us a heads up re potential problems, but they are not what you want to base your investing decisions upon.
Bulls rose to 55.9% from 52.7%. The attempt to trend lower failed pretty miserably. Bulls bottomed in early May at 43.5%.
Bears fell to 22.6% from 23.1%. That broke a three week rise from 21.1%. That still keeps them above the 20% after dipping to 19.1% four weeks back. Below 20% is considered a bearish indication for the market. Hit a high for the year at 30% in early May.
NASDAQ
Stats: -13.61 points (-0.62%) to close at 2184.83
Volume: 1.62B (-7.1%). Volume fell back below average for the first time in four sessions. As NASDAQ fell for the first time in four sessions that is the kind of price/volume action you want to see. Outside a distribution session two Thursdays back NASDAQ price/volume action has been sold though volume overall has been so-so. The rally is showing the type of action you want to see from a volume perspective though it is summertime light.
Up Volume: 518M (-529M)
Down Volume: 1.075B (+404M)
A/D and Hi/Lo: Decliners led 1.16 to 1. Breadth tried to hold up all session even with the selling. As with volume breadth was very modest in the selling.
Previous Session: Advancers led 1.75 to 1
New Highs: 226 (-1)
New Lows: 17 (-2)
The Chart: The Chart: http://www.investmenthouse.com/cd/^ixq.html
After a softer open NASDAQ managed to post a modest gain early on. Then it turned lower after a spurt higher on the Chicago PMI and sold all the way to the close. It undercut the 2191 level from January after the break higher Thursday. It is still holding the uptrend quite handily, still well above the 10 day EMA (2174). In short Friday did little to change the character of the uptrend even if NASDAQ gave up the move over 2191 and closed at the session low. It has lagged internally on this move despite showing solid price/volume action; breadth and new highs have struggled and the large cap techs have moved higher but have not challenged their highs from December and January.
Speaking of large cap techs, one reader pointed out the QQQQ made a breakout two weeks back from a somewhat ragged reverse head and shoulders base. That is an accumulation pattern and a positive for a further attempt higher to actually try those highs at 41. Overall, however, the large cap techs have lagged of late.
SOX has taken more of a breather than any of the other indices, still moving laterally in a narrow range, tapping at the 10 day EMA (470.22) on the intraday lows, feeling for that support each day. Thursday and Friday it flashed a couple of dojis, trading in that tight range over near support, refusing to give up the gains. It is actually setting up quite nicely to continue the break higher this week.
SP500/NYSE
Stats: -9.54 points (-0.77%) to close at 1234.18
NYSE Volume: 1.39B (-10.64%). Volume backed off below average on NYSE as well after three above average volume sessions that supported three consecutive gains. Good price/volume action as well is supporting the move higher.
A/D and Hi/Lo: Decliners led 1.45 to 1. With the small caps down 0.5% and the large caps drubbed 0.8%, breadth was not too bad.
Previous Session: Advancers led 2.79 to 1
New Highs: 344 (-73)
New Lows: 20 (-18)
The Chart: http://www.investmenthouse.com/cd/^spx.html
SP500 took the hardest hit Friday, fading hard in the last hour and hitting a new session low on the close. Lower volume shows no real selling, but the price loss was surprisingly sharp, giving back two-thirds of the gains the prior two sessions. Still holding the 10 day EMA (1231.82) and the uptrend.
SP600 posted a loss as well, sliding back on lower volume after breaking to a new all-time high Thursday on strong trade. Bouncing up the 10 day EMA in a show of excellent strength. As noted before, another 10 points or so (365ish) and it is overextended and needs a deeper test.
DJ30
Gave back the Thursday move, still on below average volume and still holding above the 10 day EMA (10,623), but slid back below a resistance range from 10,550ish to 10,700. It is not trying to lead, just trying to hang on as it works on an attempted handle.
Stats: -64.64 points (-0.6%) to close at 10640.91
Volume: 215 million shares Friday versus 220 million shares Thursday.
The chart: http://www.investmenthouse.com/cd/^dji.html
MONDAY
A big week of earnings that saw corporate profits rising as 75% of the results topped expectations. From what we can see the gains are in the 10% range, much better than the 7.7% anticipated. Anticipation of the results as well as the results themselves rallied stocks higher in a nice July move that led to some breakouts on the major indices.
There are more earnings to come, but the market definitely has the gist of Q2 profits at this point. There is more key economic data out this week including the ISM, personal income and spending, factory orders, and the employment report. The market will need something else to drive it from here, and the economic outlook and earnings potential, as always, will drive stock prices.
So, that leaves the economy versus the Fed and oil prices with respect to stock prices. Thus far the economy is holding on quite well but the Fed is not going to stop. It is likely to keep raising as long as it can until something significant happens that makes it clear it should stop. That is always too late to stop, but that is the Fed's way: raise rates at the first sign of a sustainable recovery but don't stop raising until you see the slowdown. The combination of oil prices and Fed tightening rates as well as money supply is powerful. If the Fed continues the market will at some point freeze up. At that time it will start distributing and leaders will break down on strong volume.
The big question is the when. Whether caused by the Fed, energy prices, both, or something else entirely, it will happen. It always does because every rally eventually ends. For now the market is showing continued positive action as it rides the wave of the solid earnings in the summer rally. As long as it continues to show good price/volume action, leadership, rotation, and can hold the recent breakouts it is in good shape. Kind of like saying as long as the sun comes up it will be a sunny day. The point is the market has been showing solid action as it moves higher. Sure volume is low overall (it is summer after all), bullishness is high, and new highs have struggled to hold their gains even as the indices hit 4 year highs. That hardly sounds like a perfect situation, but we have said before that the market is hardly ever perfect, and if you wait for perfection you will miss all of the action.
Again, the market is showing no sign of trouble right now but it is on final approach to a typically troublesome time for stocks, i.e. late summer into September. Last year the market did its selling in July to August and then rallied when stocks are typically weak. On this run it looks as if NASDAQ has another 3 weeks or so of upside. That is a very general observation based on typical historical moves; as always the market will show us the signposts as to where it is going. As of Friday they are still indicating a healthy move underway. That keeps us looking for new positions in strong stocks to play that move because regardless of what we believe, the market ahs the final say. We will continue to look down the road a bit and watch for developing problems, but we need to invest according to what the market is showing us as opposed to what our intuition, our gut feelings, or the calendar suggests.
Support and Resistance
NASDAQ: Closed at 2184.83
Resistance:
2191.60, the January intraday high.
2215 is the June 2001 closing high.
2264 is the June 2001 intraday peak.
2313 is the 5-22-01 closing high.
2328 is the May 2001 intraday high.
Support:
2178 is the January closing high.
The 10 day EMA at 2174
2163, the mid-December closing high has stalled NASDAQ recently.
The 18 day EMA at 2155
2151, the early December closing high and highs from January 2004
2100 was key resistance point, and a successful test sets it up as support.
The 50 day EMA at 2105
S&P 500: Closed at 1234.18
Resistance:
Price tops at 1265 from 1-28-99 and 2-99 & price bottoms from 12-20-00
Price top at 1-6-99 at 1272
Price tops at 1290 from 5-23-00
Price tops at 1364 from 1-29-01
Support:
The March 2005 high at 1229.11
The 10 day EMA at 1232
March 2005 closing high at 1225 and the 18 day EMA at 1226
The June high at 1220
December high at 1217
The February intraday high at 1212.
The 50 day EMA at 1210
1200 is some support
1196, the mid-January high and the early December peak in the left shoulder.
The April high at 1194
The early May high at 1178
1175 second high in that double top that spanned late 2001 and early 2002
Dow: Closed at 10,640.91
Resistance:
The June highs at 10,646 to 10,656
10,754 is the February high
10,868 is the December 2005 high.
10,985 is the March high
Support:
The 10 day EMA at 10,622
Price consolidation at 10,600 is not totally broken
The 18 day EMA at 10,585
The April high at 10,557
The 200 day SMA at 10,487
The May high at 10,406
10,400, the bottom of the November/December range
Economic Calendar
These are consensus expectations. Our expectations will vary and are discussed in the 'Economy' section.
August 01
Construction Spending, June (10:00): 0.5% expected and -0.9% prior
ISM Index, July (10:00): 54.1 expected and 53.8 prior
August 02
Auto Sales, July (00:00): 5.7M expected and 5.1M prior
Truck Sales, July (00:00): 8.8M expected and 8.9M prior
Personal Income, June (08:30): 0.4% expected and 0.2% prior
Personal Spending, June (08:30): 0.8% expected and 0.0% prior
Factory Orders, June (10:00): 1.0% expected and 2.9% prior
August 03
ISM Services, July (10:00): 61.0 expected and 62.2 prior
August 04
Initial Jobless Claims, 07/30 (08:30): 315K expected and 310K prior
August 05
Non-farm Payrolls, July (08:30): 180K expected and 146K prior
Unemployment Rate, July (08:30): 5.0% expected and 5.0% prior
Hourly Earnings, July (08:30): 0.2% expected and 0.2% prior
Average Workweek, July (08:30): 33.7 expected and 33.7 prior
Consumer Credit, June (15:00): $6.0B expected and -$3.0B prior
End part 1 of 3
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us stock market
understanding the stock market
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