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us stock market, understanding the stock market
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08/06/05 Investment House Daily
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MARKET ALERTS:
Target hit alerts: None issued. Still letting some strong stocks run as holding support nicely.
Buy alerts: VCLK; AHG (bonus)
Trailing stop alerts: PSSI; FLSH; MOT; GW. Preserved some nice gain.
Stop alerts: None issued
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SUMMARY:
- Solid jobs report, increased wages fuel further selling.
- Worries of 'wage-push' inflation are only valid because Greenspan thinks so.
- ECRI shows continued growth, modest upswing in inflation pressures.
- FOMC statement about inflation pressures will receive more attention than the rate hike.
- Expecting small and mid-caps to test further ahead of the Fed.
Good news is bad news because of Fed's view of prosperity.
A stronger than expected July employment report added downside pressure on top of Thursday's sell off. Investors were cautious in the pre-market ahead of the report, and when it was released the stronger jobs creation for July, June and May as well as the stronger gains in wages pushed futures lower. Stocks opened lower, sold all morning, tried an afternoon rebound attempt with three separate pushes higher, but they foundered as the close drew nearer and stocks closed near their session lows.
In the end more losses were piled on top of Thursday's downside, though the point loss and volume were lighter. NASDAQ and SOX managed to hold the 18 day EMA with relative ease while SP500 held the next support level down. Not too bad and something of a silver lining, but the small and mid-cap indices were rocked once more, leading the market lower as they crashed through their 18 day EMA. As noted last weekend, they were getting ripe for a pullback if they put in another strong move after leading the market with the first breakouts in early July as they moved to new all-time highs. They could always turn on a dime, but a test back toward the 50 day EMA after several bounces up off the 10 and 18 day EMA is pretty typical action. They led higher, they are leading lower. Now they have to hold the 50 day EMA to bode well for the market overall.
Good economic news was heralded the past two weeks as the market transitioned between earnings and a flood of economic data. The market responded to the upside with continued gains as the news remained positive. It reached a saturation point as we anticipated, and when that happens the market has a way of turning what would have been viewed as good news just a week ago into a negative. In other words, when the buyers get exhausted the market starts to look at what could derail the move as opposed to continue it. That means taking the negative view of data even if it is overall good. Thus with the stronger jobs data it was reasoned that more Fed rate hikes than anticipated were coming and that along with record high (in current dollar terms) oil prices had a better chance of derailing the recovery in stocks.
That is the perverse logic you get when the Fed is trying to force markets to its bidding when they want to go elsewhere. To recap this week, the Wall Street Journal through its sources articulated what we have been saying: the Fed is bound and determined to get longer term rates higher, and it is going to raise until it does the job. It does not couch it in those terms, instead using the 'measured' pace, but the Fed has never had trouble sleeping at night when it says one thing but fully intends something else. In the late 1990's it repeatedly said it was not targeting the stock market, but its tunnel vision on the 'wealth effect' and 'runaway consumer' belied its very statements. The Fed wanted to crack the market. The pathetic irony of it all is that in 2001 Greenspan admitted the Fed did not really know if such a thing as the 'wealth effect' existed and sought public comment on the issue. Of course this was after the Fed helped usher in the bear market and recession, bringing about exactly what it supposedly feared.
With the next FOMC meeting on Tuesday and the concerns as to what the Fed will say about inflation it appears the market was building in some negative expectations. It definitely had a rethink of the benefits of a strong economy with the Fed hiking rates and oil prices hitting new highs in current dollars. This is justifiable concern and an issue we said the market was going to have to confront. The old fear of the Fed has crept back in for now, and this coming week we will see if enough downside was built in with this pullback as NASDAQ and SP500 try to hold near support and the small and mid-caps test their 50 day EMA. Many leading stocks closed out the week in decent shape, managing to hold near support as a leader should. How they react along with the leading indices will tell the story of this rally from here.
THE ECONOMY
Higher jobs, upward revisions showing a modicum of strength.
Non-farm jobs topped expectations with a 207K rise (180K expected), and June and May were revised higher as well (+20K and +22K, respectively). Most of the gains, as usual, were in the service sector with 203K jobs. Retail jobs rose 50K, general merchandise 10K, leisure & hospitality 66K. Manufacturing lost 4K due to a large drop at auto plants.
The household survey was even stronger with its 438K, keeping the average the past four months at 400K. The household survey is the one where households are called up and asked 'are you working?' That data is extrapolated and voila. It ahs been much stronger than the non-farm jobs, and as we have discussed the past couple of years, with the kind of huge bust we had in the leading industries of the last boom, it is no surprise that the jobs people are finding in the recovery are jobs they have created on their own, i.e. self employment. That is what happens when you have a bunch of mature industries go through a boom and bust along with the new growth companies of the 1980's and 1990's boom. They don't come back in the same shape they were before, something evident by the layoffs in the older companies (EK, KMB, F, SBC) and the newer ones (SUNW, MSFT). It is up to the upstarts, and many of them are not at the point where they really start hiring thousands of workers. We suspect the job figures will change quite a bit when the Feds do their more exhaustive jobs survey next year, but for sure the jobs now are not all the traditional 9 to 5'ers the non-farm payrolls counts.
Rising wage costs add salt to stronger jobs report.
Average hourly wages rose 0.4% (6 cents to $16.13), twice the 0.2% expected. That piece of data was the grain that stuck in the craw of the market. There is this theory about 'wage-led' inflation whereby if workers demand more pay and get it that increases the costs to employers who have to raise prices to compensate. Further, all that extra money supposedly goes into the economy, chasing the same amount of goods with more consumer dollars.
It sounds good in theory, and Greenspan buys into it as he worries about wages all the time. Everyone recalls (or should, and never forget it) how the Fed openly stated it wanted more unemployment back in 2000 because the supposedly tight labor pool, rising wages, the 'wealth effect' and 'runaway consumer' were threatening our prosperity with potential inflation. Of course there was no sign of inflation, but it just had to be lurking somewhere. We had prosperity with jobs, innovations, incredible production and technology capabilities, and low interest rates. Surely the sky had to fall.
It did, but it was not inflation that caused it. A series of increasingly intensive rate hikes and a complete drying of the money supply choked off financial markets, venture capital, and investment in new business. The market rolled over and the economy followed it.
The problem with this theory, other than its use by the Fed to cause bear markets and recessions, is that there is no empirical evidence to back it up. The stagflation of the 1970's was the antithesis of the boom in the eighties and nineties and in many respects the current expansion. The seventies saw high inflation, high unemployment, lack of investment (money was taxed at high rates and was thus locked up in tax shelters), and a prolonged bear market in stocks and the economy. The 'wage push' theory says that high employment leads to inflation (tight job pool, workers demanding more wages). In the seventies there was inflation with high unemployment and wage and price controls (where were we living, the USSR?). In the 1990's there was a supposed tight jobs pool, high wages, a stock market wealth effect, and yet no inflation at all. What was up with that oh great 'wage push' sages?
It's all about supply and demand.
The key was investment in the US that sparked increased technology and supply. In the 1970's, high taxes and regulation kept billions of dollars locked up in tax shelters. The reward for taking a risk was so small thanks to taxes and regulations that risks were not taken and we entered a period of inventive malaise. This is when our auto, steel, and other industries fell behind foreign competition. There was no innovation.
It was not until the early 1980's when tax brackets were slashed and investment incentives were offered that the sheltered money was invested in America. Money came pouring in. Risks were taken, new technologies were born. Things were never heard of or knew we would ever need were invented (personal computers, disk drives, fax machines, modems, cellular phones) and we found out we could not live without them ("How did we ever live without fax machines?"). The point: money was released and that unleashed US ingenuity. We created new goods that made their own demand. Everyone has heard Steve Ballmer at Microsoft discussing how his mother asked him why anyone would ever need a computer. No one knew they needed it but it came to being and everyone discovered the could not live without it.
The economy boomed for 20 years without any inflation despite huge job creation, tight labor markets, etc. Yes the Fed raised rates in the late 1980's and mid nineties and some argue it staved off inflation. Just as in the late 1990's, however, there was really no inflation. Indeed, the Fed caused one a recession almost another during that period.
The difference is the supply side of the economy was easily able to meet demand because the supply side had been energized by new money invested in the US economy by reason of the tax cuts and incentives. Supply met demand and then some, creating its own demand as noted. If supply is healthy it does not matter what demand is. It will always meet demand because if money is unrestricted, it will flow to where it is needed.
A bit more inflation this time around.
The Fed has a bit of an argument this time as inflation has run hotter in this recovery. It is not wage-led, however. We have written often about how demand never died off in the recession, at least not as it does in typical recessions. Thus when the first tax incentives passed were demand-based incentives (the so-called rebates and other special interest gifts), all that did was further inflation demand while supply was dormant.
Indeed, in 2002 and early 2003 capital expenditures (businesses buying the 'stuff' of business) were basically at 0%. The business side had shut down. There was no buying other than that of sheer necessity. Today capital expenditures are 28% of GDP. During the same period consumer demand has dropped from 90% to 75% of GDP. Thus as the economy recovered it was business investment showing growth. We said all along the recovery only occurred when the tax incentives directed at making capital investments in the US were passed. That ignited the dormant business sector and led to the recovery.
Thus supply has lagged demand since the get-go and thus the inflation we are seeing in this recovery that we did not see in the 1980's and 1990's. It is positive that Q2 GDP showed a strong increase in capital expenditures once more as that helps alleviate the gap between supply and demand. It is a positive that supply has surged and demand has slacked off even as the economic expansion continues. That works to alleviate any demand-led inflation. The fact that the long bond has remained low (as it did in the eighties and nineties) and gold is still making lower highs are other signs that inflation is not about to break out.
Indeed, probably the worst thing we can do is make money harder to come by for small businesses, the businesses that make up 75% of the companies in the US and account for more than that in job production. Raising rates and drying up the money supply only makes it harder to invest in supply and thus further alleviate the demand imbalance. What happens if the Fed pushes us into another recession and demand is still solid? Inflation goes wild. Of course many say that if we slip into another recession the consumer will bomb because of huge debt loads. Either way do we want to jack up rates and drain money supply too much and risk another recession?
We always believe growth is the key to raising everyone's prosperity. In the sixties and seventies income tax rates exploded to pay for all of the new social programs, but all that did was send money into hiding in tax shelters. When that money was unleashed in the past 25 years everyone was better off with better jobs, wages, lower crime rates, better drugs and healthcare (despite what many would have you believe) and simply a better overall standard of living. Use the carrot and not the stick. Grow your way to prosperity instead of forcing everyone lower.
Unfortunately the Fed, much like sixteenth century doctors, believes the way to heal is applying leaches to rid the body of impurities. The Fed looks ready to apply three more leaches before the year is out because it believes you have to slow things down to effect the cure. It also focuses on what the past forty years have shown us are not the things to focus on. That is why even though wage-push inflation is bunk you have to worry about it: the Fed has become so pervasive in its meddling (tax policy, social security, Medicare, housing market, Fannie Mae, trade balances, budget deficits), if it thinks something is a problem, it is indeed a problem for the financial markets and the economy. Greenspan has had his good moments but he has had many bad ones. We look forward to a new chairman who will hopefully reign the Fed back in.
THE MARKET
MARKET SENTIMENT
VIX: 12.48; -0.04
VXN: 15.4; +0.46
VXO: 11.7; +0.11
Put/Call Ratio (CBOE): 1.15; +0.1. Second consecutive spike above 1.0 on the close as the ratio has trended higher the even before the past two selling sessions. Part of that was a lot of put selling as the indices broke higher. Put selling is where an investor sells the right to have a stock put to him at a certain price, betting the stock will rise. If it does the put declines and it is bought back for less than sold. Sell high, buy low. If the stock falls below the strike price sold the stock can be put to the sellers. Sell high, buy back higher. It is another sign of speculation when the market is rising and put action rises. The ratio was even higher Thursday and Friday because those puts sold were being bought back quickly. In addition there was also some buying to get in on the downside move. Speculation from both ends pushed the ratio higher.
Bulls versus Bears:
Bulls rose to 57.3% from 55.9%, the second straight session over the 55% level that is the level considered bearish. As we noted Wednesday and Thursday, the buyers had become exhausted and when that happens there is no ammunition left to push stocks higher. Bulls bottomed in early May at 43.5%.
Bears fell just a hair to 22.5% from 22.6%. Bears continue to dance just above the 20% level considered the crossover into bearish territory. With bulls running through the 55% level it is just about close enough for horseshoes. Dipped to 19.1% five weeks ago. Hit a high for the year at 30% in early May.
NASDAQ
Stats: -13.41 points (-0.61%) to close at 2177.91
Volume: 1.517B (-7.94%). Volume backed off for the second straight session, both of then downside. That is the silver lining in the pullback as lighter volume shows fewer sellers on the down days than buyers on the upside days. That indicates the upside still remains in control of the overall action.
Up Volume: 471M (+58M)
Down Volume: 1.014B (-187M)
A/D and Hi/Lo: Decliners led 2.07 to 1. Hefty negative breadth once more as most stocks sold once more. Recall that upside breadth was not nearly as strong as the downside breadth, and that was one of the weaknesses noted in the advance.
Previous Session: Decliners led 2.3 to 1
New Highs: 68 (-60)
New Lows: 31 (+7)
The Chart: The Chart: http://www.investmenthouse.com/cd/^ixq.html
After a break higher to start the week, breaking to a new post crash high on solid trade, NASDAQ churned some Wednesday and then faded to Friday on lighter, below average volume. Friday NASDAQ closed just over the 18 day EMA (2173). It fell through the January 3 high (2191) and kept on down to the 18 day. We wanted a test over the next couple of sessions; NASDAQ did it in one, and that is not the best action though it is not fatal. No distribution, no major breakdowns from the majority of leaders, and holding a level that should act as support if the move remains solid. May see it undercut this level intraday ahead of the Fed meeting on Tuesday but want to see it rebound and hold this support on the closes.
NASDAQ 100 sold back as well on that low volume. It lagged on the move higher, unable to make a new high over the November and December highs, matching that level early in the week but then fading back. It has not met the 18 day EMA (1594) on the pullback yet, and that leaves the large caps some wiggle room early this week.
SOX performed well Friday, shedding just 0.3% as it held up the best. Tapped the 18 day EMA (469) on the low and rebounded to recoup most of the losses. Still holding the breakout above the 7 month trading range. The 18 day is where we want to see it hold on this pullback and lead the market back up.
SP500/NYSE
Stats: -9.44 points (-0.76%) to close at 1226.42
NYSE Volume: 1.497B (-0.35%). Volume faded again Friday, but as with Thursday, it was almost too close to call. Trade remained above average for the fourth consecutive session with only one of those being a clear cut upside day. With the small and mid-cap stocks fading rapidly this above average volume is indicating there is some dumping ongoing in the smaller cap areas.
A/D and Hi/Lo: Decliners led 3.43 to 1. Really ugly with the small and mid-cap stocks leading the market lower.
Previous Session: Decliners led 2.04 to 1
New Highs: 80 (-87)
New Lows: 35 (+15)
The Chart: http://www.investmenthouse.com/cd/^spx.html
SP500 crashed through first support at the 18 day EMA (1230) but managed to hold at 1225, right at the March high. This March high is important as is the June high at 1220. A failure at 1220 that cannot quickly recovery is going to open the door further downside. Don't like the continued high volume as SP500 pulls back; not just a light volume pullback as on NASDAQ, and that makes 1225 and then 1220 very important.
SP600 dove lower once more on that continued above average NYSE volume, easily slicing the 18 day EMA (349) as it undercut its two prior higher highs made on the way up. We noted last week that SP600 was getting to a point where it would need a deeper test after rallying up the 18 day EMA after the breakout. It obviously hit that point and is now heading toward the 50 day EMA (339.95) where there is also price support from the June intraday high and an early July peak.
DJ30
The blue chips faded for the second straight session, falling through the 18 day EMA (10,604) and out of the 4 week lateral range that had formed as a handle to its 5 month base. Still over the 50 day EMA (10,535) and the 200 day SMA (10,505). Still lagging but this is where it needs to hold up if it is going to keep trying to build for the breakout.
Stats: -52.07 points (-0.49%) to close at 10558.03
Volume: 218 million shares Friday versus 230 million shares Thursday. At least volume faded as it fell back to end the week. Some silver linings get a little tarnished.
The chart: http://www.investmenthouse.com/cd/^dji.html
MONDAY
After 1.5 down sessions, stocks tried to find a bottom in the afternoon. They found a bottom for the session but could not follow through with three bounce attempts. It was a positive that NASDAQ and SP500 held support, but with NASDAQ volume lower and NYSE volume still strong, the fight is still on heading into Monday.
NASDAQ and SOX are in position to assert some real leadership here having held the 18 day EMA on lower volume with key stocks in each holding near support as well. With NYSE indices selling on strong volume those two may be what keeps the market from breaking down.
We expect SP600 and SP400 to test lower toward their 50 day EMA on this move. Some won't believe it, but a test of the 50 day after its breakout and run up the 18 day EMA is pretty typical.
With the downside momentum through the end of the week (though abating just a bit Friday afternoon) and the Fed meeting Tuesday, we anticipate some more softness early in the week. As noted, we expect the small and mid-caps to continue lower while NASDAQ and SP500 may undercut their 18 day EMA. For the latter two we want to see them recover and hold the 18 day on the close. That shakes out the remaining sellers and shows buyers moving back in at this support. It will be a real test as the NYSE indices are selling on harder volume and not just a nice low volume test.
With most earnings over and the market saturated with news on the economy, the FOMC meeting Tuesday is the focus. Not the 25 basis point hike but the language in the statement following it and the comments regarding inflation will pique everyone's interest. Last statement the Fed talked more about elevated near term inflation and well contained long term inflation. Investors will be looking for a softening stance, but we are not counting on it.
That leaves investors where they were to end the week. Some of the air is out of the rally in anticipation, and we expect a little more downside ahead of the Fed. The real issue is whether a modest pullback is enough for the big money to feel comfortable to come back in even with the Fed still bent on raising rates and oil still moving higher and higher, approaching the all-time highs in inflation adjusted dollars. That is a powerful 1-2 punch that the market is once again pondering with this pullback. How the small and mid-caps as well as NASDAQ and SOX come off of this test will tell us what the market has decided on this round. So far it is a split decision with NASDAQ and SOX looking very ready to continue higher after this low volume pullback to the 18 day EMA. NYSE is more problematical with its stronger volume selling and the smaller caps knifing lower.
We were patient as possible with positions to end the week with most of them hovering around near term support on low volume. Similar to NASDAQ and SOX they are set up to rebound this week if the big investors can come to grips with the Fed's plans and oil prices. This is where they need to show they are ready to continue higher with their upside moves. Even with the pullback to end the week they still look promising and we will continue to be patient as long as they hold this support. When they start back up on solid trade they will offer new and solid entry points. Nothing like a leader coming off an orderly test on a nice surge in volume.
Support and Resistance
NASDAQ: Closed at 2177.91
Resistance:
The 10 day EMA at 2189
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 and is trying to hold
The 18 day EMA at 2173
2163, the mid-December closing high has stalled NASDAQ recently.
2151, the early December closing high and highs from January 2004
The 50 day EMA at 2122
2100 was key resistance point, and a successful test sets it up as support.
S&P 500: Closed at 1226.42
Resistance:
The March 2005 high at 1229.11
The 18 day EMA at 1231
The 10 day EMA at 1235
The recent July highs at 1245.15
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:
March 2005 closing high at 1225
The June high at 1220
December high at 1217
The 50 day EMA at 1215
February intraday high at 1212.
1200 is some support
1196, the mid-January high and the early December peak in the left shoulder.
Dow: Closed at 10,588.03
Resistance:
The 18 day EMA at 10,604
Price consolidation at 10,600
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 April high at 10,557
The 50 day EMA at 10,535
The 200 day SMA at 10,504
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 09
Productivity-Preliminary, Q2 (08:30): 2.0% expected and 2.9% prior
Wholesale Inventories, June (10:00): 0.4% expected and 0.1% prior
FOMC announcement (2:15): 25 basis point rate hike expected. No change in statement as Fed will be wary of near term inflation and comfortable with 'well-contained' long term inflation.
August 10
Treasury Budget, July (2:00): -$56.0B expected and -$69.2B prior
August 11
Retail Sales, July (08:30): 1.9% expected and 1.7% prior
Retail Sales ex-auto, July (08:30): 0.8% expected and 0.7% prior
Initial Jobless Claims, 08/06 (08:30): 315K expected and 312K prior
Business Inventories, June (10:00): 0.1% expected and 0.1% prior
August 12
Export Prices ex-agriculture, July (08:30): -0.1% prior
Import Prices ex-oil, July (08:30): -0.4% prior
Trade Balance, June (08:30): -$57.1B expected and -$55.3B prior
Michigan Sentiment-Preliminary., August (09:45): 96.0 expected and 96.5 prior
End part 1 of 3
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us stock market
understanding the stock market
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