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money investment, Breakout test
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10/29/05 Investment House Daily
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SUMMARY:
- Stocks snap back as SP500 roars off up trendline.
- GDP pretty damn solid, posting 3+% growth for tenth consecutive quarter.
- Core inflation continues to shrink, wages applying no pressure (as if they ever do).
- Market continues its bottoming process in the face of plenty of pessimism.
Stocks rebound in the face of even more gloom.
With the potential CIA related indictments coming midday, the litany of negative issues confronting the market ratcheted up another notch Friday. As we discussed earlier in the week, the gloom or anxiety about a host of problems was reaching an oppressive level. Friday we heard about the 'worst week ever' for the President, predictions of a Watergate-like scandal, a crippled presidency, etc. On top of everything else confronting us this type of problem can be a crowning blow: the administration in a scandal.
The market did not notice. The market sold off hard Thursday afternoon when rumor hit that Mr. Rove was likely to be indicted. After the news turned negative on just about all fronts some buyers came in. Futures were higher early Friday. When Q3 GDP stormed in at 3.8% with a low core PCE deflator stocks were goosed even more. Despite all of the gloom, the drop in consumer sentiment, and fears about the Fed and energy wrecking the economy, this strong expansion overcame serious obstacles and posted a tenth quarter of growth in excess of 3%.
Stocks opened higher, made a mid-morning test of the move that looked ready to wreck the move, but then caught support an hour and one-half into the session and rallied to the close. The GDP provided some kick and when the grand jury only passed down one indictment the market was goosed a bit more.
SP500 blasted off the slight undercut of its up trendline and NASDAQ jumped off its 200 day SMA after gapping over that level, testing the gap intraday. SP600 turned right back up and recovered the 200 day SMA as well. SOX was a serious laggard; it gapped sharply lower on weak guidance from MXIM. By the close, however, the strong semiconductors, the leaders in the sector, were flying back up.
In short the indices did what they had to do: reversed the Thursday breach of support and continued the October bottoming process. It was not 'the' move though some were calling the Thursday thud lower by SP500 and SP600 and the Friday rebound a successful test of the early October low. Maybe, but they indices are not out of the woods. They are still strong overhead resistance, a pretty pernicious downtrend that started in August, and NYSE volume did not advance on the Friday gains.
On the other hand NASDAQ volume was great, though you like to see everyone rowing together on a turn. SP600 and SP500 did test lower toward the early October lows and then rebounded sharply. Many leaders held up and then advanced on strong volume when the selling pressure abated. Further, key support held after a one day breach as the major indices continue to work on a bottom in the face of some serious issues.
Plenty of volatility as market continues work on putting in a bottom.
Early this month we talked about the volatility to come as the market tried to put in a bottom. No question the volatility showed up and it continued even at the close of last week. Volatility is a sign of a change in the market just as volatility in weather is a sign of a change in season. Must be a hell of a change in the making given the whiplash experienced as stocks jerk back and forth every couple of sessions.
All the while the indices are roughly holding the range since hitting the October low after that plunge lower. That shows quite a fight between buyers and sellers at the bottom of a leg lower with the sellers unable to push stocks lower. The sellers were strong in early October and stocks sold on strong volume. The past 3 weeks the sellers and buyers have traded blows but the market has not dropped further.
That hold of support, the high volatility, and the high level of gloom indicate a change in the making. The critical issue as always is whether this is enough to show that a bottom has been set. If SP500 had rallied on stronger volume, if SOX had recovered more, if breadth was a bit better, maybe that call could be definitively made. We do know that the bottoming process continues and that Friday was a good response to the low volume Thursday selling: stocks sold Thursday but the volume was not surging. That means the sellers were not as strong on this turn lower and that buyers were, at least on NASDAQ, strengthening.
While not conclusive, we still like the bottoming action and when coupled with some continued solid leadership what we do is move into those strong stocks when they hold support in the selling and then rebound on strong volume. The only certainty in the market is that by the time things are certain the move is well on its way. You have to read the market signals and when they suggest a move in the making and leaders are actually making moves of their own you act. If you wait until you are certain you are trying to pick up the scraps. The action we are seeing suggests a bottom being set. We will work on positions in strong stocks as they show us good entry points. Indeed, one of the constants in this volatility is the strength in leaders.
THE ECONOMY
Q3 GDP runs past expectations as economy posts strong gains in the face of obstacles.
The 3.8% reading beat the 3.6% expected (3.3% in Q2) and really raised some eyebrows, in a pleasant way, given the storms and other issues confronting the economy in the quarter. Now there will likely be some revisions that could lower this number. In the first iteration of GDP, the final month's trade numbers are estimated. While the estimate takes into account the Mississippi river and port closures, it remains to be seen just what the actual impacts where.
Nonetheless this was a strong number as the economy posted its tenth straight quarter of 3% or better growth. That is an excellent expansion, particularly when you factor in close to a year of high oil prices and over a year of Fed rate hikes. Toss in a war and multiple hurricanes dragging at it, and you have a picture of a very strong economy. Indeed, the government estimated that incomes (lost wages and rents) fell $40B; while the numbers regarding trade may be estimates, the loss of those wages held GDP lower than it would have been.
There was strength across the board. Consumer spending rose 3.9%, topping 3.2% in Q2. Durable goods orders rose 10.8% versus 7.9%. Equipment and software rose 8.9% versus 6.9%. Business investment dropped to 6.2% from 8.8%; somewhat disappointing but somewhat understandable given the uncertainty we are hearing from business leaders who almost to the man or woman are saying things are good but they are worried about the Fed going too far once again.
The GDP growth could have been even stronger but there was a big drawdown in inventories for the second straight quarter ($16.6B/year in Q3, $1.7B drop in Q2). That was the largest drop since Q4 2001 (after 9-11) when they tumbled $86.7B on an annual basis. This could be good; companies could ramp up production if needed to meet consumer demand and thus expand GDP even further. It could also be a negative, i.e. companies not seeing the need to replace inventory because of a weaker consumer or thinking there will be a weakened consumer due to high energy prices. The consumer does not seem weak, at least in Q3 with the 3.9% growth in spending.
Core inflation continues to decrease despite Fed's worries.
The Fed's favorite inflation indicator, at least Greenspan's favorite, was lower in Q3. The core personal consumption expenditure measure (PCE, a.k.a. the chain deflator), rose at a meager 1.3% annual rate after a 1.7% rise in Q2. Q2 left inflation closing in on the 2% level the Fed considers the limit. Take out food and energy and inflation is decreasing its rate of growth. Indeed the Q3 reading was the lowest rise since Q2 of 2003.
While the Q3 reading is old news and we have to focus on the future and the rise in gold and what it is telling us, with the core PCE falling you wonder if the Fed will have some mitigating language in its policy statements in the future. The Fed meets Wednesday for a one day meeting where it will likely raise rates 25BP. It has not changed its language to remove 'measured,' and thus it cannot stop hiking this time. Indeed with all of the tough Fed-speak on inflation of late there is no way it can stop now after just one decline in the PCE. Given that the next quarter won't be out until late January, just before Greenspan's last meeting we cannot really expect anything less than three more 25BP hikes.
Indeed, the tough Fed-speak makes one wonder if the Fed knew the PCE was coming in light and it had to bolster its position for hiking rates more. It did this back in 1999 and 2000 when it was coming up with reasons to raise rates when there was no inflation but it was targeting the market (though it denied this). Now that the Fed is targeting the housing market it has tom come up with reasons to continue raising rates even with its favorite indicator falling to a very palatable level.
We still feel the Fed has little choice but to raise rates next week and again December. It has not changed its tune and the market has built in those hikes. More substantively, however, much of the Gulf oil and gas production remains shut in and even with the larger than expected crude builds the past two weeks there is still the problem of shortages in the short run that are exerting some inflationary pressures. Those have yet to filter through the economy, and thus the Fed does have to stay on track with inflation, particularly given that GDP is a snapshot that is much older than contemporary economic readings.
Wages rise but remain tame year over year.
The Employment Cost Index, a measure of wages and benefits, rose 0.8% in Q3, in line with expectations but faster than the 0.7% gain in Q2. Year over year, however, employment costs rose 3.1% and wages rose 2.3%. The overall rise was the lowest in 6 years while the wage rise was the lowest on record. Adjusted for inflation dropped 2.3%.
The Fed also looks at wages because it always worries that employed, successful workers will somehow ignite inflation through wanton, reckless consumption. This is part of the Phillips Curve mentality on the Fed that believes if you pay employees more they will spend more, and with more dollars chasing the same amount of goods you get inflation. Of course that ignores reality where a supplier will make more supply available if there is demand for it. Supply meets demand if supply is not hindered by regulation, tax laws, etc.
Given the Fed's focus on wages, however, this combined with the core PCE made Friday's economic news really inflation friendly. Many are wondering out loud why the Fed would feel the need to indefinitely jack up rates given these indications are falling. After all, the Fed often says that if you wait until you see inflation it is too late. Conversely, if you wait until you see actual economic slowing, you are already into an economic decline.
Conflicting data has everyone at odds over what to do.
The consensus is that the Fed has to keep hiking rates, but the reasoning is mostly based upon a steadfast belief that Greenspan knows what he is doing. You would think he has enough practice at causing recessions to know when he is doing it again, but not many take much solace in that as evidenced by the CEO's we are talking with.
With the storm shortages still in place the Fed feels it has to keep hiking rates to fend off inflation. It said in its recent minutes that those pressures are short term in nature and that longer term inflation remains well in check. What does not add up is that Fed rate hikes take many months to take effect. In other words those implemented now won't be felt until next summer or later. Rate hikes that won't be felt for at least 6 months as a means to combat a short term rise in inflationary pressures is like using a sundial to time a one hundred meter dash.
Interest rates are that clumsy at micromanaging the economy as this Fed wants to do. Thus in order to achieve results, it has to overshoot the mark. All the more reason the Fed under the new chairman should adopt a 'target' approach where inflation is not targeted, but a Fed funds rate for those times the Fed feels the need to intervene. It should state that rate up front and then let the markets adjust to that. If they don't make it, the Fed can modify its 'target'. It is not perfect, but it beats the perpetual flying by the seat of the pants, market guessing, and the all too often Fed-induced recessions.
THE MARKET
MARKET SENTIMENT
Thursday we discussed the rise in pessimism once more that could finally work to set a bottom. There was no further drop to spike sentiment higher before the market rebounded. That kept VIX from jumping up to 18 or better. Thus the sentiment indicators, while high, did not reach levels that would clearly show a bottom.
VIX: 14.25; -1.77. Topped out at 16.30 on the Thursday high, not where we wanted it to go. As seen in other bottoming events, however, VIX often gyrates for 3 to 4 weeks as the market tries to form a bottom, as in April and May, it may actually makes its subsequent spike after the bottom is set.
VXN: 17.52; -0.18
VXO: 13.8; -2.11
Put/Call Ratio (CBOE): 0.84; -0.29
Bulls versus Bears:
Bulls posted another nice 0.5% decline while bears backed down a fraction. After this past week we will likely see bulls drop further and bears rise a bit. Not a bad showing from the bears on this rise but would have liked to see bulls fall further and bears rise a bit more.
Bulls: 44.8%. Down from 45.3%. Another solid decline but has slowed dramatically from the 3.7% declines to start October when the selling was strong. Bottomed in May at 43.5%.
Bears: 29.2%. Down from 29.5%, the high water mark on this cycle thus far. Hit a high for the year at 30% in early May.
NASDAQ
Stats: +26.07 points (+1.26%) to close at 2089.88
Volume: 1.887B (+5.61%). Volume rallied back above average Friday as NASDAQ jumped back up through the 200 day SMA. Low volume selling through that level Thursday and then a volume move back up shows buyers moving back in at this level.
Up Volume: 1.218B (+974M)
Down Volume: 650M (-873M)
A/D and Hi/Lo: Advancers led 2.03 to 1. Solid but not matching the downside selling. Still, the 3.3:1 clubbing Thursday even as volume was lower shows it was getting extreme.
Previous Session: Decliners led 3.3 to 1
New Highs: 53 (+11)
New Lows: 112 (-16)
The Chart: The Chart: http://www.investmenthouse.com/cd/^ixq.html
NASDAQ recovered the 200 day SMA (2073) after a one-day breach. Stronger volume than the selling shows some renewed strength after making a lower high midweek at the 50 day EMA (2108). We were looking for a further move lower to better test the early October low (2025) and throw a good scare into tech investors. This higher low on rising volume is often the trigger to a breakout move. Holding at the 200 day SMA sets it for the attempt to make the breakout above resistance, starting with 2100, then the 50 day EMA (2108), followed by the down trendline at 2118. Surprising strength, a good showing, but it has to turn this into a breakout.
SOX (-0.65%) was the big laggard, gapping lower after the breach of its 200 day SMA (435). It sold off sharply to 413 and then surged back. It was unable to close the gap as it got a late start at the rebound. NASDAQ needs SOX to come along as NASDAQ tries a breakout. After a good consolidation above the 200 day SMA, the breakdown turned it ugly. As with NASDAQ, need to see a quick recovery.
SP500/NYSE
Stats: +19.51 points (+1.65%) to close at 1198.41
NYSE Volume: 1.743B (-2.26%). Volume remained above average but it faded from the Thursday and Wednesday levels. Unlike NASDAQ volume did not ramp up on the selling to match the price move. Price/volume action has not improved yet on this round of the up and down action at the trendline. We will see if it can follow NASDAQ's lead.
A/D and Hi/Lo: Advancers led 2.76 to 1. Matched to the T the declining breadth on Thursday. Solid upside breadth as the small caps led the session higher.
Previous Session: Decliners led 2.76 to 1
New Highs: 53 (+13)
New Lows: 153 (-76)
The Chart: http://www.investmenthouse.com/cd/^gspc.html
SP500 surged off the up trendline (1181.50) after a one-day modest close below that level just as it did just over a week back. The Thursday close at 1179 came close to the early October closing low at 1178 and then SP500 wasted no time surging up to the 200 day SMA (1199) and price resistance at 1200, the level that has acted as the ceiling on this lateral move the past three weeks. Nice retest and rebound. The weakness in the move was that volume did not follow it higher. It will need upside trade to get it through the 200 day and the rest of the resistance from the 50 day EMA (1204) to 1220. A lot of work to do, but holding where it has to hold is a first step.
SP600 (2%) led the rebound, recapturing the 200 day SMA (331) after a hard fall through that level Thursday. One day reversal after slightly undercutting the early October closing low (327) on Thursday. If volume had ramped higher the move would have been classic. As with SP500, a lot of near resistance at 335 to 337 and then 339 (50 day EMA). Still in the downtrend but a good start at a recovery attempt.
DJ30
After a third test of the 10,200 closing levels DJ30 finally got some volume as the blue chips got some traction and put in a solid move. Rallied up to the 50 day EMA (10,410), in the middle of the August and September lows. This is where it stalled the past two weeks, making it a key level to break through on a recovery attempt as it moves toward the 200 day SMA (10,499). One step at a time.
Stats: +172.82 points (+1.69%) to close at 10402.77
Volume: 283M shares Friday versus 236M shares Thursday.
The chart: http://www.investmenthouse.com/cd/^dji.html
MONDAY
The earnings flood is slowing, but it will proceed into November. The market is hardly immune to the news, however, as we still see daily blowups as a company steps on a guidance landmine. Along with the earnings there will be more heavy economic data, e.g. personal income and spending, Chicago PMI, ISM, the FOMC Wednesday, and the jobs report. Heavy hitters.
The market has taken plenty of blows from earnings and outside influences in addition to the ever-present oil and Fed issues. It has trended lower since August as the continued negative news confronts it. It is, however, working on a bottom right at the height of the negative news. Three legs down on this move since the August peak, a typical move in a selling run and now trying to make a higher low. Friday was a good start on NASDAQ, but the NYSE stocks did not follow with the same vigor.
There is still plenty of pessimism as to the future, and indeed in 2006 there are questions as to whether the Fed will go too far and if oil prices will finally overburden consumers. Near term we still view the market as making a bottom and ready to move up to the end of the year. Looking at the index chart patterns the downtrend is still in force and there is a lot of overhead supply to overcome. We are looking for NASDAQ to lead higher as noted last week, and Friday it was the index up on stronger volume. Its prospects of a higher low here look better.
As noted, we still see many strong stocks that broke higher and have pulled back in the selling to test the move. We are looking at those as our rides on the rebound to the end of the year. Each day we see a few make the test and then the rebound. That does not make them automatically safe; there are still earnings landmines going off each day. We are going to keep pitching here because we see positives still developing in NASDAQ for a year end run. A lot came together this past week with the test lower, the rising pessimism and anxiety over economic and political issues, and a decent close to the week by NASDAQ. Even with the downtrend still in place we are willing to commit more money to the right stocks for a year end run.
Support and Resistance
NASDAQ: Closed at 2089.88
Resistance:
2100 was key resistance and support in the past
The 50 day EMA at 2108
The 50 day SMA at 2120
2154 from January 2004 high
2178 is the January closing high
2187 is the September high.
2191.60, the January intraday high.
2192 is the mid-July high.
2220 is the August high
Support:
The 200 day SMA at 2073
2050-51 from spring and summer 2005 consolidations
2025 is the early October low
2018 is the early April high.
The August 2004/April 2005 up trendline at 2022 that forms the bottom of the big triangle pattern
S&P 500: Closed at 1198.41
Resistance:
The 200 day SMA at 1199
1200 was solid price support at one time
The 50 day EMA at 1204
1210 held in late September on the close.
The 50 day SMA at 1210
December 2004 high at 1219 and June high at 1220
March 2005 closing high at 1225 and intraday high at 1229.11
The September high at 1243 and the recent August high at 1246
Support:
1190 from prior prices
1183 - 1184 from November 2004 highs and July 2005 intraday low and a high way back in July 1998
1181.50 is the August 2003/August 2004 up trendline is in trouble
The October intraday low at 1168 is a key point to watch
1165 - 1155 from late 2001/early 2002 double top
1140 from the April low
Dow: Closed at 10,402.77
Resistance:
The May high at 10,406 and 10,400, the bottom of the November/December range
The 50 day EMA at 10,411
The 200 day SMA at 10,500
Price consolidation at 10,600
The June highs at 10,646 to 10,656
10,720 is the high in the recent lateral move. This is the key resistance.
10,754 is the February high
10,868 is the December 2005 high.
10,985 is the March high
Support:
10,350 turned out to be support in the recent August and September pullbacks
10,250 held in the June and July lows but is blowing out now
10,200 from April.
10,175 from the July intraday low.
10,000 from the April low.
Economic Calendar
These are consensus expectations. Our expectations will vary and are discussed in the 'Economy' section.
October 31
Personal Income, September (08:30): 0.4% expected and -0.1% prior
Personal Spending, September (08:30): 0.5% expected and -0.5% prior
Chicago PMI, October (10:00): 57.2 expected and 60.5 prior
November 01
Auto Sales, October (00:00): 5.4M expected and 5.7M prior
Truck Sales, October (00:00): 7.0M expected and 7.3M prior
Construction Spending, September (10:00): 0.6% expected and 0.4% prior
ISM Index, October (10:00): 57.0 expected and 59.4 prior
FOMC policy announce, 0 (14:15): Expecting another 25BP hike and no change in the statement.
November 02
Crude Inventories, 10/28 (10:30): +4.414M prior
November 03
Productivity-Prelim., Q3 (08:30): 2.3% expected and 1.8% prior
Initial Jobless Claims, 10/29 (08:30): 328K prior
Factory Orders, September (10:00): 0.0% expected and 2.5% prior
ISM Services, October (10:00): 57.0 expected and 53.3 prior
November 04
Non-farm Payrolls, October (08:30): 125K expected and -35K prior
Unemployment Rate, October (08:30): 5.1% expected and 5.1% prior
Hourly Earnings, October (08:30): 0.2% expected and 0.2% prior
Average Workweek, October (08:30): 33.7 expected and 33.7 prior
End part 1 of 3
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money investment
Breakout test
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