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11/01/05 Investment House Daily
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SUMMARY:
- Stocks post modest losses on mostly light volume as they chew on Dell results, FOMC decision, and two sessions of gains.
- FOMC raises rates, stays the course.
- ISM follows Chicago, comes in ahead of expectations.
- First case of bird flu in US: Tax reform proposals
- Modest pullback leaves the market in good shape to rebound.
Sluggish session is not a bad session.
As expected stocks started soft on the Dell earnings warning and ahead of the next iteration of the FOMC rate hiking campaign. After two solid upside sessions that saw NASDAQ make a higher low at key support and then test its downtrend, a pause is normal.
Stocks started soft, then got a bit softer as the ISM and construction spending came in stronger than expectations. At this juncture investors like a strong economy, but not one so openly positive that the Fed has no inclination to even think about the end of the rate hikes. Stocks held support with NASDAQ holding the 50 day EMA early on, and then recovered midday. Moving into the meeting, however, they some cold feet. No major sell off, just some last minute worry that the Fed was going to go stronger than expected after all of that trash talk from Ferguson et al in the weeks leading up to this meeting.
The Fed did nothing new other than spending less time this statement discussing the storm impacts. That shot stocks higher with financials leading the way, prompting some to say the market liked what it saw. In truth what happened was that shorts covered positions they had opened on the financials in anticipation of a possible stronger rate hike. When that did not occur they buttoned them up quickly and the market jumped. Right after that 15 minute run stocks turned completely over, giving back all of the gain and more. In other words, once the short covering was over the buying interest was gone and the market fell back to where it was pre-FOMC.
Stocks held the early lows and managed a weak bounce to the close. That left the indices negative for the day, still below the next key resistance but holding up reasonably well after the strong prior sessions. Volume fell on NYSE and rose just slightly on NASDAQ. Breadth was modest at -1.5:1. Some strong stocks still found their way higher on volume while other solid leaders of late eased back on lower trade. All in all it was good action: modest losses holding support, modest breadth, no spiking downside volume, and leadership holding up fine. After two solid upside sessions this kind of rest sets the market back up for the next run higher.
THE ECONOMY
Fed set to raise through Greenspan's last meeting.
The Fed did as expected, though as noted above, there were some fears it might do more as some of the market action demonstrated. The statement went basically back to where it was pre-Katrina and Rita, deleting much of the commentary regarding those storms while continuing its view that long term inflation was well contained, that there continue to be some short term inflationary pressures, but that the risks of inflation versus deflation remained roughly equal, thus allowing the Fed to remove the policy accommodation at a measured pace. It unanimously raised rates 25BP to 4% and said see you same time in December.
The language also intimates, as it has done for some time now, that but for the Fed's action in raising rates, inflation would be out of hand. Kind of patting itself on the back as it views inflation as a given but for its 'brake tapping.' The Fed did specifically mention that there were still some near term inflationary pressures from the storms due to the supply disruptions obviously caused by damaged infrastructure and the shut in of most Gulf energy production. It talked less of them, but in our view that is really the only justification for really being inflation hawkish at this juncture. Those supply disruptions have brought about short term shortages that give rise to inflation: consumers and businesses have the money to buy it, but supply is simply lower. That is a problem and in our view that is what the Fed has been and should be addressing.
Fed targeting more than just short term inflation pressures.
The market, and us, fears something else is afoot, however. The Fed uses items such as the storms to bolster its position with respect to other unmentioned issues it is dealing with. In this case the Fed is taking on the housing market, and it was quite convenient to have the storms to give it some room to continue its efforts to slow the market. Housing is still rising, but it has been showing the signs of slowly cooling off. Maybe the Fed's rate hikes are doing this as well, but what every market watcher knows is that the Fed's ability to micromanage a market is poor. As we noted last week, using interest rates to control a market is like carving a turkey with a chainsaw (now that Halloween is over we can move onto Thanksgiving references or jump ahead to Christmas as in the retail stores): you can get it done if you will have to make turkey gumbo.
Thus the market has not only priced in two more hikes (December and January 31) to 4.5%, but is already working on the next 25BP to 4.75%. That is the Bernanke factor; he is viewed as more dovish, but many say he has something to prove to the markets, that he has the testosterone to be tough on inflation. This is very similar to how Greenspan made his bones as Fed chairman: he came in back in 1987 and felt he was going to show everyone he was a tough guy. He was tough alright. And stupid. He jacked up rates and ended with a 50 BP bomb that sent the market into Black Monday. Yes, the market loves a good shot of machismo just to show everyone who is boss.
PCE core deflator starting to head lower.
The question is whether any more is needed. We don't have a problem with some more rate hiking, but we do have a problem if it starts to invert the curve. It is getting very close with the 2 year at 4.39% and the 10 year at 4.56%; that is spitting distance, and the bond market is already working on 4.75%. Unless something changes in the curve or the Fed lets up, we could see an inverted curve by March.
What is the inflation rate? There are so many measures, but since the Fed holds the keys to monetary supply, let's look at the Fed's favorite indicator, the core PCE deflator. For the past 8 quarters it is as follows (starting in Q3 2003): 1.5%, 1.4%, 2.7%, 2.5%, 1.5%, 2.3%, 2.4%, 1.7%, 1.3%. We still need to see what Q4 shows after the storms, but we have a feeling we will see it low again. There was a spike in 2004, but it looks to have been contained even with the strong rise in energy through the summer. We only get one more look at the PCE before January 31, but if it comes in low, the Bernanke Fed may be done before he even takes office.
ISM index tops expectations with a modest drop.
59.1 beat the 57.0 expected, and not far off from the 59.4 in September. As usual, the prices paid index received all the buzz, hitting a high not seen since May 2004 (84 versus 78 in September). Employment rose to 55 from 53. New orders expanded nicely, rising 30%. Production rose 31%.
It was a strong report that was basically overlooked by everyone. The market did not like it ahead of the FOMC meeting and greeted the stronger report with some selling. No distribution or anything like that, just more of a slump on the news. It is a case of cheering the economy secretly while fearing continued strength only keeps the Fed active longer. It is a game of attrition where the market hopes the economy can keep the fires burning while inflation burns itself out. Once that happens the Fed lets up and the market and economy can continue on.
Sounds great, but it rarely happens when the Fed hikes. Greenspan points to 1994 as his example of inverting the yield curve, cooling the inflation he thought he saw, and then having the expansion continue merrily. One time out of nine or ten is not the odds I like to play. Thus far the Fed has no problem with those odds; never seems to.
Of bird flu and tax reform. Swine flue anyone?
There are no cases of bird flu in the US. Yet, Bush wants $8B to prepare for parrot flu or any other pandemic that may wash up on our shores. That seems to be very cautious in the approach; he said the threat was not imminent but that we needed to be prepared. We cannot wait until that is twisted to saying, as with the Iraq WMD's, that the threat IS imminent. The immediate response was equally amusing some democrat leaders said it was too little too late.
Too late for what? The damn flu hasn't reached our shores and it cannot jump from human to human. You have to have an infected bird around to get it. Today some top line experts were happy something was being done regarding potential pandemics in general, but they were also quick to say the bird flue has a long way to go to get to be really deadly, i.e. the human to human variety. By the time it gets here they are also suggesting that Tamiflu and similar drugs will be in such wide use that they will provide little help. Thus, some work on this is not a bad idea.
But this is getting blown WAY out of proportion. Do you recall the swine flu epidemic back in the 1970's? You don't? Because there WAS NO swine flu epidemic. The US spent billions on getting vaccine for it and maybe three pig farmers got it (the disease, that is).
When in trouble find a diversion.
This looks a lot more like the usual Washington two-step: when an administration gets in trouble, find a distraction. Get caught lying about having sex with an intern? Lob some cruise missiles into the Middle East. Get blamed for storms that raise the price of gasoline, nominate an unqualified person to the Supreme Court, and have one of the VP's staffers indicted? Blame the birds. Hitchcock's 'The Birds' was on TMC the other day; maybe Bush was watching it and had a flash of inspiration of sorts.
Problem is, the bird flu is the least of our worries. Bush is off course and his 'blue ribbon' tax reform panel demonstrates this. There is a groundswell of support to do away with the IRS and go to a flat tax or a national sales tax (called the 'fair tax'). Instead the 'blue ribbon' panel compromised on everything in order to get a unanimous vote on the proposals. What do you get when you compromise out of the box? Mediocrity.
Some examples. Limitations on health care benefit deductions. Limitations on mortgage deductions. Elimination of sales tax deductions. No real reduction in rates for anyone. There are some good points to be sure, but they mandate to the panel contained flaws that doomed it to failure: revenue neutral, eliminate the AMT, make it 'fairer.' That ruled out the flat tax because many view everyone paying the same tax as somehow unfair. No it is much fairer to tax those who work very hard, build their businesses, and create jobs more than those who don't take chances or those who simply want to live off the rest of us. Nothing wrong with not being a risk taker, but should we penalize those who are and who are fortunate enough to 'make it?'
What has happened is something this administration is having a lot of trouble with lately: missed opportunities. Its weak sell of its social security reform could not convince reform's strongest supporters to go along with it. Its inability to effectively proclaim the benefits of tax cutting almost doomed its tax cut incentives to failure. Its foolish nomination of Miers just added gasoline to the fire. It is now back on its heels and is basically acknowledging its eunuch status. A chance to do something bold, something that Ireland, Russia and several other booming economies have done, i.e. real flat tax reform, has gone by the wayside. These 'reform' proposals have set back true tax reform at least 20 years. Bring on the swine flu.
THE MARKET
MARKET SENTIMENT
A solid bump higher in the put/call ratio, but note how volatility fell on the down session. Mixed indications here, but we also note that at this point in the move, the sentiment indicators have probably done all they are going to do to contribute.
VIX: 14.85; -0.47
VXN: 17.39; -0.6
VXO: 14.07; +0.42
Put/Call Ratio (CBOE): 0.99; +0.08.
Bulls versus Bears:
Last week's numbers:
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: -6.25 points (-0.29%) to close at 2114.05
Volume: 1.952B (+1.02%). Volume edged higher Tuesday, holding well above average as NASDAQ gapped lower but then recovered some lost ground for the close. Not really a negative session, but does show some churn just below resistance.
Up Volume: 901M (-664M)
Down Volume: 1.037B (+721M). Unlike Monday, the up to down volume was very close. Monday up volume outpaced down volume 5 to 1. This shows the move was not really violent.
A/D and Hi/Lo: Decliners led 1.37 to 1. Very modest negative breadth. Again no real issue Tuesday.
Previous Session: Advancers led 2.55 to 1
New Highs: 97 (-14)
New Lows: 73 (+19)
The Chart: The Chart: http://www.investmenthouse.com/cd/^ixq.html
NASDAQ tapped at the August down trendline (2025) and the 50 day SMA (2118) on the highs but never turned positive on the session after gapping to the 50 day EMA (2109) to begin the session. Closed off the lows, showing fairly decent action at this support level as NASDAQ takes a breather and tries to set up for another move at resistance after making the higher low at the 200 day SMA (2073) last week. This is basically what we expected, though we would have preferred to see volume fall off to average or lower.
SOX (-0.95%) gapped lower giving back just over half of the Monday recovery to test the 200 day SMA (435.20). SOX was doomed to failure with the Dell warning; everything that goes into those boxes and peripherals that hook to those boxes was struggling some Tuesday. SOX reached down deep Friday and rebounded. It has come back to the 200 day SMA and then faded some in a day of weak action. This is where it needs to make a move in support of the other indices.
SP500/NYSE
Stats: -4.25 points (-0.35%) to close at 1202.76
NYSE Volume: 1.782B (-6.13%). Lower volume though still above average as the large cap and small cap indices gave back a smidge of the Monday gain. Like to see that trade contract during a pullback.
A/D and Hi/Lo: Decliners led 1.12 to 1. Very modest downside breadth, a good sign not many are unloading their shares.
Previous Session: Advancers led 3.09 to 1
New Highs: 93 (-13)
New Lows: 107 (+17)
The Chart: http://www.investmenthouse.com/cd/^gspc.html
SP500 was lagging all session, holding near the session lows throughout the day with just that blip higher after the FOMC meeting on the covering when the Fed held the course. SP500 fell back through the 50 day EMA (1204) after its Monday try at the 50 day SMA (1209) and price resistance at 1210. Modest losses, lower volume, narrow breadth. Want to see it hold above the 200 day SMA (1199) and then give us the move through the 50 day SMA.
Very solid action on SP600 (-0.25%), stymied at the 50 day EMA (338.93) once more but coming back well off its lows where it tapped at the 18 day EMA (335.52) and rebounded to close. It still has a passel of resistance to clear at the 50 day EMA, 340, and the 50 day SMA (341.39) in order to make this a move with some strength. As noted earlier in the week, SP600 has set up a good bottoming pattern with the early October test followed by the sharp drop and rebound last Thursday and Friday. May take another session or part of Wednesday before it is ready to make its move.
DJ30
DJ30 stalled at the 50 day SMA (10,431) and closed right at the 50 day EMA (10,412). Volume backed off but was still above average, basically what you want to see on a pullback. Still below a thick wall of resistance from 10,400 to over the 200 day SMA (10,498), but it is trying to follow the lead of the other indices.
Stats: -33.3 points (-0.32%) to close at 10406.77
Volume: 293M shares Tuesday versus 320M shares Monday.
The chart: http://www.investmenthouse.com/cd/^dji.html
WEDNESDAY
No major earnings swings and misses after the Tuesday close; kind of anticlimactic after Monday's Dell news followed by the FOMC Tuesday. When the market is taking a breather, that is exactly what you like to see: quiet action to let it consolidate and set the stage for the next move. Indeed, the fact that the action was very orderly even with the Dell news and the FOMC is a very good sign the market is doing just that.
Wednesday oil inventories are the only scheduled news, and with oil prices back below $60/bbl again (59.85), a strong build could give the market a boost after its rest. We anticipated it might take all day for the market to work through the Dell news given the FOMC was to follow, and now that it has done that it could be ready to go as early as Wednesday. We are likely to see a bit of early softness again, but barring any new upsets the market looks as if it is going to be ready to make another run at that resistance standing in the way of SP500 and NASDAQ.
As we have noted, we like the higher low made by NASDAQ along with the quick tests and then rebounds above the early October lows by SP500 and SP600. With leadership still holding up, it really looks as if the indices are not only going to make another run at resistance, but it also looks as if that will be successful.
That would send the market on its year end move higher. Whether that lasts through December or is just two weeks in November remains to be seen, but we intend to take advantage of any such move. Indeed we have been moving into positions this week as strong stocks turned back up on solid trade. Maybe the market sees the Fed stopping in January, maybe it likes the idea of these tax proposals, maybe it sees oil heading lower. Maybe it sees all of that and more. What we know is that the action has been good the past week and leaders are still looking solid. That is what we take our cue from, and we are looking for a run through this resistance near term.
Support and Resistance
NASDAQ: Closed at 2114.05
Resistance:
The 50 day SMA at 2119
2125 is the August downtrend.
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 50 day EMA at 2108.97
2100 was key resistance and support in the past
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 2023 that forms the bottom of the big triangle pattern
S&P 500: Closed at 1202.76
Resistance:
The 50 day EMA at 1204.38
The 50 day SMA at 1209.28
1210 held in late September on the close.
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:
1200 was solid price support at one time
The 200 day SMA at 1199.34
1190 from prior prices
1183 - 1184 from November 2004 highs and July 2005 intraday low and a high way back in July 1998
1183 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 10,406.77
Resistance:
The 200 day SMA at 10,498
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:
The 50 day EMA at 10,411.84 is trying to hold
The May high at 10,406 and 10,400, the bottom of the November/December range
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): 1.7% actual versus 0.4% expected and -0.9% prior (revised from -0.1%)
Personal Spending, September (08:30): 0.5% actual versus 0.5% expected and -0.5% prior
Chicago PMI, October (10:00): 62.9 actual versus 57.4 expected and 60.5 prior
November 01
Auto Sales, October: 5.4M expected and 5.7M prior
Truck Sales, October: 7.0M expected and 7.3M prior
Construction Spending, September (10:00): 0.5% actual versus 0.5% expected and 0.6% prior (revised from 0.4%)
ISM Index, October (10:00): 59.1 actual versus 57.0 expected and 59.4 prior
FOMC policy announce (2:15): 25BP hike to 4% and no change in the 'measured' or 'accommodation' portions.
November 02
Crude Inventories, 10/28 (10:30): +4.414M prior
November 03
Productivity-Prelim., Q3 (08:30): 2.6% expected and 1.8% prior
Initial Jobless Claims, 10/29 (08:30): 330K expected versus 328K prior
Factory Orders, September (10:00): -1.0% 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): 100K 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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