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us stock market, trend trading stock
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12/02/06 Investment House Daily
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SUMMARY:
- National ISM falls through 50 and stocks struggle to on the news.
- The ISM decline and the economic cycle: has the Fed done it to us again?
- Economic data blitzkrieg continues to dog a tired market, but can new money come to the rescue?
Afternoon comeback cannot change the day or the week.
Some said the sub-par Chicago PMI performance was an outrider, an aberration given the better showing in Philly and in New York. But as we noted before, the regions were declining in strength and the national number was fading as well. In November the nation's manufacturing report reflected the slowing in the sub-regions and contracted. It was a whisker below neutral at 50 (49.9), but it was the lowest since April 2003 and as such it may as well have been a whole point low versus just one-tenth a point.
The market was already sluggish even before the ISM data hit, however, as the relief bounce from the Monday dump lower waned. As discussed often, SP500 and DJ30 are on an extended run, and they showed some strain in late October/early November. They recovered, but just a few weeks later they are struggling to hang on again. Still in the uptrend without question, but a long run makes keeping up with the Joneses harder.
The news Friday morning made it no easier. Threats of Al Qaeda cyber attacks against financial institutions, another day of dollar decline, and DOJ antitrust subpoenas for AMD and NVDA again set the stage for another tough session. Stocks started lower, and when the ISM hit they jerked even lower. Of course stocks tried a midmorning bounce after that first drive lower, but by mid-afternoon the indices were at new session lows with NASDAQ peeling back 40 points, SP500 14 points, and DJ30 100 points.
Once more NASDAQ tapped its July up trendline (it hit it on the Tuesday intraday low), and that helped trigger a rebound. SP500 came close to its trendline as well and it too obviously rebounded. The indices did not recover to positive, but the losses were more than cut in half. Techs, chips and small caps took the worst beating, no surprise there as they are the growth areas, and with the weaker ISM growth areas were not the locus for money. By the end of the session the losses were reduced but the indices were unable to make up the Monday deficit and closed negative for the week.
Technically there was again nothing to change the recent picture. The indices continue to hold their uptrends but SP500 and DJ30 look top heavy once more, struggling again after that early November bounce in techs and small caps helped drag them out of what looked to be an interim top. NASDAQ and SP600 have a similar look but to a lesser extent. They are not as extended as the large cap NYSE indices but they have the look of a failed relief bounce after that strong dump lower on Monday following the Thanksgiving holiday. They have not given up the ghost at all, just looking a bit winded here as opposed to setting up for a major decline.
Volume faded on NYSE and NASD, but it was not a major drop off. NASDAQ remained just above average but NYSE trade held at the elevated levels shown Thursday. Thus though it was lower and technically not a distribution session, the high back to back volume as SP500 showed a pair of dojis after the rebound attempt from the Monday dump. That high volume as a bounce slows, particularly at resistance or another high, shows money still coming in, but it is also leaving as fast as it enters as an equal number of investors want out as want in. When that dynamic is over there is typically a fade to regroup. When a run has lasted as long as on SP500 and DJ30, that fade typically is to the 50 day EMA if the rally is going to continue. If not it will fall through the 50 day EMA.
Leadership is still in the game though it had a pretty rough week as well with many stocks unable to shake off the early week selling. There are many that held near support and many that fell further to the 50 day EMA, and that still leaves them in good shape to continue higher. Indeed, those kind of pullbacks can give us very nice entry points. Others did not survive, and that leaves the leaders and the indices trying to regain balance and continue the rally.
When you look at the chart of say SP500 you see the nice tight bounces up the 10 and 18 day EMA into late October. Indeed, there are 5 such bounces into mid-October. Then there is a larger than average (for this run) surge into the last half of October, followed by a larger than average (again for this run) fade below the 18 day EMA into early November. It waffles with a modest rebound and then another larger run that coincided with the NASDAQ and SP600 breakouts. Then the more violent decline last Monday and the rebound last week that could not quite take out that late October high. What does this mean? This is a typical run after a breakout: a breakout, nice, even bounces for 4 to 5 turns up the 10 and 18 day EMA, and then things get a bit more volatile. As we preach, volatility after a trend means change. Thus we are looking for SP500 to make change here, namely a likely test of the 50 day EMA. If all things remain equal, i.e. the lower ISM does not presage an economic meltdown, then it should hold and continue the rally. Same for the Dow. Indeed, large caps should still perform relatively well given the stage of the economic expansion.
In short, the indices are using up their lives on this run and the indications are an interim top and a bit deeper test ahead. Remember, September and October, traditionally weaker months, were all gains. Thus to finally get some weakness after a run off of the July bottom is no market shattering event. Indeed, a deeper pullback should set up a lot of stocks for good buys but it may mean a bit of rockiness near term. These times are volatile as the past month has shown, and thus we can easily get some bounces here as many leaders have faded to some support. Those bounces would be good opportunities to lighten up some on options and marginal positions, and we are going to do that and then see what stocks are set up well after a deeper test. Those will be the next round of super leaders.
THE ECONOMY
Is the ISM a portent of a slow economy to come?
The details of the November manufacturing report sound pretty grim. It was the first sup-50 level since April 2003. Five of the ten categories fell below 50, and all five were key growth indicators. New orders fell to 48.7, production 48.5, employment 49.2, order backlogs 46.5, and inventories 49.7. Prices, on the other hand, rose to 53.5 after a 14 point swan dive in October. Exports were a bright spot, rising to 56.9 as the weak dollar makes US goods look pretty tasty.
Construction did not help things either, posting a 1% decline versus the -0.4% expected, the worst decline in 5 years. Worse, September was revised to a 0.8% loss versus the -0.3% originally reported. Once again we have to say nice work on those estimates government; seems your estimating skills have deteriorated from already low standards. Residential construction declined 1.9% for the month and 9% year/year; housing still a major drag.
Pretty grim indications, but lets put the ISM in the historical perspective. In the 1990's the Fed was active in early in the decade, mid-decade, and at the end of the decade when it finally ended its 10 year assault with a major economic collapse. As an aside, when you look at the 1929 central bank and its actions, you see a parallel, almost manic approach. It held the view that there was too much growth and inflation had to follow. It was relentless in its efforts to contain the stock market, culminating with a 1% hike in rates after a series of hikes. Inflation never showed up and indeed we suffered some of the greatest deflation of all time. In the nineties Greenspan was on a campaign, fearing prosperity as he uttered such infamous phrases as 'irrational exuberance' and engaged in three separate rate hiking campaigns in addition to his verbal assaults. In the end inflation never showed up but the economy crashed from 10% growth rates to recession and we had to balance on the edge of deflation before some investment tax cuts helped spark investment once more.
Taking a trip down memory lane.
During that time, however, the ISM dipped in the early 1990's even after the economy recovered. In the mid-1990's after the second round of hikes the ISM dipped below 50 in 1995 and 1996, and indeed below 45. All the while the stock market not only rallied but surged. The ISM dipped again in late 1998 in that quick bear market with the Russian currency crisis but the market resumed its move. In short, if the economic cycle is continuing and not peaking, then a dip below 50 is not fatal. Indeed, after a Fed rate hiking campaign it is normal. Again, the key is whether the economy is still able to expand once more, i.e. whether the Fed went too far.
The Fed views this current slump as a mid-cycle decline with the economy picking back up once this 'soft patch' (as Greenspan described them) is over. Thus it remains worried about inflation because if the economy remains strong it fears inflation will do the same. Of course there is no linkage between economic strength or weakness and inflation. Inflation depends upon how much money is in the system. The economy can race ahead and generate no inflation if there is enough money in the system to fuel growth but not too much so as extra money goes into prices. All of the tinkering with interest rates and money supply throws off the natural economic equilibrium, and at some point the Fed missteps and we pay the bill. While Bernanke likely believes this, the Greenspan so engrained in the public mindset the idea that a fast economy equals inflation and a slow economy equals no inflation, speaking to the contrary would be similar to the Democrats admitting that Social Security cannot be fixed as it exists and that age requirements need to be raised to avoid a 20% tax hike on everyone in the next 15 years.
Forget what the Fed is peddling. What is really going on with the economy.
Thus we have to look at what the true leading indicators are showing and not what the Fed is peddling to see what the future holds. They are, unfortunately, mixed. The best forecaster that is not a market is ECRI. It continues to suggest improvement down the road as its 4-week annualized growth rate is the best since early June. Remember, this is a leading indicator, looking well down the road. It forecast the current slowdown six months ago, and it is now firming, forecasting a leveling of growth end of Q1, early Q2 in 2007, then some (repeat some) acceleration. Recall that ECRI called the inflation top a year ago, and now we are seeing the very lagging actual inflation indicators begin to soften. You might say it was wrong, but ECRI measures pressures that result in inflation (inflation lags the economic cycle) not inflation itself. That way it looks down the road to see what is coming versus looking at inflation itself and seeing opportunities. Thus it saw the elements that result in inflation declining and made the call that the inflation bout for this cycle had peaked, and it is the correct call. Again, the problem is the Fed looks at inflation itself, at least in its public commentary, and that leads to the box the Fed has built around itself in terms of what it can do without looking indecisive to the rather uninformed public. Ironic isn't it? The Fed creates this fog around its policies so it can do as it wants, yet this very fog ends up restricting what it can do lest it upset the public and markets.
Is the economy still in bondage?
Always, always overhanging every economic discussion is the bond market. Specifically the bond curve inversion. It views the Fed as out of step if not out of touch with reality. The Fed Funds rate is 5.25%. On Friday the 10 year bond yield fell to 4.44% with the 2 year at 4.53%. It broke the key 4.5% on Thursday after the Chicago PMI hit, and it retreated further Friday as bonds rallied. That rally sent the likelihood of a Fed rate cut in March from 32% to start the week to 57% on Thursday and then 77% on Friday. At 4.44% the 10 year yield is 81 basis points below the overnight rate set by the Fed. So, you can in theory get more return agreeing to tie up your money overnight than you can agreeing to lend the government your money for 10 years. That is the definition of expecting a weaker economic future. That is one of the bond inversions that points to something way out of whack in the markets. The problem is, no one can agree upon what is out of whack.
The 2 year versus 10 year inversion hit almost 20 basis points just about two weeks ago. That is not good by any read. The inversion has already lasted long enough by historical standards to indicate a recession, and with that jump it was just about at the level that indicates recession no matter how long the inversion lasted. In other words there are two routes by which bond inversions can reveal recession. One is a small inversion over a long period of time. The other is a big inversion over a short (or long) period of time. With that spike close to 20 the bond market almost satisfied both. A move to 25 would have pretty much set the clock. Fortunately it did not make it that far and thus the continuing argument about what a smaller yet persistent inversion means for the economy (remember, Greenspan fostered the theory that foreign purchases were holding the short term rates higher; he is right to a certain extent, but even he could not say just how much it was impacting the short term rate).
Friday showed us other important change in addition to the 10 year yield breaking below 4.50%, however. The inversion between the 2 and 10 year bond narrowed sharply to 'just' 9 basis points. We say 'just' because after the Fed paused in August the inversion disappeared for a fleeting few sessions and hung around 5 BP for the longest time before it started the climb toward 20 through November. Friday both the short and long end yield declined, but the short end fell the hardest, dropping 9 basis points while the 10 year fell just 2 BP. That is closing the inversion, but of course what the Fed wants is the long end to rise to catch and surpass the short end because it wants higher real rates. It doesn't simply want the short end to win the race to the bottom.
Of course we don't care. The market is telling everyone who will listen that the Fed has rates pegged too high for the economy, and by keeping rates artificially too high it is only exacerbating the problem, meaning it is slowing the economy too much and thus cause rates to fall further. Kind of like the parable about holding the water in your hand: the more you squeeze the more it runs out and does you no good, but if you let it water a plant, quench the thirst of a bird, etc. it comes back to you with more bounty. The market is saying rates should be lower, and lower rates are good for business and earnings and thus the market. In the 1980's and early 1990's rates fell as the economy surged. If the Fed gets off this absurd 'inflation outweighs all other risks' kick and cuts rates 50 BP while keeping money supply reigned in as it is doing then we would have a boom. Quite frankly, the economic analysis you hear from the likes of Mr. Moskow simply borders on remedial Phillips curve analysis. In the 1970's we all received a textbook lesson that there is no linkage between economic activity and employment vis- -vis inflation, but the lesson didn't take with many. Moskow is one, and unfortunately this harsh stand against inflation that has already peaked (the battle is won) only prolongs how long it will be before the Fed actually does what it needs to do.
That leaves us once more in a race against time: can the market find the strength to continue to grow even with the Fed overhang while the Fed waits for inflation to fall below, and likely well below, 2%? At this stage of the economic expansion that is a taller order, and thus the conflict between bonds and other leading indicators.
THE MARKET
MARKET SENTIMENT
VIX: 11.66; +0.75. Friday we heard some more nonsense about the VIX being at record lows. It is not. It is low, but it was lower in late 1993 and early 1994. More importantly, it is important not to get a tunnel vision perspective of volatility, a.k.a. the caveman approach (Ugh. Volatility low. Market must fall. Ugh.). There are times when volatility can indicate a top or a bottom is approaching. Is this the case now? Unlikely. As seen in 1994, volatility can be low and then the market surges for oh, 6 years. Volatility is relative to what else is happening in the market. In 1994 the Fed was threatening to raise and then did raise rates. That kept a lid on everything including volatility. As the market rallied after that flat year, volatility rose as well. Thus we expect to see volatility rise before any real volatility-based problem arises in the market.
VXN: 16.6; +0.07
VXO: 11.44; +1.08
Put/Call Ratio (CBOE): 0.91; +0.14. Quickly up near 1.0 again on some selling and we note the overall ratio (combining all options markets) closed at 0.95 on Friday, even stronger than the CBOE.
Bulls versus Bears: Bulls have moved above the key 55% but this is not the best timing indicator. It is a warning to watch for distribution, failing leadership and the like.
Bulls: 58.5%. Bulls are jumping even more, posting another big gain from the already high 56.4% last week. Second week the bullish advisors topped 55%, the level where the market is viewed as overdone and some corrective activity can enter. It started to do just that Friday and Monday. A sharp jump from 52.1% the week before and closing in on the January peak at just above 60%.
Bears: Held steady at 22.3%, hovering just above the 20% level considered bearish. Sharp drop from 26.0% and flirting with the 20% level considered bearish. Well off the 37.1% hit in July (the highest level in this entire cycle). Hit a new post-2002 high in that late June move, eclipsing the March 2006 high (33%) and well above the 2005 highs that spawned new rallies (30% in May 2005, 29.2% in October 2005).
NASDAQ
Stats: -18.56 points (-0.76%) to close at 2413.21
Volume: 2.055B (-5.22%). Volume declined but was still above average as NASDAQ faded on the session. Not textbook distribution but another high volume session following the Thursday churn (as much money leaving as coming in), and that continues to show some unloading of tech stocks near term.
Up Volume: 541.631M (-649.369M)
Down Volume: 1.471B (+516.287M)
A/D and Hi/Lo: Decliners led 1.62 to 1. Not a wallflower negative breadth session but not a surge thanks to the afternoon comeback.
Previous Session: Advancers led 1.14 to 1
New Highs: 84 (-62)
New Lows: 24 (-14)
The Chart: http://www.investmenthouse.com/cd/^ixic.html
Once again NASDAQ tapped the July trendline and once again it rebounded though Friday it was unable to turn positive as it did on Tuesday. On the week NASDAQ lost ground gratis the Monday dump lower and the inability to gain enough traction to recapture the turf. Good to see it rebound off the trendline, but not good to require two relatively closely spaced tests (within the same week). NASDAQ's breakout is fresher than the NYSE large caps, but NASDAQ is also made up of large caps, at least for weighting purposes, and thus the SP500 drag is a drag on it as well. It too may need a test to the 50 day EMA (2357) to get things back on track for a new run.
SOX (-1.03) struggled and fell below 475, but not by a big margin. It is hanging in above the 200 day SMA (467) that is also above the 50 day EMA, and that is a key level as it attempts to continue its rather orderly consolidation.
SP500/NYSE
Stats: -3.92 points (-0.28%) to close at 1396.71
NYSE Volume: 1.877B (-4.76%). Volume fell on NYSE as well but it remained well above average and elevated over just about all of November. As with NASDAQ, a churn on Thursday and another ambivalent, high volume session Friday shows money leaving as fast as it comes in. This action often precedes some weakness when an index has rebounded and is sitting below a prior high or some resistance.
Up Volume: 668.29M (-549.568M)
Down Volume: 1.175B (+458.544M)
A/D and Hi/Lo: Decliners led 1.16 to 1. Pretty modest, helped by a positive close in the mid-cap sector.
Previous Session: Advancers led 1.79 to 1
New Highs: 242 (-131)
New Lows: 6 (-13)
The Chart: http://investmenthouse.com/cd/^gspc.html
A late rebound cut almost 11 points off the decline and left SP500 at the 10 day EMA on the close, not too far from the November high. Just a few weeks after getting a bit dicey in early November the large cap index is showing similar action. As discussed in the market summary, this is action typical in an extended rally and thus you would expect a pullback to the trendline or the 50 day EMA (1370). Thus far, however, SP500 has left a lot of tombstones for those trying to fight its uptrend.
SP600 (-0.45%) showed a similar intraday rebound off early selling that closed it right at the 10 day EMA. It tapped the October high on the session low and again rebounded, refusing to give up that level. Good action holding onto the breakout. As with NASDAQ, its breakout is 'fresher' and thus SP600 could weather the pullback in good shape and be ready for more upside once the pressure is off.
DJ30
Reached lower intraday again, posting a triple digit loss before the last hour rebound cut that to chicken feed. Volume was lower but above average on the action. The close left DJ30 down for the week and unable to retake the pre-Monday dump levels. It very much as the look of a failed relief bounce form that selling and the peak of the right shoulder to a small head and shoulders top formed over the past 6 weeks. That remains to be seen, but the action is definitely sluggish with some churn both on Thursday and Friday as money moved out as fast as it moved in. That 50 day EMA (12,010) looks more and more like the path of least resistance here. It needs the test.
Stats: -27.8 points (-0.23%) to close at 12194.13
Volume: 275M shares Friday versus 295M shares Thursday. Volume surged to end the week as DJ30 held steady below the November highs. That suggests there was some unloading and heightens the likelihood of a fade to test the 50 day EMA.
The chart: http://www.investmenthouse.com/cd/^dji.html
MONDAY
The big cheese ISM Friday helped stink up the economic picture some but of course it did not change the Fed's company line about inflation being our greatest risk. This week there is another passel of economic data culminating with the jobs report, though that has less impact than before and particularly since it is such a lagging indicator. Productivity revisions, factory orders, and the ISM Services will be watched along with more Fed-speak, dollar weakness, and oil watching. It is worth noting the return of oil stocks to breakout status just as oil started to push back over $60/bbl. After several months of consolidation they are back in the mix.
The market is tired from its run, and it is not receiving a lot of soothing news to help it catch its breath. An election and change of power, a Fed that seems not to acknowledge reality (at least outside its own alternate version), currency pressures, economic data slowing. You can add more, but that is enough. In truth the market can use a breather after a stronger than typical September and October moved the traditional run to New Years earlier on the calendar. Certainly another run higher from here brings a harsher day of reckoning, but we cannot discount another bounce attempt given that many strong stocks are at support levels and ready to try a bounce.
Either way the action has turned choppier, and that is an attribute of consolidation or the need to consolidate. With many stocks holding support we decided to look for a bounce up to test resistance and use that to close marginal positions, nearer term options plays, or any other play we don't want to hang onto. Of course we will have to gauge the strength of any bounce that occurs; this market has to this point littered its path with those trying to stand in its way.
That said, the path of least resistance seems lower, and on any bounce higher we will want to see some good action in order to take any new positions. We still see plenty of good stocks setting up in position to rally, and we are going to be ready to move in if this turns into just another momentary rough spot on the path higher. Our analysis of the technical position shows weaker action and the need for a rest, but the market has the final say. We just want to move in with caution and pick up really good buys on any further move higher.
It is a new month and new money will be put to work even with the market a bit toppy here. With the dollar weakening some multinationals are a consideration. Energy as oil continues its recovery, aided by OPEC's apparent determination to keep oil at $60/bbl or better. Healthcare is also picking up money. Metals are also doing well. We are also looking at some downside plays to take advantage of the path downside during the test. These will be good sectors to explore as the market works through this more volatile action.
Support and Resistance
NASDAQ: Closed at 2413.21
Resistance:
The 10 day EMA at 2427
2468.42 is the November 2006 high
2477 from January 1999
2493 is an interim peak from February 1999
Support:
The 18 day EMA at 2417 is trying to hold
2412 from June 1999 low
2395 is the July up trendline
2384 is an interim peak from January 1999
2379 is the October high.
2376 is the April high, the former post-2002 high
2368 is the early October handle high.
The 50 day EMA at 2357
2333 is the top of the Q1 2006 trading range (the January and mid-March 2006 highs)
2316 from interim tops in January and March 2006 trading range
2300 represents some price support
S&P 500: Closed at 1396.71
Resistance:
1401 is a low from April 2000
1408 is the November high
1410 is an interim high from March 2000
1420 is a July 2000 low
1425 is an interim high from November 1999
1444 from February 2000
1475 from peaks in December 1999 and January 2000
Support:
The 10 day EMA at 1395
The 18 day EMA at 1392
1390 is the October high.
1389 is a low from November 1999
1378 is a low from May 2000
1378 is the July up trendline.
1371 to 1373 is the December 2000 peak and the January 2001 peak
The 50 day EMA at 1370
1358 to 1362 mark a series of peaks from April 1999 to August 1999 high and the February
2002 low at 1360.
1354 from the early October consolidation
1339 is the late September closing high
1334 is an October 1999 peak
1326.70 is the May 2006 high
1324 to 1329 from the October 2000 lows.
Dow: Closed at 12,194.13
Resistance:
The 10 day EMA at 12,216
12,361 is the November 2006 high
Support:
The 18 day EMA at 12,195
October high is 12,167
The 50 day EMA at 12,010
11,986 is price support from mid-October and the early November low.
11,865 from the early October consolidation
11,750.28 is the prior all-time high
11,723 is the January 2000 closing high
11,670 is the May intraday high
11,642 is the May 2006 closing high
11,488 is the early September high.
Economic Calendar
These are consensus expectations. Our expectations will vary and are discussed in the 'Economy' section.
December 5
Productivity, Q3 revision (8:30): 0.5% expected, 0.0% prior
Factory orders, October (10:00): -3.7% expected, 2.1% prior
ISM Services, November (10:00): 56.0 expected, 57.1 prior
December 6
Crude oil inventories (10:30): -360K prior
December 7
Initial jobless claims (8:30): 320K expected, 357K prior
Consumer credit, October (2:00): $4.5B expected, -$1.2B prior
December 8
Non-farm payrolls, November (8:30): 115K expected, 92K prior
Unemployment rate (8:30): 4.5% expected, 4.4% prior
Hourly earnings (8:30): 0.3% expected, 0.4% prior
Average workweek (8:30): 33.9 expected, 33.9 prior
Michigan sentiment, Dec. preliminary (9:45): 92.5 expected, 92.1 prior
End part 1 of 3
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