- Stocks fade into the weekend on the same low volume that got them there. - Oil price rise part dollar, part demand. Does that make it different this time? - Dollar starting to rise despite administration desire to keep it low. - Stocks rally modestly ahead of earnings but initial results getting no respect. - Earnings swing to full speed just as indices reach near term peak.
Stocks turn back after low volume bounce with a low volume fade.
It was Friday and that means a weekend, and after a four day bounce in this market, that meant a pullback. Stocks feinted north at the open on some middling futures action, holding positive for the first half hour. There were some good earnings (STZ), some positive guidance (ELX), and some negative guidance (LAB, WEBM), but stocks were ready to rise anyway. Perhaps the continued decline in oil ($53.32/bbl, -0.79) was having its impact, but if that was the driver behind last week’s move, it was not that great a power as volume was extremely weak the entire move.
Whatever the culprit, it did not last long. Stocks turned over after the first half hour and started on a session long trend lower. The reality of the session was stocks had rallied four straight days on low volume, had reached resistance levels, and were ready for some selling ahead of the weekend. Stocks sold all day, and by the close had given back the Wednesday and Thursday moves. Small caps were the downside leaders with a pretty nasty break down from the 50 day EMA. SOX was the relative strength leader as it held steady but could not hold a move above its 50 day MA.
Volume remained low, finishing with the lowest volume of the week. Pretty apparent that the sellers were not surging back in to feast on a low volume relief bounce. Breadth was pretty darn ugly, however, at better than 2:1 on both exchanges. SP500 had just 66 advances versus 426 declines, DJ30 had 28 decliners. The scenario was the same throughout the market. Coming off a peak after a week long rebound, that kind of breadth is atypical. Lots of smaller oil and gas stocks, steel stocks, and cyclical stocks contributed to the weak showing, but the big names were there as well. This kind of heavy negative breadth off a top is almost as bad as a volume surge on the selling.
Almost. Volume was very low as stocks rolled back some of the gains. The general rule is that low volume rises or falls don’t have much significance because they show just a small part of the market participating. It would only take a few more buyers or sellers to dramatically change the result of a low volume move. The move higher was on low volume, and it was a steady, sustained advance that seemed to have nothing to get in its way. Friday the selling was steady and sustained as well. Stocks can sell off a low volume gain on low volume just as easy as with higher volume. It may not show the return of share dumping, just a continuation of the low volume consolidation work continuing.
In short, the 4 days to the upside does not automatically gain more strength simply because it sells back on low volume. It was a weak move up and if the buyers don’t step back in, it will be followed by a weak move down (if the sellers don’t pile in). That action shows that without any new catalyst, the market is not ready to make any strong upside move but still trying to change from distribution to accumulation. To produce more upside the market will have to avoid hard downside this week, make a higher low, and find some strength from a catalyst such as earnings.
THE ECONOMY
Is it different this time with oil?
With a cartel in control of much of the world’s oil supply there is always a lot of posturing with respect to price. OPEC wants price high enough to provide it a high return balanced with keeping the western economies strong enough to require a steady supply of crude. The west wants prices low enough to promote their economies as well.
There has been some posturing as well during this run such as when oil was ready to roll over in a head and shoulders pattern in late 2004 before Saudi said OPEC was ready to cut production without warning if prices continued to fall. That helped forestall a breakdown and bought enough time for heating oil supplies to dwindle and lead the current spike in prices.
There is unprecedented demand as well, however, with the Chinese and Indian economies surging. They are competing with the US, Europe, and Japan for a large share of the world oil supply. After Saudi Arabia tried to drive all marginal producing countries out of business in the early 1980’s, the world’s source of supply has contracted. The US partied through the 1990’s on low oil prices, refusing to put together an energy plan. The current administration started refilling the strategic petroleum reserve when oil was in the thirties; one wonders why it was not filled to the brim during the lower prices of the eighties and nineties, but we all know the answer. Not until prices surged past $50/bbl this year did Congress finally act to open some of the richest US acreage ever.
Supply has thus waned while demand has burgeoned. That is the price of a steady spread of freedom in the world. Not a bad price to pay, but you have to plan sensibly for it. ANWR should have been explored long ago and readied for production. We are not advocating draining the US first, but it would have been a huge strategic advantage to have the ability to deliver 1M bbl of crude per day from that area, half of what we currently use each day. It can do that for twenty years. Huge, huge, huge strategic advantage . . . that we don’t currently have.
Many are saying that since oil prices are demand driven, this time around it is different from the 1970’s, early 1980’s, and early 1990’s when oil spiked and recessions followed. The theory is that because the economies are steaming along so well higher prices won’t hurt because everyone is making more money to support the prices. They point to continued strong consumer demand, business investment, home sales, business construction, etc. as proof that higher prices are not stifling demand. They liken it to rising interest rates: rising rates are a sign of economic health. As an economy recovers rates rise because there is more demand for money and more demand is anticipated down the road. Thus rising rates are not necessarily indicative of trouble ahead.
Everything must be in moderation, however. There is a point where higher prices, no matter how strong an economy or market is, will cause trouble. At some point the incremental increase is too much and consumption starts to decline. VP Cheney says the US can function at $60/bbl. The Fed has said it would take $80 to $100/bbl to impact the economy. The market does not act as if it agrees with the latter, but we are close to $60/bbl and the economy has, as of yet, not shown major wear and tear. It is often said that higher energy prices are a tax. Just as there is a point where taxes get too high and stifle investment, prices get too high and stifle consumption. Maybe the economy can handle oil and gasoline prices at these levels indefinitely (a dubious hypothesis), but if they continue to rise the point of economic sustainability will be met. Either by a function of time at a high price or a continuing increase, the critical point will be hit.
There is another aspect to continued demand driven price increases. Demand-led increases in price are inflationary. OPEC production cuts are not market forces at work so it was always preposterous for the Fed to take them on with rate hikes. Rate hikes won’t cause OPEC to lower prices unless the hikes stall the economy and significantly cut energy usage. In the 1970’s the Fed responded to OPEC embargos and production cuts with rate hikes. We benefited from the worst bear market since the Great Depression, stagflation, interest rates at 20%, high unemployment, and of course, high oil prices.
It is a question of supply and demand, and after Saudi drove many producers out of business in the 1980’s and regulation strangled any serious domestic exploration and refining capacity increases, supply is now not able to meet demand, particularly for refined products. We have discussed at length in the past how supply has to be able to meet demand in order to avoid inflation. We agree 100% that growth is no problem IF supply is unfettered. If you have supply you have growth without inflation. If supply is hamstrung by regulation and controlled markets you restrict capital flows and investment and thus get supply and demand imbalances. Years of OPEC, no domestic energy plan, and heavy regulation have left us in a position where demand is not a great thing because supply cannot match it.
Thus this demand driven price increase is inflationary, and there is no near term solution because it takes a long time to find, drill for, and then produce energy supplies. It will take a slowing economic demand to help supply catch up, but you are talking 10 years before significant finds can be made to ramp supply higher. During that interim period there will be a time when that critical point is hit and the world economies have to cool off.
The dollar suddenly looks a bit golden.
The US energy problems have only been exacerbated by a falling dollar. As the dollar falls each barrel of oil becomes more expensive for the US. We will get to that critical point of consumption and economic fall off before other non-dollar denominated economies if the dollar continues its slide as oil continues its demand driven rise. That means the energy price rise is skewed even more harshly against the US. That makes others smugly happy around the world (enemies and some allies as well), but a weak US economy is good for no one in the world. As we have discussed before, the US sucks in most of the world’s goods, and if the US is not there to buy, the entire world suffers. That is why so many are so willing to buy so many dollars in order to support the US trade gap.
There is, however, a change in the winds. The new, tougher Fed that is talking about a faster pace of rate hikes is helping raise real interest rates and that is one front strengthening the dollar. Higher rates mean a better return from safe US debt instruments; that attracts foreign capital buying dollars.
The first rate hikes bumped up the dollar, but that did not last for long. The recent ‘get tough’ talk from the Fed, however, is having an impact. It has not raised rates any faster, but the Fed is has been able to talk up the dollar by the half-promise it is going to get serious about controlling inflation. Thus the dollar has been on a slow rise versus the euro and the yen. It is at a critical point right now as the US dollar index approaches the February high and the 200 day SMA. It has been unable to sustain a move above the 200 day SMA since it broke below it in the first half of 2002.
There is more than just Fed talk helping the dollar. France is selling 60 metric tons of gold to buy dollars. France sells gold every year. Last year it sold 40 tons. It plans to sell 500 to 600 tons over the next five years. What is interesting is the dollar buy. France is selling gold at a time it feels it can maximize its gain, and it is buying a depressed asset, dollars. You try to sell high and buy low, and the French actions are often indicative of what other nations are doing as well. That is a positive for the dollar, but it is still a ways from panning out.
For now the dollar is at a critical point and the US is paying more for its energy while it struggles. While a lower dollar may help the trade imbalance, a lower dollar also helps create the trade imbalance because it takes more and more dollars to buy the same amount of oil.
THE MARKET
The market may have made its move higher too early. They rose ahead of earnings, before earnings really got started. The first results are not helping with the market volume still low and some pretty hefty point selling Friday. Better to have held off on the rally and then be pleasantly surprised than to rally and then hope earnings exceed expectations.
Overall volume was poor last week as the market rallied. The market was not without leadership, however, as some defensive medical and healthcare stocks posted good volume moves even as the energy, steel, materials, and cyclical stocks turned in a mixed week. Overall it was spotty action with respect to leadership. Some good moves were made, some started but reversed, and others are still out there, ready for a catalyst. You naturally think of earnings to provide the boost, but as noted, the early returns are not providing much push, even for the stocks that are reporting strong results. It is not a great sign when a company reports good results or significantly boosts guidance and gets ignored or worse, sold off. ELX raised its guidance Friday, gapped higher, but then finished the day lower on high trade.
The small caps tanked hard from the 50 day EMA, though with the light overall volume it is hard to call the fall ‘hard.’ It was another clean break lower, however. SP500 fell back from its 50 day EMA as well, easing just below the March 2003 up trendline. We were looking at the 50 day EMA as SP500’s target on a rebound when it started higher two Wednesdays back. Now it has made that move and the issue is whether volume starts rising on any further pullback.
Thus far Friday was just a low volume turn back, though one that showed crappy internals. SOX even showed some relative strength, with just a modest loss after bounce off solid support Thursday. There are still positives, but overall the low volume move higher has not reversed the prior distribution. The market has avoided recent heavy volume selling and is working off the hangover from that prior distribution. Indeed it tried to follow through last week but had no volume, no real backing. That was a start, but it still has more work to do before it puts together a sustained move. The odds of further selling are higher now than a strong upside move unless earnings really supply a catalyst.
Market Sentiment
Bulls versus Bears: Bulls fell once more last week, this time a solid 3.7% drop to 47.9% (51.6% prior). That is the lowest reading since September 2004 as bullish sentiment was rising off the late August 2004 low at 40%. Bears rose as well, moving to 29.2% from 28% the prior week. Back in August 2004 bears only made it to 30% with bulls at 40%, and that was enough to trigger the NASDAQ rally to the end of the year. Another pullback in the market could very well push bullishness down to matching levels and bearishness above 30%. That would be a big step closer to finally getting sentiment in line for a more sustained upside move.
Put/Call Ratio (CBOE): 0.93; +0.24. The ratio has been higher the past month, back up in the nineties Friday. A reading at that level was enough to give interim rebounds in 2004, but this far in 2005 it has not worked.
One thing we do note is that put prices have started to climb the past month. It is harder to find the right combination of pattern, option price, and option delta to give you a comfortable return for the risk. That is an indication that there is a lot more interest in put options. During a strong bull run you pay more premium for call options while getting a smaller delta. This is particularly true on the ‘hot’ or popular stocks. The market makers know what the options buyers want, and they price them to make them really have to pay for what they want.
Same with the downside. When more start looking to the downside as the put/call ratio has shown the past month, the market makers put the ‘shift’ on to make puts more expensive and return less. We have to cull through many, many potential downside plays to find the right combination of elements to give us the advantage and make the best return the fastest when the stock moves our way.
What does this mean? This is a contrary indicator just as the put/call ratio. Sentiment indicators are all about extremes, all about herd mentality. When most of the crowd believes or is acting the same way that typically indicates the end of the move is nearing. Unfortunately it is not a great timing device but more of a warning sign to watch for other indications of change such as pattern and price/volume action. Of late we have seen the distribution wane as the indices try to move more laterally and on lower, quieter volume. That is a real change coupled with a sentiment shift. It suggests there is indeed change trying to take root.
NASDAQ
NASDAQ turned back well shy of its 50 day EMA, but it easily held above the 200 day SMA Friday as volume backed way off. NASDAQ may have given back the move out of the lateral consolidation, but it is still showing a good lateral move on almost all below average volume.
Stats: -19.44 points (-0.96%) to close at 1999.35 Volume: 1.525B (-11.04%). Volume was the lowest of the past two weeks as there was no distribution, just a complete lack of buying interest. Volume has only cracked average one time in the past 3 weeks, and that was the start of the month with a pretty nasty selling session. Other than that, however, volume has been low as NASDAQ has churned sideways. That is consolidation action, and despite the Friday fade it is still working to set up the next move.
Up Volume: 382M (-946M) Down Volume: 1.11B (+741M)
A/D and Hi/Lo: Decliners led 2.19 to 1. Not good breadth. Indeed, bad breadth. Good thing volume was as light as it was. Previous Session: Advancers led 1.59 to 1
New Highs: 36 (-19) New Lows: 71 (-10)
The Chart: (Click to view the chart)
NASDAQ finished Thursday in the neutral zone between the 200 day SMA (1993) on the downside and the 50 day EMA (2033) on the upside. It did not like that much and immediately turned back to the 200 day. It has been rather comfortable at the 200 day SMA, using that level as its homing beacon during this second attempt to consolidate the 2005 selling. It failed the first 6 week try in early March, and is trying once more. It is still a long way from putting together any solid looking pattern, but with some of the other indicators coming into line it could be ready to lead higher just as the other indices make pretty nasty falls. SP500 and SP600 could continue their falls, get sentiment indicators jumping, while NASDAQ continues its consolidation. Then techs would be ready to lead higher. Nice theory. Will have to prove it.
NASDAQ 100 managed to hold its 200 day SMA as it fell back as well. Similar to NASDAQ it is between the 50 day and 200 day SMA and trying work laterally along the 200 day.
SOX held up very well compared to the other indices, rallying over the 50 day EMA (419.54) intraday but then giving it up with a 2 point loss on the close. AS with the other indices it is still far from a decisive move but it is working laterally over key support at 410, a level it has refused to give up.
SP500/NYSE
SP500 made it up to the 50 day EMA Thursday and then turned completely over and gave everything back from the prior two sessions.
Stats: -9.94 points (-0.83%) to close at 1181.2 NYSE Volume: 1.328B (-10.88%). Despite the rumors on the floor, there was volume on NYSE Friday, but it was the lowest since Valentine’s Day. Thus there was no conviction in the selling, just a complete abatement of the buyers from earlier in the week.
Up Volume: 374M (-940M) Down Volume: 1.267B (+718M)
A/D and Hi/Lo: Decliners led 2.51 to 1. Very poor breadth as the small caps led the selling. Coming off a recent bounce this breadth is not a good sign. Previous Session: Advancers led 1.72 to 1
New Highs: 62 (-28) New Lows: 40 (+18)
The Chart: (Click to view the chart)
The large caps made it to the 50 day EMA (1189), the logical point we noted a couple of weeks back. It turned over at that level Friday and sold back through the March 2003 up trendline (1183.50) as well. Low volume so there was not a lot of conviction in the Friday rollover. The pattern, however, is rather ominous if volume does emerge to the downside. A 10 week head and shoulders pattern with a lower right shoulder if Thursday proves to be the high. That suggests an even stronger downside move, but with the 200 day SMA (1152), the extent of any fall would have some support to slow it. SP500 can sell without the volume, but continued low volume most likely just puts it back in its recent range as opposed to taking it substantially lower. Right now it looks set to come back and test the 1175 to 1165 range from late March, a level that also marks the January low (1163).
The small caps ran from the 50 day EMA (323) like a scalded dog Friday, leading the market lower and easily falling through some pretty key support at 320. As with SP500, it has formed a 10 week head and shoulders with a lower right shoulder. That is setting up a deeper fall. Near support is at 316 from the March low and then a pretty solid band at 310.
DJ30
DJ30 rolled over as well, stalling at the 18 day EMA (10,532), never making the 50 day EMA (10,602). Very, very low volume as with the other indices, and it is also close to support at the 200 day SMA (10,380) and the January low (10,368). With the low volume and near support it has a good chance of holding and then trying to put together another consolidation over the 200 day.
Stats: -84.98 points (-0.81%) to close at 10461.34 Volume: 201 million shares Friday versus 283 million shares Thursday.
The Chart: (Click to view the chart)
MONDAY
Economic data returns this week along with earnings reports. The latter starts hitting its stride this week. Thus far the returns have been underwhelming, but it is early. As for the economic data, the retail sales will garner much of the attention to see what result higher energy costs are having. The Michigan sentiment prelim is out Friday, and while worthless, it is watched by the market. Again, another look at how the consumer is feeling about high oil prices.
With the market posting a rally last week ahead of earnings and then starting to fade it needs a catalyst. Earnings could be that catalyst. Expectations have cooled considerably as to how much growth they show. Q1 expectations are 8 to 8.5% growth versus Q4’s 19.7% vault higher. If they start coming in stronger and have good things still to say about the future that would be the trigger.
There is still a lot to overcome, namely some pretty ugly patterns in SP500 and SP600. The distribution has stopped for now, and basically the indices are trying to shake free in a low volume lateral move that just happened to have some up sessions last week. As long as the trade does not jack up this week as it falls back it is still working on the consolidation and strong earnings could break it higher.
We still feel that is a pretty big could at this juncture. Lots of overhead supply in the large cap and small cap indices still needs to be worked off. As noted above, NASDAQ is in one of the better consolidations as it is really moving laterally and has not shown as much distributive action as the NYSE indices. It has lagged all 2005 but its action is setting up an upside move even as the other indices look ready to roll over.
That remains to be seen. We anticipate a further pullback this week into the range where stocks will try to hold and continue to consolidate. There are still many leadership stocks in very good position even after the move higher last week, and a pullback could set them up for another move.
The move higher has also set up some of the weaker stocks at resistance, ready to resume their downtrends. We will be looking at those for some nice downside moves and will look to add to some existing downside positions after the bounce last week. As noted above, despite the weakness, finding the right combination of pattern, option price, potential downside movement, and delta to give us a fat, comfortable return is getting more difficult based on put option pricing changes. For example, index option prices have jumped while their deltas have shrunk. That means more movement to get the same return.
With put options we like to get in and out relatively quickly, and we like to play single moves down. For example, a stock will break through key support, test it and then start to trend lower along the 10 or 18 day EMA in roughly equal moves lower. We like to catch a put play as it starts down from that resistance and capture that move lower before it makes the rebound to next test the 10 or 18 day EMA. We want to the play to have the potential to capture a 40% gain, more or less, on that move. We run each downside play through the our formulas to make sure it fits our criteria and then choose the best patterns. It is more difficult to finds those right now, but again, there are still some nice downside plays available.
Support and Resistance
NASDAQ: Closed at 1999.35 Resistance: The 50 day EMA at 2033 The 50 day SMA at 2042 2050-54, prior resistance and the June high is stronger 2066 to 2070, the bottom of the January lateral move. 2100 from February and March. January high at 2154 (early 2004 high)
Support: The 200 day SMA at 1993 Early October high at 1971. Late 2003 highs from 1960 to 1970. 1954 from October as well. 1921 at the September 2004 highs.
S&P 500: Closed at 1181.20 Resistance: March 2003 up trendline at 1183.50 1185, the top of the November consolidation range. The 50 day EMA at 1189 The 50 day SMA at 1193.89 1196, the mid-January high and the early December peak in the left shoulder. 1200 Q1 1999 lows at 1215 December high at 1218.
Support: 1175 second high in that double top that spanned late 2001 and early 2002 is being boxed around of late. 1163 is minor support. 1154-1157 tops from early 2004. The 200 day SMA at 1152
Dow: Closed at 10,461.34 Resistance: The 18 day EMA at 10,533 Price consolidation at 10,600 The 50 day EMA at 10,602 The 50 day SMA at 10,659 10,754 is the February high 10,868 from the December 2004 high. 10,975 - 11,000 from Q4 2000, Q1 2001
Support: 10,400, the bottom of the November/December range The 200 day SMA at 10,380 September high at 10,342.
Economic Calendar
These are consensus expectations. Our expectations will vary and are discussed in the ‘Economy’ section.
April 12 - Trade Balance, Feb (08:30): -$59.0B expected and -$58.3B prior - FOMC Minutes, March 22 (2:00) - Treasury Budget, March (14:00): -$70.5B expected and -$72.9B prior
April 13 - Retail Sales, March (08:30): 0.7% expected and 0.5% prior - Retail Sales ex-auto, March (08:30): 0.6% expected and 0.4% prior
April 14 - Initial Jobless Claims, 04/09 (08:30): 330K expected and 334K prior - Business Inventories, Feb (08:30): 0.5% expected and 0.9% prior
April 15 - Export Prices ex-ag., March (08:30): 0.1% prior - Import Prices ex-oil, March (08:30): 0.2% prior - NY Empire State Index, April (08:30): 18.3 expected and 19.60 prior - Industrial Production, March (09:15): 0.3% expected and 0.3% prior - Capacity Utilization, March (09:15): 79.6% expected and 79.4% prior - Michigan Sentiment-Prelim., April (09:45): 91.9 expected and 92.6 prior
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