- Typical pullback on Thursday becomes a typical tail kicking on Friday.
- Friday economic data closes out a week and month showing a weakening picture.
- Market trying to discount an economic recovery, but will have to hold the January lows to do so.
- Commodities take a breather, setting up a new buy opportunity.
Bad news, end of month, end of the recent leg higher.
Whatever was typical about Thursday's pullback is academic. Friday was a rout. Okay, that is out of the way. After leading the market with a surge higher, energy, agriculture and commodities were ready to take a breather after their run. That took a major upside force in the past week's rally off the table. Strike one. There was some bad news from the mortgage sector in the pre-market as USB predicted another $600B in write-downs still to come versus the $160B expected. The ABK bailout deal that sparked last Fridays short covering rally and the start of this week's rally hit . . . surprise . . . a snag. That started things on the downside. Strike two.
After the open some weak Michigan sentiment data (70.8 was better than the 70.0 expected though less than January's 78.4) and some really bad Chicago manufacturing data (44.5 versus 49.5 expected, 51.5 prior) really got the selling going with a dive right off a cliff. Strike three.
That was not the end of the action, however. The market tried a three hour lateral consolidation, even moving up and showing signs it might make a run into the close. Nope. With a couple of hours left the selling renewed with another big leg lower. Another bounce attempt, another leg lower. Then it got really ugly in the last hour.
The sellers finally came out from hibernation, pushing the market lower on rising volume and quite negative breadth. Of course it was the end of the month and that usually has one of two effects: an exaggerated move to the upside or an exaggerated move to the downside. Pretty clear what it opted for Friday. Maybe a leap year thing.
TECHNICALLY it was as ugly as it seemed. A lower open, some selling, a consolidation attempt, then some more selling. Little doubt this is what you would classify as a negative session, more bearish than bullish.
INTERNALS: Massively negative, and if they keep doing this you could start calling it extreme. -6.3:1 breadth on NYSE, -3.6:1 on NASDAQ. When the leaders of late took a break, the negatives really piled up. Volume jumped as well, moving above average for the first time in three weeks. Just had to be on a downside session, meaning some distribution, i.e. the sellers were stronger than the buyers. They were a lot stronger than the recent buyers. As noted above, some of this had to do with the end of the month jacking up the trade. Keep that in mind as next week unfolds; if things recover nicely then chalk it up to end of month activity. If it doesn't, well then it really won't matter.
CHARTS: A hard break lower but even with the 2.5+% losses the indices still maintained their trading ranges and are above the February lows. Sure they gave up the break higher out of the short lateral consolidation, not to mention the consolidation itself, but they are still in the trading range above the February lows, at least for now. A big chunk to the downside was taken, and it is interesting to note that the large cap indices all made a short double top the past three weeks immediately preceding the Friday break lower.
LEADERSHIP: Most of the leadership for the past two weeks decided to take a break. Energy, metals, agriculture and commodities in general tested back. They had held the market up, and when they went off their feed the market struggled. It did more than that as described above. The selling snowballed with the end of month effect. Leadership is making a pullback, something it needed to do. If the market can hold above the prior lows in February or even January then the leaders in commodities, ag, etc. will present us some good buys. If the indices cannot hold then even the leadership is going to be tested.
Friday data caps a week of continued eroding economic activity.
The PPI was hot thanks to our boondoggle into ethanol that is taking wheat acreage out of production to feed ethanol, consequently helping triple the price of wheat. Even without food and energy (after all, man cannot live by wheat bread alone) PPI was still stoked. While the PPI was hot, consumer sentiment was not, still above surefire recession levels, but declining at a pace that that indicates recession is coming. Durable orders were down 5%, housing sales were lower than expected, and jobless claims jumped to 373K, showing the rise is not a fluke due to adjustments.
Friday data presents good and not so good.
Friday the personal spending and income figures were better than expected, and the PCE rose in line with expectations leaving the year over year core at 2.2%. Something of a relief given the stronger CPI and the jumping PPI on Monday.
After that the data was not so friendly. Michigan sentiment final showed 70.8, a bit better than the 70.0 expected, and rebounding from the 69.6 previously reported. Still heading too low, too quickly.
Manufacturing is struggling.
While the US economy is not the manufacturing giant it used to be, it is still no slouch. Thus when the manufacturing sector climbs or falls it is worth taking notice. Back in 2002 manufacturing was a key leading indicator. It started to firm and even improve ahead of most anything, other than the market.
Over the past four months the regional reports and the overall ISM have softened considerably. Sub-50 readings started to surface. There were the usual suspects that were weak, namely the Philly Fed. The weakness has spread, however, with the national index showing a month below 50 and now Chicago moving below that level as well.
It was not just a move lower, it was a plunge from 51.5 (hanging on) to 44.5. That is the lowest level since late 2001 when the economy was trying to bottom. Every component to the report was at contraction levels except the prices paid (of course). New orders actually rose to 48.8 from 44.7. Production fell to 46.5 from 51.3. Employment continued tanking, falling to 33.5 from 47.0. It has been below 50 for three months now.
Chicago is considered a harbinger of the national number, and after that 50.7 showing nationwide in February, expectations are the national number will fall below 50 again. Again, manufacturing is key as we learned in the last recession when the consumer remained healthy but businesses, burdened by a huge overhang with inventories and a collapse in venture capital, did not invest for three years.
Thus we don't want to see business sentiment (that is what the PMI reports are) become firmly entrenched. That would mean a longer recession and that the economy is still on the downswing and not ready to bottom.
Market discounting economic improvement or just a bounce higher in continuing selling?
That is what is being decided right now. The market sold hard in January and then bottomed into this lateral trading range here in February. Some believe the January lows were the bottom brought on by unusual circumstances relating to the rogue trader in Europe. Right. Nothing to do with the mortgage crisis, credit crisis, slowing economies, surging oil, food or commodity prices.
The market made a recovery, but as we have noted, the move was on low volume. Not bad for a consolidation, and even with the Friday selling the indices are still in their trading ranges for November. Moving toward the bottom of those ranges, but still holding in them for now.
They are also still well above the January lows though with this kind of selling they will get there without too much effort. If they hold and can move back up and continue the base, that indicates the recession is not going to be that deep and the market is already discounting the bottom of the rather shallow decline. If the prior lows give way with a serious break lower, then the clock starts again for a market recovery, and it also indicates the economy has not bottomed and has further to decline.
Either way there is more work to be done near term before the current market condition and thus the economy show there hand. It is a stretch to believe that the slowdown seen thus far and maybe a bit more through summer is all we are going to get out of such a huge housing bulge that is deflating, a credit freeze, inflation, surging oil prices, and election, and worries of protectionism, tax hikes and more regulation.
By: Jon Johnson, Editor