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MORNING COMMENTS WEEK OF 7/12/99-7/16/99

 

7/16/99

The best of all possible worlds failed to excite in yesterday's trading.  The stock market rallied, NASDAQ and the SP 500 hit new highs, but it was a subdued rally with enthusiasm held firmly in check.

The S&P Futures made a new high, topping the key 1418 level, but the cash failed to top resistance at 1413, and resistance held on the Dow, Microsoft, and the long bond.

It was the bond market that was chiefly to blame for yesterday's muted reaction to better than expected economic data.  Bond traders briefly smiled following the release of June CPI, but upon closer look at the figures a few frowns broke out when traders realized that the largest contributor to the flat headline CPI figure was falling gasoline prices, a situation which has since reversed sharply.

The bond market has already turned its attention to the July inflation data, and the the possibility of an oil induced upward blip in the numbers, but the stock market remains jitter free, with its eyes firmly planted on last month's data, a situation which will likely persist for a few weeks, giving the stock market some breathing room as it tries to push higher.

The stock market's ability to push higher remains in doubt, however.  A spark is needed to elevate enthusiasm to the next level, and the possible sources for that needed spark are few and far in between. Microsoft's earnings on Monday could ignite a rally in the complacency laden NASDAQ, but the rally would have limited staying power as euphoria would be quickly be replaced by jitters ahead of the Pre-emptive Crusader's speech on the hill.

It is Alan Greenspan alone who can provide the necessary spark needed to send the broader market into orbit, and it is unlikely that Greenspan, with an eye on pre-empting inflation, will provide the market with the needed fuel to rally.  Inflation data since the Fed's rate hike has been tame, but the stock market has rallied sharply, increasing the risks of future inflationary pressures developing in this wealth effect driven economy.  It is the consumer confidence boosting, wealth effect producing effect of a surging stock market which remains the number one beast to be tamed in the war against inflation yet to come.

With Greenspan unlikely to offer the market the needed upward push, and complacency remaining at extreme levels, the risks remain to the downside.

The unexpected is likely to be the instigator of the next major market move, and the possible trouble spots where the unexpected will emerge from continue to multiply: from Argentina to China (Taiwan tension), from Iran back to China (this time in the form of a decelerating economy and a subtle shift in wording: the phrase "Read my lips, No devaluation" has quietly been replaced by "The balance of payments situation will determine the future course of monetary policy").

The widespread belief in the rosy scenario could be its fatal flaw.    

7/15/99

Today's close holds the key to the near term future of both the bond and stock markets.  The markets must overcome the twin obstacles of technical resistance and a lack of new recruits to the cause if the summer rally is to continue.

On the earnings and economic fronts all bets have been placed on the best possible scenario. With complacency running at an extreme level, and the majority of traders having placed their bets before the fact, the market's main obstacle to higher prices remains a paucity of new buyers entering the market.  The news has met expectations, and in many cases exceeded expectations, but no one is impressed: the news is already discounted.

The post bias change/pre earnings season rally's sustainability is now in doubt.  With bets already on the table, there is no one left to enter the fray on the release of positive news and bid prices higher.  From the institutional investor to the retail investor, there is an unwillingness to put new money to work in an environment where the maximum upside push of the positive has already been discounted.

Yesterday's market reaction to benign economic data painted a picture of a market that is in the midst of topping out and is ready to roll over and correct.  Enthusiasm is rapidly waning, and players are stepping to the side, with only a narrow strata of issues retaining the necessary momentum to push higher.   The usual warning signs of a top were all too evident yesterday: the failure of the long bond and the Dow to advance yesterday on the back of better than expected news, the continued pouring of money into the market's most speculative areas even as the broader market rolled over.

It is the narrowing of breadth, and the rally's reliance on the crowd pleasing large cap tech stocks and Internet issues for its continuation that is especially troubling. End of rally money traditionally gravitates towards the best known and most speculative issues as the last to the party rush in to buy from those going out the door.

The market must reverse its recent patterns of selling on the news and narrowing breadth in today's trading if the rally is to be sustained, and so far, the signs are not good that this will occur.  The bond and stock market's staged an initial sharp rally following the release of June CPI figures (which showed a less than expected rise of 0.1% in core CPI and a flat CPI figure), but have been unable to break through technical resistance.  The major averages have since given back the majority of their gains, and the long bond has now reversed with the yield rising to 5.913%.

The key numbers to watch at the close today are 5.89% yield on the long bond, 1413 on SP 500 cash and the July 12th high of 1418 on the SP 500 futures, and 11256 on the Dow. A failure to move above resistance by either the long bond or the SP 500 futures will significantly increase the chances of a near term correction.   We would also keep an eye on shares of Microsoft, a failure of the stock to break its April 6th high of 95.63 would be a negative non-confirmation of the current tech sector rally.

7/14/99

For a moment, fear dominated and Argentina took center stage, temporarily pushing thoughts of earnings yet to come and economic jitters to the back stage, but only for a moment.

The markets quickly regained their composure, with stocks recouping the lion's share of their losses and the bond market's flight to quality driven rally sputtering out.  Argentina quickly became a nonevent as the focus of trader's returned to the two E's: earnings and economics.

We wouldn't close the book on the Argentina saga just yet however.  The country remains caught between a rock and a hard place, plagued by a deepening recession and an overvalued currency.  A default is unlikely, but a devaluation after the October elections remains a real possibility.

For U.S. investors, a deepening of Latin America's economic troubles would prove to be a two sided sword. On the one hand, continued turmoil in Argentina would largely tie the Fed's hands. On the other hand, the positives of a Fed with its rate hike hands firmly tied would not be able to overcome the negatives of a serious downturn in a region which accounts for 20% of the U.S.'s trade.

While an immediate devaluation is not a threat to investors, events on the global front will likely have a chilling effect on the third quarter earnings of many U.S. multinationals. With Latin America sinking into recession country by country, European growth remaining in the doldrums, and the euro making a bid to enter the Guinness Book of World Records in the category of most consecutive new lows, the potential for a spate of third quarter profit warnings is increasing.

But that's in the future. For now, second quarter earnings and economic data remain in the spotlight, and the reaction to the better than expected continues to disappoint, both on the earnings front and on the bond market front.

Taking a cue from the recent reaction of stock market investors to better than expected earnings, bond traders reaction thus far to this morning's better than expected economic data has been to be net sellers, with yields on the long bond rising 0.01% to 5.92% as traders quickly turn their focus to tomorrow's CPI.   The key number to watch over the next two days is 5.89%, if bond yields fail to break below this level a quick return to 6% plus yields is likely.

While today's economic data was benign, with core PPI falling an unexpected 0.2%, we would not jump on the complacency band wagon just yet.   Oil is sitting at another 20 month high, a 20 month high that was not reflected in June PPI but will be all to evident in the July inflation numbers.

The Fed rate hike watch will continue to weigh on bond traders until the next FOMC, with the uncertainty beginning to spread to the stock market as this earnings season winds down at the end of the month. Goldilocks lives, but the jury is still out on how long she will remain.

7/13/99

The ingredients for a powerful stock market rally were all there: yields plummeted out of the danger zone to 5.91%, bonds staged a powerful rally, and earnings came in better than expected. The rally never materialized, instead stocks spent the day dancing with breakeven, with traders unwilling to make commitments ahead of this week's barrage of economic data.

The rally in the bond market failed to produce wide spread smiles on the faces of traders, perhaps because a bond market rally accompanied by the words "flight to quality" never does. Renewed concerns about Argentina's deteriorating economy and its ability to repay its debt prompted an 8.7% nosedive in the MerVal, and plunges in other Latin American markets.   As often happens when the specter of widespread regional panic rears its ugly head, the money fleeing Latin America found a safe haven in the U.S. treasury market.

We would not get to excited by yesterday's bond market rally, or view it as the start of a trend, moves prompted by a flight to quality have a way of reversing themselves when panic driven sentiment ebbs.  Yields reversed after touching support at 5.885%, adding another cautionary note.  The bond market's best hope for a sustainable rally remains this week's economic data, data which we believe is more likely to prompt a rise in yields, rather than a fall.

The stock market's non response to the fear driven bond market rally was to be expected.  A decline in yields prompted by a flight to quality produces uncertainty in the stock market, which translates into stagnant or falling share prices.  It will take a bond market rally sparked by a lessening of inflationary concerns before the stock market rallies on the news of falling yields.

Also falling in the expected category yesterday was the continued failure of better than expected earnings to cause a rally. With all bets placed on the side of the upside surprise beforehand, this earnings season continues to do its best job of providing a perfect textbook example of "buy on the news, sell on the rumor".

Yesterday's better than expected results by Ameritrade, like Yahoo's earnings last week, were met by selling in the Internet sector, an Internet sector which is looking increasingly like it is on the downside of a dead cat bounce.   Yahoo's failure last week to close above the 50% retracement of its April-June decline (see Today's Chart), and a corresponding failure by other prominent Internet stocks to clear their 50% retracement levels makes a retest of the June lows more likely at this point than a move to new highs.

Today, concerns over Intel's after the bell earnings release will put a damper on tech sector rally attempts.  In many ways, the earnings will be pivotal for the market. If Intel exceeds expectations and the shares fail to rally, the recent tech sector surge will more than likely be dead.

Earnings will dominate trading today,  but look for renewed worries about the global economy in the wake of Argentina's troubles and a weaker than expected German Retail sales report to exert a downward pressure on any rally attempts.  Tomorrow, earnings will once again take a back seat to the rate-hike jitters as the market is swamped by a deluge of economic data.

7/12/99

Think back to your youth, to that day when you were 5 that your parents told you that the circus was coming to town next month.  Your excitement built, and built, right up to the anticipated event.  The day finally arrived, the circus was attended, clowns were laughed at and popcorn consumed, and then, after the circus was over , the inevitable dissipation of  emotional extremes built up in anticipation of the event occurred.

The key question facing the stock market as we enter the week is whether the reaction of investors to the news, in specific to this week's heavy calendar of earnings releases, will continue to emulate the reaction of the child to the circus: a big emotional build up before the fact which climaxes at the event, and then a let down as sentiment which has already reached its zenith has nowhere to go but down.

Last week's initial earnings season returns, and the subsequent reaction of investors to them, bode ill for the durability of the current summer rally.  The extremes in sentiment built up in anticipation of this earnings season make the scenario of buy on the rumor (which investors did, bidding the SP 500 up 6.7% and NASDAQ up 9.4% in a two week span), sell on the news a far more likely outcome to this week's slate of releases than the scenario of buy on the rumor, buy still more on the news.

We would pay close reaction to this week's tech sector earnings, where anticipation has been the greatest and the potential post event let down is the greatest, for clues to the market's ability to move higher.  Intel will have to exceed its much whispered whisper number tomorrow if the recent stampede into the top tier tech stocks is to continue.  Anything less would be an excuse for rampant profit taking in the sector.

We would also keep an eye on the Internet sector which is at a pivotal technical point following its post May rate-fear jitters runup.  The rapid recovery of investor sentiment towards the sector has left expectations at a fever pitch where even the slightest disappointment can be devastating.  Today's Ameritrade earnings will kick off the flurry of this week's Internet releases, and they will need to surprise on the upside if they are to counter the negative blows that were dealt to investor's sentiment towards e-commerce and online brokerage stocks over the weekend following outages at E*Trade and eBay.

Second quarter earnings anticipations are not the only area where investor sentiment has built to an extreme level however.  Expectations for a continuation of the present strong economic growth, benign inflation outlook are also at an extreme of positive sentiment, an extreme which could be tested by this week's economic releases.

While we expect no major surprises from either the CPI or PPI this month, it should be remembered that Friday's 22 month high in the price of crude oil has yet to filter down to the consumer level, and could spell trouble in future months if oil remains at current price.  The one report we would keep our eye glued to, and the one which has the potential to hasten the return of the Jitters from their two week sabbatical, is the Retail Sales report.  Last week's strong same store sales numbers, and the continued climb in consumer sentiment numbers, make the potential of a stronger than expected Retail sales report a strong possibility.

Selling on the news, a potential return of the jitters, and a level of complacency which has driven the VIX down to last July's pre-market selloff levels, mean that the potential for a sentiment denting letdown broad siding the summer rally continue to increase with each new high by the major averages.

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Last modified: April 02, 2001

Published By Tulips and Bears LLC