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Jubak's Journal
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| | Jubak's Journal
Will the year-end rally survive October?
Expectations for a rally have taken a beating in the last week. There's still great potential for year end, but only if these stars align.
By Jim Jubak
Coming into this week, I thought wed turned the corner: The market looked like it was going to get out of October without major damage and that it had set itself up for a major year-end rally.
And now . . . well, frankly, Im looking for more confirmation before I put any more money to work in this stock market.
I felt sure of that rally until 12:50 p.m. on Wednesday. At that point the Dow Jones Industrial Average ($INDU) was down 38 points, while the Nasdaq Composite ($COMPX) was up 7 points. With investors selling off big year-to-date winners in energy and basic materials, the market looked like it was making that turn in leadership thats necessary for a year-end rally.
And then the signs got darker. The Dow plunged more than 100 points intraday and it took the Nasdaq along with it. Suddenly, a week that I thought would confirm a future rally was instead raising new doubts. (And it certainly didnt help that the next day, the Dow fell another 100 points.)
If stocks can muddle through the next two or three weeks and, despite oil prices well north of $50 a barrel, get out of October without major damage, then investors can start to let visions of sugarplums dance in their heads. If not, if October inflicts significant damage on the indexes, then its coal in everyones stockings for year end.
Yes, but
I still think the odds are in favor of a late rally. But the market could still tip either way at this point. Heres how I lay out my yes, but odds for a rally.
Yes, it appears investors are rotating out of the year-to-date winners into lagging sectors. Here are some of the big, high-volume losers from Wednesday: AK Steel Holding (AKS, news, msgs) down 9%, Phelps Dodge (PD, news, msgs) down 10%, Southern Peru Copper (PCU, news, msgs) down 11%, Oregon Steel Mills (OS, news, msgs) down 10%, Nucor (NUE, news, msgs) down 5%, Steel Dynamics (STLD, news, msgs) down 8%. The steel and metal mining sectors have been among the strongest sectors this year. Energy minerals and non-energy minerals were in fact the strongest sectors of the market as of Oct. 11, according to the Erlanger Squeeze Play.
But it's less certain that investors are rotating into technology, which needs to take a leadership role if theres going to be a year-end rally. On Wednesday, technology leaders Intel (INTC, news, msgs), Yahoo! (YHOO, news, msgs), and Applied Materials (AMAT, news, msgs) were all up despite the Nasdaqs dip. But they didnt show stunning strength, with gains of only 3.8%, 2.4%, 3.8% and 1.6%, respectively. Even more troubling, 1,177 stocks advanced on the Nasdaq for the day, but 1,841 fell. While better than the 1,050-to-2,195 advance-decline ratio on the New York Stock Exchange, it was, nonetheless, a down day. And after moving up from the bottom of Erlangers sector strength rating, technology service and electronic technology stocks had moved back down near the bottom, ranking 12 and 14 out of 18 sectors.
Yes, the stock markets very choppiness -- rallying one day to sell off the next -- could be a positive sign since, according to Phil Erlanger, the newsletter editor, markets move back and forth in a choppy pattern while trends form. So this markets seeming lack of conviction could be setting the stage for an emerging upward trend.
But if the sell-off gets too pronounced it could undermine building support and stop any upward trend in its tracks. Erlanger suggests watching the Standard & Poors 100 Index (OEX) to track support levels and look for any test of that support. (You can, for example, watch the Bollinger Bands or Price Channel indicators that youll find under Analysis/Price Indicators on our chart tool.) On Oct. 13, the Nasdaq did hold above 1,915, and on Oct. 14, it managed to close above 1,900 -- both important signals of strength for the technology sector. But I need to see the index move above 1,928 before Ill breathe easy.
Yes, technology earnings have been encouraging. On Oct. 12, Yahoo! reported third-quarter earnings of 9 cents a share, in line with the Wall Street consensus and projected fourth-quarter revenue of $710 million to $760 million. At $760 million, the company would be about $30 million ahead of consensus estimates for revenue in the quarter. After the close on Oct. 13, Apple Computer (AAPL, news, msgs) reported earnings of 27 cents a share, well ahead of the 18 cents that Wall Street was expecting, on revenue of $2.35 billion, also ahead of the $2.15 billion projected for the quarter.
But earnings reports havent been strong enough to make anyone giddy. In fact, they only look as good as they do because investors have been so worried that technology companies would turn their recent string of earnings warnings into earnings misses. So, for example, Intels results made investors feel better because the company didnt announce any more bad news. Earnings per share of 30 cents beat the consensus by 3 cents a share only because the company reported a lower-than-expected tax rate of 21% instead of the projected 29%. Exclude the 4 cents that lower tax rate contributed to earnings in the quarter and Intel actually missed estimates by a penny a share. And gross margins came in at just 56%, at the low end of the range of 58%, give or take a point or two, that the company had projected. Any disappointment, however, was overwhelmed by relief that the company reported inventory levels had stopped climbing, a big problem for Intel recently caused by customers holding back on orders until they cleared their own inventory, and had actually dropped by $43 million in the quarter and would fall further in the upcoming fourth quarter.
Yes, energy stocks actually sold off as oil prices moved higher late in the day on Oct. 13. Thats a good sign since it signals rotation out of the sector because investors see better opportunities elsewhere rather than a simple reaction to a move in the price of the commodity. If oil stocks had tumbled on a fall in the price of oil, it wouldnt have been nearly so significant.
But the metals sector sold off on exactly that kind of news. Copper prices showed their biggest drop in 16 years on fears that economic growth in China had slowed. Those fears were ignited by a report that Chinese buying of copper had declined 21% in June from a year earlier. If growth is slowing in China, then copper isnt the only vulnerable material. Hence the drop in the stocks of steel producers and iron ore miners. But a news-driven drop in industrial commodity stock prices isnt the same as a sector rotation, and its unlikely to inspire a year-end rally. Slow growth in China, if true, would be a downer for just about the entire stock market.
Yes, speculation is rising on Wall Street that the latest surge in oil prices will lead the Federal Reserve to call a halt to its current round of interest rate increases after a November cut, bringing the Feds short-term interest rate target to 2%. A halt in rate increases would be good for the stock market (and for bonds). But a change in interest-rate policy that is sparked by worries over higher oil prices would not be good news for stocks, since economic expansion and profits would also likely slow.
OK, enough of this on-the-one-hand/on-the-other-hand analysis. Its fine for The New York Times, but investors need to know what to do.
3 signals to watch
Heres my recommendation: I think the odds of this list of Yes/But favor a year-end rally, but at the moment the odds arent very strongly in favor. Id say theyre somewhere around 52/48 in favor. Thats just about a landslide in politics, but its too close for comfort in investing. Especially since to profit from any year-end rally, an investor will have to buy relatively risky technology sector stocks. Id feel more comfortable with the risk if the odds of a rally were closer to 60/40.
I think it pays to wait and watch. What youre watching for is:- Whether technology stocks show market price leadership.
- If earnings from bellwethers IBM (IBM, news, msgs) and Texas Instruments (TXN, news, msgs) on Oct. 18, EMC (EMC, news, msgs) and Motorola (MOT, news, msgs) on Oct. 19, and Broadcom (BRCM, news, msgs) and Microsoft (MSFT, news, msgs) on Oct. 21 are strong enough to generate enthusiasm (even short-term) about the sector.
- If the Nasdaq breaks above technical resistance and continues to outperform the Dow.
If I get confirmation like that, Ill be looking to add another buy or two for the late-year rally at the end of next week. If not, I think Ill wait for better odds, thanks.
New developments on past columns
5 big questions for the last debate
Ive received more than 200 e-mails in response to my column on five critical economic problems that the two presidential candidates hadnt touched on in the first two debates. Most offered another problem that they would have added to my list; a few readers sent me a list that would have bumped my column up from five to 10. I will try to answer everyone who sent me an e-mail. (It may take a few days.) And Ill put together the most interesting responses in a column for Oct. 19. Thats a few days after the third and final debate, but still a good two weeks before the actual election. My thanks to everyone who contributed.
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jubak owned or controlled shares in the following equities mentioned in this column: Microsoft. He does not own short positions in any stock mentioned in this column.
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