Inside the Latest Industrial Production Numbers

From the Federal Reserve:

Industrial production fell 1.5 percent in March after a similar decrease in February. For the first quarter as a whole, output dropped at an annual rate of 20.0 percent, the largest quarterly decrease of the current contraction. At 97.4 percent of its 2002 average, output in March fell to its lowest level since December 1998 and was nearly 13 percent below its year-earlier level. Production in manufacturing moved down 1.7 percent in March and has registered five consecutive quarterly decreases. Broad-based declines in production continued; one exception was the output of motor vehicles and parts, which advanced slightly in March but remained well below its year-earlier level. Outside of manufacturing, the output of mines fell 3.2 percent in March, as oil and gas well drilling continued to drop. After a relatively mild February, a return to more seasonal temperatures pushed up the output of utilities. The capacity utilization rate for total industry fell further to 69.3 percent, a historical low for this series, which begins in 1967.

First quarter production dropped at a 20% annual rate. There is no way to spin that as good news. That is terrible news. In addition, production has dropped 13% below the same level as last year -- another terrible statistic. Finally, there have been 5 monthly drops in production. That -- again -- is terrible.

Now -- consider this chart of overall industrial production. Click on a larger image:



Above is a long-term chart of overall industrial production with a logarithmic scale. Notice the latest contraction that started in December 2007 has wiped out any production gain made during the latest expansion. That has not happened since the great depression. Here's a closer look at the last 40 years or so:



In addition:



Capacity utilization is at its lowest level in over 40 years. Let's assume we get of this recession by the end of the year. Do you think companies that are at 40+ year lows in capacity utilization are going to be purchasing new equipment? Neither do I. This does not bode well for equipment and software investment, which is about 8.4% of US chained GDP. This means we can't count on that to pull us out of the recession in any meaningful way.

Consider these charts from the report. Notice that construction and durable goods are dropping like stones.



And all of this is having a negative impact on manufacturing stocks:

Thursday Oil Market Round-Up

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The weekly chart still has a bullish bias. Notice the MACD and RSI is rising and prices have broken out of a triangle consolidation pattern. While prices are still below the 50 week SMA, the 10 week SMA is moving higher and has crossed over the 20 week SMA. Also note the 20 week SMA is leveling off. Finnally, prices are above the 10 and 20 week SMAs which will pull these SMAs higher.


Prices broke out of a triangle consolidation pattern in early March. However, prices peaked from that rally in late March. Since then prices have been consolidating in a sideways move. Notice that the MACD is now drifting lower and gave a sell signal at the beginning of April. Also note that the RSI printed a lower high on the second price top in mid-April. Prices and the SMAs are jumbled together giving no clear reading of direction.

The reason for the difference between the weekly and daily charts' bias could be the difference between the technical and fundamental picture. The technical picture on the weekly chart says bull market. The daily picture was strong but is now cloudy. Consider the following fundamental issues:


Crude stocks are incredibly high


And gas stocks are above average, yet


Gas prices are still increasing slightly.

Simply put, supplies are high which should lead to lower prices, not higher. The reason is prices are rising in anticipation of recovery:

The timing and pace of the global economic recovery will determine whether the higher crude oil prices seen during March are sustainable. The prospects of limited growth in non-OPEC production and the expected start of economic recovery later this year, that should increase oil consumption and the demand for OPEC oil, are the main factors supporting the upward price path. If economic recovery begins earlier and is stronger than assumed in this Outlook, there is an upside risk of higher oil prices than currently projected. The downside risk to oil prices is a scenario of a prolonged economic downturn followed by a weak recovery, which could produce a greater decline in consumption than currently expected. This latter scenario would challenge the willingness of OPEC's members to sustain lower output levels for a longer period.

And then there is this:

Consumption. World oil consumption is expected to drop by 1.35 million barrels per day (bbl/d) in 2009 compared with year-earlier levels, due to the global economic recession. EIA assumes that the global gross domestic product (GDP), weighted by oil consumption, will fall by 0.8 percent this year. Consumption is expected to fall by 1.6 million bbl/d in the OECD countries and rise by 270,000 bbl/d in non-OECD nations. The bulk of the decline is expected to be concentrated in the first half of the year (World Liquid Fuels Consumption). World oil consumption is expected to grow by 1.1 million bbl/d in 2010, driven by a recovery of global GDP growth to 2.6 percent.

In other words, there are mixed signals in the oil market. Current prices are the result of expectations, not underlying facts. Traders are hoping that fundamentals will catch up with prices. Further complicating the mix are the continued OPEC production cuts.

Right now the daily chart says prices are going to move sideways for awhile and wait. Prices have already rallied; now traders want to see if fundamentals catch-up.

Today's Markets

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The main point to note with all three charts below is prices are approaching or are directly on the upward sloping trendline that started in early March. That means we are at technically important levels. In addition, we have two more days for this week and traders may not want to hold positions over a two day weekend. Also remember we are in the middle of earnings season, possibly adding to the hair trigger of traders. Finally there is the basic question of whether or not the economic fundamentals support the current market rally.

In the event of a sell-off (which would be a natural development considering the run we've had) there are plenty of technically important support levels. Those are in the second series of charts which include all the simple SMAs along with Fibonacci levels and various other technically important levels.







Technical support levels for the SPYs, QQQQs and IWMs

A Closer Look at Inflation

We've had both PPI and CPI come out over the last two days. Let's take a look at the reports to see what they say:

Form the BLS:

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.2 percent in March, before seasonal adjustment, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. The index has decreased 0.4 percent over the last year, the first 12 month decline since August 1955.

On a seasonally adjusted basis, the CPI-U decreased 0.1 percent in March after rising 0.4 percent in February. The decrease was due to a downturn in the energy index, which declined 3.0 percent in March after rising 3.3 percent the previous month. All the energy indexes decreased, particularly the indexes for fuel oil, natural gas, and motor fuel. The food index declined 0.1 percent for the second straight month to virtually the same level as October 2008. The food at home index declined 0.4 percent, the second straight such decrease, as the index for dairy and related products continued to decline.

Here's the year over year chart from Econoday:


Prices have been hanging right around the 0% YOY for the last 4 months. This is a dangerous place because it could signal price deflation which would be terrible. The good news in the report is the energy prices and to a lesser degree food prices appear to be the main culprit of deflation:

All the energy indexes decreased, particularly the indexes for fuel oil, natural gas, and motor fuel. The food index declined 0.1 percent for the second straight month to virtually the same level as October 2008. The food at home index declined 0.4 percent, the second straight such decrease, as the index for dairy and related products continued to decline.

And there is this as well:

The index for all items less food and energy increased 0.2 percent for the third month in a row.

Looking at the chart above, note the gray lines the show the year over year percent change in the core rate. That series of data points stands just shy of two percent which is also encouraging from an anti-deflation standpoint. That does not mean we are out of the woods yet, however.

But then there is this information about producer prices:

The Producer Price Index for Finished Goods decreased 1.2 percent in March, seasonally adjusted. This decline followed a 0.1-percent advance in February and a 0.8-percent increase in January.

Accompanied by this chart:



Remember, producer prices feed into consumer prices. This means they happen first. So the drop above could start to hit CPI eventually.

PPI prices are broken down into three categories: crude goods, intermediate goods and finished goods. Here are the charts of the year over year percentage change in all three.







All three show incredibly large year over year drops. While at some time in the past we have been at these levels, its not very often. As a result, we need to keep an incredibly close eye on these data points.

Intel's Earnings Surprise

From IBD:

Tech bellwether Intel late Tuesday reported first-quarter profit far above analyst views, but it again opted not to provide guidance for the current quarter because of the uncertain economy.

Worried investors sent Intel shares falling about 5.5% after hours, after it released results that included some positive indicators.

"We believe PC sales bottomed out during the first quarter, and that the industry is returning to normal seasonal patterns," Intel (INTC) Chief Executive Paul Otellini said in a statement.

The No. 1 chipmaker reported per-share profit of 11 cents. That's down 56% from the year-earlier quarter, but far above the 3-cent consensus estimate of analysts polled by Thomson Reuters.

Sales fell 26% to $7.14 billion, just above the $6.98 billion expected by analysts.

In a conference call with analysts, Otellini said the "global economy continues to be weak and uncertain" and "demand remains difficult to predict," but Intel's execution during the quarter "was outstanding."

For the second quarter in a row — and just the second time in 10 years — Intel didn't provide formal guidance for this quarter. (In January, when it gave fourth-quarter results, Intel said it expected first-quarter revenue "in the vicinity of $7 billion.")

The lack of guidance shouldn't surprise anyone right now. There are way too many wild cards in the economy for anyone to say with any degree of certainty what is going to happen in the next quarter -- let alone next week. But consider the previous information in conjunction with this chart from the Federal Reserve's latest industrial production report:



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All industrial production save communication's equipment is down and overall capacity utilization in the high tech sector has taken a nose dive. Semiconductors are down more sharply than the last recession which is obviously an issue for Intel.

And consider this chart from the BEA which shows the percentage change from the previous quarter in investment in software and technical equipment in real terms:


The above chart is why Intel is not offering any forward guidance.

Wednesday Commodities Round-Up

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Industrial prices are doing well; they have broken through the upside resistance of the consolidation pattern they were in. This break is strong. In addition, the MACD and RSI are rising and have room to run. The 10 week SMA is rising and has moved through the 20 week SMA. The 20 is turning positive but is not there yet. Prices are above the shorter SMAs which will pull them higher, but prices are still below the longer SMAs which is still heading lower.



Although agriculural prices have moved out of the triangle consolidation pattern, they hvae not followed industrial metals higher in as strong a manner. This despite strong readings from both the MACD and the RSI. Notice the weekly SMAs are meandering with prices instead of forming a solid bullish pattern. This indicates indecision on the part of traders about the future price moves.

My guess is industrial metals are rising in anticipation of recovery. Whether we are there or not is a different story. Consider this chart of the year over year percentage change in US industrial production:


This is not an environment where demand for industrial metals is increasing. At least not in my opinion.

Today's Markets

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The main issue with the market is will it or won't it rise over the trend line that stands just above current prices. Right now -- and for the last two days -- we've had prices essentially move somewhat sideways and towards the upward sloping trendline just to the right. Essentially prices are biding time until ... something. There is also the need to consolidate recent gains. It should be noted that it's impressive that prices have not dropped through the trendline, indicating there is still some bullish sentiment about the market right now.



On the 10 day 5 minute chart, notice that for the last three days the 84.25 level has been incredibly important. A move through that level would indicate a breakdown of the the last three days price action.

Bernanke on Future Inflation

From the Federal Reserve:

I mentioned earlier that the Fed's mandate from the Congress is to foster price stability as well as maximum sustainable employment. The FOMC treats its obligation to ensure price stability extremely seriously. Price stability supports healthy economic growth, for example, by making it easier for households and businesses to plan for the future. In practice, price stability does not require that inflation be literally zero; indeed, although inflation can certainly be too high, it can also be too low. Experience suggests that inflation rates that are close to zero or even negative (corresponding to deflation, or falling prices) can at times be associated with poor economic performance. Cases in point include the United States in the 1930s and the more recent experience of Japan. In their latest quarterly projections of the economy, most members of the FOMC indicated that they would like to see an annual inflation rate of about 2 percent in the longer term. Right now, because of the weakness in economic conditions here and around the world, inflation has been running less than that, and our best forecast is that inflation will remain quite low for some time. Thus, the Fed's proactive policy approach is not at all inconsistent with the goal of price stability in the medium term.

Although inflation seems set to be low for a while, the time will come when the economy has begun to strengthen, financial markets are healing, and the demand for goods and services, which is currently very weak, begins to increase again. At that point, the liquidity that the Fed has put into the system could begin to pose an inflationary threat unless the FOMC acts to remove some of that liquidity and raise the federal funds rate. We have a number of effective tools that will allow us to drain excess liquidity and begin to raise rates at the appropriate time; that said, unwinding or scaling down some of our special lending programs will almost certainly have to be part of our strategy for reducing policy stimulus once the recovery is under way.

We are thinking carefully about these issues; indeed, they have occupied a significant portion of recent FOMC meetings. I can assure you that monetary policy makers are fully committed to acting as needed to withdraw on a timely basis the extraordinary support now being provided to the economy, and we are confident in our ability to do so. To be sure, decisions about when and how quickly to proceed will require a careful balancing of the risk of withdrawing support before the recovery is firmly established versus the risk of allowing inflation to rise above its preferred level in the medium term. However, this delicate balancing of risks is a challenge that central banks face in the early stages of every economic recovery. I believe that we are well equipped to make those judgments appropriately. In addition, when the time comes, our ability to clearly communicate our policy goals and our assessment of the outlook will be crucial to minimizing public uncertainty about our policy decisions.

First, I love the Fed's dual mandate: price stability and maximum employment. Talk about a great way to drive you crazy....

Secondly, and far more importantly, the argument I continually hear is "there is a huge risk of inflation because of all the money the Fed is printing." And if the Fed stood pat for an extended period of time that would be a problem. But people seem to forget the Fed can raise rates as well as lower them. That means when the economy starts to get stronger, the Fed can start to mop up excess liquidity.

While I think it's possible to have too much confidence in the Fed, I also think it's extremely possible to have too little.

Retail Sales Disappoint

First -- this is without a doubt one of the most useless when issued statistics imaginable. It's not inflation adjusted and the total number includes an entire variety of numbers that make more sense as a solo statistics.

That being said:

The U.S. Census Bureau announced today that advance estimates of U.S. retail and food services sales for March, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $344.4 billion, a decrease of 1.1 percent (±0.5%) from the previous month and 9.4 percent (±0.7%) below March 2008. Total sales for the January through March 2009 period were down 8.8 percent (±0.5%) from the same period a year ago. The January 2009 to February 2009 percent change was revised from -0.1 percent (±0.5%)* to +0.3 percent (±0.3%)*.

Retail trade sales were down 1.1 percent (±0.7%) from February 2009 and 10.7 percent (±0.7%) below last year. Gasoline stations sales were down 34.0 percent (±1.5%) from March 2008 and motor vehicle and parts dealers sales were down 23.5 percent (±2.3%) from last year.

Notice the following points:

-- Sales are down 9.4% from March 2008

-- Sales are down 8.8% from the January - March period of last year

Auto sales are still getting hammered



All of the categories are down year over year. Here is the chart from the St. Louis Fed:



And here's the year over year percentage change

Credit Markets Continue to Thaw

From Bloomberg:

The London interbank offered rate for three-month dollar loans is dropping at the fastest pace since January as bankers gain confidence that the worst of the financial crisis is over.

Debt strategists at Credit Suisse Group AG, Societe Generale SA and Royal Bank of Canada, three of the 16 banks that provide the data that sets Libor each day, say the declines will continue. Momentum may be building as signs of economic stability emerge, according to Federal Reserve Chairman Ben S. Bernanke.

“Not so long ago the main worry was whether the bank you’re dealing with was going to be around in three months time,” said Ira Jersey, head of U.S. interest-rate strategy at RBC Capital Markets in New York. “Now that concern is on the back burner. We’re going to see Libor coming down steadily.”

Libor, the British Bankers’ Association interest rate that determines borrowing costs on about $360 trillion of financial agreements ranging from home mortgages to corporate bonds, fell to 1.12 percent today from 1.32 percent a month ago. The fastest drop since the start of the year, when the rate tumbled to 1.08 percent on Jan. 14 from 1.42 percent nine days earlier, coincides with President Barack Obama’s efforts to restore the economy and the banking system to health.

A big issue for many financial institutions over the last year and a half is the viability of the counter-party. That is, "if I lend you money, will you be around in the next three months to repay the loan?" That is what essentially froze the credit markets. Now that we've seen the government pour trillions into the system, people are now more and more confident that a counter-party will be around. And that has increased confidence.

The Problem With Credit Default Swaps

Well, there are many problems. Probably the biggest is they are a shadow market when in fact they should be traded on an open, regulated exchange. That would end many of the problems we currently have.

However, the second biggest problem we have no idea how to tax them. The problem is they could be conceivably be three things, although I think it boils down to two.

Are they insurance? In some CDS transactions, the person purchasing the contract is compensated for in cash. The person selling the contract pays the purchaser cash based upon the difference between a value specified in the contract and the then market value of the CDS. Essentially, the person purchasing the contract has shifted the risk (key legal term) to the seller, forcing the seller to pay x amount of dollars at a specific time. There is another key legal issue with risk distribution which raises some problems here, but I believe that proper regulation would prevent that from happening.

Are they an option? In other CDS transactions, the buyer will put a specific investment to the seller much like an option. In effect, the buyer pays for the right to say, "this is now worthless. You take it. By the way, you have to pay a previously agreed to price." This is essentially an option.

Further complicating the matter is the way CDS are documented. First, there is a "master agreement" between parties which essentially establishes an entire framework for how they will interact. Then each transaction can have its own terms and conditions. The point of this methodology is to promote the transaction process -- that is, to create an environment where people write a lot of transactions. These documents are available from the International Swaps and Derivatives Association.

I'm currently writing a paper on this -- which is why I bring it up. Unfortunately there are no clear answers -- just intellectual mud.

Treasury Tuesdays

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The above chart is another reason why I don't think we're in a new bull market. Notice that prices are consolidating in a triangle consolidation pattern and have been since the end of last year. If the markets were really in a rally then I would expect a far sharper sell-off as money flowed from the bond market to the stock market. Part of the reason could be the Fed buying Treasuries thereby providing a floor on prices, but I think momentum out of the market would overcome that situation. In addition, notice the following:

-- The SMA picture is a mess; it's jumbled and unclear. Compare that to a standard bull market chart where prices are above all the SMAs and the shorter SMAs are above the longer SMAs.

-- Volume has been extremely weak over the last few days, indicating a lack of overall interest



Remember that in a consolidating market stochastics are a better indicator of possible future directions. Here we see a stochastic that says the possibilities of moving higher are, well, higher. Remember -- that is a technical conclusion that does not include fundamental calculations.

Today's Markets

Before we get to today's chart, here's the basic conclusion from all the charts about whether or not we're in a bull market.

The answer is not yet. There are two reason I think this. First, technically we are overbought right now according to the MACD and RSI. But more importantly, the market is assuming the economy is on the verge of a rebound and frankly, I don't see it. Consider the following from the latest FOMC minutes:

The information reviewed at the March 17-18 meeting indicated that economic activity had fallen sharply in recent months. The contraction was reflected in widespread declines in payroll employment and industrial production. Consumer spending appeared to remain at a low level after changing little, on balance, in recent months. The housing market weakened further, and nonresidential construction fell. Business spending on equipment and software continued to fall across a broad range of categories. Despite the cutbacks in production, inventory overhangs appeared to worsen in a number of areas. Both headline and core consumer prices edged up in January and February.

Simply put, this is not an environment where stocks have the economic fundamentals at their backs. And that makes this a bear market rally.

Now -- on to today's market. As always, click on all images for a larger image



The 6 day chart shows that prices consolidated last Tuesday and Wednesday, jumped on Thursday and then continued their move higher today. Today note that prices opened lower, rallied and then fell until about 11 AM when they started to move higher for the remainder of the day. However, there was a large sell-off at the end of the day on high volume indicating traders did not want to keep positions overnight.



On the daily chart, notice that prices are still in an uptrend. Today's action merely provided us with a slight technical improvement over yesterday. However, pay particular attention to the lack of volume, especially over the last week or so. Trader's have not been participating in a big way. Now -- there has not been a sell-off either, which is good news. But, there is still plenty of reason to be concerned at this point.

Long Term View of Advance/Declines and New Highs/Lows

The NYSE advance/decline line still hasn't moved above the upside resistance levels established right at the beginning of this year.


The NYSE new high/new low number is still clearly declining



The NASDAQ advance/decline line is clearly moving higher and has done so for the duration of the latest rally


The NYSE new high/new low is still clearly moving lower.

Aside from the NASDAQ advance/decline line, all three other market breadth indicators are still moving lower. That tells us there is a lack of market breadth to this rally which does not bode well fore the future prospects of this rally.

The IWMs

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As I mentioned below, I'm taking an in-depth look at all the averages today to see if we really are in a bull market or whether this is a bear market rally. Below are overviews of the SPYs and the QQQQs. Below is a look at the IWMs, or the Russell 2000. These companies require overall GDP growth to move higher. Therefore this index is a good proxy for investor's and trader's risk appetites.


The index did remarkably well for an extended period of time, especially considering the economic backdrop started to falter in the middle of 2007. But it wasn't until the end of the third quarter of 2008 that the index really took it on the chin. From top to bottom, the IWMs have lost about 46%. A large chunk of that occurred in the last half of last year.



Despite the recent rally, the MACD is in overbought territory as is


the RSI,



The short term (6 month chart) shows some current action that is strong.

-- Prices have been rallying since the beginning of June

-- The 10 and 20 day SMA are moving higher

-- The 10 and 20 day crossed over the 50 day SMA

-- Prices are above all the SMAs

-- Prices have moved through the downward sloping trend line that connects several recent lows.

-- Prices are just shy of another downward sloping trend line.

My primary concern is the overbought condition of the MACD and RSI. However, as I mentioned below, RSIs can remain overbought for sometime. But the MACD is especially disconcerting as it is usually a pretty reliable indicator of momentum. In addition, the market is pricing in a big economic turnaround and I'm not sure that's in the card right now. While I do think the economy will rebound somewhere between the 4th quarter of this year and the end of the 2nd quarter next year, that could still be a year+ away right now.

The QQQQs

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The above chart raises an interesting question: what exactly does a market bottom look like? In his book Profits in the Stock Market, Gartley outlines 7 different bottoms: head and shoulders, double, rounding, descending, triangle broadening and complex. There are two possible interpretations of the above chart. The first is a double bottom with the first bottom occurring at the end of last year and the second occurring recently in early March. Using this analysis the next question is "how much time can occur between the bottoms?" There is no firm rule here, although I don't think three months on a multi-year chart stretches the issue beyond credulity.

This bottom also has several features outlined in the book "Encyclopedia of Chart Patterns" by Bulkowski. There is at least a 10% rise between the bottoms, the volume under the second bottom is less than the volume under the first volume and there is less than a 4% difference between the lows in both (I'm eyeballing and using 25 and 26 as the price levels).

The other possible chart pattern is "complex" which is Gartley's way of saying, "this pattern doesn't fit into any other pattern on the books." However, after all the writing of the last two paragraphs, I'm leaning toward the double bottom formation.


The MACD is overbought at these levels, as is




The RSI


The 6 months chart has many bullish characteristics.

-- Prices are above all the SMAs

-- The shorter SMAs are above the longer SMAs

-- All the SMAs are moving higher

-- Prices have been advancing for about a month now

-- Prices have moved through key resistance established by connecting two recent highs

The problem is several important technical indicators indicate we are overbought. The MACD is particularly concerning at current levels. The RSI is less so because an RSI can stay at a 70+ reading for an extended period of time.

Market Monday's

I'm going to spend today taking an in-depth look at all the averages. Last Monday, I asked the question whether or not this was a real rally and answered no -- but just barely. Last week we saw another gain which may have tipped the scales to a bullish picture. So, let's see what's there.

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On the three year chart we have a clear picture of prices moving lower, rallying and them moving through previous lows. This pattern has continued for the last year and a half during which time the market has fallen roughly 45%. Prices are still below the 200 day SMA by 15% but are above all the shorter SMAs.



The MACD is telling us the market is overbought.



The RSI is telling us prices are overbought.



The 6 month chart shows an bullish technical picture. Prices have moved through one downward sloping trendline and are just below a second. The 10 and 20 day SMA are both moving higher and each has already moved through the 50 day SMA. The SMAs are now in the most bullish orientation possible.

However, notice the drop-off in trading volume over the last few days. That tells us people are not participating in the rally as they previously did. Combine that with the longer-term technical information presented above and it could be argued the rally has petered out -- or is about to.

Next up is the QQQQs