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Market Wrap

Economy Slows Significantly

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The advance GDP for Q4 stunned everyone with only a +1.1% growth rate. This was well below the +4.1% rate for Q3 and well below the consensus estimates of +3.0%. The economy went from more than three years of strong numbers averaging better than +3.5% growth to almost a dead stop at +1% in only one quarter. The last quarter with growth of less than +3% was Q1-2003 at +1.9%. The cycle high was Q3-2003 at +7.4%. Obviously there were many excuses for the drop that were tied to the hurricane impact but many analysts discounted those excuses. A sharp drop in auto sales accounted for a -0.6% drop in GDP. Government spending slowed accounting for a -0.5% drop. A sharp rise in imports of oil and oil products after the hurricanes also knocked -0.5% off the Q4 GDP number. Those three factors only account for -1.6% of the total -3.0% GDP drop. That leaves a drop of -1.4% to be spread across a slowing housing market, weak tech sales and a sharp drop in non-residential investments. There was an -8.5% drop in non-residential investment spending and a -7% drop in government spending. Tech spending slowed substantially from +10.6% growth in Q3 to only +3.5% growth in Q4. Consumption also fell to only +1.1% growth from +4.1% in Q3. Inflation was also higher with inflation excluding food and energy up +2.2% in Q4 from +1.4% in Q3. Those numbers are on an annualized basis but the direction is clear. The minimal +1.1% GDP growth for Q4 was a real disappointment and the slowest growth rate in over three years. Remember however, the advance GDP numbers are highly volatile and could see some sharp revisions over the coming weeks. With Greenspan's last Fed meeting scheduled for next Tuesday he is probably glad to be exiting at this point in the recovery. Bernanke is being handed a live economic hand grenade and a pat on the back as Greenspan rushes out the door with his legacy intact.

Dow Chart - Daily

Nasdaq Chart - Daily

SPX Chart - Weekly

The Fed meeting on Tuesday should be exciting for the participants with a flurry of recent economics pointing to a slowing economy at a time when the Fed is reaching the end of its rate hike cycle. Bernanke may be seeing a potential recession in the not to distant future. His options are to halt the hikes now in hopes of heading it off or continue hiking through March in hopes of getting rates as high as possible to provide leverage if a serious recession does appear. I am sure Bernanke is approaching his new position with a considerable amount of apprehension. His term could be defined by the economy and his actions within his first 12 months.

The economic calendar for the coming week is very full and the Fed will have no shortage of information to work with. The highlights are the NAPM, PMI, ISM and Jobs on Friday.

Economic Reports for Week of Jan-30th

If the ISM follows the trend set by the Chicago Fed National Activity Index from last week, which fell sharply to .08 from .59 in November. The drop too barely positive in December from its .98 level in October has been fast and Friday's GDP confirms the drop. If the ISM follows suit then the Fed will be on notice that conditions have changed drastically. Given the sharp drops in the CFNAI and GDP the ISM could miss the consensus target of 56.0 by a substantial margin. A move below 50.0 would indicate a contraction in the economy but I doubt we will see that in this report.

The continuing signs of economic weakness as evidenced by the GDP on Friday suggests the Fed may be closer to a rate hike halt than previously thought. However, the Fed funds futures are still calling for a hike next week and at the March meeting. That may change after the announcement next Tuesday. If the wording changes dramatically then all bets are off for the March meeting. Investors cheered the weak GDP in hopes the Fed may be done soon.

In addition to the GDP on Friday there was also surprising news about home sales. December New home Sales jumped to 1,269,000 on an annualized basis from 1,233,000 in November. This month over month gain of +2.9% showed that the housing sector may not be as weak as previously expected. There was a change in the methodology of the survey so a direct comparison is difficult to obtain. The inventory of new homes for sale rose to 4.9 months and the highest level since 1996. This high inventory level has prompted builders to dust off some very strong incentives. For instance Centex ran a full-page ad on Friday offering a $100,000 discount for any home bought on Saturday between 10:AM and 10:PM in specific areas in the northeast.


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The high inventory levels did not scare investors and the headline number renewed hope that the bubble talk had failed to actually slow sales. Shorts were squeezed once again as investors celebrated the low GDP and jump in housing sales. The market rebound was aided by results from Microsoft on Thursday night that propelled MSFT to a +1.29 gain or +5%. This was a reversal of fortune for tech stocks after a two-week decline.

The indexes were helped by a sharp jump in oil prices of +$1.50 to $67.80. Oil stocks rallied back from their midweek lows with many setting new highs. Even the transportation index rallied to a new high, oblivious to the fact that oil was creeping towards $70 once again. OPEC meets again on Tuesday in Vienna and there are no production cuts on the table for Q1. They are talking about a potential cut in Q2 or Q3 if needed but also an increase in production in Q4. They are managing expectations amazingly well and prices are not expected to dip below $60 any time soon despite some comments from OPEC members last week that prices over $60 were too high. That is like a crack dealer 100 miles from his closest competition saying he is charging too much and prices should be lower. He would be kidding nobody but the non-users and those addicted would continue to pay whatever price he asked until a new dealer appeared. OPEC is not kidding anyone but the general public with their constant announcements. OPEC deliveries actually fell last month as supply constraints, production outages and problems with rebels in Nigeria restricted output. OPEC realizes that inventory levels are not rising and that is fine with them.

The SOX broke out of strong resistance at 538 on Friday to trade over 550 most of the day. The jump was largely attributed to earnings gains by Sony (SNE) and Broadcom (BCM) +$11.15 or +20%. Broadcom beat the street by +6 cents and raised guidance to +5% to +7% growth compared to analyst's expectations for a decline of -2%to -3%. This enabled the sector to shake off some questionable earnings from the last two weeks and in two days rebound from 515 to Friday's high of 560.

SOX Chart - Weekly

The SOX gain was even more surprising because SanDisk did not take part in the rally. SNDK fell -$7.30 or -10% after saying they were going to cut prices up to -35% in order to maintain high production levels. The CEO said they were seeing very soft Q1 sales and wanted to support those sales by sharply cutting prices. SanDisk is facing growing competition from Hynix Semi and Micron and a price war appears to be developing as competition for slowing sales increases. Chipmakers must maintain high volume to keep costs down and margins up and stronger competition will depress both of those factors.

Friday was a day of big moves by individual stocks as evidenced by the BRCM and SNDK news above. Affiliated Computer (ACS) rallied +$6.10 or nearly +11% after saying they were going to buy back up to 45% of their outstanding stock. This is really a strange announcement. ACS said they were going to use debt provided by Citigroup to buy back the $3.5 billion in stock. Something is going on under the headlines here. Companies don't normally go into debt to buyback stock, especially this large of an amount. ACS has been in talks to be acquired by some private equity firms for the last couple months but those talks reportedly fell apart on Jan-17th. I say reportedly because the buyback suggests there is some news we have not been told. Maybe the talks were put on hold until ACS changed its acquisition profile through the buyback. It still poses a lot of questions since any acquiring company would still end up with the debt. ACS is going to conduct a Dutch auction between Feb-6th and March-6th with prices between $56 and $63 per share. They will purchase 55.5 million shares at the lowest price possible in that range. Shares closed at $63.27 on Friday, which suggests they could be stuck buying at the top of the range. Reducing the number of shares outstanding increases the earnings attributable to the remaining shareholders. Buying back the stock in advance of a buyout does fix the price of that stock which has been repurchased. This would allow a buyout firm to offer a higher amount for the remaining shares knowing that 45% of the stock cannot appreciate. If I see any decline in the stock price I am going to speculate in some distance call options. Keep a watch on ACS and I bet we will see the buyout reappear in the not two distant future.

George Soros is making news again and he is making waves contrary to current investor sentiment. According to Soros, investors today are cruising into the sunset. Unfortunately they are cruising on the Titanic according to him. He is predicting a global recession stimulated among other things by a slowdown in housing prices and higher energy prices. He feels it will accelerate into 2007 as consumers run out of purchasing power as home equities shrink. Speaking at the World Economic Forum in Davos Switzerland he said, "The conference is remarkable for its complacency. It's a bit like dancing on the Titanic. They're having a very good time and there's a very cheerful atmosphere." However, he said the veneer of relative calm both in the U.S. and international markets is masking some troubling problems in the global economy. He said the Russian gas crisis should be a wake-up call for Europe. Russia has shown that they are willing to use their energy assets to control other countries. Starting with Georgia and the Ukraine as examples it is only a matter of time before their economic reach stretches over nearly all of Europe.

Russia has shown it is also willing to use its energy supplies to punish countries leaning toward western values in order to bring them back into the fold. I warned about this as far back as early 2004. As oil and gas supplies shrink those countries with surpluses will control the fate of those who don't. Those countries with large populations and energy shortages will try to take them by force from their smaller neighbors. Russia's recent natural gas blackmail attempt is just another sign that the energy future is going to be rocky. Europe relies on Russia for 25% of its natural gas supplies. Turn that off and Europe comes to a halt economically. Russia also supplies 10% of all the oil exports in the world, over 5 mbpd, with the majority of that oil going to Europe. Would you want Russia to control your future? They will even if you don't live in Europe. If they cut off supplies Europe will turn to other sources for oil and gas. Those sources are the same ones America uses and competition for those supplies will send prices soaring. Don't think just because Russia is waging economic war with Europe it is not our concern. You may be surprised.

Iran is still being listed as the main reason for $68 oil and there appears to be no resolution in the near future. The U.S. said Special Forces are already in Iran marking targets and generals are on TV talking about taking out not only the nuclear targets but the government as well in a single 24 hour bombing campaign. Regardless of whether this will ever come to pass it is increasing the speculation over future supplies. Iran exports 2.7 mbpd of crude.

Earnings over the past week were better than the prior week but were still nothing to get excited about. Guidance remains generally weak with only a few exceptions. Last week was the heaviest week for earnings for the Q1 cycle and while there are still some notables ahead it is mostly down hill from here. The highlight for next week will probably be Google on Tuesday. Google is expected to report +$1.76 in earnings but they do have a history of beating estimates. Eventually this trend will change but nobody expects it to be Tuesday. A positive report could benefit the Nasdaq and other Internets. Amazon reports on Thursday and is expected to post a gain of +21 cents. There are dozens of energy stocks reporting as well and any post earnings dips should be seen as buying opportunities but give them time to settle first.

Two days of short covering pushed the indexes back to some strong resistance levels. The Dow jumped +225 points on Thr/Fri with the majority of those gains coming in the first 30 min of trading on both days. The rebound took the Dow to just over 10900 where it stalled at resistance at 10925. This was where it failed back on Jan-19th and it will be a critical area to watch as earnings begin to fade. The next material resistance is +200 points higher at 11025.

The Nasdaq performed an identical bounce to resistance at 2310 that held on the last rebound attempt on the 19th. Both indexes sold off slightly at the close on profit taking but are poised to take another run at that resistance on Monday if investors feel bullish.

Our directional indicator of choice, the SPX, spent the first three days of the week bumping its head on our 1270 long/short indicator. That level broke on Thursday but the 1275 overhead resistance I told you to watch last Sunday held firm. On Friday the Broadcom earnings sent the SOX into overdrive and a nearly +20 point gap open. That SOX gap and strong oil prices powered the SPX through the resistance at 1275 and right to the same Jan-19th resistance that held the Dow and Nasdaq. That resistance on the SPX is just over 1285. Technically we should all be long over 1275 if you followed my advice from last Sunday.

I have really mixed emotions about next week. Everyone appears to be thinking the Fed is going to surprise investors with a sudden halt to rate hikes at Tuesday's meeting. Since everyone seems to be whispering about this surprise it would be an even bigger shock if they kept language that said further rate hikes would still be needed. This sets up the potential for a big move based on the outcome of the Fed meeting. Monday could be positive as retail investors push the envelope thinking that there are only blue skies ahead. Tuesday should bring some hesitation and probably some profit taking ahead of the Fed announcement. After the announcement it is up to the Fed statement to provide direction. Without any surprise we are likely to wander without sufficient power to break the overhead resistance at 11025, 2330 and 1295.

A positive for the bulls is new all time highs by the NYSE Composite ($NYA.x), Russell ($RUT.x), S&P Smallcaps ($SML.x) and Transports ($TRAN). The Wilshire 5000 is also very close to a new high over 13000 with Friday's romp to 12994. All of these broader indexes are showing far more bullishness than the standard Dow, Nasdaq and S&P. The weighting of individual stocks in the Dow and Nasdaq is keeping those indexes from flying as earnings disappointments wreak more havoc in those smaller indexes.

Russell 2000 Chart - Weekly

NYSE Composite Chart - Weekly

S&P SmallCap 600 Index Chart - Weekly

SPX Chart - 60 min

If you are only looking at the big three the picture is entirely different than that being projected by the broader market. Unfortunately, most market decisions are made based on those three common indexes. This puts us in the position of being bullish overall but held hostage to the Dow, Nasdaq and SPX as well as the Fed on Tuesday. It would be a remarkable event to see the Fed pause on Tuesday and the remaining indexes break final resistance. But, as Soros says, there is far too much bullishness among the partygoers and disaster does tend to strike when least expected. I will continue to suggest SPX 1270-1275 be our long/short indicator. Remain long over 1275 and short under 1270. This takes the guesswork and the emotion out of our trading decision and lets the market direction control our choices.

Challenger Explosion

January 25th was the 20th anniversary of the space shuttle Challenger disaster and the death of its seven crew members. Unfortunately it was not the only fatal shuttle accident. Three years ago on Feb-1st 2003 the shuttle Columbia exploded on reentry and seven more astronauts lost their lives. The sacrifices of these brave men and women make us appreciate the rather mundane risk we take as investors commuting to our own offices. On a brighter note Friday was the 250th birthday of Wolfgang Amadeus Mozart. Tune in to a classical station this weekend and be exposed to an incredible composer.

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