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Market Wrap

Chip Dip Deja Vu

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Just when things appeared to be going so well some cautious comments out of Micron caused an immediate tech reaction to the downside. This brings back memories of numerous tech corrections in the past that occurred because of a sudden change of outlook for chips. Add in worries about the impact of sub prime loans to the banking system, new guidance challenges from the homebuilders and some hawkish Fed comments and you have a recipe for profit taking on a lazy Friday afternoon. There were plenty of bulls out singing the "Don't worry, be happy" jingle to themselves since support held and proclaiming it as just another buying opportunity. We should know by Monday's close if they were right.

Dow Chart - Daily

Nasdaq Chart - Daily

There were no economic reports on Friday so the markets were left to fret over the slowing earnings guidance and comments from various Fed officials. It was a slow week for economics in general but that will change next week. They will start to increase in intensity as the January reports begin to appear. The major reports are the manufacturing surveys on Thursday and the Producer Price Index (PPI) on Friday. These manufacturing reports will show if the decline in the ISM into contraction status last week was an anomaly or a prediction of things to come. The PPI will show if inflation is on the right track and decreasing as the Fed claims. There are numerous filler reports but those three headliners should be the only market movers. After Friday's chip decline the Semi Book-to-Bill may also have an impact but typically this number is so well managed that it takes several months for bad news to slip out.

Next Wednesday we will also have Ben Bernanke testifying before the Senate Banking Committee on Capitol Hill. On Thursday he will repeat the performance in front of the House Financial Services. The key as always will be any indications from Bernanke that we are heading for another series of rate hikes if the economy continues to strengthen.

Economic Calendar

Three Fed presidents made hawkish market moving comments on Friday. Dallas Fed President Richard Fisher said he was fairly comfortable with the inflation outlook but would "aggressively" argue for further rate hikes if needed. Currently he said he "was as comfortable with the inflationary outlook as a prudent central banker can be." He said the strong Q4 GDP would not hold and was likely to be revised down to about 3% growth. Cleveland Fed President Sandra Pinalto said she "was not convinced" the underlying trend in inflation had moved lower and suggested higher rates may still be needed. She said the inflation picture had been impacted by large swings in energy, commodities and housing prices. "As these markets normalize, we may see that inflation risks remain. In that case, some additional firming may be needed." St. Louis Fed President William Poole said inflation should moderate this year amid solid growth, BUT, if this failed to happen he would press for higher rates. "If core inflation seems to be settling in at a rate above 2% then such an outcome would be unacceptable to me." Also, "My commitment is to do what I can to promote policy adjustments that will yield an inflation outcome, on average over a period of several years, centered on 1.5% on the core PCE price index." The core PCE came in last week at +2.1% quarter over quarter and +2.3% year over year. These numbers are declining but not as quickly as the Fed would like. It could be a long time before Poole sees his 1.5% target. If we are seeing a strong recovery in the economy as evidenced by the +3.5% Q4 GDP then it is almost a certainty that we will see future rate hikes. I don't believe it was a coincidence that three Fed presidents gave nearly the same hawkish comments only three days before Bernanke is due to testify. I believe it is part of a plan to talk up bond rates and set the stage for his testimony. This flurry of hawkish comments helped turn Friday morning's low volume stroll into a nearly a -100 point Dow decline. The bulls bought the dip reversing that decline to only -56 points.

The Nasdaq imploded to a -35 point drop at 2:30 after Micron stunk up their analyst meeting with some bearish comments. Micron told analysts that prices for memory chips used in consumer electronics would fall -30% to -40% this quarter. Micron said the falling prices came after they boosted production of NAND memory chips amid an industry glut. The spokesman said Micron did not see any signs of strengthening demand and it was just bad timing for Micron to ramp up production as demand slowed. He also said that DRAM memory prices would fall another -15%. DRAM chips produce about 70% of Micron's revenue but only 20% of its profits. Micron fell off a cliff when the news hit the markets but with an already depressed $13 stock the loss was not material. The problem came from the impact of the news on the sector. Chip companies of every variety dropped sharply.

Chipmaker SanDisk (SNDK) had already warned about future expectations but the Micron news erased almost all of the gains made since that warning on the 31st. Silicon Image (SIMG) dropped -24% after warning that sales would be lower than expected for Q1. Six investment firms cut their ratings on SIMG. Gateway lost -10% after saying that revenue declined in Q4 and margins shrank to a miniscule 5.2%. Intel, AMD, NVLS, AMCC, NVDA and nearly every chip stock declined to some extent. The exception was Broadcom. BRCM said sales rose +12.5% and beat estimates. Brokers were upbeat on their guidance and BRCM finished fractionally in the green. The SOX just can't seem to find any traction amid the almost constant warnings and lowered guidance for the sector. As chips go, so goes the Nasdaq.

The Nasdaq is finding it difficult to make any forward progress carrying an 800-lb software giant on its back. Microsoft has stretched its losses to seven consecutive days with Friday's close at $28.94 a new two-month low. Microsoft has posted a loss for seven of the eight days since Vista was released to the public. Horror stories of conversion difficulties, massive overhead requirements and hardware incompatibility is keeping buyers away in droves. It is going to be an interesting quarter for Microsoft but they did shift over a billion dollars of revenue into Q1 from Q4 so maybe they won't warn. That would be a very bad omen for Microsoft to warn in the quarter they release their long awaited operating system. Microsoft will spend almost as much marketing Vista ($300 million) as their entire company sales in 1987.

Techs are also having trouble moving higher as cautions continue to appear regarding the future of tech sales. Stock buybacks are actually higher than capex spending by tech companies suggesting there are few new products in the pipeline and corporate buying patterns are not improving. When companies resort to buying back stock rather than investing in new products it suggests there is a lull in our future.


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Toll Brothers (TOL) fell -10% over the last three days after warning that Q1 revenue would fall by -19% and saying the housing market would likely remain weak in early 2007. They also said write downs would spike to between $60-$160 million or more for the quarter. In December Toll projected a $60 million write down for the entire year. That is a significant change in view in only 45 days. Contracts signed fell by -33% so far this quarter. The cancellation rate was 29.8% but better than the 36.9% in the prior quarter. This is still worse than the historical average by 7%. It amazes me that you can run a business even in good times with a 23% historical cancellation rate. Toll said the continued cancellations should shrink because most speculators buying the homes just to flip them had already canceled their orders. Robert Toll continues to be bullish because the American population is outpacing the rate at which new homes are built. "We are adding people at a clip that is much greater than the ability to add supply to the homebuilding stream." That may be true but few of those immigrants and young families just getting started can afford a luxury Toll Brothers home. Their success is truly a result of the ripple up effect. Successful people climb the ladder to prosperity while the new workers fight for a foothold on the bottom rung.

Subprime mortgage lenders continue to take heat as mortgage defaults continue to climb. HSBC Holdings (HBC) fell to a new 5-month low on Friday only two days after warning that it was raising its reserve for bad loans by +20% to $10.6 billion. New Century Financial (NEW) said it will have to restate results for the first three quarters of 2006 and now expects a loss for Q4. That knocked -$12 off the stock over the last two days. The company said it had to buy back loans it originated and sold to other investors. Several subprime lenders have closed over the last three months. Other subprime lenders IndyMac (NDE), Novastar (NFI), H&R Block (HRB) and Accredited Financial (LEND) took heavy losses for the week. Only Countrywide Financial (CFC) weathered the storm but still lost -8% over the last two days. Countrywide has been in the business for 40 years and is expected to survive the cycle. CFC saw its stock price soar in late January on rumors of a buyout and this week's losses still have not erased that spike.

MasterCard reported earnings of 31 cents that beat the street estimate of 17 cents by the proverbial mile. The stock dropped -$11 after the company told analysts that margin growth was likely to slow in 2007. CEO Robert Selander said that MasterCard's +3% margin growth in 2006 might be difficult to duplicate in 2007. Their operating margins of 19.5% were helped by higher fees for cross border charges in 2006. MasterCard does not expect any special items or price increases in 2007. The stock was hammered as investors took profits after the stock hit an all time high of $118 on the initial earnings news. That was nearly a +200% gain over its $40 low when it went public back in May. MA found some pretty strong buying support at $100 and managed to rebound +3.50 off its lows before the close.

Real Estate Investment Trusts (REIT) are also feeling the pressure of investors taking profits. The weakness in the housing sector is starting to bleed over into the REITs even though they are not related. More than likely investors are simply undecided if the housing weakness will eventually cause a recession and are just locking in profits on REITs many of which have been strong performers. Public Storage (PSA) for instance had risen +67% since May. That is a lot of profit at risk if the housing sector turns into a recession. Boston Property (BXP) was another big winner with a +61% gain since May. Both PSA and BXP hit new historic highs this week and then sold off hard on Thr/Fri along with the rest of the sector.

The public hedge fund business got off to a rousing start today with shares of Fortress Investment Group (FIG) soaring +67% in its IPO. Only 23% of the company was sold to the public with the founders and principals still holding 77% and voting control. The stock was priced at $18.50 and closed at $31 after a brief spike to $35. This values the entire company at $12 billion and much higher than previous estimates of $8 billion pre IPO. Ken Hebner said it best on CNBC. He said he would avoid jumping in the water because the initial IPO was just chumming for the sharks. Chumming is where fishermen throw chunks of cut up fish in the water hoping the scent will attract the much bigger fish like sharks. In this case the limited 23% in the IPO was designed to generate a highly oversold offering and push the stock price well over what some would consider a reasonable value. As retail investors fight for the limited shares it pushes the prices higher and allows the founders and principals to exit for a windfall profit when their lockup expires leaving the retail investor holding the bag. Nobody is saying that is what the Fortress insiders are doing but the winks and nods were making the rounds on Friday. Based on Friday's close FIG is trading at 36 times trailing earnings. According to Ted Gooden, a partner at Berkshire Capital, other U.S. asset managers trade at 20-30 times earnings. The most vocal critics suggested buying Goldman Sachs instead which is essentially a hedge fund as well and trades at only 11 times earnings with a market cap of $88 billion. In the Fortress IPO prospectus they planned to acquire some smaller hedge funds and branch into other areas of business. Let's hope they are as successful in their new businesses as they were in this IPO.

March Crude Oil Chart - Daily

The energy sector saw oil trade higher once again with only a last minute selling spree forcing a close back under $60 at $59.90. Oil reached an intraday high of $60.80 on continued cold weather and a temporary shutdown of a field on the West Coast. Geopolitical news was also driving prices with Nigeria declaring Force Majeure on deliveries for the rest of February and March. Nigeria said production would be down by 370,000 bpd for the rest of February and by 260,000 bpd in March. This is major news since Nigeria produces the light sweet crude refiners need for making gasoline.

Lloyd's Marine Intelligence Unit said OPEC production for January really did fall by another 200,000 bpd. This confirmation is coming from various sources and suggests OPEC is really getting serious about supporting prices. With another 500,000 bpd cut supposedly starting on Feb-1st this could get interesting very soon. According to the EIA they only expect about 60% (300,000 bpd) of that cut to actually occur due to cheating. Iran is also on the calendar with the Iranian President scheduled to make a big speech this Sunday on the 20th anniversary of the Islamic Revolution. In this speech he is reportedly going to make a major announcement about their nuclear project. I doubt they are canceling it. Supreme leader Ayatollah Khameni warned on Thursday that Iran would strike U.S. interests around the world if his country was attacked. Analysts wonder if his statement was a warning planned ahead of Ahmadinejad's speech due to some potentially explosive content. On Friday the International Atomic Energy Agency (IAEA) suspended 22 of its 55 technical aid programs to Iran. Iranian officials immediately condemned the suspensions. This is going to be an interesting weekend in the oil markets!

As we begin to test the air over $60 again we should not forget that rising oil prices are inflationary. All this reduced inflation talk we have had over the last three months has largely been due to falling oil prices. Should they continue to rise it would jeopardize the fragile inflationary balancing act the Fed is trying to manage. This fact is sure to come out in the various speeches next week.

Next week could be rocky for the markets. We have some major economic reports and a couple Bernanke appearances. Earnings are dwindling but guidance warnings appear to be increasing. Recent market leaders are showing signs of profit taking on stronger volume. Is it just another dip to buy or the start of something bigger? Obviously nobody knows for sure and it could be just position shuffling ahead of some high profile events. On a chart basis the Dow had two serious days of losses after setting another historic high on Wednesday at 12700. Despite those two days of major intraday drops the Dow only lost 72 points for the week. No harm, no foul and the long term bullish trend is still intact. 12450 is current support followed by 12350. Neither is out of range and neither would represent any material change in the trend. A dip to 12450 would almost hit that -2% retracement analysts have been expecting. A continued dip to 12350 would only be a -2.5% drop from the Dow's recent record close. That would be a great spot to launch a new rally with real legs BUT it might also be enough to sour investors on buying the dips.

We saw strong dip buying on Thursday that lifted the Dow +100 points off its lows. The Friday drop of -125 points from that Thursday rebound high had to hurt sentiment and there was far less buying interest Friday afternoon. The rebound only managed +35 points from the day's lows. Since it was a Friday ahead of a heavy reporting week that could have influenced buyers to stay on the sidelines.

The Nasdaq may have fallen -35 points intraday but that dip to 2455 was only to initial support. That is the same support that produced a nice rebound on Tuesday with follow through on Wednesday to a new four week high. Friday's rebound was only 5 points from that same support. With tech warnings increasing I am becoming doubtful that this rebound trend will continue. The next material support is 2425 followed by 2400. With Microsoft and several of the other tech giants bleeding points it could be difficult for buyers to push the indexes higher even if individual stocks can post some gains.

S&P-500 Chart - Daily

The S&P-500 lost -10 points for the week and that was the largest weekly loss in the last eight weeks. The S&P struggled to break resistance at 1450 all week and could not produce a breakout. This failure was a defining moment for some analysts that indicates a tired market with bullish sentiment waning. That is a very big leap of faith to think the bulls are just going to roll over because resistance at 1450 held. If that is the case we may not know it for a couple more days. There is strong support at 1420 and again at 1400. There is massive support even lower at 1385. The bulls may be tired but they have a lot of places to rest and regain their strength on any continued decline.

With the big three indexes giving us mixed views we need to look elsewhere to see if bullish sentiment is fading. The Russell-2000 retreated from Thursday's record high close at 816 to close at 806. A -10 point drop on the Russell is a big move (1.13%) but there was a dead stop at support at 804. There was not even a hint of a breakdown below that support. Like the other indexes there is monster support lurking just a tad bit lower. It would be very surprising if the Russell breaks the various support levels between 780-800 and while there may be some softness ahead it would take a major change in sentiment to break that 780 level. As long as the dips are being bought in the small caps the market is not going significantly lower. Watch the Russell and you will see the real market sentiment.

Russell-2000 Chart - Daily

Wilshire-5000 Chart - Daily

The broadest market index the Wilshire 5000 collapsed from the morning's historic high at 14705 to 14505 intraday for a -200 point move. The rebound was also muted but managed +50 points off the bottom. The Wilshire did NOT breakdown along with the Dow on Wed/Thr. Traders were still buying stock until the sell programs began firing at noon on Friday. That is another sentiment indicator that the broadest market indicator was still showing bullish indications up until noon on Friday. Real support on the Wilshire is 14300 and I would expect that level to hold on anything but a complete reversal of sentiment. That 14300 level would be only a -2.7% decline from the highs and I would view that as a strong buying opportunity.

I think everyone should realize there is a decent bout of profit taking in our future. We just never know when. As I have reported before Ned Davis research said that as of Friday it has been 143 trading days since the Dow had a very minor -2% dip. That would be roughly 12412 on a closing basis and something we could easily hit very quickly if fund managers pulled their bids. Friday's drop was not a retail drop. It was pure sell program inspired drop from 12:30 to 2:30. We saw that same sell program activity late Wednesday and early Thursday. A few strong programs combined to push the markets lower. This is a departure from our recent norm. Sell programs have been almost nonexistent. Their return could suggest that institutional sentiment is changing.

For us as retail traders we just need to follow a few simple guidelines to stay on the right side of the trend. When the S&P fell below 1440 that was our cue to switch to a short bias with a target of 1420. Last week our plan was to run with the bulls and remain long over 1440. I am going to change that recommendation this week. We want to remain short under 1440 but should a rebound appear I want to be flat over 1440 and reenter a short position with another failure at 1450. I don't think we are going to see that level tested again early in the week but Robert Craig "Evil" Knievel thought he could jump the Snake River Canyon too. What I think does not matter. What matters is how we react to what the market gives us. If it gives us another rebound to 1450 I am going to short it ahead of Bernanke's testimony. After his testimony conditions could change if he says the right thing. Be prepared to change your plan if he blesses the markets with some form of no hike language. I am actually hoping for that -2% dip to appear so people will quit worrying about it. Maybe Bernanke can provide us with the motive power to do it. We were Greenspamed many times in the past but as yet never seriously Bernanked.

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