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Market Wrap

Uncle Ben Wins Again

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So far the Bernanke reign has been very market friendly. Uncle Ben again proved to be a kinder, gentler and more easily understandable Fed chairman. His positive view of the economy and his calm outlook for inflation provided the bulls with another chance to buy the dip and race to new highs. Just when it appeared to the bears the markets were going to break support and take a much-needed rest they found themselves racing to cover their shorts on the Bernanke comments. The bears have nothing to cheer about this week, this month or this year. Every shorting opportunity has turned into a monster short squeeze that pushed the markets to new highs. Eventually they will be right but for now the bulls remain in control.

Dow Chart - Daily

Nasdaq Chart - Daily

The week was peppered with mixed economic results and Friday was no different. The Producer Price Index (PPI) showed a headline drop of -0.6% and a sharper dip than was expected. The majority of the decline was led by the impact of lower energy prices still filtering through the system from the Q4 lows. Core producer prices, which exclude food and energy rose +0.2% and inline with expectations. Finished energy products fell by 4.6% after two months of strong gains while crude energy products fell 16.2%. Gasoline prices fell 13% in January. However, early February indications are that prices for all products related to oil are rising sharply.

Housing starts for new residential construction fell -14.3% to 1.408 million on an annualized basis. This was down from the 1.643 million pace seen in December. That was the biggest decline in nearly ten years. While this seems disastrous on the surface it should be taken in context. Both the November and December numbers showed sharp gains of 5% or more as unseasonably warm weather spurred an abnormal winter build cycle. In January winter arrived with a vengeance and starts slowed to a crawl due to heavy snow cover and zero degree temperatures. Remember ice storms and snowplows in the news in California and airport shutdowns in multiple states? This was simply a weather related dip and not evidence of a new downturn in the sector. Actually a drop in starts would mean less inventory for spring and help bolster sagging prices for new homes. Starts for single-family homes are down 40% from year ago levels.

Consumer Sentiment for February fell sharply to 93.3 from the last reading of 96.9 for January. That January reading was a two-year high. Both the present conditions component and the expectations component fell thee points or more. Rising jobless claims, a resetting of ARM loans at higher interest rates and a high rate of foreclosures due to a lack of rebound in housing prices is impacting consumer sentiment. Gasoline may be under $2 a gallon in some places but the home equity ATM is running dry to pay for it.

After a week chock full of economic reports next week will seem like a holiday with Wednesday the only day with market moving possibilities. The Consumer Price Index will be key for its insight into the continuing progress of inflation. The FOMC minutes will provide an insight into what the Fed was thinking in their recent meeting and which Fed officials wanted higher rates. Thursday's Kansas Fed Survey will be of interest but it is not normally a market mover. The Wednesday oil inventory levels will be moved forward a day to Thursday due to the government holiday on Monday.

Economic Calendar

Friday was a lazy day for the markets with many traders leaving early for the 3-day weekend. The markets will be closed on Monday for President's Day. The biggest news items were a rumored buyout of American Airlines, a GM buyout of Chrysler and a warning of sorts from Microsoft.

AMR, parent of American Airlines spiked on a rumor that a partnership of British Airways and Goldman Sachs were preparing a bid of $46-$52 for the carrier. Reuters and Bloomberg immediately countered with comments that no deal was imminent or possible. AMR has far too much debt at $18 billion to be attractive and especially at that price. There is also a rule preventing more than 25% foreign ownership of an American airline. The rumor was sparked by an upcoming article in Businessweek suggesting this buyout may be in the works. Prudential, Morgan Stanley and numerous other brokers said the deal would never fly even if the rumor were true.

Much more interesting was news that GM may be in talks to acquire Chrysler. That rumor drew praise from some and ridicule from others. Chrysler is the number three car maker in the US with a 14% market share and sells two million units annually. They have 3400 dealerships and numerous manufacturing plants in the US. GM is the largest automaker although Toyota is expected to pass them soon. GM has 7100 dealerships and a 22% market share. Should the buyout happen it would cause dramatic problems for GM but give them a 36% market share. GM probably would not be considering this move except to keep a Chinese company from buying Chrysler and getting an immediate foothold and major market share in GM's home market. Daimler Chrysler has been looking for a takeout of Chrysler and a GM buy would be seen as self defense rather than an offensive move.

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GM has been shifting away from cars manufactured in America due to the higher costs of unions and health care. They are moving to a foreign manufactured model where cars are made outside the US with far cheaper overhead. By acquiring Chrysler they would be picking up numerous North American production facilities and that would lead to even more plant closures and layoffs. Chrysler announced a restructuring plan this week that will eliminate 13,000 jobs. There were so many analysts coming out against this deal that it probably has little chance of occurring as an outright acquisition. Personally I think it would be an interesting move. GM would eliminate a major competitor at a time when competition is heating up against the onslaught of foreign makers. There would be a lot of duplication in product lines but if GM owned Chrysler it could eliminate that duplication and increase share for the surviving model. GM would pickup 3400 dealerships and broaden its marketing footprint. That would be a blessing and a curse since some would have to be eliminated as product lines were narrowed. GM would pickup the profitable Jeep, truck and minivan lines and could shed the far less popular passenger car models. By combining model lines and streamlining production they could sell more units of the remaining models at a lower cost. It would not be an easy acquisition and could cause GM to assume a huge amount of additional debt. It would also cement GM as the largest domestic automaker for years to come. With the eventual cost savings from reducing model overlap they might be able to pay off some of their monstrous debt. Just my two cents and that is about what my opinion is worth to GM. Analysts are so negative it will probably never happen but it was an interesting scenario.

Steve Ballmer, CEO at Microsoft, said late Thursday that revenue projections for Vista were "overly aggressive." That was the first crack in the Microsoft armor and one I have been speculating would be coming. It was not a real profit warning but more of a first attempt to talk down estimates with lots of time left in this quarter. Vista is not flying off the shelves and most experts are now recommending NOT to buy the software only for a do it yourself upgrade. The number of hardware challenges and the large number of bugs being reported are a daunting challenge for the normal consumer. Experts suggest waiting until you upgrade to a new computer to move to Vista. They suggest letting the hardware manufacturers solve all the compatibility problems for you. Those same experts are now saying if you just have to upgrade then at least wait for the release of the first service pack (SP1) before taking the plunge. This service pack is said to be growing in size as each day passes and will solve hundreds of reported problems once installed. Another reason Microsoft is trying to talk down Vista expectations is the strength of the sales in emerging markets. Microsoft typically heavily discounts sales to emerging markets to compensate for the lower income levels, stiff competition from piracy and lower pain threshold by early adopters. Analysts fear that the sales of deeply discounted Vista to emerging markets is outstripping sales at full retail in the US. In a presentation to analysts Ballmer said Vista would create a "small surge" in PC sales over the next year but would NOT spur a big increase over normal growth rates. This is not what the analyst community had been expecting and not what Microsoft had been informally talking about for the last year. Ballmer said, "Some of the revenue models and revenue forecasts I've seen out there for Windows Vista are overly aggressive. I don't think that much new money will race out of the consumers pockets into PCs." Since 75 cents of every dollar of Microsoft profit comes from the Windows operating systems a slow acceptance of Vista could cause profit pains at Microsoft. MSFT stock rose +30% since June ahead of the Vista release. MSFT has lost ground in 3 of the 13 trading days since the Vista release. Friday's close at $28.72 was a new three-month low.

Microsoft Chart - Daily

After the bell the semiconductor sector took another blow after SanDisk warned that it was cutting 10% of its payroll and cutting salaries of all executives by as much as 20% due to declining prices for flash memory. Salaries for all remaining employees would be frozen as well as new hiring. SanDisk said profit margins would remain under pressure for several quarters to come. The cost cutting measures were designed to cut costs by $30-$35 million a year. SanDisk said weak Q1 demand had caused prices to decline by 50% over the last two months. In order to maintain market share SanDisk said it was cutting prices by as much as 40%. You may remember it was Micron who warned last Friday that flash memory prices would be down 30% to 40% in the current quarter. That caused a sharp drop in the Nasdaq last Friday. SanDisk waited until after the close but you can bet the impact will be felt on Tuesday. SanDisk said they were confident the sharply lower prices would accelerate demand and stimulate new markets for the products. Since those new markets would be predicated on the lower prices for chips it appears SanDisk and Micron have a long rough road ahead to regain any profit margins.

In the energy sector the price of oil rebounded from a two week low at $56.62 on Thursday to close at $59.40 and right back to that $60 resistance level. Supporting the rebound was a warning from the US government that Nigerian militants were planning to escalate their attacks. Possible new targets included expatriate personnel, Western businesses or facilities and locales visited by tourists in other regions of Nigeria. Meanwhile OPEC's new secretary-general, Abdullah Salem el-Badri, said the global oil market had become more balanced thanks to compliance with recent production cut agreements. He said supply and demand are now balanced at 86 mbpd and adherence to the announced cuts was about 66%. In OPEC a 66% compliance is like 100% everywhere else. The announced cuts totaled 1.7 mbpd putting 66% compliance at only 1,122,000 bpd. Independent surveys put the cuts more like 50% at 850,000 bpd. If these production cuts continue we should see prices eventually move back over the $60 level. OPEC also said they were raising their demand estimates for OPEC crude by 200,000 bpd. The reason is failing supplies at non-OPEC suppliers. OPEC expects supply from non-OPEC sources to drop by 170,000 bpd compared to expectations in late 2006 for an increase from those same suppliers.

March Crude Oil Chart - Daily

April Crude Oil Chart - Daily

The International Energy Agency raised their world demand estimates earlier this week by 273,000 bpd in 2007 and warned that the OPEC cuts could seriously tighten the markets and push prices higher. The IEA said demand from China would grow by 500,000 bpd to 7.6 mbpd in 2007. Vehicle sales in China rose by 25% to a record 7.2 million units in 2006. Despite strict controls put in place to curb this growth in autos another 25% growth year is expected for 2007.

Next Wednesday we will also see the head of the International Atomic Energy Agency (IAEA), Mohammed el-Baradei, give a report to the UN Security Council on the compliance by Iran with the halt of uranium enrichment. It should be a short report. No compliance. The council will then decide on additional sanctions to force compliance. Given reluctance by Russia and China that could be another long debate. However, they did come around and allow the present sanctions and Iran has rebuffed them at every turn. Last Sunday Iranian President Mahmoud Ahmadinejad vowed to never give up enrichment but refrained from making the huge announcement that was expected and from showing his wilder side during the speech on the 28th anniversary of the Islamic revolution. He had announced he would make a major nuclear announcement but there was no announcement. Analysts believe he presented a calmer demeanor because of the IAEA/UN event next Wednesday. It is easier to pass additional sanctions against a wild man than a leader showing restraint.

Also supporting prices was the impending expiration of the March crude futures contract next Tuesday. Traders short that contract ahead of the 3-day weekend decided to exit at the close rather than risk some event over the weekend that would put them in a world of pain before the markets opened to thin trading on Tuesday. Next Friday the March options will expire on heating oil, reformulated gasoline and natural gas. That could produce some further volatility in those products. The national weather service NOAA said warmer than normal temperatures are expected for next week and that should have pressured prices but the long weekend and pending expiration prevented that downward move.

Speaking of downward moves there were none in the market this week. After Monday's dip by the Dow to initial support at 12550 ahead of Bernanke's testimony the rebound was vertical from there. The Bernanke testimony convinced investors that inflation was slowing, the economy was growing steadily and the Fed, although watchful, was going to be on the sidelines for quite sometime. The Dow soared past the prior resistance high from last week at 12700 and continued to set new highs right into Friday's close. The mixed economics on Friday caused the markets to dip only slightly intraday. The Dow traded in only a 25-point range before closing only slightly positive with a +2.56 gain but yet another new historic high close at 12767.89. It is hard to draw any resistance lines on the Dow that are not unbelievable. Any breakout chart is always difficult to really tell where the next resistance level might be. The only way to chart it that is reasonably correct would show 12800 to be the next challenge. It also suggests that a breakout over 12800 could go ballistic very quickly to the stratospheric level of 13000. There is simply no selling pressure and no fear with the VIX hovering at lows near 10. Until this trend breaks the bulls will keep buying any dips to the 30-day average like popcorn for a buck at the movies. With popcorn going for the inflated price of $5-$8 a barrel the same thing for a buck would create a serious feeding frenzy. The bulls may not be in frenzy mode yet but if the Dow breaks out again it could be a real fun ride.

Before the SanDisk implosion after the close on Friday the Nasdaq was calmly putting in higher highs and higher lows as it approached 2500 again in stealth mode. The last trip to 2500 ended badly and the slow pace of movement this time virtually assured a breakout until the SanDisk disaster on Friday night. How that will impact the Nasdaq on Tuesday is unclear since Micron already warned of the same price problem. SanDisk is just reacting to the same circumstances but a lot sharper. After the close SNDK fell -$2 to $38 and a new six month low. Traders will probably hammer SNDK on Tuesday but it remains to be seen if the rest of the chips will follow suit. Micron was the only reactor I saw in after hours on Friday. Of course it was a holiday Friday and very few traders were even around to see the warning much less react to it.

S&P-500 Chart - Daily

On Tuesday the S&P recovered from its Monday drop to 1431 to come to a dead stop at 1440 and our prior long/short indicator. It hovered there for about 2 hours but finally broke out to begin a run to 1455 where it closed on Friday. Last Sunday I suggested not going long again over 1440 but to look to short any unexpected return to 1450 BEFORE the Bernanke testimony. I cautioned that should he say something positive it could change the ballgame and we should be prepared to change the plan if that happened. Obviously it happened and it was very obvious once it started so I hope everyone "changed the plan" back to a long bias over 1440. I remain the stubborn one and after three days of being pinned to 1455 I took a small futures short into Friday's close. If the market shakes off the SanDisk news on Tuesday I will be the first to go long again over 1458. The S&P has been using the 30-day average for support since August and last week's dip did nothing to change that. The 50-day, currently at 1427, has not even been touched since July. A move below the 50-day would be a game changer.

Russell-2000 Chart - Weekly

NYSE Composite Chart - Weekly

Wilshire-5000 Chart - Weekly

If you recall the last couple of weeks I have been discussing the rebirth of the Russell-2000 and small cap stocks. The Russell suffered the same Micron induced bout of profit taking last Friday as the large cap indexes but it was back to historic highs when Bernanke blessed the economy. Friday's close at 818 was a new historic closing high. As long as the small caps are in favor the rest of the market will also prosper. The Russell appears ready to finally make that break over 818 and also go blue sky on us. With a move over 820 the Russell could easily sprint to 850 before reaching the next material resistance level. I would love to be along for that ride. The Russell is my sentiment indicator for the rest of the market and it was waving flags and popping champagne at Friday's close.

Assisting in the flag waving was the Dow transports with another close over 5100. The breakout on the Transports and the Russell in the same week represents very strong bullish sentiment. The NYSE Composite closed at 9432 and while that was -3 points from Thursday's record close it was still very bullish. The Wilshire-5000, the broadest index also closed at a new record high. The problem with all this extreme bullishness is simply that it is extreme! All the signs are pointing to a very strong week ahead and there are no signs of any impending correction. That should worry everyone but it does not seem to matter. Everyone with money burning a hole in their pocket is throwing it at the market on every minor dip. Eventually this is going to bite the bulls but the setup this weekend looks very bullish. Extremely bullish! My advice today would be to buy any SanDisk dip on Tuesday. Actually it would be to buy the "rebound" from any SanDisk dip. We want to make sure there will be a rebound before spending those bucks. SPX 1440 is off the table for next week. Instead monitor Russell 820, SPX 1458, Dow 12800, NYSE Composite 9450 and Wilshire 14750. A move over any or all of these levels should produce a race to levels we could only dream about back in December. Eventually there will be an event appear out of nowhere to trigger a real reversal but this weekend I can't imagine what it would be. We have had bad news from nearly every corner both in guidance warnings and economic reports and nothing seems to faze the bulls. When the bulls are stampeding it is best to follow and not stand in their path. As Richard Gere said in Pretty Woman, just try to avoid the steaming divots. In this case it would be a divot like SanDisk.
 

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