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Thank Merck, McDonalds and Cisco

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You can thank Merck, McDonalds and Cisco for Friday's low volume breakout. The bullish underlying bid was continuing to push prices higher on the back of several earnings upgrades but inflation fears were slowing that advance. On Friday Merck surprised traders when they revised guidance higher and the stock spiked +$4 on heavy volume. As a Dow component the spike in MRK gave the Dow a +30 point lift. Dow component McDonalds (MCD) also surprised traders saying March sales were stronger than expected and possibly its best month ever in Europe. MCD gained +$1 and that gave the Dow another +8 point boost. Cisco's CDO said at 2:30 on Friday that Cisco customers were at the early stages of a new upgrade cycle and sales were running toward the top of their prior projections. Cisco stock shot up nearly 75 cents on the comment but due to Cisco's weighting in the Nasdaq and the associated jump in companion stocks the Nasdaq spiked nearly +10 points in just seconds creating a short covering surprise that lasted into the close. Thank you Merck, McDonalds and Cisco for giving us a boost over that pesky resistance level that had plagued us all week.

Dow Chart - 240 min

Nasdaq Chart - Daily

Economically Friday was not a good day so we really needed those positive stock events to provide upward momentum. The Producer Price Index (PPI) rose sharply once again with a +1.0% gain. Most of that inflation was in food and energy so the core rate remained unchanged. Core inflation components were showing some signs of surging with the prices for intermediate crude goods jumping +7.7%. Finished goods rose by +6.9% on an annualized rate and core finished goods spiked +2.3%. Finished energy goods rose +9.4%. Taking the component lead was a jump in core crude goods at +59.3%. On the surface the flat core rate excluding food and energy prices may seem Fed positive but the Fed also has to take into account the impact of those factors. This suggests the Fed is much closer to a rate hike than a rate cut despite the impact of the subprime loan problem.

Consumer sentiment fell unexpectedly to 85.3 from 88.4 and well below expectations for a slight gain. The drop put the index at the lowest level since August. The biggest drop came in the expectations component, which fell -4.4 points to 74.3. The one-year inflation expectations component surged to 3.3% from 3.0% giving the Fed one more reason to stay away from any rate cuts. The weakening housing market was given as the major reason for the drop with higher gasoline prices a close second. The National Association of Realtors said on Thursday they expect home prices to fall in 2007 for the first time in the 40 years they have been tracking this data. The expectations component is strongly impacted by negative headlines and housing has definitely been producing those headlines.

Consumer Sentiment

Next week economic activity increases with the major reports being the Consumer Price Index (CPI) and New Residential Construction on Tuesday followed by the Philly Fed Survey on Thursday. There are plenty of filler reports but those three are the key. The CPI will show how much of the inflation shown in the PPI has filtered down to the consumer level. This will be another point for the Fed to ponder. The new home construction will be mostly a sentiment item for traders rather than a major economic event. If home construction has been better than expected this could help boost investor sentiment. The Philly Fed survey on Thursday has a high correlation to the national ISM report 10-days later. This will give traders a hint of what may be to come.

Economic Calendar

More important than economics next week will be the acceleration in earnings reports with several majors like Intel, Ebay, Yahoo and Google in the list. So far in this earnings cycle only 34 of the S&P-500 have reported with earnings growth of +14%. That was +9% over analyst estimates but this cycle is still very young and those should not be considered signs of a full quarter trend. Thomson Financial is still forecasting 3.3% growth after all 500 companies report. So far 61% beat estimates, 21% reported inline and only 15% missed their targets. 71% reported earnings equal to or higher than the same period in 2006 while 29% reported earnings that were lower.

Next week the earnings from Intel and AMD will be key for techs. Intel will report they are regaining market share AMD stole a couple years ago and AMD will confirm this share loss. The key here is sales volume at Intel and margins. If they are able to regain this share on strong margins and report rising volume then tech stocks should benefit. If Intel says anything about soft processor sales we could be in trouble because nobody is expecting anything but good news. Yahoo and Google both report and we will see if Yahoo is any closer to taking back some of its online ad share stolen by Google over the last couple years. Google investors will be holding their breath in hope Google has found some way to produce even more earnings in the future. Motorola earnings will tell us how well cell phones are selling worldwide. There are numerous financial stocks reporting and that sector has been performing very poorly. There are considerable fears that the subprime problem is going to really rear its ugly head in these reports and bank investors are running scared. Earnings will be the key next week with the CPI the highest profile report likely to steal some thunder from earnings.

Partial Earnings Calendar

The extent of the subprime problem has only been guestimated based on the various bankruptcies of 50 some odd subprime mortgage companies and a couple warnings from banks unable to resell loans into the securities market. On Friday GE reported earnings that were inline with estimates and they claimed no material impact from subprime loans already on the books. GE owns WMC Mortgage, the 8th largest mortgage loan originator in the country. The real problem did not come from loans on the books BUT from loan originations and this was largely overlooked by the street. In Q4 WMC originated $10 billion in loans. That fell to $3.5B in Q1, only $500 million in March and month to date only $50 million in April. If the current origination rate holds that suggests originations for Q2 could fall to less than $200 million and only 1/50th of the rate in Q4. This data should be surprising to everyone. In fact it should be downright shocking. If this loan origination rate is holding industry wide we are in deep trouble and the housing sector is about to take a serious drop. If loan originations have really skidded to a halt as evidenced by the GE loan rate then home purchases have fallen off a cliff in the last 45 days. Fortunately we are not seeing confirmation of this in the weekly MBA Mortgage Applications Survey. Originations in the survey are declining slightly but nothing catastrophic. Purchase loans actually increased +2.7% last week. That suggests the decline in GE's WMC originations are due to some other reason. However, I do expect to hear some more horror stories as financials begin to report and that is why they have been trading lower in a rising market.

Washington Mutual (WM) reportedly has 10% of its portfolio in subprime and they report on Tuesday. This will be seen as a major road sign on the subprime highway to oblivion. They can put everyone at ease or produce a complete dump in the sector.

Citigroup will report earnings on Monday and give us further guidance in relation to its restructuring plan announced this week. Citigroup also announced they were buying Old Lane Partners, a hedge fund founded by former Morgan Stanley executive Vikram Pandit. Terms were not disclosed but the price was thought to have been over $600 million. Pandit will become CEO of Citi Alternative Investments and oversee $59 billion in assets. This was not a bad career move for Pandit. Old Lane managed $4.5 billion in assets.

Student loan company Sallie Mae (SLM) is reportedly in talks to be acquired by a private group headed by Blackstone for something in excess of $20 billion. I never cease to be amazed. The buyout mania has evidently run its course if LBO firms are looking at a previously government supported company currently in serious trouble with various government agencies. SLM is under fire for questionable lending practices and the stock has fallen nearly 20% since November. They announced a $2 million settlement with the state of New York on Friday but that is only one of its current problems. Sallie Mae was created in 1972 as a government sponsored entity (GSE). SLM began cutting government ties in 1997 and completed their separation in 2004. The takeover rumors sent SLM credit default swaps up more than double to $78,000 per year for every $10 million of insured principal. This is a major blow to SLM and its future business profits.

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McDonalds reports earnings next week and Friday's sales update was nothing short of amazing. Same store sales jumped +8.2% for the month and +6.3% for the quarter. Across the Atlantic sales jumped +11.2% in Europe. Earnings expectations are now 62 cents and that is +5 cents more than analysts were projecting. S&P analyst Mark Basham upgraded MCD to a strong buy with a $58 price target. MCD closed at $47 with a +$1 gain.

Google announced after the bell it was buying DoubleClick for $3.1 billion. Doubleclick was a superstar during the dot.com boom but the company fell on hard times during the dot.com bust. Hellman & Friedman bought Doubleclick for $1.1 billion in 2005. That is the kind of return I like. $1 billion a year for each year they held the company and Google is taking them out for cash. Microsoft had been in the bidding but withdrew after bids rose over $2 billion. Doubleclick has more than 1500 corporate clients in its ad placement business. ValueClick (VCLK) spiked +5% in after hours on the increased valuations given DoubleClick.

Cisco does not report earnings for several weeks but their comments on Friday did wonders for the market. Cisco's Chief Development Officer (CDO) Charlie Giancario said in an interview that the company was seeing strong demand for its products. While we have seen strong demand over the year as of last quarter we are seeing really good growth around the world. He felt this was led by emerging markets overall and a rebound in Europe from the recent capex slump. Giancario said the market was still in the early phases of the current technology upgrade cycle and Cisco was heading in new directions equipping companies for increased communications both internally and externally. Cisco bought online conference producer WebEx to add to their capabilities in this area. The comments powered the Nasdaq over resistance at 2480 and produced short covering in techs that lasted until after the close.

Earnings are coming and trading profits are about to explode. However, that all depends on how you trade them. I mentioned on Tuesday night that RIMM earnings on Wednesday were a recipe for disaster. RIMM had traded as high as $149 the day it was to report earnings. This was a +$13 sprint in only five days on expectations it would report strong results. On Friday two days after earnings RIMM traded under $132 for a -$17 post earnings drop. Earnings were good but the forecast was disappointing. This is a perfect example of why you should not normally hold over an earnings report. For the last ten years I have been recommending in these pages for traders take profits on the earnings expectations by exiting a day or two before the actual report. There are always going to be those companies that surprise to the upside and race a few bucks higher but the vast majority will either do nothing in price or disappoint producing a monster loss as RIMM did last week. If you must hold a position over earnings at least try to make sure it is opposite the current trend. Whatever the trend has been attracts the most investors. When the trend changes due to something in the earnings report the strongest reaction is in the opposite direction. That would have been a put in the case of RIMM. Those holding optimistic calls saw their profit erased completely before options even opened for trading. Trade smart and exit before earnings to capture repeatable profits.

RIMM Chart - 30 min

Apple Chart - Daily

Apple shares fell for the 4th day losing nearly $2 after Apple said it was going to delay the next version of the Mac operating system codenamed Leopard. The operating system was initially slated to be released at its Worldwide Developers Conference on June 11th. Apple said the delay was due to the upcoming iPhone launch. The "iPhone contains the most sophisticated software ever shipped on a mobile device and finishing it on time has not come without a price. We had to borrow some key software engineering and quality assurance resources from our Mac OS X team." Analysts feel the priority switch was the right choice since the iPhone buzz is so strong. The iPhone release needs to be on time and with flawless software and the success will produce billions in profit for Apple. The Mac OS X operating system will not be a strong revenue driver relative to that of the iPhone. If you had to choose only one the iPhone was the right choice. Apple expects to sell 10 million units in 2008 and judging by the current waiting list at Cingular Wireless it will be a slam dunk. Current estimates put iPhone inquiries at more than two million with extreme pre launch demand. Apple always poked fun at Microsoft and its operating system delays. Apple rarely missed prior dates because they almost never gave dates. I guess they know how it feels now. They also missed the delivery date of the Apple TV device which was targeted for an early February launch. They did not begin shipping until March 21st.

Oil prices rebounded to $64.35 from their Monday low of $61.35 but faded at the close to $63.63. The majority of the rebound was powered by a sharp drop in gasoline inventories and expiring crude futures. On Wednesday gasoline inventories fell -5.5 million barrels, more than three times what was expected. Refinery activity levels improved but there are still outages at various plants and a bottleneck of crude in Cushing Oklahoma. Crude imports fell -440,000 bpd for the week. Gasoline supplies are now 4.5% below 2006 levels and implied gasoline demand has risen +2.5% on a four-week basis. Gasoline inventories have declined -27 million barrels in recent weeks. Analysts expect inventory levels to increase as refineries begin to come back online from outages and planned maintenance conversions to summer blends. This increase in refinery activity will produce a stronger draw on crude but those same analysts feel there is sufficient crude in the pipeline to cover demand. Time will tell and we are only about six weeks from the start of hurricane season. Boone Pickens was on CNBC last week saying he could see oil returning to $78 on any minor combination of outside events. This sentiment has been echoed by most major energy traders.

Friday's Cisco induced breakout by the Nasdaq helped drag the Dow over resistance at 12600 and sets the stage for a continuation rally next week on positive earnings news. The NYSE Composite ($NYA or ETF = NYC) is leading the pack with another strong performance to a new historic closing high on Friday at 9522. The index gained +45 points for the day and +96 for the week. Compared to the +51 weekly gain on the Dow and +20 on the Nasdaq this is a clear sentiment breakout in progress. The best performing sectors for the week were transports +2.4%, Oil Service +3.5% and Health Care at +2.3%. Commodities and gold in particular were also strong on inflation fears.

NYSE Composite Chart - Daily

Russell Chart - Daily

The Dow struggled to close over 12600 even with MRK and MCD adding nearly +40 Dow points by them selves. There are only two major resistance levels still left at 12680 and the historic high at 12800. The Dow rally has been lackluster and nearly a third of the Dow components closed in the red on Friday. Sentiment is shifting away from the large blue chips and into techs and small caps. This is very positive for the market since it suggests growing bullish sentiment among fund managers. If earnings continue to surprise to the upside the small caps could extend their performance lead.

The Nasdaq fought resistance at 2480 for the last six days and the Cisco news could not have come at a better time. The Nasdaq was trading at 2480.25 when the news broke and the resulting short covering rally and volume breadth in the QQQQ produced a spike that was still active after the close. The Russell and S&P futures both closed in after hours at the highs for the day. The Nasdaq will be keying on earnings from INTC, AMD, MOT, YHOO, GOOG and EBAY next week. This could light a real fire under techs or smother the rally completely depending on the results. Support is 2465 and resistance is the February high at 2525.

S&P-500 Chart - Daily

The S&P continues to plod along in the shadow of the other indexes but did manage to break into the current resistance range at 1450-1460 with a 1453 close. We will really see some fireworks if the S&P can break that 1460 level along with the NYA and RUT. Until then we are in danger of another failed breakdown at current resistance and a long slow grind into summer. What could cause this would be earnings disappointments on a wider scale like we saw on RIMM last week. Expectations are so bullish today after the first 34 S&P companies to report posted +14% earnings growth that disappointment could settle in hard if we get too many guidance warnings. Rather than burn a million brain cells trying to contemplate the various earnings scenarios we just need to play the cards we are dealt as next week progresses. I am bullish based on the NYA and RUT but conditions can change in an instant as we saw with RIMM. I will remain long with the S&P over 1450 or even 1445 but a move under 1440 would cause an immediate change in bias. April is normally a good month for stocks and it is starting off with a decent trend. Let's hope it continues.
 

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