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Market Wrap

Holiday Hoopla

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The bulls celebrated their independence last week with a very broad based rally that returned the major indexes to near their recent highs. The rally came on low volume and without any associated hoopla. It was as stealthy as any we have seen in recent months with gains coming slowly on that low volume. It appeared the bears took the holiday and the bulls celebrated by grazing calmly on a few tech stocks.

Dow Chart - Daily

Nasdaq Chart - Daily

The big economic report on Friday was the Non-Farm Payrolls for June. The headline number of +132,000 new jobs came in almost exactly as expected compared to estimates for a gain of +130,000. The surprise came from a revision to May from 157,000 to 190,000 and April was revised up to 122,000 from 80,000. This +75,000 two-month revision brought the three-month average to 148,000 new jobs per month. This is exactly where it needs to be to accommodate the 150,000 new workers moving into the market each month. This was slightly higher than the +142,000 monthly average for the first quarter. The unemployment rate remained unchanged at 4.5%. Job gains were grouped mostly in the health and hospitality sectors. Manufacturing lost -18K, Retail -24K, Construction gained +12K, Hospitality +39K and Education and Health +59K. Government jobs accounted for an additional +40K gain. Year over year average earnings were up +3.9%.

Some analysts expect jobs gains to slow as the year progresses do mostly to a further slowdown in housing construction. As the new mortgage underwriting rules begin to be enforced the homebuilding sector, a prime employer nationwide, is expected to see another round of layoffs as summer ends.

The stronger than expected payroll report, when you take into account the +75,000 in upward revisions to prior months, sent the equity market into an opening tail spin. That dive was quickly erased once analysts hit the wires saying there was nothing in the report that would cause the Fed to change its current stance on rates. The next big economic events will be the GDP for Q2 on July 27th and the Bernanke testimony to the House and Senate on the 18th and 19th. Since this is an election cycle year you can bet Bernanke will be seriously grilled on all matters economic in an effort to make election points for the questioner. This is Bernanke's state of the economy testimony and traders are hoping for a little insight into the Fed mindset other than the canned FOMC statements. The first reading on Q2-GDP on the 27th is producing street estimates from the high 1% growth range (+1.8-1.9%) to the low 4% range for Q2. Expectations are all over the map with the official numbers in the mid 3% range. There is a serious opportunity for expectations to be crushed if the housing implosion caused a bigger drain on GDP than expected. Any GDP number under 2% would be nearly disastrous given the rising whisper numbers over 4%.

Economic Calendar

Next week there are plenty of economic reports but none are material enough to be market movers without an extreme deviation from expectations. The economic calendar gets busy towards the end of the week but nobody will be watching. The highlight for next week will be the beginning of the Q2 earnings cycle. That reporting cycle kicks off on Monday with Alcoa (AA) as the first Dow component to report. The earnings calendar for the week has only a few names you would recognize but it does signal the official start of the Q2 cycle.

Earnings Table

Oil prices have clearly broken out over resistance at $70 with Friday's close at $72.81 an 11-month high. The same old reasons are still there and consist of violence in Nigeria, Iran's defiance, US and China demand increases and less production from OPEC. Brent crude is also rising to $75 on fears of a -300,000 bpd drop in output from the North Sea due to a variety of factors including a steep increase in depletion rates and some individual platform outages. Locally things are looking up with the 85 Kbpd Sunoco refinery in Tulsa restarting after a 30-day outage. Conoco's 150 kbpd refinery in Borger restarted after a 6-week outage. Exxon also is restarting its big Beaumont refinery. There is no target date yet for the restart of the Kansas refinery that was flooded out last week. These refineries will be running flat out trying to catch up with lagging product production in various areas. Crude inventories may be at decade highs but refined products are well below normal levels. Gasoline is -4.7% below 2006 levels but heating oil is -42% below 2006. The reason for the big discrepancy is a shift by all operating refineries to gasoline to avoid summer shortages and capture the high crack spread on gasoline. Some of that refinery capacity will have to be diverted back to heating oil soon or there will be shortages this winter. Because of the refineries coming back online the price of gasoline has resisted moves higher but with the spike in oil prices over $70 this week we did see August gasoline futures move to a new 11-month high at $2.31 on Friday. According to AAA the average retail price of gasoline last week was $2.95 but you can bet it will be higher soon. Demand in the U.S. actually dropped about -85,000 bpd in the prior week compared to 2006 but odds are good the July 4th week made up for it. Those numbers will be out next Wednesday.

August Crude Oil Chart - Daily

Gasoline Futures Chart - Daily

Microsoft is going to take a $1.15 billion pre tax charge in this quarterly cycle due to extending warranties on its Xbox-360 game consoles. Many of the Xbox game consoles have shown a general hardware failure error on the console lights and Microsoft said they were extending the warranty on those consoles to 3-years from the date of purchase. Customers who previously paid for those repairs will be reimbursed. Even though Xbox sales have failed to reach Microsoft targets the company reiterated on Friday that they expect the division to be profitable in 2008. Microsoft also reported that regulators had failed to request any additional information in the allotted 30-day time period for their announced $6 billion acquisition of aQuantive. By failing to request further documents in the 30-day period the deal is automatically cleared by regulatory rules. Google's $3 billion acquisition of DoubleClick was not so lucky. Regulators responded to calls by Microsoft and many others about the GOOG/DCLK acquisition and they have requested documents for further review. Many industry watchers feared a GOOG/DCLK combination would put too much advertising power in one firm and be non-competitive.

Macy's Chart - 30 min

The takeover speculation we saw in Macys (M) back on Friday June 22nd had fallen silent in the two weeks that followed with the stock returning to its previous levels. Just like clockwork that speculation returned on Friday and the stock shot up nearly +$4 intraday to touch $43 once again. Options volume reached hysterical levels with 75,700 call contracts traded compared to 42,161 puts. Normal volume for all their options is around 45K. Only weeks after changing its name from Federated to Macys and securing the coveted single character NYSE listing of (M) it appears the LBO vultures are circling.

Takeover speculation hit Monster Worldwide again with the stock spiking +3% on Friday. This speculation is almost a monthly event so little attention is paid to the rumors.


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Boeing (BA) will formerly present the first 787 Dreamliners in ceremonies on Sunday. More than 640 787s have been ordered but until now nobody has actually seen a real one. In Seattle, Qwest Field will host the 787 activities with about 50,000 current and former Boeing employees expected to attend. In Everett Washington Tom Brokaw will emcee the activities with 15,000 expected to attend. The six test aircraft are expected to begin flying in late August or early September. Various major customers will each receive one of the six aircraft. All Nippon Airways will receive one of the six because of its large order for 50 planes. On Friday Quantas increased its order by another 20 planes. Boeing sees no delays in its production schedule and although it took months to produce the first six planes Boeing expects to be cut that down to six days each once full production begins and then to three days each once those production lines gain experience. Boeing expects to produce 100 planes per year with a target eventually exceeding 2000 total planes. The first aircraft to be presented on July 8th will still have over 1000 temporary fastener bolts due to a shortage of titanium parts that Boeing said could take up to nine months to resolve. Here is your test plane. We ran out of bolts but we used plenty of duck tape.

Only two days after the National Association of Realtors said its index of pending home sales fell to 97.7 in May from 101.2 in April, the homebuilders were rebounding strongly. The reading was the weakest on record since the 9/11 low. Friday's gains included TOL +3%, CTX +3%, HOV +4%, LEN +3%, NVR +3.7% and even BZH +4%.

RIMM fell -84 cents despite having its price target raised to $350 from $205 by Crown Capital. I believe profit taking was offset by the upgrade and the announcement RIM has received approval to sell the BlackBerry in China. RIM said it was finalizing delivery availability to corporate customers in mainland China.

RIMM Chart - Daily

The major indexes returned to near their highs last week with the exception of one. The Nasdaq exceeded its recent high and surged another +30 points to 2666 in only three days of trading. Why did the Nasdaq suddenly take flight on July 2nd? A little research provided the answer. The Nasdaq is a modified form of a capitalization-weighted index. The bigger the company the more of the index it controls. One company is responsible for 9% of the Nasdaq 100 index. It is not Intel, Cisco, Oracle or even Microsoft. Those giants are in the top ten but not at the top. The largest weighted company in the Nasdaq index is Apple at 8.98% of the index value. Apple spiked +12 from Monday night to Friday morning. RIMM at 2.27% spiked +16 in the same period. Google at 4.49% rose +$20. Add in strong gains by Cisco with a 3.68% weighting, Intel at 2.95%, Oracle at 2.58% and Ebay at 2.0% and you have a seven stock rally. Remember when one stock or a handful of stocks in the Nasdaq catch fire it causes the value of the QQQQ to rise. Traders don't see the individual components moving only the price of the QQQQ. They jump on the bandwagon and buy more Qs and that causes Q shorts to cover. Buying in the Qs causes QQQQ managers to buy the entire index to cover the new demand. The rise in the Qs causes the entire index to rise even when the rally may have only been in a handful of stocks. The top ten Nasdaq stocks account for nearly 39% of the total index.

Nasdaq Index Weightings

I said last Sunday that should the Nasdaq rally continue it could spread to the other indexes. The seven stock rally in the Nasdaq did carry over to the other indexes to some extent but none of the others with the exception of the NYSE Composite tested their prior highs. The NYSE Composite did exceed its prior high by +7 points. For an index at 10,074 that 7 points is infinitesimal.

I think the major indexes did an outstanding job of following the Nasdaq higher. The Dow gained +203 points for the week and the Wilshire 5000 nearly +300. It was one of the better weeks we have seen this year. Unfortunately it came on low volume with most institutional traders off on an extended holiday. Next week will be the real test to see if this rally has legs. If the major indexes can reach their old highs and then breakout over that resistance then everyone will jump on the wagon with the tech bulls and go along for the ride.

What do you think would happen if we suddenly saw some profit taking in those highflying techs I mentioned above? AAPL +12, RIMM +16 and GOOG +20. Those are pretty strong gains for low volume trading. Those same index percentages work on the downside as well.

Apple Inc Chart - 15 min

Google Chart - 120 min

I believe we are poised for some consolidation. With earnings just ahead and expectations fading over the last couple weeks we could see some positive surprises. I am not sure fund managers will want to take profits ahead of the earnings cycle. They may want to hold on to see what surprises lay ahead. At the same time I doubt they will be adding to positions at these levels with the normal summer doldrums just ahead. The Q2 earnings cycle is normally peppered with guidance warnings for Q3. The summer quarter is not normally a strong quarter and guidance will reflect this. Eventually we are going to see a real correction between now and the 4th quarter. Normally that correction comes or ends in October. It can last several weeks or drag on for months but it normally ends in October. That means the timing for any potential dip is getting shorter as each day passes. The ideal time for a summer dip is after the Q2 earnings. Not all of them but enough that we know how the story ends. That would be 2-3 weeks from now.

S&P-500 Chart - Daily

That sets up several possible scenarios. If the rally continues next week and the other indexes breakout to new highs then we party on until the punchbowl goes dry. If we fail to make those breakouts and consolidate at these levels then I believe it is a warning that confidence is slipping or that the number of stocks bulls are willing to buy is dwindling. Apple and RIMM can't continue to power the rally by themselves. It has to broaden out to have any chance for success. The third scenario would be a failure at these levels and the beginning of another decline into August. That is the scenario I see least possibility of occurring so it may be the one most likely to happen. I think the one with the most chance of occurring is a consolidation at this level while we wait for earnings. If by some miracle earnings are a blowout across the board then we could move higher. Eventually there will be a correction but that scenario could put it off for another month or so. Picking a market direction ahead of Q2 earnings is the mission of fools. I can't say I am the head fool today because another website has already got dibs on that title. Let's just say that without any material economics or material earnings events the market will be left to find its own direction and in its overbought state it may take a few days for that direction to be determined. I would gladly go long over S&P 1540 or short a failure under 1535. I don't care which direction the market goes just as long as it maintains that direction for more than a few hours. It is the indecision that chews up trading accounts.

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