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Market Wrap

Erase August

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You can erase the August jobs report and while you are at it you can erase July as well. The ugly period for employment was almost completely erased with a strong September report and upward revisions to the prior two months. With a stroke of the magic revision pen all the anguish from last month's employment report evaporated in seconds.

Dow Chart - Daily

Nasdaq Chart - Daily

The September Employment report posted a gain of +110,000 jobs and right inline with the official estimate of 115,000 jobs. The August loss of -4,000 jobs was erased with an upward revision of +93,000 jobs pushing the total job gain for September to +89,000. July was also revised higher by +25,000 jobs to a gain of +93,000. Counting September and the revisions to the prior two months we saw a total job gain of +228,000 jobs. That is quite a reversal from the -4,000 job loss initially reported in August and the horrible economic sentiment it created. As you can see in the chart below the entire curve has changed from last month being a multiyear low to a confirmed rebound from now what appears to be the low way back in June. Employment has done a complete reversal from the August disaster. After the revision and the September job gains this cycle of positive job growth has extended to 49 consecutive months of gains. This is the longest period of consecutive job growth on record.

Non-Farm Payroll Chart

The market liked the good jobs news and exploded out of the gate to new highs. That exuberance, rational or otherwise, faded as the afternoon came and chances for another Fed rate cut continued to fall. As the chances for an October 31st rate cut fell to around 40% the market anxiety began to climb. The strong jobs report along with some positive comments from several banks and brokers this week suggests the credit crunch is over and inflation, not recession, could quickly become the main concern. The Fed may have to take Greenspan's inflation warning earlier this week to heart and start moving back to a tightening bias. That may not be a bad situation because the markets would rather have higher growth than lower rates as long as rates are neutral. The current rate environment is considered neutral around 5%.

Next week has only a couple economic events that will interest the street. The minutes of the last FOMC meeting will be released on Tuesday and analysts will be very interested in why they decided to cut rates a full 50 points. This report will be dissected word for word. Secondly, the Producer Price Index (PPI) on Friday will be scoured for hints of inflation pressures at the producer level. With energy holding at its recent highs it is only a matter of time before it becomes a major inflation problem in the production chain.

Economic Calendar

More important than the economics will be the earnings. Next week is the start of the Q3 earnings cycle with Alcoa leading off on Tuesday. Earnings warnings have been flying fast with the ratio as of Friday nearing 3:1 in warnings over positive guidance. Surprisingly warnings, especially from the banks and brokers, have actually been a positive impact to the markets. Citigroup (C) warned on Monday that they were going to take a charge of $1.4 billion due to subprime problems and a write down of corporate loans. Citigroup stock plunged to $45.86 on the news but rallied the rest of the week to close nearly $3 higher. The gains came on comments that Citi thought the worst was over in the credit markets and conditions would return closer to normal in Q4. UBS warned it would take a $3.4 billion charge due to the credit crunch and it rallied +$5 off the prior Friday's close. Again, a positive comment about the future was the key. Deutsche Bank (DB) warned they were taking a charge of $3.1 billion and rallied +$6. Washington Mutual (WM) warned on Friday they would post earnings that would drop as much as -75%, take charge offs of $550 million and raise loan loss provisions to $975 million. Normally that would be a disaster for the stock price but WM closed up nearly a buck for the day. Merrill Lynch (MER) warned before the open on Friday they would post a loss of up to 50 cents for Q3 instead of a profit of $1.34 and take a charge of nearly $5 billion related to subprime obligations and write downs of LBO commitments. MER closed up nearly $2 on the news. Why did these warnings have little negative impact? They all said the worst was over and they were seeing signs of business returning to normal in Q4. That was exactly what investors wanted to hear. Yes, those were some nasty losses but investors were eager to learn that the crisis was over. All clear, green light, full speed ahead and no more looking back. Investors were so happy they ignored the 3:1 ratio of warnings to guidance and the billions in losses as old news.

Stock Gains For Companies Warning

Helping create a positive view of earnings was the +13 bounce in Research in Motion (RIMM) after they reported strong earnings Thursday night. The weak PALM results earlier in the week were completely forgotten and traders were quick to buy more RIMM. Granted a lot of that was short covering after the weak PALM results but it is still a gain. Goldman Sachs added RIMM to its conviction focus list and raised the 2008 price target to $147 from their prior target of $117. RIMM said business was booming thanks to the iPhone. Those looking for something more than a music/Internet phone are selecting the Blackberry in record numbers. RIMM closed at $113 on Friday.

Google (GOOG) gained +$15 to $595 after Bear Stearns raised their price target for 2008 to $700. That was nearly a $30 move for the week. Not to be outdone Jim Cramer raised his price target to $701. The Bear Stearns analyst, Robert Peck, said Google was "one of the best operating companies within our coverage universe."

Next week only has a handful of recognizable names reporting earnings but it is enough to get investors focused on the next three weeks where the real flood of earnings will come. On Tuesday we have the first Dow component to report, Alcoa (AA), Wednesday COST, LRCX and MON. Sallie Mae (SLM) will report on Thursday and we should get some more background on the aborted J.C. Flowers buyout attempt.

Partial Earnings Calendar

Up until last week the market was pricing in substantial earnings risk for Q3. Now that the majority of the major banks and brokerages have either posted earnings or warned and nobody is going out of business there is a good possibility that risk is now overstated. In other words there is too much pessimism priced into the market in relation to earnings. That means there could be a lot of explosive reports like RIMM where the good news outweighs the bad and shorts must scramble to cover. If this scenario comes to pass it could produce a strong Q4 rally. With the economy stronger than we thought a month ago, earnings better than expected and a friendly Fed the wall of worry seems to have crumbled. Hopefully there are enough shorts left to give the bulls some stepping-stones to continued new highs.

The stumbling block could come in the form of some worse than expected earnings but anyone planning to spoil the party should have already warned. It is always better to warn and then do better than not warn and do worse.

The Dow hit a new intraday all time high at 14124 but could not hold it. The Dow declined -62 points into the close but still ended with a +91 point gain. It was a good day for the Dow with only four stocks closing lower and only one losing more than 13 cents. That one was Boeing with a -2.25 loss. That loss in Boeing helped pressure the Dow into the close but it was not relative to the overall performance. The Boeing drop came when a Lehman analyst suggested the 787 Dreamliner program could be delayed by 4-6 months. Boeing is expected to release further details on its production schedule before it reports earnings on Oct-22nd. We already know there are some problems with titanium fasteners and the initial planes are being completed with some temporary ones in their place. In September Boeing's CEO assured investors it would deliver the first 787 on time in May. Initial test flights have been postponed to mid-November or possibly mid-December because of complications in the final assembly process and flight-control software. The Lehman analyst cautioned that Boeing might have to adjust earnings expectations if the deliveries are postponed.

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Even with the Boeing loss the Dow was able to notch an all time high and distance itself from the current support at 13950. Every day the Dow creeps a little higher it is getting that much closer to an explosive breakout. Monday's spike to 14115 saw three days of consolidation before the jobs gains retested that level. That gives us a trading range from 13950 to about 14120 and we closed right in the middle on Friday. The first high on Monday found some sellers waiting. The second high on Friday found those same sellers. This shows there are still some shorts alive and well and willing to be road kill sometime in the near future. When that level is broken again it could be explosive. On the flip side should support at 13950 be broken that would widen the range to support at 13800 and give us plenty of room to roam while waiting for the real earnings to begin.

The Nasdaq has already broken out and is racing ahead of the pack posting a +47 point gain on Friday and a +3% gain for the week compared to the Dow's +1.23% gain. It should be noted that the Nasdaq breakout has come without the help of chip stocks. The SOX fell almost 20 points from Monday to Thursday's lows and the Nasdaq barely faltered. This drive is broad based being helped by the Internet stocks, software and biotech stocks. Chips and PC stocks were no help due to earnings warnings in the group. If the chips suddenly start posting earnings better than the warnings the Nasdaq could really catch fire. Lam Research (LRCX) reports earnings on Wednesday. Current support for the Nasdaq is 2725 and it closed at 2778. It was a good day for techs!

S&P-500 Chart - Daily

The S&P-500 also inched over its previous resistance at 1555 to make a new closing high at 1557. The S&P has a solid pattern of big gains followed by days of consolidation and last week was no exception. Monday's gains were followed by three days of consolidation prior to the Friday short squeeze. The S&P is at a critical threshold. It needs to hold its gains at this point and move higher to thwart the bears that shorted the new high when it was reached late Friday.

The Russell 2000 exploded higher on Friday gaining nearly +2% to expand its gains for the week to nearly +5% compared to 1.2% for the Dow and +2% on the S&P. The small caps are on fire and rapidly approaching their resistance highs at 856. This will be the final stand for the bears and a quick defeat here would setup a strong Q4 rally if the earnings really do come in better than previously warned. Remember, this is the fund manager sentiment indicator and it is flashing bright green today.

Russell-2000 Chart - Daily

What could derail this rally? We still have a potential pothole when China reopens for trading on Monday after a weeklong holiday. There has not been three consecutive days of profit taking in nearly two months. There have been some rumors that the National Congress could limit ownership of shares outside the country when it meets in mid October. This could be a challenge to the seriously over bought market. They could also implement another trading tax or raise rates sharply to slow the economy. Since any correction in China would be felt around the globe that could be a problem in our economics and earnings deprived market next week. There will also be sound bite after sound bite all week speculating about the future of Fed rate cuts. After Friday's jobs report the chance of a Fed rate cut on Oct-31st fell to only 40% and it is likely to drop further next week. There are no signs of a recession and the corporate credit crunch has passed. The 50-point cut did exactly what it was supposed to do and that was shock the credit markets back to life. The Fed pulled out its defibrillator and the patient quickly recovered. The dollar rebounded on the strong jobs but fell back again on fears that the Fed might still cut rates again to help the mortgage market. Most analysts are moving in the opposite direction and suggesting the Fed will not cut again in order to protect the dollar. Lower rates put additional pressure on the already weak dollar. The Fed no longer needs to help the markets but it does need to protect the dollar and not aggravate inflation by cutting when they really don't have a need. The inflation hawks will be circling again pointing to the strong jobs and high energy and commodity prices. That means the two things that could slow the rally would be China and fear of the Fed. Other than those possibilities all eyes should be on the coming earnings cycle.
 

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