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Market Wrap

Jobs Week or Weak Jobs

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The coming week is full of various employment reports and the question today is how badly has employment declined. We saw U.S. non-farm payrolls fall -63,000 in February and official estimates today are for another loss of 25,000 jobs. That would be the third consecutive month of losses after one of the longest periods of jobs growth in U.S. history. Most whisper numbers making the rounds are pretty close to the consensus estimates so the labor conditions don't seem to be deteriorating. That makes all the employment reports next week very critical to investor sentiment.

Dow Chart - Daily

Nasdaq Chart - Daily

Friday's big report was Consumer Sentiment and there were no surprises. The headline number fell -1.3 points to 69.5 and -1 point below the preliminary reading. This was the lowest reading in 16 years. The headline drop was caused by a -2.3 point decline in the expectations component to 60.1. This level is consistent with levels seen in prior recessions. Weak confidence and sentiment cause consumers to slow their spending habits and that reinforces the recessionary conditions. Obviously the culprits remain the housing crisis, high gasoline prices and the daily dose of negative news about the financial crisis. Continued daily reporting about the impending recession becomes a self-fulfilling prophecy. The tax rebate checks due out in May will do little to boost sentiment since most of this money will be spent on credit card debt, gasoline or food. Many analysts are now suggesting the price of gasoline could hit $4 in May and that will crush sentiment once again.

Consumer Sentiment Chart

Reports next week are heavily weighted towards employment but there are other things on the calendar. The Chicago PMI on Monday is expected to drop even further below the six year low of 44.5 seen in February. That drop into contraction territory set the stage for increased recession worry. The current American Axle strike has forced GM to idle plants and that could weigh heavily on the Chicago region and could have a strong impact on this week's PMI. On Tuesday the national version of the Chicago PMI, the ISM, is expected to fall even farther into contraction territory to 48.5. There should be no surprises in either of those reports but that makes them more dangerous to the market if an unexpected surprise appears. The ISM Services report will follow on Thursday and is not expected to show any material changes from last months reading of 49.3.

On Wednesday the Factory Orders report is actually expected to show a small increase of +0.7% after falling -2.5% last month. This number if very volatile and without a very large swing the market typically ignores it.


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The employment reports begin on Wednesday with the Challenger Report and continue on Thursday with Jobless Claims and the Monster Employment Index. The big hurdle for the week is the Non-Farm Payrolls on Friday. One analyst is looking for a drop of -75,000 jobs. The estimates will change daily ahead of the event but in reality nobody has a clue where the number will fall. With current consensus estimates for a loss of 25,000 jobs almost any number smaller than a loss of 50,000 jobs will be met with indifference by traders. If we accidentally post a job gain the market volatility could return. On one side there would be a group cheering that the economy was not as bad as we thought but on the other side would be immediate trader worry that the Fed rate cuts are over. You just can't have it both ways with rising jobs and falling Fed rates. If jobs begin to climb the Fed would immediately shift into inflation worry mode and begin discussing rate hikes rather than cuts. The Jobs report could be the pivotal event for a change in thinking by the market and therefore a volatility event.

Chairman Bernanke could create that volatility event when he testifies before Congress again on the economy. He is expected to gain praise from some but criticism from others as the interrogators use their 5-min on camera to their best advantage.

Economic Calendar

The biggest negative for the market on Friday was a strong warning by JC Penny (JCP). The company said sales through Easter were well below expectations and cut their earnings estimates by 35% to 50-cents per share from 75-80 cents. They also referenced the declining consumer sentiment and rising fuel prices as factors. According to one analyst JC Penny is operating right in the bull's-eye for the current consumer slowdown. They operate mall based retail stores for the lower income sector. The red target logo for Target Stores should be on JC Penny as the bulls-eye for the retail slowdown. JC Penny same store sales in February fell -6.7% compared to analyst estimates for a decline of 1.9 percent. JCP stock fell about 10% and pressured the entire retail sector.

Lehman shares traded down sharply on Thursday and brought back fears of another Bear Stearns type disaster and put option volume was extreme in the out of the money strikes. A lot of the ugly disappeared when Citigroup upgraded Lehman from sell to buy at the open. Citi said Lehman had $34 billion in liquidity and access to $200 billion in liquidity from the Fed's primary dealer credit facility. Citi put a $65 price target on Lehman at today's price of $38. The Citi upgrade halted the strong selling but did not change the trend. It may take the weekend for traders to actually overcome the denial stage and begin to decide that being short Lehman has no future. Lehman posted better than expected Q1 earnings last week but still saw a lack of respect by traders.

Lehman Chart - 90 Min

Since the Fed opened the discount window to firms like Lehman the business has been brisk. Average daily borrowing from the Fed last week was $32.9 billion. This compares to bank borrowing in the same period of $550 million. Banks have been able to borrow from the Fed with minimal restrictions but the investment companies like Lehman have never had this option. Now that the financial spigot is open those companies are lining up with fire hoses for an injection of liquidity to solve their short-term credit problems. These investment companies have been suffering gridlock for months with all major sources of loans in the sector locked up tight. Nobody either wanted to loan to investment companies fearing hidden problems like Bear Stearns or were facing a shortage of capital themselves in light of the credit crunch. The new Fed loan facilities are slowly reducing this gridlock but there are still problems.

Unfortunately after the bell the credit crunch reared its head once again. S&P downgraded bond insurer Financial Guaranty Insurance Co credit rating from "A" to junk status at "BB." This followed the downgrade from Fitch earlier last week to BBB from AA. Earlier in the week FGIC said its exposure to mortgage losses exceeded legal risk limits required by New York state insurance laws and it may be forced to raise loss reserves. If they do not reverse this situation immediately the state has the ability to take control of the company. FGIC said it was going to submit a plan to the state to reduce risk but one outside analyst said it would take a capital infusion of more than $2 billion to stabilize the company. In their weakened state this may not be possible at terms that would be acceptable to the company.

Also late in the day UBS said it was going to mark down the value of auction-rate securities held in customer accounts. They did not say what the total dollar value of those securities that were held in UBS accounts but UBS oversees $920 billion in client assets in the USA. The market has been frozen in auction rate securities since the credit crunch began. These instruments have been traded like cash for two decades. More than $300 billion are held by private investors. These are long term bonds sold by issuers like municipalities, universities and closed-end funds like Nuveen and BlackRock with interest rates reset by auctions held every 7-35 days. The auctions have been failing for months because banks like UBS, Goldman, Merrill, Citi and Wachovia, that often conduct as many as 100 auctions per day have balked at buying the securities when there are not enough bidders. Even though these are good credits the banks don't want to add the assets to their own already debt-laden balance sheets. In order for there is be a market there has to be a worst-case bidder and these companies filled that roll in the past. Other private investors are avoiding the auctions because they do not want to get stuck with securities they can't sell. That has effectively locked up that market and UBS is going to write down values this weekend by as much as 20%. This is news because they previously told investors because the market was locked up they would keep them on the books at 100% of value. They thought the freeze was just temporary. If they drop the value by 20% then many accounts could be hit with margin calls. Since these were previously treated as cash this move could impact many thousands of investors negatively. This does not mean the securities will not eventually be worth face value but it means today's value will be a lot less and this sets the precedent for another markdown in the future if conditions don't change.

Do you have a home equity line of credit? If so you might want to watch your mail closely over the coming weeks. There are rumors circulating that the major banks, BAC, JPM, Citi, CFC etc are canceling or reducing outstanding but unused HELOCs. If you have a $75,000 HELOC with a $10,000 balance you might be getting a letter saying your credit line has been reduced to $20,000. The banks are seeing the combination of slowing economy, rising consumer debt and falling house prices put the squeeze on HELOCs. Some homeowners are using the HELOC to live on or even to make their house payments. The banks are seeing balances rise sharply at a time when reserves are low and defaults are high. They are reportedly ready to take action to reduce their exposure until the housing crisis passes. If you think you might need the money I would write that HELOC check now.

As part of the consumer slowdown Blue Nile (NILE) was downgraded to sell by a Merrill analyst saying that although they were somewhat resistant to recession pressures their sales were slowing. She cut their price target to $45 with it trading at $54 on Friday. Tiffany was downgraded to neutral by Oppenheimer earlier in the week. Even though they cater to a pricey crowd the recession worries are causing a slowdown in traffic.

KB Home (KBH) posted a $268 million loss for Q1 on continued dismal sales. Orders fell -75% and cancellation hit 53%. The company said in a statement "Until prices stabilize and consumer confidence returns, we believe inventory levels will remain significantly out of balance with demand." Also, "We do not anticipate meaningful improvement in these conditions in the near term as it is likely to take some time for the market to absorb the current excess housing supply and for confidence to improve." The average price of a KB Home fell -7% to $248,000 during the quarter. KBH stock fell -1.25 on the news. Lennar (LEN) also reported a loss of $88 million earlier in the week.

Shares of education company Apollo Group fell 30% on Friday after investors were shocked by their worse than expected earnings. It was not really that bad with earnings of 48 cents compared to estimates of 52 cents but the market is very nervous today. Enrollment was up +6.2% but one analyst was expecting gains of 9.5%. APOL lost $15 to $41.

Chart of Apollo

MGIC Investment Corp (MTG) reported on Friday that it had completed a stock offering for $483 million and another for $365 million in convertible debentures in an effort to increase its capital to offset liquidity concerns. MGIC writes mortgage guaranty insurance for home loan borrowers putting down only a minimal down payment. Obviously business conditions have turned sour but the success of the offerings suggests they are in no danger. Bank America was the underwriter on the deal.

On the brighter side of the ledger Apple computer is expected to launch a high-speed version of the iPhone in Q2 and produce 8 million of the devices in Q3. This news came from Bank America who said channel checks point to significant production of the 3G-iPhone beginning in June after a small initial run in May. Apple is expected to launch an upgrade to the iPhone software in June and it makes sense that they release the phone at the same time. AAPL gained +2.76 on the news.

Research in Motion (RIMM) jumped +3.19 after RBC Capital raised their price target to $150 saying the momentum in the BlackBerry defies concerns of an economic slowdown. The analyst expects RIMM to guide above current expectations when it reports earnings in early April. Channel checks showed strong Q1 momentum and revenue somewhere in the $2.2 billion range. RBC's Technology Adoption Panel showed RIMM making strong share gains against Motorola and Palm. The analyst also raised 2009 and 2010 estimates.

The JC Penny warning is a reminder that we are right in the middle of warning season with the start of earnings just a week away. So far there have not been any earth shaking warnings disasters. Everyone expects negative news and it would be hard to surprise to the downside but it is still possible. We need to keep our eyes and ears open to those warnings that do come and try to determine if the trend is worsening, improving or just more of the same.

Monday is the end of the quarter and an ugly quarter at that. Normally you would expect some window dressing here. Art Cashin pointed out on Friday that the majority of hedge funds are still heavily short and their idea of window dressing today is to short some more to protect their quarter end profits. That suggests Monday could be a down day but I am not seeing any serious negativity building in the charts.

Oppenheimer said last week that financial firms will trade at least 25% lower from current levels. Financials were one of the weakest sectors after the Monday high. This suggests the hedge funds were active in adding to or reestablishing their shorts all week. If these large traders are leaning on the market then the perceived market bottom on the 17th may not be a bottom.

When I started writing on Friday I was still partly bullish. My Tuesday recommendation was to buy a dip on the S&P back to 1300. Under 1300 the rally has died and I would expect to see a new low. By the time I got to this point in the commentary I had read many news articles, stock updates, listened to about six hours of stock TV and spent time with the staff researching stocks for potential plays. During that time my outlook changed. I am now more bearish than bullish and feel the odds are growing that trouble is heading our way. One commentator said too many people want the Jan-17th dip to be a bottom but very few are actually voting with their money. It is not enough to wish for a bottom you actually had to invest like it was a bottom.

The market internals for the week do NOT suggest it was a bottom. Volume accelerated for the prior two weeks to top at 10.4 billion shares on Thursday Mar-20th. It has declined every single day since to barely break 6.1 billion on Friday. New lows are not increasing but new highs are decreasing. You have heard me say many times that volume is the weapon of the bulls. Last week it looks like they ran out of ammunition.

In the table below note the ramp up in volume from the Mar-17th low. There are two qualifiers. It was an option expiration week and there was a tremendous amount of short covering. After expiration the volume has declined significantly from pre-expiration levels and it has been decidedly negative. It appears the shorts covered found there was no bullish conviction under the market and the shorts began to load up again. It is not necessarily a bearish stampede but more of a buyer boycott. It may have been just that window dressing for shorts that Art Cashin was talking about and after Monday the pressure could ease. The pattern of subtle selling pressure was almost identical to that we see on bullish window dressing where the funds nibble away at longs to keep prices moving higher in the last days of the quarter. If the S&P breaks 1300 to the downside it could turn into a full-fledged rout but that commentary will be reserved for Tuesday and after the first day of Q2 trading.

Market Internals Table

The Dow managed to stretch its rebound to 12621 on Monday but that was the high for the week. It was not dramatic but it was ugly. The Dow closed right at 12200 on Friday and just above initial support at 12100. Last Monday I did not think we would be discussing that support again. The Fed had gone to Herculean means to liquefy the credit markets. Banks, financials, homebuilders, etc, were breaking out over to new multi-week highs. The bottom was in and the Dow had tacked on 800 points in its rebound. Half of that gain is now history and despite the Citi upgrade of Lehman the lead analyst at Oppenheimer, Meredith Whitney, is calling for a 25% haircut on financials from their current levels. If she is right, as she has been on several recent calls, then we will see new lows.

The Nasdaq performed slightly better than the Dow and actually posted a fractional gain for the week. If it closed the quarter here it would still be a 15% loss. It is not a pretty picture with warnings from chip companies helping to knock nearly 90 points off the highs for the week. Friday's close was still an almost 100 points above the March-17th lows but that could be erased in a heartbeat if a couple tech giants repeat the warnings from little guys like SIRF last week.

Russell-2000 Chart

S&P-500 Chart

The S&P could be the most dangerous index next week. If the banks complete their roll over and start fulfilling the Oppenheimer prophecy then the S&P has no chance. Financials are 21% of the S&P with oil at 18%. The oil companies are already sliding even with oil at $105 because there are fears about the growing inventory levels and falling demand. Refiner capacity utilization is down to 82.2% from a normal level in the 92-95% range because gasoline inventories are at a 15-year high and even with gasoline prices at $3.25 the refiners can't make any money if nobody drives. They would rather idle capacity and do maintenance instead of refine gasoline for a loss. There is no reason for oil prices to remain over $105 until this situation corrects. That means 18% of the S&P could continue to be week on oil and 21% weak on financials. That is not a recipe for a rally. I would look to be short again under 1300.

Jim Brown

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