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Market Wrap

What A Difference A Week Makes!

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Last week the market imploded on a negative earning surprise from GE. All the analysts were projecting gloom and doom for the rest of the earnings cycle since the bluest of the blue chips had surprised so negatively. Surprise, surprise, this week's earnings have been nearly the exact opposite of GE. We had upside surprises and strong guidance from a diverse group including Intel, IBM, Merrill Lynch, Caterpillar and even Google. Did we dodge the recession bullet?

Dow Chart - Daily

The only economic report on Friday was the regional and state employment report. It was less than exciting. Employment increased in 22 states and declined in 27 states. The states with the best hiring were Texas, Minnesota, Colorado and Utah. The biggest decline in employment came in Michigan, Florida, Missouri and Nevada. South Dakota had the lowest unemployment rate of 2.5% and Michigan the highest at 7.2%. There was little change in the trends from the prior month suggesting the recession worries are not translating into real employment cuts.

The monthly surge of key economic reports is over for April. Next week is one of the lightest calendars we have seen in recent months. The two regional reports are the only items of interest and light interest at that. The event creating the biggest volatility will probably be the May crude futures expiration on Tuesday. The CFTC said open interest in crude futures increased by 40% over the last two weeks and the only way to create open interest is for somebody to sell a contract short. May open interest is well over 10 times the actual volume of oil available and that suggests a lot of those contracts will have to be bought back by Tuesday. It should be very interesting to see those shorts squirm and see what happens to the June contract as some of those shorts roll forward.

Weekly Economic Calendar

The earnings parade started with the 800lb gorilla (GE) doing a face plant in front of the viewing stand. After GE hobbled away the parade picked up speed and the crowd cheered each passing report. It was a dramatic change from the negativity of the prior week. Intel, IBM, Google, Merrill, Citigroup, Caterpillar, Honeywell, etc, all beat the street and some by a wide margin or in the case of Merrill was not as negative as some expected. Not all the earnings have been positive. 20% of the S&P have reported and headline earnings are down -22%. That is not the entire story. If you take out the financials the S&P earnings to date would be 8%. Financial earnings are down -68% for the quarter and that is dragging down the entire S&P. At today's close the S&P is valued at a PE of 13.8 and that is traditionally low.

Unfortunately this positive earnings news may not continue. As the earnings process moves forward the quality of the companies reporting will deteriorate. The large multinational blue chips report early in the cycle and the smaller less diverse companies report later. The companies already reported generally made their money overseas instead of inside the U.S. Intel gets 80% of its earnings from outside the United States, IBM 65% and CAT 60%. Even Google got 51% of its earning for the quarter from overseas sources. These companies are relatively insulated from the U.S. recession as long as it does not contaminate the rest of the world. Once we get into earnings from those companies who deal primarily in the U.S. we could see more damage from the slowing economy.


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Next week there are nearly 1000 companies reporting. The column numbers in the calendar below are the number of companies reporting on that day. The rough total is about 973 but that number changes daily. The most important ones for me are in orange headed by Bank America on Monday. There are some worries that BAC could produce a negative surprise. Yahoo is next up on Tuesday and we should get some more news about the Microsoft offer. Apple, Amazon and UPS are Wednesday. Amazon exploded higher by $6 on Friday after the bullish Google report. Will the Google Internet earnings trend carry over into Amazon? Apple is expected to post very strong earnings but there are some worries that iPhone sales have slowed as consumers wait for the 3G version rumored to be out in June. UPS will give us another update on how the recession is impacting package volume inside in North America. Thursday has Microsoft and they are expected to post strong numbers even though there are cracks appearing in the corporate acceptance of Vista. American Express could tell us if the higher dollar corporate customer is still charging ahead. MMM will be a key to watch for the manufacturing sector. MOT will be another update on the chip sector and YRCW could be confirmation of any trend UPS discusses. There is nothing material on Friday.

The expectations continue to be relatively low so there is the potential for more upside surprises than downside disasters. There is no guarantee but as long as last week's trend continues the market should be positive.

EEarnings Calendar

Citigroup reported on Friday they lost -$5.1 billion on additional write-downs of more than $12 billion. The street was just happy they did not do worse. iti reported a $10 billion loss in Q4 so this was a decent improvement. There were some signs they may need to go out for additional capital but that was perceived positively. Citi gained 1.08 on the day.

E*Trade (ETFC) posted disappointing results but reported they added 60,000 new customers in the quarter. This was the largest increase since Q4-2005. They now have 4.8 million accounts. ETFC had been losing customers after they warned they lost billions in the subprime mortgage problem. Traders were afraid they would go under but that fear has subsided. ETFC gained 10% for the day.

The biggest winner for the day was Google with a $90 gain to $540. OI had recommended a strangle play to hold over earnings and buyers were well rewarded! Expectations were very low for Google with signs of falling click through rates around the world. Those signs were very wrong with Google getting 51% of their earnings from overseas. Google also updated their online ad system to enhance earnings from existing business. Analysts were quick to reiterate their price targets in the $750 range. After dropping 40% from its highs analysts are now calling it a must own stock once again.

A byproduct of the positive earnings has been a complete removal of the next Fed rate cut from the markets. Just over a week ago there was a 79% chance of a 50-point cut at the April 29th meeting. That has fallen to slightly less than a 50% chance of a 25-point rate cut. Nobody is whining now about the loss of the rate cut with the Dow up 523 for the week. That may change as we get closer to the FOMC meeting.

Oil prices continued to soar with crude settling at $117 late Friday. There are no words to describe this move and shorts are getting crushed. The move on Friday was "reportedly" due to renewed violence in Nigeria. Nigeria is the 3rd largest exporter of oil to the U.S. and this is light crude not the heavy Saudi grade. Nigeria already had about one million barrels of daily production shut in for most of 2007 and a loss of more supply from there would impact the world market and the U.S. in particular. Personally I think the noise from Nigeria helped the spike but most of the move is more likely due to the May crude futures expiration next Tuesday. Anyone short this contract and hoping for a correction to escape the pain is suffering from new highs every day. Once this contract expires I do expect to see some profit taking. The two days after expiration in March saw crude fall from $109 on expiration day to $98.64 two days later. That was a 10% drop.

May Crude Futures Chart - Daily

Next week is energy week in the earnings cycle with more than twenty energy companies reporting. The exceptions are Exxon and Chevron, which don't report until the following week. Schlumberger (LB) reported earnings on Friday that rose 18% to $1.06 but that was less than the $1.12 analysts expected. The CEO blamed the loss on bad weather with quite a few winter storms restraining field activity. SLB gained $6 on the news plus an announcement they were going to buy back $8 billion in stock over the next three years.

Cisco does not report earnings until May 6th. With their growing overseas business model they should do well. On Friday Lazard initiated coverage on CSCO with a buy. CSCO has strong resistance at $26 but with the good tech results we could see CSCO ease up to that level ahead of earnings. They would be primed to make a break if they say anything positive. CEO John Chambers said last week overseas business was good and they were moving to sell even more into those markets.

Friday's strong gains were greatly appreciated but volume was still weak. Friday was an option expiration day, which should have generated a significant volume spike but it did not happen. Volume across all markets was only 7.3 billion shares compared to the 10.4 billion on expiration day in March. The internals were very good with advancing volume 6:1 over declining. New 52-week highs at 215 was the largest number since Dec-26th. That is bullish but after a week of strong gains you would expect new highs to be strong. We really need to see more volume before we can really claim the rally has legs.

The Dow gained 228 on Friday and 523 for the week. On Friday 56 of those Dow points or 25% of the Dow's gain came from the $6.69 gain in CAT. Other big gainers were MMM 2.25, AIG 2.06, BA 1.75 and UTX 1.72. Dow components KO, T, WMT and PG finished down for the day. The Dow spiked 100 points past strong resistance at 12750 and is right on the verge of a breakout. Friday's close was a two-month high. A move over 12900 would be very bullish.

Dow Chart - Daily

Dow Transport Chart - Daily

Even more amazing was the breakout for the Dow Transports (TRAN) to 5100. The 5000 level had been strong resistance dating back to last August. Transports breaking out with oil at $117 and diesel at $4.15 is a major change in sentiment. We are close to a Dow theory confirmation if the Dow can move over 12900 and the transports continue higher. This would be very bullish for the broader markets. If oil does correct after expiration next Tuesday it could give the transports another boost. Potential problems would be the UPS earnings on Wednesday and RCW on Thursday.

The Nasdaq broke above its resistance for the last two months but came to a dead stop at even stronger resistance at 2400. I view this as the biggest problem in the markets. There are no material Nasdaq earnings on Monday with BRCM and YHOO the leaders on Tuesday. Yahoo is not expected to be especially positive and BRCM will probably not beat by much. Apple and Amazon on Wednesday is the first real chance for another earnings pop. Those will be followed by Microsoft earnings on Thursday. I suspect we will see some profit taking on the Nasdaq on Monday and any weakness that takes us back below 2400 is only going to make that resistance level even stronger. The Russell confirmed this same resistance level with a move to 720 and a dead stop. It is possible we will see some funds picking up some bargains on the Russell but not if the Nasdaq goes into decline.

Nasdaq Chart - Daily

S&P-500 Chart - Daily

S&P-500 Chart - Expanded View - Daily

The S&P-500 rallied to exactly where it failed back on Feb-4th at 1395. This is a very strong resistance level and getting over 1395-1400 could be a major challenge. We have a nice series of higher highs and higher lows out of the March bottom but we still have not broken that key resistance.

Russell 2000 Chart - Daily

Everybody should realize that Friday's rally was just one more short squeeze out of the Tuesday lows. Wednesday saw a textbook short squeeze on an earnings surprise. Thursday saw no follow through and it is likely some of those shorts that were blown out on Wednesday loaded up again on Thursday. Others who thought Wednesday's spike was an anomaly probably just held their shorts. Friday was option expiration and the 200 point gap open on the Google news was a crushing blow to those still nursing their wounds from Wednesday and those waiting until the last minute to close April options. Funds do NOT rush into the market on Google earnings news. The only people rushing into the market on Friday morning were people covering their shorts. You can't convince me that any retail investor rushed to pay a $90 premium to Thursday's close just so they could invest in Google. It was a short squeeze NOT a new bull market.

Let me switch sides here a minute. Many bull markets began as short squeezes. Shorts load up on the way down and then get crushed when conditions change. Real investors don't buy squeezes because they are skeptical the rally will hold. However, they will buy subsequent dips if they think conditions have changed. Have conditions really changed? We can't be sure yet because everyone who beat the street did so on international earnings. We need to see some U.S. earnings to confirm things are not as bad as they seemed a week ago. This squeeze could be the start or the continuation of the March rebound but until we get confirmation with a move over S&P 1400, Nasdaq 2400 and Dow 12900 it is just a trade.

Another problem for the market is $117 oil. For that matter if we actually got a $10 correction next week it would still be a problem. Remember the table I showed on Tuesday of changes consumers were making to offset the price of gasoline? I am reprinting it here.

BigResearch Gasoline Impact Survey

There is nothing in that table that suggests we will avoid a recession. Consumers are being crushed by the price of gasoline and increase in food prices. Do you think the market is going to continue to rise on $117 oil or even $110 oil? Gasoline prices are expected to be $3.75 to $4.00 per gallon in May. See my commentary from Thursday night for the reason for that move and why May gasoline is so expensive. I would love to be wildly bullish on the markets but we need to see some confirmation first. For several weeks I have been in dip buy mode to SPX 1320. For next week I would continue to buy the dips unless we have a downturn in earnings. We should see buyers appear on any dip back to 1350. A move under 1350 would mean the negative sentiment is returning. Remember the "sell in May and go away" cycle that starts in about 2 weeks. That will be a decision point for the markets. Earnings will be over for all practical purposes and investors will have to really decide if they want to stand aside or chance riding gains through the normally rough summer markets. Since we had a significant sell off from Oct to mid March I am betting that sell in May and go away cycle will not occur this year but we need to remain cautious. A second reason that cycle may not occur is the recession trade. Historically long term investors like to buy the market at the bottom of a recession because the market is normally much higher six months later. Rallying out of a recession is a time tested trading strategy. All of those points suggest the next couple weeks will be crucial to market direction. I would continue to buy dips to 1350 and hope for a breakout over 1400 but under 1350 I would be negative.

Jim Brown

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