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Market Wrap

Economic Overload

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Friday was a skinny day for economics and there are none scheduled for Monday. Consider that a pause for a deep breath by economic analysts because the rest of the week will be extremely heavy. Nearly every heavyweight report for the month has crowded into next week's schedule.

The only material report on Friday was the second reading for April Consumer Sentiment. The index fell another 0.6 points from the initial reading to close the month at 62.6 and a new 26-year low. The present conditions component fell to 77.0 from 84.2 and the expectations component fell to 53.3 from 60.1. A whopping 9 out of 10 respondents believe the economy is already in a recession. Inflation expectations over the next 12 months rose to 4.8% from 4.3%. The current level of sentiment is consistent with a more severe recession than is currently expected. You have to go back to the 1981 recession to find sentiment this low. Worry about $4 gasoline is weighing on consumers. The national average hit $3.58 on Friday making the projections for $4 gasoline in May very achievable.

April Consumer Sentiment Chart

The calendar for next week is jam packed with major economic time bombs. The first one will be the first look at the Q1 GDP with estimates for only 0.2% growth in the quarter. Since almost everyone believes we are already in a recession any positive reading would be a good sign. There is a very strong chance the GDP could come in negative and that would not be a huge surprise unless it was very negative. A positive GDP would give the bulls a reason to run despite the FOMC meeting this week. Traders would rather have growth rather than rate cuts so the GDP will be a key report.

Also on Wednesday is the Chicago Purchasing Managers Index (PMI) and expectations are for a contractionary drop to 48.0 for April. That would be the second month in contraction territory. We saw new orders and production rise slightly in March so there is the potential for an upside surprise.

The biggest economic event on Wednesday is the FOMC announcement. The various events in the financial sector over the last couple weeks have almost erased the chance for a rate cut. Most believe the Fed will still cut rates by 25-points simply because they have not given any signals they were going to move off their easing bias. Recently the Fed speakers have raised their talk about inflation so they may be setting the stage for a bias change at next week's meeting. The majority of analysts now expect a one-and-done message next week. The FOMC will cut rates one more time by 25-points to 2.0% and announce the problem is improving and they are moving to the sidelines to watch while their prior cuts filter through the system. Most expect them to remain on the sidelines for the rest of 2008 due to the continued problems in the housing market. They can't afford to raise rates until the housing reset peak passes in June/July. There is a small contingent that believes the Fed could cut by another 50-points to help that reset peak but then come back to the market in Q4 with a series of rate hikes. The Fed Funds Futures are only showing a 38% chance of a 50-point cut so this option is not garnering a lot of followers.

Following the FOMC event on Wednesday is the national Institute for Supply Management (ISM) report on Thursday. The ISM is also expected to have a contractionary number at 48.0 and that would be the 4th month out of the last five that were under 50. Last month saw a very minor gain from the 48.3 low in February but that gain is expected to be erased in April. If the ISM did happen to turn higher it would be very bullish for the market. This would be especially bullish if the FOMC said on Wednesday that the economy may have bottomed.

The last major report for the week is the Non-Farm Payrolls on Friday. After revisions the report has shown job losses for the last three months averaging 77,000 per month. The economy is expected to have lost another 75,000 jobs in April. It would be hard for the report to surprise investors unless it was horribly skewed to the downside. Most are expecting it to show another loss and that is priced into the market. If the number suddenly showed a decent gain after the FOMC made positive statements it would be the best of all worlds and I would expect the markets to rally hard.

The best scenario for the week would be for a positive ISM, a 25-point cut and positive statement from the Fed and a positive job gain on Friday. That would induce billions in idle cash to come off the sidelines and back into play.

Economic Calendar

The majority of the major earnings reporters have already made their confessions but there are still plenty of smaller companies to report. Next week there are approximately 1075 companies reporting but I would bet there are few names in the list below that really matter to the average investor.

There are a lot of energy names and I probably could have filled the list using only names related to the energy sector. BP reports on Tuesday, ExxonMobil (XOM) reports on Thursday and ChevronTexaco (CVX) on Friday.

The current earnings cycle has seen 260 S&P-500 companies report with average earnings declining -18.6%. Take out the financials and the S&P would still be up +11% for the quarter. Guidance has been mixed and mostly dependent on how much of the earnings came from overseas business. Those large multinationals did very well relatively speaking.

Earnings Calendar

Microsoft was the exception to the rule for multinational earnings. Microsoft disappointed the street and was rewarded with a 6% drop on Friday. Considering they were up about 15% over the prior 7 days that was not as bad as it seemed. Microsoft posted earnings that were down slightly from the comparison period but still managed to beat the street. The culprit was slowing sales of Vista and Office. The acceptance rate for Vista has been less than expected. Most of the major computer makers, HPQ, DELL and Lenovo have announced programs in place to continue shipping computers with Windows-XP instead of Vista despite Microsoft's deadline of June to stop selling XP. Vendors have reportedly been stocking up on Windows-XP and have plans to ship units with a Vista CD but with XP installed. This should be clear evidence that consumers are revolting and are not buying the bloated Vista software. Add in the worry that Microsoft might bid higher to get the Yahoo deal done and MSFT shareholders had a bad day.

American Express (AXP) posted earnings that declined -6% but beat street estimates and AXP affirmed full year earnings. AXP said revenue rose +11% and total spending on its cards rose 14% to $166.4 billion. Unfortunately most of those gains came from outside the country. AXP said they increased loan loss reserves by $881 million for credit losses during the quarter. Losses were up 52% from the comparison period. Unlike Mastercard and Visa, American Express has exposure to credit risk from its 88 million cardholders. Visa reports earnings on Monday.


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Citibank broke out to new 2-month highs on Friday as money rotated into financials and out of commodity stocks. Fitch downgraded several classes of CDOs belonging to various financial firms and that should come as no surprise. What does surprise me is the $179 billion in CDOs currently in default. Of those in default Citigroup owns 24 valued at $30 billion, UBS owns 24 valued at $26 billion and the biggest group of 26 valued at $29 billion belongs to Merrill Lynch. None of those stocks seem to be impacted from the news.

The biggest spike on Friday came from oil once again. Crude prices had fallen for two days and hit $114.25 overnight before another news event sent the futures spiking to $119.55. Predicting the price of oil is harder than predicting the weather. There are thousands of oil facilities in over 100 countries. As we approach Peak Oil the odds are good something negative will happen in at least one of those countries every week. On Friday it was news from the Persian Gulf that an American merchant ship under contract to the military had fired on an Iranian boat. Iran denies they had any boats in the neighborhood and the news report was more than 24 hours old before it surfaced on the wires. It immediately spiked the crude futures over $5 on fears a shooting war could close the Straits of Hormuz to oil tankers. More than 30% of the worlds oil supply transits that passage every day. The shipping lanes are only 6-miles wide through the strait and it is considered an easily attacked choke point. There have been 5 or 6 reports of shots fired at boats harassing U.S. ships in the last 4 months. Thursday's event came only one day after a report surfaced in the U.S. saying the Joint Chiefs of Staff were preparing "potential military courses of action" against Iran. Reportedly the U.S. will make public evidence next week that Iran has stepped up its aid to insurgents in Iraq and that they funded/supplied the Basra uprising a couple weeks ago.

Straits of Hormuz

The news about the warning shots came at a bad time for crude supplies. We also heard this week that a strike at the 210,000 bpd Grangemouth Refinery in Scotland would cause the shutdown of the British Forties pipeline. That pipeline carries 700,000 bpd of crude. The refinery supplies steam that is used in the pipeline operations. There was also news from Nigeria of another pipeline attack against Shell but there was no mention of supply numbers. Also in Nigeria workers went on strike against Exxon and that strike caused a shut in of 200,000 bpd of crude. These types of localized events would not have any impact except for the small surplus of daily capacity on the global stage. If there were 2-3 million barrels of extra capacity nobody would ever notice these events. With less than one million barrels of spare capacity every little event has the potential to combine with others to put global supplies at risk of falling below demand. If you are short oil the combination of these 4 events was very painful despite there being no immediate impact to global supplies. These conditions can exist for weeks before a supply constraint develops. You would think from the $5 rebound a meteor had taken out an entire field permanently.

Crude Oil Chart - Daily

Speaking of meteors Research in Motion (RIMM) shares fell -3% on Friday after the delayed the introduction of their new 3G BlackBerry model named Meteor from June until August. The phone will use the faster AT&T network and reportedly AT&T was concerned about call quality in some tests. RIMM already had problems with its chip supplier Marvel (MRVL) but those problems are over. Now the network certification process that takes about 3-months has begun. The Meteor is expected to be officially unveiled in about 6-weeks for a projected August launch. The phone has been wildly anticipated and initial deliveries are expected to be huge. Apple hinted that it would have a 3G iPhone at a trade show in early April but they did not give a date. RIMM lost 3% on the news.

This was a heck of a week for market direction. Officially the major indexes only gained about half a percent for the week after being down significantly several times. Last Friday the Dow topped at 12893 and it closed this Friday at 12891. It was one of those weeks. I believe next week will be significantly better.

I believe the economic reports will not be that bad and assuming the Fed does not spoil the party on Wednesday we could be trading a lot higher by next weekend. The financials are breaking out and they are leading indexes higher. Energy stocks, the second biggest group in the S&P are also moving higher despite some directional challenges. It would be almost impossible for the markets not to move higher with both of those groups in rally mode.

The FOMC meeting on Wednesday is the only material challenge since they can ruin the entire picture if they do something stupid. I don't believe they want to do that. They want the markets to move higher. They want financials to recover and for sentiment to improve. I would expect them to be passing each other high fives in the meeting if this rebound extends through Wednesday. They also need to avoid a long statement on inflation concerns if they want to keep the rally going. With the yield on the 2-year note above the Fed funds rate this is a clear sign that the rate cut scenario is over. The market is pricing in a recovery and the Fed is going to confirm that with a change in their bias.

The Dow closed right at resistance at 12900 and continued the uptrend started back in early March. It has been a rocky road but once we break over 12900 with conviction I think we will pick up speed in a hurry. 12700 has appeared as initial support but I hope we don't test it again. Next major resistance is 13500.

Dow Chart - Daily

Nasdaq Chart - Daily

The Nasdaq finally broke out over 2400 and then fought to hold it all week. Even with Microsoft and RIMM declining on Friday it still managed to hold near the flat line with only a -6 loss. Initial support is 2385 and the next material resistance is 2725 and that is a long way off.

The S&P is still the laggard but managed to close ever so slightly over 1395 and a new 3-month high. Being +2 points over 1395 does not classify as an overwhelming breakout and could have been just Friday afternoon short covering. However, if financials and energy open positive on Monday we could be off to the races.

S&P-500 Chart - Daily

Dow Transports Chart - Daily

The Transports rallied in the face of $119 oil and closed at a new 8-month high at 5120. If the Dow can move over 12900 we would have a potential Dow theory confirmation. I am still just amazed that the transports are not at 4100 instead of 5100 given the airline disaster and the price of fuel. This is definitely confirmation of a change in market sentiment and evidence that investors are already taking positions and looking for a new post recession bull market.

The Russell-2000 is an even bigger laggard than the S&P with strong three-month resistance at 723 still providing a solid ceiling. The funds have not been as bullish on the small caps and that suggests there is still a lack of conviction this rebound will hold. Once the Russell breaks over 725 with conviction it should be a green light to load the boat assuming we are past the FOMC announcement.

Russell-2000 Chart - Daily

With the continued upward pressure on the indexes I am going to move my decision trigger to S&P 1370. That should be support on any dip and I would look to buy any dips to that level. Under 1370 I would be more cautious if not downright bearish for a short-term trade. I would look for the PMI, ISM, FOMC and NonFarm Payrolls to provide inflection points next week and trade accordingly. We did get a volume increase on Wed/Thr with Thursday coming very close to 8 billion shares. Friday clocked in at only 6.5 billion but it was a Friday. I was encouraged we did not get a sell off, as has been the trend on several recent Fridays. The attempt to sell the open on the Microsoft news was stopped and traders bought that dip. For next week buy dips to 1370 and breakouts over 1400. Look to change direction if 1370 fails.

Jim Brown

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