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Economic Feast to Famine

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Least week was a banner week for economics with nearly every major report for the month crammed into the last four days. Next week the calendar is almost bare. The earnings cycle is nearly over and there are only a few majors left to report. The markets will have to look hard to find something to provide direction. Linda and I called Thursday conviction day where the bulls had to decide if the Fed outlook supported their bullish views. Next week could be seen as conviction week now that the economics and earnings are behind us. Do we continue higher or does the sell in May strategy now appear more attractive?

Dow Chart - Daily

There were so many economics last week I thought I would provide s short recap today. I doubt everyone caught all the reports and this was a pivotal week for economic news.

Consumer Sentiment 62.6, 26-year low. This is a level consistent with a severe recession.
Consumer Confidence 62.3, right at a 15-year low.
Case-Shiller February Home Prices declined -13.6% year over year.
GDP +0.6%, inline with "official" estimates but a huge relief to those expecting the first quarter of recessionary decline.
NAPM-NY dropped to 419.6 from 425.8 for 4th consecutive decline.
Chicago PMI rose fractionally to 48.3 from 48.2 but was much better than the expected drop to 47.5. This was the second month of a minor up tick.
FOMC cut rates 25-points to 2.0% and did NOT specifically indicate they were pausing. The next meeting is 8 weeks away on June 24th.
Monster Employment Index rose unexpectedly to 174 from 167.
Challenger Employment for April showed layoffs rose sharply to 90,015 workers, up from 53,579 in March. This was the highest number since Sept-2006.
Personal Income growth slowed to 0.3% from 0.5%.
Construction Spending fell -1.1%
ISM remained unchanged in contraction territory at 48.6 and did not decline as analysts had expected. This is the 3rd month under 50.
Non-Farm Payrolls declined only 20,000 jobs and much better than expectations for another 75,000 job loss.
Factory Orders for March rose +1.4% after February's -0.9% decline.

The Non-Farm Payrolls on Friday saw a loss of 20,000 jobs but that might as well have been a gain of 100,000. Analysts had expected a fourth consecutive month of more than 75,000 jobs. This was a positive report and had the bulls speculating the worst was over. It would be tough to make that leap of faith given the internal data but any improvement helps investor sentiment. I should note that the drops over the last four months have been very mild compared to prior recessions. The initial 4-month average loss was -123,000 in 1990 and -120,000 in 2001. That compares to the current 4-month average of -65,000 in 2008. This was a very good report for the markets and relieved a lot of worries. There were a lot of whisper numbers for well over 100,000 job losses. It was kind of anticlimactic after the Fed failed to signal a definite pause and after their pre-market announcement on Friday.

Non-Farm Payrolls Chart

Compared to last week the calendar for next week is positively boring. There is nothing on the calendar that should concern traders. There will be very little chance for any of these reports to move the markets.

Economic Calendar

The Federal Reserve surprised the markets again on Friday. Just before the open they announced they raised the Term Auction Facility amount from $100 billion to $150 billion per month. They said they would now accept AAA asset backed securities including auto loans, credit card balances and student loans. They also increased the ECB swap line to $50 billion from $20B. That means the Fed is going to give the ECB $50 billion in dollars to loan to European banks who need liquidity support. Swaps with the SNB (Swiss) rose to $12B from $6B. Obviously that was to benefit Credit Suisse, RBS, DB, etc. The markets reacted very positively to the announcement as shorts who entered on Thursday's rally were crushed again at the open.

The opening rally did not last long. Traders and analysts began to ask themselves why did the Fed increase all their liquidity tools so strongly when the last round of borrowings under these facilities was under subscribed? Did the Fed know something we don't know? Is the banking system still under that much stress? This is clear evidence that banks are still not lending to each other and the Fed is the bank of last resort. Maybe I should say the taxpayers are the bank of last resort since we will ultimately pay for any failures in these loan portfolios. It concerns me that the Fed is willing to backstop auto loans with gasoline heading for $4 and credit card loans when bankruptcies are up 47% and foreclosures 112%. Granted they are only going to take AAA securities but given the problems with the rating agencies how do you know what a rating is worth?

On the earnings front Sun Microsystems (JAVA) said it would cut 1500-2000 jobs in a plan to reduce expenses by $100-$150 million a year. Sun will take a restructuring charge of $130-$220 million in the current quarter relating to these cuts. Sun predicted revenue would be flat and below street estimates. The Sun CEO said they saw "a substantive change in U.S. sentiment" during March. "In subsequent weeks we experienced a significant number of deferrals of purchases from many of our large U.S. end user customers." Also channel partners were not seeing the sell-through products they had expected. Sun was the first major tech company to report a significant slowdown in U.S. orders. Others said orders were sluggish and relied on overseas sales to bolster profits. This news from Sun was not well received. JAVA fell -22% on the news.

Berkshire Hathaway Chart - Daily

Berkshire Hathaway reported earnings of $1,247 per share or $1.93 billion. Analysts had expected earnings of $1,447 per share. Were Berkshire shares crushed by the news? Not a chance unless you count a $300 drop on a $134,000 share a crush. Berkshire saw a 24% drop in revenue and profits fell -64%. The problem was tied directly to insurance premiums and about $2 billion in derivatives that did not go as planned. Berkshire said it booked a $1.2 billion pre-tax "unrealized" loss on put options it "wrote" on the S&P-500. Writing puts on the S&P is a bullish strategy if you expect the S&P to go up. Obviously we have not seen a lot of that until just recently. Berkshire also reported a $490 million loss on some high yield bond puts but those positions are good until 2013 so that loss could also evaporate. In February Berkshire reported they had $40 billion in exposure to these kinds of derivatives. Buffett has always called derivatives "financial weapons of mass destruction, carrying dangers that, while not latent, are potentially lethal." In his February letter discussing these derivatives Buffett said Berkshire had already been paid for its contracts, giving it cash to invest, and there was no counter party risk. He warned that investors should be prepared for gains or losses that could "easily" top $1 billion in any quarter. Berkshire's annual meeting is Saturday where Warren will take up to 6 hours of questions from shareholders. We will see on Monday how that derivative position weighs on shareholders.


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Chevron reported earnings of $5.17 billion or $2.48 per share. I know what you are thinking. Along with high oil prices those record high gasoline prices are fueling the profits. You would be wrong. Chevron's division that refines and sells gasoline only made $252 million for the quarter. That is down from $1.6 billion in the comparison 2007 quarter. The big oil companies and refiners in general are not making money from high gasoline prices. They simply cannot raise prices on gasoline fast enough or high enough to cover their costs at $120 oil. I heard today that Hillary has a plan to remove the 19-cent Federal gasoline tax and make the big oil companies pay it instead. Some politicians never learn. If you raise taxes on oil companies they raise their prices to compensate. Consumers will pay the same regardless of whose hand is in their pocket. There were two key points in the Chevron earnings report. The average price they received for a barrel of oil was $90, not $110 or $120. Those record high prices are spot prices not every day contract prices. Secondly Chevron's production fell by 44,000 bpd in Q1 over the same period in 2007. It is getting tougher to replace falling production with new discoveries. Older fields are in permanent decline and new fields cannon be brought online fast enough to compensate.

Gas Prices Palo Alto California on May 1st

Earnings are nearly over with more than 75% of the S&P-500 reported. Goldman was rather upbeat on the earnings cycle saying the results were not as negative as they expected. They also said guidance was not as bad as many had predicted. The majority of the earnings disasters came from the financial sector. That sector was ravaged by the Bear Stearns implosion in late March. There was simply not enough quarter left for the good news to overcome the bad after the BSC debacle crushed the sector. The BSC problem caused valuations for many types of securities to plummet and that caused even larger write-downs than their current value today. The financial sector is in strong rebound mode and that suggests Q2 earnings will be substantially better overall even though the economy is still weak.

I had a hard time finding enough stocks with names you might recognize to put on the list for next week despite there being hundreds of companies still to report. The big dog next week is Cisco Systems (CSCO) on Tuesday. Many expect Cisco to beat their estimates due to sales overseas. BUT, the put call ratio is rising and that suggests there is a lack of conviction by the bulls. Cisco broke out over $26 last week on positive expectations but there are still fears that the U.S. side of the business will drag down their overall results. The Sun Microsystems earnings on Friday are a prime example of slowing U.S. tech sales. I believe it was symptomatic more to Sun Micro's product line rather than the Cisco line. Cisco is the current 800lb gorilla where Sun is a past Y2K vintage superstar fallen out of favor with the mainstream tech sector. It will be interesting to see how Cisco reports and more specifically how they guide since CEO John Chambers is seen as always bullish on his outlook.

Earnings Calendar

Deal or no deal? The Microsoft/Yahoo deal may be back on again. The news services reported late Friday that the companies were in heated negotiations in an effort to strike a deal that would not involve a hostile bid or a prolonged battle. Microsoft was reportedly offering $33 in an effort to conclude the deal peacefully. Yahoo was reportedly holding out for $35-$37 but was feeling the heat after their shares fell to below $26 last week. The stock spiked in late trading to $29.75. Analysts cautioned that should Yahoo remain stubborn in the face of a revised offer Microsoft could walk, let the stock fall then start buying it on the open market for a lot less than $31. It was $19 when Microsoft made the first offer for $31 and would be $19 again in a heartbeat if Microsoft officially terminated the deal.

Crude Oil Chart - Daily

It would not be a market commentary without a short look at oil prices. After falling from $119.89 to $110.30 in four days oil rebounded strongly to close at $116.36 on Friday. A $10 drop and $6 rebound in only five days. Oil was up +$3.80 on Friday alone. It appears, and I emphasize appears, that there was a combination of several factors. Shorts loaded up once the decline began and were heavily short at Thursday's lows. Thursday's close saw a commodity buy program hit just like we saw a major equity sell program at Wednesday's close. It had all the appearance of sector rotation on better than expected Fed news. Commodities had corrected as a group all week. When May arrived funds started putting new money to work and what better place than oil after nearly a 10% correction ahead of the normally strong summer driving season. That buy program at Thursday's close triggered some short covering but caught most traders off guard. On Friday news broke that Turkish planes were bombing Kurdish rebels in oil rich northern Iraq. This was the first series of strikes since December. Fears of a halt to the oil flowing north across Turkey sent futures higher again overnight. Suddenly shorts were in trouble and more fund money chasing oil higher on Friday caused a major short squeeze. The news pundits continue to tell you that oil is moving higher because of the falling dollar. The dollar had its best two days (Thr/Fri) since mid April and closed at a 2-month high. That should squash that rumor somewhat. Oil trades primarily on oil news and speculator involvement. The value of the dollar is only a miniscule portion.

U.S. Dollar Index Chart

The markets celebrated the better than expected economics and the lack of a pause statement by the Fed. It was a very good statement. Inflation is still expected to decline and the economy is still expected to be weak but the "downside risks to growth remain" comment was removed. Goldman says earnings were better than expected and expectations for Q2 could be raised. There should not be anything in our way for a continued rally but that is normally when lightning strikes.

The Dow rallied over resistance at 12900 before the closing sell program on Wednesday. Bulls bought the dip to 12800 and pushed the Dow to a high of 13132 on Friday before easing back to close at 13058. That is the highest close this year! The bulls appear to be finally in control and we are definitely in dip buy mode. That Friday afternoon dip was back to 13000 and to what appears to be growing support. The next major resistance level is just over 13500.

S&P-500 Chart - Daily

The S&P-500 mirrored the Dow with a resounding breakout over 1400 and a continuation of the bullish trend out of the March lows. The next material resistance on the S&P is around 1425 followed by 1485. To say the bull is back may be premature but the signs are definitely encouraging.

The Nasdaq had been leading the other indexes higher and came within .96 of hitting 2500 on Friday. If it were not for the drag caused by JAVA, GOOG, BOOM and BIDU it is entirely possible it could have closed at that resistance. Support is now 2400 and well below our current level.

Nasdaq Composite Chart - Daily

Russell-2000 Chart - Daily

Of all the indexes the Russell-2000 is showing the least conviction. It touched major resistance at 735 on Friday but it was a struggle. Until the Russell makes the same breakout as the other indexes this is not a bull market. The Russell is a sentiment indicator for mutual funds. If fund managers are not investing in small caps they are not convinced the market is going to move higher. So far that conviction is still lacking.

Volume is also showing a lack of conviction. You can't count Wednesday because of the post FOMC meeting gyrations but even with all the hedge funds playing Fed games it only came to about 7.5 billion shares for the day. Thursday was stronger at 7.6B but Friday was back in the high 6B range again. After all it was Friday and maybe we should count that as decent. It is simply not enough to claim the rally has legs. We need to be long and continue to buy the dips but do it cautiously. If the Russell moves over 735 I would be more aggressive. I would buy dips back to 1380 on the S&P and turn bearish below that level.

The next two weeks are the start of the "sell in May and go away" cycle. The selling normally begins when earnings are over and after the influx of new money fades around the 10th. I have said repeatedly that I think the current setup will negate that strategy this year but we still need to see if institutional investors feel the same way. That is the reason we need to be cautious over the next couple weeks and probably the reason the small caps are lagging. Fund managers are also watching to see how the cycle will play out in 2008. Hopefully there will be a couple dips to buy as those inclined to sell in May take their leave. Just make sure to watch that S&P 1380 level as a key inflection point.

Jim Brown

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