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Market Wrap

Oil Provides Lift

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Crude oil prices fell more than $5 today on top of a $4 drop on Monday. The combined $9 drop from record highs last Thursday provided lubrication to ease the broader markets from the grip of the bears. The ensuing short squeeze was unable to pierce overhead resistance but at least we are well off the lows. Odds are slim either the bounce in the markets or the sell off in oil will stick but at lease there was a change in the status quo.

Russell-2000 Chart - Daily

The economic reports this morning were lackluster and hardly worth mentioning so I will make it quick. The Pending Home Sales Index declined -4.7% from 88.2 to 84.7. This was a lagging indicator since it covered the May period and several other reports have given us numbers that were more current. Today's report showed that sales had declined -14% from a year ago compared to April's -12.4% drop. Not all areas declined. The western region actually rose +0.2% but the South fell a whopping -7.1% to make it the weakest region. The overall decline in sales during a normally strong calendar period indicate there are not enough buyers to absorb the flood of foreclosures currently hitting the market. Treasury Secretary Paulson said today that foreclosures would continue and there was nothing the banking sector could do despite signs of demand stabilizing. He did say there was plenty of financing available for low credit borrowers. That market has loosened somewhat.

Wholesale Inventories for May rose by -0.8% and right inline with expectations. Sales were up +1.6% and unchanged from the 1.6% increase in April. The inventory to sales ratio fell to 1.08 and an all time low. Consumer Credit rose by +$7.8 billion to $2.571 trillion. This is equivalent to a 3.6% annualized rate of growth for what is known as revolving credit. This suggests consumers are resorting to credit cards to make ends meet. The sharp drop in auto sales produced a corresponding slowdown in nonrevolving credit with only a +$2.1 billion increase compared to +$8.2 billion in April.


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Tomorrow's economic reports should be even more boring with Mortgage Application and Job Openings the highlight. Of course there is also the weekly oil inventory report and that should increase volatility in crude prices if it is possible to increase the already high volatility.

The $9 drop in crude prices was widely credited with stimulating the rebound in the equity markets. Oil was hit by multiple news events but nothing earthshaking. Iran indicated a willingness to negotiate on the last package offered to them as an inducement to stop their nuclear program. Most analysts think it is just a stalling tactic and negotiations will eventually fail just like the first dozen times they failed. Still it represented a temporary lessening of tensions surrounding Iran. The EIA said they were lowering their demand estimates by another 100,000 bpd for Q3. This is in addition to their last estimate for a 300,000 bpd drop. Current U.S. oil demand has sunk to a 5-year low. The weekly MasterCard Spending Pulse report showed that gasoline consumption had declined for the 11th straight week with a 4% drop. The G8 talks focused on the greater risk to the global economy by high oil prices and how to cut demand to lower prices. Hurricane Bertha is turning north and may now even miss Bermuda. There is now no chance it could turn further west and impact the oil patch. The combination of this negative news for oil bulls just happened to arrive in the week when oil prices tend to begin declining after the July 4th driving weekend. Without a hurricane headed into the oil patch the price of oil has likely peaked for the summer. However, as you can see from the chart below the uptrend support at $135 has been very strong and offered good entry points over the last five months. I would not rule out a strong rebound from that level. A continued dip under $132 could produce some monster selling and signal the end of this rally without a news event to jumpstart the trade again. There are still analysts projecting $175 oil before the year is out so there is plenty of cash ready to jump back in if conditions warrant.

Hurricane Bertha Chart

August Crude Oil Chart - Daily

T. Boone Pickens was on CNBC this morning and taking the opportunity to publicize his commercial that will run on TV over the next several months. He claims neither presidential candidate has a grip on the severity of the energy crisis facing the U.S. and he wants to stimulate that discussion. He is promoting wind power and cars fueled by natural gas. He is spending $10 million of his own money to run the commercial on the major TV networks. His tagline is "we can't drill our way out of this crisis." Pickens claims we are currently seeing the greatest redistribution of wealth in history with $700 billion a year flowing out of the U.S. and into the pockets of countries that don't really like us. He believes it is not only a financial crisis but a national security problem where we are funding the buildup of weapons technology and equipment for countries that could turn against us in a heartbeat. I believe he is completely correct and once the oil wars begin in a few years it is the U.S. that indirectly bought the military hardware that could be used against us.

If it is Tuesday it must be Yahoo day. I am sure everyone heard that Microsoft has been in talks with Carl Icahn about replacing the Yahoo board and Jerry Yang. Reportedly Microsoft is willing to restart acquisition talks once those changes have been made. YHOO surged $3 on Monday and gained another 73-cents today. However, not everyone thinks the purchase price will be back in the $30+ range. A very large investor placed what appeared to be a ratio call spread on Yahoo on Tuesday morning. Someone bought 70,000 October call contracts at the $25 strike at $2.28 each and sold 140,000 of the October $27.50 strike for $1.19 each. The resulting spread had a net credit of 10-cents but would imply significant exposure if the price of Yahoo moved over $27.50. Basically the investor is betting the sales price of any eventual acquisition will be between $25 and $27.50. His $25 calls would expire in the money but the $27.50 calls would expire worthless for roughly a $16 million profit. A close at the $27.50 level in October increases that profit to about $18.2 million. I would bet this is Carl Icahn making a bet that he can sell Yahoo to Microsoft for $27 after he replaces the board. He is known to frequently trade options on companies he is attacking.

Stock news today was even more boring than the economic news. Google and Ebay announced a joint effort to end phishing through Gmail and PayPal. They are going to use the DomainKeys Identified Mail technology to stop phishing emails at the server level rather than have them proceed down the delivery path to the user. Basically they are going to choose what email a user will receive. Censorship for our own good? AOL has done this for years by deleting mail they felt was spam without telling their users. Our newsletters were routinely deleted for years without any notice. Fortunately they have improved their screening considerably. Google also received another $635 price target from Think Resources. GOOG closed at $555 with a gain of $10.

RIMM spiked $6 after Lehman made positive comments about the company. Lehman analyst Jeffery Kvaal said BlackBerry's integration of email service, enterprise software and handsets make it an "unrivaled leader" in the marketplace. He said significant barriers to entry would continue to allow RIMM to capture the majority of the market. "None of RIMM's competitors have a material presence in this market." RIMM has made a clearly visible bottom at $115 and the 200-day average. I would be a buyer again over $125.

After the bell Alcoa (AA) kicked off the earnings cycle with earnings of 66-cents per share compared to 81 cents for the same period in 2007. This was 2-cents more than analysts expected. Revenue also beat analyst's reduced estimates. Alcoa is the first Dow component to report and their earnings are seen as the official kickoff for the cycle although the pace does not really pickup until next week. Overall S&P earnings are expected to show a drop of 11.5% based on the last number I saw.

If we are going to see an earnings rally this is almost exactly the place for it to begin. We had the triple play of Bernanke, Paulson and Dimon giving speeches on the same platform today and while they did not sugar coat the current situation they were positive about the future. Bernanke said the Fed could keep its lending facility open past year-end if conditions warranted. Paulson said housing demand was stabilizing. Dimon was seen as the non-governmental wildcard giving credibility to what the others said. The combination of those three speakers plus several noted analysts calling Monday's lows a short-term bottom were enough to trick some bears into covering shorts into the close. Noted analyst John Mendelson of the Stanford Group said, "I think the long correction in the stock market that began early last summer - is ending and I look for a resumption of the advance that began in Oct-2002."

The amount of bearishness heading into this morning was amazing. The S&P bullish percent indicator was 26.5% on Monday. This indicates a very low level of buying interest. This is the very bottom of its normal range and suggests the current sell cycle has run its course and we can expect a relief rally of 1-3 days. We also had capitulation by the retail investor. TrimTabs said stock mutual funds saw outflows of $13.28 billion last week compared with outflows of only $2.75 billion the prior week. When the herd stampedes out of the pasture the worst is normally over. The bullish percents on the other major indexes had also fallen deep into the red-zone as indicated by the chart below. These are all historical levels where buyers typically come back into the market.

Bullish Percent Table

Another bullish indicator is the solid bottom on the Dow at 11200. This had all the appearances of just another stop on the elevator down last week but after six days of failing to give into the selling it is starting to look like a short-term bottom. I say short-term because we don't know what the earnings picture holds and there is still a lot of sunshine left in the summer. We don't normally put in a long-term bottom during the summer months. Long-term bottoms are normally seen in Sep-Oct and with the current economic picture so drab there is nothing on the fundamental horizon to cause a lasting rally. We could just wander higher from here until the bulls regain their confidence but I would not bet the farm on it. Short-term resistance on the Dow is 11430.

Dow Chart - Daily

Nasdaq Chart - Daily

The Nasdaq Composite hit a low of 2214 on Monday and that was very close to strong support of 2200 created back in January and March. Is 2214 close enough to 2200 to claim a retest? I don't know but today's close at 2294 was far enough from that level to at least hope it qualifies. Interim support was 2250 and initial overhead resistance is around 2300-2320.

The S&P dipped to 1241 on Monday and that was the neutral zone right in the middle of the 1225-1250 support dating back to June/July 2006. 1240 was support for those months but there was a couple dips to as low as 1220 with immediate bounces. If you go back and look at the chart for 2006 there is a strong case for 1240 being decent support today. By today's close the S&P had rebounded +33 points from that Monday dip. Short-term overhead resistance is 1290.

S&P-500 Chart - Daily

Russell-2000 Chart

The Russell 2000 completed a retest to 650 and nearly to the Jan/March lows of 643-645. Again, this is close enough to be the real thing and today's outsized +24 point sprint suggests fund managers were buying the dip. Resistance is 700 with a close at 682.

The Wilshire 5000 exceeded its March lows of 12650 with back-to-back dips to 12585 on both Mon/Tue. The Wilshire had been lagging the other indexes and these dips were definitely a catch up and evidence of retail capitulation.

Advance/Decline Line Chart

The internals showed a nearly 7:1 ratio of declining volume to advancing on July 2nd. It improved on the 3rd and 7th and then completely reversed to the upside today with a 3:1 advancing volume over declining. Volume was also high at more than 10 billion shares. I will be the first person to tell you that today's volume and gains were likely the result of a short squeeze prompted by the three musketeers speaking and analysts calling a short-term bottom. The $9 drop in oil definitely did not hurt. There is also ample evidence in the A/D chart above that today's gain could have been triggered by a buy program. You don't get a vertical set of green candles like that on just a short squeeze alone. The buy program would have triggered a squeeze but the continued ramp suggests the program was still running into the close. A one-day spike is a short squeeze but it takes multiple days of gains to make a rally. If you treat your positions as short-term trades and keep looking for the rally to roll over you will be ok. It is the trader who bets the farm today and refuses to close the positions on a market failure who loses his shirt.

Jim Brown

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