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Market Wrap

Who Has the Ball?

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It was a headliner day with all the major headline makers appearing before Congress to talk about the economy and the banking crisis. Competing sound bites were flying like bullets on a battlefield but it is still unclear whether any of those verbal bullets actually hit anything. When Bernanke, Paulson and Cox share the spotlight on the same day about the only thing guaranteed is gridlock. With all the banking news and the competing economic views clouding the airwaves it is tough to know who has the ball.

StockCharts Wilshire 5000 Chart - Weekly

The main topic of conversation may have been Fannie and Freddie but there were other topics making the news. The Producer Price Index (PPI) headline number spiked +1.8% in June following a 1.4% increase in May. Inflation at the headline level has risen +9.1% over the last 12 months and is rising at a +12.4% annualized rate today. That was the largest increase since 1981. Inflation was led by large price increases in food and energy. The core rate without food and energy rose only a minor +0.2% but that was enough to push the trailing 12-month rate to 3.1% and a current annualized rate of 4.5% and well over the Fed's comfort level. Core crude goods slipped -0.2% for the first decline in seven months but the trailing 12-month inflation rate for core crude goods is still 33.3% and the current annualized rate of 38%. Intermediate energy goods have risen 49% during the last six months while crude energy goods rose +133%. Inflation is rapid at all stages of processing and the Fed has to realize that just using the core rate in their decisions is the equivalent of burying their head in the sand. This was the producer report today and on Wednesday we will get the same report for on consumer prices.

Retail sales rose only 0.1% for June after a +0.8% rise in May. Declines in auto sales offset strong growth at gasoline stations. Sales excluding autos rose +0.8% after rising +1.2% in May. As you might have guessed sales at gasoline stations rose the most in June at a +4.6% rate. We saw gasoline rise from $3.75 to well over $4 in many areas and that powered sale volume enough to skew all the categories. Motor vehicles and parts dealers saw sales drop -3.3%. Furniture dealers came in second on the losing side at -1.4%. Year over year sales at gasoline stations were up +25% but sales at auto dealers were down -10%. Overall retail sales fell giving support to the idea that consumers were spending their tax rebates on gasoline and food rather than hard items like big screen TVs and washing machines. With talks increasing about offering another stimulus package it is clear the consumer is in trouble and spending is not going to increase any time soon.


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The New York Empire State Manufacturing Survey fell for the 3rd consecutive month and the 5th month out of the last six. The headline number fell to -4.9 but that was still better than the drop to -8.7 in June. Shipments improved to 13.5 from -6.5 and New Orders rose to 8.3 from -5.5. Unfortunately those were the only components with a positive change. The prices paid index rose to 77.9 from 66.3 indicating the strong rise of inflation at the manufacturer level.

Tomorrow's economic reports include the CPI, Industrial Production and the FOMC minutes for June.

Depressing markets this morning other than the continued Fannie and Freddie news was Bernanke's testimony to Congress. He said FOMC members expect gradual growth over the next two years as the housing problem ends and credit becomes more available for homebuyers. However, current FOMC members said considerable uncertainty surrounded their outlook for economic growth and viewed the risk to their forecasts as skewed to the downside. This is a change from the FOMC statement released after the June 25th meeting. In that statement they said, "Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased." Basically the "diminished downside risks" appears to have changed to "risks skewed to the downside." It is a confusing time for the Fed with growth slowing and inflation rising and nobody wants to mention the "S" word.

The combination of lackluster congressional testimony and confusing sound bites kept investors on the sidelines at the open and the Dow declined -227 points at its low. Helping to revive the indexes was a monster drop in oil prices from the morning high of $146.73 to the low of the day at $136.23. This better than a $10 drop eased by the close to about $6.50 but it was still enough to make the record books as the second biggest dollar drop in history. It was also enough to give the market a kick in the butt and help provide power for the rebound.

August Crude Oil Chart - Daily

Unfortunately the banking sector could not hold its gains and led the market lower at the close. Fannie and Freddie should have been the poster children for renewed buyer interest with all the government big wigs going to bat for them. Instead Fannie (FNM) fell -28% to close at $7 and Freddie (FRE) -26% to close at $5.29. Freddie traded one-third of its outstanding shares and Fannie 20% of their shares. Both closed at new decade lows. With everyone supporting the stocks and the CEOs themselves appearing on TV more than once with calming remarks you would think these stocks would rally. Both have claimed to not be in trouble and be fully capitalized but investors are still selling them.

After the IndyMac bank failure announced late Friday there was a flurry of analysts trying to pick which bank would be next to go under. Some of those interviews may have gone too far with reporters naming names and pertinent financial data. The worst thing you can do for a bank is to put them on a list of possible failures. Some of those reports and the negative reactions prompted several high profile retractions in the media. CNBC's Jane Wells had a piece on Monday where she named several banks high on the potential failure list and claimed RBC Capital had a list of 300 banks on the danger list. On Tuesday Jane was forced to qualify much of the report as pressure mounted. Everyone referenced as a source issued a qualification including RBC Capital. Instead of a list of 300 banks at risk RBC said we don't have a list but "as many as 300 banks" could fail. How do they know it is 300 if they did not have a list to count? On Monday Dick Bove, the bank analyst at Punk Ziegal, released a list of the top ten banks in danger of failing. The list was shown on CNBC with attribution to him. On Tuesday it was qualified by CNBC saying names on the list had higher ratios that matched ratios of banks that failed in the past but did not mean they were in danger today. FYI, Dick Bove was bullish on banks back in March. It was a day of backtracking all over the media and suggests there was an edict from on high saying essentially "what the heck were you thinking? Do you want to start a run on the entire banking system? Retract those comments now!" Unfortunately trying to remove the impact of negative news is like trying to remove one rotten egg from an omelet. It can't be done and the continued positive news on TV failed to keep the sector from closing lower again. I debated whether to post the list here but decided that subscribers may have money on deposit and would like to know. http://abcnews.go.com/Blotter/story?id=5374205&page=1

A new problem hitting the banking sector is the dumping by banks and funds outside the country. Foreign investors are not as complacent as those in the U.S. regarding our banking sector. It was reported that the top three banks in Japan have more than $45 billion in exposure to Fannie/Freddie. The top three banks in Taiwan have more than $20 billion in exposure. You can repeat that sentence as many times as you want and insert different countries but the key is simply the fear of the health of the U.S. banking system and their instant urge to exit. The foreign firms don't have stock exposure but debt exposure to Fannie/Freddie. With $5.5 trillion in mortgages they have issued more than $4 trillion in debt secured in some form by the mortgages. Some of these mortgages have been sliced and diced and exist in various forms in mortgage backed securities (MBS), collateral debt obligations (CDO) and structured investment vehicles or SIVs. As such the exposure is much larger than the face amount of the mortgages. Those CDO/SIV positions are highly leveraged to increase returns. Unfortunately leverage works both ways. Even though the news is improving in the U.S. those foreign firms are still dumping stock and debt. When they dump debt it depresses the value of the remaining debt outstanding. There are guarantees on this debt and some of those guarantees require a repurchase if the value declines to specific levels. This is the major headache for Fannie/Freddie and could be the straw that breaks their back even with all the government support. They are not going to fail but there could be major headaches ahead. Regulators appear to be moving to support the debt rather than the stock because they know that is the problem that can come back to haunt them and the banking system.

GM made news today with announced plans to raise/save $15 billion for 2009. They are planning on $10 billion in operational cost savings and will try to raise another $4 to $7 billion through the sale of assets and new loans. GM cut the dividend for the first time since 1922 in order to save $800 million through 2009. GM is trading at a 54 year low but GM gained +5% on the news. Bankruptcy rumors are making the rounds on Wall Street but the GM CEO said they had ample liquidity to meet 2008 funding requirements. Wagoner said today's moves would provide it enough liquidity to make it through 2009 as well.

Polaris Industries (PII) reported earnings that rose +7% on strong demand for side-by-side vehicles and strong international sales. PII reported earnings of 72 cents compared to analyst estimates of 68 cents. Polaris guided higher for the full year to $3.48 from $3.40 per share. Sales rose by 21% for the quarter and they are targeting +11% for the year.

Sprint (S) rallied +10% on news that it had been approached by Korea's SK Telecom (SKM) about a $22 billion buyout. Since SKM has a market cap of only $15 billion they will need to find some significant debt capability to swallow the bigger company. Sprint denied the rumor and said the companies were negotiating on technology issues and not a merger.

The first of the big techs reported earnings after the bell. Intel (INTC) reported a 25% increase in quarterly profits helped by strong sales of notebook processors. Intel reported earnings of 28 cents compared to estimates of 25 cents. Revenue was up as well although not as much as analysts had hoped because of lower margin notebook models. Intel said demand remained strong in all segments and all parts of the globe. Sales of mobile processors and chipsets both set records for the quarter. Total processor shipments rose from Q1 and were higher than normal seasonal trends. Intel spiked on the news then declined on the guidance but returned to close in after hours almost exactly where it closed regular trading at $20.81.

Railroad operator CSX reported earnings that rose +19% to 93 cents per share. This was above the analyst estimates of 90 cents. CSX said demand for coal, grains and fertilizer was very strong. CSX reiterated their full year targets but investors were not impressed and shares moved slightly lower in after hours despite a -$2.46 loss for the day.

Key earnings for the rest of the week include EBAY and WFC on Wednesday, IBM, MSFT, GOOG, MER, JPM, UTX and NOK on Thursday followed by Citigroup on Friday.

The Dow first closed above 11,000 on July-16th 1999. Today exactly nine years later the Dow closed under 11,000. The entire nine years of gains have been erased if you believe the talking heads on TV. Sure it is frustrating but investors had better brace themselves for the next leg down. The low for today was 10827 and the afternoon high 11123 for a 296-point range. The bad news was the continued selling of the rebounds. The +296 point rebound was sold hard knocking the Dow back -125 points from its high. Had the day lasted another 30 minutes we could easily have retested the lows. Every major chartist I heard today was predicting lower lows. Maybe that is bullish since nobody is expecting a bounce but time will tell.

The Wall Street Journal reported late this afternoon that short interest had hit another all time high. That should also be bullish since it represents a lit fuse on a huge amount of market dynamite. The VIX spiked to nearly 31 today and is nearing bullish territory. At least one analyst was calling today a capitulation day but although the internals were extremely bearish it just did not feel like capitulation. Granted we could be close but there are still problems.

I updated the market internals table from Sunday adding two more rows. Note that volume is rising but it was still only 2:1 negative and far from a capitulation rate of 8-10 to 1 negative. Note also that the new 52-week lows hit 1786 on Tuesday and 400 more than the 1381 peak set on the March 17th dip. You have to go back to the Jan-22nd dip for a larger number at 2389. That was also the day before a true capitulation bottom. On the second internals table for Jan-22nd note that the A/D volume did not indicate a capitulation on the 22nd when the new 52-week lows and the Dow itself were at their extremes. The actual capitulation in volume was on Jan-17th at nearly 8:1 declining. On Jan-23rd there was an opening dip to almost the same Dow low as the 22nd but the rebound began and pushed the volume to nearly 13 billion shares and 2:1 positive. Now look at the current table. On July 9th volume was 5:1 negative but very light. That is not capitulation. Nothing happens on light volume. You need strong volume for either a capitulation day or a rebound day and there needs to be a strong imbalance in the A/D volume. Today was close with the high volume and peak in new lows but the A/D imbalance was still only 2:1 negative. We could be setting up for a capitulation day or a rebound day and we will know it when it happens but watching the internals.

Market Internals Today

Market Internals around Jan-22nd

The chart shows the Jan-22 dip and the beginning of the rebound on Jan-23rd. That was a +1000 point rebound but it still needed to come back and test the lows again in March. This is another reason you do not want to be married to any rebound when it appears. Plan on the lows being retested between now and Halloween.

Dow Chart - Jan 22nd Dips

Today the Dow came within 127 points of my target of 10700 for this decline. We could easily hit that target this week and then begin a rebound. The problem continues to be the financial sector. As long as Bernanke, Paulson, Cox, Congress and the media continue running around like Chicken Little saying the banks are failing there will be no rebound. Bernanke said his main task today is supporting the banking system. Glad to hear that but if he is admitting his main job today is supporting the system then he is confirming it is broken. Look for a test of 10700.

Dow Chart from StockCharts.com

The Nasdaq actually closed positive ahead of the Intel earnings but that should not be construed as a bullish event. GOOG, RIMM and CSCO were hitting new monthly lows ahead of Intel earnings and even though Intel beat there was no reaction. If 2200 breaks the odds are very good we eventually test 2000.

Nasdaq Chart - Daily

Surprise, the S&P-500 dropped another 13 points. Of course that was probably not a surprise since the 21% of the S&P are in the financial sector. That should be a clue to our future. Until the financials find some love the S&P will continue to decline. If the price of oil declines further it will weaken the energy component of the S&P and that accounts for 18% of the index. The intraday low was 1200 and that is well below the June-2006 support lows making 1175 the next support target from October 2005.

S&P-500 Chart from StockCharts.com

Rather than continue beating this dead horse I think we simply need to short the failure of any rally until the financial sector recovers. We have earnings from COF, JPM, CMA and MER on Thursday and Citigroup on Friday. It is possible those companies will say something to entice investors to stick their tow back in the financial water but remember any bounce is questionable until proven to have legs.

Jim Brown

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