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Market Wrap

Financials Lead Again

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Unfortunately the financials led us down not up. Three major investment banks, GS, UBS and JPM either made confessions of their own or were downgraded by influential analysts. The declines in these stocks deflated the sector and prompted a day of profit taking ahead of option expiration.

Wilshire-5000 Chart - Daily

It was a busy morning for economic reports but none were of interest to the markets so I won't dwell on them. Chain Store sales were down -1.1% and Job Openings fell -15%. The International Trade deficit shrank to $56.8 billion due to a 4% increase in exports. Imports grew by only 1.8%. This was the second month of shrinking trade deficits. The Treasury Budget deficit rose to $103 billion and slightly larger than the $97 billion estimate. Drags on the budget included the slowing economy, strong spending growth and economic stimulus package. A second stimulus package would increase the size of the deficit.

Today's Economic Results

The big news impacting the market was not economics but another round of bad news in the financial sector. Dow component JP Morgan was hit by multiple downgrades after saying it would take another $1.5 billion write-down in Q3 on mortgage-backed securities saying, "Trading conditions have substantially deteriorated in the second quarter." That is a quarter to date number and more than all of Q2 losses. Noted analyst Richard Bove cut his estimates for 2008, 2009 and 2010 and lowered his price target from $43 to $39. JPM lost nearly $4 for the day and was a major drag on the Dow. Bove said "the original concept is not working" referring to the concept behind the bank's creation with two segments of a consumer finance bank and a capital markets company. He said both cycles tend to be contra-cyclical where one is up while the other is down. In this environment both areas are down at the same time. He also warned that the purchase of Bear Stearns might have accentuated the negative impact of the downturn in the capital markets. Bove said, "This was as close to a perfect storm as the bank can get." Bove said Goldman's business had "dried up." On Monday Attorney General Andrew Cuomo said he was targeting JPM, WB and MS in his probe of auction rate securities.

Goldman Sachs, the poster child for escaping the slowdown unscathed, was hit by multiple downgrades. Worries persist that the current financial crisis could eventually drag Goldman down into the muck with the rest of the sector. Bank analyst at Oppenheimer, Meredith Whitney, cut her estimates for Goldman by 40% citing customer volumes, overall weak global equity markets and weak advisory and underwriting revenues. Mike Mayo at Deutsche Bank cut Goldman from a buy to a hold saying the slowdown in European economies was hitting Goldman hard. Recent weakness in terms of equity underwriting, equities trading and private equity is hitting Goldman at its core strength. The result will be earnings from Goldman that will be weaker than expected. Goldman was seen as the Teflon bank in a sector imploding. It appears that Teflon is wearing thin with Goldman losing $10.70 for the day.

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UBS announced it was reorganizing into three distinct businesses after reporting a large quarterly loss. UBS said it was taking another $5.1 billion in write-downs. UBS has taken write-downs of $37.4 billion over the previous nine-months. UBS also reported it was losing market share as customers took their business elsewhere to banks assumed to be more stable. I can see where a $37 billion loss would not be seen as a position of strength and an institution where I would want to deposit my money. UBS lost $1.39 in regular trading.

On the tech front the Nasdaq resisted the selling with Apple (AAPL) supporting the Nasdaq with a +3.45 gain. Lehman upgraded Apple to overweight with a price target of $220. Apple closed today at $176.73. I guess Lehman didn't see the posts on the new 3G-iPhone dropping calls up to 50% of the time on 3G networks. Reportedly the number of dropped calls is increasing as the number of iPhones increases the depth of the 3G system. Nomura International analyst Richard Windsor said the problem was Apple's use of a chip set from Infineon (IFX). Windsor said the chipset was immature and in locations were the 3G signal was weak it would show that immaturity by dropping calls. AT&T admitted it has received complaints and they were working to resolve the problem and were happy as possible with the device. Windsor said there were no problems being reported for other devices on the AT&T network suggesting it was strictly an Apple problem. Windsor did not reduce expectations for shipments due to the extreme demand despite the problems.

Dell announced a new line of ultra-portable laptop computers similar to those produced by Apple. The smallest has a 12.1-inch screen and weighs about two pounds. That is lighter than the MacBook Air, which debuted earlier this year. Jeff Clarke, SVP of Dell Product Groups joked at the event, "I believe this will easily fit in an envelope." He was poking fun at Steve Jobs bringing the MacBook Air onstage in an envelope to show how small it was. The new Dell laptops don't have regular disk drives and use solid-state flash memory in place of the drive. The laptops are capable of up to 19 hours of battery life with an add on device called Battery Slice. Dell dumped AMD and said all the new Lattitude notebooks will be powered by Intel chips. Dell rallied off its morning lows but closed only fractionally positive thanks to the down market.

Nividia (NVDA) reported earnings that beat the street but sales missed estimates on weakness in the global personal computer market. Profits per share fell 80% to 13 cents. NVDA spiked over 10% in after hours trading to $12.25.

Amazon (AMZN) held on to its gains from Monday after several analysts made positive comments on the Kindle reader. A Citi analyst doubled his estimates of Kindle sales to 380,000 units. He pointed out that was exactly how many iPods were sold in its first year. He said overall customer reviews of the Kindle had been overwhelmingly positive. He expects it to contribute $1 billion in sales by 2010. A Piper Jaffray analyst, Gene Munster, said Amazon's opportunity to continue taking share from Ebay and other e-commerce sites is still large. Munster said third party sellers have sold something over $6 billion on Amazon over the last 12 months compared to $62 billion on Ebay.

GM made news with an announcement they would increase the gas mileage on their SUVs and trucks this year in an effort to boost slowing sales. The increase? One mile per gallon. Yes, pardon me while I laugh. The new vehicles will average 15 mpg in the city and 21 highway. They are going to lower the front under bumper spoiler, swap the steel wheel spare tire for an aluminum wheel and create firmer tires to provide less rolling resistance. I am under whelmed by those efforts. Some cars will also have an aluminum engine to reduce weight. Meanwhile 33,000 people have signed up on the waiting list for the Chevrolet electric car, the Volt. The average price they claim they are willing to pay is $31,261. Chevrolet is planning on asking over $40,000.

Casino stocks suffered with Wynn Resorts (WYNN) dropping $6.31 after a JP Morgan analyst cut the stock to neutral and suspended his $115 price target. Joseph Greff said the benefits from the Macau business and from falling gasoline prices were already priced into the stock. WYNN had risen for five straight sessions prior to today's loss. MGM dropped -2.31.

Remember the spring floods in the Midwest and the limit up spike in grain prices for several days? There were fears that the corn crop would be decimated due to flooding and the inability of farmers to get into the fields. The Dept of Agriculture said today that weather since the flood had been almost perfect and they are now expecting the 2nd biggest corn crop in history and the 4th largest crop of soybeans. Those farmers that were not impacted by the floods and hedged into those record prices back in the spring should pocket a pile of cash this year while those that didn't will end up getting the lower prices now expected due to the record harvest. Odds are good our food prices are not going to decline.

Crude Oil Chart - Daily

Oil prices continue to fall with a dip under $112.50 overnight and a close just over $113 today. The conflict in Georgia and the closing of two pipelines representing capacity of about 1.3 mbpd appears to have been ignored. Instead traders are focusing on last week's 3.8% decline in demand over the same week in 2007. MasterCard's Spending Pulse saw a drop in spending on gasoline for the 16th consecutive week. The EIA said demand for the first half of 2008 fell by 800,000 bpd compared to H1-2007 and was the biggest volume decline in 26 years. The EIA said "Prospects of improved oil market fundamentals over the next 18 months point to an easing in the market balance and price weakness over the near term." Another six month high for the dollar also pressured crude prices.

The markets were sunk by a salvo of negative financial news. That was the bottom line on all the analysis by dozens of analysts on TV and on the net. I completely agree. Having Dow components JPM fall $4 and Bank America lose another $2 was a bad start the markets could not overcome. Remember, the financial sector is the largest component in the S&P. Where semiconductors are the leading sector in the Nasdaq the financials lead in the S&P. Picture the financial sector as the head of a snake. Wherever that head goes the body will follow. Today that head was seeking a darker environment safe from the glare of analyst scrutiny.

Dow Chart - Daily

The Dow declined from Monday's 11,867 high to close back at prior resistance at 11650. Last week we saw the Nasdaq fall back to its prior resistance at 2350 and then use it as support to blast off to a new high. Let's hope the Dow mimics the Nasdaq and uses 11,650 as support for a new move higher tomorrow. Despite today's decline the Dow uptrend is still intact with 11400 the point where it would start to breakdown. The S&P chart is a carbon copy of the Dow simply because of the financial influence. Support is 1265 and resistance about 1310.

The Nasdaq broke over 2450 on Monday and struggled to remain even for most of today. The final Dow drop on the Richard Bove comments on JPM was too much for the Nasdaq to handle and it gave up -9 points for the day. Not bad when you realize the Dow was down -180 at 3:30. I will take that divergence every day. Tech stocks are in a bullish trend and Nasdaq futures are positive in overnight trading. Support is still 2350 but that is well below today's close at 2430.

Nasdaq Chart - Daily

The Russell continues to be the Michael Phelps of the market. Monday's ramp to 757 was extremely unexpected but still appreciated for those of us long the Russell from the last dip. Today's minor 6-point decline came right at the close when the Dow was heading south at a high rate of speed. The close at 745 was just under that prior resistance at 750 and the Russell futures rebounded +5 points off their lows at the close. Because of the Russell strength and the help from the Nasdaq I am still cautiously bullish and will continue to buy the dips back to Russell 720 as a trade. Unless something new appears in the financials to totally tank the market I believe the Russell will continue higher.

Russell-2000 Chart - Daily

Financial write-downs are now well over $500 billion and there is at least one more write-down cycle coming. Fortunately everyone not living in a cave already knows this and I expect the impact to be minimal. The market had been on a strong two-day buying binge and the JPM/GS/UBS news provided an excuse for profit taking. Volume was very weak at only 7.9 billion and you want to see low volume on a down day. The next material economic report is the CPI on Thursday. The rest of the week could be choppy because of option expiration on Friday. Market makers are going to try and pin the individual stocks to their favorite strike price in hopes the maximum amount of options expire worthless. Let's hope your options are at a strike that is in the money.

Jim Brown
 

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