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Market Wrap

Earnings In Sharp Focus

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Investors turned their attention away from the months of financial crisis and towards the earnings cycle for Q3. What they saw was another crisis of confidence as company after company missed already lowered estimates and provided bleak forecasts. Tech stocks led the broader indexes lower but the negativity was slowly spreading across all sectors.

Wilshire 5000 Chart - 120 Min

The economic headliner for the day was the Chicago Fed National Activity Index or CFNAI. The headline number fell to -2.57 and a new 26-year low. The three-month moving average fell to -1.78 and a level consistent with a recession. This was a 17-year low. The average has fallen to -0.7 or below seven times since 1967 and six times the country was in a recession. The drop in the CFNAI was largely due to the biggest decline in industrial production since 1974. A total of 64 indicators out of the 85 that make up the index posted declines in September.


The weekly Chain Store Sales report posted a drop of -1.6% and erased the gains over the prior two weeks. Year over year growth slipped to only +0.9% and the lowest level since May. This was the largest drop in five weeks. The drop in gasoline sales has not yet prompted a resurgence of consumer buying in other areas. The bounce we saw from the tax rebates has faded and consumers are showing the stress of running out of money before they ran out of month. Weakening consumer confidence, now at 28-year lows, is weighing on consumer spending. Consumers are hoarding what little cash they have with the holidays just around the corner.

In the Regional and State Employment report we saw employment fall in 41 states and the District of Columbia. Regional employment fell sharply with several states showing unemployment over 7%. For instance California's 7.7% unemployment is a direct result of the severe housing correction. According to Moody's 27 states are already in a recession and those states account for 63% of the national job market. Unemployment in New York is expected to rise sharply as massive layoffs in the financial sector create another wave of job losses in the service sector.


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The Fed announced yet another bailout program worth $600 billion to support money market firms. Those firms are currently seeing an outflow of funds because of fears the funds investments in corporate bonds and commercial paper will default and leave the funds with less than $1 for every $1 on deposit. This is called breaking the buck. Money funds have always loosely guaranteed that every dollar parked in their fund would always return a dollar and hopefully a little interest. With the freeze in the commercial paper market investors are afraid they will get back less than a buck if they decide to withdraw their deposits. Under the new bailout plan JP Morgan will create some special purpose vehicles (SPV) to buy commercial paper from the 50 largest companies in the market. The Fed will supply JPM with $600 billion to make the buys. For money market funds selling their paper into these SPVs they will get 90 cents on the dollar in cash and a note for 10 cents. The SPV will hold the paper and eventually pay off the notes if the bonds pay as agreed. The funds are at risk for the first ten-cents of loss but they can get back 90 cents immediately to provide liquidity for redemptions.

The focus for traders was not on economics but earnings. Unfortunately there was little to cheer about as company after company reported negative results. Caterpillar (CAT) led the Dow lower after posting earnings of $1.39 per share when analysts were expecting $1.41. CAT said higher material costs and transportation costs continued to weigh on profits. CAT said it was seeing recessionary conditions in North America and forecast flat sales for 2009. Shares of CAT fell -2.07 for the day.

After the bell Apple (AAPL) reported sales of $7.89 billion and earnings of $1.26 per share. Analysts were expecting $1.11 per share and $8.05 billion. Initially shares fell about $3.50 in after hours to $85 despite the great quarter. After traders had time to digest the report they pushed shares back to $105.00. Apple projected profits between $1.06 and $1.35 per share in Q4 while analysts are expecting profits around $1.69 per share. Apple said it had sold 6.9 million iPhones, 11.1 million iPods and 2.61 million Macs. They have $25 billion in cash and no debt. Gross margins rose from 33.6% to 34.7%. In any normal market Apple shares should be exploding.

Apple Chart - 15 Min

Freeport McMoRan (FCX) said profits fell -33% after the price of copper imploded over the last quarter. At the beginning of the quarter copper was going for more than $4 per pound. When the commodity complex collapsed the price dropped sharply with prices currently hovering around $2 per pound. This was the lowest price since 2005. In 2003 it was 61-cents per pound. Companies are now limiting investments in future capacity and cutting back on expenses. Most people don't realize that it was not just oil that crashed when hedge funds began liquidating. Every commodity complex was hit just as hard as oil.

FCX Chart - daily

Shares in Sun Microsystems (JAVA) fell -17.5% after saying it expects to lose 25-35 cents per share compared to analyst estimates for a loss of a penny. There was a $60 million restructuring charge in the Sun projections and net of that charge they still expect to lose 2-12 cents. Sun blamed the slowdown in the economy and weak sales in the company's server business for the loss. Sun also said, "it is likely that the fair value of one or more of its reporting units has been reduced below its carrying value." Sun is preparing another charge of goodwill impairment to offset that value loss.

NetFlix (NFLX) warned for the second time in a month that subscriber growth was slowing as a result of the economic problems. They still beat the street on earnings but after the second warning the stock lost -12% for the day. This is a direct indication that Joe Sixpack is suffering a budget crisis of his own.

Yahoo (YHOO) beat he street by a penny at +9 cents and said it would fire 1500 employees or 10% of its workforce. Profits fell to 4-cents from 11-cents in the comparison quarter. Yahoo also cut their projections for revenue in Q4 to $1.87 billion and also under analyst estimates. Many analysts had privately expected the numbers to be worse and YHOO rebounded +$1 in after hours.

American Express (AXP) said earnings fell more than 20% because of a large increase in loan loss reserves and account charge offs. AXP said they put an additional $1.37 billion aside for bad loans. Some analysts thought bad debts would be worse and shares of AXP rebounded +2.15. US Bank (USB) saw its profits fall by 47% because of higher loan loss reserves. USB added +$748 million to reserves for bad debts. USB said it was considering accepting some capital from the Fed's TARP program even though they said last week they did not need it. USB said it might now accept the Fed's capital in order to make some future acquisitions.

Dupont (DD) said profits fell -30% by declining North American and Western Europe markets and forcing the company to lower its full year outlook. Dupont earned 56-cents after adjusting for a 16-cent hurricane damage charge and analysts were expecting earnings of 52-cents per share. Dupont lost -$2.44 on the news.

I could go on for several more pages with dozens of other companies that had earnings below projections. Almost every company is also lowering their outlook for the next several quarters. There is a recession regardless of what the economic numbers show. Almost every company claims the economy went into a steep dive over just the last 90 days with several reporting that the decline worsened in the last two weeks of Q3.

The negativity from this steady stream of earnings misses and downward projections is having a negative impact on investor sentiment. Add in the continued worries over the financial sector and many investors are worried. I believe everyone expected a decline in earnings but the severity is still a surprise to many. S&P warned today that dividend payouts in Q4 would fall by -10% and the biggest drop in over 50 years.

Another major concern to the market was the closing on the credit default swaps on Lehman. The auction on the $400 billion in Lehman CDS debt was held two weeks ago and that debt was scheduled to be cleared among holders and insurers today. The Fixed Income Clearing Corp said the liquidation process occurred without any material problems and there would be no "loss allocations imposed" on member firms as a result. If any firm had failed to cough up the cash the FICC could have taken action against them. When the news broke the markets rebounded over 285 points back to even but sellers immediately crushed the Dow back to 9000 at the close.

This end of day selling suggests mutual funds are still receiving redemption requests. I reported over the weekend that TrimTabs said funds were seeing outflows of $5 billion per day and October outflows would be a record.

The November crude futures contract expired at the close at $71.29 and a loss of -3.26 despite comments from OPEC members that they could cut production by as much as three million barrels per day. This is not a function of supply and demand but remains a function of fund liquidation. It is not oil specific but continued commodity liquidation.

November Crude Futures Chart - Daily

Natural gas prices rose slightly after Russia, Iran and Qatar agreed to form a "gas troika" for joint exploration and production. Those three countries control more than half of the world's natural gas. This will be similar to OPEC but more of a joint cooperation agreement. They agreed to create a technical committee and one of its missions will be to review projects that can be implemented in a trilateral way. The U.S. and Europe have warned against the Iran-led initiative to create a gas OPEC aimed at controlling supplies and prices. OPEC has been successful in avoiding price fixing charges because every country can always set a price for their own natural resources. Nobody can make a country sell a natural resource. It is purely voluntary and OPEC gets around global rules because in the past they kept prices from rising too high just as they kept them from falling too low. With Russia and Iran at two-thirds of the troika the odds of price fixing are about 100% once the group evolves into something besides a name with good intentions.

I heard somebody in the news today say the Dow drop of just over 200 points was not that bad. That is an example of how far we have come. Market moves of 5% are so common that a trivial -2.3% drop by the Dow today was "not that bad." The NYSE composite fell -3.75% and SOX -4.03%. The Dow appears to be trying to build support at 9000 but it remains to be seen if that will happen. Solid resistance has formed at 9250.

Dow Chart - 30 Min

Nasdaq Chart - 30 Min

The Nasdaq "only" lost -73 points or -1.59% to close at 1695 and that was the low for the week. However, with Apple's sharp rebound to $105 in after hours has pushed the Nasdaq futures up sharply and suggesting the Nasdaq will have a strongly positive open on Wednesday. Considering the Semiconductor Index ($SOX) closed at 234 and very close to a new multiyear low at 223 the Nasdaq can use all the Apple help it can get. The numerous chip stocks disappointing the street over the last week have really soured tech sentiment. I don't know if Apple can single handedly turn this around but we will get that opportunity to see on Wednesday morning.

The Russell lost -2.96% to close at 531 and still well above support at 500. There was no buying interest and sellers did hit it at the close. Funds have not shown any interest in moving back into the small cap market and until end of day redemption selling ends we need to be patient about going long this market.

Russell 2000 Chart - 60 Min

The rest of the week will continue to be earnings driven. This is the heaviest week of the quarter for earnings and once this week has passed we will know the answer for the entire quarter. Earnings will continue to drag on but the excitement will be muted. Analysts will be busy changing estimates for Q4 and trying to decide what they are going to pump up for year-end. In my weekend commentary I warned that we could see another retest of the lows but I felt we were at or very close to a bottom. My outlook really has not changed. The financial crisis is showing signs of easing after nearly $3 trillion in government bailouts. If $3 trillion in cash can't fix it then I need to buy a horse and a plow and start growing my own food. I can't even comprehend what else they could do to further grease the wheels and get the banks lending again. The Fed meets again next Tuesday and they are widely expected to cut rates by another 50-points just to provide confirmation the Fed is still in control. I guess $3 trillion was not enough confirmation. The coming Fed meeting could provide some incentive to cover shorts on any future dip. The markets typically rise into a Fed meeting where a cut is expected and then decline after the cut is announced. If we could get 2-3 days of gains in a row and slow down those fund redemptions we might have a chance for a year-end rally. I would continue to be cautious in entering new positions but I am looking for a real rebound soon.

Jim Brown

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