Quadruple witching expired on Friday with hardly any volatility and very little movement in the indexes. It appears that all the major positions were closed when the markets tanked on Monday/Tuesday and that left traders standing on the sidelines as the quadruple witching passed uneventfully.

Market Statistics

Options expiration was the focus on Friday but it was like waiting for a bus that never showed up. Traders were waiting for the extreme volatility to appear but it never came. Volume was average for an expiration Friday and prices remained pinned to the most common strikes. There was not enough volume to overcome the market makers as they kept prices in a tight range so the most options would expire worthless. It was a typical summer Friday rather than a high volatility options expiration day. Note that Thursday's volume very low for the day before expiration. The additional volume on Friday was due more to the S&P rebalance then expiration. Of particular interest was the very low volume on Monday when the market tanked hard. It was not that selling was heavy but just one sided. There was no rush to the exits.

Internals Table

Friday was also a void in terms of meaningful economic reports with Regional Employment the only material release. This is a lagging report for May and it showed employment fell in 39 states. This was nothing new and the market ignored it.

Next week is going to be drastically different in terms of meaningful economic releases. Nothing happens on Monday but Tuesday starts a three-day surge. The Richmond Fed Survey has rebounded from -55 in December to +4 in May. This five-month rebound is expected to continue but the bears are circling in hopes of a failure of the economic rebound. The Richmond Fed region has rebounded stronger than the rest of the country and all eyes will be on the Tuesday report. The coverage is for June so it is a current look at the manufacturing conditions in the region. The Philly Fed Survey from last Wednesday is show for comparison. Green shoots?

May Richmond Fed Survey

Philly Fed Survey

Also on the schedule for Tuesday is the Existing Home Sales for May. This is slightly lagging but a continued improvement is expected. The consensus is for a minor rise to 4.81 million annualized units from 4.68 million in April.

Wednesday is the big day with the Fed meeting announcement at 2:15 and $27 billion in 7-year notes up for sale. The FOMC meeting is the major event for the week. Fear of the Fed kept investors on the sidelines all week with daily stock TV discussions questioning when they will begin to raise rates. There are quite a few analysts that believe the Fed will change its statement next week to set the stage for future rate hikes.

The current statement has this sentence: "The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period." Once they take away the "extended period" language the investing public will begin to speculate on when they will actually change rates. Most analysts believe it is at least three meetings away. The first change, which many believe will be next week, is to remove the extended period language.

The second change at the August meeting would be to add language warning that the Fed's bias was moving towards tightening. The third change would be an actual rate hike that could come as quickly as the September 22nd meeting. If this process does not move as fast as described above the next and most likely date for a rate hike is the November 4th meeting. The Fed Funds Futures were pricing in a 50-point rate hike by January just over a week ago. Regardless of the future timetable the confusion over when the rate hike process will start has got analysts running in circles trying to out speculate each other and institutional investors may be holding off on further investment until after Wednesday's meeting.

The ideal scenario would be for the Fed to acknowledge the confusion but again say rates will stay low for an extended period. That would tell investors that the Fed is not ready to reverse their bias and the outlook is for continued cheap money for several more months.

There is another storm brewing on the horizon. Fed Chairman Bernanke, with economic degrees from Harvard and a doctorate in economics from MIT, was kept on the job by President Obama rather than add to the economic confusion during the president's transition into office. Rumors are growing that Bernanke is about to be replaced by Larry Summers. Summers is respected in the market place but not as much as uncle Ben. Bernanke's life focus has been the great depression and how to avoid a reoccurrence. His thesis was on this topic at MIT and he is acknowledged as an expert on the subject. He was a professor at Princeton and chairman of the economics dept. Do we really want to kick Bernanke out of the position before the current crisis has gone away? Do we want Summers moving into the position and then trying to prove he is worthy of respect by suddenly changing the Fed's direction? This is not an event anybody wants to see until well into 2010 but rumors are heating up. In economic circles Bernanke is recognized as one of the smartest economic guys on the planet and a leading expert on monetary theory. Let's hope he keeps his job until the economy is rolling smoothly again.

Bernanke's problem now is the rising mortgage rates. If he continues to support the equity market with a free money program then mortgage rates are going to climb back towards 7%. If he puts the screws to the equity market and forces mortgage rates back down to 4% then the equity markets are going to tank. It is impossible for the Fed to provide support to the bond market and equity market at the same time. Add in the inflation problem created by free money and the Fed has a big challenge ahead and I hope the president is not going to try and change drivers in the middle of the race.

Next up on Wednesday is the $27 billion auction of seven-year notes. Every auction of late has been a bump in the road as investors wait to see if there will be enough bidders to take down the full amount and at what price. The 10-year and 30-year notes are more critical but there are none this week. There are $104 billion of treasuries up for auction with $40 billion two-year, $37B five-year and $27B seven-year. Sure hope there are still buyers overseas who want our debt or this recovery will come to an immediate halt.

If we can somehow dodge the economic guillotine on Wednesday the Thursday economics will be anticlimactic. The next revision of the Q1 GDP is still expected to show -5.7% growth. No news there. The Kansas City Fed Manufacturing Survey is expected to move into positive territory after nine months in the red. The Kansas survey is not seen to be as critical as the Richmond survey on Tuesday. The low in the Kansas numbers came in January at -25 and that had recovered to -3 in May.

Friday rounds out the week with Consumer Sentiment and Personal Income. If we dodged the bigger bullets on Wed/Thr the Friday reports will be ignored.

Economic Calendar

Actual market news next week will be controlled by the pace of earnings warnings. If we are going to see an uptick in warnings the last week of the month is where they should appear. The first Dow component to report Q2 earnings will be Alcoa on July 7th. That is only two weeks from now and there is a lot of water to go under the bridge in terms of earnings guidance before Alcoa starts the earnings cycle.

We have seen some late cycle companies reporting earnings over the last couple weeks and a large majority reported weaker guidance and weaker consumer sales. We are definitely not out of the woods yet and any further warnings should give us a view of what to expect in Q2 earnings. Thomson Financial S&P-500 earnings estimates for Q2 2009 have improved to a drop of -34.4% from Q2-2008. Earnings for the entire S&P 500 are now expected to be $14.31 compared to $26.73 in Q2-2008. Most of the improvement is due to one stock. GM was dropped from the S&P and the elimination of their monster loss took the consumer discretionary sector of the S&P from expectations of a -40.3% loss to a gain of +36.64%. Still that was not enough to rescue the total S&P from a -34% decline. Also helping was the financial sector estimates with a +309% (not a typo) increase in earnings for Q2. If you have a 70% swing in consumer discretionary and a +309% gain in financials and the S&P earnings are still down -34% that tells you how bad the rest of the sectors are performing.

Health care stocks rallied on Friday because it appears the President's $1 trillion dollar healthcare reform program may not happen in 2009. The number commonly quoted is 46.5 million Americans are uncovered by health insurance. Of that number 5.6 million are illegal aliens. 12 million are already covered or are eligible for the SCHIP program for children. 20.1 million make more than twice the poverty level in wages and choose not to buy health insurance. That leaves only 8.8 million truly uncovered and adding them for $1 trillion is considered too costly by most lawmakers. This has caused the stocks of many healthcare companies to rally on expectations that the reform will become bogged down in the process until next year and by them President Obama may not have enough political capital left to get it passed before the 2010 elections.

China's $200 billion sovereign wealth fund China Investment Corp said it was going to invest $500 million in hedge funds run by Blackrock Group. This is the first deposit in what CIC said would be a $1.6 billion investment in the Blackrock funds and $6 billion in U.S. hedge funds in general. This is a 180-degree about face after CIC Chairman Lou Jiwei said in December he did not dare invest in financial institutions after losing money in Blackstone and Morgan Stanley. CIC invested an additional $1.2 billion in shares of Morgan Stanley earlier this month so that concern over the financial sector has evaporated. Analysts feel that the $6 billion commitment by CIC in the U.S. markets is a strong endorsement and confirmation the worst is behind us.

Sir Allen Stanford won't be making any new investments any time soon. Federal prosecutors filed criminal charges on him and several others in the firm for taking part in a $7 billion ponzi scheme. Stanford turned himself over to the FBI and will remain confined as a flight risk until over $1 billion in missing money that was under his control is found. If convicted Stanford could face up to 250 years in prison. Sure hope he enjoyed spending that money while he was riding high.

Three more banks failed and were closed on Friday bringing the total to 40 for 2009. Southern Community in Fayetteville GA, Cooperative Bank in Wilmington NC and First National Bank of Anthony KS were closed. $1.47 billion in combined assets were sold to other banks that took over the deposits of the failed institutions. The FDIC said the cost to the fund would be $363 million. The FDIC has closed more banks so far in 2009 than any year since 1993 and there is still half a year to go. RBC Capital estimated over 1,000 banks could be closed in the next three years. The FDIC reported 305 banks as problem banks at the end of Q1. That is a 24% increase since Q4 and also a high since 1993. The FDIC fund has fallen to $13 billion and the lowest level since 1993. Obviously the early 1990s was a challenge for the financial community and one the FDIC would like to prevent in 2009-2010. The FDIC insures 8,246 banks with $13.5 trillion in assets.

As if the markets don't have enough to worry about the axis of evil is heating up this weekend. Iran's contested election results are producing some serious problems and they won't go away. It appears evident to everyone now that the election results were really rigged and the supreme leader Ali Khamenei has given up trying to pacify the people. He is now threatening them if they continue to protest. Analysts expect this to produce a showdown on Saturday that could be similar to China's Tiananmen Square massacre where more than 2600 people were killed. The Sea of Green protest march, which was planned for Saturday at 4:PM was expected to be the biggest yet. Riot police reportedly tried to breakup the protests but news out of Iran on Saturday afternoon is very sparse. Outside communications on Twitter, Facebook, YouTube, cell phones etc are being turned off and reporters have been asked to leave the country. Sporadic communications from hospitals report dozens to hundreds of gunshot wounds. Bodies were seized by the army and loaded on army trucks and taken away so there would be no evidence.

Secondly North Korea is reportedly going to launch a missile towards Hawaii on July 4th. They tried this once before several years ago but the missile aborted several second after takeoff. The U.S. military has activated a missile defense screen around Hawaii for next weekend and a launch is sure to escalate the current hostility towards North Korea. They are not trying to hit Hawaii but simply prove they can if they want to. If events transpire as expected there is sure to be an international incident and the North Korean reaction to that incident will not be rational. The UN is also tracking a NK ship suspected of carrying weapons for delivery to another country in violation of the recent UN weapons ban on North Korea.

Since NK is a flea compared to the U.S. the markets will probably show only a token response to any showdown. Iran is a different problem. If their army escalates the shooting of their own people the markets could react negatively on Monday since Iran is a much bigger problem.

Oil prices crashed after 12:00 on Friday. At noon the futures were trading just a couple cents under $72 when the selling began. For the rest of the day it was seller panic and crude traded as low as $68.90 before closing at $69.92. The problem for crude prices is the expiration of July futures on Monday afternoon. The expiration of futures forces the leveraged ETFs to roll contracts forward to the next expiration period. The USO ETF controls over 20% of the open interest in crude futures. When they roll out of contracts it always causes a blip. The DXO only holds July contracts so they have to roll all their positions before the June 22 expiration. Obviously managers of these ETFs are not going to wait until 12:30 on Monday to launch a sell program. I firmly believe Friday's selling was due to crude expiration pressures and not external events. The drop in crude carried over into gasoline as well.

Crude Oil Chart

Gasoline Futures Chart

Late Friday the Wall Street Journal reported that Steve Jobs had a liver transplant earlier this spring and was recovering from the operation. The WSJ said Jobs is still expected to return to work by month end. The transplant occurred in late March or early April and was not disclosed by the Apple board. (Nasdaq:AAPL)

I heard two reports on Friday about option open interest falling sharply after Monday. I believe this was a result of stops getting hit when the Russell deleted stock list was pounded by the funds and shorts on Monday morning. The sharp drop in open interest early in the week produced a calm close for the week.

The S&P rebalance was completed at the close on Friday so that is no longer a factor in the market. The Russell rebalance is alive and well but most positions gaming the rebalance should already be in place. The next time we are likely to see an impact from the Russell rebalance is from next Friday afternoon through month end.

We should also see the normal quarter end window dressing the last three days of the month and that should help buoy the markets until then. Funds that did invest in equities over the last three months will want to keep those positions in the green at least until month end.

All the indexes with the with the exception of the Dow are holding over their 200-day averages. I view this as bullish support. However, the market is more than likely going to trade on news next week rather than technicals. Nearly every technician in the press and on stock TV appears to be turning bearish. This is a bullish event for contrarians. When everyone was bullish over the last six weeks the market struggled to move higher. Now that the bulls are throwing in the towel and turning bearish I believe the markets have a chance of moving higher.

In Robert's Contrarian update on Thursday he showed that all three indicators, the VIX, put-call ratios and the Investors Intelligence numbers had all turned negative for sentiment. This is rare that all three indicators are showing the same signal. It also suggests even more so that we should apply contrarian logic to the signals.

When I look at the Dow chart I see two major down days in Mon/Tue (Russell shorting) but I also see three tests of support at 8500 and all three held. This could just be a plateau before the next leg down or it could be the pause that refreshes the bulls. There were a tremendous number of extraneous events last week that pressured the market and the bears could only force a -3% drop. That is pocket change compared to the three-month rally.

However, if this is just a staging point while we await the Fed decision then we could be vulnerable to something in the 8200-8300 range. I personally don't think it will happen without some further external pressure like negative Fed language, earnings warnings, international incident, etc. I continue to favor buying the dip from 8800 but at the same time realizing that dip could continue to 8200.

However, fund managers don't make money in a declining market. In order to draw cash in from the sidelines the market needs to maintain a positive trend. Managers have been waiting for a decent pullback to buy and this is it. Now, as it usually happens, they are probably second guessing themselves and wondering if they can buy it a little lower. The greed gene is potentially fatal. It kept them from getting in the first time when the markets rebounded in March. "Surely it will come back and I can buy it cheaper." Instead of biting the bullet a week into the rally many managers remained under invested while the markets rallied +35%. The $64 question is will they make the same mistake twice? If you just look at the Dow chart it is saying sell but this is not the first time the indicators have pointed down in this rally and then failed to follow through on their indications.

Dow Chart

The S&P-500 rebounded off the support of the 200-day average for the last three days and stubbornly refused to give up its prior gains. A -2.6% retracement, -25 points, was nothing compared to the +280 points gained in the rally. Even with the expiration pressures the S&P did not even come close to the 900 level and appeared pinned to 920 by the market makers. With expiration and rebalance pressures behind us the S&P will be free to mount another attack on the 950 level.

The last three days showed progressively higher highs/lows after the Mon/Tue beating. Like the Dow the RSI and MACD are suggesting sell but there are minor reversal indications showing as well. I don't want to be using a magnifying glass to search out a positive turn on the indicators so holding above the 200-day is where I will hang my hope. If that support fails I believe we could see a continued decline to as low as 880 if news events control our fate.

S&P Chart

The Nasdaq remains much more bullish than the other indexes. It is well over the 200-day average and continues to respect the 30-day average as support. The dip last week bounced exactly on support at a hair under 1800 and while it is not enough to proclaim a rebound it was still a bounce. The Apple trend is turning positive again and the $4 decline in RIMM on Friday could not keep the Nasdaq from posting a 20-point gain. Even Google appears to be trying to build a consolidation base. Bing has not harmed its support at the 30-day average. If a real correction appeared the Nasdaq has risk to 1675 but it would take a real bout of selling and some seriously negative news to hit that support.

Nasdaq Chart

The Russell 2000 is not confirming anything but it did hold at support at 500. Until the rebalance is over on July 1st we can't rely on the Russell indexes for any market direction.

The transports have declined from their 3400 resistance from the prior week to rest at 3200. Rail car traffic is apparently improving in June after 22 months of declines. The rails need to hold up because the truckers are heading to the bottom of the barrel. The combination of higher fuel costs and continued slower retail sales is a problem. Container traffic is down -22% from the same period in 2008 but rose +2% in April. If there are green shoots in the shipping sector they are very fragile. If the transports start to move higher over 3200 then equities should follow.

Dow Transports Chart

The Wilshire 5000 Total Market Index set a new 8-month high in early June and only gave back a small portion of its gains. The Dow has been unable to move over 9000, which would be the equivalent level. The Dow is handicapped by the individual stocks in the 30 stock index and we saw two of them kicked out last month. The Wilshire is more representative of the overall market health. Over the last six weeks we saw two consolidation periods and last week's decline was minimal. Strong resistance at 9750 would be the key to knowing when the next market move higher had traction. This index eliminates single stock impact like Google, RIMM or IBM. This is the market. If it moves over 9750 it is a confirmed rally but 10,000 will be the next challenge.

Wilshire 5000 Total Market Index Chart

I would continue to buy the dip but be aware that there may be a larger dip in our future. Summer is typically weak for the markets and Q2 earnings may not be exciting. The biggest event next week is the FOMC announcement on Wednesday so be prepared.

Jim Brown