Surprisingly weak consumer sentiment and a warning from Chevron and the IEA overcame a bullish tech call by Goldman to keep stocks negative for the week.

Market Statistics

On Friday a surprise drop in Consumer Sentiment for July caught traders off guard and the Dow lost ground for the fourth consecutive week. Consumer Sentiment for July fell unexpectedly to 64.6 from 70.0 and increased fears of a double dip recession. The July decline was led by a sharp drop in the expectations component from 69.2 to 60.9. The present conditions component fell from 73.2 to 70.4. The drop in the headline number erased gains from the last two months and knocked the index back to levels not seen since late March.

The accelerated drop in non-farm payrolls we saw last week and continued high weekly jobless claims appear to he weighing on consumers. We saw a sharp drop in weekly same store sales and mortgage loan applications are falling. Credit card companies are continuing to lower available credit and raising interest rates and payment terms on existing balances. The stage is set for a double dip recession if something does not happen soon.

Consumer Sentiment Chart

The other two reports on Friday were lagging reports and were ignored. The International Trade deficit narrowed slightly from $26 billion in May from $28.8 billion in April. Import prices rose for the seventh consecutive month in June by +3.2% but the majority of the surge was due to the rise in crude prices.

The economic calendar for next week is very heavy with several critical events. Tuesday will headline with the Producer Price Index (PPI) and will show the impact of inflated prices at the producer level. Prices are actually expected to have declined in June with the exception of crude prices. The excess capacity in the system is preventing anyone from raising prices. Because of the energy impact the headline number should rise about +0.8% but the core rate could be negative.

On Wednesday the Consumer Price Index (CPI) is expected to show an increase in prices of +0.5%, again an increase due to the price of oil. Also on Wednesday are the FOMC minutes from the June 24th meeting. Because of the lengthy post meeting statement I don't expect any material impact from the minutes unless the Fed expresses concern for another drop in economic activity. This was not evident in the post meeting statement but could be discussed in the minutes. They had to talk about the possibility but we don't know that it was enough to include in the minutes.

Thursday is the first of the regional activity reports with the Philly Fed survey. This report is expected to show a drop in activity with a headline number falling to -10.0 from -2.2 in June. If this comes in as expected it will be one more indicator that the economy is losing traction over the summer months.

Economic Calendar

The big key next week will be the earnings cycle with big names in the tech sector and the banking sector that are likely to set the tone for the rest of the earnings period. Reports critical to the tech sector will be Intel (Nasdaq:INTC) on Tuesday, IBM (Nyse:IBM), Nokia (Nyse:NOK) and Google (Nasdaq:GOOG) on Thursday. Intel has already called a bottom in the PC sector and Goldman Sachs also turned bullish on the sector on Friday. Goldman raised Dell (Nasdaq:DELL) from a hold to a strong buy on Friday and placed Dell on their conviction buy list.

The banking sector will be represented by Goldman Sachs (Nyse:GS) on Tuesday with earnings expected to be $3.54 per share. That will be followed up by JP Morgan (Nyse:JPM) on Thursday with expectations for +0.05 in earnings. Friday closes the week with Bank America (Nyse:BAC) (+0.05) and Citigroup (Nyse:C) with a 34-cent loss. The bank earnings and more importantly guidance will be critical for market health.

CSX (Nyse:CSX) reports on Monday and hopefully will give us an update on railcar loadings. Recent reports claim a drop in rail shipments over the last several weeks. If this is true then the outlook for the economy is likely to weaken. American Airlines (Nyse:AMR) reports on Wednesday and will tell us how they see traffic patterns for the quarter and that will give us another look at the consumer mindset. Harley Davidson (Nyse:HOG) reports on Thursday and as a seller of high dollar consumer discretionary products will be another read on consumer spending. Last but not least GE (Nyse:GE) reports on Friday and they will give investors guidance on the health of the manufacturing sector from a different perspective. GE is normally seen as a proxy for the U.S. economy so their outlook will be an outlook for the economy.

While the earnings calendar is light in numbers of reports those key companies I highlighted above will give us a pretty good indication of how the rest of the earnings cycle will go. Even though the pace of earnings will pick up significantly the following week we will already have the outlook that matters from the week ahead. Traders will have already made up their minds and market direction could already be decided.

Earnings Calendar

Chevron (Nyse:CVX) reported earnings estimates on Thursday and with their earnings they warned that the outlook was not good. The impact of the falling dollar had cost them about $400 million for Q2. Earnings were also hurt by declining refining margins. Lower gasoline demand equates to lower crack spreads and for a company like Chevron with lots of overhead they need to push product through the system regardless of the demand.

This weekend is the anniversary of the $147 high in crude prices on July 11th 2008. The oil companies will be faced with an $80 drop in crude prices putting a serious crimp in profits both in Q2 and Q3. Chevron was just the first major to report the bad news and there will be many more to follow.

The current worry over possible rule changes for investing in commodities is keeping pressure on oil prices. Crude has been imploding since July 1st when it hit $71.85. Crude traded as low as $58.72 on Friday and closed at $59.66. That is the lowest close since mid May. Since the $73.90 high in mid June crude has fallen -$14.24 or -19%.

The IEA added to the gloom on Friday by saying the signs of a strong rally in global economic growth this year are fading but there could be a dramatic turnaround in 2010. The IEA fears that the summer driving season in the U.S. is going to be below average and job losses were forcing cutbacks on vacation trips. The IEA says now that when the rebound comes in 2010 is will come from emerging economies not from the US. Summer travel in the USA is down -25% this summer according to a survey out this week. Vacation travel to Mexico for instance has died due to the drug wars and swine flu. Driving vacations in the US are being cut back by rising unemployment, shrinking credit availability and the need to conserve cash.

The IEA said crude demand was now forecast to fall -2.9% in 2009 (-2.5 mbpd) but rise +1.7% in 2010 (+1.4 mbpd). Demand was expected to rise to 86.6 mbpd in 2010. The IEA also reported that compliance with the OPEC production cuts had fallen to 68%.

Crude Oil Chart

JP Morgan (JPM) told the Treasury Dept to take a hike when the Treasury told JPM how much they wanted for their TARP warrants. Under the TARP process the Treasury received warrants when they made a loan to the major banks. JPM has already paid back the TARP loans and has started the process to cancel the warrants. Under this process the bank submits a value they would offer for the warrants and the government submits an offer. If they can't agree then a third party will attempt to settle the dispute. If all else fails the warrants can be auctioned by the Treasury Dept.

Treasury told JPM their warrants were worth $1.2 billion and JPM was thinking more in the $500 million range. After several discussions JPM told the Treasury to start the auction process. These are ten year warrants and JPM either thinks they can get them back at a bargain price through the auction or they don't want to put out the additional cash today. Either way the auction process should start next week. Eleven smaller banks were able to buy back their warrants at 66% of estimates fair market value. Because of the smaller amounts that discount only cost the Treasury $10 million. With JPM that same discount would be around $400 million.

I mentioned earlier that Goldman Sachs had upgraded Dell to a strong buy on Friday. They also upgraded Hewlett Packard (Nyse:HPQ), Seagate Technology (Nyse:STX) and Apple Inc (Nasdaq:AAPL). In the same note they downgraded IBM (Nyse:IBM), Western Digital (Nyse:WDC) and CA (Nyse:CA) to a neutral from buy. Goldman believes the PC sector has bottomed and the Windows 7 upgrade cycle will produce a hardware wave late in 2009 and early 2010. Microsoft is the real buy here given the decline from the highs last week. Because there was no corporate upgrade cycle for Vista there are a lot of company PCs that have reached the end of their life and IT managers will replace them with new Windows 7 PCs. Obviously that assumes the recession will end soon and companies release their grip on their cash hoard.

Government Motors (GMGMQ.PK) exited bankruptcy after only 40 days and the CEO vowed to be leaner and meaner and make waves in the market. The government owns 61% of the new GM so it will be interesting to see how many waves they make. If you are still holding on to your shares of GM your time is running out. The stock will be cancelled any day now and anyone holding stock will be hung out to dry. Ironically the stock rallied 37% on Friday to $1.15 on news GM had exited bankruptcy. Since the stock is no longer tied to GM it is foolish to hold it. Buying GM stock today would be the equivalent of buying a lottery ticket for a lottery held last week. It has no value and we already know the ticket is a loser. Volume was over 70 million shares in GMGMQ on Friday and there is still more than 30,000 open interest in the July $2 puts and 45,000 in the Sept $2 puts.

Government Motors Chart

If it is Friday another bank must have closed. Sure enough when I checked the 53rd bank closure of the year took place in Thermopolis Wyoming to the Bank of Wyoming. It is the first Wyoming bank to fail since 1991. The FDIC estimated it would cost the fund $27 million to close and transfer the banks $67 million in deposits. Sounds like the BoW was in serious trouble and not just mildly overdrawn.

David Darst from Morgan Stanley Smith Barney said on Friday that 86% of the market cap of the Wilshire 5000 was currently in cash on the sidelines. He said normally those cash levels average about 40%. When a real economic rebound occurs he believes that money will be put back to work very quickly and the eventual rally will be huge. The keywords here are "when an economic rebound occurs." However, he did believe that many sectors were within 5% of their bottoms and he believes long-term investors should be getting ready to back up the truck. I don't have the benefit of knowing how correct his 86% in cash estimate it but I do believe the post recession rally has not yet begun. FYI, the total market cap of the index on June 30th was $10.79 trillion. If that only represents 14% invested (86% in cash according to Darst) then I want to be on that train when it leaves the station.

The key to a stock rally has always been increasing earnings and we don't have that yet. Add in the roll over in the economic reports and it appears we may not see those earnings improve much in Q2 or Q3. The percentage of companies that normally beat their earnings estimates is 65%. In Q1 it was only 46.1%. Obviously we don't have a Q2 number yet and it will be weeks before we do. Some analysts are expecting Q2 earnings to be much better than expected. I want some of what they are smoking. I would love to see that happen but I am not counting on it. About the only company I expect to beat strongly is Apple. I think the rest of the corporate world is just happy to get out of Q2 alive.

The banks could do better because interest rates are low and demand for business is high. What loans they are making are very profitable. Plus the mark to market rule is history so those semi-toxic assets they are still holding can be valued higher than they were in Q1 and that improves earnings. The real hindrance on the banks this quarter is the TARP repayment expenses. Most have already disclosed how much of a hit they will take to earnings for the repayment and they are glad to be out of the trap. This is why the bank earnings next week will be so critical. Show us the money or at least show us where it went.

Late Friday the Obama Administration said the might use the $700 billion in TARP funds to help small businesses now that the crisis in the financial sector appears to have passed. This comes after various administration spokesmen floated the idea of a second stimulus package last week. President Obama said at a stop in Africa on Friday that he was confident the new government health plan would be passed before the August recess. We heard this week that various methods had been proposed to pay for it. One trial balloon floated was a 4% tax on everyone who made more than $200,000 per year. The second plan was a graduated tax on the wealthy, described as anyone that makes over $280,000 a year. The new tax on the wealthy was expected to bring in $540 billion to offset the more than $1 trillion cost of the plan. Tax Description

The Dow has now firmly broken below support at 8200 and the bottom of the head and shoulders neckline. On both Wednesday and Friday the Dow found interim support at 8100 but the clear target is still 7750. The problem for the markets is the expectations for earnings and the declining economic indicators. The rally out of the March lows was on expectations for a quick economic recovery. Unfortunately that is either not happening or best case just temporarily stalled.

The market internals are not that bad but the volume is horrible so we really can't make a case for a continued decline based on the internals. Volume across all markets on Friday was only 6.7 billion shares and the lowest volume day for all of 2009. Thursday was barely better at 7.6 billion shares.

We are clearly in a holding pattern until next week's earnings. We have not really seen a flood of sellers but more of a buyer boycott. Advancers and decliners were almost equal on Friday but declining volume was 2:1 over advancing.

The Dow should continue to trade slowly lower without some positive news. The uptrend has been broken and now there needs to be an event to change the direction. Next week's earnings are setting up to be critical and the potential for a negative surprise is rising. If one or more of the Dow components posts a lousy report next week the result could be ugly. Dow components JPM, BAC, INTC, IBM, GE and JNJ all report next week.

Dow Chart

Dow Chart 15 min

The S&P-500 is clinging to a measure of respectability by the slimmest of margins. For the last three days the S&P traded below support at 880 only to recover at the close to that 880 level and on the 200-day average as support. A solid move/close below 880 should be lights out for the index. The S&P will be hostage to any Dow move next week because of the number of Dow components reporting. If we get a triple digit decline in the Dow the S&P is going to follow and confirm the head and shoulders breakdown. Analysts have been talking about a breakdown to 830 but it is possible we could even see 800 if enough of the big earnings reports begin to stink up the place.

S&P-500 Chart

The Nasdaq finally broke below the June lows but remains well above the disaster setups we are seeing in the Dow and S&P charts. The Goldman and JP Morgan upgrades to tech stocks are keeping the damage to the tech indexes to a minimum. This Nasdaq Composite chart has 100 points of buffer before the critical 1660 level comes back into play.

Nasdaq Chart

An even longer-term bearish resistance level on the monthly chart is the 200-month average and the 38% Fib retracement at 1840/1875. If the Nasdaq did manage to rally out of the normal summer slump this is serious resistance it will have to overcome.

Nasdaq Chart - Monthly

By comparison the Nasdaq-100 Ex-Tech Index ($NDXX) has declined slightly lower but remains solidly over support at 750. A breakdown here would be the signal to abandon ship. The next material support would not be until 700 and again at 650.

Nasdaq 100 Chart

The Russell is a carbon copy of the S&P with critical support at 475. It is currently riding support at the 200-day average (blue) lower. Something has to give here soon with either a rebound off 475 or a confirmed break lower. The pressure is building for a breakdown.

Russell 2000 Chart

The Dow transports chart is entirely different than the major equity indexes. The transports are fighting the 200-day as overhead resistance while the equity indexes are using the 200-day as support. The transports also have considerable support at 3000 and as long as CSX does not implode on Monday that support should hold next week. The transports rallied strongly out of the March lows on thoughts that shipments would pickup quickly. Recent reports claim that the increase in rail shipments in May has ended and late June numbers were showing declines in rail loadings. I am hearing the same from the trucking sector. I have heard from friends in the business that truck shippers are cold calling business owners looking for loads because conditions have declined so sharply. I heard one analyst suggesting shorting the transports on a break of 3000 by using the IYT ETF.

Dow Transports Chart

Last but definitely not least is the Dow Total Market Index ($DWC). The DWC is the broadest market index that includes the top 5,000 stocks. The index has strong support at 9000 and that is exactly where it closed on Friday. Like the Russell and S&P it is riding the 200-day average lower. The convergence at the 9000 level is critical. If this level breaks we could be looking at a major technical drop.

Dow Total market Index Chart

This will be a pivotal week in the markets. We will get earnings from the giants in two critical sectors, tech and banking, along with some fillers from manufacturing and consumer discretionary. This is the final exam before the market lets out for the summer break. If stocks fail this exam we could be looking at summer school for traders as we spend the next two months trying to find a bottom. Unfortunately I am not sure that even a passing grade will keep us from that fate.

We are entering the dog days of summer and the economy seems to be worsening again. That is not a good combination. This is also option expiration week and volume is at the lows for the year. This means volatility will either be nonexistent or huge. My best bet is for a continued buyer boycott because there is no overwhelming reason to be long the market until we see the economics begin to turn positive again and corporate earnings begin to rise to something other than "less bad." August and September are historically the two worst months of the year for the market and with economics worsening I am afraid of what may lie ahead. The minor decline last week could have just been the calm before the storm. I would be very cautious about entering new long positions next week. Who knows, if all the earnings are positive surprises maybe the gloom will lift. Until then I would keep my cash in reserve.

Jim Brown