The markets continue to confound analysts with the best two days performance since the middle of August. It was not without some volatility with the Dow dropping -108 points off its high intraday.

Market Stats Table

There were no economic reports of note this morning and stocks reacted to the unexpected news that Australia raised rates and OPEC was holding secret meetings on replacing the dollar for pricing oil. This caused the U.S. Dollar index to gap lower by .5% and that invigorated stock and commodity prices. The dollar rallied intraday and that corresponded with the -100 point drop in the Dow intraday.

Dollar Index compared to Dow

Stocks were up globally on the Australian quarter point rate increase. Apparently a quarter point increase in rates off the 49 year low of 3% indicated economic growth on a global scale. Who knew Australia had that kind of economic power? I believe it is more likely shorts are afraid good news may breakout at any time and are overly cautious on any announcement.

Gold exploded on the drop in the dollar to a new nominal high of $1045 intraday. I say nominal because the inflation adjusted high from 1980 would be over $2300 today. Gold is being used today as a hedge against the drop in the dollar, a hedge against coming inflation and a hedge against a double dip recession.

Gold Chart

Stocks also got a boost from New York Fed President William Dudley saying the Fed will continue to keep rates at zero for a very long time. His concern was over the current deflationary pressures rather than speculation over possible future inflation. The Fed's favorite inflation indicator is the core PCE, which at 1.3% is well under the Fed's +2% inflation target. Dudley said the Fed expects the PCE to continue to weaken before hitting its lows in mid 2010. It is currently on track to post the slowest inflation growth in the last 50 years. Dudley also said analyst claims that the Fed's balance sheet will lead to higher inflation are not "well founded." Assets are now $2.14 trillion, up +43% on a year ago basis and well above the $900 billion back in 2007 before the crisis hit. All his views were not positive. He believes the current increase in real estate values and consumer spending. He feels once the housing stimulus ends consumers could fall into renewed trouble and jeopardize the recovery.

After the bell Yum Brands reported earnings for Q3 that rose +21% to 70-cents compared to estimates of 58-cents. Before you start thinking that the KFC on the corner must be trading in drugs out the back door along with chicken out the front door there was an * to the number. The majority of its profits came from its 3,300 restaurants in mainland China and strong cost cutting measures. Sales in China rose +11% for the quarter. YUM operates 36,000 stores in 110 countries. System wide sales were down -7% without accounting for the weak dollar. In the U.S. sales were down -6% at KFC and -13% at Pizza Hut. Overall revenue fell -2% to $2.78 billion. YUM said the overall worldwide environment continues to be challenging but they did raise full year estimates slightly. YUM rose +50 cents in after hours.

YUM Chart

Tomorrow typically marks the official start of the earnings cycle when Alcoa (AA) reports earnings. They are the first Dow component to report but not the biggest company to report on Wednesday. Also reporting are Monsanto (MON), Costco (COST), Family Dollar (FDO) and Ruby Tuesday (RT).

Earnings are widely expected to beat estimates but most analysts claim this is already priced into the market. Most earnings are going to come from extensive cost cutting rather than from rapidly increasing sales. Smith Barney's Tobias Lefkovitch said today that it will take more than a strong earnings beat for stocks to outperform. I would take a blowout beat to push stocks higher. In Q2 75% of companies ended up beating estimates. That was a record with most bullish quarters seeing a high of 60-65% of companies beat. How do you compete with a record quarter? Since the earnings came on cost cutting it would really help if companies could show an increase in top line sales. But YUM, a very low dollar price point product saw same store sales decline -10% in the USA. If people are not buying cheap fast food then I doubt they are buying flat screen TVs and other consumer items. It will be an interesting earnings cycle for sure.

American Airlines (AMR) has implemented a miscellaneous surcharge of $10 on each leg of travel on high volume travel days. For instance if you book a flight the Wednesday before Thanksgiving and return on the Sunday after the holiday your will be charged extra on each leg of the trip. The plan was immediately copied by UAL, LCC and DAL. AMR immediately added 10 more dates to the surcharge list. American also announced a $249 "check all you want" bag fee. I guess if you are going to Paris for a month with your wife then all the bags can go on one ticket for $249. Amazing what travelers are paying for now that used to be free. Southwest has been running a lot more of the "bags fly free" ads and you can bet they are cashing in on the promotion. They also did not add the holiday surcharges.

With rising oil prices I am sure there will be further increases in airline travel prices. Crude rose to $72 intraday after the EIA raised their oil demand estimates for Q4. The EIA said they now expect a 410,000 bpd increase in oil demand for Q4. This is up from their last estimate revision of 240,000 bpd a month ago. This would put demand for all of 2009 around 83.67 mbpd compared to the 2008 level of 85.46 mbpd. The EIA also expects demand to climb in 2010 by another 1.1 mbpd compared to 2009. This was 200,000 bpd higher than their last estimate. Sustained growth in China and signs of a turnaround in other Asian countries led to the rising estimates. Chinese demand is expected to be 8.17 mbpd in 2009. US Demand is expected to rise 320,000 bpd in 2010. These estimates change every month so this is not a hard and fast number but merely a moving target of expectations.

Oil Futures Chart

I explained a lot about the labor market and unemployment problem in the Sunday newsletter. On Monday two Rutgers economists released a disturbing forecast. They claim the U.S. may not be back to full employment until 2017 or longer even if the economy adds two million jobs a year starting in 2010. Even worse they pointed out that a seven year economic expansion cycle would be about twice as long as the average for postwar recoveries. In other words we could only be halfway out of the unemployment slump when the next recession hits in 3-4 years. They pointed out that job creation after the 2001 recession through 2007 was anemic at best. You may remember the oft-repeated phrase "jobless recovery" throughout those years.

The Rutgers economists are calling 1999-2009 the lost employment decade since there are roughly 1.3 million fewer jobs as we near the end of 2009 as there were at the end of 1999. This is the first time since the Great Depression that America has seen jobs decline over a 10-year period. Pimco's Mohamed El-Erian and Nouriel Roubini have repeatedly warned that the 15-17 million people currently unemployed would be a significant drain on the economy in the coming years with pressures on consumption, housing and welfare system. Over the last 30 years the number of male manufacturing jobs as a percentage of all jobs has fallen from 35% to only 19% today. These jobs are not coming back because they are now in Mexico, China and other Asian countries. If there is going to be an explosive recovery that pulls America out of the recession it is going to come from somewhere else on the globe.

Bloomberg reported today that apartment vacancies rose +7.8% in Q3 and the highest level since 1986. Rising unemployment is reducing demand for rentals despite the flight of prior homeowners to apartments after they lost their homes. Actual rents fell -2.7% during the quarter. Vacancy rates are expected to drop even further in Q4.

The Treasury auctioned $39 billion of 3-year notes on Tuesday and demand was still good. The auction rated a B+ grade on the bid to cover ratio of 2.72 and price. On Wednesday there will be $20 billion of 10-year notes and $12 billion of 30-year paper will be sold on Thursday. You hear a lot in the press about the large amount of U.S. debt held by foreign countries. If you glance at the table below I think you will be surprised by the amount of debt NOT held by foreign countries. This is just the top 15 in a very long list of debt holders but you get the idea. It is also a lagging total. The Treasury has auctioned over $700 billion in various notes since these numbers were collected in June. What does it mean that various government agencies including the Federal Reserve are holding over $5 trillion in government debt? I think this is almost more troubling than China holding nearly $900 billion but I am not an economist.

Top Debt Holders Table

It was an ugly day in the markets for me with the Dow up triple digits for the second day. Why? Because I was expecting a move in the other direction. I don't completely understand this rally because everyone will tell you the technicals are terrible and the earnings are already priced into the market. Obviously "everybody" is wrong or so it appears. Economics appear to be getting worse on everything but ISM Services but stocks keep moving higher. The decline we had last week was more of an air pocket than a decline and short-term resistance held. Is that it for an October decline? Personally I am still expecting a lower low over the next couple weeks but I am outnumbered today. Unfortunately another high profile personality, Jim Cramer, told his listeners after the close to take profits at these levels. If he is telling listeners to sell then we are obviously going higher.

I am not going to repeat my reasons I am expecting a lower low and frankly they don't count if the market is moving higher. I have learned my lesson in the past that the markets can remain irrational far longer than I can remain liquid. I am a firm believer in trading what you see rather than what you believe but when in doubt I stay out. I am out at present but I will not hesitate to go long if the markets move over resistance from late September.

The Dow rallied to 9774 and exactly to initial resistance from late September. It failed at that level and retreated from +175 to +75 in afternoon trading before a recovery at the close to 9731. The Dow has resistance from 9775 to 9850 and after two days of strong gains I would be surprised to see that resistance broken on Wednesday but I have already been surprised twice this week. The third time is the charm and a move over 9850 would be very bullish. The same six Dow components at the top of the leader board were the same as Monday.

Dow Chart

Dow Component Table

The S&P rallied to exactly 1060 and the beginning of strong resistance that extends to 1075. I would expect a break over 1060 to produce short covering but that resistance range from 1060-1075 could also attract new shorts. This is a very critical resistance range that may control the next couple weeks of trading. I remain skeptical that we will breakout this week but I am not betting against it.

SPX Chart

The Nasdaq was buoyed by upgrades to Apple and Intel and a new high of $190 on Apple with a $4 gain. RIMM is still not participating but at least it seems to have found support at $65. Resistance on the Nasdaq is 2120, 2140 and 2160 with a close at 2100. These resistance levels have held since Sept 15th and this is October and portfolio restructure month. The Nasdaq appears a little weaker than the Dow/S&P but it could be just my perception colored by my bias.

Nasdaq Chart

I am really afraid of a sell the news event on earnings. I still believe the market is priced to perfection and I seriously doubt that earnings perfection will appear. I know earnings will be good but will they be good enough to push us higher? On the Russell chart below I show one possibility for your consideration. If Tuesday's high turns out to be another lower high the technicians would immediately begin to worry about a lower low. On the Russell the 570 level would be ideal since it is uptrend support. I would be a buyer of that dip.

Russell Chart

This could turn out to be a pivotal week in many ways. I would love to see the rally explode higher and everyone but me make a killing. There is no lonelier place than being the cautious trader on the sidelines in cash and standing alone while the bulls race higher. I doubt I am the only one but I am the only one I see tonight.

Jim Brown