Despite a week of earnings that beat the street and some major gains in individual stocks the markets gave up their gains on Friday.

Market Statistics

Friday was a light day for economic reports but a big day for earnings reactions and news stories. On the economic front Existing Home Sales for September jumped from 5.10 million to 5.57 million units (annualized) mostly with the help of the homebuyer stimulus program. The +9.4% gain in one month was the strongest since August 2007. Inventories improved significantly to only a 7.8-month supply.

Unfortunately those statistics are misleading. The only homes selling are at the lower end of the spectrum. Those are exactly the ones being helped by the first time homebuyer credit. The $0-$100K price range accounted for 21% of sales. The $100K to $250K range accounted for 48.5% of sales. Homes from $250K to homes in the millions accounted for 30.4% of all sales and the majority of those sales were on the low end. Home inventory in the under $250K level has shrunk to only a three month supply compared to over a year's supply once you move over $500K. The numbers of sales of the very low priced homes are skewing the overall home sales statistics.

The northeast and southern regions led sales with more than an 11% gain while the west only managed a 6% increase. I heard one statistic that illustrated the foreclosure problem. 81% of the homes sold in Las Vegas were bank owned. Obviously Las Vegas is a different market than the rest of the country but you get the picture. Freddie Mac reported the highest ever rate of delinquencies in September at 3.3% of all loans. Freddie's total portfolio of loans now totals $2.243 trillion. On the bright side inventories are shrinking, prices are stabilizing and sales are rising all across the country. These metrics are at their highs for the year. However, the NAR numbers are seasonally adjusted and there is some discussion over their credibility. On a non-adjusted basis home sales actually fell -5.2%. I don't know how we interpret this BS except that the NAR seasonally adjusted numbers are commonly accepted in the marketplace.

The talk about extending the buyer stimulus program is increasing and rightly so. This is keeping the pipeline full of buyers and by stabilizing prices it is keeping marginal owners from letting their homes go back to the bank. As long as there are signs of rising prices many delinquent homeowners will keep trying to make their payments. Some ideas being floated would keep the stimulus program active through November of 2010. I would vote for that one since it gives the economy time to recover and for unemployment to shrink. Once workers lose their fear of being laid off they will be more open to the idea of buying a home.

Next week has a very active economic calendar. Actually the next two weeks are filled with critical economic events including another FOMC meeting. The most critical report for next week is the first look at the Q3 GDP on Thursday. Expectations are for a gain of +3.2% compared to the drop of -0.74% in Q2. Needless to say this Q3 expectation is already priced into the market rebound and a miss on expectations could have a very serious impact on the markets.

On Friday the GDP for the U.K. was released and showed a -0.4% drop instead of the 0.2% gain economists had expected. The European markets fell on the news and the British pound fell -1.5% against the dollar in early trading. The reason this is so critical is that the U.K. is basically a mirror of the USA. They have implemented many of the same stimulus programs as the U.S. and they are still in recession. This made analysts question their predictions for the USA and Thursday's Q3 GDP estimates. This was a material reason for the market weakness on Friday.

The rest of the week is littered with regional Fed reports and sentiment surveys with the really big economic events the following week. Next week is a build up of expectations for the following week's climax with ISM, Fed meeting and Non-Farm Payrolls.

The coming week is also another big bond sale week with $123 billion in debt being sold at auction. With the interest rate on the 10-year note hovering at a six week high just under 3.5% the cost of government borrowing may be moving higher. With a $1.5 trillion annual deficit growing to a $2 trillion by 2019 the cost of money is eventually going to be a problem. Once these auctions start going badly with higher rates and fewer bidders it is going to get ugly in the equity markets. I don't expect that this week because the bid to cover has remained unbelievably high but it will happen eventually.

Economic Calendar

The earnings cycle is in full swing and next week has the most earnings reports of any week in the season. Unfortunately the quality of the earnings will begin to decline because the majority of the big cap blue chips have already reported. In the list below I am sure there are a lot of symbols you may not recognize simply because most of the well-known names have already reported. Next week is primarily small tech and energy with COP, XOM and CVX leading the energy sector reports. On the tech side we have GLW, ADPT, AKAM, LVLT, FLEX and SYMC to name a few. We also get the inside scoop on the retail brokers Ameritrade and Etrade. After this week the quality and quantity of earnings declines even further.

Earnings Calendar

So far the earnings winner for the Q3 cycle is Amazon. AMZN posted amazing earnings that beat the street by a mile and then upgraded guidance for Q4. Amazon earnings rose +68% to $199 million while revenue jumped +28% to $5.45 billion. This was basically a holiday quarter before the normal holiday quarter. This is the kind of performance they previously did only in Q4. Amazon upgraded revenue projections for Q4 saying they could see $9.1 billion compared to analyst estimates for $8.19 billion. The Kindle book reader is selling more units and contributes more revenue than any other item on the website. A Citigroup analyst estimated they will sell 1.5 million in Q4. The Kindle has spawned several copycats but the Kindle still leads the pack. Barnes & Noble (BKS) was downgraded on Friday because analysts believe the impact of the Kindle and other readers will diminish the value of their brick and mortar stores. BKS has already released its own book reader with more features than the Kindle but the Kindle is still way out in front. Amazon's market cap is now 50 times larger than Barnes & Noble. BKS closed at a new 8 month low on Friday.

Amazon shares spiked +27% or $25 to close at $118.51 after the news. That was a new, all time, split adjusted high for Amazon shares. It was a big win for Jeff Bezos. Jeff has undergone years of insults and slurs since Amazon fell off its previous high of $113 in December 1999. Amazon was routinely beaten to a pulp in the press as too big with miniscule margins to ever succeed. Surprise, surprise, it appears they are succeeding and Jeff got better than a $2 billion bonus in his stock account from Friday's gain. He owns 23% of Amazon stock. Looks like Jeff gets the last laugh on his detractors. However, Amazon is now trading at a PE of 78 and that is historically a rich number. It did not concern one analyst who promptly raised his price target to $130.

Amazon Chart - Daily

Amazon Chart - Monthly

Microsoft (MSFT) reported earnings of 40 cents on Friday morning and beat analyst estimates of 32 cents. Revenue fell to $12.92 billion but the majority of that drop was $1.47 billion in revenue deferred to future quarters for upgrades to Windows 7. Microsoft shares rallied to their highest level since June 2008 with an opening spike to $29.35. However, that gain did not hold and MSFT closed at $28 but still a 5.4% gain for the day.

Microsoft did not include any pre-sales of Windows 7 in its results and that suggests Q4 could be another blowout. The CFO gave a characteristically bland outlook saying, "The quarter ending on June 30th may well have been the bottom of the economic reset." He also said they expected PC spending to strengthen in 2010 but they were not yet seeing a large rebound. Profits rose in the server software business and the entertainment business (Xbox) but fell in the online services unit, thanks to development costs for the Bing search engine.

Microsoft Chart - Weekly

In other earnings news Honeywell (HON) reported profits that fell -15% on falling sales but the company still managed to beat the street. Reported earnings were 80-cents per share compared to analyst estimates of 72-cents. The profits came from strong cost cutting efforts. Honeywell affirmed guidance for full year 2009 at $2.85 per share compared to estimates of $2.81 per share. Honeywell reported a somewhat distressing trend. They said sales of spare parts for aircraft engines were declining because airlines were aggressively managing part replacements and increasing the number of flight hours on maintenance parts. That is NOT reassuring to anyone that travels. The company also said municipalities and other government agencies had actually pulled back on purchases while they wait for stimulus money from Washington. Honeywell increased its pension expense forecast to $700 million from $500 million for 2010. HON stock closed flat for the day.

Schlumberger (SLB) put a damper on the energy sector with comments made with their earnings on Friday. SLB revenue fell -25% to $5.43 billion and that was slightly below analyst estimates. Earnings were 65-cents per share and that was a 61% drop in profits. SLB said energy demand would increase but increase slowly as countries recovered slowly from the recession. SLB said demand for oil and gas would be hampered by high unemployment and a worldwide glut in oil and natural gas. While gas drilling has increased in the U.S. SLB warned that the recovery was fragile and service activity and prices won't improve much until late 2010. SLB did say that the move in crude over $80 would likely spur an increase in drilling. The average price paid for crude in Q2 was $59.80 per barrel. SLB was cut to a sell at S&P Equity Research based on the expected low margins for the next three quarters.

Schlumberger Chart - 90 Min

Appliance maker Whirlpool (WHR) reported a sharp drop in profits but raised its outlook for the full year. WHR reported profits of $1.15 per share compared to analyst estimates for 77-cents. That is a major beat and WHR was rewarded with a +5% spike in the stock price to a new 52-week high. Whirlpool had been scaling down over the last couple years and now feels it is competitively positioned for the rebound.

Broadcom also reported earnings and was responsible for a large part of the Nasdaq loss. Earnings beat the street but the company warned that revenue should remain flat in Q4. The CEO said there was some concern on whether Santa would show up this season for consumer electronics sales. An analyst at Baird said order growth should slow until mid 2010 when the rebound would likely turn bullish for chips. A Jefferies analyst said Broadcom remained his favorite pick but he did lower estimates based on the earnings. BRCM lost 7.2% on the report and succeeded in tanking the entire chip sector.

Broadcom Chart

Semiconductor Index Chart - Daily

Financial tanked -2% for the week despite some positive comments from Capital One and American Express. Capital One (COF) rallied +7% after posting a surprise 14% increase in Q3 profits. COF did raise loan loss provisions but they were positive on the trend in consumer credit accounts. American Express (AXP) said earnings fell -21% but they reported progress in cleaning up their accounts. Loan loss provisions actually decreased at AXP.

Unfortunately there were seven more banks that were closed on Friday bringing the total to 106 for the year. Before the closures on Friday the total assets of failed banks year to date was $107.14 billion. The banks closed on Friday were all small and the estimated cost to the FDIC fund was only $357 million.

Closed Banks: (http://www.fdic.gov/)

Bank Closures By State in 2009

It was not a sunny day for SunPower (SPWRA) after they posted a 48% drop in profits and lowered their 2009 full year outlook. SPWRA lost -15% or -$4.94 to close at $28.33. A Barclay's analyst reiterated his buy on SPWRA saying the drop was over done and they saw limited downside from here. He reminded investors that the company's production in the residential and commercial segments was sold out. He said the lowered outlook came from lowered tax incentives in Germany.

The transportation sector has been a train wreck for the last couple of days. Burlington Northern and Union Pacific were both derailed after posting double digit profit declines. UNP said they expected a pickup in traffic in the spring but lower volumes of new cars and no real rebound in industrial shipments cost them in Q3. BNI fell -$7 since Wednesday and UNP fell -$8.

The drop in the railroads and some cautious comments from the airline sector knocked the Dow transports back to support and odds are good we will see a retest of 3600 given the pessimistic forecasts by the railroads. This was a shocker because I told James on Tuesday it looked like the Transports were about to breakout if their earnings were at least decent. Obviously they were not decent and resistance held.

Transportation Index Chart

So far in this earnings cycle 37% of the S&P has reported and 81% of those companies have beaten estimates by an average of 18%. That would be an astounding number except that the majority of it came from additional cost cutting and some companies are still announcing layoffs. Earnings for the entire S&P are only expected to be $14.79 per share for the quarter. That is well below the $23-$24 per share for Q3 in 2006/2007. It is also below the $15.96 actually reported in Q3 2008. Companies are beating estimates but estimates are still so low a snake could crawl over them. Revenue has improved since Tuesday with an average beat of 3.65% over estimates compared to the 0.7% as of Tuesday. That was due to a couple big beats by companies like Amazon.

Volume was still working against us with the largest volume day in three weeks of 10.1 billion shares on Wednesday's decline. Thursday's rally was actually decent at 9.2 billion but Friday's decline was also in the 9 billion range and continued the trend of higher volume on down days. MSFT and AMZN traded more than their average daily volume in the first 30 minutes of trading on Friday. The spike in price boosted the combined market cap of those companies by $25 billion.

I have tried to be open minded about the market over the last couple weeks but it is becoming harder with every day that passes. The volatility this week is confirmation to me that we are probably going to face some market weakness before we escape October. We have had some really big earnings surprises but other than the initial short covering spike there has been no follow through.

The major indexes are showing the kind of volatility that normally appears at market tops. I don't mean a long-term top but just a top in general. Investors become less committed and more cautious. Everybody wants the market to move higher but all the bulls are already fully invested. The strong earnings surprises are opportunities for the bulls to exit rather than buy more. Would you buy Amazon on Monday? The Q3 earnings cycle is fully priced in and there is no upside to being fully invested until some of the profit is wrung out of the market.

The Dow has failed at 10100 three separate times over the past week. It tested the 10100 resistance and fell back to trade under 10,000 each time. It closed at 9973 on Friday and close to the low for the day. It is like going to a fireworks show. After the final burst of awe-inspiring airbursts the operators walk around relighting all the duds that failed to fire during the program. There are still sparks and random flashes but the excitement has passed. Sightseers are all heading for their cars to beat the traffic to the exits.

That is exactly where we are today in the market. The big shooting stars of AMZN, GOOG, IBM, INTC, MSFT, YHOO, AAPL, etc have already flamed out and are poised for profit taking. The rest of the earnings cycle becomes less exciting and less important as each day passes. Fund managers should be heading for the exits to complete their portfolio restructuring before their fiscal year end on Oct 31st.

Meanwhile the Dow may have failed at 10100 three times but it also held support at 9550 three times. The bulls are not ready to call it a day but they should be getting close. If we see 9950 break convincingly on heavy volume then the stampede for the exits may be underway. The markets are up +60% from the March lows and I read last week that fund manager bonuses are going to be down -35% to -50% from 2008 and 2008 was a bad year. If I had a bonus at risk next week I would be running for the exits. If we do get some needed profit taking the Dow has support at nearly every 50-point increment starting at 9850 through 9400. Dow 9410 is the 38% Fib retracement of the rally from the March lows.

Dow Chart

Dow Chart - 180 Min

Dow Chart - 30 min

The S&P-500 tested 1100 twice and then failed to reach that level on Thursday's rally. This is a lower high and Friday's close was a lower low. Twice it tested support at 1075 and both times it held but the lower close on Friday has bearish implications. A break of support here could test 1050 in a blink with 1020 easily possible.

However, the S&P has duplicated this setup at different levels on numerous Fridays for the last several months. Every Monday it rises refreshed and ready to rock. You have to wonder how long this trend will continue. Personally I would love to see the uptrend support tested again because it would be a great entry point for November. Note that the downtrend line from the October 2007 highs was touched on Wednesday and not on Friday. This should be decent resistance. Decliners were 10:1 over advancers (448:46) on the S&P.

S&P-500 Chart - 60 Min

S&P-500 Chart - Daily

The Nasdaq gave up 10 points on Friday despite the gains by Microsoft and the +$25 spike by Amazon. If the Nasdaq could not remain positive with those heavyweights posting solid gains it gives you an idea of investor sentiment. However, decliners were 4:1 over advancers on the Nasdaq and only 3:1 over advancers on the NYSE. That was much better than the 10:1 on the S&P. Tech stocks may have been out of favor on Friday but not nearly as bad as banks, energy and transports.

Chip stocks led the Nasdaq decline thanks to Broadcom but I believe it was simple profit taking rather than a change in sentiment. The volatility in the Nasdaq has been strong all week with 50-point ranges more than once. I believe 2100 will be tested without any material Nasdaq earner to push it higher next week.

Nasdaq Chart - Weekly

Nasdaq Chart - 60 Min

The Russell was much weaker than the other major indexes and lost -2.5% for the week with the Dow and Nasdaq down only fractionally. This is not a good sign. On the first chart note that the Russell has two lower highs and closed at a two week low. Decliners were 6:1 over advancers on Friday. The Russell appears ready to test support at 575 and possibly 550. A break under 550 is lights out and I don't see that in the near future.

If the Russell is falling faster than the other indexes it means fund managers are moving out of positions and they are favoring large caps with any excess cash because of the extra liquidity. This is typical of behavior at market turning points. It may only be temporary and just October profit taking but we should be able to tell when it is over by watching the Russell for signs of life.

Russell Chart - 60 Min & Daily

More than one Friday in recent weeks I have leaned to my bearish side because the markets gave the bears a perfect setup of failed highs and a close on Friday at the low for the week. Nearly every Monday the situation was reversed because of some event that "supposedly" was a savior for the bulls. I don't know what that would be on this Monday.

The next couple weeks are going to be tough economically with major reports and events and none of them are likely to be bullish for the market. With earnings excitement beginning to fade I believe the markets are going to struggle to make any gains.

Jim Brown