Monday's big rally gave back some ground intraday as cracks began to form in market support. However, the buyers stepped in once again and brought the indexes back to level before day's end.

Market Stats Table

After a +155 gain on the first trading day of the year we should not expect much on the second day. Monday's rally came on low volume and today was not much better although a two week high. Not all traders are back to work and there is no conviction ahead of the Non-Farm Payroll report on Friday. Today's conflicting economics did not help in convincing traders that better times are ahead.

The first piece of negative news came from a -16% drop in the pending home sales for November. This is a lagging report but it was still a major decline and much stronger than analysts expected. The pending home sales index fell to 96.0 from October's 114.1 reading. This was the largest one-month decline on record. The level of sales fell back to levels not seen since June/July. The drop in sales ended a nine-month string of consecutive increases.

Sales still rose +15.5% over November 2008 but nobody was buying homes last November because nobody could get a loan. Sales were boosted in Sep/Oct by the homebuyer tax credit and buyers raced to make purchases before the November cutoff. The credit has since been extended but apparently there was a sell forward effect that moved sales into the Sept/Oct period. Since this index tracks contract signings and not closings it makes sense that few buyers waited to sign a deal in November when they knew it had to close in November. With financing a struggle buyers signing a contract after October would have likely been unable to close in November. The new homebuyer credit program only requires that a contract be signed before May 1st. That should make March and April home sales rather brisk.

Pending Home Sales Chart

Auto sales came in at a 11.2 million annual rate for December compared to analyst estimates for 10.8 million. However for all of 2009 sales totaled 10.4 million units and the lowest on record since 1982. Sales were down -21% below 2008 levels. All of the improvements in December sales came from autos with truck sales flat. Ford was the standout performer with a market share increase to 17% in December from 15.9% in November. You may remember that market share was 24% at the beginning of the decade. Ford sales increased +23.3% in December and Toyota +23%. Chrysler sales fell -10.5%.

GM saw sales fall -12.8% for December and this was much weaker than analysts expected. GM sold 208,511 cars and trucks in December. They have about 385,000 vehicles in inventory and the VP of sales said that was about a four-month supply at current sales rates. They only have 900 Saturn cars and 700 Pontiacs left as they wind down and discontinue those brands. If you want one they have cut prices to dealers by nearly 50%. To say they were giving them away would almost be true. GM is moving to four brands from their prior eight brands. Hummer sales declined by -85%, SAAB -26.4%, Saturn -59%, Pontiac -49% and Buick bucked the trend with a rise in sales of +37%. GM was forecasting 2009 sales in the auto sector to be in the range of 10.6 million units. This is below the 10.8-10.9 million analysts were expecting but everyone was well above the actual number at 10.4 million.

On the positive side Factory Orders for November rose +1.1% and nearly double the +0.6% rate in October. This was still slightly less than the +1.5% increase analysts had anticipated. However nondurable goods orders rose +1.8% for the month. The report showed a continued improvement in the manufacturing sector but the pace of improvement is at a snails pace. Both consumer goods and capital goods showed small gains. Business investment is expected to decline slightly in early 2010 as the initial impact of stimulus fades.

Reports due out on Wednesday include Mortgage Applications, Challenger Employment, ISM Services, Oil and Gas Inventories and FOMC minutes for December. By far the most important is the FOMC minutes. With everyone worried about when the Fed will begin to raise rates this could be a highly volatile release.

The biggest report for the week is still the Non-Farm Payrolls on Friday. Estimates are all over the board and have been changing daily. Over the weekend I reported that analysts were expecting a gain of 25,000 jobs but that has now changed to a consensus decline of -23,000 jobs. Regardless of the estimate the actual number reported on Friday will be extremely important. A positive number means the Fed is that much closer to raising rates. Another job loss puts the Fed months farther out into the future on rates. Because of seasonal factors the January and February reports are expected to show strong losses. A positive report on Friday could change the perception of those reports and the outlook for Fed action.

In stock news Google unveiled the long awaited super phone. The new phone is a slimmer, lighter iPhone clone but uses the Android operating system. Despite good reviews the phone is not expected to be a game changer to anyone but existing Android phone makers. The new phone will retail at $529 unlocked and ready to run on any network. It will be offered on T-Mobile for $179 for a two-year contract. Google hopes the Nexus One can compete with the iPhone but nobody expects it to make a big dent in Apple's popularity. There will also be Verizon and Vodaphone versions available in the spring.

Some view it as more of a pocket PC than a smart phone. The Android system is now running on more than 20 phones from vendors including Motorola and Samsung. Phones using the Android operating system now account for more than 25% of the phone data traffic with the iPhone just over 50% today. The Android phones have only been out a little less than a year and they are rapidly gaining market share. Now that Google has created their own phone they are actually in competition with other vendors using the Android operating system. If you are a minor phone maker using Android you have to wonder when Google will start restricting usage or upgrades to give the Google phone a marketing edge. The lukewarm anticipation of the phone appears to have slowed Google's momentum over 620.

Google Chart

Goldman Sachs was in the spotlight after Meredith Whitney lowered her earnings estimates on Goldman for the second time in three weeks. Must be tough to have a new business and no clients and you have to resort to constant highly visible upgrades and downgrades to attract attention. Whitney cut her estimates for Q4 to $5.50 per share from $6. She also cut fiscal years 2010 through 2012. It should be noted that her estimates are still above the street consensus of $5.43 for Q4. Goldman was up +2.5% before the Whitney downgrade and nearing $176. After the cut Goldman fell to near $173 but recovered quickly to close at the high for the day. Apparently people are paying less attention to Whitney's weekly announcements. Another analyst said he would use the downgrade as a buying opportunity whenever Goldman neared its 50-day average currently at $170. Yet another analyst, Douglas Sipkin at Pali Research, called Goldman the "most attractive stock in the banking universe." Goldman reports earnings on January 21st at 7:30 ET.

Goldman Sachs Chart

Goldman was also in the news with an upgrade on the chemicals sector. Deutsche Bank upgraded the refining sector and Credit Suisse upgraded the fertilizer sector. Credit Suisse said they were raising ratings on Potash (POT) to outperform from neutral based on new contracts with Chinese firms. These contracts will put a floor under prices and provide a base for prices elsewhere to move higher. The analysts also said that existing inventory had been consumed last year and needed to be restocked. They like POT best of the fab five but she also upgraded Agrium (AGU) and Intrpid Potash (IPI). No comments on Mosaic (MOS) and Bunge (BG).

Mosaic (MOS) reported earnings after the bell and it was not pretty. Mosaic missed estimates for the fifth time in six quarters. They reported a 24-cent profit, 32-cents excluding charges. Analysts were expecting 35-cents per share. Mosaic said it lost $22.6 million in currency translation during the quarter. Sales declined -43% to $1.71 billion. That was slightly above analyst estimates of $1.68 billion. CEO Jim Prokopanko said he was confident in the long-term demand as the recovery continued. Prokopanko said nutrient depleted soils in the U.S. was driving increased sales of potash fertilizer. Shares were volatile after the close but ended the session flat.

Chart of Mosaic

AT&T and Accenture have already abandoned the Tiger Woods entourage but Electronic Arts (ERTS) said today they were sticking with the disgraced sports star. "We entered the relationship with Tiger in 1997 because we saw him as the world's best, most talented and exciting golfer. He has made some mistakes off the course but he is still one of the greatest athletes in history." The said their Tiger Woods online game has been in closed beta test for eight months with more than 75,000 people playing the game. It is reportedly a "breakthrough experience" in online gaming. Let's see, does the fact that they have millions tied up in development of this online game affect their decision to "stand beside" Tiger? Do fish swim?

Crude prices rose to $82 intraday as retirement money flowed into commodity funds. However, there are signs of trouble ahead. The API inventory report after the close showed that gasoline stocks rose by 5.6 million barrels in the week ended on Jan-1st. They also said oil supplies declined slightly but I expect that will be the last report for several weeks that will show a decline. Prices dropped in after hours after the report but the decline was muted. Wednesday's EIA inventory report is the one that moves the crude market. Since it is for the week ended Jan 1st it may not show a big gain but I am betting that next week's report is a blockbuster.

We are also facing the annual rebalancing of various commodity indexes on Friday. This rise in crude prices could be an advance shift on the expectations that oil will be a larger weighting in the new index ratios.

Crude Oil Chart

The market rally late in the day really came on the rebound in financials driven by the intraday rebound in Goldman Sachs. The financials have rallied both days this week but they are reaching a level where we are either going to see a major breakout or another failure at resistance. The Bank Index (BKX) rebounded from Thursday's ugly close to a dead stop just under $45. A break over $45 would be very bullish and a market leading event.

Banking Index Chart

Despite the nearly flat close I thought it was a bullish recovery on bad news. The housing market took a serious hit with the pending home sales but the Housing Index rallied over +1% to close just shy of a breakout. For two days financials and homebuilders have done well. Historically the first 2-3 days of January are bullish due to the inflows of retirement cash. So far the scenario is going according to plan. Obviously some of that retirement cash is find its way into banks and housing. That suggests we may have seen the bottom in those sectors. Both declined over the last couple months but both are now on the verge of a breakout. It appears a violent trend change is about to appear.

Housing Index Chart

I view the new high on the Dow as right on schedule with the scenario I laid out a couple weeks ago calling for a minor new high on the indexes in the first couple days of January and then a decline. Last weekend I had modified that thinking a little and thought maybe the new high last week could have been that false breakout I was expecting. The high on the Dow this week was about 24 points over last Tuesday's high at 10580. Only 24 points on an index that large is only a blip on the screen and not a major change in the trend.

However, the VIX is now suggesting a change and the change could be violent. The VIX closed at 19.35 and 17.18 on the VXO. That is the old version of the VIX. At 19.35 that is the lowest level of volatility since August of 2008. You might remember that period since it was about a week before the markets unexpectedly fell off the cliff. The Dow was trading around 11,700 and the markets were calm. Analysts were talking about a rebound from the subprime problem just before the various news events exploded in their face.

I am not expecting any specific news event. I am simply warning that the VIX under 20 and the VXO under 18 are serious warning signs of strong complacency. The number of newsletter writers with a bearish outlook is at a ten year low. Everybody in the market is expecting a continued rally ahead. I do too but just not in the very short term.

VIX Chart

VXO Chart

I may have to change that view if conditions continue to improve. I view the Dow rebound on Monday from that drop to 10424 on Friday as a strong bullish event even though it was probably mostly short covering and retirement cash flows. That was a strong bounce regardless of the reason.

For me to change my stripes I would need to see it hold these levels until Friday and then move sharply higher on the jobs data. The Dow does not have any meaningful resistance until just over 10750 so it has plenty of room to run. Support is 10525 and it was tested twice on Tuesday. A break under 10500 would have the bears sharpening their claws.

Dow Chart

The S&P chart is much more bullish than the Dow. The S&P closed at a new high on Tuesday and is clearly in breakout mode if it can hold the gains for the rest of the week. Support at 1115 was tested on Friday and the rebound was very bullish.

However, remember, this is mostly year-end retirement inflows to index funds. These flows will cease over the next 24-28 hours. What happens after that is the key.

S&P-500 Chart

The Nasdaq blasted out of its three-day slump on Monday and is so far above its prior pattern that it is no longer relative. Current support should be the fib retracement at 2251. Tech stocks are in favor despite the fractional gain today. Just holding the big gains from Monday is bullish. It is however very over extended. The Nasdaq seems to like stretching 8-10 days of gains together before it rests. Just on the chart below there are five periods where gains ran for long strings before resting. Watch 2251 as support and a break below that level indicates a trend change.

Nasdaq Chart

In summary the markets are defying gravity on inflows into index funds from retirement accounts. When that cash flow ends the markets will be on their own to find direction. With multiple sectors being upgraded every day the bullish outlook for the economy is increasing. The FOMC minutes on Wednesday and Payrolls on Friday will either confirm or refute that current outlook. If you are long I would keep your stops tight in case the normal end of the first week of the year profit taking appears.

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