February ended with a whimper with the markets barely positive on Friday but we saw decent gains for the month.

Market Statistics

February was a Jekyll and Hyde month. There were 19 trading days in February and 10 of those days saw triple digit ranges alternating between strongly positive and strongly negative days. The markets were battered by surprising economics, sovereign debt problems, Fed actions, earnings misses, warnings and new worries over a double dip recession but in the end the markets closed with a sizeable monthly gain. The Dow gained +2.5%, S&P +2.7%, Nasdaq +4.1% and Russell +4.5%. Commodities were the leaf in a storm with fluctuations in currencies causing extreme volatility. Like in the equity markets the majority ended the month with a gain. Oil gained +9.1%, gasoline +9.0%, copper +7% and gold +3.2%.

The economics were responsible for a large part of the volatility with the Fed giving an extra push more than once. Early in the month Bernanke submitted testimony to the House suggesting the Fed was getting closer to withdrawing some stimulus. That roiled the markets but they quickly got over it. A week later the Fed raised the discount rate in an unexpected announcement after the close and the markets were roiled once again but eventually recovered. With more than 50% of the trading days in February posting triple digit ranges it was a tough month to trade for anyone using stop losses.

On Friday the GDP for Q4 was revised higher to +5.9% from +5.7% and the markets celebrated with the muted enthusiasm of an office birthday party. The reaction was short but positive. The gain in the revision came from an increase in the inventory component and no real consumer growth. I guess we should be glad the country is finally replenishing inventories because it means the business community is positive about future sales.

The headline number of 5.9% was the strongest quarterly GDP in more than six years. It is too bad it is only a technical bounce and not real growth. For the full year of 2009 the GDP fell by -2.4% and the biggest drop since 1938. The core PCE price index, the Fed's preferred inflation indicator, was revised higher to 1.6% from 1.4% in the first Q4 release. That is still low by Fed standards and no reason to raise rates.

We can see from the internal data in the Q4-GDP that inventories will continue to boost growth in the first half of 2010 and but consumer spending is still soft. Consumers are still boosting savings and cutting credit in fear of future job losses. Business investment is improving but still sluggish. Businesses are waiting to see if the recovery has legs before taking their saved up capital and putting it to work.

Stimulus has added to activity in late 2009 but it will fade after the first half of 2010. State and local governments are still cutting back on spending due to budget shortfalls. Analysts expect GDP growth of 2.0-2.5% over the next few quarters. Job growth should turn positive in March-May with the help from census hiring and positive jobs numbers should help consumer confidence.

GDP Chart

The New York ISM rose sharply to 417.4 in February from 403.9 in January. That is the highest level since late 2006. However, the six-month outlook component fell to 81.1 from 97.0. That 97.0 reading was the highest in the history of the report. The current conditions component rose slightly to 77 from 72.6 and the employment component fell slightly to 53.4 from 54.2. A special question in the survey for February asked about capital spending plans for 2010 compared to 2009. 37% reported they were going to spend less in 2010 and 44% said they would hold spending steady in 2010.

ISM-NY Chart

The Chicago ISM, formerly Chicago PMI, rose to 62.6 in February. This is the fifth consecutive month of gains and the highest level since 2005. However, the internals were not exciting. Inventories declined from 48.7 to 42.4 and employment fell from 59.8 to 53.0. New orders fell by 4 points to 62.2 and the first decline since September. We need to remember that the Chicago numbers are impacted significantly by auto production.

Chicago ISM Chart

The second reading of Consumer Sentiment for February at 73.6 fell only fractionally from the 73.7 initial reading. Sentiment, not to be confused with the Consumer Confidence report, did not show the sharp decline in February that we saw in the confidence report. This leads me to believe that the confidence report did have some bad data but we won't know that for several weeks. The two reports survey different groups of people with an entirely different set of questions. The confidence survey was released back on Feb-23rd and fell to 46.0 from 55.9 for a major decline that shocked the market into a triple digit loss.

Consumer Sentiment Chart

Existing Home Sales for January fell sharply by -7% after a -16% decline in December. Annualized sales fell to 5.05 million units from the 6.49 million high in November. This is the slowest pace of sales since last June. First time homebuyers comprised only 40% of January sales. This is down from the 51% in November as the initial homebuyer tax credit expired. The February numbers should show improvement as buyers line up for the current tax credit program that ends April 30th.

I know in the Denver area sales are more than brisk. My daughter is trying to buy a house and has been looking at 8-10 houses a day. They qualify them ahead of the visit that there is no current offer and it is not a short sale. She has tried to buy four houses in the last week and wrote the contract the same day of the visit only to be told someone else beat her to it. She has even offered more than the asking price on one and somebody else had already offered even more. The realtors are so busy all their calls go to voicemail. These are bubble type statistics and of course they are powered by current buyer tax credit. This tells me that the housing market is going to fall off a cliff in May just like the December drop if the tax credit is not extended.

Existing Home Sales Chart

Next week is also going to be a tough week for economics. The national manufacturing ISM on Monday is expected to show a drop to 57.3 from 58.4 and most are blaming it on the weather. With three blizzards in the northeast in the month of February analysts are predicting declines in almost every indicator. For the ISM they claim factories were closed and workers were snowed in. The ISM Services on Wednesday will be the same story. Nobody serviced because they were snowed in.

On Tuesday the auto sales for February are expected to fall to an annualized rate of 10.3 million from 10.8 million in January. The sharp drop off is again blamed on the weather. This one I can believe because few people go car shopping when there are a couple feet of snow on the ground. The storms were responsible for removing ten selling days from the month of February.

The Fed Beige book on Wednesday should not have been impacted by the weather but you never know how the Fed is going to report the regional conditions. With the weather a catchall excuse for February they could blame declining economic conditions on the weather just to have an excuse.

Factory Orders on Thursday are expected to show an increase of +1.7% compared to +1.0% in the prior month. No weather excuse here because this is a January reporting period. Next month they can use the weather excuse. The increase in factory orders is mostly due to the inventory replenishment cycle currently pushing the GDP higher. It is not a sudden improvement in the economic conditions.

The 800-pound gorilla on the calendar is the Non-Farm Payrolls on Friday. Expectations are falling faster than temperatures in New England because of, drum roll please, the weather. This one I believe because job hunting is not a task that many people will undertake in blizzard conditions. Nobody wants to get dressed up, fight the elements and other drivers only to be told on your arrival for the interview that the office is closed or the executive elected to take the day off to play in the snow with his kids. The hiring cycle, like the auto sales report lost ten days to weather.

Another challenge to the payroll report is the weekly Jobless Claims. We saw claims spike last week to 496,000 and well over estimates of 450,000. The prior week rose to 473,000 with estimates at 415,000. The two-week spike in claims forced analysts to downgrade expectations for payrolls to a loss of 75,000 jobs instead of the gain of 20,000 jobs in prior estimates. I have heard nothing about census hiring this week so either analysts have forgotten about it and there will be an upside surprise or they are allowing for those hires and the employment outlook is actually weaker than it already appears.

Economic Calendar

About 1.1 million unemployed workers will see their unemployment benefits expire Sunday night. The House and Senate were working on a bill to extend the benefits another month until a longer-term solution can be enacted but the bill failed in the Senate on Friday. Other programs set to expire on Sunday are Federal flood insurance, Small Business Administration loans, changes to Medicare payments to doctors, COBRA insurance and some transportation funding.

The bill failed because the House version failed to say how the $10 billion cost would be paid and a fiscal conservative in the Senate blocked the bill without a method of payment. The Senate is expected to debate a longer-term fix next week with passage likely before next weekend. If the bill is not passed in some form most doctors will see a 21% cut in Medicare payments. Many doctors are already making plans to stop seeing Medicare patients if the payment cut goes through. Also, over one million rural TV viewers will not be able to watch local TV stations on their satellite systems without an extension of the copyright provisions expiring on Sunday.

There was a flurry of big stock moves on Friday that attracted trader's attention. Heading the list is Crocs (CROX) after they missed earnings, warned on the current quarter and the CEO quit unexpectedly. CEO John Duerdan announced his resignation on Thursday, saying he had accomplished all he had hoped in just one year as head of the floundering shoemaker and was ready to let somebody else lead Crocs into the next phase. Duerdan came to Crocs as a short-term turnaround specialist. Crocs was given up for dead a year ago but its auditors recently issued a statement saying the company was no longer at risk. CROX lost -10% on Friday.

On the other side of the shoe trade Deckers Outdoor (DECK) gained +13% to $120 after saying profits jumped 67% and raised guidance for 2010. Deckers posted Q4 profits of $5.22 compared to analyst estimates of $4.28 per share. The company doubled international sales of its UGG brand.

Chart of DECK

AthenaHealth (ATHN) was crushed for a 15% drop after they delayed their Q4 earnings report to review deferred revenue accounting. Athena recognizes its revenue over the life of its service contracts, which are normally one year in length. The company may change its revenue recognition rules and will have to restate past earnings if this happens. Whenever the terms "revenue recognition" and "restate earnings" appear in the same paragraph the reaction is never good. Athena has already announced two accounting revisions in the last month so credibility has been stretched to the breaking point.

AthenaHealth Chart

Palm is in trouble. They have developed a serious credibility problem and two of their major carriers have quit ordering phones. They also pre-announced their earnings and cut the revenue outlook for the current quarter and the full year. If that was not bad enough an internal memo was leaked suggesting that Verizon and Sprint were no longer ordering new phones. All of this news has PALM stock dropping like a rock.

On Feb-11th rumors began circulating that the Chinese manufacturer for Palm's smart phones have suspended production on the Pre and Pre-Plus. Palm tried to head off the rumor saying they had ramped up production ahead of the Chinese new year so the company could shutdown for the holidays and resume production afterwards. Ok, that makes sense but there was also a line in the release saying Palm was adjusting production to fit sales trends. Ok, no problem because they "ramped up" ahead of the New Year closure.

Now it appears Palm knew about the order halts before the previous disclosures and it appeared they were trying to disguise the truth while they worked on damage control. It turns out manufacturing was shutdown for an entire month not just for the New Year celebration week. Whenever a company is caught trying to hide or disguise the truth the stock is going to suffer. Add in the halt in orders from Verizon and Sprint and this could be terminal. Apparently their smart phones are not selling and investors are running for the exits.

Chart of PALM

NuVasive (NUVA) rallied +35% after announcing that Aetna and United Health had approved its new spinal surgery procedure for insurance coverage. The NuVasive procedure allows surgeons to operate on the spine through small slits on the side rather than big incisions in the back. This procedure does not impact the major muscles and allows for faster healing. The treatment had been labeled experimental and not accepted by insurance. The change by United Health and Aetna is a major step forward for NuVasive and should eventually allow many more of their innovative surgical procedures to be more readily accepted.

CKE Restaurants (CKR) gained +27% after announcing a buyout by Thomas H Lee Partners for $928 million. CKE operates Carl's Jr, Hardee's, Green Burrito and Red Burrito restaurants. Earlier in February CKE had said same store sales had declined -9% at Carl's as a result of the burger wars and the recession. The acquisition price represented a 25% premium to Thursday's close. The company can accept additional offers for the next 40 days and THL Partners can match the offers or bow out.

Chart of CKR

The oil market is troubling traders because there is no fundamental reason for the price of crude to be $80. Crude prices rallied +9% in February. Volatility has been extreme with a move from $74 to $85 in Dec/Jan and back to $70 in February and now back to $80. Inventories have risen for the last three weeks but so has prices. Crude normally moves inversely to the dollar but the dollar has been at 12-month highs for most of last week. Crude prices should have been down.

Major banks like UBS, Goldman Sachs and Morgan Stanley are telling investors to stay long oil with a price target of $100 later this year. This is completely contrary to the current fundamentals and suggests these advisors are betting on a geopolitical crisis like an attack or embargo on Iran to ratchet up prices. China and India are seeing demand rise steadily but the developed countries are still mired in a low demand recovery. If there were a fundamental reason for the rise in prices the futures would be showing a higher price farther out on the calendar. This is called contango.

Instead the contango has almost entirely evaporated and we are on the verge of backwardation. That means prices would be higher in the front months than farther out on the calendar. If the U.S. said it was going to bomb Iran in March then current month futures would be high on the worries about a shortage of oil. Prices farther our on the calendar would be lower because within 90-days Saudi Arabia can pump an estimated five million barrels of oil per day more than they are producing now. They could fill any Iranian shortfall and prices would return to normal. I believe the current rise in prices is due to an Iranian premium that could be with us for some time.

Iran makes some announcement almost every day that is meant to agitate the U.N. nations into making some kind of obscene deal to shut down the uranium enrichment. Of course they also benefit from escalating the war of words because it is keeping oil prices high and funding their country. I wrote an article in early February on how Saudi Arabia could bankrupt Iran and put an end to their regime by simply turning on the pumps for that additional five million barrels. They did it before when asked by Ronald Reagan and put the Soviet Union out of business. There are other ramifications to pushing oil prices a lot lower but what are the ramifications of a nuclear Iran?

Crude Oil Chart

Volume last week was very light with the market alternating direction every day. Evidently there is much confusion about direction just like there is confusion about the potential for another recessionary dip. Former Fed governor Robert Heller made the case for a second dip on Thursday saying the deficit is going to force interest rates up as the government continues to sell massive amounts of debt. He believes the spike in real rates will kill both the business and consumer recovery. The current recovery is struggling even though being helped by the stimulus and the inventory cycle. According to Heller, as those things end in Q2 the recovery will end because of the high unemployment.

JP Morgan's CEO, Jamie Dimon, warned again on Friday of huge potential negatives ahead. He said JP Morgan was in no hurry to raise the dividend because the bank wanted to continue to hold additional capital in case of a second recessionary dip. Dimon said he wanted to increase the dividend to around 75-cents to a dollar but only when he was convinced the worst of this crisis is over. He also warned that the banking sector was in danger from the administration and major banks were not going to resume lending until the danger passed. James Staley, the JPM Investment Banking Chief also acknowledged that fear of punitive regulations was changing the way banks and investor clients viewed their acquisition strategies. That means mergers and acquisitions will be very slow until the regulation danger passes.

Rising fear about that potential second dip is preventing the markets from acting on the record earnings from Q4. Several analysts claimed the hedge funds pulled out all the stops last week to keep the markets at the current level into month end and next week could be a rocky ride. I don't know why February month end would be so critical that funds would be struggling to keep the markets at a specific level. After all March is historically a bullish month 65% of the time. The March triple witching expiration week is bullish 85% of the time.

If hedge funds really were trying to hold the markets up they did a good job. The rally from the Feb-5th lows was strong and uninterrupted until last week. Unfortunately we are starting to develop some bearish formations on the charts. On the daily chart of the Dow the prior uptrend support is proving to be stubborn resistance, currently at 10400 and initial support is 10300. A failure at initial support suggests a lower high from January and the potential for a serious second dip.

Dow Daily Line Chart

The Dow formation for the last week is a definite series of lower highs and lower lows and another retest of 10200 may not hold. There is nothing in the news to keep us elevated and we have a real possibility of a seriously negative number on the payroll report on Friday. The path of least resistance is down on the Dow.

Dow Chart - 120 Min

The S&P is having a tortured relationship with 1100. It can't seem to move away from it for more than a brief period. Monday was the only day the index did not cross 1100 but it came very close. We saw new resistance form just under the 1115 50% fib retracement and we saw a lower low on Thursday.

The second chart is the daily and you can see how it respected the 50/100-day averages as support and resistance. That will not continue since the averages are on a converging path. 1085 is going to be our line in the sand on the support side and 1115 the resistance barrier. I strongly suspect one of those is going to be broken next week and without a news event to the contrary the path of least resistance is down.

S&P-500 Chart - 120 Min

S&P-500 Chart - Daily

The Nasdaq chart is slightly more positive than the Dow/SPX but only slightly. The 61% fib retracement was rock solid last week but support at 2200 also held on two tests. I am neutral on the Nasdaq and I believe tech investors are braver than the general population and will try to keep betting on the bullish trend until they run out of money. If they can punch through that 2250 level then the rally may continue.

The chart of the NDX (big caps) is a little easier to read. We have the same 50/100-day trading range and the resistance at 1815-1818 is wearing down. It would not take much to punch through. Unfortunately GOOG, AAPL, QCOM and DELL are not positive charts. Apple saw a bounce on Thursday on the rumor they were going to split 4:1 but that rumor and the dividend rumor were firmly dashed on Friday. Cisco is the most positive big cap with rumors of a major announcement in March that "will change the Internet forever." Whether that is enough to keep the Nasdaq moving higher remains to be seen.

Nasdaq Chart - Daily

Nasdaq 10 Chart - Daily

The Russell 2000 hit resistance at 633 on the prior Friday and could not break through despite several subsequent tries. Trapped between support at 623 and declining resistance at 633-630 the box is growing progressively smaller. Something is going to break on the Russell next week and it could be explosive. The rebound from 580 back on Feb-5th was very strong and pushed the Russell to a +4% gain for the month despite starting off with a -22 point disadvantage. It recovered all of those points and added 30 more.

This rally has seen five days of consolidation without any real evidence of the next direction. There was a pattern of lower highs, lower lows last week but it was very minimal with Friday's close only -4 points below Monday's close. Fund managers are not dumping small caps. They are still dancing with stocks that got them to this level. A break below 620 would be a short signal and a break over 633 would be a signal to go long.

Russell Chart - Daily

I left you last weekend with the NYSE Composite chart and resistance at the 100-day average. That resistance has not changed and the index still holding the high ground over 7000 but like 1100 on the S&P it can't seem to remain over 7000 for an entire day. The dip on Thursday saw it trade under 6900 but the rebound was quick and back to the initial resistance at 7035. The 100-day is just below 7100 so there is plenty of room to play.

I would use the NYSE and the Russell as confirming indicators of a breakout/down because the levels are so clearly defined. Both are broad market indexes and both are currently stronger than the Dow.

NYSE Composite Chart - Daily

The wildcards for next week are the ISM Manufacturing number on Monday, the payroll number on Friday and the potential for a Greek bailout by Germany. I know they have said several times that it won't happen but a rumor after the close on Friday suggested the German bank KfW could either buy Greek bonds or guarantee up to $34 billion in aid when the Greek prime minister visited Germany next week. It was Friday at month end so a rumor about something was bound to appear. Late Saturday a senior German official denied the report while a parliamentary source told Reuters Germany and France were preparing an aid package.

However, conditions in Greece continue to deteriorate and Greece did not sell the 10 billion in 10-year bonds it had threatened to offer last week. Odds are good the sale would have failed and that is why it did not take place. Greece claims it has sufficient money to last through the middle of March so something has to happen soon. If Greece did sell the bonds and the sale was successful then the market would celebrate even if the interest rate was high. If a bailout is announced the market would rally sharply on the perceived view that the debt crisis was over.

A bailout could come in the form of EU state banks pledging support and actually bidding on the 10B in bonds to make sure the sale is successful. Buying debt in the open auction would be different than just giving Greece the money in a bailout. It would circumvent the EU rules and spread the risk around the EU in manageable amounts. This would only be temporary but could buy another 90-120 days for austerity measures to be enacted.

I believe the potential for at least a partial resolution on Greece is the biggest wildcard for next week. That could provide a substantial lift to the equity market. However, if that spike were sold I would run to the sidelines or adopt a bearish bias.

I believe by Friday the payroll expectations will be priced into the market and while there is likely to be volatility on the announcement the reaction should be muted by the week of pessimism regarding the report and the impact of the weather.

I just finished reading a book called the China Study by T. Colin Campbell. It is not about the market but about solving your health problems. I strongly advise everyone to read it. I don't advertise products in the newsletter other than the EOY subscription in December. I feel this is important enough to personally recommend it to everyone. What good is making money in the market if you don't live to spend it?

The China Study: The Startling Implications for Long-Term Health

Jim Brown

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