The markets have seen a marked change in sentiment over the last week as we head into the start of the Q2 earnings cycle.

Market Statistics

After languishing around the flat line most of the day we saw another short covering rally in the last 30-minutes of trading push all the indexes into the green. This capped a stellar rebound week where half of the +511 Dow points were gained in the last 30 minutes of the trading day. The sell the close trend has changed into a buy the close trend. This is probably caused by funds that were hoping for a dip to buy each day but when the dips don't appear they have to buy the close or risk being left behind.

The economic news was sparse with only the WLI and the Wholesale Trade report for May. The trade headline number rose +0.5% compared to +0.2% in April. This was a slightly bullish report except that the sales component fell -0.3% after a +0.9% gain in April. That was the first decline in sales in 15 months. While the decline in sales was disconcerting this report still suggests the U.S. is growing at a +3.0% GDP rate.

The report that continues to be troubling is the Weekly Leading Index. The headline number declined to 121.5 from 122.2 and the smoothed annualized growth rate fell to -8.3% from -7.6%. This was the eighth decline in nine weeks for the headline number and it is closing in on the lows for 2009. The annualized growth rate bottomed at -30.2% in December 2008. The decline in the WLI is a leading indicator to U.S. economic health and it is definitely heading lower.

Weekly Leading Index Chart

The economic calendar next week has quite a few more entries and plenty of data points for investors to stress over. The most market reactive will be the release of the FOMC minutes on Wednesday. This is the minutes for the June 22/23rd meeting and analysts will be pouring over the phrasing to see if the Fed is really thinking the economy is going to sink again or maintain its forward motion.

Economic Calendar

The real focus of investors next week will be the beginning of the Q2 earnings cycle. Alcoa officially kicks off the cycle when they report on Monday but investors will be watching INTC, GOOG, JPM, BAC, C and GE for the real news. Intel and GE will be the biggest tells on the state of the economy. JPM, C and BAC will tell us about the health of the banking sector. Traders are evidently expecting big things from the banking sector. There were 287,000 calls traded on the XLF on Friday. That was three times the four-week average and twice the number of puts traded.

There are a few high profile companies on the schedule next week but the following week there are hundreds more announcements. This week is just the pre-show.

Earnings Calendar

Earnings for S&P companies are expected to have risen +34% in Q2 compared to 52% in Q1. The estimates for Q3 are for a +25% gain and the slowest quarter in 2010. That is mostly do to the harder comparisons with 2009-Q3. Tech earnings are expected to have risen +57% in Q2. This will be the third quarter of consecutive earnings growth after nine quarters of decline. With the pace of earnings growth expected to decline in the current quarter this makes the earnings guidance much more critical. Do analysts have it right or are they too optimistic or too pessimistic? The next two weeks will answer that question.

In stock news Visa (V) was added to the "conviction buy" list at Goldman and the stock gained +3.1%. Visa does not report earnings until July 28th.

Research in Motion (RIMM) gained +8% after the company said it was going to extend Internet services and application stores in China. The company launched Blackberry service there in May.

Google said its Internet license in China was renewed after they made concessions to the government on forwarding search traffic to their uncensored Hong Kong website. Google stock had lost nearly 25% of its value in Q2 over the China censor issue as well as earnings guidance for Q2. Google rallied +2.39% on the news and Baidu (BIDU) lost -1.7%.

NTP Corp is a company whose sole reason for being is to come up with obscure patents they hope applies to somebody's current technology and then sue those who might be inadvertently violating that patent. NTP Corp filed suit against Apple, Google, Microsoft, Motorola, HTC Corp and LG Electronics on Friday. NTP claims the smart phones sold by those companies violate their "email over wireless" patent. NTP was founded in 1992 on patents held by a Chicago inventor named Tom Campana. He had developed wireless email technology in the 1980s that was never commercialized. I struggle to understand how wireless email would have been transmitted in the 1980s without wireless devices but I guess the concept is the key.

They sued Research in Motion over this same patent several years ago in reference to the Blackberry. RIMM eventually settled for $612.65 million after NTP won an injunction to shutdown the Blackberry network. Apparently NTP's bank account is running low so they decided to attack those six other companies. However, when you take on six giants at once that are sitting on more than $200 billion in cash the odds are not as good as they were against RIMM as a much smaller company at the time. Microsoft, Apple and Google can afford the best lawyers and NTP will be the equivalent of a pesky mosquito for years to come. Eventually they will get their day in court but I doubt they will get a major judgment. Courts have recently taken dim views of these kinds of generic technology suits.

NTP has previously sued Verizon, Sprint and T-Mobile over the same issue. Since the RIMM settlement there have been other cases and one against Ebay that went to the Supreme Court changed the legal process and getting a shutdown injunction today would be next to impossible. That takes away much of the NTP leverage. However, the phones at risk the most are the Android versions. The license fee awarded in the RIMM case was 8.5% and that would be a big hit to the cost of the low cost Android phones.

Anadarko Petroleum (APC) told BP to take a hike when BP presented them with a $272 million bill for the first installment of the oil cleanup expenses. APC is a 25% "non-operating" owner of the leaking Macondo well. Anadarko's CEO has gone on record in recent weeks saying that BP engaged in reckless and potentially criminally negligent actions that caused the Horizon explosion. He believes the reckless and irresponsible actions leading up to the explosion violated the agreements between BP and APC and APC is not going to pay the BP bill. BP also sent Mitsui, a 10% non-operating owner a $112 million bill. There is no word yet on Mitsui's intent but I think we all know how they are going to react.

Chart of Anadarko

Goldman Sachs has raised their estimates of the cleanup costs to as much as $163 billion if the spill was halted today. Cleanup costs are just a part of the problem. The government has already started a criminal investigation that will almost undoubtedly find cause for negligence. That will earn BP another round of fines and penalties over an above the cleanup costs.

BP said it would begin the process of changing out the LMRP containment cap as soon as Saturday in order to take advantage of an expected week of mild weather. The current cap is a loose fit contraption that allows BP to capture about 25,000 bpd of oil but allows as much as 30,000 bpd to continue escaping into the gulf. The new cap is reportedly a tight fitting custom built cap that will be bolted onto the flange where the bent pipes were cut off several weeks ago. In theory the new cap will allow up to four containment vessels to be connected at once and will prevent any further oil from leaking into the gulf. Unfortunately it will take 5-9 days to make the switch and during that time the well will be flowing at full force into the gulf. The robotic vehicles worked all day Saturday to remove the bolts and the old flange with the broken pipe.

Chart of BP

Crude prices rallied to close over $76 on Friday on improving global sentiment and solid demand for gasoline in the U.S. over the last two weeks. The decline in initial jobless claims on Thursday and the hike in global economic estimates by the IMF on Thursday helped to improve sentiment.

Also helping push prices higher was the beginning of the new quarter. Every quarter end there is a new flow of long only money hitting the commodity funds. This translates into rises in the price of crude and other commodities. This flow of cash into funds normally ends by the 10th of the month and commodities will be left to trade on real fundamentals for the rest of the quarter.

Helping fuel positive sentiment on crude was a five million barrel decline in crude inventories in Thursday's EIA report. That was the second consecutive weekly decline. However, the declines were related more to output cuts in the gulf and tanker rerouting for hurricane Alex than a sudden surge of consumption. The July 4th weekend helped raise gasoline demand by +2% for the prior two weeks. Analysts were somewhat disappointed in that increase since the July 4th weekend is normally a high consumption period.

The results of the stress tests on European banks are expected on July 23rd. Recent comments from analysts in Europe suggest most banks will pass with flying colors. This has improved sentiment about a banking crisis in Europe. The banks are being tested on three scenarios. One scenario will assume economic growth hits targets from the European Commission. The second scenario is for a -3% drop in GDP and the third scenario is a so-called "shock" event in the bond markets. Ninety-one banks are being tested and the results are due out on July 23rd.

In the U.S. the FDIC closed two more banks on Friday bringing the total to 90 for the year. New York based USA Bank and Oklahoma based Home National Bank were closed for a cost to the FDIC of $140.4 million. FDIC head Shelia Bair said the pace of closures should decline after Q3.

There were several positive data points last week. The IMF upgraded its estimate of global growth and this buoyed markets around the world. German exports rose by 9.2% in May and imports rose by +14%. Australia and Canada both reported a strong increase in employment. Canada said there were 90,000 new jobs created in June compared to estimates for 20,000.

In the U.S. tax receipts from corporations rose by +37% in May indicating corporate profits are rising. Costco said same store sales were up +4%. Capital spending in the U.S. was up +20% year-over-year in May.

On the downside the IMF said there was a strong possibility of a double dip in housing caused by a large backlog of foreclosures, negative equity and elevated unemployment. However, several indicators in the U.S. suggested the foreclosure backlog was shrinking and we could be seeing a smaller numbers of homes on the market in the coming months. The weekly mortgage applications survey spiked +6.7% from the prior week to 721 on the index. Purchase applications plummeted to a 12 month low thanks to the expiration of the tax credit but refinance applications rose to a 12 month high with a +9.2% gain thanks to record low interest rates. The 30-year fixed mortgage rate was 4.68%. This is a positive indicator for consumer sentiment.

Overall I am shocked at the change in economic sentiment in just the last two weeks. Just a couple weeks ago the analyst chatter was almost entirely consumed with the potential for a double dip recession. In the space of two weeks it has turned 180 degrees and they are talking about a 3.2% to 3.5% GDP rate for Q2. I find that exceedingly hard to imagine given the rate of decline in May and June but I am not an economist.

The market has also turned on a dime and despite negative technical indicators it is in strong rally mode. I told you I expected a rally this week but I did not expect it to be a 5% gain. This proves how a good short squeeze and sentiment change can catch everyone off guard.

Three prominent authors have not changed their estimates. Robert Prechter is predicting Dow 1000 over the next six years. He believes we are going to see a major bear market as a result of the economic problems. Richard Russell author of the Dow Theory letters for the last 30 years is also predicting a major bear market but has not targeted a specific Dow level. Robert Kiyosaki said in his online blog that he expects a return to Dow 5000. Obviously opinions are like noses, everybody has one. Research has proven that those analysts with the most radical forecasts are accepted as likely right in their predictions over those who are less radical with say a Dow 9000 target. Apparently those with radical forecasts are assumed to have done extensive research before they risk their credibility with such a radical claim.

I reported last week on Abby Joseph Cohen's continued S&P target at year-end 2010 of 1,250-1,300. David Bianco at BACML also has a 1275 target. A Morgan Stanley analyst was targeting 1375 as of Friday. These analysts were not getting as much airtime as the major bears until this week. Now that sentiment has turned they are getting plenty of face time on stock TV. Amazing how quickly the news feed changes.

The S&P rallied to close at 1077 and just under decent support at 1080 for better than a 5% gain for the week. The majority of the gains came in the last 30 minutes of the trading day every day last week. We have gone from a sell the close mentality the prior week to a buy the close mentality. As I mentioned earlier the end of quarter cash flows are predominantly into long only funds and this end of day buying is that money being put to work. The funds would buy a dip if one appeared but in a rising market like this they can't afford to be left out so if no dip by 3:30 they buy the close. This helps juice the shorts to cover as well because they are hoping for another end of day sell on close and when it does not happen they are forced to cover.

Last weekend I said I was looking for a rally into earnings and that has come to pass. I expect it to continue for another week or so but I doubt it will continue at the same vertical rate. The S&P has decent resistance at 1080 and it is over extended from the +5.5 gain. The market as a whole is still long-term oversold but in the very short-term it is over extended. We still need a 20-point decline on the S&P to equalize pressures before we can move higher in confidence.

I can't tell you how many times in the last 14 years I have written "it should pull back after last week's gains." Sometimes rallies don't cooperate with logical concepts and they move up in defiance of what logic would dictate. This forces traders to chase stocks higher just so they don't get left out. I believe that is a possibility for next week. We should rest for a day but I think any dips will be bought until 1111 or so and the bears will make an initial stand there. The 200-day is interim resistance at 1111 along with the 50-day at 1100. A break over 1120-1125 would be very bullish. The 50/200-day "death cross" is in full bloom and will remain an active technical indication for the weeks ahead.

S&P-500 Chart

On the Dow the initial resistance is 10250 (red line) followed by the 200-day at 10365. The brick wall will be 10500. The Dow has several components reporting earnings next week with INTC, JPM, BAC, AA and GE. Their guidance will be the critical support for any continued gains. The Dow is over extended with a +511 point rebound for the week. This is the most visible indicator of the market and a decline here could poison sentiment for the other indexes. If you look at the chart you will see an identical 500-point rally that started on June tenth and ran for five days to end at 10400. A 500-point short covering rally is not an indication of a bullish market but simply an oversold bounce.

Dow Chart

The Nasdaq rallied the least of the major indexes despite some strong gains by the big caps. Tech stocks are not normally favored in the summer months despite expected earnings growth of 57% for Q2. The Nasdaq performed a perfect test of the 50% retracement level as support but even with a +5% rebound it is just now moving back into the congestion range from May/June. When individual tech stocks report in July they normally sell off almost immediately as investors move on to other plays. There is no conviction for techs in the summer months. They are kicked to the curb and picked up again in October.

The next resistance point is 2235 with an interim gap fill at 2220. The Nasdaq as an index is not showing me any trading signals this week. You need to key on the individual stocks for tech plays. Support on profit taking should be 2150.

Nasdaq Chart

I would like to say the Russell made a technically perfect test of support at 590 but as I reported on Tuesday the decline was really just a carry over from the rebalance and not fundamentally significant. However, support is support and I am sure it played a part in the process. The Russell, like the Nasdaq is entering its congestion range again and other than continued short covering I suspect 650 will be resistance. Critical resistance is 670 but I would be very surprised if the Russell made it that far.

Russell Chart

In summary the rally I predicted last week appeared on schedule although the short covering was stronger than I expected. The sudden improvement in global economic indicators overshadowed the weak jobs report from the prior Friday. The earnings calendar will be the main focus for the next two weeks. I expect the markets to continue to trend higher until the last week of July and then weaken again. We need to see the economics in the U.S. begin to improve before the rally will gain any real strength.

Jim Brown