A bad run of economic numbers punctuated by the eighth largest drop in history in sentiment knocked the Dow for a -260 point loss.

Market Statistics

Remember the phrase, "when the market wants to go down it will find a reason." Friday was a prime example of that axiom. After an 8% rally over the last two weeks the market was looking for a reason to take profits. Add in the volatility from the expiring options and the low volume of a summer Friday and the recipe for a drop was complete. There were no bids because nobody was trading. Declining volume was 13:1 over advancing as unattended sell stops were hit.

The excuse du jour for Friday was the preliminary Consumer Sentiment report for July. The headline number fell -9.5 points to 66.5 for the 8th largest drop in recorded history. The monthly sentiment numbers have been reported for 390 consecutive months. To put this drop in perspective the September 2001 drop was -9.7 points after 9/11 caused consumers to hide in their homes.

Top Sentiment Drops

The 66.5 headline number was the lowest level for sentiment since last August and it is only 10 points above the 28 year low set in November 2008. The present conditions component fell -10.1 points to 75.5 and the expectations component fell -9.1 points to 60.6. With both components taking a major dive this was not related to some short-term news event although there is some correlation of sentiment to the stock market. The market took a major fall in the last two weeks of June but it began to rebound the day after the July 4th holiday. Also, the market suffered a much bigger drop from late April to early June and the sentiment numbers continued to climb. Blaming the ten-point decline on the stock market does not add up this time.

The BP oil spill has been around since April 22nd so that should not have been a factor. What was different in late June was the rapid escalation of headlines and talk about a potential double dip recession. Analysts led by Alan Greenspan were talking about the invisible wall the economy hit in June. Then the jobs numbers went negative again with a loss of -125,000. The vast majority of consumers don't listen beyond the headlines and did not know about the census fluctuation. They saw a gain of 431,000 jobs in May and a headline loss of -125,000 in June. (reported on July 9th) This was headline sticker shock to go along with the double dip recession talk.

You may remember back on June 29th the Consumer Confidence headline number also dropped a whopping -10.4 to 52.9 and the Dow lost -266 points on the news. Friday's sentiment report was a confirmation of the confidence number decline. The reports are entirely different and survey a completely different set of consumers so I would say this was solid confirmation of a change in mindset.

The sentiment numbers will become vastly more important next month. If the trend continues lower the double dip could become a self-fulfilling event as concerned consumers stay away from the mall and skip the back to school specials.

Consumer Sentiment Chart

Also raising red flags on Friday was the negative reading on the Consumer Price Index. The CPI is supposed to measure the amount of inflation in consumer prices. Instead it reported a headline drop of -0.1%. That is not earth shaking except that it was the third consecutive month of negative numbers.

If you take out food and energy prices rose +0.2% but most consumers would find it difficult to live without those components. Even without those components the year over year core CPI number is about to break under 1.0% and its historic low. This has fallen like a rock since the December reading of 1.8%. It has been 1.0% for the last three months and with prices falling it is only a matter of time before we see it in fractional territory.

There is no inflation, period. The term deflation, which was purposefully not used for years and "disinflation" used in its place, is now being heard daily in the news and is being muttered by the Fed heads themselves. The deflation scenario is still far from certain but a collapse of the job market could accelerate that possibility.

The FOMC minutes specifically pointed out that inflation was worryingly slow. They would love to be fighting inflation now because they have run out of recession bullets. Their only option now is to warm up the helicopters and fire up the printing presses. It is time for "helicopter Ben" to live up to his nickname.

Helicopter Ben Bernanke

Deloitte and the Harrison Group just completed a consumer study on buying habits now that the recession is over. The American Pantry Study found an amazing amount of frugality compared to prior habits.

93% expect to continue spending cautiously even when the economy improves.
92% have made changes in their grocery related shopping habits.
89% feel they have become more resourceful because of the economy.
84% have become a lot more precise about what they buy.
81% try to see how much they can save with coupons or loyalty cards.
55% of those cutting back suffered no decline in income but cut back anyway.

The big drop in Consumer Sentiment impacted the market even harder because of the other negative data points earlier in the week. The Philly Fed Survey dropped to 5.0 from 8.0 and analysts were expecting a rise to 10.0. Last month it dropped to 8.0 from 21.4. The Philly Fed Survey is nearly in free fall.

The NY Empire Manufacturing Survey fell from 19.6 to 5.1. That is the lowest reading since December. The backorder component went decidedly negative at -15.9.

The Producer Price Index headline number fell -0.5% and it was the third consecutive decline deeper into negative territory. Retail Sales for June declined -0.5% after a -1.1% decline in May.

These are serious declines in major reports. In addition the FOMC minutes showed the Fed lowered its growth estimates and suggested the recovery could take 5-6 years. That was not well received and set the tone for the rest of the week.

The Weekly Leading Index declined again but the prior week was revised lower so it appears there was no change. However, you can bet that next week is going to show an acceleration of the downward trend. The smoothed annual growth rate declined to -9.8 stretching its decline to 10 straight weeks and 15 of the last 16 weeks. The all time high of 28.5% was set last October and the all time low was -30.2% in December 2008.

Weekly Leading Index Chart

The economic calendar for next week is heavily weighted with real estate reports and they are not expected to be bullish. The selling season is almost over but the demand after the tax credits expired has fallen to almost nothing. Pending home sales fell -30% in the last report.

Economic Calendar

The focus next week will be earnings with the heaviest schedule of blue chips for the Q2 earnings cycle. Twelve Dow stocks report along with 122 S&P companies. There are 73 companies reporting that are seen as key bellwether stocks. Some of those would be IBM, MSFT, MMM, EBAY, AMZN, AAPL, UTX, CAT, etc. The earnings are expected to be good but the guidance and top line revenue numbers from those that reported last week are not exciting. This led to considerable disappointment for traders.

Earnings Calendar

Google was a major disappointment on Thursday night. Google missed estimates of $6.52 per share with earnings of $6.45. It wasn't that the miss was that bad but Google has been having trouble convincing analysts that it can keep up the pace of growth. Google has branched out into dozens of alternate products lines but none are really turning into profit centers. Now they have started a stock trading division. I guess with $29 billion in cash and marketable securities they need to do something besides park it in a brokerage account and money market fund. Unfortunately with stock trading comes risk. Next week they will probably branch out into Nerf ball manufacturing or turtle farming. Google's head count continues to rise with 1,200 employees added in Q2.

Investors are losing interest in Google's different endeavors and moving on to other stocks. Google lost -$34 on Friday after the earnings news.

Google Chart

General Electric (GE) reported earnings of 30-cents that beat the street estimate of 27-cents but revenue fell -4.3% and was below analyst estimates. Cost cutting and not a sharp rise in sales helped push profits up +16%. However, new orders did rise +8%, the first time they have increased since 2008. GE shares lost -4.6% on the revenue decline.

Bank of America shares took a -9% hit wiping out more than $10 billion in market cap after reporting earnings that disappointed the street. Earnings rose +15% to $2.78 billion. Loan loss reserves fell -17% from Q1 levels and credit quality was rapidly improving. However, loan demand was falling and BAC said it could take a $10 billion charge for costs related to the FinReg bill passed this week. Trading revenue fell 42% from year ago levels. They said trading dropped sharply after the flash crash and in response to the European debt crisis. The CEO said the bank's economists do not believe there will be a double dip recession but they were worried about the suddenly slowing momentum in consumer spending. Earnings beat the street but the cloudy future crushed the stock price.

Bank of America Chart

BAC said there was a new wave of foreclosures ahead and a new problem developing was an increased delinquency rate on prime loans. This has been reported by other banks and agencies as well. Realty Trac said on Friday that bank foreclosures were up a record 38% last month and more than one million homes would be foreclosed over the rest of 2010.

Citigroup said it earned $2.7 billion last quarter which works out to 9-cents per share but revenue fell -37%. Investment banking revenue fell -36% from the prior quarter. Wall street was expecting 5-cents per share. Loan loss reserves dropped slightly to $46.2 billion or 6.8% of outstanding loans. Allowance for consumer loan losses was $39.6 billion or 7.87% of consumer loans. The CEO said credit quality was improving but loan demand was light. They credited growth in Latin America and Asia for their profits. Citi shares lost -6% on the earnings news.

Citigroup Chart

Antennagate continued to drag on in the press and stole airtime from the release of the Droid X phone this week. Apple called a hastily scheduled press conference for Friday afternoon and spent 45 minutes bragging about the iPhone 4 before finally announcing the fix for the antenna problem. It was pure Apple led by Steve Jobs and became more of an advertising pitch with free publicity than a press conference. The fix turned out to be a free plastic case with every iPhone. They could have just announced it on the website and an email to the press but why waste a perfectly good opportunity for free advertising.

Jobs said more than three million have been sold in the last three weeks. They are getting ready to open up sales in 18 more countries. Only .055% of users have complained about the antenna problem. Only 1.7% of users have returned the phones compared to a 4.6% return rate of the iPhone 3G. Jobs said the iPhone 4 dropped more calls than the 3G but only 1 more per 100 calls. He did not say how many of the 100 calls were dropped only that the I4 drops one more than the 3G rate.

Jobs came across as hostile that reviewers and customers were making such a big deal of the problem. "Apple is not perfect, phones are not perfect." If you don't like your phone bring it back. Maybe the I4 is not the phone for you. The played a video comparing existing reception problems with a dozen competitor phones as a way of downplaying the problem with the I4. Apple shares rallied into positive territory with the fix announcement but returned to negative territory as Jobs fielded questions with a less than pleasant tone.

Apple Computer Chart

Goldman Sachs settled the SEC charges for chump change and did not admit any wrongdoing. Goldman will pay $550 million to make the problem go away. That is the equivalent of eight days of trading profits for Goldman. Interesting that the Goldman charges came just as the FinReg debates began in Congress and ended the same week that FinReg was finally passed. Surely that is just a coincidence now that the need for a scapegoat has passed. Goldman shares spiked over $150 on the announcement but were dragged lower by the negative market. Several brokers were quick to reiterate their price targets from $185 to $225. Goldman reports earnings on Tuesday.

Goldman Sachs Chart

The S&P dropped to a low of 1065.79 on the May 6th flash crash. That was a -900 Dow points at the lowest point of the day. The world was coming to an end for about 20 minutes that day. The S&P closed at 1064.88 on Friday and back below that flash crash low. Of course we have seen three dips with much lower lows over the last two months but the return to that level at the close is worth watching.

Personally I think the Dow and S&P were simply over extended and returned to levels that could be considered support and did so on an expiration Friday on a strong news event. Remember the Dow dropped -266 points when the consumer confidence report was released with a -10 point drop in late June.

I would like to think that we will see a rebound on Monday. We have a big earnings calendar with some blue chips that should beat on both EPS and revenue. I don't think they can generate a prolonged rally given the recent economics but they should be able to resurrect the markets for trading next week.

Late Friday the IMF upgraded the outlook for Latin America to 4.5% to 5% GDP for 2010 from a prior estimate of 4%. This came after the close and should be bullish. It should offset some of the negative economics from the U.S. last week.

Brazil and Canada are expected to hike rates this week. That is bullish since it means their economies are doing well enough to justify the increases.

There are three European debt sales next week. Spain, Greece and Portugal will attempt to sell debt on the open market. Since the Greece debt sale last week was over subscribed by three times they should have no trouble with the sales. This should be bullish for the European outlook. The European bank stress test results are supposed to be released on Friday and the scuttlebutt from the European press is that the majority of banks will pass with flying colors. The anticipation of a successful stress test should be positive for market sentiment.

On the negative side will be all the real estate reports due out this week. None are expected to be positive but anyone not waking up from a multiyear coma this week should already know that housing will be down. Expectations should already be priced into the market.

The net of all those events should be a more bullish tone to the markets for at least the early part of the week. With IBM reporting on Monday and Microsoft on Thursday we should at least see a little buying ahead of those events.

Remember, we were grossly over extended after an 8% rally off the July 2nd lows. The S&P failed exactly where it should have failed at 1100 and then sold off -3% from the Thursday close at 1096. Friday looked ugly but in reality it was way overdue.

The S&P has support at 1060. I would have preferred to see it stop at the stronger support at 1070 on the way down but the big declines in Google, BAC, MA and others were too much to overcome. SPX 1060 is the last line in the sand before a return to 1020. A break of 1060 would negate any potentially bullish news events and return us to a downward trend. We could see 1050 as a speed bump but I believe a break of 1060 will be the key.

S&P-500 Chart

The Dow had support at 10100 and the close at 10098 is close enough for me. This is a critical level and a break here targets 9900 then 9600. The Dow has 12 components reporting earnings next week. There will be plenty of volatility in the index as each company takes a turn in the spotlight.

We really need to see the Dow bulls rally on Monday morning and pull us back from the brink or it could get ugly very quickly. IBM will be the biggest Dow component to report on Monday and they are expected to beat everything. Hopefully they can drive a stake in the heart of the sellers.

Dow Chart

The Nasdaq broke all near term support and appears to be targeting 2140. With Google losing $34 and a dozen other Nasdaq stocks losing $3 or more it was an ugly day. The Nasdaq lost 3.1% or -70 points. Support at 2220 was not even a speed bump on the opening drop and the Nasdaq only closed a point off its lows.

There are a bunch of tech stocks reporting next week but I don't know if that is a good thing or a bad thing. Almost every stock that reported earnings last week was crushed. If that trend continues then the Nasdaq is in trouble. However, IBM, APPL and MSFT should beat on every metric so hopefully they can offset declines by the chip sector and the dozen or so chip stocks that will report.

Nasdaq Chart

The Russell lost almost 4% on Friday with a -24 point drop to 610. The small caps are being sold because they are illiquid. In times of market stress the small caps are sacrificed first in favor of holding the large caps where funds can enter and exit without making waves.

This was an option expiration Friday and that causes additional volatility in small caps. Plus it was a summer Friday and traders were at the beach or on the golf course and not monitoring their stops. The sharp downdraft accelerated because of the thin volume and that is why there was a 4% decline. With support at 610 the Russell could be poised for a rebound but the index will likely under perform for the next two months if the economics remain weak.

If the Russell continues lower the next target would be a third test of 590 as support. However, a third test of support normally fails.

Russell Chart

The flaw in the bullish argument is that markets don't rally when financials are weak. The Bank Index fell -5.71% on Friday because of the earnings disappointments from Citi and BAC. Even the blowout earnings from JPM on Thursday failed to save it from a 4% loss on Friday. The banks are all warning that life under the new FinReg rules could be costly and unpredictable. JPM warned of "unintended consequences" from the 262 new rules that have yet to be turned into laws. Banks will see fees cut, trading restricted and opportunities narrowed. Worst of all they have no real clue when and how this will be enacted. The new regulators need to be found, vetted, confirmed and then go to work turning the FinReg reform bill into actual rules and policies so that they can be disseminated to banks. It could take a year or more for the process to progress to the point where they can actually start regulating. Indecision produces volatility.

In summary I expect a choppy to slightly bullish market next week. After the week is over I expect the market to weaken as we head into the summer doldrums. The earnings from the largest of the big caps will be over and we will know how the rest of the reports will likely play out. No potential surprises means no incentive to trade.

Jim Brown