Earnings and economics combined to create a serious short squeeze at the open but sellers came back at the close.

Market Stats Table

Earnings from major retailers including Home Depot and Wal-Mart combined with some surprising economics to send a few shorts running for cover at the open. The short squeeze did not last and the S&P failed exactly at the 1100 resistance level.

Starting with the economics the Producer Price Index rose +0.2% and inline with consensus estimates. This gain came after three months of consecutive declines totaling -0.9%. Core prices rose +0.3% and the largest increase since January. However, auto and truck prices accounted for the majority of the increase. Intermediate prices declined -0.4% amid falling prices for commodities and metals. This was a marginally bullish report simply because the string of declines was broken.

Industrial production for July rose +1.0% in July and that was twice the expected rate. Automobile output was the driving force behind the numbers. Manufacturing output was up a +4.9% on an annualized rate compared to +8.4% average for Q2. This was a positive report except for the capacity utilization level, which remains at a very low 72.2 percent. This is better than the 65.1% low last summer but well below the 30-year average at 78.3% and the 81% rate before the recession.

The feedback from the Industrial Production report suggests manufacturing growth will continue to slow but remain growth at a solid pace. It may take several years for this slow growth to support the economy and improve employment but it is far better than the economic alternative.

Industrial Production

In the housing sector New Residential Construction for July actually rose slightly to an annualized rate of 546,000 units from a downwardly revised 537,000 units in June. That was a +1.7% increase but there was some negativity in the report. Single family starts declined by -4.2% so the majority of that headline gain came from apartment houses and multi-family home construction. Completions plunged from 874,000 to 587,000 for a -32.8% drop in July. Single-family completions fell -28%.

While starts rose slightly the number of new permits declined by -1.2% for single family and -8% for multi-family homes. Total permits fell to 565,000 for a decline of -3.1%. This pace of permits will not offset the current inventory levels, which are at 40-year lows. This suggests once home buying begins again there will be a monster boom in building and potentially a shortage of available homes for a couple years. This will spike home prices. Analysts do not expect the housing sector to pickup until 2012 although there should be a temporary spike in the spring of 2011. The high unemployment rate is going to keep most buyers out of the market.

There are no material economic reports on the calendar for Wednesday.

Helping push the markets higher at the open were earnings reports from two Dow components. Home Depot (HD) reported earnings that beat the street by a penny at 72-cents. Revenue rose +2% to $19.41 billion but that was less than analysts were expecting at $19.59 billion. HD gained +4% on the news but I am unsure why. Earnings rose on cost cutting and revenue was less than expected despite a small incremental increase. HD also lowered its outlook for the rest of the year. High dollar sales were down -5% while tickets under $50 rose +2.4%. By all rights they should have tanked.

The positive metric was the +1.7% growth in same store sales. They also projected a continued gain in revenue for Q3 despite a drop in estimates from +3.5% to +2.6%. They raised their earnings estimates per share to $1.90 from $1.88. While that sounds like improved guidance they said it was because of share buybacks and fewer shares outstanding.

I think it was a better or "less worse" report than traders expected and that provided the short squeeze momentum. Expectations were already pretty low and shorts were probably thinking the stock would break down on an earnings miss. When they did not miss the shorts had to cover and that boosted the Dow.

Home Depot Chart

Wal-Mart, another Dow component, posted earnings of 97-cents that beat the street by a penny but revenue was light at $103.73 billion compared to estimates of $105.33 billion. The profit beat came on cost cuts and international growth. Same store sales fell -1.8%. Wal-Mart said steep price cuts did not boost sales as hoped. The company warned investors to expect a decline in sales of up to 2% in Q3. You would have expected the stock to tank but it gained +2% on the news.

Despite the weak quarter the company raised full year profit estimates by a nickel to an average of $4 per share from prior median predictions of $3.95 per share. International sales rose +11% because of strength in Mexico, Brazil and China. Analysts said Wal-Mart has been hurt in the U.S. because of the high unemployment in their core customer base. Those without jobs have moved down to the dollar stores while those with jobs have moved up to more fashionable merchandise in stores like Target. Wal-Mart removed hundreds of items from its stores over the last two years in an effort to streamline their offerings. In retrospect that appears to have left a void for shoppers with a little extra cash to spend and they are spending it at Target. Target will release earnings on Wednesday morning.

I also believe Wal-Mart rallied on the "less bad" earnings rather than excitement that they beat the street by a penny on cost cutting.

Wal-Mart Chart

TJ Max (TJX) reported higher profits in Q2 on a +6.8% rise in sales. Same store sales rose +3%. However, TJX said sales in the second half of the year to be flat to down by -1%. They revised Q3 estimates to a range of 86-91 cents and analysts were expecting 89-cents. Same store sales are expected to be flat to +2% in Q3. It was another lackluster retail earnings report but the stock gained +2% at the open.

Forty-five days after the end of the quarter we get to see the SEC 13F filings that show what various large investors and hedge funds bought and sold last quarter. The biggest move appears to be into gold. Nearly every major hedge fund increased its investments into gold and gold miners.

George Soros still has 13% of his assets in gold. He owns 5.4 million shares of the GLD ETF even after selling 341,250 shares in Q2. He also owns small positions in the GDX and GDXJ. He did sell 5.8 million shares of NovaGold (NG).

John Paulson is the largest single holder of the GLD at 31.5 million shares. He also owns major positions in seven mining and producing stocks. Paulson also started a separate gold hedge fund in which he invested $250 million in stocks and physical gold. He is betting serious money that gold prices are going higher. Just his investment in the GLD is worth $3.78 billion.

Major banks and investment companies including MS, GS, BAC, JPM and many others also increased their investments in the gold ETFs and the gold miners over the quarter. Apparently nearly all the major players are expecting gold to continue higher.

The GLD ETF is now the sixth largest holder of gold worldwide. The gold trust owns 41,622,808 ounces of gold worth $51 billion as of today's close. Some people don't realize that the tax rate on GLD shares is higher than normal equities. Because the government considers gold a collectible the capital gains rate on shares held for more than 12 months is 28%. What you don't know can and sometimes will bite you.

Chart of GLD - Weekly

The biggest news this morning was an unsolicited bid for Potash Corp (POT) of $130 per share by BHP Billiton. This has been rumored in the market for sometime but it was still a surprise today. POT closed at $111 on Monday and shares shot up to close at $143 today, a +28% gain, when it rejected the BHP deal as grossly undervalued.

Potash immediately adopted a shareholder rights plan that would ensure the company has sufficient time in the event of another formal offer to explore and develop alternatives to maximize and enhance shareholder value. The Potash board also approved the issuance of one "rights share" for each outstanding share of the company's common stock on August 16th. Should anyone acquire more than 20% of POT shares the rights shares would become active upon board approval and allow the holder to purchase a common share of POT stock at a substantial discount to the then current price. The board would determine when or if the rights shares became active. This plan allows a "permitted purchase" by anyone with board and shareholder approval but functions as a poison pill should anyone attempt a hostile takeover.

Since Potash was so quick to call the bid "grossly inadequate" and implement the shareholder rights plan I suspect there will not be a quick deal. Several analysts believe BHP will eventually acquire a fertilizer company but it won't be POT unless they bump their offer significantly. POT has traded as high as $240 in the last three years so there is a lot of share price memory by shareholders. They are not likely to accept a low offer any time soon.

The world is rapidly approaching seven billion people in 2012 and we all need to eat. According to estimates the world will reach eight million by 2024. That extra billion people will require every acre of farmland to produce at its highest capacity and that means heavily fertilized. The excess inventory of potash deposits from the 1980s and 1990s has been used up and there is nothing but higher prices ahead and that is why global materials producer BHP is so hot to acquire a producer with deposits. BHP is a big supplier of commodities to Asia and Asia is going to be consuming fertilizer faster than Americans eat French fries.

There is a new stimulus program coming to a mortgage near you. It has been rumored for weeks but Pimco's Bill Gross was in Washington pushing it hard today. The government held a meeting of VIPs over what to do with Fannie and Freddie. There is a big push to just nationalize the mortgage business since few public banks are doing mortgages outside of Fannie and Freddie. The banks originate the mortgages but then sell them to Fannie and Freddie. If they were completely nationalized from their quasi government owned state today then the government could do deals to keep rates low and keep Americans buying houses. There is also an opposite push to break them up into 10 new companies and privatize them completely. I doubt there will be a decision on this in the near future because the economy depends on them remaining open for business.

The new stimulus program would involve converting ALL existing NON DELIQUENT loans to 30-year fixed rate loans at 4%. Up until now only the delinquent borrowers have been given deals like principle reductions and bargain interest rates to keep them out of foreclosure. Now there is a push to reward non-delinquent borrowers as well. Since Fannie and Freddie already own or guarantee 90% of the existing mortgages in the U.S. they already have the debt on their books. Rewriting the loans would not increase their debt but extend it at lower payments. This would prevent future foreclosures since the payments could drop by as much as a third. The average interest rate on a current loan today is around 6.75%. Dropping it to 4% would be a major cut in house payments.

When asked about the borrowers with loans at private banks like BAC, JPM, etc, Gross said basically, life is not fair. Those with loans at Fannie and Freddie get a bargain and those with loans elsewhere get nothing. It is the luck of the draw. Gross is pushing this plan because it would provide quick and easy cash to homeowners through the 30% drop in their house payments. This would immediately pump a substantial amount of money into the economy every month and speed the recovery.

Gross did not say it but it would also guarantee a reelection of the democratic administration. If mortgage payments on $5.5 trillion in mortgages were suddenly cut by 30% there would be some seriously grateful voters. Since Fannie and Freddie don't do many jumbo loans it means the beneficiaries of the plan would most likely be the working class rather than business owners and investors. This is far from a done deal but the chatter is heating up quickly. You can bet if the administration decides to take this drastic step they are going to want to announce it before the November elections.

JP Morgan said investors are buying treasuries at a rate that they have not seen in years. In a recent survey 27% of investors now own treasuries compared to 17% in 2009. It is not just treasuries but corporate bonds as well. Last week was the highest issuance for corporate bonds in history. This year is shaping up as the largest year on record. We are currently only $54 billion away from exceeding the entire year of 2006 and the highest level in recent history. With four months to go in 2010 we are definitely going to break the record. The extremely low interest rates are prompting corporations to sell paper even when they don't need the money. For instance two companies with massive cash hoards, Cisco and Apple both sold debt recently. Bond funds have seen record inflows of cash totaling $186 billion year to date.

General Motors had been expected to file for its IPO on Monday but the filing was delayed until today. When it did not happen this morning they said "after the close." It is well after the close and the IPO was a no show again today. GM claims it has completed the paperwork and satisfied the SEC with its timing but is now waiting on final board approval. They are expected to try and raise between $15 and $20 billion. A group of ten banks that provided a $5 billion credit line have agreed to serve as underwriters for the IPO. The U.S. government owns 61% of GM and the "Government Motors" nickname has stuck with them like a scarlet A on GM's forehead. Did I mention the IPO was being rushed to make sure it happens before election day and provide another campaign plank?

There are two major earnings reports due out on Thursday. Those would be Hewlett Packard and Dell. Both have preannounced so there is little in the way of excitement but the HPQ earnings call could provide some fireworks surrounding the resignation of Hurd.

In market action the opening short squeeze powered the S&P to exactly 1100 and prior resistance. This is where the squeeze finally ran out of traction and sellers began piling on again. The market was due for a rebound. It was severely oversold and Monday's opening dip to 1070 completed a -60 point drop since August 9th. The spring was coiled too tight to press any lower without a release of energy.

I would not read too much into this rebound unless it continues tomorrow and moves over the 1100 level. That would change the character of the rebound from a short squeeze that lost traction to a squeeze that triggered some hope. Getting over 1100 is not the answer to all questions but it is the first step in drawing the bulls back into the market. Support is now 1075-1080.

This is an option expiration week and SPX 1100 would be an ideal place for the market makers to pin the index for expiration. As such it has some magnetic properties this week.

S&P-500 Chart

The Dow rallied on the earnings from Dow components Wal-Mart and Home Depot even though those earnings were less than exciting. They were simply "less bad" than expected. The slightly better than expected economic news helped power DD, JNJ, CAT, MCD and BA to gains of more than a buck and keep the Dow moving higher early in the morning.

The rebound did not make it to the resistance at 10500 from the 100-day average and the rally gave back -80 points before the close. That left a +104 point gain after five days of declines. I would have expected more if the buying were genuine. Support is now 10250-10300 and resistance remains 10500.

Dow Chart

The Nasdaq rebounded exactly to resistance at 2225 and failed. The rebound came on short covering and gains in Google and Apple and both rolled over in the afternoon. Every Nasdaq component chart I saw showed the exact same pattern. It was clearly index and ETF sellers covering their shorts and new sellers coming back at the close.

The Semiconductor stocks rallied +1% but failed to show the same strength as the Nasdaq. This suggests they will continue leading the Nasdaq lower in the days to come. Resistance on the Nasdaq is 2225 and support 2175.

Nasdaq Chart

In summary I believe this was an oversold short squeeze and there is nothing to continue to power stocks higher. However, this is option expiration week and pushing the S&P back to 1100 may allow the most options to expire worthless.

Volume was slightly better at 6.8 billion shares but most of that increase was probable stop losses being hit on the short positions. The key this week will be Wednesday's market action. If the S&P can move over 1100 then I would have more confidence but until that happens nothing has changed in the market from last week. One day does not make a trend. Why buy?

Jim Brown