News events and gains in overseas markets produced a bad day for the bears with a monster short squeeze and the biggest gain in September.

Market Statistics

This could really be a September to remember with the Dow up +843 points from the August 31st close at 10014. That is an 8.4% rally for the Dow, +9.4% for the S&P and a whopping +12.6% rally for the Nasdaq. Since September 1st the uptrend has been rather dramatic and there are four days left in the month and quarter. If this trend holds this could be the best September since 1939 according to Reuters.

One of the reports boosting the market on Friday was another "less bad" report from the housing sector. Sales of new homes clocked in at 288,000 and near a record low but still better than the 276,000 rate from July. Analysts were expecting a further decline in sales and the uptick, despite it being minimal, was a positive surprise. The number of new homes on the market declined and the average price slipped another -1%. These are far from bullish numbers but another in a string of unexpected economic improvements.

You may remember on Thursday the existing home sales report also surprised to the upside with a moderate jump to a rate of 4.13 million homes compared to the 3.83 million pace in July. The increase in sales was broad based while months of available inventory fell from 12.5 to 11.6.

The Wall Street Journal also reported that new foreclosures initiated in August declined for the first monthly drop in over a year.

These are all positive signs but the rate of change is excruciatingly slow. Employment will have to improve before we will see an acceleration in home buying. Most homeowners are just happy to have survived the recession with a home and are not yet thinking about moving up.

Another less bad report was the Durable Goods report for August. The headline number was -1.3% and the biggest drop in over a year but the internal components showed signs of improvement. The headline number was down because of a -10% drop in transportation equipment. (Planes)

The positive component was the +1.6% jump in core capital goods shipments and inline with an +8% rate for Q3 spending. Core capital goods rebounded +4.1% in August after a -5.3% decline in July. Capital goods orders are up +18% over the same period in 2009 and +30% since the recession lows. The increase in core orders prompted some analysts to start talking about a +2% GDP again. Estimates had fallen to +1.2% to +1.6% over the last month.

Overall it was a positive week for economics and the FOMC statement reinforced the idea that the Fed is going to take further action if the economy does not accelerate soon. Next week is going to be even more important with a flood of regional manufacturing reports plus the next GDP revision.

We should know by next weekend if the economy recovered from the July soft patch and ticked up again in August or if that soft patch is turning into quicksand. The double dip conversations have lessened significantly but a resumption of bad news from the regional manufacturing reports could bring it back fast. This is going to be a pivotal week for economics. It will be a critical milepost as we head into Q3 earnings in just over a week. Alcoa kicks off the Q3 earnings parade only nine trading days from today.

Economic Calendar

In stock news Amazon garnered a new upgrade and hit a new all time high at $161. JP Morgan reiterated a buy rating on Amazon and raised the price target to $198 from $154. The analyst raised earnings estimates from $2.57 for 2010 to $3.64 in 2011 and a whopping $4.97 in 2012. The analyst said the thesis is simple. Amazon continues to gain market share in the e-commerce world and the e-commerce world is taking share from brick and mortar retailers. He said Amazon is rapidly expanding in non-US sites and sales and its international margin should continue to rise as the markets are developed. Also the "Fulfillment by Amazon" service is also a revenue growth driver. This is where other companies sell products and Amazon ships them from an Amazon fulfillment center.

Amazon announced some new features for its Kindle application for Android products. The app will allow you to search text of e-books and Wikipedia using voice commands only. Electronic Arts also announced some new games for the Kindle in case you are bored with reading or you are between books or appointments and just need a diversion.

Amazon Chart

Apple (AAPL) is on its way to being the largest market cap of any U.S. company when the stock reaches $345 according to Rich Peterson at S&P. The story about a Verizon iPhone won't die and the iPad is taking over the retail world. Apple shareholders should be very happy. Anyone who bought Apple in August when it reached support at $240 should also be happy.

Apple shares were boosted by news that the iPad would be sold in Target stores beginning in October with a starting price of $499. They will be the largest retailer to offer the product and just in time for holiday wish list inclusion.

Unfortunately for Apple bulls there are problems on the horizon. The various competing tablets are starting to appear in the market and there will be a veritable flood of new devices over the next six months. None will have the fully stocked app store but that does not seem to be slowing down Android purchasers.

The various Android tablets will be the biggest competition. The Android tablet has the same 1280x768 resolution as the iPad and the next OS version 3.0 is specifically targeted at tablet users. Analysts are already claiming the Android tablet will make up 26% of the market in 2011 compared to a 57% share of the iPad. Some analysts believe the Android will eventually outnumber iPads simply because of the vast number of models by various makers.

While this may sound negative for Apple just remember that Apple will continue to sell as many as they can produce for a very long time. Apple users are very loyal and every iPhone user is a potential iPad owner. Piper Jaffray expects Apple to sell 21 million iPads in 2011. At a roughly $600 average price that is roughly $12.6 billion in iPad sales alone. Steve Jobs could actually afford a raise.

Apple Chart

If you look at the charts for Apple and Amazon you have a good reason for the September rally in the Nasdaq. Add in NFLX, FFIV, FSLR, PCLN, CTXS and GOOG and the rest of the tech stocks could have taken the month off. All of those charts are poster children for severely overbought but analysts believe the tech rally will continue next week.

An example of irrational exuberance in tech stocks would be AMD. The chipmaker slashed its guidance on Friday and is now expecting revenue to decline by -1% to -4% from Q2 levels. AMD warned that slower notebook sales (thank you iPad) would push revenue to less than $1.65 billion. Analysts were expecting $1.72 billion. You may remember on July 15th AMD guided higher for Q3. Evidently management was overly optimistic.

The example of irrationality is AMD's +7% gain on Friday. They slashed estimates and gained +7%. Obviously the bad new bulls are in stampede mode. Helping push chip stocks up was a comment from Oracle's Larry Ellison that he was considering buying some chip companies. Who knew Ellison wanted to compete with Intel as well as Microsoft and Apple. What next from Oracle, maybe an oPhone or a tablet that runs databases? Oracle has acquired 65 companies in the last five years. Chip companies mentioned as targets were AMD, Nvidia and IBM's chip division. Since Oracle bought Sun Microsystems Ellison may be thinking more about beefing up its server business and adding new products.

AMD Chart

Gold rallied to close at $1296 after a brief tick over $1300 intraday. With the dollar imploding and the Fed almost guaranteed to launch QE2 in November there are some analysts predicting $1500 an ounce. It makes the hysteria over the old $1000 barrier seem almost calm.

The dollar index has fallen almost 5% since the end of August and there appears to be no letup in sight. Friday's close at 79.39 was a seven-month low. The drop is based on worries the U.S. economy is not improving and the Fed is likely to launch another trillion dollar quantitative easing program that will further devalue the dollar. This makes commodities like gold and oil more valuable because it takes more dollars to buy the same amount of product.

Dollar Index Chart

Gold Chart

There may not be any official inflation but if you look at the things that hurt if you drop them on your foot there is rampant inflation. Copper, lumber, wheat, corn, metals, etc are all soaring. Obviously this has something to do with the fall in the dollar and the droughts overseas but not 100%. Commodities are in rally mode because the rest of the world is in growth mode. Just because the U.S. is lagging does not mean the rest of the world is sitting on the sidelines waiting on us.

Commodity Chart

Petrobras (PBR) may have succeeded in its $70 billion share sale but the stock declined -2% Friday and will likely continue declining in the days ahead. That is simply too large a block of stock to not weigh on the share price. A day after the offering there are some analysts that believe it will mark a high point in the emerging market bubble. Money managers were literally throwing money at the offering despite the negative political ramifications.

Petrobras lost $70 billion in market cap over the last year as the government changed the rules, passed new oil laws and conjured up a scheme to increase their ownership of Petrobras from 32% to nearly 50%. One analyst called it the first stages of Venezuelation of the Brazilian energy sector. I like Petrobras as a company because they are in the top five offshore drilling and exploration companies. They have a monster asset in the new 50 billion barrel offshore find. Unfortunately the share offering was a bet that the find could be commercialized. They are not even sure they will be able to produce oil in quantity from the subsalt reserves. There are a lot of unknowns ahead for the company and a failure to show some progress in the months ahead will keep pressure on their stock.

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BlackRock vice chairman Bob Doll was pounding the table on stocks Friday saying the S&P should gain another +6.6% this year to begin a decade of 8% annual returns as concerns of a return to recession prove unfounded. BlackRock oversees $3.4 trillion in assets. Doll said the risk of a double dip has declined to 10% but the stock market had priced in a return to recession. "The economic recovery is becoming self-sustaining. U.S. consumers have not retreated into a long period of deleveraging as some feared. They got tired of that real fast, came running out of their homes and straight into the mall."

He said corporate earnings are going to explode because companies got so scared they cut costs to the bone and this will produce record earnings when the economy gains traction. He said the biggest problem U.S. corporations have today is an adverse political climate. He projects a drop of 1% in GDP if the tax cuts are not extended. He sees 2010 as the beginning of a fantastic decade with 8% annual returns led by healthcare, technology and alternative energy stocks performing best. He expects emerging markets to exceed those returns.

While on that topic the Democrats announced on Friday they will not vote on extending the tax cuts before the election but "may" talk about it after the election. Analysts said this was clear evidence they were throwing in the towel and conceding the election to the Republicans. The tax cut vote was seen as the Democrats only chance to gain in the polls before November. Now the Republicans can hammer them as out of touch with voters and the financial pain the recession has caused.

There are many reasons for any rally. The one last week seemed to center on the unmistakable fact that the economy is either going to get better by November 3rd or the Fed is going to spike the punch again. Either way the economy and the market go higher. The only difference is the speed of the increase.

If the economic reports continue to come in less bad, corporations will begin to have more confidence about hiring. If the stock market continues to move higher, consumers will feel better and spend more over the holidays. If the Republicans maintain their lead over Democrats heading into the election then corporations will look forward to reduced uncertainty, fewer regulations and lower taxes. That will stimulate business expansion and increase hiring. All of these things are probably underway already because the signs of change are already evident. We just need another month or two for traction to appear.

The talking heads were all excited with the "major rally" on Friday. They should all take a semester off and take a class in market analysis. It was NOT a rally. It was simply another monster short squeeze prompted by a combination of news events.

The S&P gained +22 points in the first 45 minutes as shorts covered in panic. For the next five hours it gained only two additional points. In a rally the markets rise all day. In a short squeeze they rise at the open, move sideways all day and then see an "I give up" candle at the close as those shorts hoping for a reprieve are forced to cover before the close.

After the market decline on Wednesday and Thursday, with Thursday ending with a major sell program to close on the lows for the week, the shorts were loaded up again with expectations of an end to the September rally. Surprise, surprise, it was a classic bear trap and the bulls loaded up on bear skins for the winter.

The S&P could not punch through the solid resistance from January at 1150. It was a dead stop on Tuesday (1148.59) and a dead stop on Friday (1148.90). That is not to say it won't happen but it remains strong resistance.

I believe it will happen next week but not because of some economic scenario. I believe it will happen simply because it is quarter end and fund managers will be forced to join the party and add some winners to their portfolios so it appears in the quarterly statements that they participated in the September rally.

Managers are going to be holding their nose and buying big cap winners. The small caps have yet to break over lower resistance because fund managers still have no confidence in the economy or the market. I would bet that a vast majority are holding cash in reserve in hopes of an October surprise that gives them a buying opportunity to catch up on missed chances in August.

I would not be surprised to see the S&P breakout on Monday and then trade sideways through Thursday. Friday could be a black day for the markets unless we have some strongly positive news from the ISM. Friday is a new quarter and an opportunity to turn some of those winners back into cash.

Traders forget that October 31st is more than Halloween. It is the fiscal year-end for the vast majority of mutual funds. Any portfolio manipulations for year-end statements and taxable events have to be concluded in October. That means if a fund bought Apple in January at $190 they have better than a $100 profit today. They have to decide if future upside potential is worth keeping the stock OR should they take the profit now to offset their losers and reduce the taxable impact. Spread that risk across dozens or even hundreds of stocks that have risen more than 100% since the 2009 lows and fund managers in need of a bonus fix may be itching to unload. If they do it early in October they can use that cash to buy the normal October dip in preparation for 2011.

I think it is a forgone conclusion the market will be better in 2011. At the same time it is not a safe bet that October will mimic September. I am wary of an October surprise.

S&P-500 Chart

The Dow broke over strong resistance at 10,700 but then failed to show any follow through until Friday's short squeeze. The Dow gained +186 points in the first 45 min squeeze and added only +11 points for the rest of the day. This was definitely not a rally.

I suspect the Dow will test 10,900 on Monday and then move sideways through Thursday. I don't think we will see a mad dash to strong resistance at 11,200 but it depends on how many fund managers are holding cash they need to spend before Friday. Support is well back at 10,500.

Dow Chart

The Nasdaq continues to power the broader markets higher. Actually it is the Nasdaq 100 not necessarily the Nasdaq Composite. The NDX has blown past prior resistance at 1930 and broke over 2000 on Friday. If it can maintain the pace and blow pass 2050 it would be a major accomplishment. That resistance dates back to July 2007. With the strength of AMZN, APPL and GOOG it has a good chance but that 2050 level is going to be tough. It would be the perfect spot for next week's advance to fail and setup an October decline.

Nasdaq-100 Chart - Daily

Nasdaq-100 Chart - Weekly

The Nasdaq Composite stopped just barely over resistance at 2375 with another hurdle at 2430. However those are just milestones in the journey to real resistance at 2519 and the 78% Fib retracement level from the March 2009 lows. This was major resistance before and should be equally as hard to cross on the next attempt. Only the next attempt will likely be in November and on a strengthening economy.

Nasdaq Composite Chart

The Russell-2000 example is proof of what I have been preaching. Despite the short covering on Friday it was another dead stop on strong resistance at 670 and another failure to thrive. Fund managers are still avoiding small caps in favor of high liquidity names. There is ONLY one reason for this. They are planning on a quick exit in October. They will then take their profits and buy small caps on any October dip. Compare the charts above to the Russell chart and the evidence is clear.

Russell 2000 Chart

In summary, I expect limited gains next week and a decline in October. I view that decline as a buying opportunity but I believe it will be steep enough to give traders some shorting opportunities in the first few days. You know I have had a bullish bias for the last month AND I am still bullish long term. I just believe there will be some volatility in October and smart traders will capitalize on it.

Jim Brown