Japan matched the U.S. quantitive easing on bonds and went two steps further to add ETFs and REITs.

Market Statistics

The Bank of Japan surprised everyone with a monster quantitive easing program to increase liquidity in the financial system as part of a comprehensive monetary easing policy. They also cut the interest rate to between zero and 0.1%. After an initial drop in the yen the currency rebounded to close higher to close near the 15-year high that it hit last month.

The surprising factor in this QE program was not that they would buy more bonds but they are going to expand the program into buying ETFs and REITs. Basically they are hoping to boost the equity market and the real estate market with this major program.

This move by Japan boosted expectations the U.S. Fed will expand its QE program by up to $1 trillion in November and possibly branch out into other asset classes following Japan's lead. The prospect of the Fed buying equities caused a major market spike at the open and another round of short covering was born. The Fed may be forced to buy equities or some other asset class because they are going to run out of available treasuries.

If you analyze the speeches from the various Fed governors there is a lot of disagreement on how future stimulus should be handled or even if there should be another round of stimulus. A QE2 program from the Fed is not a done deal but after today's rally it is baked into the market cake.

Friday's payroll report could give us a critical clue into the Fed's next move. This report will give us the first look at the annual benchmark revisions for the past year. Many analysts believe the revisions will significantly reduce the reported employment numbers and show that conditions were worse during the recession than we thought at the time. The revisions will cover the 12 months ending in March 2010. The final revision will be published with the January 2011 jobs report.

The Bureau of Labor Statistics produces estimates each month and then once a year they revise those estimates based on data received after those estimates were made. This revision could show that significantly more people lost their jobs than previously thought. The impact of a large downward revision would be a lengthening of the time analysts expect it will take for a recovery. For every million additional jobs lost it will take roughly another year to recover completely, if in fact we ever will recover completely.

Currently analysts are looking out to 2014-2015 for the economy to fully recover. Since the U.S. recessionary cycle runs about every 4-6 years that suggests we could see another recession in the 2012-2014 period and that would delay the recovery from the current recession even farther into the future, if ever. There are quite a few analysts that believe we will never recover because of the baby boomer wave set to retire in this decade. They believe the current rebound will end in 2012 and then begin a long decline into 2020 and beyond.

The boomer generation controls over 80% of personal financial assets and more than 50% of discretionary spending power. They are responsible for more than 50% of all consumer spending, buy 77% of all prescription drugs, 61% of all OTC medications and more than 80% of all leisure travel. More than 76 million people were born between 1046-1964 and they began retiring in 2009 with the peak expected over the next 5-7 years. That is 76 million people who will go from wage earners and spenders to social security incomes and hoarding savings for their old age. It will be a once in a hundred years economic shift as retirees downsize their lifestyles and spending.

The dollar collapsed again losing nearly -1% and reaching lows not seen since January. The dollar has declined -8% in the last three months. The dollar is dropping because of the expectations for a new round of Fed easing. Gold soared to a new intraday high at $1,342, a gain of +$24.70 or nearly +2%. There appears to be no end in sight for the gold rally.

Gold Chart

Dollar Index Chart

The only material economic report today was the ISM Non-Manufacturing for September. The headline number came in at 53.2 and a decent increase from the 51.5 in August. It did not completely erase the August decline of nearly three points but it was a move in the right direction.

Specifically interesting was the export component, which soared to 58.0 from 46.5 in August. This is a factor of the cheaper dollar that makes our goods and services more attractive in other countries. This was the largest monthly gain since records were started in 1997. New orders rose by 2.5 points to 54.9 but back orders declined by 2.5 points to 48.0 and into retraction territory.

This report and the ISM Manufacturing were not strong enough to prevent the Fed from easing. In fact these reports probably gave the Fed added incentive to provide extra stimulus. These reports are consistent to a Q3 GDP under 2%.

The chart below is showing some continued respect for the declining trend from March 2006. The next move higher needs to break this resistance and the Fed will want to reinforce that move.

ISM Chart

The biggest report left for this week is the Nonfarm Payrolls on Friday. With the benchmark revision causing additional concern about how the market perceives the data there is risk ahead of the report.

Economic Calendar

In earnings news Yum Brands reported earnings that beat the street and gave guidance that matched analyst expectations. Earnings were 73-cents compared to estimates of 72-cents on revenue of $2.87 billion. Sales were powered by gains in China. After sinking in Monday's afterhours trading the stock rallied slightly on Tuesday to an all time high at $47.50.

Wolverine Worldwide (WWW) posted earnings that beat the street and raised guidance. Earnings were 70-cents compared to estimates for 67-cents. Revenue rose +11% and profits +6%. Wolverine is a shoe manufacturer for brands including Timberland, Caterpillar, Harley Davidson and Hush Puppies. Wolverine raised guidance to $2.04-$2.08 from $1.98-$2.04. Wolverine shares rallied 3.5% on the news.

Diamond Foods (DMND) posted earnings that beat the street and raised guidance slightly. The company produces Pop Secret popcorn, Emerald snack nuts, Diamond nuts and Kettle Chips. Earnings were 30-cents compared to estimates for 28-cents. Their shares rallied +4% on the news.

Earnings due out on Wednesday include STZ, MAR, MON, RPM and RT.

Harley Davidson (HOG) shares spiked +9% to $32 after RBC Capital Markets raised his price target saying sales were improving significantly following the recession slump. Based on checks with dealers and their reports of improving business he raised his target to $36 from $33. He said this was the first indications of improving sales since April. Meanwhile there does not appear to be any expectations in the market for a business recovery. In July Harley said it would ship 5-10% fewer motorcycles this year in an effort to support prices. Nothing creates price support better than limited supply. If consumers are buying Harleys again then the recession is definitely over.

Harley Davidson Chart

Trader Jerome Kerviel was convicted on all counts, sentenced to three years in prison and ordered to pay $6.7 billion in restitution. Yes, Billion with a B. Kerviel was the rogue trader that nearly bankrupted France's second largest bank, Societe Generale. The court rejected arguments that he was a scapegoat for a failed banking system. This is the biggest fine on record for a trading violation. That is the amount of money SocGen lost unwinding his trades. Unfortunately for SocGen he has no money so the fine is not going to replenish their coffers. Odds are good Kerviel will not be working in the financial sector when he gets out of prison.

The term "bond bubble" is getting more airtime as each day passes. However, with competing governments racing to devalue their currency more than everyone else by purchasing their own bonds the bubble may persist for some time.

Mexico became the first government to issue a century bond when it offered $1 billion in 100-year bonds expected to yield 6%. The bond will become a benchmark rate for Mexico as it tries to sell additional debt before year-end. Mexico's debt was recently downgraded but remains investment grade and that gives them the low rate. Demand for the century bond was so strong they are considering doubling the offer. In a filing with the SEC they said they could issue up to $80 billion. Ironically their 10-year bond yields were only 6.14% so there was little difference between the two other than duration. Institutions like the 100-year bonds because they can lock in their yields for a very long time. Brazil is rumored to be considering a century bond offering. RBC Capital said they had clients lined up to buy century bonds and waiting for the next offering.

Goldman told investors today to avoid bonds and buy stocks because bonds were overpriced and stocks were cheap. One analyst believes the S&P will post record earnings in 2011 but stocks are still priced for a recession. This sentiment appears to be spreading.

Meanwhile a Bank of America analyst, Mary Ann Bartels, said she is expecting a 10% to 12% pullback in October. If she is right it would take the S&P below the September low and be the tenth major move of the year. She is expecting a decline to the 1000-1040 range on the S&P.

Eliot Spitzer launched a new career as a TV journalist this week on the Parker Spitzer show on CNN. The reviews were so bad that he will probably be looking for another new career within weeks. The disgraced ex-New York governor was forced to resign in 2008 after being caught paying for high prices call girls. The NY Post called the show "Freak show unbearable to watch" and the Baltimore Sun said it was "a load of obnoxious, self-important noise."

I wish I had better things to say about today's rally. Unfortunately I have no confidence it will last. The opening spike was pure short covering. After last week's lack of a gain and solid halt under 1150 the Monday decline was an open invitation for shorts to back up the truck in expectations for an October decline.

Internals were negative 3:1 on Monday and the number of declining issues was the highest since September 7th at 4,716. Everyone was definitely setting up for a bearish week. That setup was trashed at the open today and the strength of the spike was a testament to how broadly the market was shorted on Monday.

The opening spike took the S&P to 1150 in the first 30 minutes where is stalled for a very short time before the move higher continued. Once over 1150 it triggered an entirely new set of stop losses and buy stops. Once these dominoes began to fall the rest of the day was clear. I suspect there are quite a few traders still in disbelief and still short overnight with futures already moving higher.

Even though I don't believe in this rally we have to respect the move. Going counter trend to the market bias can continue for days if not weeks as we saw in September. This is really going to confuse fund managers. Do they follow through on plans to sell their losers or wait on the outside chance they turn back into winners if they wait long enough?

Don't forget option expiration comes early this month only eight days from today. That means an increased sense of urgency for managers that have options as part of their insurance and income strategy. They have to close positions before the 15th or face a loss of those positions.

For the rest of the week S&P 1130 remains support but that is 30 points below where we closed. That means we could see some serious volatility without endangering the September trend. Meaningful overhead resistance is now 1175.

S&P Chart

The Dow managed to hold over resistance at 10,920 at the close but only barely. Only one Dow stock was negative and that was American Express. The first Dow stock to report earnings will be Alcoa on Thursday.

I don't believe the Dow closed far enough over 10,920 to be free from its influence. If we dip down below that level tomorrow it would reinforce its value as resistance. Conversely if it continues to move higher the 10,975-11,000 range will become a resistance magnet and setup a test of the market strength.

Dow Chart

It was an amazing day for the Nasdaq with a 2.3% gain. That gain was powered by AMZN +5%, AAPL +4%, GOOG +3%, PCLN +4% and FFIV +5% to name just a few. Every stock was heavily shorted and every short paid the price.

The Nasdaq Composite slammed into 2400 at the close and screeched to a sudden stop. This is psychological resistance rather than a technical level but sometimes those levels have an even bigger influence on traders. Next resistance at 2415-2420 is minimal and I believe a move over 2400 will have legs.

Nasdaq Chart

The chart with the most positive impact for me is the Russell 2000. The Russell is clearly in breakout mode and it appears at least some fund managers are buying in self-defense. The breakout over 670 last week lagged the big caps but when that same 670 level acted as support on Monday's dip it was a solid buy the dip signal.

I still believe the Tuesday rally was almost completely short covering but many times a long-term rally begins with a heavy dose of shorts getting creamed. Just looking at the Russell chart I would say the rally has legs but this is only one part of the market. Use continued strength in the Russell as a confirming indicator.

Russell 2000 Chart

In summary the global governments are racing each other to the bottom to see who can have the cheapest currency. Cheap currency values mean your exports are more desirable around the world. It is an offensive tactic and a defensive move at the same time. When the dollar is getting cheaper you need to own stocks and that could eliminate a normal October decline.

Most analysts would claim any future QE move by the Fed was now baked into the market cake. However, we are probably faced with no move until November and that allows plenty of time for economics to improve and take the Fed move off the table. We could be setting up for a big disappointment in the weeks ahead. The jobs report on Friday could be a downer if the benchmark revisions are ugly. However, an ugly jobs number could provide even more reasons for the Fed to act.

This is going to be an event driven market until after the elections so keep your seatbelts fastened and your stop losses in place.

Jim Brown