Rampant inflation in China caused worries about a new round of tightening and crushed commodity prices and equities.

Market Statistics

China was the focus on Friday with inflation at two-year highs and worries over further tightening to slow its rise. China's inflation for October came in at 4.4% and nearly a full point higher than the 3.6% rate in September. Inflation has tripled since January's 1.5% rate. The Shanghai Composite Index plunged more than 5.2% on Friday on fears China would hike rates over the weekend. This dragged down all Asian markets and pushed the U.S. market to a negative open as well.

This was a perfect excuse to sell equities and commodities. You have heard me say it before. When the market wants to go down it will always find an excuse. While China's 4.4% inflation rate might sound terrible it is only because traders don't understand China. From 1994 through 2010 the average inflation rate in China was 4.25%. It went as high as 27.7% in October 1994 and was well over 8% back in May/June 2008. For China's inflation to be 4.4% today it is right inline with the average and not a major problem. Yes, China might hike rates or take some other action to slow its rate of growth but the action will not be crippling to China's 10% growth rate. Growth will continue and even if it declined to 9% it would still be the hottest economy on the planet. Blaming the U.S. market decline on China was easy because the market was already looking for an excuse to take profits the week before option expiration.

The S&P rallied for +188 points from the 1039 low on August 27th. As of Friday's close it has given back only 28 of those points. I understand the worry over a potential bearish decline but you can't really draw that conclusion from the chart. This was the week before expiration after two months of gains and a very heavy news cycle for the last two weeks. Last week is when volatility should have occurred and it came right on schedule. I warned last weekend that we could see some volatility this week so lay off the caffeine and kick back with your choice of adult beverage and don't worry about this market. This is a buying opportunity over S&P 1190 or even 1175.

S&P-500 Chart w/Retracements

The economic calendar was light on Friday with the only material report the Consumer Sentiment for November. Sentiment rose to 69.3 from the prior reading of 67.7. This is the highest level since June and it was led by rise in the present conditions component to 79.7 from 76.6 while the expectations component rose only one point to 62.7.

I was expecting a decent bounce in sentiment and confidence once the elections were over but this report only covered about five days after the election before the cutoff for this reporting period. About three-fifths of the monthly survey data is reflected in the first report of the month. The remaining two-fifths will be reported on Nov-24th. Rising gasoline prices and falling house prices are still a major drag on sentiment.

Consumer Sentiment Chart

For next week there is a busy calendar but only three reports of any specific interest. The PPI on Tuesday and CPI on Wednesday would normally be worrisome because of the inflation component but inflation is currently near zero. That makes them important only if they show a sudden spike in the core rate of inflation.

The Philly Fed Manufacturing Survey on Thursday is seen as a preview of the national ISM two weeks later. The Philly survey this month is notable because of the expected improvement. Consensus estimates are for a jump to 5.0 from 1.0 on the headline number. That would completely reverse the last three months of declines and predict a strong showing for the national ISM. This report could revive U.S. expectations for economic improvement.

Economic Calendar

Cisco's earnings were the only event I highlighted on last week's calendar and it turns out it was the only event that mattered. As you know Cisco significantly lowered guidance for future quarters and shares declined -18% on the news to close at $20.15 on Friday. Cisco is a Dow component and its lost was a major impact on the Dow for the last two days.

Cisco's warning was also a major blow to market sentiment at least in the tech sector. The tech stocks had been leading the markets higher and Cisco turned into a major drag on the networking and PC sub sectors. Cisco said decreased government spending worldwide due to austerity programs and budget cuts would drag on revenues for the next two years. It was a bleak outlook from the normally positive tech giant.

Dell reports earnings next Thursday after the bell and they are expected to report a 22% gain in sales. The spike in sales is expected to be from corporate sales rather than consumer PCs. I would agree with those expectations. A friend from a local ISP here in Denver claims they receive 2-4 Hewlett Packard servers a week, a couple each of EMC and Qlogic and 25-30 of Dell servers. Apparently Dell has found a price point that works and they are selling a lot of servers. The shipping boxes say "Assembled in Mexico" so Dell is benefiting from the cheaper labor. We will know how cheap this labor really is when Dell reports next week. Can Dell, a company that has disappointed far more than Cisco has in the past become a market darling once again? Dell's shares imploded after the Cisco warning so the stage is set for a big rebound if they don’t disappoint. More than 26% of Dell's revenues come from government spending and that is what caused the Cisco warning, a slowdown in government spending.

Dell servers waiting to be installed

Dell Chart

The Fed launched its first purchase under the QE2 program on Friday. The Fed offered to buy $7.2 billion in bonds and dealers offered to sell $29 billion in 3-5 year maturities. The auction had some technical challenges and had to be restarted. After the smoke cleared it was $7 billion done and $593 billion to go. The Fed is expected to buy $105 billion in total on auctions almost every business day for the next month in an effort to push rates lower. That did not work Friday with yields on the 10-year notes jumping +5.17% and the biggest increase since August. Yields on the 2-year jumped +17% and the biggest one day increase since April. Eventually the daily Fed purchases will have the desired effect.

Investors may want to sell their bond positions soon because once the Fed quits buying bonds there will be a disaster of a crash.

With the first QE2 purchase now behind us the QE program is officially old news. The topics grabbing the headlines are China and Ireland. The rise in inflation prompted China to raise reserve limits for banks, which has the effect of removing money from the market since they have to hold more back in reserve. Analysts are "reportedly" concerned that China might take an even harder stand than simply raising rates another quarter point this weekend.

Ireland is the new Greece. All week we have been hearing about the growing debt crisis in Ireland but that eased somewhat on Friday. Irish debt prices rose for the first time in 14 days after Britain, France and Germany issued a joint statement promising to stand behind all of Ireland's debts. Before the pledge Bloomberg surveyed analysts and 51% said they "regard a default as likely." That is triple the number who felt is was likely back in June.

By Friday nearly everyone believed the EU and the IMF would be forced to come to Ireland's rescue. The problem with that is the list of countries behind Ireland with the same problems only less urgent. How many countries can the EU bail out before it goes broke? As one analyst put it, "who will rescue the rescuers?"

Hopefully the pledge by the EU countries to guarantee Ireland's debt will put an end to the current round of debt worries. The Euro gained slightly on the news.

The drop in the Euro over the last week suddenly made the U.S. dollar a safe haven play despite the Fed's QE program. The dollar rebounded to a five-week high and suddenly made those in the "short the dollar, long commodities" trade very uncomfortable. The weak traders raced to the exits and caused an immediate and painful drop in commodity prices.

Gold declined -$35 on Friday for the biggest one day drop in months to close at $1365 and well below the $1424 high Tuesday. Copper fell -$12.60 or -3.1% and the most in four months. Crude prices fell -3.4% to $84.87 after hitting a new two-year high on Thursday at $88.60. Sugar fell -12% in London and the most in 22 years. Corn and Soybeans traded limit down. The CRB Index fell -3.6% and the biggest drop since April 20th 2009. China is the world's leading consumer of many commodities and the combination of possible Chinese tightening and the spike in the dollar crushed prices.

Gold Chart

Commodity Index Chart

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The dollar will reverse as the Fed increases the pace of its bond purchases and the U.S. goes further into debt. It may not rally next week unless the pledge by the Euro nations to guarantee Ireland's debt was enough to placate currency traders.

Dollar Index Chart

Apple (AAPL) lost a big shareholder in September. Ken Heebner, manager of the Capital Growth Management fund sold 90% of his position. That was roughly one million shares or roughly $280 million at September's prices. In the SEC 13F filing the fund said it reduced it's holding to only 100,000 shares. Ken Heebner is widely followed by investors although his gains tend to run in streaks. The news was partly responsible for a $12 intraday drop in Apple shares on Friday. It closed at $308 and well off the $321 high for the week.

Bloomberg ran a story on Friday warning that Apple could see some weaker holiday sales due to lower consumer spending and production problems. The story was written by Ashok Kumar and he has a substantial following. He claims consensus estimates for holiday sales are as high as 3 million units a month but channel checks are not showing much over 2 million units being produced. Therefore street estimates may be over extended in his view. This was also weighing on Apple shares. He also warned that there were also sales or production problems with the Samsung Galaxy tablet, Dell's Tablet and the RIMM Playbook.

Apple Chart

Bucking the market drop was Disney with a +1.82 gain despite missing analyst estimates by a penny. There was some confusion about which analysts included items and which did not and the stock initially declined sharply to nearly $35. Nomura Securities reiterated a buy rating and raised the price target to $43. On the call the CFO said revenue at ESPN was up by +19%. The dip was short lived and Disney closed near the high of the day.

Shares of Nvidia rose +5% after raising sales guidance well over analyst estimates. The company said new products were gaining back market share they had lost to AMD.

Intel rallied after saying it would raise its dividend by 14% and CEO Paul Otellini said the company remained on track to have its best year ever. In August Intel cut its sales forecast citing weaker than expected demand for consumer PCs. In October Intel raised its forecast to levels that met expectations.

Providing support to the market next week will be 10 different IPOs headlined by GM. The GM IPO will raise $10 billion for GM on Nov-18th. Brokers claim it is 600% over subscribed with $60 billion in orders. This one is sure to move higher when it opens. China's SAIC Motor Corp is expected to buy $500 million in shares but rank and file U.S. investors will be blocked from owning them at the IPO price and be forced to buy on the open market. The expected price range is $26-$29.

Other high profile IPOs include Booze Allen Hamilton, LPL Investment Holdings and Aeroflex Holding Corp an electronics manufacturer. This will be the most active week for IPOs since 2007.

Harrah's Entertainment is going to IPO as Caesars Entertainment Corp (CZR) and is expected to raise $532 million. Investor John Paulson will also sell $710 million in shares to cash out most of his stake in the company. Harrah's was taken private in 2008 in a deal worth $27.8 billion by TPG Capital and Apollo Global Management. They piled debt on the company over the last two years but also enacted some severe cost cutting. Harrah's now has $19.8 billion in debt. Shares will price between $15-$17 when it lists on the Nasdaq.

I love Harrah's casinos but I am not sure how fond I would be of buying an IPO on a company with $20 billion in debt. The current owners will keep 82% of the company. If my math is right they are selling 18% of the company for $1.242 billion in the IPO and Paulson share sale. That would appear to value the entire company at $6.9 billion. It has nearly three times that amount in debt and lost money last quarter. This one scares me.

The market drop was the biggest weekly decline in more than three months. The talking heads on TV kept saying the decline was on low volume but I did not see it. Volume over the last four days averaged over eight billion shares per day. That is not heavy but definitely not light.

Volume on Friday was heavily weighted to the downside with down volume 7:1 over advancing volume. New 52-week highs declined to only 110 compared to the 1,320 high back on November 4th.

Those putting money into the market were welcomed with an average drop of -2.3% for the week. The week ended on Wednesday was the fifth consecutive week of inflows into U.S. equity funds after six months of outflows.

I still believe this decline is a buying opportunity. However, the situation has changed slightly with the Cisco warning weighing on investor sentiment, the Irish debt problem, which should be less important next week and the worry over another round of tightening by China. The dollar is the wild card. None of those problems are critical. I view Cisco as the worst because they are a key tech component and a slowdown in their business should mean a slowdown in everyone's high tech business. Hopefully Dell can repair the sentiment damage when they report on Thursday. The worst case would be if they add to it with an earnings miss and lowered guidance of their own.

Even if China does hike rates the country will still continue grow around 10% so the impact to commodities will be minimal at best. This should be just a news blip more than a real change in status.

The S&P declined only 28 points from its highs over the last week. I believe this was a delayed sell the news event from the hyped buildup to the FOMC and Jobs, profit taking and option expiration position shuffling all rolled into one week. The pace of the selling was slow once past the open. Each day had an afternoon rebound. Not closing on the lows is a positive signal. Once the downtrend was set for the week Friday had no chance. The shorts were gaining confidence and the news events just kept coming.

If China or Ireland continues to make headlines over the weekend we could have another dip on Monday. As long as the S&P remains over 1190 or even 1175 I would be a buyer of that dip.

There may be numerous structural problems impacting the economy and the market long term but I believe the short term will be positive. Money is flowing into mutual funds and the Fed plans to keep it that way.

I understand the worry over a potential bearish decline but you can't really draw that conclusion from the chart. The uptrend is still intact. The S&P would have to decline to 1180 just to retrace 25% of the August to November rally. That same 1175-1180 level is also strong support from the pre Fed meeting bullish consolidation period. I seriously doubt it will move below 1175.

If we do see a move below 1175 that would change the game and setup a potential double top at 1225. I am betting that the anticipation of economic improvement in 2011 is going to keep investors motivated and bargain hunting on every dip.

The herd tends to get all bent out of shape when we get a couple of news events appearing at the same time. The gloom and doomers come out of the woodwork and the shorts get all fired up. When the smoke clears and the light of day erases the shadows the true investors begin snapping up all the bargains. The shorts get squeezed and the cycle repeats.

The qualification to this outlook is of course a worsening of Ireland or China or a disaster earnings report from Dell.

S&P-500 Index Chart

S&P-500 Chart - Weekly

The Dow was severely handicapped by the Cisco warning. Cisco is a Dow component and the -18% drop in Cisco would have been catastrophic if it had been a high dollar stock. The Dow is a price-weighted index where the higher the price of the stock accounts for a greater percentage of the Dow. For instance IBM accounts for 9.72% of the Dow because it is a $144 stock. Bank America is only 0.82% of the Dow because it is the lowest priced stock at $12. Cisco is fifth from the bottom at 1.36% of the Dow. If Dell does a face plant on Thursday at least it won't directly tank the Dow.

The Dow would have to move below 11,070 to retrace 25% of the August to November move. There is also strong support at 11,000 so the entire range of support from 11,000 to 11,100 should be substantial. There were only three Dow components that lost more than a dollar on Friday. Boeing -2.28, IBM -1.69 and CAT -1.40. That is far from a rout despite the -90 point headline number.

I would be very surprised to see much more of a decline in the Dow without a worsening of some existing problem.

Dow Components

Dow Chart

Unlike the Dow and S&P the Nasdaq broke uptrend support at 2550 and has already returned to the bullish consolidation area from late October. Thank you Cisco, Google and Apple. The Nasdaq declined -60 points to come to rest just above 2500. The support range from 2470-2500 needs to hold and halt this Cisco generated tech flight. This is why Dell needs to post stunning results instead of following Cisco's lead. Remember, Intel just upgraded guidance so processors are still selling and every processor needs a computer to run. At the same time one Cisco router can handle dozens to hundreds of computers.

I know, I am probably putting too much emphasis on Dell and I have not even liked Dell since it broke below $40 in late 2000. I will forgive them all their past sins and missed earnings estimates if they can pull a rabbit out of the proverbial hat next week. This is Michael Dell's opportunity to redeem himself. A Dell director bought 20,000 shares in the market last week and I doubt he would have done that if they were going to miss earnings.

If the market is going to recover we need to see the Nasdaq hold the line at 2470 for sure and hopefully at 2480 or higher.

Nasdaq Chart

The Russell was my confirming indicator again last week. The Russell lost the same -2.3% as the other indexes but the decline remained above the uptrend and well above strong support at 700. If fund managers were really scared about China and Ireland they would have bailed from the Russell in heavy volume. For me this confirms my bullish bias and gives us a clear line in the sand for confirmation of any market move. As long as the Russell is over 700 I would stick with any weakness in the other indexes. Once support at 700 breaks I become a bear.

Russell Chart

In summary I remain bullish and in buy the dip mode through Thanksgiving and possibly into year-end. Once the market returns to its winning ways we will play it week by week. I believe the news events from last week will fade now that the G20 is not producing a couple dozen sound bites a day and dozens of "currency war" headlines. Ireland should fade because of the EU pledge to stand behind Ireland's debt. And lastly the Cisco stigma should fade if Dell can report earnings that are at least close and end the call without a warning.

Late Saturday the Greece PM said the country might ask for an extension on repayment of the $150 billion loan from the EU and the IMF. It is not a good time for the return of Greece to the headlines. This could heighten the worries over Ireland and Portugal and the ability of the EU to continue bailing out countries that may eventually default.

Don't fight the Fed!

Jim Brown

Money isn't everything but it sure keeps you in touch with your children. - J. Paul Getty