Weaker than expected earnings from some high profile companies knocked the indexes back to initial support early in the day but the bad news bulls showed up on schedule and bought the dip.

Market Statistics

It was a very hectic day for earnings and economics with several Dow components reporting and mixed messages coming from the economic reports. Dow components VZ, MMM and JNJ reported mixed results and followed by some steep declines in the case of JNJ and MMM. Non-Dow components also found themselves in some hot water including a 19% decline in Tellabs.

First the economic news. The Consumer Confidence for January spiked significantly to 60.6 from 52.5 in December. This is a monster move to the highest level since May and it was powered by the expectations component. Expectations spiked from 72.3 to 80.3 for a major change in consumer outlooks. The present conditions component also rallied sharply from 24.9 to 31.0 and the highest level since Nov 2008. This was a blowout report for confidence for an index that normally moves in tenths of a point.

Those who felt jobs were plentiful rose from 4.2% to 5.2% and jobs hard to get fell from 46.0% to 43.4%. Those expecting a raise jumped nearly 2% to 11.4%. Auto and home buying plans also increased. It appears there is good news breakout all over if you believe this report.

Analysts believe the payroll tax cuts were instrumental in powering confidence higher. Whenever workers see more money on their paychecks it always improves their outlook. The noise coming out of Washington about significant spending cuts is also boosting expectations. High gasoline failed to dampen consumer confidence and that suggests it will continue to improve in coming months.

Consumer Confidence Chart

On the negative side the Richmond Fed Manufacturing Survey fell to 18 in January from 25 in December. New orders fell from 29 to 17. This may be just a blip because the average workweek rose five points from 15 to 20 and capital spending plans rose +2 points to 29.0. The Richmond Fed numbers have been highly volatile in recent months and it is not unexpected for manufacturing to slow after the holiday period. I would not apply too much importance to these January numbers out of Virginia.

Richmond Fed Chart

The FHFA Purchase Only House Price Index came in with a decline of -4.3% from the prior reading of -3.4%. The index is now 14.9% below its peak in April 2007. While this seems negative on the surface the actual internal index components were flat and suggested home prices could be bottoming. Unfortunately this is a lagging report for November and recent price trends have been lower in December and January as is normal for those months to be slow in sales.

The economic calendar for the rest of the week remains congested with the FOMC announcement on Wednesday afternoon the biggest problem for the market and followed by the GDP on Friday.

Economic Calendar

The FOMC meeting began today and they will release their announcement at 2:15 on Wednesday. Nobody really expects them to make any changes in their QE2 program but they are expected to give a nod to the boost in economic activity. They are not expected to mention any changes in the inflation outlook even though every third news article over the last two weeks has been something about rising inflation.

The Fed is playing a game of chicken with the inflation monster. The Fed has to keep its foot on the gas pedal until the very last minute in order to produce the most momentum possible before it is forced to back off the gas. The Fed hopes the momentum will keep the economy moving as they transition away from their extremely accommodative bias, through a neutral bias and then ready to drop the hammer on inflation as it begins to accelerate. That transition process is expected to take about six months.

Fed policy is like the rudder on a VLCC oil tanker carrying two million barrels of crude. The Fed can turn the rudder but it takes a very long time for the economic ship to react. Once it begins to react they have to immediately make new decisions about where they want the ship to be well into the future. They are not making plans for events right in front of them but 6-18 months into the future. This is why policymaking is so difficult and very few times do they get it right. Who knows what is going to be happening in the economy or in the world 12-18 months in advance.

To avoid major mistakes the Fed moves in very small steps, the equivalent of just moving the rudder a couple inches each time and then watching to see if what they thought was going to happen actually happens. They can correct a little more each month as they anticipate where their moves to that point will leave them six months from now. It has got to be very stressful for Bernanke and the team.

It will be practically impossible to avoid a collision with reality 12-18 months fro now. The Fed has been spiking the punch and with QE2 it is passing out car keys to the guests. How can it be possible that we can escape a wreck? Fortunately we don't have to worry about that eventual collision today.

This earnings cycle is not shaping up to be everything everyone hoped. Earnings misses are popping up all over and individual stocks are getting hammered. Dow component JNJ reported a -12% decline in profits and -5.5% decline in sales. Shares of JNJ fell -2% after the report. Not only were profits below estimates the forecast was also below analyst estimates. JNJ has been hurt by 17 product recalls since September 2009. The loss of sales from those recalled products was another $900 million or 50% more than JNJ had predicted. JNJ is not normally a volatile company but the last year or so it has not acted like a normal consumer products company.

JNJ Chart

3M, another major Dow component, beat the street by a penny on profits that were lower than the same period in 2009. Analysts were expecting a profit of $1.27 and sales of $6.6 billion. MM reported $1.28 per share on $6.7 billion. Compared to the blowout earnings from companies like GE this was a disappointing report. It is not that the earnings were bad but they were less than exciting. 3M said optical films used to brighten LCD TVs continued to decline suggesting sales of flat screen TVs are also declining.

Verizon (VZ) posted earnings of 54-cents that missed street estimates of 55-cents but the stock spiked higher on expectations for better times ahead thanks to the iPhone. Verizon said it would offer an unlimited data plan for iPhone subscribers at $30 per month to start. Revenue fell -2.6% to $26.4 billion and right inline with estimates. Verizon is expected to take a charge of up to $5 billion when it starts selling iPhones but then make up that shortfall in the first 12 months on subscriber fees. Verizon is going to charge $199 for the 16GB version and $299 for the 32GB version with a two-year plan. Verizon shares initially dipped on the news but ended up sharply higher on the positive outlook.

Verizon Chart

Tellabs (TLAB) posted disappointing earnings and warned on current quarter sales. The result was not pretty. Shares fell -20%. Analysts believe TLAB is losing market share to Cisco. One of Tellab's biggest customers is AT&T and they are upgrading their network using Cisco gear. Analysts believe this upgrade is happening faster than previously expected. TLAB reported revenue that rose only +5% to $410 million and analysts were looking for $418.4 million. TLAB reported a loss of -3 cents for the quarter.

TLAB Chart

RF Micro Devices (RFMD) after posting disappointing revenue. Earnings of 19 cents were a penny better than expected but revenue was $279 million compared to estimates for $286 million. They projected revenue in the current quarter would decline by another 10% to 15% for a median range of $242 million. They are also going to take a charge of $25 million for closing down lines for legacy products.

Chart of RFMD

Callaway Golf plunged after the close when it reported a larger than expected loss of 54-cents compared to a 29-cent loss in the year ago quarter. They also guided lower in 2011 sales. The recovery in the golf sector stalled in 2010 when golfers were having trouble coming up with the money to play a round after courses and suppliers raised prices trying to make up for recession losses.

Callaway Golf Chart

On a more positive note Harley Davidson (HOG) reported a better than expected loss of only 20-cents compared to 94-cents in the year ago quarter. Harley said sales were improving and they were benefiting from restructuring actions they took throughout the recession. On the conference call the company said it planned to increase production in 2011. Shares of HOG gained nearly $3.

Chart of HOG

After the bell Yahoo (YHOO) reported earnings of 24-cents that included a 2-cent charge for restructuring. Analysts were expecting 23 cents. However, Yahoo revenues declined -4% to $1.21 billion and they projected further revenue declines in Q1. This was the third consecutive quarter of declining page views as readers move to Google and Facebook for most of their Internet searching. The ten-year partnership with Microsoft the companies entered in 2009 has not paid off for Yahoo. Microsoft gets 12% of Yahoo's revenue for sending readers to the Yahoo pages.

Yahoo Chart

What we are seeing from the Q4 earnings are expectations that are too high and especially for tech stocks. Analysts were expecting 32% earnings growth for the quarter and it is looking more like 27% today. That is not the end of the world but it is a wet blanket on the market. So far in Q4 75% of companies reporting have been the earnings estimates. Last quarter it was 83% and the historical average is 62%. That still makes it a good quarter but investors were expecting better.

Funny thing about earnings expectations is they rarely fit reality. When the market is bullish analysts catch the upgrade fever and get too excited in their predictions. When companies don't measure up they are punished in the market. The same is true in bearish market only in reverse.

The wave of disappointing earnings is giving the bad news bulls plenty of steps to claim that wall of worry and they are doing a good job in shaking off the repeated blows. A new problem they are facing is the flood of IPOs coming to market. There are eight to be priced over the coming week. This will suck money out of existing stocks but if they all rise in trading it will produce some additional positive sentiment.

The eight new IPOs are Adecoagro (AGRO), InterXion Holding (INXN), Velti (VELT), Nielson Holdings (NLSN), Zuoan Fashion (ZA), BCD Semiconductor (BCDS), BankUnited (BKU), Demand Media (DMD). Nielson Holdings at 71.4 million shares pricing between $20-$22 is the largest IPO in recent history.

Laszlo Birinyi was on CNBC today with the most bullish call I have ever heard. He expects the S&P to rally to 2,854 by September 4th, 2013. He is basing his prediction on prior structural bull markets over the last 40 years. I won't bore you with the various reasons he gave but he is pretty confident. Laszlo has a very good reputation and was included in the Wall Street all stars in the past. Personally I have serious doubts we will EVER see 2854 on the S&P because of other factors that will tank the market by September 2013 but he is welcome to make that claim every week if he wants because it promotes additional bullish sentiment. Other analysts begin to wonder if their estimates are high enough and investors want to be invested for the big rally.

Commodities and oil prices declined again on worries China will slow its economy to quickly. Oil was down on worries OPEC is about ready to increase production in order to cover rapidly rising demand. Without the energy sector and banking sector providing market support it will be hard for traders to push the markets higher.

Crude Oil Chart

Late this afternoon the Dow spiked higher after there were some unexplained trades in IBM that occurred at $3 over the current price at the time. The spike stimulated some additional buying since IBM as a Dow component spiked the Dow and S&P for a few minutes.

IBM Chart

The S&P has gone three days now without testing support at 1280 although this morning's low was only a point over that level. That actually qualifies as at test in my book. Unfortunately resistance at 1290 has been pretty solid as well.

I believe the bulls are still in control. The dip back on Thursday was quickly bought as has been every intraday dip since. The S&P may not be breaking out to new highs like the Dow but it remains very close.

Most analysts were predicting a rally for Wednesday because of what the President was expected to say tonight. He is supposed to call for a five-year freeze on discretionary spending. (14% of the budget) In theory they believe this would show resolve to fix our spending problems and heal the economy. Obviously we know that whoever was speaking those words from the podium tonight it would be just political posturing and even if the freeze took place and there was no cheating it would not fix the problem.

I would welcome a rally on the announcement and I would love to see the S&P move over 1300 and the Dow over 12000 BUT there are some other factors in play. Remember the FOMC announcement at 2:15 on Wednesday. I would be really surprised to see a major rally before that announcement but I would not complain if it happened.

Similarly any bad news or a sell off on a weaker than expected speech should find support at 1280. The bigger problem is the weaker than expected earnings. The Q4 earnings cycle peaks this week and begins to lessen in intensity in the days ahead. Secondly the next wave of companies to report are smaller capitalization and typically report lower quality earnings. I would love to see the rally continue. We need to remain long over S&P 1280 regardless of our bias. However, we need to not be married to our positions and remain nimble to take advantages of future moves.

S&P-500 Chart

The Dow rallied over converging resistance to end up very close to the psychological 12,000 level. This breakout is bullish and came mostly on the back of IBM. A single stock cannot push the Dow up forever and some other components have to take up the slack pretty quick or the Dow will have to rest. Support is now 11800 with resistance 12000.

Dow Chart

The Nasdaq rebounded to resistance at 2725 thanks to strong gains in Apple and Google. This rebound from the morning dip to 2697 came in spite of earnings disappointments from RFMD and TLAB. A move over 2725 would be bullish and signify the weeklong consolidation has ended. Support is now 2690.

Nasdaq Chart

Regardless of what happens in the president's speech tonight the big event for Wednesday is the FOMC announcement at 2:15. Everyone will be looking for a hint of the future of QE2 and positive comments about the economy. Nearly everyone knows what they will say but that does not mean they won't be holding their breath in anticipation. Watch for a sell the news event and remember the big market move is normally the day after the announcement.

The GDP on Friday will be the next hurdle with monster expectations for growth of +3.6%. I suspect we could be disappointed in that number.

Just getting through this week is going to be challenging but the bulls are in charge. As long as the Fed is applying the cattle prod the stampede should continue even if it is at a slower pace. The rally still has no credibility. Once that credibility begins to appear it should pickup speed. However, nothing goes straight up so any dips along the way should still be considered buying opportunities.

Jim Brown

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