The markets rebounded from a strong deficit to close mostly positive but although the Dow tried hard the -15% loss in Dow component Cisco was too much to overcome.

Market Statistics

The big news for the day was of course the Cisco earnings disaster and the anticipation for Hosni Mubarak to step down in Egypt. Cisco was crushed after a really poor earnings report on Wednesday night. Cisco reported a decline in earnings and issued revenue guidance for the next two quarters at the high end of Wall Street estimates. Cisco said margins were being squeezed by increased competition and lower margin routing and switching platforms. Revenue was also being pressured by lower prices on newer generations of equipment. High-speed networks are becoming so common the gear required for these networks is being commoditized at a lower price point. Competitors are making strong inroads into Cisco's prior areas of dominance. For instance switching sales have been down for three consecutive quarters Sales were down -8.9% in Q4.

This is the second quarter that Cisco strongly disappointed investors and it does not appear the trend is going to change in the near future. Cisco was collecting analyst downgrades faster than Hosni Mubarak is creating enemies. Stifel Nicolaus and Piper Jaffray both lowered ratings from buy to hold but they were not alone.

Cisco Chart

The market waited all day as rumors from Egypt suggested Mubarak would resign in a speech late in the afternoon Eastern Time. When that speech finally came at the close he refused to step down and said he refuses to be dictated to by others. This is not going to set well with demonstrators and the protests on Friday, already planned to be the biggest yet, could turn very ugly. The military appeared to be planning for trouble as they strung barbed wire around government buildings in Cairo and moved in additional tanks and armored vehicles. The military could be preparing to breakup the demonstrations by force and the prospects for Friday are grim.

35% of Egyptians are employed by the government and the government has been shutdown for three weeks plus most of the retail sector in Cairo. This is going to produce a significant decline in productivity, GDP, taxes and wages in a country that already has a very high level of poverty. Just getting rid of Mubarak is not going to solve all their problems. This will be a challenge for Egypt for many months ahead.

Mubarak is rumored to be the richest man in the world with estimates of his personal fortune around $70 billion. Not bad for a soldier that became president and has been in power for over 30 years. Obviously he did not make that on his presidential salary. If I were him and I could get my money out of the country I would be running like his son did to some neutral country. Why risk a countrywide meltdown and possible death at age 82? Some analysts believe he can't leave because he can't get the money out of the country. His son Gamal, also a billionaire from his years in government service, left with 100 large suitcases for London. I doubt he had that many clothes.

Regardless of what people outside Egypt feel about Mubarak the big problem is going to be the potential for demonstrations to quickly spiral out of control or to see a bloody crackdown by the military that plunges Egypt back into a deep recession. Neither option will go over well on world markets. The more heated the crisis gets the more worries will increase over the operation of the Suez Canal and the Sumed Oil Pipeline. S&P futures are already down -4.50 and crude prices are up a buck since the speech.

Egypt V.P. Suleiman spoke on TV about an hour later and pleaded with protestors to go home and ignore outside influences like satellite TV. Mubarak said he was transferring "some" presidential powers to Suleiman but Mubarak would remain in office. In the eyes of the protestors Suleiman is a clone of Mubarak so that is not a solution.

Mubarak has set the stage for a final confrontation that will eventually lead to his forced removal. This is very negative for the surrounding countries where citizens are watching and thinking about overthrowing their own governments. Saudi Arabia is the biggest risk where citizens object strongly to the ruling family.

In the U.S. there were several economic reports and all were positive. The weekly Jobless Claims fell -36,000 to 383,000 from 419,000. This was the second week of significant declines from the 457,000 reported on Jan-22nd. If this kind of improvement continues it would be very bullish for the economy and the outlook on employment growth. However, the low numbers could be a snapback effect from the higher blizzard related numbers.

The NAR Metro Home Price report showed prices actually rose in Q4 by +0.2%. That was only the second year-to-year quarterly increase since 2006. Seasonally adjusted Q4 sales were up +15.4% from Q3. This is a lagging report so it was mostly ignored.

Wholesale Trade for December rose +1.0% compared to a -0.2% decline in November. Analysts were expecting a +0.7% increase. The inventory to sales ratio rose to 1.16. That is the number of months at the current pace of sales it would take to deplete inventory. This is very low and continued consumer demand should kick the manufacturing sector into a faster pace soon.

Reports due out on Friday are the International Trade for December and Consumer Sentiment for February.

Other earnings besides Cisco included Whole Foods, Akamai and Wynn Resorts. Whole Foods (WFMI) reported earnings on Wednesday night that jumped +70% on a +40% increase in revenue. This is a huge boost for economic sentiment. Whole Foods is the Neiman Marcus (Needless Markup) of the grocery sector. If consumers are electing to spend sometimes more than twice what the same product would cost in a normal store then the recession is clearly over. For instance raw brussell sprouts cost .99 to $1.29 for regular, $1.89 for organic at our local Kroger and Safeway chains in Denver. At Whole Foods they are $3.89. Shares of the grocer rose +12%.

Chart of Whole Foods

Akamai Technology (AKAM) was crushed after warning that increased competition from other vendors was forcing the company to renew contracts at lower prices. Akamai beat the street with their Q4 earnings but then lowered revenue forecasts to between $265 - $275 million and short of the $284 million analysts expected. An Oppenheimer analyst predicted lower prices for the sector including Level 3 Communications (LVLT). Shares of Akamai fell -15% to $40.75.

Akamai Chart

Wynn Resorts (WYNN) beat the street with earnings of 91-cents compared to estimates for 70-cents. Macau is booming for the casino sector and revenue there surged +58% in 2010. Q4 cash flow before Ebitda rose +86%. Steve Wynn said indicators for Las Vegas were all looking up and he had changed his mind about investing new money in Vegas. He did not elaborate. He has complained that opening new casinos in CityCenter and Cosmopolitan over the past year had dampened the Vegas rebound because they added thousands of rooms to existing capacity. Shares of WYNN fell -1.50 in afterhours.

WYNN Chart

Crude prices were all over the board today as the news about Egypt changed direction several times. The price of U.S. WTI fell to $85.96 when the abundance of rumors suggested Mubarak was going to resign. As rumors began to break that he might not resign the WTI contract spiked to $87.90. Another dip knocked off more than a dollar before the speech but the contract spiked again afterwards to trade at $87.60 tonight.

Worries of a larger uprising by protestors that spreads into violence and attacks on government buildings and institutions like the Sumed Pipeline and the Suez Canal, although improbable, are pushing prices higher. The Brent contract rallied to nearly $103 on the early news.

The civil unrest premium also factors in worries the eventual overthrow of Mubarak will translate into duplicate uprisings in Saudi Arabia and other oil producing countries. A successful conclusion to the Egypt crisis may allow prices to retreat temporarily but that security premium will return instantly if demonstrations increase in other nations.

WTI Crude Chart

Brent Crude Oil Chart

When I wrote about Bernanke and the economy on Tuesday I think I left some readers with the wrong impression. In some circles Bernanke is the most hated man in America. When I wrote about his successful inflation of the stock market and suggested Option Investor readers should thank him for pushing the market higher I was speaking from a market observer perspective and not that Bernanke himself was doing great things for the country. A couple readers fired off some hostile emails asking why I would praise Bernanke for spending the Fed into oblivion and creating debts their grandchildren would have to pay.

First, I have no opinion on Bernanke as a person except that I believe he is the most knowledgeable depression expert in the country. He has studied the Great Depression nearly all his life. What I think about Bernanke is not relevant to the discussion. I was writing from a market perspective. We have no control over what he does but by observing his actions we can profit in the stock market. By saying we should thank Bernanke for pushing the stock market higher is not a comment on Bernanke's worth as head of the Fed. It was simply a statement on the billions of dollars investors have made since the August 27th speech on QE2. I may not be happy about his methods but I am happy about the gains most readers have made.

Secondly I think the debt rhetoric is misplaced. It has nothing to do with Bernanke. The U.S. debt is different from the Fed debt. The money the Fed used to buy bonds is money they had on hand or created in the Fed account. It will be repaid as principal and interest on the bonds. It has no impact on individual taxpayers and is not a part of the Federal debt.

Lastly, I also warned that we will have the mother of all hangovers when Bernanke takes the spiked punch away this summer. I think many readers misunderstand my timeframe for various market comments. When I say "Don't fight the Fed, buy the dip instead" that does not mean the market is going to continue to spiral higher for years to come. It is a statement about the market today and in the near future as in weeks not months or years. I personally believe we are going to see a very significant market decline when the Fed halts the QE2 in June. Actually I believe it will start at the end of April as Q2 earnings peak and hedge funds start preparing for the end of QE2. They started buying everything in sight two months before QE2 began in anticipation of QE2. I believe they will begin unloading stocks two months before QE2 ends in June.

My comments, unless stated otherwise in these pages, are short-term expectations. I have enough trouble trying to stay focused on the next 3-4 weeks rather than looking years into the future. You actually don't want to know what I think about the market in the 2012-2014 timeframe because it is not pretty. We will worry about that market when we get close enough to matter.

I get a lot of email from readers questioning my recent bullish statements when they believe the country is on the highway to hell because of policies in Washington and the spiraling debt. While I agree with their long term views that is not the point today. We are option traders. Our trade window is normally 3-4 weeks or less. I am focused on the market direction for the next 3-4 weeks not the fate of the country and its impact on my naked puts on FFIV. As events in Egypt and Europe have recently proved it is tough enough just to predict market direction for next week yet alone next year.

In Fed news today Federal Reserve Governor Kevin Warsh resigned effective March 31st. The 40-year-old former investment banker was one of Bernanke's closest advisers. He was the only governor to strongly question the Fed's reasoning behind QE2 in November but he did not dissent. There was no reason given for the resignation. He previously worked as a VP of M&A for Morgan Stanley and was the only member of the Fed to have experience on Wall Street.

After a rocky session in Asia last night our markets plunged at the open with help from the Cisco earnings. The S&P declined to a four day low at 1311 but immediately rebounded as the bulls bought the dip again. Even the horrible news from Cisco was not enough to send the bulls running for cover. The rebound to close positive for the day at 1321 was again bullish.

The S&P is at strong resistance but it does not appear to be afraid of that resistance. The key on Friday will be Egypt. If protests turn violent we could see markets take a temporary hit until that crisis is resolved. The close at 1320 would be the perfect resistance point for a news event decline. I still believe it will be a buying opportunity.

S&P-500 Chart

The Dow snapped its eight day winning streak but with only a -10 point loss. The morning dip was quickly bought even though Dow component Cisco was down -15%. There were just not enough buyers to push the Dow into positive territory while traders waited on the Mubarak speech from Egypt. Lots of event risk going into the close.

The Dow returned to newly formed resistance at 12230 and used 12200 as support all afternoon. Baring some positive overnight change in Egypt the odds are good the markets will open lower again on Friday. Secondary support at 12150 could be tested again.

If it were not for the geopolitical risk from Egypt I really believe we would have overcome the impact of Cisco and moved higher. The dips are being bought too quickly to suggest there is a real risk of an imminent decline.

Dow Chart - 15 Min

Dow Chart - Daily

The Nasdaq dropped nearly 30 points on the Cisco earnings disaster but recovered to close in positive territory. This is very bullish to see such a nice rebound on such a disaster in Cisco's earnings. Obviously traders are convinced it is a Cisco problem and not a sector problem. Nasdaq Chart

The Russell rebounded from a dip to support at 805 to exactly touch its prior high at 813.36 before easing to close at 812.56. This is very bullish to see small caps bought on a day with so much geopolitical risk. The Russell was the second best performing index after the Dow Transports. To have both of them strongly positive after a dismal start is confirmation of improving economic sentiment.

Russell Chart

Dow Transports Chart

In summary I think Friday's market will be controlled by events in Egypt. It is not that Egypt is that important to our economy but after months of bullish gains there could be some substantial event risk to holding positions over the weekend. You never know when the unexpected will jump up to bite us in the back.

If by chance the crisis is resolved we could see a move higher but I would bet on next week and not on Friday. I still believe any real dip will be a buying opportunity. I do expect more volatility, which means we could have some short intraday dips before any material decline appears.

Jim Brown

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