Geopolitical event risk weighed on the markets on Friday afternoon and the indexes closed off their highs but still posted the best weekly gain since October.

Market Statistics

With the various indexes rebounding nearly 6% in the last seven days I am very surprised we did not close negative on Friday. With the indexes up six of the last sevens days this should have been a prime opportunity to take profits ahead of the weekend event risk. The decline off the opening highs was minimal and it sure looks like the bull is back.

The economics on Friday helped push prices higher. The list was led by the final look at Q4 GDP, which ended stronger than expended at +3.1% growth compared to the prior revision at +2.8%. Final sales of domestic products rose to +6.7% in Q4 and showing very strong demand. That was the strongest quarterly demand since 1998. Corporate profits rose +2.3% over Q3 levels.

The Fed is still predicting real GDP of +3.1% to +3.9% for the rest of 2011. Some believe it will be stronger because of the tax incentives on investment passed in the closing days of 2010. The first look at Q1 GDP will be on April 28th.

U.S. GDP Chart

The final reading on Consumer Sentiment for March came in at 67.5 and a slight decline from the preliminary reading at 68.2. This was down significantly since the 77.5 reported in February. The decline was attributed to the nuclear problem in Japan, higher gas prices and the crisis in Libya. The lack of a material change from the earlier report suggests consumers have grown numb over the constant geopolitical headlines. I would expect sentiment to rise in April even in the face of higher gasoline prices. The winter weather has passed and consumers no longer have to buy heating oil or pay the high heating bills.

Consumer Sentiment Chart

The Regional and State Employment report for February showed a positive trend in hiring. Thirty-five states reported a net increase in nonfarm payroll employment in February. Only 14 posted declines. Twenty-seven states reported a decline in unemployment rates. This is a lagging report but suggests we will see a further improvement in the March payroll report.

The economic calendar for next week is weighted to payrolls and ISM reports. The local ISMs from NY and Chicago will precede the national ISM report on Friday. All are expected to show continued manufacturing growth. The payroll reports will be led by the ADP preview on Wednesday and estimates are for a gain of 200,000 jobs. That is down slightly from the 217,000 in February. The NonFarm Payrolls on Friday are expected to show a gain of +188,000 jobs but there are plenty of whisper numbers that suggest we could see a number over 200,000. There were 192,000 jobs added in February.

Economic Calendar

The next FOMC meeting is not until April 26th but there was a virtual FOMC meeting on Friday with five Fed heads speaking in different places. The one that mattered most was Philly Fed president Charles Plosser. His contends the Fed has overstayed its welcome in the treasury market and should begin to exit sooner rather than later. Exiting is going to be a problem for the Fed with $1.5 trillion in treasuries on the Fed's balance sheet.

Plosser suggested the Fed lay out a plan to sell $125 billion in treasuries for every 25-basis point rise in Fed Funds interest rates. By tying the treasury sales to the rate hikes it allows the sale process to be conditional on economy rather than a fixed schedule like they are doing with QE2 and buying $150 billion a month come hell or high water. He believes the process would be easily understood by the markets and would free up the Fed from worrying about asset sales. He said he was only focusing on the design of the plan and not when to launch it.

On the positive side Plosser believes the economy is now self-sustaining and has gained significant strength and momentum since last summer. He saw the risk from Japan and higher oil prices as small and short term as long as Saudi Arabia was not affected by the democracy virus.

Speaking in France, Minneapolis Fed president Narayana Kocherlakota said the U.S. economy would have to "worsen materially" for the Fed to consider extending its bond purchases past June.

Rounding out the trio of inflation hawks, Dallas Fed president Richard Fisher said there were signs that liquidity was not just abundant but excessive in the USA. "Today we have abundant liquidity and the cost of money is zero," he said, adding that no amount of policy accommodation or new accommodation would solve the U.S. economy's problems. Fisher is seen as one of the most hawkish policymakers.

A fourth inflation hawk, Kansas Fed president Thomas Hoenig, announced his retirement as of Oct 1st and said the Fed had begun a search for his replacement. He dissented against the easy money policies of the FOMC at all eight Fed meetings in 2010. Hoenig does not have a vote on the FOMC in 2011.

On the dove side of the ledger Atlanta Fed president Dennis Lockhart said the Fed's current monetary policy is appropriate to bring about a moderate expansion and stable prices BUT he is ready to tighten policy if recent higher inflation persists. "For now, however, I remain satisfied that the current stance of monetary policy is appropriately calibrated to the current and projected state of the economy and supportive of both the employment and price stability objectives."

The last Fed speaker on Friday was Chicago Fed president Charles Evans who is considered to be a dove. "The Federal Reserve has less need to support an improving economy beyond the $600 billion Treasury purchase plan already in place, and any changes to the central bank's stimulative policies should be considered some time after the program ends." He said it would be natural for the Fed to monitor the economy for "some time" after QE2 ends before deciding on its next course of action. He said, "I personally don't see as many needs for further purchases as I expected last fall. I thought $600B was a good starting point and we would evaluate conditions at the appropriate time."

Currently the Fed is also investing the proceeds from expiring mortgage backed securities into treasuries along with the $600 billion QE2. That equates to about $50 billion a month in additional purchases. He suggested ending that reinvestment would be a good first step after QE2 ends. The way he said it suggests the investment would continue for several months after QE2 so that is in effect a QE2 extension of sorts. As confirmation he is still in the dove camp he said "In this environment, I still think accommodation is the right decision. Our current low rates continue to be appropriate and will continue to be appropriate for an extended period." Evans may feel the need to be more accomodative because his region includes Michigan, Illinois, Indiana, Iowa and Wisconsin. Michigan has been devastated over the last several years and may be weighing on his thought process.

It appears the FOMC is going to be volatile in the months ahead. Bernanke's decision to host a press conference after the April meeting could go a long way towards smoothing the public's perception of a fragmented Fed. What he says in the highly publicized press conference will be seen as the voice of the Fed rather than these random shots from individual Fed members.

The markets ignored all the fedspeak and they ignored the handful of geopolitical events making headlines on Friday. Portugal's political parties opted to hold an early election rather than form a new government even though that could force the country to take an unwanted bailout. The socialist government quit last week in a dispute over needed austerity measures. Portugal is likely to require a 75 billion euro bailout from the new EU bailout fund. The fund has the money but the Portugal problem is compounding fears about the health of the entire 17 nation eurozone. The lack of a government will delay any loan to Portugal until early summer and that is expected to produce a cash flow problem. Portugal has enough cash to make an euro 4.5 billion payment in April but they are not expected to have enough cash for another euro 4.9 billion payment in June. That could lead to a default.

In Syria protests turned violent again when at least 37 people killed in Daraa by security police and dozens more wounded. More than 100,000 people gathered in the protests. Protestors want the ruling Assad family to step down after 41 years of reign.

In Yemen thousands of people took to the streets again in a funeral procession to bury the dead from Thursday's demonstrations. The president of Yemen is beginning to cave in to demands and the situation there could be stabalizing at a high level of unrest but at least not worsening. It appears he has agreed to leave office but the conditions are still in dispute.

In Bahrain another series of protests planned for Friday were immediately crushed by security forces smothering the crowds in tear gas. There were no reports of any deaths. The 60% Shiite population was trying to demand a constitutional monarchy but after weeks of violence they are shifting their claims to a complete change in leadership. The problem with Bahrain is its close relationship with Saudi Arabia. Saudi wants to make sure the revolutionary virus does not spread into Saudi Arabia.

In Libya, NATO appointed a Canadian general to take charge of the no-fly zone but coalition forces are still responsible for the attacks on tanks and artillery on the ground. NATO is expected to take control of the no-fly zone on Monday. The coalition is in danger of fragmenting over the transfer of command from the U.S. to NATO but is still functioning. Several countries have expressed an unwillingness to be a part of a NATO operation and are deciding if they want to allow their airports to handle NATO planes. President Obama is adamant about passing control to somebody besides the U.S. because he does not want to own a third war against a Muslim country going into the 2012 election cycle. This is clearly politics over substance because regardless of who is in "control" of the operation the U.S. will continue to supply the lion's share of the firepower, logistics and surveillance. This is a political move only. The president has been widely criticized about his handling of the conflict (by democrats, republicans and the press alike) and he will try to smooth that over with an address to the people on Monday night. Personally I think the more he tries to shift responsibility the more it will come back to haunt him later.

Our neighbor to the north has some problems of their own. The Conservative minority government collapsed on Friday with the passage of no confidence vote in the House of Commons by 156-145. The vote came after the three opposition parties rejected the Conservative party's budget. According to the rules the country must now hold a federal election with a tentative date of May 2nd. This will be the fourth federal election in seven years. The Conservative party won power in 2006. Despite the news the Canadian markets were flat. Analysts believe the new election will not change the balance of power.

The market ignored all of these problems just like it has for the last week. Baring some new and significant development it will probably keep ignoring them. The one sector that is paying close attention is the energy sector. WTI crude closed at $105.40 on Friday and Brent crude at $115.59. We could be looking back at those prices in a couple months and wishing they would return.

JP Morgan raised their estimates for Brent crude for Q2 to between $120-$130. Think that is high? Bank America said Brent prices could average $122, up from $88, and reach as high as $140. That assumes Libyan crude remains offline for up to six months. "IF" Libya remains offline for the rest of 2011 they expect Brent to average between $125 and $160 per barrel.

I am not sure oil traders believe all of these guidance increases. Volume in crude futures contracts last week was the lowest week of the year and it included an expiration of the April contract. Volume should increase next week as money flows into energy funds increases as the quarter draws to a close. Despite rising oil prices demand is expected to increase as warmer weather arrives and the summer driving season begins. Demand in China has already increased +15% in just the first two months of 2011. Total demand is expected to grow to 90 million barrels per day by 2012 compared to 86.7 million in 2010. Selected energy stocks have been in rally mode for some time but it is not the same across the entire sector. Those with a heavy natural gas component are still lagging. Readers of my OilSlick newsletter have been celebrating the high oil prices.

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WTI Crude Chart

Brent Crude Chart

In stock news Eastman Kodak (EK) rallied +9% on Friday when a federal agency said it will review a patent infringement claim against Apple and Research in Motion. The U.S. International Trade Commission (ITC) agreed to review a judge's finding in January that the iPhone and BlackBerry did not violate the image-preview patent filed by EK in 2001.

Kodak expects to receive more than $1 billion in royalties if the patent is upheld. The six commissioners will decide by May 23rd if the initial determination by the chief administrative judge will stand. Kodak has more than 1,000 patents on digital imaging. Kodak received a one-time royalty payment for $550 million from Samsung and $414 million from LG Electronics on the same patents. The same commission found those companies infringed the same patent in question so the outlook for Kodak is very good.

Kodak Chart

Wynn Resorts (WYNN) rallied $3 on news it had teamed with PokerStars.com in anticipation of a change in the legalization of online gaming. PokerStars is the largest online poker business and is already legal and regulated in many European countries. There is a push on in the Nevada to legalize online poker since millions of Americans already do it illegally. Assembly Bill 258 would require a gaming company to have two years of established business in another state before opening an online business in Nevada. That covers all the major casino chains. Proponents claim Nevada and other states are missing out on millions in taxes by not legalizing the games. If Nevada passes the law you can bet others will pass similar laws in order to not lose out on the revenue stream. Once the law is approved the two companies will launch a joint site called PokerStarsWynn.com. On Thursday Nevada regulators approved a marketing agreement between Caesars Entertainment (Harrah's) and 888 Holdings PLC, an Israeli company that offers online poker and casino games in Europe.

WYNN Chart

Las Vegas Sands (LVS) was upgraded to a buy from hold at UBS on the strength of their business in Macau. In the recently released February statistics the number of arrivals in Macau rose +4.2% from January and +5.2% over February 2010. More than 2.16 million people went to Macau in February and 1.2 million of those came from China.

PC Company Acer, not listed in the states, warned that sales were down -10% in Q1 due to weak demand from the U.S. and Europe. They do not expect demand to increase in Q2. Exports from Taiwan in February rose by the slowest pace since October 2009. Acer has a strong presence in the notebook market and it is being crushed by the tablet revolution. Acer had predicted a sales gain of +3% in Q1 so a decline of -10% is a material change. Revenue in the first two months was down -35.6% from the same period in 2010. The world's No 2 contract laptop maker, Compal, reported a -21% drop and Quanta, the largest contract manufacturer, dropped -10%. This news caused a minor drop in the semiconductor index and barely dented the +4% gains for the week.

Apple fans lined up in 25 countries on Friday to get their chance at buying an iPad 2. Online shopping in several of the countries was showing delivery delays of 3-4 weeks at time of order. That is the same delay online buyers in the U.S. are experiencing. Several of the parts in the iPad are made in Japan but Apple normally contracts with more than one vendor to assure supply. Apple has not announced any delays due to the problem in Japan. In a press release on Friday Steve Jobs asked buyers to be patient saying, "We appreciate everyone's patience and we are working hard to build enough iPads for everyone." Apple shares gained $6.50 to $351 on Friday.

Rumors of an iPhone 5 are already circulating. Several NFC companies are claiming the new phone will offer NFC. That acronym stands for Near Field Communication. It will allow you to use your iPhone to pay for things at a cash register equipped with a pay/pass reader. You swipe your phone near the device like you do with a pay/pass credit card as opposed to actually sliding a card through a reader. The phone is expected to be announced later this summer. Never a dull moment!

Research in Motion crashed and burned with an -11% loss on their Thursday earnings warning. There was also some Internet sniping going on after it was revealed the PlayBook will only run Android apps built for the Android 2.3 operating system for phones and not the 3.0 version built for tablets. Obviously RIMM rushed the announcement so they could say, "thousands of Android apps will run on PlayBook." Unfortunately they will only run in the equivalent of phone mode. RIMMs credibility over the PlayBook product has been damaged due to the long lead-time and some shortfalls in the software and it has not even been released yet.

RIMM Chart

The markets may have been ignoring almost all the negative news but you could tell traders were afraid of what could pop up over the weekend. The markets rallied into the lunch break but the afternoon turned into a siesta. It was not an active sell cycle but simply a conscious effort by some to take profits and avoid weekend event risk. Volume was the second lowest day of the year at 6.4 billion shares but new 52-week highs rocketed to 372 and the most since March 7th.

S&P-500 Chart - 5 min

The Volatility Index ($VIX) declined from over 31 on the 16th to 17 intraday on Friday. That was the biggest seven-day drop on record in the 20-year history of the VIX. The sellers appear to have vanished and the bulls are back in charge. I read some quotes by a fund manager saying they have a bigger fear of under performance than a fear of losing money. In the highly competitive mutual fund field everything rests on not doing any worse than your competition. If everybody is fully invested and market goes down then everyone loses the same. However, if you are under invested and the market goes up then your relative performance suffers.

Money markets continue to hemorrhage cash, with holdings down to $2.732 trillion, according to the Investment Company Institute. That is the lowest number since August 2007 and two months before the Dow and S&P 500 hit their historical highs. Balances have fallen four weeks in a row.

Volatility Index Chart

You may remember my constant comment several weeks ago that funds were hoping for a decent dip to buy. They were hesitant to keep throwing money at a rising market but they had to in order to remain competitive. When the decent dip finally arrived it appears they scraped every penny together to buy that dip. Now that the indexes have risen about 6% in seven days they are broke and hoping for a big cash bonanza to replenish discretionary cash at month end. Hence, the volume on the last four days has been dismal. Despite the low volume the internals have been very positive. As I said on Thursday night all the bad news is already priced into the market.

This honeymoon will eventually end as we get closer to the end of QE2 but for next week we have the end of the quarter window dressing and a bit of investor euphoria as we head into the Q3 earnings cycle. The S&P had its best week since October and is only 30 points away from a new high. The Dow and Nasdaq had their best week since July. It was just a week ago the big cap techs were shrinking because of fears about the broken supply chain from Japan. I don't think I have even heard anyone mention that since Tuesday. Like I said, all the bad news (that is known) is already priced into the market.

I am sure there is a headline in our future that will knock the smile off the bull's faces but we can't go through our investing life always worried about what the next headline will be. We have to weigh the fundamentals and how that plays out in the longer term and then invest in that direction. Those that spend all their time staring in the rear view mirror and worrying about the past problems are doomed to frustration. The market is a highly efficient discounting mechanism. A problem arrives, the markets hiccup and millions of traders decide how that impacts stocks 3-6 months into the future and they invest based on that outlook. That hiccup can take a few minutes, hours or days but seldom does an event appear that will provide a lasting dip when the fundamentals are so bullish.

It took three days for the Japan quake and nuclear disaster to be factored into the market. The quake occurred on Friday the 11th but the real extent of the damage was not known until Monday the 14th and the rebound began on Thursday the 17th. Now, take a minute and decide what event could appear next week that would be worse than Japan? Bernanke drops dead? Gaddafi launches an unexpected missile barrage at a U.S. carrier? Iran tries to nuke Israel? The Fed unexpectedly halts QE2 and raised rates by 50 points? Yes, it would have to be pretty bad to beat Japan. Since the odds of those events happening next week are pretty slim I would say we have nothing to worry about. (I know, famous last words.)

The S&P rallied to just under 1320 on Friday before pulling back -6 points into the close at 1314. That is over the downtrend resistance and the 30-day average at 1310 that many analysts were worried about. It is far enough over 1300 that it would take a serious decline to retest 1300 as support. Overhead resistance is 1330 and I suspect that will be tested next week.

S&P-500 Chart

The Dow is 171 points away from a new high. Do you have any idea how much short covering that would cause if some event pushed the Dow to a +200 point intraday gain? I can't even imagine this close to a quarter end how bullish that would be. I don't want to be a cheerleader for the market as I was called last Sunday but sometimes you have to go with the facts and if that makes me a cheerleader then so be it.

3/19/11 - Jim, I love your analysis but this week felt you're thinking with your heart and not your head. You sounded more like one of those CNBC cheerleaders than the sage investor/advisor that we love. Do you really think the supply disruptions from Japan are not going to weaken the recovery in this era of "just in time supply inventory"? I just don't see how the economy gets better with the mess in Japan, a third war in Libya and the housing market still in the tank.

I replied that I thought all the bad news was already priced in and we should watch the NDX as an indicator of broken supply chain problems. The NDX rallied at the open on Monday and the rest is history.

(Please email me using the link on this page if you ever disagree with my views. I am always open to a different viewpoint and I believe thousands of pairs of eyes are always better than just one. As Nicki Hendrickson said, "It is always good to keep an open mind. Just not so open that your brains fall out.")

On Friday the Dow rallied to strong resistance at 12250 and +89 points before giving back -39 to close at 12220. Considering how strong the resistance is from 12250-12275, I believe that was a pretty bullish end to an amazing week. With the close at 12220 the Dow is poised to break that resistance with even an average day next week. Over 12275 it should gain speed. If it fails there I would not expect a material pullback but more of a consolidation in place until the momentum returns.

Remember, this is quarter end on Thursday. Cash flows into funds should be positive and window dressing is in full bloom.

Dow Chart

The Nasdaq chart is really interesting this weekend. The Nasdaq declined farther into the close than the other indexes leaving a "shooting star" candle. That is normally a bearish pattern. The $64 question this weekend is this. Is this one bearish because the rally ran out of steam OR is it simulating a bearish candle because of the fear of weekend event risk? I believe it was the latter. The Nasdaq was up +4% for the week and there were plenty of profits at risk. I believe traders simply took some profits off the table before heading out to happy hour.

Note that the Nasdaq closed right on what should be decent support at the convergence of the 30/50 day averages. The intraday high was 2762 and just below decent resistance at 2766. That 20-point buffer between resistance and the close should allow some upward movement before having to do battle with the sellers. Support would be back at 2700 if the averages fail.

Nasdaq Chart

Nasdaq 100 Chart

The Russell 2000 came within SEVEN points of a new high before profit taking appeared. With any luck at all I believe the end of quarter gains could see that new high next week, even if it is just an intraday print. I know that sounds like cheerleading but baring some unforeseen headline or monster earnings warning the window dressing should push through that resistance at 830. Once past that level we could see short covering works its magic.

I don't like the long shadow on the top of Friday's candle but remember the weekend event risk. After better than a +5% gain for the week we were due for some fear of darkness profit taking.

Russell 2000 Chart

Here is where reality must be discussed. As you can see from all the charts above there is a good possibility of a retest of the multi year highs on the Dow and Russell. It is possible on the S&P but I would not bet on it. In the interest of fair and balanced reporting there is a possibility of that retest turning into a double top instead of a breakout. That means, if those highs are retested, we need to be conscious of the potential for a strong failure at that level. Traders/funds who have been cussing themselves for the last month for not exiting at the February highs could get another opportunity next week.

Personally I think the EOQ window dressing will keep the indexes up until the following Monday/Tuesday but the potential for profit taking in the new quarter will be strong. Q1 will be in the books and funds may become more conservative ahead of the next FOMC meeting and the Bernanke press conference on the 27th. However, earnings start the second week in April so managers may try to squeeze another week into the books before worrying about the Fed. That would get us to option expiration on the 15th. After that all bets are off.

That is a short term "what if" thought process. I still believe the longer-term fundamentals will eventually win out and we will see the S&P at 1400 later this year but that does not mean there are no land mines and retracements in our path.

Jim Brown

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"You can't just wish for it, you have to work for it." - Nicholas Sheldon