The earnings cycle continued to provide big gains for those who beat and big losses for those who disappoint. Fortunately the winners outnumbered the sinners once again.

Market Statistics

Thankfully the earnings parade continues to be strong because the economic reports are continuing to worsen. If this divergence continues the end result is not going to be pretty. Eventually economics will trump earnings because a weakening economy will eventually weaken earnings.

The weekly Jobless Claims rose again to 429,000 and the highest level since January 22nd. This was an increase of 25,000 for the week. This is the third consecutive week over 400,000 claims after four weeks below that level. The trend lower appears to have ended and this is troubling news for the future.

The key question is whether this is just a blip or the start of a new trend? This could be just the result of the various shutdowns by automakers due to parts shortages. Automakers had planned on building 3.6 million cars in the second quarter but current estimates are for 500,000 fewer vehicles.

Jobless Claims

The first reading on the GDP for Q1 at +1.75% growth and well below earlier estimates over 3% and the actual Q4 growth of +3.1%. This was below the already lowered estimates at +2.0%. Weaker growth in fixed investment and stronger imports were blamed. Final sales of domestic products rose only +0.8% in Q1 compared to +6.7% in Q4. Personal consumption expenditures rose only +2.7% compared to 4% in Q4. Sales of durable goods did rise strongly by +10.6% but that was only 25% of the Q4 growth rate.

Analysts continue to predict these numbers will improve as the year progresses but their claims are growing weaker as the year progresses. Overall estimates for the full year are now in the 3.1% to 3.5% range but shrinking.

The fear is growing that rising fuel prices will weigh on the economy and eventually create a new recession. This is a very strong possibility with the average U.S. price for gasoline at $3.89 today.

GDP Chart

The headline number on the Kansas Fed Manufacturing Survey declined to 14 for April from 27 in March. This nearly 50% decline is another confirmation of the sudden decrease in manufacturing activity in April. We saw this in the Philly Fed Survey that fell to 18.5 from 43.4 and the Richmond Fed Survey that fell to 10 from 20. It appears the decline was not localized and should it continue at this rate we could be in serious trouble.

New orders dropped from 31 to 11, a 65% drop. Backorders fell to 9 from 25. The employment component fell to 17 from 25 and capital expenditure plans fell to 4 from 14. These are major declines that indicate sentiment is deteriorating rapidly.

Analysts believe it is due to the rising fuel prices and the supply chain problems from Japan. However, we are seeing it in multiple geographic locations and industries so the supply chain argument is questionable. So far analysts have yet to predict the end of the rebound but you have to think those predictions may not be far off.

Economy.com Richmond Fed Survey Chart

On the positive side the Chicago Fed National Activity Index rose slightly from 0.16 to 0.26. However this was a lagging report for March and prior to the sudden decline in activity in April.

The Pending Home Sales Index, also a lagging report for March, rose to 94.1 from 89.5 in February. Contract signings were higher in all markets. Despite the gains in the index the actual sales are still lower than the same period in 2010. The index itself is -11.4% below the same period in 2010. The risk to home sales are weighted to the downside as fuel prices rise and the spring selling season passes.

The economic calendar for Friday has two ISM reports and the final reading on Consumer Sentiment.

Economic Calendar

Thank goodness for continued decent earnings. The winners outweighed the sinners again today and that helped push the indexes higher. So far 44% of the S&P has reported and 76.6% have beaten on earnings and 70.9% have beaten on revenue. Earnings are currently expected to end the cycle showing an average of +16% growth. That is also the full year estimate.

Time Warner Cable (TWC) started the morning off with a +52% increase in profits thanks to a big increase in the number of cable customers adding Internet and phone service as well. TWC added +189,000 high-speed Internet subscribers bringing their total to more than ten million. It also lost 65,000 basic cable viewers as more people switch to Hulu.com, Amazon and NetFlix. TWC posted earnings of $1.01 per share compared to estimates of 98-cents. TWC shares rose on the news.

Starwood Hotels (HOT) said earnings declined due to the problems in the Middle East an the tsunami in Japan. Earnings declined to 14-cents from 16-cents in the comparison quarter. Analysts were expecting 25-cents. Turmoil in Tunisia, Egypt, Libya and Bahrain caused widespread cancellations. There were also multiple blizzards in the Northeast early in the quarter that slowed bookings.

Starwood predicted earnings of 42-46 cents in Q2 and raised estimates for the full year to $1.60 to $1.70. Prior predictions were $1.55-$1.65. After spiking early on the guidance the stock closed on its lows for a minor loss.

Driller Helmerich & Payne missed street estimates and was severely punished. Earnings of 93-cents missed estimates of 97-cents. The decline in profits came from disruptions in activity by events in the Middle East. Nabors (NBR) blamed the same disruptions in Yemen and Oman for its earnings problems on Wednesday.

Relatively speaking the HP earnings were still great compared to the 53-cents earned in the comparison quarter. Revenue of $604.4 million was well above the $592 million expected. HP builds and operates very high specification land rigs specially designed for horizontal drilling. HP has 240 rigs operating in the U.S. and signed deals to build and operate eight more FlexRigs during the quarter. HP shares declined -7% on the news to $65.

HP Chart

Exxon (XOM) posted near record earnings of $10.65 billion for Q1 thanks to the rise in oil prices. That was a +69% increase in profits from Q1-2010. Exxon reported earnings of $2.14 per share compared to estimates of $2.04 on sales of $112.6 billion. Exxon was quick to point out that only 3-cents of every dollar earned came from sales of gasoline and diesel fuel. Most of Exxon's profits come from oil and natural gas sales outside the USA. Oil companies have no control over the price of oil or gasoline. With gasoline prices averaging over $3.89 nationwide and now over $4 in eight states the call to end tax deductions for oil companies is quickly growing. Exxon paid $26 billion in taxes for the quarter including $8 billion in income taxes.

Most people hear $11 billion in profits and $4 billion in tax deductions and think that is an easy answer. Unfortunately that is $4 billion across the entire sector not just on Exxon. That means hundreds of smaller companies that make far less and are struggling to finance ongoing exploration programs would lose deductions for things they depend on to explore and produce oil. Eliminating the tax deductions, commonly referred to as subsidies because it sounds better politically, would probably only cost Exxon a few million but the bulk of that $4 billion would come from hundreds of smaller companies and result in less money available to drill and produce oil in America. This is a bad idea!

Gasoline demand fell for the fourth consecutive week and was down -1.6% last week according to the EIA. The rising prices for fuel are going to be economically crippling. I have been warning about the coming fuel price recession for over a year now since prices were just over $60 a barrel. I keep telling everyone to prepare themselves for even higher prices as we move into 2012. WTI crude traded up to $113.97 intraday and although it weakened into the close it is only temporary.

Crude Oil Chart

After the bell Microsoft (MSFT) reported earnings of 61-cents but that included a 5-cent tax gain putting the earnings only a penny over estimates of 55-cents. Revenue increased +13% to $16.4 billion. Windows revenue fell -4% and slightly more than the drop in PC shipments reported by IDC. The earnings were not impressive even though earnings rose +31%. They are seeing an erosion of PC software sales due to the wave of new tablets displacing new PC sales. Microsoft said there was a -40% decline in the sales of netbooks in the quarter. The two bright spots were sales of its Office software, which rose +21% and a +60% gain in the entertainment division with the Kinect device. MSFT shares fell -2% in afterhours trading.

Microsoft Chart

Akamai (AKAM) posted earnings of 38-cents that beat the estimates by 2-cents but then guided lower on second quarter sales. The company said sales would be in the range of $270-$280 million and analysts had been expecting $280.7 million. The company said it had to offer discounts to induce sales. Shares declined -15% on the news to $35.

AKAM Chart

The biggest gainer for the day came from Carbo Ceramics (CRR). This drilling service company produces proppants to inject into the well when fracturing the shale. These proppants are blown into the cracks created by fracturing and keep the cracks open when the frac fluids are withdrawn. Sales spiked +22% to $150.8 million compared to estimates of $129.5 million. Earnings rose +59% to $1.30 compared to estimates for $1.02. Shares rose +$21 on the news.

Carbo Ceramics Chart

Citrix Systems (CTXS) posted an 18% increase in revenue and earnings of 41-cents. That was well above the analyst estimate of 32-cents. Gross margins were a whopping 88.3%. Product licenses were up +22% and license renewals were up +17%. Technical services revenue rose +44%. It was a good quarter for Citrix and shares rallied +10% on the news.

Citrix Chart

Also after the bell Research in Motion (RIMM) warned that sales and earnings would fall short of prior forecasts. RIMM now sees earnings in the range of $1.30-$1.37 compared to prior forecasts of $1.47-$1.55. This is the second guidance warning in the last month. RIMM said the decline was due to lower shipment volumes of its BlackBerry phones and higher sales of its cheaper devices. The company now believes shipments will be at the low end of the 13.5-14.5 million forecast from March. RIMM shares dropped -$6 in afterhours and would probably have fallen further except that the company left intact its full year earnings forecast of $7.50 per share. Personally I seriously doubt that will happen and they are saving that forecast adjustment for a later date.

RIMM Chart

The dollar continued to fall to another three year low after Wednesday's FOMC statement and press conference pretty much confirmed rates would stay low for the rest of the year. While bad for our buying power it is bullish for stocks and commodities.

Dollar Index Chart

Gold soared to another new high today and now solidly over $1500 and traders starting to talk about $1600 in May.

Gold Chart

Silver Chart

The earnings parade, despite some ugly ducklings trailing behind the star performers, has pushed all the indexes to new highs. It would appear the bull market is starting to build a new leg higher but I would hesitate to rush to that conclusion. This is the last week of the month and buying this week and next is normally stronger because of the influx of retirement funds. Income tax refunds are bring put to work in the market and the cheaper dollar is pushing stocks and metals higher. This can't last forever. We are approaching the sell in May point and several noted analysts have been predicting this could be a stronger than usual cycle.

Citi's Chief Equity Strategist, Tobias Levkovich, said today he believes the chances for the sell in May cycle are particularly strong this year. He said the 100% rebound from the March 2009 lows is a critical sentiment level and once earnings begin to slow the buying should slow also. He said the market really has some overlying negative sentiment from retail traders who have never believed in this rally. He cited the billions that moved into money market and bond funds and only a trickle has come back to equities. He cited the continued low volume and the weakening economics.

Nobody is specifically predicting another recession over the summer but the markets are typically weaker in the May-September timeframe thanks to slower earnings and a slow down in activity as workers take vacations.

If you look at the S&P it is clearly in breakout mode and well over 1340. The next material resistance it 1425 but as I mentioned last week we are starting to hit S&P targets from some of the less optimistic analysts. Those targets start at 1350 and we are only one good day away from that level. As targets are hit the cautious will begin to take profits. The average looks to be in the 1400-1425 but there are estimates up to 1550. I would expect getting over 1400-1425 would take a major change in sentiment and I see no catalyst on the horizon to make that happen before fall.

I received two different newsletters after the Bernanke press conference that were calling a market top for this week. I am not in that camp but I certainly understand their rationale. If internals begin to weaken next week as the earnings cycle slows and end of month contributions dry up it will be very easy to justify a switch to a short-term bearish posture. The problem with that is the number one rule in the market. Don't fight the Fed. Bernanke clearly said there will not be any rise in rates likely this year and there will be a two meeting warning when that bias is likely to change. Rates are going to remain low and the dollar is going to continue falling. Both of those are positive motivators for the equity markets.

S&P Chart

The Dow is clearly in breakout mode. It blew through minimal resistance in the 12,600-12,700 range without even slowing. The next material resistance is 12,950-13,075 with strong round number resistance at 13,000. Caterpillar will report on Friday and they are expected to report a blowout number. However, those expectations may be overdone. I fear the Dow is very overextended and is due for some profit taking.

Dow Chart

Both Nasdaq indexes struggled on Thursday but the troubles were not really tied to a broad weakness in tech stocks. Novellus did miss earnings and the semiconductor index closed lower but the real problem is the Nasdaq-100 rebalance on Friday. This has been lost in the shuffle on the network TV shows but we saw clear evidence of it today.

To refresh, the Nasdaq-100 will be rebalanced at Friday's close with the weighting on the current top 18 stocks reduced and the bottom 82 stocks will be increased. That means stocks representing about 40% of the current weighting in the Nasdaq 100 will sold to reduce their weighting to about 20%. The bottom 60% will see their weighting increase. Since the new weightings won't take affect until Monday's open we will see negative pressure on the index on Friday. On Monday that will turn into a positive pressure as the lagging funds continue to add to positions in those 82 stocks with increased weightings.

This should produce some increased volume on Friday. For those who don't know what is happening they may see a decline in the Nasdaq and interpret that as market weakness rather than rebalance noise.

Nasdaq Chart

Nasdaq-100 Chart

The Russell 2000 rallied to a new historic high at 861 and is also in breakout mode but is due for some profit taking. Prior uptrend support should now be resistance but when charts are in breakout mode that resistance tends to be ignored.

Russell 2000 Chart

The Dow Transports hit a new historic "closing" high at 5510 and just short of the historic intraday high at 5536. It is amazing to me the transports can be making new highs with oil prices closing in on $115 a barrel and airlines losing money by the plane load. This is the power of positive expectations for global growth but I fear those expectations may be developing some cracks soon if oil prices don't decline.

Dow Transports

In summary I expect the Nasdaq to struggle on Friday due to the rebalance at the close. The Dow may struggle if expectations for CAT prove to be overdone. The London metals markets will be closed on Friday and Monday due to the royal wedding so metals trading could be either extremely calm or extremely erratic.

With 500,000 people expected to turn out to watch the wedding and the parade it will be a monster terrorist target. The country is doing everything possible to prevent a tragedy but fears of a potential event could cause traders to want to take profits before Friday's close. Earnings have been very good but next week begins the downhill slide as the frequency and quality of earnings begins to decline. I would be cautious about entering new long positions on Friday.

Definitely, enter passively and exit aggressively.

Jim Brown

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