Another day of dismal economics and news headlines from the European debt crisis and another day of declines in the equity markets. Investors may be growing numb to the news because the damage was minimal.

Market Statistics

The Dow and S&P traded down to support on Monday and then retested that support on Tuesday but there was no rebound. The Nasdaq closed slightly below support and was the biggest percentage decliner. Volume continues to decline as we head for the holiday weekend and the normal bullish sentiment ahead of a three day weekend appears to be lacking.

Leading the market lower this morning was a really ugly report in the form of the Richmond Fed Manufacturing Survey. The headline number fell into contraction territory with a -6.0 reading and the third consecutive month of decline since the high of 25.0 in February. The -16 point decline pushed the index to the lowest level since April 2009.

The decline in the individual components was very steep with the major components going seriously negative. The shipments component, which is the difference between new orders and inventories fell to -27 suggesting there has been a sudden halt in consumption. Shipments, new orders and back orders are now at multi-year lows.

Richmond Fed Table

The headline number fell back into contraction territory. This is not just slowing growth but now it is declining activity. The only positive was a flat payroll component at 14.0 indicating manufacturers are still adding employees even though business activity is slowing. You can bet that won't continue very long if conditions don't improve quickly.

Adding to their problems the survey respondents reported raw materials prices rose to the highest levels since the survey was created.

Richmond Fed Chart

Offsetting the Richmond Survey was an unexpected rise in New Home Sales to 323,000 from 300,000 in the prior month on an annualized basis. The consensus estimates were for a decline in sales to 294,000. The +7% increase in sales pushed the months of supply on hand to 6.5 and the lowest level since early 2010 when the sector was benefiting from the homebuyer tax credit. Even with the increase in sales the pace of sales is still -23% below the same period in 2010 but that was with the tax credit so the comparison is skewed.

This report is encouraging but the foreclosure problem still exists. More than 219,000 homes went into foreclosure in April and only slightly more than 21,000 foreclosed homes were sold. There is roughly a four-year supply of bank owned properties either on the market or in the process of coming to market.

Sales are improving but at a very slow pace. April-June are key home sales months for moves before school starts in the fall. Once out of this seasonal period we could see inventory begin to build again. A "normal" rate of sales for new homes is in the one million range.

There are no material events on the calendar for Wednesday with the GDP and Kansas Fed Survey the next two reports to watch on Thursday. Most traders will be heading out the door for a long weekend by lunchtime on Thursday so unless the GDP is dramatically different than the first release it will not move the market.

Economic Calendar

Goldman Sachs must have covered their commodity shorts from early April because they are now recommending investors initiate new long positions in oil, copper and zinc. Goldman increased their forecasts for crude prices by 20%. You may remember Goldman told investors to sell commodities at the beginning of April and that was a good call with oil, gold, silver, copper all declining sharply. Now Goldman is predicting Brent crude will rise to $130 over the next 12 months and average $120 in 2011 and $140 in 2012. Goldman said global economic growth will likely be sufficient to tighten key "supply-constrained" markets in the second half, leading to higher prices from the current levels. The company said the sustained loss of Libyan crude coupled with disappointing output fro non-OPEC nations will tighten the oil market to critical levels in early 2012. Brent closed at $112.65 today.

Not to be outdone Morgan Stanley raised their estimates to $120 for 2011 and $130 in 2012. JP Morgan joined the crowd with a call for $130 oil in Q3-2011. Morgan Stanley said OPEC will likely raise production levels by 1.5 million barrels per day at the June 8th meeting and that will cut into their "2.0 mbpd of excess capacity." Also, "We see prices moving higher as spare capacity continues its fall to "untenable levels." This is a key point. OPEC claims they have 4.5 mbpd available but most analysts, including myself, believe they only have two million. We are rapidly approaching the point where their credibility will be tested.

Goldman made the new call after net long positions in crude futures declined by -11% for the weekend ended on May 17th. Long positions are now at their lowest level since last July. This was also due to the hike in margin requirements over the last month. The smoke seems to have cleared and with summer driving kicking off next week we should see prices rise as longs come back into the market.

Brent Crude Futures Chart

This appears to be the week for big IPOs. AIG priced 300 million shares today at $29 and will generate $8.7 billion in proceeds. 100 million shares are being sold by AIG and 200 million by the U.S. Treasury. The breakeven point for the Treasury shares is $28.73 and the government has said it would not sell its shares for a loss. That would be political suicide for the current administration and give candidates plenty of headlines to use in the current election cycle. This sale reduces Treasury's stake from 92.1% of AIG to 76.7%. If the shares continue to decline, which they should given AIG's deteriorating fundamentals it will be very hard for the Treasury to further reduce its stake. Shares of AIG declined to $29.18 in after hours.

AIG Chart

Russian Internet giant Yandex (YNDX) raised $1.3 billion by selling 52.2 million shares at $25 per share. The anticipated range was $20-$22 so it prices above its range. This values the company at $8 billion. More than 36.8 million shares sold came from early investors in Yandex. The stock spiked to open at $42 and quickly declined as more than 15 million shares were sold in the first five minutes.

Yandex Chart

After the close today S&P announced Alpha Natural Resources (ANR) would replace Massey Energy (MEE) in the S&P-500 at the close of trading on June 1st. Alpha is buying Massey so this is a natural progression of events. Alpha shares were up $1 in after hours trading.

Applied Materials (AMAT) reported earnings after the bell that rose +85% to 38-cents per share and beating analyst estimates by a penny. Revenue of $2.86 billion also beat estimates of $2.77 billion. While the actual earnings were good news the guidance that came with them was terrible. AMAT said sales would fall up to -10% in Q3 with earnings as low as 31-cents. Analysts were expecting 37-cents. Shares of AMAT declined only slightly after the report because they were downgraded pretty severely over the last couple weeks.

Take Two Interactive (TTWO) posted a loss of 18-cents compared to earnings of 4-cents in the year ago quarter. This was significantly better than their prior forecast for a loss of 40-45 cents. The CEO said they had made significant strides in diversifying their product line and would be profitable for the next two years. TTWO is always at the mercy of the video game release cycle. Quarter to quarter comparisons are very tough since revenue tends to pile up in quarters where new titles are released. Two of their biggest games are Grand Theft Auto and Red Dead Redemption. They have a very large pipeline of titles coming in 2012 and 2013 with earnings expected to double in 2013. Shares dipped about a dollar in after hours but immediately recovered on the guidance.

Take Two Interactive Chart

Foxconn, the Chinese company that makes iPads for Apple and notebooks for Hewlett Packard said it closed all its plants pending a safety review after an explosion killed three workers and injured more than a dozen others last week. The plants are only expected to be closed for several days but the crimp in the supply chain could be significant. The factory that exploded produces 20% of the iPads sold by Apple. Apple is expected to sell between 32-40 million this year and they are already on backorder. Depending on the length of the closure and any repairs required this could cause a delay of 200,000-300,000 units. Foxconn said it was attempting to shift production into other plants to avoid a serious slowdown. Since they were already working 24/7 and running behind with orders it remains to be seen if they can avert a further slowdown. Apple shares declined another $2 today.

The markets today suffered from Bill Murray's Ground Hog Day syndrome. Every day we are deluged by more bad news from Europe, declining economics, declining volume and weak indexes. Nothing has changed in the last two weeks and until something does change I believe we will continue grinding lower. The S&P closed right on the bottom of the down trend channel and right on support of the 100-day average. This is a logical place for a bounce but I would expect it to only be a minor gain. With the holiday weekend ahead we don't know if investors will turn normally bullish OR become more risk averse about a three day weekend with daily debt crisis in the news. They could see this as a reason to run and hide rather than go bargain hunting.

If the S&P does break below the 100-day (1314) I expect it to test 1295.

S&P-500 Chart

Despite gains by Exxon and Chevron the Dow declined to close below the 50-day average at 12,397 and a new lower low. The Dow appears on track to test the 100-day at 12,201. There were no big losers with Boeing (-0.71) and AXP (-0.56) the biggest decliners. The Dow is suffering from low volume and lack of investor interest. Odds are good we will continue to slide lower without any major events to power any short covering.

Dow Chart

The Nasdaq has already broken the same support levels the Dow and S&P are currently testing. This suggests those tests on those indexes will fail. The Nasdaq has fallen below both the 50 and 100-day averages and the next support target is 2725 followed by 2675.

The Nasdaq big caps are continuing to decline and the semiconductor index closed at a new two month low today. There is simply nothing positive to power techs higher. PC sales are declining, chip sales are flat to down and $4 gasoline is pressuring consumers to hold off on those impulse purchases.

Nasdaq Chart

The Russell is a day ahead of the Nasdaq. The Russell closed at a new two month low on Monday with a break under the 100-day average. Today's decline to close at 810 appears to be targeting 775-780 in what would be a decent decline ahead of summer. This break of support suggests fund managers have turned negative on the market and there are lower lows ahead.

Russell Chart

Normally three days before a holiday weekend we could expect to see the bullish sentiment return. Unfortunately I don’t think it will happen this week. The economic and geopolitical news is depressing sentiment and the daily declines are making investors shy about putting more money to work.

The European debt crisis is a big factor because most investors/traders don't understand the relationship to our markets. They only understand that every headline causes a new decline in the indexes. This is chasing more investors to the sidelines and the fear of a three-day weekend is now a negative factor.

We could see a short squeeze any day but that would require some unexpected piece of good news and I see nothing on the horizon to produce that news this week. The most likely direction is still down.

Definitely, enter passively and exit aggressively.

Jim Brown

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