The major indexes completed their fourth consecutive week of losses with the exception of the Russell 2000 and NYSE Composite. The NYSE was higher thanks to influence from the energy sector.

Market Statistics

It was definitely a holiday Friday; the news was light and volume even lighter. Only 5.3 billion shares traded and the lowest since April 25th, the Monday after Easter. Everyone was focused on their plans for the holiday weekend rather than trading.

More than 35 million people will travel over the weekend and 31 million of those will travel by car. That is an increase of +0.5% over 2010. They are fortunate that the national average for gasoline has declined to $3.81 per gallon and as low as $3.60 in the Midwest. Only New York, California, Chicago and DC are still averaging about $4.06 per gallon.

Two surveys were taken last week and the results were slightly different. In one survey 76% of the responders said the high gasoline prices were impacting their plans for the weekend. However, in the other survey 65% said it would not change their plans for driving. The way I read that is simple. The distance to grandma's house or the beach has not changed. If you always go to a relative's house or the lake for Memorial Day then your distance traveled will not change. However, reading the headline from the second survey in another way it suggests 35% of consumers DID change their plans because of high gasoline prices.

Friday's Consumer Sentiment Survey showed an unexpected rise in sentiment to 74.3 from 72.4 for May. That is a +4.5 point increase from the April reading. The complete March decline has not yet been erased but we are making progress. The present conditions component declined slightly from 82.5 to 81.9 but the expectations component rose sharply from 61.6 to 69.5. Inflation expectations declined from 4.6% to 4.1%.

Analysts seem to believe we went through a soft patch in March and early April and that softness is easing thanks to the falling gasoline prices and the worry over a nuclear disaster in Japan spreading to the USA that failed to come to pass.

Consumer Sentiment Chart

It is strange that sentiment improved as well as it did with another report showing Pending Home Sales Index for April declined by -11.6% to 81.9 from 94.1. Analysts blame the drop in contract signings to severe weather and rising oil prices. The index fell in all regions with the exception of the Northeast. Nationally sales are now -26.5% below the April 2010 level. That was the end of the homebuyer tax credit and the cyclical peak in the index. Obviously making comparisons to that period are going to be tough. Sales slipped to the lowest level since Sept 2010.

On the flipside home affordability today is at an all time high. Foreclosures are expected to decline by year-end and the summer buying season will help reduce some of the excess inventory on the market.

Moody's Pending Home Sales Chart

The economic calendar for next week is packed full of critical events. Three different ISM reports culminating with the national ISM on Wednesday. Expectations are for a decline in the Chicago and national ISM reports.

Also on the list are three employment reports led by the ADP report on Wednesday and ending with the Non-Farm Payrolls on Friday. That is the most important report for the week and even more so after the sharp downturn in the regional Fed surveys. However, everyone expected a sharper decline in hiring last month and it did not happen. Will hiring in May also be better than expected? Estimates are for a gain of 185,000 jobs compared to the +244,000 gain in April.

The national ISM and the Non-Farm Payrolls are going to be the major potholes in the market's path next week.

Economic Calendar

Friday's equity rally was powered by a sharp decline in the dollar because of the continued decline in our economic reports. This was a reaction to the lackluster +1.8% GDP growth for Q1 that was reported on Thursday. The sharp drop in the dollar was accentuated by a +1.50 rise in the Euro. The dollar was weak because a sagging economy suggests it may be a long time before the Fed begins to raise interest rates. The Financial Times reported a Eurozone officer as saying China may buy euro bonds in June and that would reduce demand for U.S. treasuries. The ECB raised its interest rate to 1.25% in April compared to the Fed's interest rate at less than 0.25%. Analysts believe the Fed will not increase rates until 2012-Q1 at the earliest. If the economy continues to weaken it could be a lot longer.

Dollar Index Chart

Euro Chart

In stock news Broadcom (BRCM) moved sharply higher after FBR Capital Markets said they had the potential to become one of the world's largest suppliers of chipsets for smartphones. FBR added Broadcom to their "top picks" list. They rate the company an outperform. FBR believes Broadcom is poised to benefit from the rapid growth of the 4G smartphone mania. Broadcom reported a weak view of Q2 revenue when they reported earnings. They said weakness in orders from major customers was the reason. FBR feels this is a temporary pause in what will be an increasingly busy market.

Broadcom Chart

Another chipmaker, Marvell Technology (MRVL) survived missing estimates by a penny on Thursday night and rallied +11% on Friday thanks to some strong guidance. Marvell reported earnings of 29-cents with analysts expecting 30-cents. Shares initially declined but immediately reversed after the company raised estimates for Q2 and the full year. Marvell said Q1 would be the low point for the year and projected earnings of 37-cents for Q2 compared to analyst estimates for 34-cents. Marvell predicted revenue from the mobile and wireless market to grow in excess of 20%.

Marvel Chart

Abbott Laboratories (ABT) got its second dose of bad medicine on Thursday when federal scientists halted a large study of the drug Niaspan when it failed to reduce heart attacks and slightly increased the number of strokes among patients in the study. Niaspan is an extra strong prescription strength dose of a form of Niacin that raises good HDL and lowers LDL and triglycerides. Raising good cholesterol (HDL) was thought to reduce the impact of the bad cholesterol (LDL) and lead to fewer heart attacks. It is not without some serious side effects but it does work well in patients that are either not getting the desired results with a statin drug or are allergic to statins.

I have taken Niaspan in the past because I am allergic to statins so I paid particular attention to the news on Friday. Niaspan has been taken for decades and it is a fairly expensive drug at $325 per month for the 2,000MG per day dose. I am sure it will continue to be sold and be effective for its original purpose. They just can't claim the rise in HDL will reduce heart attacks. Abbott received just over $900 million in revenue from Niaspan in 2010. Several analysts slashed their estimates by half for 2011 to account for a possible decline in sales.

Only a week ago Abbott was told by a panel of advisers that the drug Trilipix would need to be relabeled to indicate that it failed to lower heart attacks in a study of diabetics. Trilipix is a fibrate that was advertised to lower triglycerides while boosting HDL.

Abbott's cholesterol drugs account for $2.6 billion or 7% of its total revenue. The small drop because of the label changes in both these drugs should be inconsequential toward Abbott's earnings. They will likely offset any decline in sales by cost cutting or repricing to account for the drop. Wells Fargo cut 6-cents from their projected 2010 earnings of $4.90 per share. That lessened the impact to the stock to a decline of only 59-cents on Friday but there was a dollar loss on Thursday as well.

Abbott Chart

Medco Health Solutions (MHS) was crushed on Friday after Blue Cross Blue Shield chose CVS Caremark (CVS) over MHS for a three-year contract worth $3 billion. MHS had the contract and filled 9.8 million mail-in prescriptions for Blue Cross but BCBS opted to renew the contract with CVS instead of MHS. Medco earnings won't be impacted until 2012 because the existing contract still has time remaining. Lazard Capital said the contract was worth 35-cents a year in earnings for MHS or roughly less than 10% with projected earnings in the $4.07 range. MHS lost -9% while CVS gained +2%.

Medco Chart

Polo Ralph Lauren (RL) was knocked for a major loss on Wednesday after reporting earnings that missed street estimates. RL dropped -$14 on the news. By Friday's close they had gained $11 of that back. Several analysts reiterated their buy ratings on the stock and went out of their way to call the drop a buying opportunity. Obviously somebody was listening.

Polo Ralph Lauren Chart

Lululemon Athletica (LULU) continued its plunge from a harsh downgrade on Thursday. FBR cut their rating to underperform (aka "reduce" rating) from market perform or neutral. Analyst Lizabeth Dunn said the shares were priced to perfection and there was earnings risk for the June 10th earnings. A Nomura analyst reiterated his "reduce" rating and a price target of $47. LULU closed at $90 on Friday.

LULU Chart

Happy Memorial Day and welcome to the official start of the summer doldrums. To celebrate the kickoff of summer most people eventually end up at a group barbecue or dinner of some sort. This year it will cost a lot more to feed the hungry mob because of the rise in food inflation. One survey estimated it would cost $199 to feed a group of twelve. That is a $45 increase over Memorial Day 2010.

The cost of food has rocketed higher over the last year but fortunately that is not included in the government's inflation numbers. (Sarcasm) For instance ground beef for those hamburgers is up +14%, lettuce +28%, tomatoes +86%, potatoes +27%, and corn on the cob +150%. An ear of corn cost 20-cents last year and 50-cents this year. This is due in part to 43% of the 2010 corn crop being used as ethanol. Gasoline to get you to the picnic will cost +37% more and coffee after desert is up +83%. However, a case of beer only rose +3% so buy an extra case to help you forget about the price inflation for the picnic.

In some areas of the country Memorial Day also marks the first weekend of swimsuit season. For some that is exciting but for others it is the start of torture season. Another survey found that 41% of U.S. adults would rather go to the dentist than go shopping for a new swimsuit. Those self-conscious individuals will spend the summer making up excuses for not going to the beach or appearing in public partially clothed. For me, I am scheduling a dentist appointment. Maybe several!

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As we head into June the outlook is not bright. So far in May the Dow has declined -2.8% from the 12,810 high close on the last day of April. That is -369 points and relatively speaking the decline has been rather painless. There were some big moves but most were erased the next day or even the same day with rebounds. If we are going to have a correction this is definitely preferable to a -10% drop in two weeks. This type of move allows traders to enter and exit positions within the trend without the stomach churning volatility that accompanies many corrections.

There are still stocks making new highs with 220 on Friday alone. That was the most in more than a week. There were only 64 new lows on Friday.

It should be no surprise to anyone that the economy is going through a soft patch. We report on it almost every day. However, the election cycle is in full bloom and we know from experience that politicians will do everything possible to add stimulus in some form in order to get reelected. They just may not call it stimulus this time. That should keep the markets from declining to far although the debt ceiling confrontation is going to add some negative sentiment. Once we are past that hurdle and the politicians have gamed the event to their best advantage the markets should begin to rebound. Unfortunately that scenario has a couple of months to run with August 2nd the unofficial drop dead date on the debt ceiling.

Most of us would ignore the possibility of a U.S. debt default the same way we ignore the possibility of a large asteroid strike eliminating a major U.S. city. However, the background chatter has increased to the point that credit default swaps on U.S. debt have more than doubled in volume over the last year. The Financial Times reported that the amount of one-year credit default swaps on U.S. debt has increased to $24 billion in derivative value today compared to only $12 billion for the same month in 2010.

Zero Hedge reported treasuries held in custody by the Federal Reserve for foreign accounts this week experienced their biggest drop in four years. That could suggest foreign investors and central banks are scaling back their investments in U.S. debt. On the other side of that coin the yield on 10-year treasuries has been falling as investors buy treasuries as a safe haven as the economy weakens. The yield on the 10-year closed at 3.06% on Friday, nearly a six month low and well below the 3.6% on April 8th.

Some analysts are predicting a rocky June. Even though the end of QE2 has been known and discussed for months there is still the uncertainty about what will really happen to rates when it expires. If the economy was accelerating the rate would not be that material but in a declining economy real interest rates are critical.

The current worry is that the current soft patch will turn into a rough patch or even another recessionary dip caused by high fuel prices. That was not supposed to happen until the middle of 2012 but the Libyan crisis took 1.3 mbpd out of circulation and accelerated the coming oil crisis.

Regardless of the filler surveys on how gasoline prices are affecting Memorial Day travel they are affecting the daily lives of consumers. The rising prices have slowed the economy and that decline was rather dramatic. I believe it is because consumers have a very vivid recent memory of the price spike in 2008 to make them pay attention in 2011. They did not wait as long this time around to park the gas-guzzler and avoid the weekly trips to Wal-Mart. Fool me once shame on you, fool me twice shame on me. Consumers were not going into debt again over gasoline prices.

John Mauldin has made the term "muddle through economy" famous. He claims it means years of slow below trend growth and more susceptible to short term recessions. We definitely have the slow growth and unless it changes almost immediately we could drop back into a recession. However, various analysts are now calling for the summer to be a short-term version of the muddle through economy. Growth is +1.8% and could decline even lower in Q2 but remain in growth mode. In the fall most analysts expect it to accelerate again thanks to the rising corporate profits and election politics. The QE2 end and debt ceiling battle will be behind us by then.

The real point of concern for me is the gasoline prices. I wrote on Thursday about the new and higher price predictions for crude by Goldman, Morgan Stanley and JP Morgan. If crude hits those $120-$130 targets later this year the price of gasoline is going right back to $4 and consumers are going to stay home again. Every 50-cent increase in gasoline takes $70 billion out of the economy over a year's time. AAA predicted the average family will spend only $692 on its vacation in 2011 compared to $809 in 2010. Out of every $10 earned by an average family they estimate just under $1 is spent on fuel. (8.9%) That is a 40% bigger chunk than normal. In 2000 it was 5.7%. Only twice before have they spent this much. That was 1981 and the first gas crisis at 8.8% and in July 2008 at 10.2%. Households spent an average of $369 on fuel in April. For the same period in 2009 they spent just $201.

We are already seeing analysts lower their S&P targets for the year based on the weakening fundamentals. Goldman lowered their estimates from 1500 to 1450 for the S&P. Citigroup and UBS both raised their earnings estimates for the S&P-500 but left their price targets the same. That means they are pricing in more risk along with more earnings power.

June could be rough simply because there is no reason to buy stocks with so much economic and political uncertainty. Market volume is going to slow until vacations are over and Labor Day arrives to signal the close of summer. It happens this way every year only this time there is an entire list of potential problems hanging like a cloud over the market.

I am actually encouraged by the lack of a major decline in May. Given the "sell in May and go away" trend we could have seen a decent decline. That is especially true given the QE2 end, European debt crisis, weakening economy, debt ceiling, etc. Heck we could be trading at Dow 12,000 again and I would not have been surprised. Instead there has been little real effort to sell off the market. The volatility index routinely trades under 16 in what would be a strong sell signal but nothing happens.

I think investors are confused. They saw the 1425 to 1550 S&P targets from a couple months ago and took them as gospel. Up until last week those targets had not changed. How much longer will they continue to hold stocks in anticipation of those targets being hit? Obviously nobody knows.

On Friday the S&P rallied to downtrend resistance at 1335 and managed to hold over the 1330 level despite some afternoon selling. I am pretty sure this was short covering ahead of the three-day weekend but we will never know for sure. The pattern has not changed and the declines have now stretched for four consecutive weeks. That has not happened since February 2010. Support is now 1315 and resistance 1335.

S&P Chart

The Dow pattern is the same as the S&P with a narrow downtrend channel and rising support in the form of the 100-day average. The chart suggests we will see a test of support at 12,200-12,225 soon. The rebound from the lows of the week was lackluster and failed to touch the top of the descending channel. Sector rotation is causing blocks of Dow stocks to weaken and the defensive stocks are not strong enough to compensate.

Dow Chart - Daily Short Term

Dow Chart - Daily Longer Term

All the big cap techs seemed to rally on Friday and that included FFIV, BIDU, GOOG, FSLR, AAPL, SINA, CREE and BRCM. Since most of those were heavily shorted earlier in the week I still believe it was just short covering on Friday. The Nasdaq is in the same pattern as the other indexes although it has been somewhat weaker based on the moving average breaks. I still expect further weakness. Support is 2750 and resistance 2800.

Nasdaq Chart

The Russell 2000 is somewhat confusing since it closed with a gain for the week. The pattern is the same but evidently there was enough short covering to push it back over the 50-day. The two-day support test at 810 could be significant but I think it was more coincidental than strategic. However, a continued push higher to close over 838 and the February high would be a very positive sign. It would suggest fund manager sentiment is improving. Why that would be the case is beyond me but let's wait and see if it happens before I consult my crystal ball for a reason.

Russell Chart

The Wilshire-5000, now the Dow Total Stock Market Index, cannot be gamed by hedge funds or pushed around by strategically placed trades. It is a true picture of the overall market. Obviously the chart looks exactly like the ones above only with a perfect textbook rebound off the 100-day. Should that average break in the coming weeks it would be a warning with a dip below 13,800 a sell signal.

Total Stock Market Index Chart

In summary I believe there will be more weakness ahead. I am not looking for a sudden washout but more of a choppy market with minor rebounds and declines. The trend appears to be heading slowly lower.

European event risk and currency fluctuations will continue to be a problem. The economic reports next week are market movers with the national ISM and Non-Farm Payrolls the most critical.

We are at that point on the calendar where I like to use the term "why buy?" Investors, as opposed to traders, have no real incentive to put additional money at risk ahead of the summer doldrums. This year they have even less reason because of the uncertainty surrounding QE2 and the economy. Until this cloud of uncertainty clears I doubt we will see a sustained rally.

I would continue to be cautious. Enter passively, exit aggressively.

Jim Brown

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"The only difference between me and a madman is that I'm not mad."
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