Big cap tech stocks broke out to high on Friday thanks to Google, Apple, Microsoft, Intel, Amazon and Baidu. All of those companies contributed between 1-5 points to the Nasdaq 100 Index ($NDX).

Market Statistics

The Nasdaq 100 may have been setting new highs but the Dow was trailing the broader market thanks to an earnings miss by Caterpillar. CAT was crushed for a $6.50 loss and was solely responsible for a decline of more than 50 Dow points. Without the CAT loss the Dow would have posted a minor gain.

Earnings remained the focal point because of a lack of material economic reports and the lack of a debt limit deal. The only economic report was the Mass Layoffs for June. The number of reported events declined slightly for the second month to 1,532 from 1,599. The number of workers impacted declined only slightly to 143,444 from 143,540.

This report was market neutral because it was a lagging report for June and there was almost no change. The manufacturing reports next week will be far more important.

The Regional and State Employment report, also for June, showed employment rose in 26 states and DC and declined in 24 states. The largest gains in employment came from Texas +32,000, California +28,800, Michigan +18,000 and Minnesota +13,200. The biggest declines came from Tennessee -16,900, Missouri -15,700, Virginia -14,600 and North Carolina -9,500.

Next week is regional report week with reports on economic conditions in Chicago, Texas, Richmond, Kansas and New York. The Fed Beige Book on Wednesday will also tell us how the economy is doing in each of the twelve Fed districts. In short this week plus the national ISM on the following Monday will tell us if the soft patch is over, improving or still holding the economy back.

Economic Calendar

The earnings for Q2 have been a very diverse collection of mixed results. There have been quite a few blowouts on earnings but also a few misses and quite a few guidance warnings. Caterpillar's earnings covered the entire gamut. CAT posted earnings of $1.72 compared to estimates of $1.75. The reason for the earnings miss was the impact to production in Japan after the earthquake and increasing costs. With backlogs at record levels and sales increasing sharply analysts had expected another earnings beat and a new hike in guidance. Unfortunately in the real world CAT was seeing the results of higher commodity prices, less than expected manufacturing output in Japan and some increased acquisition costs from buying Bucyrus for $8.8 billion.

Despite the miss Caterpillar still had a phenomenal quarter. Earnings rose +44% and sales rose +37%. They increased guidance from a midrange of $6.50 per share to $7.00 per share for the full year. They raised full year revenue guidance by +$2 billion to $55 billion. CAT said the slowdown in China had impacted growth but sales were still increasing. They were just increasing at a slightly slower rate. The CEO said CAT had record order backlogs and those backlogs were growing.

The drop on Friday was significantly overdone because the Caterpillar story is still alive and well. The stock had risen +54% over the last 12 months and the sell off was knee jerk profit taking on the earthquake related earnings miss. I believe CAT is a strong buy at these levels with risk to $100.

Caterpillar Chart

Just because the U.S. economy is stuck in the mud does not mean the rest of the world is waiting for us. The rest of the world is growing much faster than the USA and Caterpillar is seeing robust sales growth in these areas. Don't toss CAT into the trash bin because they have the capability of continuing to grow earnings for years to come. Once the USA growth catches up to the rest of the world their sales will explode.

Global GDP Rates

While on the subject of Caterpillar the CEO had some harsh words for lawmakers. He said he had been meeting with the leaders of his biggest customers in the USA and they reported U.S. businesses were rapidly shrinking purchases in an effort to stockpile cash because of events in Washington. He said there was "extreme uncertainty" in the U.S. business community over the country's future because of the high deficit and not the current artificial crisis of the debt ceiling. Those managers reported worry over future debt payments, taxes, regulation, healthcare costs, interest rates and inflation. Until that uncertainty begins to ease those customers are going to be buying less and hoarding more.

CEO Doug Oberhelman said, "Lack of clarity on a U.S. debt reduction plan, trade policy, regulation, much needed tax reform and the absence of a long-term plan to improve the countries deteriorating infrastructure does not create an environment that provides our customers with the confidence to invest."

Offsetting some of the CAT impact on the Dow was McDonalds (MCD). The burger seller roared off to a new high at $89 with a +$2 gain after reporting profits that increased +19%. A weaker consumer appears to be benefiting McDonalds as more people turn in for fast food rather than visiting a higher priced sit down restaurant. Also helping were the new coffee offerings along with smoothies and new breakfast items. Drink sales at the McCafe increased by +29%. McDonalds raised prices in March and May to keep pace with soaring commodity prices. The company said it was planning to offer some "premium burgers" in the U.S. in order to fend off competition from places like Five Guys. The U.S. same store sales rose only +4% while Europe sales rose +21% and Asia and Middle East rose +25%.

McDonald's Chart

General Electric (GE), another Dow component, reported earnings that rose +18% to $3.73 billion or 34-cents per share. That beat estimates by a penny but GE is never one to produce a blowout. Analysts watch GE earnings for a clue to the pace of the U.S. and global economy. GE reported industrial order backlogs rose +6.8% to record levels at $189 billion and that is a good sign for the future economy. Equipment orders rose +33%, service orders +16%, transportation +74% and infrastructure orders +24%. Revenue was $35.6 billion and well over estimates of $34.7 billion. CEO Immelt said GE would post double-digit earnings growth for the rest of the year and earnings would increase in 2012.

Overall the GE earnings were very positive. The earnings from GE Capital more than doubled and Immelt repeated his claim the worst was behind the troubled division. He said GE was making profitable loans again.

GE Chart

Oilfield services firm Schlumberger (SLB) posted earnings that rose +64% to 87-cents per share. That was a slight beat of two cents over estimates. Analysts were very positive on the sector and we saw Halliburton also post strong earnings on Monday. Schlumberger said sales rose +62% to $9.62 billion. The average number of rigs in operation worldwide rose +15% to 3,163 in Q2. Crude oil prices averaged $102.34 for the quarter compared to the $78.05 average in Q2-2010. SLB said drilling activity was very strong and there was a shortage developing in people and equipment. The company said the acceleration of onshore exploration and development will put considerable strain on the service industry to meet those activity levels. This will lead to an increase in pricing power by SLB, HAL and others.

This was a very strong quarter but remember the weather in Q2 in North America was very bad and hampered drilling activity. Also the activity in the Gulf has not returned to normal although several companies have been able to restart drilling activity. As Gulf activity increases so will earnings from the various service companies. Halliburton gets half its revenue from North America while it only accounts for one third of revenue for SLB. Schlumberger gets the majority of its revenue from overseas with Saudi Arabia a strong growth market for SLB today. Iraq is currently SLB's 7th strongest market out of their top 15 and it is expected to rise to third place in 2012.

Schlumberger Chart

The biggest winner for the day was Athena Health (ATHN) with a +17% spike after reporting earnings of 22-cents compared to estimates for 19-cents. On a net basis they reported 14-cents that was more than three times the 4-cents earned in the comparison quarter. Revenue rose +33% to $77.8 million compared to estimates of $74.9 million. Analysts were very pleased with the results but the shorts were not so happy.

Athena Health Chart

Next week is the busiest week of the Q2 earnings cycle and the sheer volume of earnings will over power everything but the debt ceiling crisis. Energy stocks will highlight the list next week with Exxon, Conoco, BP and Chevron leading the charge. Earnings should be very strong with the average price for crude over $100 in Q2. The downside to earnings will be any impact from rigs still on standby in the Gulf incurring daily rental payments while waiting for the administration to release permits. Otherwise energy earnings should be outstanding. I am sure the numbers posted by the majors will prompt renewed calls for higher taxes.

Amazon will report on Tuesday and that company can't seem to do anything wrong. They just lost a major competitor with the shutdown and liquidation of Borders this weekend.

Of all the reports this week I view the UPS earnings on Tuesday as the most relative. UPS has their finger on the day-to-day shipments of millions of packages. They can tell on a daily basis if the economy is slowing or recovering. Their earnings and guidance is critical.

Earnings Calendar

So far 143 S&P companies have reported earnings. 75% of those have beaten the street on earnings and 69% on revenue. That is much higher than the normal 66%. However, the number of companies guiding lower has also risen sharply. Of the 345 total companies that have reported 5.8% raised guidance and 6.1% lowered guidance. This produces a net negative guidance of -0.3%. That may not seem like much but it is the lowest guidance outlook since Q1-2009. Guidance after Q1 reporting was positive +3.5% and the eighth consecutive quarter of positive guidance upgrades. There are 180 S&P 500 companies reporting next week.

Net Guidance By Quarter

Current overall earnings estimates for the S&P 500 for Q2 have declined to growth of only +9.2% and well off the +15% from the beginning of the quarter and +12.7% just two weeks ago. This is astounding since 75% of companies have beaten estimates. Apparently the size of the beats has been lower than normal.

The new deal on Greece appears on the surface to have moved Greece out of the headlines for the near term. Most analysts believe the EU successfully kicked the can down the road for another 6-12 months but it will come back to haunt them. The deal requires quite a bit of accommodation (selective haircuts in either principal or duration) from the private sector. It remains to be seen if the private sector will cooperate. The new deal for dealing with future EU problems will eventually require the ECB to take on more than one trillion euros in new debt of a very long-term variety. That debt will have to be paid by the healthier Eurozone countries in a roundabout bailout of Greece and eventually Italy, Portugal, Ireland and probably Spain. Despite the apparent solution being reported in the press most analysts believe the Greek debt crisis will come back in an even stronger form. For now we should be happy the problem has at least been moved out of the headlines and should no longer be a drag on the U.S. markets.

The main force behind the market next week will still be the debt ceiling. It is deal or no deal time and lawmakers must act to avoid a financial Armageddon. That point seems to be lost on lawmakers because we are moving ever closer to a disaster that could cause untold harm to the U.S. economy. The risk is two fold. The first is the risk of ratings downgrades by the ratings agencies. That will push our interest rates higher and increase the amount of new debt we will have to sell to pay off the old debt. Just imagine if the interest rate on all your credit cards suddenly went up by 35%. The implied interest rate on a ten-year treasury today is less than three percent. If S&P and Moody's downgraded the credit rating that could rise to 4%, a +33% increase on all future debt. Since the U.S. has to sell another $2.5 trillion in debt by the end of 2012 that will equate to a lot of additional interest. Demand for the new debt could decrease once our credit is lowered and that could push interest rates up even higher.

The second risk is that of a default. While the odds of this happening are very slim the possibility is growing. We have never defaulted on an obligation in the history of the USA. A default would cause our credit rating to not be just lowered but slashed and our interest rates would rocket higher by several percent. We could actually be paying 100% more interest on our debt within weeks. For every 1% increase in interest it would cost taxpayers $150 billion a year in additional interest.

These events do not need to occur. This is a political battle not a real crisis. Since 1960 Congress has acted 78 separate times to permanently raise, extend or revise the debt limit. This has occurred under republican presidents and democratic presidents. The debt limit was just raised by $1.9 trillion in January 2010 and very few people even knew about it. The current war of words is political posturing for the next election.

The deficit is out of control and will eventually cause America serious grief but that is a longer-term issue not one that has to be solved next week. The debt is commonly referred to as $14.5 trillion. That is up from just over $5 trillion only a decade ago. That does not include the "unfunded liabilities" like Social Security, Medicare, Medicaid, etc. The total debt including the unfunded liabilities is more like $115 trillion. Either number is more than we can ever pay but that is not the problem today. How much is $1 trillion dollars?

On Thursday night I was hopeful the President and Speaker Boehner would announce a compromise on Monday. Secret discussions were being held daily. Late Friday they both announced the negotiations had ended. The parting was not amicable. The president held an immediate press conference to say he had demanded Boehner, McConnell, Reid and Pelosi return to the White House on Saturday at 11:AM with hard plans to discuss in an effort to work out a deal.

The meeting occurred with full attendance by the press with camera flashes blazing. After 10-15 minutes of posturing for the cameras the meeting began and then ended at 11:58. Being generous there was roughly 45 minutes of conversation on ways to avoid a national default, avoid a downgrade of our credit rating and come together in a bipartisan agreement. Considering the weeks of conversations before this I view the meeting as nothing more than a photo opportunity to show leaders hard at work on a Saturday. Post meeting comments from Boehner, Reid and McConnell claimed they were working through the weekend in an effort to reach a compromise by Monday. Late Saturday Boehner told House republicans he would have a draft framework prepared by 4:PM on Sunday. Treasury Secretary Geithner, also at the Saturday meeting, reminded the participants a deal needed to be concluded at least in principal before the Asian markets opened on Sunday night.

I wish I could say I was confident they will work out a deal by Monday but after reading dozens of articles my confidence is fading. They may work out a deal to extend the debt limit but I have no confidence it will have enough credible changes to avoid a credit downgrade. S&P and Moody's have said they will likely downgrade the U.S. debt even if the limit is raised if there is no credible plan to cut spending. The chances for a credible plan are shrinking hour by hour.

The most likely outcome for next week is a band-aid to postpone the crisis and kick the can down the road. Basically we become Greece with an ever-increasing pile of debt and no real way to pay it off only there is nobody to bail us out.

Unless some "grand bargain" is struck over the weekend the debt news is likely to weigh heavily on the markets on Monday. The view that lawmakers would never allow the U.S. to default is rapidly fading and being replaced by a dumbfounded stare of disbelief.

One final point. I read in one of the debt deal articles that as part of any deal lawmakers were going to claim $1 trillion in spending cuts over the next decade because the wars in Iraq and Afghanistan were ending. For me this is another stupid lawmaker trick. We already know the wars are ending and the president has announced a timetable for withdrawal. To announce a "new" deal with a trillion dollars in savings for something that has already been planned and in the system for two years is nothing more than an accounting trick to claim a "grand bargain" of larger proportions. Do they think S&P and Moody's are too stupid to see through this smoke and mirrors?

The markets finished better than I had expected on Friday. The opening dip was erased and were it not for Caterpillar it would have been a positive day all around. Unfortunately, the S&P could not punch through the resistance from Thursday at 1,345. However, it was a summer Friday with very low volume of only 5.7 billion shares compared to 8.1 billion on Thursday. There was no conviction on either side as investors held their breath waiting for a debt limit resolution.

The S&P stall at 1345 was not surprising given the shock to the Dow from the Caterpillar decline. Without the Dow posting a gain the S&P was unable to find any traction. Surprisingly the Nasdaq was able to post a decent gain of +25 points without the Dow and S&P going along for the ride. Big gainers were Apple +6, Google +11, SNDK +3.93, ATHN +8.51, CPHD +8.83, VRUS +6.22 and APKT +5.37.

The 1345 level on the S&P is the resistance high from February. That high has been bested more than once since then but it keeps returning to cause problems. Real resistance is from 1350-1365 and the highs from May.

Rather than try to attach too much technical significance to Friday's market action I believe everyone understands the market is in a wait and see mode until the debt limit is resolved. When it is solved the market will rally but the strength of the rally will depend on the eventual solution and the likelihood of a rating downgrade.

This means anything is possible next week but the most likely scenario is some ugly work around on the debt and a minor market rally. If that rally succeeds in breaking out to new highs then an entirely new version of bullish sentiment will take hold.

The bad news bulls are waiting for an answer so they can discount the news and rally on. As long as the solution is palatable they will likely ignore the news and move on. A week from now everyone will look back and wonder what all the worry was about. At least I hope that is what we are doing a week from now.

S&P support is 1325 and resistance 1345-1365. Every point we move higher will be a battle without some market moving news.

S&P Chart

The Dow stalled at 12700 once again but the lack of forward motion was due entirely to the Caterpillar loss of -51 Dow points. I won't rehash those comments but suffice to say without the CAT loss the Dow would have been positive.

The 12700 level has been solid on both attempts in July and 12800 is very strong resistance as a three year high. With the high profile Dow stocks already reported there will be less upward pressure from earnings anticipation. IBM closed at the exact same level on Friday as it did on Tuesday. Their forward motion has ended.

Fortunately Dow components Chevron and Exxon report next week and earnings should be outstanding. Unfortunately they don't report until Thursday and Friday so the early week moves will have to be on 3M and UPS. This is not going to be a technical or fundamental week but a news reactive week so be prepared.

Dow Chart

The Nasdaq was bullish on Friday despite the lackluster performance by the Dow and S&P. This is entirely out of character for the Nasdaq and clearly a bullish sign. This is not normally a good season for tech stocks so a breakout would be very bullish. Support is 2800 and new high resistance is 2872. Netflix is the next big tech stock to report on Monday followed by AMZN and JNPR on Tuesday.

Nasdaq Composite Chart

Nasdaq 100 ($NDX) Chart

In summary I believe a deal of some sort will appear. Market reaction and ratings results will depend on the grand scale of the deal. Our market will not be trading on fundamentals, but purely news focused. Since the downside potential is so significant I can't conceive we will get to August 2nd without a resolution. For that reason I am still mildly bullish. Once the debt ceiling war ends the markets should rally.

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Jim Brown

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"Bull markets are born in despair, grow in skepticism, mature in optimism and die in euphoria."
John Templeton