The markets extended their gains to four consecutive days because the EU applied yet another Band-Aid on the Greek problem. Four positive days may be stretching our luck.

Market Statistics

The news moving the markets today was an announcement by the European Central Bank along with the Federal Reserve, Bank of England, Bank of Japan and Swiss National Bank they were going to make dollar denominated loans to European banks in an effort to improve liquidity. The problem they are addressing is the lack of liquidity caused by a reluctance for banks to loan to other banks because of unknown sovereign debt liabilities.

This is the same thing that happened to our banks during the financial crisis. Banks quit dealing with other banks because they did not know how much exposure the other bank might have had to subprime debt. This nearly brought our banking system to a complete halt until the Treasury and the Fed stepped in with short term loans.

You would think the fact the banks thought it was necessary to take this drastic action would have been a negative event. However the news the ECB was taking action to head off a growing liquidity problem sent the French and German markets up over 3% on Thursday. The euro rallied +1% and the dollar declined sharply by -0.7%.

The European markets had been in a spiral on worries of bank problems as a result of the sovereign debt crisis. The dollar loans did not affect the crisis but it did remove some of the immediate worries over the banks. It was just a Band-Aid to stop the bleeding but the actual debt problem has not changed. It did take the immediate pressure off for the banks and gives the EU a few more weeks to resolve the actual problem.

The loans will be made in October, November and December at fixed interest rates and for "unlimited amounts" as long as the bank has "collateral." That is the key word. Will sovereign bonds from Italy, Portugal and Greece be considered collateral? I doubt it but nobody seemed to worry about that today.

On our side of the pond there was a strong calendar of economic releases. The weekly jobless claims soared to 428,000 from an upwardly revised 417,000 the prior week. The sharp increase was unexpected. Most analysts expected the claims to decline as they normally do the week after Labor Day. I suspect the claims were impacted by Hurricane Irene and the normal seasonal cycle was disrupted. North Carolina and New Jersey led the list of new claims with more than 1,000 each. If the claims continue to rise next week this could be a serious problem for the economic outlook.

Weekly Jobless Claims Chart

The Consumer Price Index (CPI) rose unexpectedly by +0.4% when expectations were for a decline to +0.1%. The headline number was only slightly below the +0.5% from July. The Fed keeps telling us inflation is easing but numbers like we have seen over the last two months suggest otherwise.

Energy was the biggest addition with a +1.2% hike. The core rate, excluding food and energy, rose +0.2% and the same rate of increase seen in July.

The lack of a decline in the CPI is going to be troubling for the FOMC when they meet next Tuesday. This is not enough of a gain to prevent them from adding additional stimulus but it will give the hawks more ammunition to lobby against a strong stimulus program. There are some factors that could give the Fed a greater comfort factor. Grain prices have surged due to droughts and floods and that is a temporary spike. Energy prices declined sharply in August and those declines have not yet been fully priced into the economy. That takes 30-60 days for the impact to be felt.

Consumer Price Index Chart

Industrial Production for August rose +0.2% but that was significantly below the +0.9% in July. The spike in July was related to the rebound in auto production as the supply chain recovered. In August the gains were the strongest in transportation where production increased +1.6% so that sector is still in rebound mode.

The annualized rate of production growth is +4.2% and that is significantly better than what you would expect based on the other economic reports. It is also below the Q1 rate of +7.1% but well above the nearly zero rate of Q2.

The regional manufacturing reports continued to show declined but not significantly lower than the prior month. The NY Empire Manufacturing Survey for September came in a -8.8 compared to -7.7 in August. This was a decline but it was minimal. That is somewhat encouraging that conditions did not continue to deteriorate at a rapid pace.

New orders barely worsened at -8.0 compared to -7.8 the prior month. Backorders were still in contraction territory at -7.6 but that was a significant improvement from the -15.2 in August. Employment did fall into negative territory at -5.4 from +3.3 the prior month. On the positive side expectation component for new orders, shipments, capital spending and tech spending all improved. Inventories are expected to decline, prices move higher and employment to remain level.

NY Empire Manufacturing Survey

There was better news from the Philly Fed survey. The headline number for September was still negative at -17.5 but that was significantly better than the -30.7 in the prior month. New orders improved to -11.3 from -26.8 and backorders improved to -10.4 from -20.9. While those were significant improvements they still represent a continued contraction in the sector. It just means the rate of contraction slowed. A very positive indicator was the employment component, which rose to +5.8 from -5.2. Companies would not be increasing employment if they did not expect conditions to improve soon.

Inventories rose to +10.2 from -9.8 but that implies slower sales or possibly just increases ahead of the holiday shopping season. That will also support GDP as a positive data point. On the negative side the shipments component fell to -22.8 from -13.9 and that is the lowest level since 2009.

The Philly Fed has a high correlation to the national ISM due out the first week in October. Today's report suggests the ISM should improve slightly.

Philly Fed Chart

Lastly the SEMI book-to-bill for August declined to 0.80 from 0.85. That means they only received $80 in orders for every $100 in orders shipped. Equipment orders declined -8.8% and shipments declined -3%. The weakness in the semiconductor sector has been known for some time. If you are not building parts for iPhones, iPads and Android compatibles it has been a tough summer. They are also fighting a declining price point. If your chip costs 75-cents today, down from 95-cents six months ago then you have to sell 25% more in order to keep the book-to-bill above 1.00. Obviously that is not happening and the declining price of chips is weighing on the sector.

For Friday the only material reports are the Regional Employment and Consumer Sentiment.

The stock news was headlined by NetFlix (NFLX). They previously projected an increase in subscribers to 25 million by the end of Q3. The company warned today that prediction was too high. They now expect 24 million. That will breakdown to 21.8 million streaming accounts and 14.2 million DVD accounts with 12 million signed up for both. The headlines screamed "NetFlix loses one million customers" but that is not exactly the case. We won't know exactly if they gained or lost until the end of the quarter. What they said was they lowered their forecast of total subscribers for the end of the quarter.

Streaming subscribers are expected to be 9.8 million compared to previous forecasts of 10.0 million. DVD only projections will decline to 2.2 million from 3.0 million. However, they expect 12 million subscribers to both. That means 12 million subscribers will now be paying almost twice as much as they were last quarter. NetFlix just changed the model to individual payment for each method instead of a single rate for both. This effectively doubles the revenue NetFlix receives for those 12 million subscribers. That could be seen as the equivalent of gaining 12 million subs.

I have no opinion on NetFlix but plenty of analysts believe the model is broken. They have spent roughly $1.6 billion on content and some of their major content lines just canceled. Analysts believe the future is going to be a fight between Hulu, Amazon and NetFlix and NetFlix is going to lose. I know several people who have canceled their subscriptions but not specifically because of price. The availability of streaming content is too limited. Personally 14 of the last 16 movies I tried to download were only available on DVD. That will frustrate subscribers far more than the price in the long run.

NetFLix shares were crushed by the headline and the negative publicity as the bearish analysts flocked to the microphones and keyboards. There was a serious lack of bullish analysts to offset the negativity. JP Morgan cut their price target to $245 from $340. The stock lost -19% or -$39.46 for the day.

NetFlix Chart

After the bell a prior tech titan moved closer to being a small cap. Research in Motion (RIMM) reported earnings that fell -47% to $419 million at 80-cents on revenue of $4.2 billion. Analysts expected 87-cents. Cash on hand declined more than half to $1.4 billion. However, $780 million of that came from buying Nortel's patents.

They shipped 10.6 million BlackBerry phones and 200,000 PlayBook tablets for the three months ending in August. Those were well below forecasts of 11.8 million phones and 562,000 tablets. Guidance for the current quarter was also light. They projected $1.20-$1.40 per share and analysts were looking for $1.37. Participants on the conference call said the co-CEO seemed to be in a reality distortion machine and spent his time talking up the next version of the BlackBerry and ignoring the sharp drop in sales.

RIMM shares declined -18% in after hours to close at $24.25.

RIMM Chart

UBS, Switzerland's largest bank, reported a $2 billion loss from unauthorized trading at its investment bank. London police arrested Kweku Adoboli, a UBS employee, in connection with the loss. The 31-year old employee was charged with "suspicion of fraud by abuse of position." He was a director in Delta1 Trading at UBS. That is a division that trades in ETFs. Reportedly he got into trouble in his trading and used his computer knowledge to get around the banks risk controls to increase trades in an effort to recover his losses. There have been two other rogue traders in recent memory with losses of more than $1 billion. The first one, Nick Leeson, bankrupted Barings and forced its sale for £1 to Dutch bank ING. Ironically Leeson's trading jacket, worn while trading on SIMEX in Singapore, sold for £21,000 on Ebay.

UBS shares declined -10% on the news.

UBS Chart

Today was simply a short covering day on the banking news out of Europe. Volume was very light at only 6.3 billion shares and many of the prior leadership stocks were laggards today.

The problem in Europe did not go away. Today's Band-Aid is only temporary BUT there are plenty of rumors of a potential shock and awe move over the weekend to hopefully put an end to the slow spiral down. What that might be is of course unknown but officials are in constant high level meetings.

The G7 is considering something like the TALF program the U.S. put in place during the financial crisis. The TALF program (Term Asset-Backed Securities Loan Facility) was an attempt to improve liquidity in the Asset Backed Securities market. These securities were being quoted at fire sale prices and far below their realistic values because nobody was confident in the collateral.

If the ECB creates a TALF program you would expect them to provide non-recourse loans to third parties enabling them to purchase sovereign debt. Why the ECB would want to loan to third parties to buy the debt when the ECB won't/can't buy it outright is unknown. It is just another trial balloon floated by finance ministers who don't want to bite the bullet themselves to fix the problem. Everybody wants it fixed but they don't want to put their country at risk to do it.

The bank announcement caused those short the banks to bail on their positions and that caused a positive uptick in the overall market. With everyone leaning short after three days of gains the market bounce caught them off guard and the short covering began.

I am sure there was some stock chasing by funds adding to that rally since most of them were heavily into cash and they can't afford to be on the sidelines if the market really takes off.

The low volume is the key. There was no conviction. With option expiration on Friday this was just another cleanup day triggered by some unexpected news.

The S&P has now gained +6.3% since the Monday low at 1136. That is impressive but until today it was still below strong resistance. The S&P battled resistance at 1204 until 2:PM when a buying spurt finally pushed it over that level. That became support for the rest of the day to close at nearly 1209. This is a major accomplishment even on low volume.

The close today was a higher high over the last two weeks but we still need to move over 1220 before the majority of investors will come off the sidelines. I believe the 6% rally is overdone BUT there are rallies in bear markets and every bull market begins with an unexpected bear market rally.

I am far from claiming this is the start of any longer term rally. I think the last three days has been an option expiration short squeeze, a denial rally of sorts. Until we move over 1220 we are still in a six week trading range.

The potential for action at the FOMC meeting next week has declined. Traders still anticipating a big stimulus announcement may be disappointed. Inflation is higher than expected. Europe is starting to take some bigger steps. If there is a big announcement this weekend it could take the Fed out of the picture all together.

I view dependence on Fed action as a liability at this point. We could be setting up for the mother of all sell the news events. I am encouraged by the close over 1204 but I am not convinced it has any staying power.

The $64 question today is what will traders do about the weekend? Do they take profits to avoid event risk or do they remain long in hopes of the shock and awe trade on Monday. If they hold over they could end up with an "aw s--t" trade.

Current resistance it 1220 and support 1190.

S&P Chart

The Dow is not quite as bullish as the S&P but all 30 Dow components were positive at day's end. The Dow still has strong resistance at 11,500 and it may take another news event to propel us higher. However, there is still a heavy short component and when the breakout over secondary resistance at 11,600 comes it could be dramatic.

The 11,500 level provides the perfect target for longs to take profits on Friday.

Dow Chart

The Nasdaq had a serious headwind with NetFlix down nearly 40 points but it still managed to close over solid resistance at 2600. I view this as very positive. The RIMM earnings after the close will have some impact but that should be offset by gains in Apple on RIMM's retail misfortune. However, Apple and Google both stalled at near term resistance late in the afternoon. Traders may be contemplating a bailout of their own before the close on Friday.

If the Nasdaq does open positive and can maintain a positive gain in early trading it could trigger additional buying because a break of resistance at 2600 would be bullish. Weekend event risk "should" weigh on tech stocks but in this market we have switched to the bad news is good news mode and that can be contagious.

Nasdaq Chart

Russell Chart

I would be cautious on Friday. The potential for profit taking ahead of the weekend event risk is pretty strong. However, news from the G7 or some other headline news from Europe could juice the shorts once again and push the indexes farther over resistance and trigger another short squeeze.

This is an option expiration Friday so volume should be higher. If we move higher I would tag along with a short term trade but I am not counting on it. I would rather wait to create positions after the Fed meeting next week. The event risk on both sides of the pond is huge.

Jim Brown

Send Jim an email