Headlines again powered the market when Italy's Senate approved the reforms demanded by the European Union. The lower chamber of parliament approved the measure on Saturday.

Market Statistics

Italy has resolved not to be the new Greece and they are moving quickly to implement the reforms demanded by the EU. The lower house approved the measure on Saturday and Premier Berlusconi resigned as promised. Respected economist Mario Monti is expected to be appointed interim prime minister in his place. Monti has already been appointed senator for life because of his past contributions.

It is entirely possible we could have new governments in both Greece and Italy before the market opens on Monday and both governments committed to implementing the austerity moves. In Greece the new interim leader is Lucas Papademos who will head a coalition government for the next several months with the sole responsibility of implementing austerity.

Italian 10-year bond yields plunged from their 7.4% high earlier in the week when it appeared Berlusconi may have been reconsidering his resignation, to 6.48% on Friday. That is well under the 7% rate that is considered unsustainable and suggests the bond vigilantes have decided to let the process play out. Actually, it probably means the ECB was buying Italian bonds in volume to give the appearance of a cooling off period.

While the weekend transition of power in Italy won't solve the long term problems it should take Italy out of the spotlight. Both Italy and Greece should have reached the point where we are not trading on their headlines every day. It will be a breath of fresh air to have the markets focus on U.S. conditions rather than Europe. It amazed me that the fate of the world markets has been resting for the last year on a country, Greece, with fewer people than Los Angeles.

Italy is much bigger. It is the eighth largest world economy and world's third largest debtor, but their problems are not nearly as great as Greece. They have a budget deficit of only 25 billion euros but they have 1.9 trillion euros in debt. ($2.6 trillion) They are not having any real problems paying their immediate debts but the debt service on that debt is squeezing the life out of the country. Italy's problems are a better example of what the U.S. will face in 5-6 years if something is not done quickly.

I will be thrilled to not have to discuss European countries in every commentary. I will also be thrilled if the U.S. economics continue to improve as we have seen in recent weeks. On Friday the Consumer Sentiment for November rose to the highest level since June at 64.2, up from its prior reading of 60.9. That was the third consecutive gain since posting 55.7 in August. That was only 0.4 points from matching the 28-year low from Nov-2008. The present conditions component rose to 76.6 from 75.1 but the expectations component spiked significantly to 56.2 from 51.8. The Michigan Sentiment Survey is sensitive to home prices and fuel prices so the expected rise in fuel prices from $100 oil could weigh on sentiment for December.

Consumer Sentiment Chart

The weekly Jobless Claims were Thursday but I think the number was important. The headline was 390,000 and the lowest level since April. The prior week's number at 397,000 was revised to 400,000 but the trend remains the same. The October high was 411,000 on Oct 8th and we are starting to see some progress to the downside once again. A continued move lower would be bullish. However, I am sure there are some workers taking seasonal positions and that is influencing the numbers.

Jobless Claims Chart

We have seen some improvement in several employment metrics over the last month that suggest full time employment is also improving. Bloomberg reported on Friday that American manufacturers booked $32.6 billion in new orders for machinery equipment in September. That is the most since July 2008 and a 13% increase over the prior month.

Parker Hannifin (PH) raised its fiscal 2012 outlook for North American revenue growth to +8.3% from +6.2% saying orders had "re-accelerated" in the period ending on September 30th. Orders rose +16% for the quarter compared to +11% in Q2. Caterpillar said its order backlog rose +40% in the quarter to $24.4 billion. CEO Doug Oberhelman said, "This was the best quarter for sales in our history and our order backlog is at an all time high."

All these reports, both economic and industrial, point to an expanding economy and the risk of a new recession has declined sharply in just the last 30 days. If the market begins to focus on the story at home rather than the Euro states abroad we could see a strong rally.

The economic calendar pace picks up a little bit next week with the PPI/CPI inflation reports, Empire Manufacturing Survey and the Philly Fed Survey. The Philly Fed is the most important. That is seen as a preview of the national ISM due out the first week in December.

Economic Calendar

Investors have climbed the wall of worry for the last six weeks but it was not without a few slips along the way. Wednesday's -400 point decline was one of those slips as well as the declines at month end that knocked -600 points off the Dow. However, despite those major hiccups the markets are right back near their highs for the month and very close to testing the October three month highs.

The sell in May and go away strategy worked very well this year and now we are seeing a growing trend of investors coming back into the market. I believe most are still overly cautious and are just sticking their toe into the market and waiting for the all clear from Europe before taking the big plunge. We may not get an all clear for many more months but at least the hurricane warnings will fade into the past and future events may be more like thunder storms.

Hopefully investors are going to be free to concentrate on stocks and not on geopolitical events. On Friday Caterpillar (CAT) announced it was moving 1,000 jobs from Japan to the USA and will build a new plant to put them to work. The location of the plant has not yet been determined but will be announced before the end of the year. The plant will manufacture small tractors and excavators. The majority of those customers are in North America and Europe. The old plant in Sagami Japan will remain open and continue to fulfill a "strategic role." CAT is opening a new plant in Winston Salem NC next week to produce axles for mining machines. The company is also planning on expanding operations in Decatur and East Peoria Illinois where the majority of large trucks and tractors are built. No recession for Caterpillar.

Caterpillar Chart

Electric car maker Tesla Motors (TSLA) was shocked to a new 11-month high after Barclays named it a "top pick." The analyst said the market for electric cars could rise to 4.8 million units worldwide by 2020. The analyst thinks Tesla will lose money through 2012 but turn to a $1.02 profit in 2013 and $2.50 in 2014. He believes Tesla is selling into the right market, the high end consumer. Since Tesla has been given up for dead more than once in the last several years this was a major turn of events. Shares gained +7% on the news.

Tesla Chart

Apple (AAPL) may need an electric shock if investors don't develop some holiday cheer soon. Apple shares declined about -4% for the week on worries about cutbacks in orders. Cleveland Research cut its Q4 iPad sales estimates to 12 million units from 14 million. The company cited "surprise revisions" to supply chain orders and lack of visibility. Ticonderoga Securities also said October sales were below average and there were negative indications in the supply chain. Analysts believe Apple may have overbuilt iPhones before the 4S launch and that led to an excess in supply when the global economy did not pickup.

However, this is normally an outstanding quarter for Apple and the company has already said there was record demand for the 4S. Analysts are still unsure how the new Kindle tablet from Amazon as well as some other Android releases will impact iPad sales in Q4 since most of the other tablets are cheaper than the iPad. Ticonderoga believes this is a buying opportunity because Apple's compound annual growth rate (CAGR) can still be well over 20%. Morgan Stanley expects Apple sales to grow from $64 billion in 2010 to $108B in 2011, $140B in 2012 and $176B in 2013. That is some serious revenue growth and the Apple TV has not even been released yet. The iPad 3 is expected in Q1 and the iPhone 5 in Q3.

Apple Chart

Dillard's (DDS) posted earnings that rose +85% but the shares were crushed due to a lower profit margin. Same store sales rose +5% for the quarter and the company reported last week that October same store sales rose +8%. You would think investors would be thrilled. Gross margins were 36.8%, the same as in the year ago quarter but not enough to please analysts according to JP Morgan. Shares declined -13% on the news.

Dillards Chart

E*Trade (ETFC) cancelled its plans to sell itself. E*Trade's largest shareholder, Citadel, asked E*Trade to sell itself to another online broker like TD Ameritrade or Charles Schwab. After several months of discussions CEO Steven Freiberg, said on Friday, "Following a review by the board, the management team will continue to execute on our strategy designed to create value for both our stockholders and our customers." E*Trade had hired Goldman Sachs to advise on strategic alternatives in order to please Citadel. That hedge fund invested $2.5 billion in E*Trade in 2007 to keep it out of bankruptcy after its mortgage portfolio imploded in the subprime crisis. E*Trade has $182 billion in customer assets under management and has returned to profitability in 2011 after several years of losses. Citadel owns 9.6% of E*Trade.

Chart of E*Trade

MolyCorp, the rare earth miner everybody loves to hate, reported earnings of 67-cents compared to a loss of 10-cents in the year ago quarter but missed estimates of 70-cents and the stock was punished for a -13% loss. Sales rose to $138.1 million from $8.5 million but nobody seemed to care. MolyCorp is in the middle of an $895 million expansion program and they had to shut down production for a few days to install new equipment and bring new facilities online so they can more than double production by the end of 2012 to 19,050 tonnes a year. Last quarter they sold 1,400 tonnes of rare earths at $131.19 per kilogram, which was a record price. Installing new equipment to increase production from 1,900 tonnes a quarter to 4,800 tonnes should be a good thing. Once renovations and improvement are complete they expect production to rise to 40,000 tonnes a year. Can you say "long term buying opportunity?"

MolyCorp Chart

The dollar index fell -1.25% on news Italy had advanced the austerity bill to the lower house for approval. The declining dollar meant commodities rose once again. With the dollar trading well above levels seen for much of the summer we can expect it to trend lower again once the clouds over Italy evaporate.

Dollar Index Chart

Gold Chart

Crude oil rallied another $1.44 to close at $99.22 on the falling dollar, rising worries over Iran, declining inventories and rising demand expectations. Distillate inventories in the U.S. are 15% below average and dropping fast. There was a -6.0 million barrel drop last week alone. Demand for distillates is +4% over the same period in 2010. In the chart below the red line is the east coast distillate inventory at the end of October.

Distillate Inventories

U.S. heating oil prices are breaking out to new highs and the season is just getting started. There is a good chance we could see record prices this winter.

Heating Oil Chart

Tensions over Iran and its nuclear ambitions continue to support higher oil prices. The IAEA released a report last week citing "credible evidence" supporting the claim Iran was trying to develop nuclear weapons and mount them on long range missiles. The report has escalated the talk about a military option to shutdown Iran's nuclear capability. Israeli President Shimon Peres said "airstrikes against Iran's nuclear facilities were becoming more and more likely." Israel has struck nuclear sites in Iraq and Syria in the past so there is precedence.

Secretary of State Clinton urged Iran on Friday to "urgently" address the latest concerns about its nuclear program and said the U.S. was consulting with its allies over the next course of action. Iran responded saying it will hit back against any attack or even "a threat of military action." "Iran will respond with full force to any aggression or even to threats in a way that will demolish the aggressors from within." Iran warned its response would not be limited to the Middle East. Meanwhile Israel has ramped up civil defense drills in order to be able to respond to both "conventional and non-conventional missile attacks." The EU is reportedly preparing a new round of sanctions against Iran ahead of a meeting of its foreign ministers on Monday. Russia has already ruled out additional sanctions in the UN where it holds veto power.

One of the problems in attacking Iran is the straits of Hormuz. An average of 13 tankers carrying 16 million barrels of oil transit the strait every day. That represents 33% of the world's seaborne oil shipments. The sea lanes though the strait are only two miles wide. Iran has repeatedly threatened to seal off the strait if it was attacked for any reason. This would cause havoc in the oil markets and we could see $150 oil within days of any such action and $200 if it lasted more than a few days. Most tanker owners would refuse to transit the strait if Iran said it was closed. Insurance companies would not insure the tankers and nobody wants to lose millions of dollars invested in their tankers. A million barrel tanker is a very large slow moving target that would be nearly impossible for any Iranian missile team to miss.

Add the threat of some form of action against Iran to the other factors supporting oil prices and there is a good case for taking out an insurance position on something like the USO. Buying a long term OTM call would certainly be a decent lottery play. I don't expect anything to happen BUT the longer this drags on the more likely Iran will reach a point where somebody, like Israel, will eventually act unilaterally.

Crude Oil Chart

USO Chart

The Dow closed near the highs for the week. The S&P did not. The S&P declined from 1277 on Tuesday to 1227 on Wednesday. A 50 point move on the S&P is not a small feat. The two day rebound only managed to recover about 35 of those points to end at 1263. Nice recovery but still a lower high. The market may not be done yet so we can't confirm that as a lower high until it is in our rear view mirror. S&P 1277 remains the initial line in the sand with 1285 and 1300 the next two major areas of resistance. It could be a rough battle moving higher or we could just spring over those levels at the open on Monday if the weekend's positive events in Italy cause another monster short squeeze.

Friday was a monster short squeeze on extremely low volume. The volume on the NYSE was the lowest since July. Overall volume across all markets was only 5.9 billion shares. The bond market was closed on Friday for Veterans Day and a lot of businesses were closed as well. You can't draw any conclusions about market direction from a low volume short squeeze. Without liquidity there is no consensus.

There are many technical possibilities for the S&P. Most of the scenarios are negative. However, the economic and fundamental picture is improving daily. I believe the fundamentals and the seasonal trends will combine to produce a return to the July highs. Once there we could have significant trouble moving higher. Support remains 1225.

S&P Chart - 3 min

S&P Chart - Weekly

S&P Chart - Daily

The Dow is testing downtrend resistance from July and a breakout here would be major. Despite the big triple digit moves the Dow has been consolidating in a very wide band. The big moves work both against us and in our favor. A major news event this weekend could blow past current resistance and eliminate days of anguish. The October closing high at 12,231 is only 80 points over Friday's close. The Dow has had 88 triple digit days so far in 2011. A +100 point gain at Monday's open could trigger yet another day of short covering and begin a new leg higher. Conversely a triple digit decline knocks us back below 12,000. This is going to be a pivotal week. We need big news, big volume and a big move to confirm sentiment.

Dow Chart - Daily

The Nasdaq can't get any respect without Apple leading the way. The Nasdaq gained +53 points on Friday BUT finished the week with a loss. Nasdaq 2600 appears to be solid support but 2700 and the 200-day average has been decent resistance. Several closes above those levels have proved to be one day wonders.

We need to hope that Apple rejoins the party soon or it is going to be a long November.

Nasdaq Chart - Daily

Nasdaq 100 Chart - Daily

The Russell 2000 continues to lag the other indexes and until it takes a leadership role the rally has no legs. Fund managers are still too unsure about market direction to take a chance in small caps.

Russell 2000 Chart - Daily

The next two weeks are typically bullish. If there is a resolution in Italy over the weekend and some other country does not pop up like a bad case of chicken pox then maybe the focus will change to North America rather than Europe.

Thoughts to ponder. No country has ever managed to recover from massive overspending on the magnitude of Greece or Italy using austerity alone. Without a sudden acceleration of growth they are doomed to fail. Austerity produces recessions, lower employment, lower tax revenues, lower future budgets, etc. Eventual debt restructuring is the only answer. This is especially true with the euro zone since each country does not have its own currency. Italy cannot print more euros and thereby devalue its debt. The U.S. can print more dollars, produce inflation and eventually pay back its debt in 50-cent dollars. Euro countries no longer have that luxury. Even if Italy does everything right and moves out of the European headlines there is still trouble ahead for Europe.

Merkel and Sarkozy are making plans for the eventual departure of countries from the zone. They have skipped to the end of the book and they know how it will eventually end. The zone in its current form is on life support and the prognosis is terminal. There are rumors Germany, France and maybe a few other fiscally responsible countries will either exit out the top of the economic zone and form a new group, a super zone. There are also rumors they are planning on pushing the PIIGS out the bottom of the zone because their economic problems are terminal. They are only surviving because of a constant diet of bailout euros. They need to pull the feeding tubes and cut them loose or risk seeing the countries in the top half of the zone pulled down with them. Cutting them loose allows the remaining zone members to stiffen economic rules and will produce a stronger zone in the future.

Regardless of what happens in our markets over the next two weeks or two months there will be another European disaster. Just keep that thought in your subconscious and be prepared for the next round of volatility. Until then I remain in buy the dip mode. Buying the gaps on days the market gaps higher is not a winning strategy. Be patient, volatility has its rewards.

Jim Brown

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Red Skelton with an interesting view on today's political scene.
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