The Mega Millions Lottery is a voluntary form of taxation for those bad at math.

Market Statistics

The big news on Friday was the $640 million Mega Millions Lottery jackpot. People lined up by the thousands all over the country to spend their hard earned money on the chance to be a millionaire.

When the numbers start to rise on the prize the lotto players come out of the woodwork. Apparently $30 million or even $50 million is not enough to bring out the millions of buyers but once it moves over $100 million the frantic activity begins. A California official said on Friday more than 283 million tickets had been sold in the state already. That is just in California.

Just to be clear with one ticket you have a 1 in 175,711,536 chance of winning. To put this in perspective you have a better chance of being struck by lightning 11 times and living. You have a better chance of flipping a coin 25 times and having it come up heads all 25 times. You are 20,000 times more likely to die in a car wreck and 8,000 times more likely to be murdered.

If you were to buy 50,000 tickets every week your odds would improve. Statistically you would win the jackpot ONCE every 68,000 years according to California statistician Mike Orkin.

People buy tickets despite the odds because eventually somebody will win and you can't win if you don't have a ticket. The average American adult spent $251 on lottery tickets in 2011. This is a voluntary tax on people who don't understand the odds.

In the Mega Millions lottery 35% of the ticket sales support government services in the state where the tickets were sold. Forty two states, Washington DC and the U.S. Virgin islands participate in the lottery. 15% of the proceeds go to the retailers selling the tickets and to the operating expenses. 50% of the proceeds goes back into the prize fund. Lottery officials expected total sales for this drawing to be near $1.46 billion. Officials claim 95% of the number combinations were chosen.

Compared to the lottery the stock market is a sure thing but millions of those buying lottery tickets would not put money in the stock market because it is too risky. Obviously nobody actually expects to win the Mega Millions but it gives players a spark of hope. What if I won? I could quit my job and retire, buy a nice house for cash, travel and support my kids. For more than 100 million people the dream is alive for about 72 hours. After the drawing the vast majority will go back to work a few dollars poorer with their dreams dashed. A few will match some of the numbers and win a smaller amount. Last week alone Arizona said it had 56,000 winners in the Mega Millions drawing. Winning $2 or more will be a small consolation to the headline number of $640 million. The jackpot grew to the $640 million after 18 draws (9 weeks) without a winner. Lottery officials said tickets were selling at the rate of 14 million an hour on Friday.

You probably know by now there were three winners. One each in Illinois, Kansas and Maryland. They will each get about $213 million. Other big winners included 161 at $250,000 each and 897 at $10,000 each. In all there were more than 16 million winners plus the 44 states that will benefit from the revenue.

Mega Millions Payout

Investors won on Friday. Actually they won for the entire quarter. The gains have been outstanding even though there was a lack of conviction all the way up. The Dow gained +8%, Nasdaq +18.7%, S&P-500 +12%, Russell 2000 +12%, Semiconductor Index +20%, Banks +26%, Brokers +26%, Biotech +29% and Housing +23%. In most cases that would be a great gains for an entire year.

The strong first quarter suggests investors should be wary of Q2. The fund managers were forced to buy stocks because the market kept going up and they could not afford to be heavily invested in cash or fixed income securities at the end of the quarter. This was defensive buying on very low volume.

Funds were successful in pinning the indexes just below the recent highs to insure the quarter ended strongly. It will be VERY interesting to see what happens over the next month as earnings decline.

Economics on Friday were mixed but they were mostly ignored thanks to the Mega Millions headlines. The ISM Chicago for March declined to 62.2 from 64.0. The internal components weakened and that suggests the Q1 bounce may be fading. New orders declined to 63.3 from 69.2 for the third decline in the last four months. Employment declined to 56.3 from 64.2. Inventories increased to 57.4 from 49.6 indicating sales may be slowing. However, order backlogs actually increased slightly to 54.3 from 53.6.

The Chicago ISM is strongly influenced by auto manufacturing and lately auto sales estimates have been declining. For instance March vehicle sales, which will be reported on Tuesday, are expected to decline from a 15.1 million rate to 14.5 million. The Chicago ISM is reflecting this decline in sales.

Chicago ISM Chart

The final reading for the March Consumer Sentiment rebounded +2 points from the initial reading to 76.2 and the highest level since last February. It was the seventh consecutive month of gains since the 55.7 reading in August.

The expectations component declined fractionally from 70.3 to 69.8 but the present conditions component rose from 83.0 to 86.0 to produce the headline gains. Inflation expectations for 12 months out rose from 3.3% to 3.9% and the highest level since last May. Clearly consumers are factoring in the rise in food and fuel prices even though the government ignores those in its calculations.

Consumer Sentiment Chart

In a daily consumer index by Rasmussen their sentiment level hit 97.1 on Tuesday and the highest level since the recovery began. However, the index has fallen nearly ten points since Tuesday to 88.7 on the dip in the stock market and rising gas prices. That survey also reported that 60% of consumers believe the U.S. is currently in a recession. I see that as a mystery. Why would sentiment be reaching four year highs if consumers thought we were in a recession?

The calendar for next week is dominated by the payroll reports. The estimates for job gains have actually been declining because the weekly Jobless Claims have been rising. We went for over a month with initially reported numbers in the low to mid 350,000 range but the revisions the next week always moved the numbers higher. The average revision over the prior six weeks put the claims closer to 365,000 each week.

Jobless Claims Chart

The ADP Employment due out on Wednesday is expecting a gain of +220,000 jobs and only slightly above the prior month at +216,000. The Nonfarm Payrolls on Friday are expected to show a gain of +201,000 jobs, down from +227,000 last month.

If the Nonfarm Payrolls come in much below 200,000 it would be a serious negative for the market. Current gains in equities are being justified because of rising employment and expectations for the recovery to accelerate. We saw last week the GDP for Q4 was +2.95% and strongly influenced by inventories. We don't have that in Q1 and we will be lucky to see a GDP over 2.0%. The first report on Q1 GDP is April 27th. If jobs were to slide and then GDP decline as expected right at the end of the earnings cycle I don't believe investors would be pleased. That could accelerate the "sell in May" cycle.

The FOMC minutes will be released on Tuesday and analysts will be looking for clues about a potential QE3 to be announced at the April 23rd meeting. Analysts anticipating further Fed policy stimulation expect the first announcement at that April FOMC meeting.

The market is closed on Friday for Good Friday.

Economic Calendar

There was a little bit of stock news that slipped in between lottery headlines. Global Payment Systems (GPN) saw their stock drop -9% at the open before it was halted for news pending. Global said its credit card processing systems had been compromised. They reported to law enforcement in early March they had found "unauthorized access" and the Secret Service immediately took over the investigation. Besides protect the president the Secret Service is also responsible for protecting the money and banking system.

Global said it would disclose the details on Monday. Website Krebs on Security first broke the story saying the attack was major and could involve more than 10 million cards. Reportedly the payment processor was breached between Jan 12th and Feb 25th. MasterCard and Visa had already begun contacting banks and card holders warning them their cards had been compromised and to expect new cards in the mail. Bogus charges were already appearing on the compromised accounts. PSCU, a provider of online financial services to credit unions, said 56,455 member Visa and MasterCard accounts were compromised and fraudulent activity had already been detected on 876 accounts in diverse geographic areas.

Visa and MasterCard were quick to say their systems had not been compromised and the breach was at a third party, which was quickly determined to be Global Payment. Analysts expect the stock to decline further on Monday when it reopens for trading. It never reopened on Friday. Firms losing money on the breach would have to sue GPN because most card service agreements put the loss back on the retailer for not qualifying the transaction and checking the card for validity.

GPN Chart

Groupon (GRPN) waited until after the close on Friday, a sure warning sign, to report it was revising down its previously reported earnings after finding some accounting problems. Groupon's auditor, Ernst & Young, called the error a "material weakness in its internal controls" for 2011. Groupon said it was revising their loss to $22.6 million, an increase of $14.3 million or 4-cents per share. Reportedly the loss came from an increased number of refunds on deals.

The stock was not specifically declining on the revision but more on the news that refunds were so high. Groupon has struggled with convincing investors the business model will be profitable and finding out there were $14.3 million in refunds MORE than expected is a lot to accept. Groupon also said the pace of refunds had continued through the first quarter ending on March 31st. In its filing Groupon said the inability to obtain reimbursements from merchant partners to cover customer claims "could have an adverse effect on our liquidity and profitability." That is not what investors want to hear.

The admissions of significant refunds and the claim by E&Y of "material weakness" could seriously hinder GRPN shares for weeks to come. Groupon has already suffered from multiple accounting irregularities in the past, some of which delayed the IPO. Recovering investor confidence after yet another problem could be difficult. At some point the SEC may investigate to see it this is just a pattern of accounting errors or were they trying to appear more profitable than they were for the IPO?

Groupon Chart

Liz Claiborne (LIZ) spiked +13% on news the company had been contemplating going private. The company sold its Liz Claiborne brand in November. They are planning a name change to Fifth & Pacific. The potential deal was discussed with several private equity firms and reportedly the LIZ board was looking for a takeout at $20. After Friday's spike the stock was trading at $13.36. The news broke in a Wall Street Journal article. Late in the day LIZ issued a statement saying "There is currently no contemplation of any strategy for the company other than executing against the operating plan we have already discussed."

LIZ Chart

Research in Motion (RIMM) rallied +7% to $14.70 despite posting disappointing earnings on Thursday night. The BlackBerry maker said its phones proved to be less popular with consumers than the iPhone and Android. The company said it was doing a strategic review of its options. That is normally code for "we are looking for a buyer." Revenue was $4.2 billion and -$300 million below estimates. Adjusted earnings were 80-cents and only a penny shy of estimates. That was actually a surprise since almost everyone expected a big miss. RIMM said it was giving up trying to compete with the smartphone giants and was going back to focus on its business customers.

RIMM Chart

Apple shares declined for the second day with a loss of -$10 on no specific news. However, Apple's factories in China were cited for more than 50 grievances over labor conditions but CEO Tim Cook was treated like a visiting head of state when he visited there last week. Foxconn and Apple agreed to answer the "recommendations." If implemented they would improve the lives of the 1.2 million Foxconn employees and set a new standard for Chinese factories according to the Fair Labor Association. Apple pays about $13 to Foxconn for every iPad assembled.

I suspect Apple shares were weakening at quarter end as a result of traders getting out ahead of April rather than worried over Apple's manufacturing problems in China.

Apple Chart

Yahoo (YHOO) announced on Friday it would begin layoffs in a new restructuring program designed to make Yahoo leaner and more competitive. They claimed the layoffs would be deep and mostly aimed at the product, research and marketing units. The goal will be to cut "many" thousands from the staff that currently numbers close to 14,000. There was no word on any plans to sell off assets.

Yahoo Chart

Ohio Art Co (OART) is capitalizing on the Rick Santorum use of one of its products in a campaign speech. Santorum said, "I have not written my public policy pronouncements on an Etch A Sketch, they are written on my heart." He was referring to Mitt Romney as a flip flopper saying he would erase his past campaign promises and start over if he is elected.

The 104 year old toy company debuted the Etch A Sketch in 1960. They immediately jumped on the sudden revival of interest and have commissioned a "Shake it Up America" ad campaign that will appear in places like Facebook and Twitter. One ad shown below has a great tagline but I can't believe it was actually done on the toy. I am betting that slogan was photoshopped into the image. Another advertisement says "We have a left knob and a right knob for each political party. But remember when both work together, we can do loop de loops." Toys R Us asked them to make blue versions to go along with the traditional red versions. They are due out in June along with a red and blue collector's edition with etchings of an elephant and a donkey.

There is even an Etch A Sketch app for iPhones. After trading at $4 forever the stock spiked to more than $12 on the 22nd when the comments were made. Shares closed at $5.95 on Friday on volume of 200 shares. Yes, 200 shares. Volume is normally in the low hundreds but spiked to 6,500 shares on the comment by Santorum.

Etch A Sketch

Ohio Art Chart

Oil prices rebounded to close slightly positive on Friday after the President gave approval for the tougher sanctions on Iran. The president had until the end of March to decide if there was enough oil in the market to enact the tougher sanctions announced several months ago. The sanctions had a clause requiring the president to certify there was enough oil in the market to prevent a serious price spike if the sanctions were enacted. On Friday the president gave the go ahead for the tougher sanctions saying the move would not harm consumers.

I find this almost amusing. For several weeks the White House, the U.K., France and the IEA have been dropping hints there would be a coordinated release of oil from the Strategic Petroleum Reserve in order to lower fuel prices. They succeeded in keeping oil prices from advancing for three weeks with this tactic. Now the president announces there is plenty of oil to allow stronger sanctions on Iran to go into effect on June 28th. The IEA said the sanctions could cut about 800,000 bpd from Iranian exports by July.

In reality this move may explain why Saudi Arabia has been going out of its way to claim there is an extra 1.0 mbpd already in the market and they can produce another 2.5 mbpd if they have to. It was not because they were trying to drive down prices but they were trying to convince the U.S. and U.K. to go ahead with the Iranian sanctions by stressing the shortage was not going to be a problem. If Saudi could convince the U.S. and E.U. leaders there was enough oil then sanctions would increase and Iran would see its box shrink a little tighter. Saudi and Iran are enemies. Saudi does not want to see Iran obtain a nuclear weapon. Now the previously unexplained gyrations by the Saudi Oil Minister make a lot more sense.

WTI Crude Oil Chart

Brent Crude Chart

Maybe somebody needs to put sanctions on natural gas producers. Nat gas futures closed at a 10-year low of $2.12 on Friday after dropping to $2.10 intraday. Gas supplies are 58.6% above their five year average and at record levels for this time of year. The EIA inventory report on Thursday showed an injection of 57 Bcf compared to a decline of -7 Bcf in each of the last two years at this time. WTRG Economics pointed out that with only two exceptions, every week since the beginning of September the withdrawals from storage were either less than expected or the injections more than expected when compared to the 5-year average.

Storage levels are on track to exceed the prior record of 3,852 Bcf in storage by November 1st. Maximum storage capacity is 4,577 Bcf and analysts expect that to be reached well before Nov 1st. At that point production will have to stop in some locations because of maximum pipeline pressures. Spot prices at the Henry Hub futures delivery point are -52% lower than this time last year. It may be only a matter of days before nat gas prices break below $2. This is below the actual cost to produce it for many companies. If they are not hedged they will be forced to curtail production or lose money.

Natural Gas Chart

Volatility returned over the last two weeks with two attempts to move higher and two attempts to sell off. In the end the fund managers closed the indexes exactly where they wanted them in true window dressing fashion. The S&P over 1400, Dow over 13,200 and the Nasdaq 100 at 2750. It was a picture perfect storybook ending for Q1. There have been major gains in all the indexes and no material profit taking for more than three months.

Unfortunately every soaring eagle, aircraft or rocket will eventually have to land. The eagle and airplane will glide slowly to earth in a controlled landing and the rocket will crash back at a time of its own choosing and sometimes in many pieces.

Many analysts have been predicting the end of the rally for several months now. Every new uptick attracted more converts to that crowd. Fund managers may have been of that mindset but they could not afford to take appropriate measures to defend portfolios against a correction. They were forced to throw more and more money into the market to avoid losing. Fund managers are paid based on profits and relative performance. If hundreds of your competitor funds are invested in a market moving higher then you also have to be invested. You don't want to be listed at the bottom of the performance charts at year end.

It does not make any difference why the market is moving higher or how irrational the move. It is a trend and managers have to follow the trends.

April is where the trend may change. The quarter is over and the next three months are typically less bullish. April has been up an average of +4.5% over the last five years but as we all know past performance is no guarantee of future results. Earnings are going to be bad as in +1% profit growth or possibly even negative growth.

Typically April starts off strong as retirement funds flow into the market and everyone eagerly awaits the earnings reports. As the earnings cycle progresses the indexes begin to roll over and the "sell in May and go away" crowd does its thing.

Since the markets are already up strongly for the year there will be a strong desire to preserve those gains with tight stops. When the market does finally lose momentum the down slope could be dramatic. Picture that first big hill on a roller coaster. Everyone is enjoying the scenery from the high vantage point until the very last minute. Suddenly everyone's muscles tighten and your grip on the restraining bar goes white knuckle. The next 30 seconds are punctuated with terror and excitement as the twists, turns and dips keep your attention focused on the track ahead rather than the scenery around the park. Eventually the cars pull into the station and there is a period of transition before the ride begins again.

I believe we are nearing the top of that first big hill. We could already be there but we could also see a couple more weeks of performance chasing heading into earnings. Once earnings begin to flow the market direction will be data driven. Crummy earnings will probably produce a crummy market and the coaster ride will accelerate with the associated rise in volatility as we blast through the various peaks and valleys of the decline.

This is my short term view. Long term I believe the markets will move higher later in the year if Iran does not evolve into a war, oil prices remain reasonable, fuel prices don't exceed $4.25 per gallon and the economy continues to muddle through with growth at a better than +2.0% GDP rate. Europe is not over. Spain is the next main event with Portugal a sideshow. The new trillion dollar firewall being discussed is not big enough for Spain but should handle the coming problems with Portugal and the return of Greece. Yes, Greece.

However, I think the U.S. markets are now immune to European debt problems. Investors will be focused more on European growth or lack of it and the impact to the large multinational corporations that get more than 50% of their earnings from Europe.

China will be the new worry until the government decides to go nuclear on stimulus and to heck with inflation. Currently they are right on the edge of trouble. Inflation is manageable but growth is slowing. They need the growth more than they need to manage inflation. Eventually they will figure this out and they will take the brakes off the economy.

While all these problems are sorting themselves out the U.S. markets will be digesting the roughly 30% gains since October. There is always a digestion period and this summer should be that period. It is only a question of when investors decide they have had enough and push away from the table to start the digestion process. I suspect that will begin over the next four weeks with the most likely date the week after April option expiration.

The S&P had its best first quarter since 1998. The October low was 1074 so there is a lot of profit accrued to this rally. Historically when the S&P is up over 10% in Q1 the second quarter was decent. In 19 of the last 20 times the S&P gained more than 10% in Q1 the second quarter was either flat or higher. Only once did it decline sharply. I know, past performance is no guarantee of future results.

Initial support for next week is 1390 followed by 1375. Initial resistance is 1415 followed by 1426.

S&P Chart - 120 Min

S&P-500 Chart - Daily

The Dow posted the smallest gain of the major indexes at +8.1%. The Dow Transports only gained +4.6%. I guess you could say they both confirmed each other's underperformance. The transports were weak because of the rising oil prices. The Dow was weak because of the relative weakness in the materials and industrials like Alcoa and Caterpillar. Boeing was flat for the quarter and so was 3M. Hewlett Packard was a big drag with a -20% decline in March. IBM, DIS, HD, JPM, BAC, AXP, PFE, KO, CSCO, INTC and MSFT were the standouts that keep the Dow in the positive column.

The Dow tested support at 13,000 twice in late March and both times it held. However, each rebound produced a lower high and that suggests future weakness. The Dow needs to quickly move over the March highs at 13,265 or the next support to be tested is likely to be 12,750.

Dow Chart - 120 Min

Dow Chart - Daily

The Nasdaq had its best first quarter since 1991. The Nasdaq Composite has seven consecutive weeks of gains and the Nasdaq 100 has 13 weeks. You have heard the story before. The gains are the result of the big caps being used as safe deposit boxes for large sums of money. Apple gained +48%, Priceline +54% and so on.

Clearly when any stock gains 50% in a quarter the first reaction is to expect some profit taking. Would you buy a $600 stock after a 50% gain without first seeing some decent profit taking? Yes, I know Apple only has a PE of 12 and is still a relative bargain but I am pretty sure you would rather buy a decent dip. Most analysts have been expecting that dip for several weeks but they forgot about the safe deposit aspect of buying Apple as the quarter closed. Apple traded 26 million shares for more than $600 each on Friday and that was the second day it lost ground. The Nasdaq will follow Apple's lead next week.

The Nasdaq Composite has strong support at 3050 and we could easily pull back to that level to wait for earnings. The same level on the Nasdaq 100 is 2715. Resistance is 3135 on the Comp and 2800 on the NDX.

Nasdaq Composite Chart - 120 Min

Nasdaq Composite Chart - Daily

Nasdaq 100 Chart - Daily

Nasdaq 100 Chart - 120 Min

The Russell 2000 has been moving sideways for two months. We saw a little volatility in March for temporary breaks out of the trading range but Friday's close under 832 put it right back in that range. If the Russell could move higher from here it would be very positive for the market because it would suggest a move out of the large caps and into smaller, less liquid stocks. That normally signals a longer term market rally ahead.

Watch for the Russell to outperform or underperform the big cap indexes. Whichever trend appears it will point to the next broader market direction.

Russell 2000 Chart - Daily

Clearly the market is over extended heading into the new quarter. Obviously there is nothing preventing it from becoming even more overextended so we need to let the market tell us which way it is headed. Remember, when the market wants to go down it will find an excuse. It may be earnings, economics, geopolitical events, China, Spain, etc. We won't know it until it appears but we do know there is a profit taking cycle in our future. I am not going to say sell everything at the open on Monday because nobody can accurately pick market tops and bottoms. We can do the analysis and we can interpret the signs but there are millions of moving parts and until the majority of those parts suddenly change direction based on a specific excuse the momentum can continue. We saw that momentum slow over the last couple weeks so I would be overly cautious about entering new long positions until a new direction appears or the old one is confirmed.

Jim Brown

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"Keep on going and the chances are you will stumble on something, perhaps when you are least expecting it. I have never heard of anyone stumbling on something while sitting down."
Charles Kettering