The Dow's streak of consecutive Tuesday gains ended at 20 with a -76 point loss today.

Market Statistics

The Dow traded in a 190 point range and declined as much as -153 intraday. There was a definite try to push the Dow back into positive territory by the close with a rebound to a loss of only -30 points but they could not hold it and sellers appeared in volume at the close.

The tide may be turning from the bad news is good news trend we have seen for the last five months. The very bad news from the Manufacturing ISM on Monday was greeted with a celebration rally. However, sometimes the day after a big celebration includes a powerful hangover or at least some serious indigestion. Today was one of those days as the economic reality began dawn like the realization the day after an office party where you can't remember how you got home.

The Manufacturing ISM on Monday was not just bad, it was horrible and I am repeating it here for emphasis. The headline number dropped from 50.7 to 49.0 and into contraction territory. It was the fastest monthly decline in more than four years. New orders fell from 52.3 to 48.8. Backorders declined from 53.0 to 48.0, a full -5 points. Production declined from 53.5 to 48.6. This was an ugly report and because of the sequestration it should only get worse. The only reason the market should rally on this news was the expectations for QE to last a lot longer.

ISM Chart

Kansas City Fed President Esther George apparently did not like the market rally on Monday so despite being ill today she phoned in her speech that was to have been given in Santa Fe, New Mexico. She said, "In light of improving economic conditions, I support slowing the pace of asset purchases as an appropriate next step for monetary policy." Also, "Waiting too long to acknowledge the economy's progress and prepare markets for more normal policy settings carries no less risk than tightening too soon." She is a voting member of the FOMC and she has dissented at the last two meetings.

She warned the Fed can't be expected to use monetary policy to support the job market when "regulatory uncertainty, including health care reform" is causing businesses to be cautious. This is not the first time a Fed head has warned that Obamacare is depressing the job market and slowing business investment. She also cited the record high margin debt as a sign the stock market is moving into bubble territory. "Investors are borrowing at very low rates of interest to purchase riskier financial assets. Presumably, some investors are pursuing this strategy because they anticipate that loans will continue to be available at very low rates of interest that will allow them to ride out any market volatility." Her comments suggest the record margin debt is going to be a market problem because rates are not going to remain low.

Her comments had a bigger impact on the market because she went to extra effort to make sure they were heard by posting them online when she could not give the speech. The market sank to its lows when the comments were released.

My only question is "what economic conditions are improving?" The ISM Manufacturing declined at the fastest pace in four years. The vast majority of the jobs created in April were part time as a result of the Obamacare restrictions.

There were no major economic reports on Tuesday. The Trade deficit expanded from -$37.1 billion to -$40.3 billion. That was less than the consensus estimates for $41.6 billion. Exports of goods rose by +2% while imports excluding oil rose by +3.9%. This smaller than expected increase in the deficit is still positive but analysts would have liked to have seen stronger exports.

The New York ISM rose from 577.4 to 579.6. However, the current conditions component declined from 58.3 to 54.4. The employment component declined from 53.3 to 49.4 and the quantity of purchase component plunged from 59.4 to 45.5. The pace of activity is slowing even in the normally bullish New York area. If it were not for the rebuilding for Hurricane Sandy the New York area would probably be in contraction as well.

The economic calendar for Wednesday has three big events. The ADP Employment is the first look at jobs for May. Expectations are for a gain of +157,000 jobs compared to the +119,000 gain in April. I personally think that is very optimistic but anything is possible.

The ISM Nonmanufacturing is important but it is not expected to dip into contraction. The U.S. has moved from a manufacturing economy to a services economy so that is where we should expect to see strength. If services were to fall into contraction it would be very negative for the market.

The Fed Beige Book could be a serious blip in the Fed's plan. If the Beige Book shows deterioration in the number of Fed districts showing economic gains then QE expectations would lengthen significantly. An unexpected decline in the Beige Book conditions could end talk of tapering for the rest of the year.

The biggest report left this week is the Nonfarm Payrolls on Friday. With the employment components falling in the regional activity reports we could see a surprisingly low number of new jobs. However, if part time jobs surge as they did last month the headline number could surprise on the upside despite the decline in the quality of employment. It is not a positive trend for wage earners to be forced to work two part time jobs to support their family because full time jobs are no longer available.

If a person is laid off from a full time job because of the approach of Obamacare and mandatory healthcare that is the loss of one job. If he is forced to take two part time jobs to make up for the lost income that counts as two new jobs even though it is only one person. I know multiple people that have been forced to do this. That shows job growth but is that a positive trend that should be celebrated by the market?

Economic Calendar

Stock news was very light since we are moving towards the summer doldrums and we are not quite to the earnings warning period for Q2. That begins in about two weeks.

SalesForce.com (CRM) declined -4% to $37.80 after announcing it was going to buy ExactTarget (ET) for $33.75 per share or roughly $2.5 billion. That is a 53% premium to Monday's closing price. SalesForce has spent more than $4 billion on 40 acquisitions over the last five years. ExactTarget helps companies run advertising programs with email, social networks and mobile devices. The SalesForce CEO said he was targeting an increase in advertising revenue from the current $100 million a year to $1 billion. ET had an IPO in 2012 and has not had a profit since 2008 even though revenue has increased every year. Reportedly the bidding for ET was very active. This was the biggest acquisition of a marketing firm since Google acquired DoubleClick in 2008.

SalesForce.com Chart

ExactTarget Chart

Monster Beverage (MNST) rallied nearly +10% after reporting a 9% sales increase over the last 60 days. Stifel Nicolaus said the data actually showed an acceleration in May with growth in the 13% range. SN thought this was bullish since early April saw a barrage of negative headlines over the health effects of consuming large amounts of energy drinks. BMO Capital Markets said the negative headlines created an attractive entry point.

The breakout on Tuesday closed over two months of consolidation and the positive sales growth suggests the worst is over and it could be headed back to the highs from 2012 at $80.

Monster Chart

G-III Apparel Group (GIII), the apparel manufacturer you never heard of, soared +18% today after posting stronger than expected earnings. G-III manufacturers Calvin Klein, Guess, NFL, Vilebrequin, Wilson Leather, Tommy Hilfiger, Cole Haan, Ivanka Trump and more than 30 other brands. Who knew? I had never even heard of them until today.

G-III Chart

Apple (AAPL) received some bad news today. The U.S. International Trade Commission posted a decision on its website claiming Apple faces a ban on sales of the iPhone 4 and iPad 2 because they violate a Samsung patent. The devices impacted are the ones operated on the AT&T and T-Mobile networks. Both Samsung and Apple have won patent cases against the other on the same devices. Apple can continue selling the devices while it appeals and by the time the appeal is decided the devices will be obsolete. The iPhone 4 is still a popular model because of the price point but Apple has the 4s and iPhone 5 producing most of the sales. President Obama can overturn the ruling during the presidential review process but normally presidents stay well away from the patent process. Apple spokesman reiterated that today's decision has no impact on the availability of Apple products in the USA. Apple shares lost only -$1.41 for the day.

Apple Chart

The selloff today was broad based with financials, housing and energy leading the decline. The home construction ETF fell -2.8% to extend a week of declines. Recent weakness in some housing reports suggests the housing boom is fading. With mortgage rates rising to 12 month highs the buyers that waited are now in terminal procrastination mode.

Dow Jones Home Construction ETF

Banks have been choppy for the last three weeks and headlines today about some large companies like AIG being added to the Too Big to Fail list caused another decline. The energy sector has been weak for the last couple of weeks despite oil prices in the mid $90s. The energy ETF (XLE) is threatening to break below five-week support at $80.

The summer hurricane season started on June 1st and right on schedule a low pressure area formed that could turn into a tropical storm in the next 48 hours. Oil rigs are making preparations for the first storm more as a live drill than actually expecting it to turn into a major storm. The upper air patterns are not currently conducive to a major storm.

Possible tropical storm forming in the Gulf

XLE Chart

For the first time in a week the Japanese Nikkei did not push our markets lower. The Nikkei gained +2% on Tuesday after declining -3.7% on Monday and -17% over the last eight days. Given the severity of that sell off the minor +2% rebound is less than exciting. This was just a dead cat bounce and there may be more weakness ahead. Note that 13,000 is the current support level.

Nikkei Chart

Today appeared to signal a slight shift in market sentiment but it was probably more a fear of Wednesday's economic reports than a sudden bearish turn. Volume was moderate at 6.7 billion shares and one billion less than Monday. The advance decline ratio was 2:1 declines over advances.

The market for Wednesday is going to be focused on what happens to the Nikkei tonight and whether there will be a continued decline and on the ADP Employment report at the open. It remains to be seen if a bad payroll number will bring back the bulls in hopes for more QE. At some point the bad news is actually going to be seen as bad news.

The S&P did not make a lower low today but it was a lower high. The tentative support at 1,638 failed but support at 1,625 held. Monday's low at 1,623 could also be seen as a support hold since it did not close there and there was a strong rebound rally. The rebound rally today was much weaker and stocks were selling off into the close instead of rallying.

A break under 1,623 is going to be a critical event. A close under 1,623 cold produce that dramatic shift in sentiment everyone has been expecting. We are right at the point where the dip buyers have been active over the last five months. If they fail to buy this dip at the -3.5% range then we move into uncharted territory with 1,600 the next logical support target.

S&P Chart - Daily

The Dow made a lower low and rebounded instantly from the 15,100 level that was support in early May. The volatility has been huge with a 190 point range today from +40 to -153. Although they tried to push the Dow back into positive territory at the close the best they could do was -30 and sellers immediately piled in when that surge lost traction. The 15,050-15,100 level is critical. Multiple levels of converging support will be broken if that level fails. The next downside target would be in the 14,700 range.

Dow Chart

The Nasdaq is slowly weakening. It has been the stronger of the big three indexes but the steady pattern of lower highs is forcing a retest of converging support at 3,420. That is a critical level for the Nasdaq and a breakdown there could trigger a significant decline. Apple is no longer contributing to this weakness. The selling is starting to spread and broaden to multiple sectors. If the bulls are going to make a stand before the summer doldrums hit they need to do it this week.

Nasdaq Chart - 90 Min

The Russell 2000 chart is a clone of the Nasdaq with the lower highs and critical support. The Russell has been the strongest index and given its sentiment characteristics for the broader market it is still bullish. Fund managers are not giving up on the small caps. However, the weakness is growing and a break below 970 would be a major sell signal. If fund managers suddenly decide to cut and run we should see it first in the Russell and a break of that support level. Watch carefully!

Russell Chart - 90 Min

I am not ready to write off the rally but we are due for a rest. The Q2 warning cycle is just ahead followed by the summer doldrums. Given the big gains in the first five months of the year it would make since for fund managers to take profits in the high flyers and raise cash to buy any late summer dip. These next few weeks are going to be critical for the market. We could easily see a couple attempts at a rebound followed by lower lows. Don't get married to your positions. Practice active cash management throughout the summer and be hesitant to aggressively buy the dips. Cash is a position.

Enter passively, exit aggressively!

Jim Brown

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