An abundance of Fedspeak weighed on the markets and scared the dip buyers away.

Market Statistics

The Dow fell to session lows after Atlanta Fed President Dennis Lockhart warned that QE tapering could come as soon as next month. However, he also stressed the Fed does not have to taper in the near future if growth fails to pickup as expected over the next several months.

Lockhart said, "If we see the growth pick up in the second half and if we see a continuation of the job gains - not the 162,000 number that we saw last month but at a higher range, say 180-200,000 - I think with other fundamentals improving we probably are in a position to remove ... the extraordinary policy program over the medium term - that being the asset purchase program. If we see a deterioration from this point, and I would say my more realistic fear is just a kind of ambiguous picture of mixed data that signals neither accelerating strength nor necessarily deterioration, but that kind of moping along in the middle, then I think it's not a foregone conclusion that the asset purchase program should be removed or be removed rapidly." That sounds like he took speaking lessons from Greenspan.

What the market heard was to expect QE tapering to begin in September. What he really said was "my more realistic fear" is neither strength nor weakness but a muddle through economy and QE will not likely be changed.

Chicago Fed President Charles Evans, a noted dove on economic policy, said there has been "good improvement" in the labor market and "I would clearly not rule out" tapering at the September meeting. "I am still wanting to see greater evidence that it is a sustainable improvement" before a decision to taper in September. "The employment report was "not bad" yet it was "not great. We are looking for continued improvement in the 175,000 to 200,000 jobs per month."

Evans said he backed the timetable laid out by Bernanke in June with tapering to be announced in September, start in October and end in June. The stated goals of 6.5% unemployment and 2% inflation are known as the Evans Rule because he has long advocated for fixed thresholds for changes in Fed policy. Evans said today his thinking is "not largely inconsistent with Minneapolis Fed President Kocherlakota's proposal" to lower the unemployment threshold to 5.5% if inflation remained low. Evans and Kocherlakota would keep interest rates near zero but they are not opposed to reducing QE if the economy improves significantly.

Evans again emphasized today the decision to taper QE will be "data dependent" and should the current 1.3% inflation rate persist the Fed could choose to continue QE at the present levels.

The flurry of Fedspeak on a slow news day was all the market needed to take a break. I always say when the traders want to take a break they will find a headline to use as an excuse for profit taking.

The Fedspeak was only one set of headlines. The biggest hit to the Dow was a Credit Suisse downgrade to underperform (sell) on IBM. Kulbinder Garcha said "future growth will be challenging. Organically we believe IBM is effectively in decline." He said the shift to the cloud continues to present risks to IBM's technology position. His downgrade was immediately rebutted by numerous analysts with multiple claims the drop in IBM shares represented a buying opportunity. IBM shares fell -4.50 and knocked -35 points off the Dow. I agree with the buying opportunity claims with $190 as strong support.

IBM Chart

There was little economic news although the Trade Deficit for June fell to the lowest level since 2009 at -$34.2 billion. Exports rose slightly by $4 billion while imports declined -$6 billion. Petroleum imports declined to $17.4 billion from $20.8 billion. This decline in the deficit suggests Q2 GDP could be revised higher by as much as half a percent.

The Job Opening Labor Turnover Survey (JOLTS) was neutral for June. This is a lagging report and it is normally ignored. Available jobs rose from 3.91 million to 3.94 million and the highest level since December 2007. Hiring declined from 4.49 million to 4.2 million and a three-month low. Quits declined as well from 4.38 million to 4.08 million. Fewer people quitting means less need to hire. The only real positive in this report is the rising number of available jobs.

The economic calendar for the rest of the week lacks any material events. The focus will be entirely on Fedspeak and earnings.

Economic Calendar

The earnings for Wednesday are headlined by Green Mountain Coffee and Tesla Motors. There are bigger companies reporting but those are the momentum favorites everyone will be watching.

So far 391 S&P 500 companies reported. More than 67% beat lowered earnings estimates and only 55% beat reduced revenue estimates. The revenue percentage is the highest in four quarters. That either means the revenue estimates were revised too low or possibly the economy picked up a little in Q2.

Earnings Calendar

July has produced some significant economic surprises that could suggest the global economy is gaining traction.

On Monday the July ISM Services index rebounded a whopping +3.8 points to 56.0, up from 52.2, which was a three year low. The +3.8 point gain was the biggest monthly jump since February 2008. The new orders component soared nearly 8 points from 50.8 to 57.7. That was the largest single month increase since April 2009. Sixteen of the 18 industries surveyed said business was expanding. That is up from 14 in June.

In the U.K. services expanded in July at the fastest pace in more than six years. China's service PMI rose for the first time since March.

Last week the ISM Manufacturing Index also posted a blowout gain for July. The ISM Manufacturing headline number rose to 55.4 from 50.9 in June. New orders soared from 51.9 to 58.3. The production index exploded from 53.4 to 65.0. That was the biggest monthly gain since 2009 and puts the index at the highest level since 2004. The employment component rose +5.7 points to 54.4 and back into expansion territory.

These reports suggest economic activity may be accelerating. This also suggests we are going to hear a lot more Fedspeak as they try to prepare the market for changes in September. We saw today how the market reacted to the early warning signals.

Contrary to the points above there was some disappointing news from the retail sector. American Eagle Outfitters (AEO) slashed its earnings guidance by 50% due to weak traffic during the back to school shopping season. AEO cut guidance to 10 cents from prior forecasts of 20 cents. With American Eagle considered the bellwether of the teen retailers the warning quickly translated to losses all across the sector.

In addition to the AEO warning the National Retail Federation said they expect the average family to spend 7.8% less than they did in 2012.

AEO shares declined -12% followed by ANF -4%, ARO and GDS -2%.

AEO Chart

On the opposite side of the ledger Fossil (FOSL) surged +19% after reporting adjusted earnings of $1.10 that easily beat estimates of 93 cents. Fossil credited double-digit sales increase in its multi-brand watch portfolio for the profits. Revenue rose +11% despite a -2% hit from currency translation. Fossil has 403 stores and its products are marketed by department stores and other retailers. The company raised full year guidance from $5.85-$6.15 to $6.15-$6.35. That is the second major upgrade in outlook so far this year. More than 7% of FOSL shares are short so it was not a fun day for some traders.

Fossil Chart

On Monday McDermott International (MDR) reported a massive drop in earnings from a 22 cent profit in the year ago quarter to a loss of 63 cents in Q2. Revenues fell -28% to $647 million. Project backlogs declined -$200 million to $5.1 billion. The company tried to explain away the huge miss saying a lot of projects have been completed over the last several quarters and are no longer active. The company was promptly downgraded by several brokers. McDermott also announced the Chief Operating Officer or COO would be retiring almost immediately. As the token scapegoat John McCormack will leave "sometime" in Q4 and the search for a replacement has begun. The company needed somebody to blame for the -25% decline in the stock since February with three consecutive post earnings declines.

McDermott Chart

After the bell First Solar (FSLR) reported earnings of 39 cents compared to analyst estimates of 56 cents. Revenue declined from $957.3 million to $519.8 million. Estimates were for $729 million. The company said it had not completed the sale of its "ABW" projects in the quarter as had been expected. That sale is still expected to complete in the second half of 2013. They cut their full year outlook from $4.00-$4.50 to $3.75-$4.25.

Shares fell -$4 in afterhours but would have been much worse except for some good news. FSLR entered into a joint venture with GE on a thin-film partnership and GE will receive a 1.75 million share stake in First Solar. That gives FSLR a deep pockets partner with massive global reach.

First Solar Chart

Dow component Disney (DIS) also reported earnings after the bell. The company reported adjusted earnings of $1.03 that beat estimates of $1.01. However, they expect to lose $160-$190 million in Q3 as a result of the Lone Ranger movie that bombed. In Q2 that movie helped to drag down studio income by -36%. They also failed to post expected gains from Iron Man 3 after it did not perform as well as the previous episode. They did report an 8% increase in media network revenue, primarily from ESPN. They saw income increase +9% in the theme park unit. Interactive gaming posted a loss of $58 million. Shares of DIS declined about $1 in afterhours trading. That will be a slight drag on the Dow at the open on Wednesday.

Disney Chart

Zillow (Z) reported a +69% increase in revenue to $46.9 million but a loss of 30 cents per share. Analysts were expecting an 11 cent loss. Technology expenses and general administrative expenses nearly doubled due to the addition of engineering staff. The CEO called the results "tremendous" saying the company was gaining market share and increasing its audience. Traders called it horrible and shares declined -$8 in afterhours.

Zillow Chart

The Dollar Index declined again after the Bank of Australia cut its interest rate to a record low of 2.5% down from 2.75%. Conflicting economic signals and uncertainty over QE is helping to weaken the greenback. The drop could have been worse but the selloff in treasuries provided support.

The yield in the ten-year rose slightly to 2.62% and remains on its upward trend. The more Fedspeak we get about a September taper the more treasuries are going to be sold. The Fed already owns more than 20% of treasuries outstanding and once they quit buying the rates should accelerate higher.

Dollar Index Chart

Ten-year Yield Chart

The S&P declined -10 points to close at 1697 and only +4 points off the lows. While I would like to think we are going to see a much needed correction or at least a healthy dose of profit taking we are still in an uptrend until that trend fails. One day does not make a new trend.

The S&P still has major support at 1680-1685 and after the prior three days it has significant resistance at 1707. The unofficial resistance target is still 1725 but it will take a major headline to rekindle the momentum.

If you look at the chart over the last month the trend has been more sideways than vertical. There were several afternoon rebounds and the one short squeeze on the 1st. Other than that we have been consolidating just above 1680.

Consolidation can be just as good as profit taking as funds rotate from one position to another. However, nothing beats a good multi-day dip and a strong rebound to a new high. It clears out the weak holders and allows new buyers a clear entry point into the market. While I would hope that is on the calendar for August we never know until we get there.

I did think it was ominous the dip buyers failed to appear today. Volume was light at 5.5 billion shares after a 4.6 billion share day on Monday. Decliners outpaced advancers by a 5:2 margin. The 20% increase in volume was troubling for a down day but it was still light volume so we can't really claim a major change in market sentiment. So far this is just a hiccup.

S&P Chart - 60 Min

S&P Chart - Daily

The Dow was crushed by the declines in IBM (-4.50), UTX (-1.44) and CAT (-1.03) but those only accounted for roughly 50 points of the Dow decline. At its lows the Dow was down -138 and it rebounded to end with a -93 point loss. The +45 point rebound was roughly one-third of the range but we have been accustomed to seeing these big intraday declines completely erased.

The IBM downgrade was damaging to sentiment and having multiple Fed heads talking taper on the same day it was a wonder we did not see a bigger decline. However, dip buyers have been accustomed to immediate rebounds and 24 hour profits. Until that trend changes they will continue to buy the dips. It is not likely to happen in only one day.

Support is now 15,485-15,500 and resistance is firm at 15,645. We are due for a trend change from the sideways motion of the last month. If that change involves a steep decline below 15,485 I believe sentiment could change quickly.

Dow Chart

The Nasdaq declined -27 points but that was less than the prior three-day gain. The decline stopped at exactly the initial support from the first level uptrend resistance, now support at 3655.

Apple was no help today with a -$4 loss after breaking out to $470 on Monday to lead the charge higher. Apple received some bad news on its recent patent rulings but I believe the dip is only temporary. We are rapidly approaching the Apple announcement season where they are expected to announce several new products. Now that shares of AAPL are at/over the $465 resistance they should accelerate into those product announcements. This will help to power the Nasdaq through the summer doldrums.

Resistance on the Nasdaq is 3690 and a break of closing support suggests a retest of 3600.

Nasdaq Chart

The Russell 2000 spent three days battling resistance at 1060 before giving back -10 points today. Prior uptrend resistance at 1040-1045 should be support. Watch carefully for a break of 1040 as the signal bullish sentiment has soured.

Russell 2000 Chart

The flurry of earnings misses after the close has depressed the futures slightly. There is a lot of darkness before the dawn and our market losses are sure to impact Europe and Asia. More importantly the Fedspeak will depress those markets without any material local news to counteract it.

For some time I have been saying I expect a weaker market in August-September and that this was the week I expected the weakness to begin. When Q2 earnings begin to fade in August, fund managers begin to reshuffle their portfolios based on YTD gains and second half guidance from the individual stocks. With the large number of guidance warnings those managers will have a lot to consider. Volume should be thin for the rest of August as those traders that can take off a couple weeks before kids go back to school.

Enter passively, exit aggressively!

Jim Brown

Send Jim an email