Depending on your market view last week was an oversold bounce or the beginning of a new move higher.

Market Statistics

Even with the Friday bounce the Dow still lost ground for the week. The S&P gained less than half a point. The Nasdaq was the big winner with a +55 point gain with very little help from the big caps other than the +7% gain in Microsoft on Friday.

The market rallied late in the week for several reasons. The economic numbers from China and Europe came in better than expected suggesting a global recovery may actually be in progress. The market rebounded from very oversold on Wednesday and the taper talk appeared to be changing from taper on to taper off for September.

Friday started off with a sharp decline in equities after the New Home Sales for July plunged from 497,000 to 394,000 and the lowest level since October. Analysts were expecting between 490,000 to 517,000. In addition to the sharp decline in July the June number was revised down from 497,000 to 455,000. April and May were also revised lower. The decline in sales pushed inventory levels from 4.3 months of supply to 5.2 months. The median price rose +7.3% over year ago levels BUT prices have declined -8% since April as mortgage rates rose.

Sales in the U.S. declined -13.4%. Sales in the West fell 16.1%, South -13.4%, Midwest -12.9% and Northeast -5.7%. New homes available for sale rose +4.3% to 171,000. Analysts tried to blame the slowdown on the weather with the South getting an average of 3.5 inches in July and 22% above average. However, that was only in the South and only in July. That excuse does not work for the other regions and the prior months.

The rising mortgage rates are quickly removing homes from the capability of borrowers to finance. Long term mortgage rates have risen from a low of 3.5% to 4.6% in 2013. The payment on the average $300,000 mortgage has risen by $200 a month. The Wells Fargo Housing Opportunity Index fell from 73.7% to 69.3% indicating the average borrower was seeing the price point decline on the maximum house he could afford. Rising rates push payments higher and qualification price points decline. This was the first time under 70% since 2008.

With 70% of jobs created in 2013 being part time the working class is seeing their incomes decline. Add in the higher gasoline prices, higher taxes and lower wages and the housing boom is fading fast. Ironically the number of people who claim they want to buy a house is near an all time high. However, wanting to buy is not the same thing as being able to buy. The number of first time home buyers declined to 29% in July, down -15% from July 2012 and well under the 40% average in a normal market.

Another major retailer moved from full-time to part-time employment for its workers last week. Forever 21, a fashion retailer with 500 stores, sent out a memo stating that the majority of full time positions would become part-time positions effective August 18th. All medical, dental and FSA benefit plans would be terminated as of August 31st. All employees will work a maximum work week that will not exceed 29.5 hours. Workers will no longer be able eligible for paid time off (vacations). Welcome to Obamacare.

UPS announced last week it was dropping spousal insurance coverage for 15,000 employees because it was too expensive under Obamacare according to the UPS announcement. Those spouses will now have to get insurance on their own at a cost of several hundred dollars a month.

The Census Bureau just reported that the average American household is earning 4.4% less now than they did at the end of the recession. In June the average household income was $52,098, down from $54,478 in June 2009 and $55,480 when the recession began. Positions downgraded to part-time, high unemployment and competition for jobs is pushing wages lower, youth unemployment at 25%, higher tax rates and higher healthcare costs. Telling these people the economy is recovering would probably produce an unwelcome reaction.

In the revised chart below note the plateau of home sales in the first half of 2013 and odds are good the July decline will be the first of many.


The economic calendar for next week is headlined by the GDP revision on Thursday. The estimates range from +0.7% to +2.0% with the consensus average at +1.0% growth compared to +1.67% in the initial release. In order for the Fed's growth targets for 2013 to be met the GDP would have to average +3.5% for Q3 and Q4. Given the number of revenue misses in Q2, guidance warnings for Q3 and now wholesale sales declines across the entire retail sector the odds of the Fed forecast coming true are zero. A sharp drop in the Q2 GDP could be another nail in the taper coffin.

As we move closer to the September FOMC meeting the comments from the various Fed heads will become more important ahead of the blackout period preceding the FOMC meeting. I added the speakers for this week to the calendar.

Economic Calendar

We heard last week from several of those Fed heads surrounding the Fed retreat at Jackson Hole.

San Francisco Fed President John Williams said "I am sticking with Bernanke and the decision to taper will be data dependent."

Atlanta Fed President Dennis Lockhart said, "I would be supportive of a taper in September as long as the data that comes in between now and then basically confirms the path we're on. I think the key question is do we have, even at this moderate pace of growth, a sustainable picture, something that is going to continue or is there some risk economy gets knocked off its feet?" Lockhart said he still expects stronger growth in the second half and into 2014 but noted there were no real signs of that to date. He also warned the debt ceiling battle in September could damage consumer confidence.

St Louis Fed President James Bullard said, "I would be cautious about tapering QE." And, "I don't think we have to be in any hurry. Inflation is running low and we have mixed data on the economy." Also, "We want to take our time and assess what's going on before we make a move. We can be very deliberate in our decision making." Bullard speaks twice next week.

The speaker on the list that did not make public comments last week was Jeffery Lacker. He is scheduled to speak on Thursday. When he last spoke he said the Fed must end its bond buying program quickly and the end of the program was "in sight." He said he hoped the quick exit from QE would force Congress to agree quickly on reducing debt. "We need a sustainable solution and the sooner the better." Don't hold your breath on that Jeffrey.

Clearly three of next week's speakers are data dependent and the data is worsening. That suggests the September taper is fading. Lacker is a hawk and has dissented at recent meetings so his stance is not new.

With the sharp drop in July new home sales and the downward revision in the prior three months the outlook for the housing sector as an economic boost took a sharp decline.

That coupled with the statements from Bullard, Lockhart and Williams seemed to take the taper off the table. The yield on the ten-year treasury plunged from the 2.92% high on Thursday to close at 2.81% on Friday.

Ten-Year Yield Chart

The dollar fell sharply and commodities surged higher on expectations for the taper decision to not only be pushed forward from the September FOMC meeting but possibly all the way to January if the data continued to deteriorate. Gold, silver, oil and equities all surged higher.

Silver gained +4.4% on Friday and closed over $24. It is very close to a major breakout over strong resistance at $24.50. This could produce major short covering if the economic outlook continues to push the taper talk into the future.


Gold prices gain +1.9% to close just below $1400 with major resistance at $1415-1420. Gold blasted through the 100-day average after two weeks of consolidation at that level. Oppenheimer's Chief Market Technician, Carter Worth, said Friday "if you are not long, get long gold and gold miners." The same would be true for silver since it is even nearer a breakout level.


While I am on the subject of the Fed I have a warning for you. What was one of the worst financial instruments that flourished during the housing boom? Give up? It was the adjustable rate mortgage or ARM. The ARM loans allowed buyers to qualify for a lot more house because their rates were artificially low for the first several years. Then the rates would float to the current rate, which could be significantly higher than the initial rate with mortgage payments rising hundreds of dollars or even a thousand or more in some cases. In the Great Recession unemployment and pay cuts made it impossible for many borrowers to avoid foreclosure as rising payments and falling values made them impossible to maintain. At least they had the option of foreclosure. I doubt anyone would disagree that ARM loans were a terrible instrument that led millions of borrowers and mortgage holders to lose billions.

Why did I bring this up today? I doubt there is anyone reading this that does not expect interest rates to move up sharply over the next several years. A reasonable person would want to load up on debt now at low rates rather than incur a loan today where they knew the rate would spike significantly over the next three years.

That is what a reasonable person would do. The U.S. Treasury apparently did not get the message. Currently the U.S. Treasury enjoys the cheapest interest rates the world has ever seen on its $17 trillion in debt thanks to the Fed's QE program. We all know the Fed is going to eventually halt that program and rates will go up.

With the U.S. debt at $17 trillion and growing the international demand for treasuries has been slowing. To combat this the Treasury is going to begin selling "Floating Rate Notes" in January. These are the equivalent of an ARM on the USA. The interest rate on the notes will float with the market. Before everyone starts heading for Washington with pitchforks and torches to throw the bums out there is a small saving grace to the program. Initially the floating rate notes will only be offered in short term securities. They are hoping the lure of potentially higher rates will attract enough international investors to continue funding our government at ever higher levels of debt. If that does not work they can offer longer term floating rate notes.

If the shorter term notes are not selling well enough and the Treasury Dept lengthens the maturity I see that as the beginning of the end. Once the bond market becomes hooked on the crack cocaine of higher floating rates why would they ever buy fixed rates again? As this process pushes rates higher the payments on our debt will grow and eventually become unsustainable. Homeowners can cancel their loans through bankruptcy and foreclosure. The U.S. government does not have those options. I believe we are walking on thin ice here and we are going to see some serious problems in the years ahead.

Along that same train of thought there are going to be some major terrorist attacks in the years ahead. We found out last week that the phone call that was intercepted between Nasser al-Wuhayshi, the head of Al Qaeda in the Arabian Peninsula (AQAP) and Al Qaeda leader Ayman al-Zawahri promised an attack that "would change the face of history" according to a statement made by Yemen's president on Friday. No details have been released but the closure of 22 U.S. embassies and consulates is proof the promise was believed.

Most Americans would never notice if another embassy in the Middle East or Northern Africa was attacked. That is a world away and nobody they know. However, the U.S. border patrol routinely arrests people crossing the Mexican border from places including Saudi Arabia, Pakistan, Yemen, Egypt, etc. They believe several hundred of these people have successfully infiltrated the USA. There was a report several weeks ago the Mexican drug cartels were being paid 50,000 euros each to smuggle in Hezbollah fighters to the USA.

We know Al Qaeda has been planning attacks on the U.S. ever since 9/11 and they want to do something bigger and better. New York Congressman Pete King has said it is common knowledge that Al Qaeda is infiltrating sleeper cells into the U.S. and has been for some time.

Obviously nobody knows what the big attack on America will be or when but we can be assured it is coming. How would 100 coordinated attacks on shopping malls or attacks on NFL stadiums full of fans change the way we live in the USA? How about 100 car bombs set off randomly in U.S. cities? More than 1,000 Iraqi's died as the result of car bombs in July. How would those headlines play out in the USA?

Osama may be dead but Al Qaeda is not. It is actually growing at the fastest rate on record. Just because nothing has happened in the U.S. since 9/11 does not mean the threat is over. While I doubt they will be able to bring down another building there is always the possibility of a nuclear bomb. Pakistan, not our friend and host to Osama Bin Laden, has more than 110 of them. They could easily spare one or two and not be missed.

Adjustable rate treasuries, $17 trillion in debt, trillion dollar annual deficits, declining purchases of U.S. debt by international buyers and a pack of terrorists infiltrating our borders in attempt to "change the face of history." What could possibly go wrong?

Back to the market. It was a summer Friday and volume was very low at 4.9 billion shares. More than 225 million of those shares came from Microsoft. CEO Steve Ballmer announced he was retiring within a year and investors celebrated with a +7% gain on seven times normal volume. Microsoft options traded five times normal volume with calls far outpacing puts.

Bullishness was extreme. One investor purchased 20,000 January 2015 $45 calls for 75 cents. ($1.5 million) Investors cheered the pending exit of Ballmer since the stock has gone down -37% since he assumed the CEO position in 2000. Investors believe anyone else could do a better job. In July Microsoft reported the biggest earnings miss in a decade and shares declined -11.4%.

To compare the job Ballmer did as CEO at Microsoft you only need to look at Elon Musk. Musk became CEO of PayPal in 2000 and the fledgling company began accepting payments for Ebay items. Now 13 years later Musk sold PayPal for billions and started Tesla and Space X, both highly successful businesses and Microsoft is still languishing as an old tech company. Which CEO would you rather have running your company?

Microsoft has $85 billion in cash and investments and numerous products that are not working. Some analysts believe Xbox would be a good spinoff and be free of the Microsoft culture. The company's Surface tablet is also struggling and their Smartphone product is not competitive.

When Apple announced the iPhone Ballmer proclaimed it would never be competitive and gain market share. Since then every new product Microsoft has announced for the mobile market has not been competitive. Over his CEO term we have seen the birth of Facebook, Google crush Microsoft in the search engine wars and the emergence of Twitter, Linkedin, Pandora, etc. Multiple Windows releases have crashed, no pun intended. Steve Jobs once said, "Nothing will change at Microsoft as long as Ballmer is running it."

From inception as a public company until Bill Gates turned the CEO job over to Ballmer a $1,000 investment would have returned $554,464. Since Ballmer has been CEO a $1,000 investment would have returned $875. (Numbers courtesy of Bloomberg)

Ballmer said he has been planning his exit since 2010 and has been sending the board potential CEO candidates for the last three months. The board has appointed a search committee that includes Bill Gates.


The retail sector just keeps getting pummeled by earnings reports. Teen retailer Aeropostale (ARO) saw shares decline -20% after reporting weaker than expected earnings. The company reported a loss of -34 cents and warned for the current quarter. Same store sales fell -15% and gross margins declined from 25.3% to 17.9%.


American Eagle (AEO) and Abercrombie & Fitch (ANF) both reported weak earnings and guidance earlier in the week. Shares of ANF declined -20% and AEO -9% for the week.

In addition to AEO, ARO and ANF there has been a long line of ugly retail reports including TGT, WMT, M and KSS to name a few. It is not just a teen retailer problem. It is a problem all across the entire retail sector.

The Wal-Mart CEO was interviewed on CNBC and he blamed the high unemployment, high taxes and high gasoline prices for the drop in consumer spending. Youth unemployment is more than 25% and they are spending their money on cheap t-shirts and smartphones rather than expensive offerings at Abercrombie. The CEO said the high gasoline prices worked as a $40 per paycheck undeclared tax on their average customer. That money comes right out of their discretionary spending and leaves less for items other than food. McDonalds and other fast food chains have been forced to expand their "dollar menu" items in order to compete for the shrinking fast food dollars.

Shrinking consumer spending is another reason the Fed will not taper in September. If you look at all the economic indicators the economy is not expanding. This is a muddle through economy on its way to the next recession. We can't build a successful economy when 70% of the new jobs are part time. Surely the Fed is aware of these facts.

Facebook (FB) finally closed above its $38 IPO price last week. Shares spiked +5% on Friday to close at $40.54 after the company announced Internet.org an initiative to bring the Internet to the 5 billion people in the world that do not have a connection. Facebook partners in Internet.org are Ericsson, Mediatek, Opera Software, Samsung, Nokia and Qualcomm.

FYI, Google already has an "Internet for all" project called Loon. The Loon project has a goal of bringing the Internet to rural, remote and impoverished areas using high-altitude balloons about 12-miles above the earth to beam signals at 3G speeds to the population below. They already successfully tested it with 30 balloons over New Zealand and the next test will be 300 balloons over New Zealand, Australia, Chile and Argentina. They also have the Google Fiber project, which launched in Kansas in 2012.


Moody's warned on Thursday it could cut the credit ratings of Goldman Sachs (GS), JP Morgan (JPM), Wells Fargo (WFC), Bank of America (BAC) and Citigroup (C). BAC and C are under review and could possibly be upgraded instead of cut if changes to their balance sheets outweighed the loss of a government guaranty. State Street (STT) and Bank of New York (BK) were already on notice of a pending downgrade. Moody's said recent regulations suggested the government would be less likely to bail them out if they got into trouble. Reforms under the Dodd-Frank Act ban the use of taxpayer money to save failing banks. If banks get into trouble the government is required to setup a "resolution authority" to liquidate the banks or break them up rather than save them. Bondholders would suffer the losses.

Last week saw the largest equity outflows in five years according to Bank of America Merrill Lynch. (BAML) The Dow declined to support at 14,880 and the S&P hit 1,640. The AAII investor sentiment survey saw bears rise to 42.9% from 28.2%. That level of pessimism has only been seen 29 times since 1950. That is a contrarian buy indicator. VIX call volume was five times put volume. Traders had finally bought into the "correction" scenario.

BAML warned on Friday that the market had more weakness ahead. They cited five factors suggesting the rebound would fail. They said NYSE volume remained lackluster during the decline. There was no capitulation day or 90% volume down day. The ARMS TRIN indicator remains complacent below the 2.0 level that would indicate fear. Lastly the 5-day put/call ratio was at complacency levels last seen in Sept 2012.

A funny thing happens once everyone begins to lean in the same direction. The boat capsizes. When bearishness abounds you can expect a rebound. The oversold markets seized on the "taper off" comments and weak housing and retail sales as evidence the Fed would not taper in September. The opposite of taper is continued QE and possibly for several more months. If the economics continue to decline it could be a long time before QE ends. Suddenly the taper bears were on the run and shorts were being covered.

Traders have such a short memory. Two days does not make a trend. The Dow declined -778 points from the August 2nd high and rebounded only +127 points in the last two days. That is hardly a resounding rally. It did return to the 15,000 level at the close on Friday but that level is now resistance instead of support.

The rebound was just an oversold bounce on low volume on expectations the taper was fading. The Fed wants the markets to be uncertain and there will probably be some Fedspeak next week to put the taper back on the calendar. Remember the Fed minutes said members did not want to give any more QE guidance because it might result in an "unwanted market reaction." Translated that meant the Fed was happy with all the uncertainty because it kept the markets in check. If we knew today what would happen at the September meeting the markets would be highly directional. Not knowing keeps them chopping around without a real direction.

The S&P will be totally dependent on Fedspeak next week. Earnings are over and all eyes are on the approaching FOMC meeting. Volume is going to be low because it is the last week of summer with a three-day weekend ahead.

The S&P declined to 1640 then rebounded to close at 1663, just -2 points from resistance at 1665. That was enough to get it back over the 50-day average at 1659 but just barely. The S&P failed to reach the 100-day on the decline so that rising 100-day and 1640 could coincide over the next several days. That would be some decent support but if we drop that far again I would expect a continued decline.

The S&P came very close to the 50% retracement level of the June rebound gains. The oversold rebound occurred at exactly the right spot.

S&P Chart

S&P Chart

On the Dow the 50 and 100-day averages will be resistance. The Dow closed at 15,010 and the 100-day is 15,122. The Dow decline was deeper than the S&P and Nasdaq. With the Dow only about +125 points above support we could see a return to that level on any material headline. Investors that missed the original dip now have a chance to sell into the rebound.

The headlines in September are too serious not to have a continued decline. Support at 14,880 is calling.

Dow Chart

Microsoft did the Nasdaq a favor on Friday. The +7% gain in MSFT powered the Nasdaq over strong resistance at 3650 and triggered short covering in tech stocks. The Nasdaq spike to 3657 put it within striking distance of the recent closing high at 3692. The Nasdaq is now the best performing index on a relative basis. It has strong support at 3600 that was tested continuously for five days without breaking.

Normally the Russell 2000 is the leader but the Nasdaq has sprinted out in front. If Microsoft continues to rally it would supply positive sentiment for tech stocks. With Apple's Sept 10th announcement (still not official) the expectations could power AAPL shares higher and the Nasdaq by association. Carl Icahn tried to pump up Apple shares on Thursday with a new tweet about a share buyback and lunch with Tim Cook but the Nasdaq was offline and the tweet was ineffective. Hello, SEC? Apple shares have been flat at $500 for the last eight-days. The closer we get to September the more upward pressure we will see.

Nasdaq Chart

The Russell 2000 rebounded from its 1013 low to close at 1038 but it is still well off its highs. The 1040 level is now resistance and the Russell is normally headline averse. Monday will be a key day. If the Russell can move over 1040 it could find some new life. If that level proves impossible to pass the bearish sentiment will return.

Russell 2000 Chart

U.S. is preparing for a strike on Syria according to reports out this weekend. Warships have been staged in the Mediterranean with more on the way. Analysts believe a cruise missile attack is in the works since there would be no danger to American lives. The catalyst was the attack with nerve gas that killed hundreds outside Damascus. This will ratchet up antagonism against the U.S. and whatever allies join in the attack. It will also drive up oil prices. Syria, obviously knows it can't fight the U.S. Navy and Air Force and could strike back by attacking neighboring countries friendly to the USA. Oil facilities would be prime targets.

An attack on Syria is not without risks since Assad is strongly supported by Russia and Iran. Russia has already warned the U.S. about intervening. This could lead to a bigger problem. Putin has no respect for Obama and could see this as an opportunity to elevate Russian stature.

The Fed is in tightening mode even though they deny it. Pushing the yield on the ten-year from 1.39% to 2.9% is tightening. They talked it up by producing uncertainty. Make no mistake, they are tightening and the market has not realized it yet.

Every recession since WWII has been preceded by a rate increase by the Fed. EVERY recession. Just because the Fed did not announce a rate hike does not mean they did not engineer this one.

We need to be cautious with long positions and keep our stops tight. Traders can remain bullish as long as they are aware of the risks and plan accordingly. Volume will be low and volatility may increase into month end. September is the real risk.

Enter passively and exit aggressively!

Jim Brown

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"Don’t worry about catching tops or bottoms, that’s fools play. Keep the number of stocks you own to a controllable number. It’s hard to herd cats, and it’s hard to track a lot of securities."
Jesse Livermore