The +7.44% gain in the Nasdaq represents the strongest week in almost 10 years. The Dow posted its first weekly gain since June 12th.

Market Statistics

Last week was the perfect example of strong bearish sentiment being met with a sudden and unexpected improvement in earnings during an option expiration week. It was the perfect storm for the bears and for those short calls. Just look at some of the percentage gains in the graphic above. The SOX gained +12%, +11% for housing, +9% for oil and commodities plus 7% or better on all the major indexes. It was a banner week and the longest short squeeze I can remember. The good news just kept coming all week and those short options or stock were pushed to the breaking point with the markets closing at the high for the week.

The only economic report of note for Friday was the New Residential Construction for June. Housing starts jumped +3.6% to 582,000 annualized units. This was the fastest pace since November but it is still only about a third of normal before the crisis began. The 582,000 is also a -46% drop from June 2008 levels. For the entire second quarter housing starts increased by an annualized +10%. That is the first quarter-over-quarter gain since mid-2005. Single-family starts were up +14.4% in June. Housing completions declined by 0.4% to 818,000 units. This is due in part to the very low number of units in progress because of low starts over the last six months. You can't complete house you have not started.

The housing sector is doing better but you may remember from earlier in the week that foreclosures were up +15% for the first six months of 2009. There are 340,000 new foreclosures coming on the market each month. This is going to keep a lid on prices for new homes but the number of homes on the market continue to decline ever so slightly as new households, immigrants, etc, slowly chip away at the inventory. Homebuilder stocks were up strongly this week with a +11% gain but you may remember the prior week they were down nearly -10%. This is simply another short covering story where the most hated sector suddenly gets some good news and shorts are forced to run for cover.

To put the +3.6% increase in starts that analysts were calling fantastic into perspective you need only to look at the long-term chart below. The increase is so minor that it is nearly invisible on the bottom right.

Housing Starts Chart

The economic calendar for next week is one of the lightest for the entire year. Were it not for the Humphrey Hawkins testimony by Bernanke there would have been nothing to highlight. The rest of the reports are about as exciting as a dud firecracker. Lots of expectations but no bang.

Economic Calendar

Bernanke testifies this week on both Tuesday and Wednesday and he is expected discuss how the central bank might exit the biggest monetary expansion in history. Lawmakers will want to know how Bernanke plans to drain the liquidity in the system without causing another economic collapse. The Fed is in the sweet spot for inflation today with only a microscopic climb in prices. Once the economic recovery really kicks in that sweet spot could turn into forest fire of inflation very quickly. If they move to fast the sweet spot turns into quicksand and the economic growth continues at a snails pace.

The Fed does not have a good track record of extricating itself from these types of scenarios. They typically weigh too many variables and err on the side of caution and inflation surges. Then they hike rates sharply to catch up and the economy slows too quickly. This produces a roller coaster recovery process instead of the healthy and sustained growth they are seeking. Everyone agrees the Fed should not act yet on removing any liquidity so any conversations need to be cautious and not scare economists into thinking a major change is coming. This testimony is an ideal forum to educate investors well in advance of the change so there is no shock when it happens.

The big calendar for next week is the earnings calendar. More than 25% of the S&P report earnings and there are some heavyweights on the list. Apple Inc (Nasdaq:AAPL) and Yahoo (Nasdaq:YHOO) report on Tuesday. On Wednesday we get EBAY (Nasdaq:EBAY), Etrade (Nasdaq:ETFC)and Wells Fargo (Nyse:WFC). Thursday is the biggest day of the cycle and I could have put a couple hundred symbols in the table on Thursday if I had the room. Amazon (Nasdaq:AMZN), American Express (Nasdaq:AXP) Broadcom (Nasdaq:BRCM), Capital One (Nyse:COF), Juniper (Nasdaq:JNPR), Microsoft (Nasdaq:MSFT) and UPS (Nyse:UPS) to name just a few. The one to watch on Friday is Schlumberger (Nyse:SLB) and the health of the energy sector.

Earnings Calendar

We saw Google (Nasdaq:GOOG) drop -12 (-3%) after beating earnings. There is no guarantee beating estimates will give your stock price a lift. However, we did see the Google earnings give Yahoo a huge bounce because they said advertisers were coming back into the market. Yahoo is expected to reap the benefit of a rebound in advertising. Google said click advertising volume was up +15% but revenue per click was down -13%. Yahoo, as the distant second in the Internet advertising world was expected to benefit from cost conscious buyers looking for a cheaper click rate.

Yahoo (Nasdaq:YHOO) was also benefiting from rumors that the company was very close to finally doing a deal with Microsoft for their search business. The deal is being rumored as a partnership with Microsoft on advertising and search technology. This has been rumored for months since the new Yahoo CEO, Carol Bartz, took over. By selling search to Microsoft, Yahoo would not have to have to compete in the very costly technological arms race against Google. Every day it becomes more costly to compete because Google has billions in the bank and an army of programmers constantly refining the process. Yahoo has mounting debt and Microsoft aggressively nipping at their heels and taking market share with Bing.

Yahoo Chart

Friday was another big earnings day with earnings from Citigroup (Nyse:C), Bank America (Nyse:BAC) and General Electric (Nyse:GE). There was also a reaction from (Nyse:IBM) earnings that kept the Dow in positive territory. There were 13 Dow stocks positive and 17 negative. Points gained by 12 of those Dow stocks totaled +4.12. Total points lost by the 17 losers was -4.38. Basically those 29 stocks were tied for the day and the Dow would have been a couple points negative had it not been for IBM. IBM gained +4.78 for the day and that equates to more than 38 Dow points. The Dow ended the day up +32 points. It was all IBM.

IBM Chart

Citigroup (Nyse:C) reported a surprise profit of $4.3 billion* but there was a asterisk attached to the number. They posted the profit only because they had a one-time gain of $6.7 billion on the partial sale of the Smith Barney unit to Morgan Stanley. Stripping out the one-time gains Citigroup lost $4.2 billion for the quarter. Of that $4.2B Citi lost $1.6 billion because of downgrades to its own debt. This was only part of the $12.4 billion in losses due to credit costs during the quarter. On the bright side Citi said the rate of consumer loan losses was abating.

Citigroup Chart

Bank America (Nyse:BAC) posted a profit of $3.2 billion* but again there was that pesky asterisk. BAC benefited from the one time sale of its stake in China Construction Bank for $5.3 billion. Merrill Lynch added $5 billion in trading revenues for the quarter but credit losses took $2.9 billion off the bottom line. BAC's total credit costs for the quarter were $16.4 billion. That has got to hurt! Ken Lewis told analysts on the conference call that profitability in the second half of 2009 would be a "lot tougher." Hey, if it were easy to overcome $16 billion in added credit costs every quarter everyone would be a millionaire banker.

Bank America Chart

General Electric (Nyse:GE) profits were cut nearly in half due to recession pressures. The earnings from the finance unit were a drag and the industrial goods divisions were struggling from lowered demand. GE earnings officially beat the street but revenue fell short by about $3 billion. Sales fell across all divisions. This is a problem for economists because GE's broad reach across all areas of the economy make it a proxy for the economy. GE lowered guidance for its industrial divisions from optimistic to "hopefully we can break even this year." "Hopefully break even" suggests there is a good chance they will lose money.

GE Capital saw earnings fall -80% from the comparison quarter. However, the real estate unit, which owns office buildings and makes commercial property loans, lost $237 million compared to a profit of $484 million in the year ago quarter. GE said they were still "very cautious" about the real estate outlook. GE officially earned 24 cents compared to analyst estimates for 23 cents. GE cut costs by more than $3 billion to achieve that profit and analysts want profits to come from revenue not cost savings. Overall the GE earnings were not a bright spot for the cycle and produced a cold chill in the analyst community.

GE Chart

CIT Group (Nyse:CIT) was kicked out of the S&P-500 at Friday's close and replaced by Red Hat (Nyse:RHT). CIT was booted from the S&P because its market cap had fallen below that needed to stay in the index. CIT is struggling to avoid bankruptcy after the government agencies dropped it like a hot rock on Thursday. The possibility of another bailout for the 101-year-old finance company evaporated on Thursday and CIT went back to the public market for last ditch financing. CIT supplies financing for nearly one million small to midsized businesses.

Reportedly CIT is in talks with Goldman Sachs (Nyse:GS) and JP Morgan Chase (Nyse:JPM) over a $3 billion debtor in possession loan that will allow them to file bankruptcy and still have a chance of a recovery. CIT has already received $2.3 billion in TARP funds. CIT has $40 billion in long-term debt with $1.1 billion coming due in August and $2.5 billion before year-end. The New York Post speculated that JP Morgan could buy CIT's factoring unit, which finances more than $50 billion of wholesale inventory. That would be a major plus for JPM but a severe blow to CIT, which makes a lot of money off those loans. CIT has more than 50% market share in the retail factoring business. The outlook for CIT does not look promising.

CIT Chart

The earnings scoreboard looks pretty good for this cycle but remember the best earnings are always the early earnings. As the days drag by the quality of earnings will slip. So far there have been 55 S&P-500 companies report. 71% have beaten the lowered estimates, 20% missed and 9% reported inline. This has a surprise factor of 11.5% better than average.

Next week over 150 S&P companies report. The surprise factor is sure to decline as more companies miss their estimates. When GE is going to be happy just to break even for the rest of the year you can imagine what the guidance will be from the bottom 75% of the S&P.

Still, this has been a surprising earnings cycle. Ask anyone who was short. The news is out and with a hundred or so reports under our belt we pretty much know what the rest of the cycle will look like. Most companies will beat their lowered estimates and quite a few will echo the GE/BAC comments that profits in the second half of 2009 will be a lot tougher.

As an investor does that fill you with a strong buying urge? We have seen the various economic reports falter over the last couple of weeks indicating that the recovery is far from assured. The Fed claims the pace of the decline is moderating. That is different than saying the pace of the recovery is improving. It means that the Fed is still seeing a decline in conditions despite all the green shoots in the Intel earnings report.

It does not mean the bottom is not behind us. It does not mean that as investors we can't look six months ahead to 2.1% GDP growth and celebrate. What it means is that a 7% five-day short covering rally into option expiration may have become a tad over extended.

I told everyone last weekend that this was going to be a pivotal week and once past this week the market would likely find a direction. I am not convinced the current direction will hold but I would be thrilled if it did.

The head and shoulders pattern across all the indexes has been broken. A continued move past 946-950 on the S&P would be very bullish. I am only concerned about what will power it. What company next week is likely to announce earnings that are not already priced into the stock? Microsoft could announce better than expected earnings and because of early Windows 7 acceptance they could raise their guidance like Intel. Is that enough to push us another 7% higher? I doubt it. Microsoft stock is already up +10% last week and +65% since the March lows on just that hope.

Is Amazon (Nasdaq:AMZN) going to announce such strong Kindle sales that the stock breaks through resistance at $88? It is possible but they just lowered the price of the Kindle to $299 and claimed they were selling so many the costs came down. If they were selling so well why lower the sales price? It is just my highly skeptical mind that finds it tough to accept things on face value. On the plus side the Amazon video on demand service is far superior to Hulu and I downloaded 3 Harry Potter movies last week from Amazon. I believe their service will add to their profits. But, even if Amazon does blowout earnings is that going to be enough to push the markets another 5% higher? I doubt it. Resistance on Amazon is $88 and it closed Friday at $86.

Amazon Chart

Ebay (Nasdaq:EBAY) reports on Wednesday and they already broke out over resistance at $18 and could run if earnings are good but the stock has been very lethargic for the last three months. Ebay made some cautious comments about traffic a couple months ago suggesting the recession had cut down on the number of buyers. The stock went into hold mode and came very close to a breakdown the prior week. Now that it has rallied +20% in a week can it still move higher on decent earnings? Time will tell. The better question is will it move the market if earnings are good?

Apple (Nasdaq:AAPL) reports on Tuesday and they are widely expected to beat estimates because nobody believes their guidance. According to Gene Muenster at Piper Jaffray, Apple has guided lower in 10 of the last 12 quarters. Dan Niles said on Friday that nobody pays attention to Apple's guidance because it never makes any sense.

However, there is a chink in their armor. Apple buys 20% of all the flash memory produced in the world. That same flash memory has risen in price 40-50% over just the last 90 days according to Dan Niles. Since the iPhone is crammed with flash memory this will crimp Apple's margins going forward. The increase probably will not have hurt them significantly in Q2 since the increase is recent but this could impact their guidance. Every analyst I heard last week said that the Q2 earnings news was already priced into the stock. APPL is up +16 in the last two weeks. It is clearly in breakout mode and strong earnings could push it higher. HOWEVER, with all the bullish news already priced in there could be a disaster if they say something negative.

Apple Chart

UPS (Nyse:UPS) reports on Thursday and their guidance will be crucial to the economic outlook. If they say package traffic is down then the market is liable to follow. Always inquisitive I asked my UPS driver this week why he was running two hours later than normal. He said UPS sent home ten drivers in his terminal last week because there was not enough work. That means he has a bigger area to cover and more packages but it is due to layoffs not increased traffic. I will be watching to see if UPS corporate says anything about the layoffs. Resistance is $56 and UPS closed at $52.

UPS Chart

I think you see what I am thinking about the market's future. Even if earnings continue to surprise to the upside as we get into the weaker performers there may not be enough excitement to push the market higher. The 7% and higher gains from last week produced a market that is suddenly as over extended as it was over sold the prior week.

Oil prices helped push the market higher on Friday with a +1.40 gain to close at $63.57. The gains came on the stronger than expected housing starts plus production concerns in Iran, Iraq and Nigeria. Also a couple tropical storms appeared in the Atlantic in hurricane alley. Neither have enough coordinated movements to be considered threats yet but they are on the radar.

Crude Oil Chart

Ironically crude spiked higher despite a report from the American Petroleum Institute on Friday that demand had fallen off a cliff in the first half of 2009. Demand for low sulfur diesel fell -6.6% and ultra low sulfur demand fell -9.2%. Diesel demand is seen as a direct proxy for the economy since every product moves by truck and train on its way to market. Gasoline demand fell -5.8% and demand for jet fuel fell by -12.8%. Fuel oil demand fell -9.1%. U.S. crude production rose +3.4% to 5.29 mbpd over the same period. Even with the declines in crude inventories in 9 of the last 10 weeks to 344 million barrels, down from 375 mb, this is still well above the 5-year average of 322 mb for this time of year.

The federal minimum wage is going up to $7.25 from the current $6.55 and economists claim that will provide another $5.5 billion in income to people who will continue to spend every dime they make. Workers in this wage bracket are not savers. Every dime they make goes for food, rent and gasoline. Reportedly there are very few workers, less than 3%, who actually make the minimum wage. Those that do are getting nearly a 10% raise next week.

Washington's minimum will rise to $8.55 and California and Massachusetts currently have wages of $8. I can remember working in the 1960s when the minimum wage was $1.25 an hour. Fortunately I did not have a family to support. Economists estimate the current wage is only enough to provide 50% of the needs of a family of four at the poverty level. 130 cities now have "living wage" laws that exceed the federal minimum wage.

Federal Minimum Wage History

On the political front the health care plan is finally running into some stiff opposition and that was actually seen as bullish for the market on Friday. President Obama held a news conference late Friday and was adamant that the plan would be passed soon despite the setbacks. He must not have felt like he got the message across because less than two hours later he scheduled another prime time televised press conference from the White House. This one for Wednesday night at 9:PM ET to talk about the plan. This is his fifth White House press conference since he took office and his fourth in prime time.

I think the timing of the conference was an effort to grab the ratings from "So You Think You Can Dance" on Fox at that time. He has spoken out against Fox several times lately and scheduling a televised conference at the exact same time as their most watched show of the week was a way to get back at them for the unfavorable press coverage Fox provides. To top things off the White House did not announce the conference through regular press channels. They put it on Twitter instead. Can you imagine the confusion in the press trailers when they heard from somebody outside the regular channels that they had been scooped on Twitter?

The total of banks closed in 2009 has risen to 57 after the FDIC closed four banks on Friday. Two banks in California, Vineyard Bank and Temecula Valley Bank failed. Georgia based First Piedmont Bank and Sioux Falls based BankFirst round out the list. The two California banks had a total of $3.2 billion in assets, BankFirst $275 million and First Piedmont $115 million. The cost to the FDIC fund for all four banks will be $1.1 billion. Nearly 300 banks remain on the FDIC problem bank list so there will likely be more failures to come.

40 years ago U.S. astronauts walked on the moon. Video was shot of every moon walk along with thousands of pictures. You would think NASA would have treated those videos like solid gold and preserved them for future generations. Unfortunately those video tapes were erased along with nearly 200,000 others several years later and the tapes were reused to save money. When NASA realized this several years ago there was a mad dash to rescue any copies of the footage from news organizations around the world. First generation copies were then put through a major renovation to eliminate static and noise using today's state of the art techniques. The result is the videos you are seeing in the news program footage this weekend in remembrance of the 40-year anniversary.

On Friday the Dow closed up +32 and the Nasdaq +1.58. The S&P was fractionally negative but it was a positive market, right? You would be wrong if you said yes. I already showed you that IBM accounted for +38 Dow points and the Dow only gained +32. The internals were negative with more decliners than advancers and volume for an option expiration was pathetic at barely over 8 billion shares. You would think that for a +600 point week for the Dow that every day would have been as lopsidedly bullish as Wednesday's 9:1 Intel short squeeze. Unfortunately the internals are painting a far less bullish picture.

Market Internals Table

I am sure a lot of it was simple buyer exhaustion once everyone covered their short option positions and cussed themselves for not having stop losses on their short positions when the week began. Now all of that is behind us. Expiration is gone and earnings are basically a given for the majority of reports to come.

The Dow came ever so close to that monster resistance at 8800 but just could not make it. It is however still in reach should something happen over the weekend to boost the overseas markets. An opening spike to 8800 would be a textbook shorting opportunity even if the index eventually breaks out for a real run later in the week. The +600 point gain last week is just too tempting to not throw a bet on the don't pass line on Monday morning in case the bulls seven out.

Here is the kicker. A failed head and shoulders pattern usually results in a strong bullish move. When the right neckline fails to breakdown and the stock/index rallies back over the right shoulder the potential for a breakout is very strong. The reason for this is the pattern itself. A head and shoulders pattern is one of the easiest patterns to recognize and one of the most dependable. This means nearly every trader with access to charts is all over the falling right shoulder like stink on a skunk. Shorts had backed up the truck and hired extra workers to help load it. Obviously this resulted in the +600 point short squeeze last week. Shorts had loaded up after market technicians had been touting the H&S for over a week in advance. The market exists to fool the maximum number of traders possible whenever it can. Last week was a grand slam.

Now we have the true test of strength. If the Dow can move over 8800 it will confirm the break in the pattern and everyone that is thinking the same as me about shorting 8800 will be forced to cover again. The $64 question remains, "are there enough buyers left who want to buy earnings at this level?" We have seen this earnings story before and we know how it ends. Lowered expectations are beaten through cost cuts and asset sales and guidance is lowered again. Doesn't sound like a runaway bull market to me, but maybe a loco bull instead.

Fortunately the market has given us an extremely clear trade for next week. Over Dow 8800 we go long and we short any failure at Monday's open.

Dow Chart

The S&P-500 is nearly a perfect chart. The Friday close at 940 is almost exactly the resistance high back January and again in June. This is clear resistance and also the top of the H&S pattern that is failing. If the S&P rallies over 950 I think the sprint to 1000 will be very quick. When it eventually rallies over 1000 whether next week, or next quarter, the follow on rally will be huge. That is a clear line in the sand that could be the starting line on a real second half rally.

S&P-500 Chart

The Nasdaq closed at a new 8-month high and almost exactly at the October resistance highs. The Intel news is likely to be followed by strong news from Apple, Microsoft, Amazon and hopefully Ebay and it would be very hard to believe the Nasdaq will not move over 1900. It seems cast in stone but then stone tablets in the wrong hands have been broken. The Nasdaq has only been up for eight consecutive days four times in the last 16 years and that is a streak that is testing its luck.

Nasdaq Chart

The Russell 2000 chart did see the right shoulder high exceeded on Thursday but only by a fraction. The height of the week's gains were much less than the Dow, S&P or Nasdaq. The Russell is still 15 points below the June high at 535. This suggests fund managers did not get caught up in the shorting frenzy and did not need to cover as much as other traders. The Russell remains the fund manager sentiment indicator and it is indicating caution relative to the other indexes.

Russell Chart

I think you understand the game plan for next week. Go long over Dow 8800, S&P 950 and short any failure at Monday's open. The earnings news will keep journalists busy but we already know how the story ends. Try not to get caught up in the hysteria and pick your entry points carefully.

Jim Brown