The major indexes managed to close the week with a gain but were it not for Thursday's short squeeze it could have been a much different story.

Market Statistics

The markets shook off a GDP number on Friday that was better than the consensus but far below the whispers circulating on Wall Street. The first look at the GDP for Q2 showed a headline number of -1.02%. This was much better than the -6.43% in Q1 and better than the -1.6% consensus estimate. You would think the markets would have celebrated. Instead the markets dipped at the open because the GDP was much lower than the +1.0% to +1.5% whisper numbers making the rounds. Also, the report also showed a revision to the Q1 number from -5.49% to -6.43% and nearly a full point worse than originally thought.

Investors wanted a positive GDP number to validate their hopes for a rebounding economy. Yes, I know an improvement from -6.4% to -1.02% is a significant improvement but it still indicates an economy in decline. Investors wanted to see a growing economy not one that was still declining although at a slower pace. This is one report where "less bad" was still bad.

I am not going to bore you with all the internal components. I will point out that there was a major decline in inventories by -$141.1 billion. That stretched the inventory decline to -$359.2 billion over the last five quarters. Analysts point to this as evidence the economy has to get better soon because of the restocking cycle that needs to occur because inventories are so low. Consumer spending fell in Q2 but fears appear to be subsiding. Also bullish for GDP the housing market appears to have bottomed with some minor gains in several areas. The automotive sector should add significantly to Q3 GDP because they were almost out of business in Q2.

The risk to economic growth for the rest of 2009 remains the housing foreclosure problem and risks to financials from defaults in commercial real estate. There is more than $2.2 trillion in commercial real estate loans at risk for default. Over $1.3 trillion are already underwater in value to mortgage balances. Major buildings are going into default every day. A 47-story 1.8 million square foot Manhattan tower, Worldwide Plaza, was foreclosed by Deutsche Bank and sold to three private investment groups. There were 700,000 vacant square feet.

In San Francisco a 43-story building owned by high profile groups Hines Interests and Sterling American Properties is being surrendered to the lenders in lieu of foreclosure. The building was purchased for $281 million in 2007. These stories are being repeated daily around the country and this is making lenders very hesitant to loan money on any commercial property. Commercial properties are normally leveraged at 70-80%. Few lenders today are willing to loan more than 50% of the properties distressed value. That is a major haircut requiring massive amounts of private capital to complete any deal. With lenders seeing more and more properties go into default the odds are good that their appetite for lending will drop even further.

Of the $6.7 trillion in commercial real estate loans in the U.S. nearly 50% will come due during the next three years according to First American Core Logic. Nearly $165 billion in loans mature in the second half of 2009 and will have to be paid, sold or refinanced. This commercial real estate cloud will continue to weigh on the financial sector and the economy well into 2010 and that suggests the GDP growth will continue to be slow.

GDP Chart

Friday also had a couple of regional reports ahead of Monday's National ISM report. The New York Purchasing Manager (NAPM) report showed a slight decline in July to 358.2 from 359.0. That was far from earth shaking and the real news was that this was the second month of decline after the May uptick to 361.6. This is really just splitting hairs over the monthly changes. The bottom line is a rebound in the New York area has not appeared.

NAPM Chart

Meanwhile a rebound in the Chicago area appears to firmly underway. The Chicago ISM rose to 43.4 for July, up from 39.9 in June. The headline number is now +12 points above its low of 31.4 in March. Production jumped +4 points, unemployment +7 and new orders +7 to 48 and the highest level since September. However, order backlogs fell from 37.6 to 32.1. That was offset by a drop in inventories from 34.2 to 25.4. The bounce in the Chicago ISM was due primarily to the automakers restarting production and putting people back to work. This industry specific rebound will not be replicated in the other geographic regions.

Chicago ISM (formerly PMI)

The economic schedule for next week has some key reports. The national ISM on Monday is expected to show a rise to 46.8 but that is still in contraction territory. Anything under 50 represents a continued decline. Wednesday has Factory Orders and ISM services. Factory orders are actually expected to decline to a three month low of 0.2% and barely in positive territory. This would seem to be in disagreement with the analyst comments about an inventory rebuild cycle but this is a lagging report for June.

Friday is the big day with the Non-Farm Payrolls for July. Expectations are for a loss of -305,000 jobs compared to a loss of -467,000 in June. You may remember the consensus expectations for June were for a loss of -355,000 and the market did not react well when the -467K number was released. The July losses are expected to be lower because the automakers went back to work. That means parts suppliers also went back to work as well as everyone else in the supply chain. Will the losses drop back to -305K is the $64 question. A better than expected number would be very market friendly. The unemployment rate is expected to have increased again on its way to double digits in early 2010. The unemployment rate is calculated from a different report where households are surveyed instead of employers.

Economic Calendar

The rebound in the auto sector was about to accelerate strongly due to the Cash for Clunkers program but that rebound was in doubt Friday morning. The official name of the program is Car Allowance Rebate System or CARS. The week old program had already blown through the $1 billion in money allocated to purchase and scrap the clunkers. President Obama said he was working with lawmakers to provide additional funding. The House quickly passed a three-page bill to provide another $2 billion for the program. Finally a stimulus program that actually helped people and it was the smallest program in the batch. With programs for hundreds of billions no longer being mentioned in the news this is the little stimulus program that succeeded. When you consider the triple advantage of this program it should have been authorized for $20 billion. Each billion buys about 250,000 clunkers in exchange for purchasing 250,000 new cars.

Crushing low mile per gallon cars is a positive for the environment. Selling an equal number of high miles per gallon cars is a plus for the automakers as they try to extract themselves from the quicksand of bankruptcy, shuttered plants, laid off workers and no demand. In a survey of dealers they reported one additional car sold in addition to every cash for clunker deal. Seems shoppers that did not qualify for the deal were opting to buy cars anyway and the increased chatter about the clunker program was raising the interest level for cars in general. Some dealers were actually worried they would run out of inventory of new cars because the pace of sales was so brisk. This win-win stimulus program was probably the best one enacted and definitely needs to be refunded.

There is another view of the Cash for Clunkers program. Foes claim this only rewards those people living on the economic edge and driving crap cars because they can't afford anything better. The middle class and above don't own $2000 gas guzzling clunkers and now they are going to be taxed to pay for new cars for John & Susie Sixpack who could not come up with a down payment on their own if their life depended on it. By giving the underclass new cars they become further wards of the state and become democratic voters for life. Some foes are predicting another round of credit problems when these cars are repossessed 6-12 months from now. However, this was debunked by the Autonation CEO saying the credit scores of the CFC buyers was higher than their normal shoppers.

Quite a few message boards are full of comments about the clunker program being social engineering, the advance of socialism in the U.S. and blaming President Obama for the grand scheme of taking over GM in advance of the big auto giveaway. Personally I think they are giving the president too much credit. If it was a scheme the program would have started out at $20 billion. More likely the whiners on the Internet are just angry they don't qualify for the program because they already own a high end yuppie SUV or they are the blue collar workers who would not be caught dead in a low powered EconoBox on wheels. Opinions are like noses, everybody has one. Click on the email link at the top of this article and give me your opinion.

In stock news Las Vegas Sands (Nyse:LVS) fell -16% after the company posted a loss of $222.2 million compared to a loss of -$8.8 million in the comparison quarter. Earnings were hurt by legal settlements, lowered values on properties sold and weak consumer traffic. Moody's placed LVS on review for a possible downgrade. Moody's said it was concerned about the company's ability to maintain adequate liquidity and stay in compliance with financial covenants.

Genzyme (Nasdaq:GENZ) dropped -8% after it said the FDA was going to re-inspect a Boston facility to determine whether manufacturing issues discovered in February had been fixed. A virus had been found in bioreactors in the facility. The company had already reported in May that the problems had been fixed and the plant re-inspected so this was a surprise for investors.

Citigroup (Nyse:C) traded 1.11 billion shares on Friday with 300-400 million shares traded at the close. Citi recently exchanged a record number of common shares for preferred shares owned by private investors and the government to reduce its capital requirements and eliminate the preferred dividends. Citigroup's outstanding shares went from 5.51 billion the end of June to 21 billion. The government still owns $20 billon in preferred shares with an 8% dividend.

There were so many shares exchanged that the major index managers had to rebalance their indexes to account for the change. The Russell indexes rebalanced to the new Citi share count at the close on Friday. This means index managers for the Russell 1000 had to buy large quantities of Citi at the close and sell minor amounts of every other stock in the index. The S&P is going to do the same thing next week. Did you know that Citigroup is seeking approval to issue another 60 billion shares in the future? How will a company with 81 billion shares outstanding ever raise its stock price? Can you say, "Reverse stock split?" I would not buy Citigroup stock with your money much less mine.

Russell 1000 Chart

Citigroup Chart

AutoNation (Nyse:AN) reported earnings that fell by 29% to 29-cents per share on a -29% drop in revenue. Yep, a lot of 29s. The earnings were 4-cents over analyst estimates. AutoNation is the largest U.S. dealer with 264 dealerships. The CEO said showroom traffic had jumped +36% over the last week since the Cash for Clunkers program was started. AutoNation also increased its orders for new vehicles by +45% in Q2 to prepare for the anticipated recovery. That is some pretty strong faith in the auto sector recovery. The CEO said the credit scores for CFC buyers were higher than that of normal shoppers. That debunked the claims that many of these buyers would never make a payment or have the car repossessed 6-9 months from now. The rumors of the CFC program cancellation on Thursday night crushed the stock of AN on Friday morning but the quick action by the House saved the day. The Senate is expected to act next week to extend the program.

AutoNation Chart

While the economic calendar has some big events next week the focus until Friday will still be on earnings. The chance for the biggest market impact might come from Cisco (Nasdaq:CSCO) on Wednesday after the close. After Intel started the tech rally a couple weeks ago we have had some disappointments randomly appear in the tech earnings schedule. Amazon and Microsoft to name a couple. Strong earnings from Cisco could reassure the market and reinforce the tech rally. Remember the Nasdaq only gained +12 points for the entire week so help is definitely needed.

I could have built the entire earnings graphic with energy stocks but the only two that really matter next week are CHK and RIG. Chesapeake (Nyse:CHK) will tell us all we need to know about the state of natural gas drilling and reserves. Transocean (Nyse:RIG) will tell us how the deepwater sector is doing. Since deepwater rigs are contracted well in advance and for years at a time Transocean should have been impacted less than the rest but I am sure they will report some new delays and cancellations. Canceling a yearlong contract for a drillship at $75,000 a day does have its ramifications but normally there is someone else with a project on the schedule that can pick up some of the slack. How well RIG managed these scheduling blips should be a key point in their earnings. If RIG says business is picking up again then the entire sector of energy stocks should benefit.

There are probably a lot of stocks in the list you have never heard of and that is a factor of diminishing quality of earnings. The smaller companies bring up the rear in the earnings parade and hopefully there will be plenty of workers with wheelbarrows and shovels to clean up behind them. This is the last major week for earnings and we already know how the story ends. Most beat on earnings but missed on revenues and guidance was mostly soft.

Earnings Calendar

Five more banks were closed on Friday in five different states. Keeping the FDIC busy were the First State Bank of Altus OK, Integrity Bank in Jupiter FL, Peoples Community in West Chester OH, First BankAmericano in Elizabeth NJ and Mutual Bank in Harvey IL. Mutual was the largest at $1.6 billion and 12 branches. Total assets of all the banks was $2.69 billion and will cost the FDIC $911.7 million. This brings the total banks closed this year to 69 and nearly three times the 25 closed in 2008. The FDIC has 305 banks on the problem bank list and it insures 8,246 U.S. banks.

Crude oil went for a wild ride last week. After opening the week at $68.75 the Wednesday crash on worries over China knocked it back to $62.70. The rebound on Thursday/Friday pushed it back to close at $69.50 and a gain for the week. That was a monster bout of volatility but the uptrend support was never in danger. Part of the Wednesday decline was due to a spike of 5.2 million barrels in U.S. oil inventories just as worries over China's rebound were hitting the news. Analysts were all over the airwaves saying sell oil.

Those worries eased about the same time the dollar started imploding on Thursday. The dollar index closed at 78.34 on Friday and a new 8-month low. Oil and other commodities rallied as a dollar hedge. Finding out that traffic in U.S. auto showrooms increase 36% because of the Clunker program did not hurt. If a storm had appeared on Friday it would have punctuated the short squeeze and could have pushed the price well over $70. Fortunately for the people on the coast there are still no storms in sight.

Crude Oil Chart

US Dollar Index Chart

July was a solid for the markets with the Dow up +9% and the best July since 1989. The S&P was up +7.7%. The Nasdaq is up +44% over the last four months and had its best July since 1997. The indexes are back up to levels from before the Lehman crash. This is very difficult ground and given the decline in earnings interest it could be a tough week next week.

However, historically whenever the markets gain over 5% in July they continue to add another +2.4% in August and are up +4.6% for the rest of the year. First, this is not a normal year so historical norms are not relative. Second, even if we did follow the historical patterns the +4.6% for the rest of the year would only be half the gains made in July. How excited would we be about another +350 Dow points by year-end? I seriously doubt anyone would be selling their scrap gold to rush into stocks for that kind of return.

Another problem is the July month end markups. Other than the Thursday short squeeze at the open the markets went nowhere for the entire week. If mutual funds were painting the tape they were using crayons instead of buy orders. I did not see any markups and that worries me.

If you look at the price action on the Dow there was a monster short squeeze on the 23rd that took the Dow over 9000. Those gains held for five days but there was no follow through. The Dow was setup for a support failure at Wednesday's close. Shorts waited patiently for two days after getting blown out on the 23rd. The Tuesday high was sold and we got a solid pattern of lower highs right into Wednesday's close. They had plenty of time to load the boat again with shorts in expectation of a support failure. Instead they were blown out again on Thursday. Again there was no follow through and the Dow closed well off its highs on Thursday.

Dow Chart 30 Min

If you watch any stock TV you probably heard all week about the "golden cross." This refers to the 100-day average crossing back over the 200-day average. This is supposed to be the Holy Grail for fund managers. The Dow has not yet crossed but is very close. In the chart below you would have missed out on a 40% rebound in the Dow. The resistance I am watching is the uptrend resistance for 2009 at 9200. (blue line) The July rally came to a dead stop when it hit that resistance. Support is 9000.

Dow Chart - Daily

The S&P-500 has completed the golden cross after the 200-day acted as support for all of June and July. As a fund manager you would have given up a fortune waiting for the cross to take a position. However, there are a lot of conservative portfolio managers that use strict rule based trading and this is a very old rule. I am sure there were many managers happily adding to positions last week.

The S&P stopped dead at the 2009 uptrend resistance and it still has very strong resistance at the psychological 1000 mark. For August after a 40% rebound off the March lows it would not be a stretch of the imagination to visualize a failure at those levels.

There is no real reason for the rally to continue. Almost every major gain over the last several months has been a short squeeze. You can bet that the shorts were loading up again on Friday after Thursday's big drop from the highs. Is this another squeeze in the making? If so then the Cisco earnings could be the spark. However, if Cisco does a face plant like Microsoft then that would be a serious opportunity for a decline.

I would watch the 1000-1010 level carefully and I would be a reluctant buyer on any breakout but I would be a buyer.

S&P-500 Chart

The Nasdaq has its own set of problems. After gaining 7.7% in July the last week has been tough. On Thursday the Nasdaq stalled when it hit downtrend resistance dating back to Oct-2007. I don't know how well this will be respected but next week the odds are good we are going to find out. After a +44% rally off the March lows the Nasdaq is extremely extended and August/September are not normally kind to tech stocks. However, as I have said before this is not a normal year. Anything is possible once there are clear signs of economic growth. I fear the "expectations for growth" are already priced in and it will take some clear signs of actual growth to produce a continued rally. Support is 1950 and resistance 2000.

Nasdaq Chart - Weekly

The Russell 2000 spiked over resistance from November at 550 but immediately stalled. The moving average cross happened back on July 23rd and there was no follow through for four days until the short squeeze last week. The Russell is simply not acting like fund managers are putting money to work. It looks tired and I am worried about managers taking profits to insure gains for the full year. Support is 550 and anything over 560 should be a breakout so the opportunity is there if managers want to pursue it.

Russell Chart - Daily

Russell Chart - 30 Min

These are the factors I am considering for next week. We have the psychological resistance at 1000 for the S&P. The Nasdaq has downtrend resistance from Oct 2007. All the indexes struggled last week with the exception of the short squeeze and there was an afternoon sell off of that squeeze. Earnings are winding down and those that do report late are typically under achievers with a few exceptions like Cisco. I expect John Chambers to try and say something bullish even if Cisco's earnings are weak. Unfortunately the market will be expecting it.

The ISM on Monday should not disappoint but even if it does there may not be a major reaction. The economy is still weak and we have to expect some disappointing reports but that does not mean the recovery is over. The Non-Farm payrolls on Friday could be a challenge. Without earnings surprises to keep the market moving higher the payrolls will be even more important. There is also a Fed meeting two days later. The combination of the two events could put a damper on the market UNLESS payrolls are much better than expected. There has been a lot of talk about removing the rate stimulus despite Bernanke's strong comments to the contrary two weeks ago. It is that time in the cycle where the pressure is beginning to build. This can be a cloud over the market in the coming months.

My best guess for next week is flat to slightly down unless something unexpected happens to squeeze the shorts again. As the first week in the month we can expect some retirement funds to be put to work early in the week. Whether it will be enough to offset the growing lethargy is unknown.

Market sentiment has returned to extremely bullish at 61% and that is normally a bad sign but not always lethal. I believe that nearly everyone on the planet other than Nouriel Roubini fully expects the economy to be in full recovery mode by Q4. I heard several people on Friday saying 3% positive GDP in Q4. If investors believe we will have a strongly positive GDP in Q4 then the dips should continue to be bought. The market supposedly rallies six months before the economy. The current rally began in March on expectations for that six-month rebound. Many say the recovery is already priced into the market. I disagree.

The market was priced for another Great Depression in March and it did not happen. This period may always be known as the Great Recession but we have clear evidence it is already coming to an end. How much did the market rally from the Great Depression? Art Cashin said on Friday if the rally continues through next Friday it will equal the duration of the 1929-30 bounce. That bounce recovered 48% of the drop. The Dow is up 44% as of Friday. Obviously comparing economies and markets from 80 years ago may be interesting but it is not relative to our current situation. What happens next week will depend on what happens in earnings, economics and sentiment. As long as fund manager sentiment is an expectation for much better things six months from now the dips will be bought.

Website Changes

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Jim Brown