The Dow shook off an early morning dip and some expiration volatility to rebound +60 points off the lows and close right at 10,000 once again. Given the factors that could have pushed it lower this was a bullish recovery.

Market Statistics

The Dow had a significant headwind at Friday's open after IBM disappointed investors with their earnings. Dow component IBM gave up -$6.34 for the day and that equates to about -60 Dow points. Add in another 9-point Dow drag with GE losing a buck and another -9 points from JPM losing a buck and it was a minor miracle that the Dow clung to the 10,000 level.

The economic reports were also working against the market at least in the case of Consumer Sentiment. Sentiment fell to 69.4 from 73.5 and well below estimates for a gain to 76.5. The decline was caused by a sharp -5.9 point drop in the expectations component. Expectations for inflation rose sharply from 2.2% to 2.8%. Consumer fundamentals remain weak and job losses are continuing but at a marginally slower pace. The stock market may be hitting new highs for the year but the week this survey was taken the market was trending lower. Every day some new high profile analyst is calling for a correction given the strong gains since March. We also saw on Thursday that foreclosures hit an all time record high in Q3 with 937,840 homes receiving foreclosure letters.

Actual foreclosures are unknown because the delinquency rate is so bad that many lenders are only going through the motions to file the preliminary paperwork but are not following through with the actual foreclosure. They would rather have someone living in the home than having tens of thousands of vacant home falling into disrepair, vandalism and theft of components. The odds are much better that vandals will not strip out all the copper wiring to sell for scrap if someone is living in the home. In some areas the appliances are disappearing within days of the former owner vacating the property. The foreclosure problem will remain with us for a long time until employment returns.

Consumer Sentiment Table

Consumer Sentiment Chart

Industrial Production for September rose +0.7% marking the third consecutive gain. This is also the first period of sustained gains since 2007. Most of the gains came from the restart of the automakers and the ramping up of new models. The annualized rate of increase in Q3 was +5.2% compared to drops of -19% in Q1 and -10.3% in Q2. Manufacturing output increased by +7.7% in Q3 and the biggest increase since 1999. Again, automakers were the reason. To put it into perspective business equipment rose only +0.1%. However upward revisions to prior months project an annual rate of +3.5%. Total manufacturing output rose nearly 8% annualized in Q3 and the fastest pace in nearly three years. Overall capacity utilization rose from 69.9% to 70.5% and the highest level since January but still well below pre recession levels of 79%.

Industrial Production Chart

Next week has a busy economic calendar but only a couple of reports will distract analysts from the earnings parade. The PPI on Tuesday and the Fed Beige Book on Wednesday are the reports that will attract the most attention.

Economic Calendar

The true focus for the week will be earnings. This is the second busiest week of the quarter and over a third of the Dow components will report. A total of 61 S&P companies have already reported and 79% have beaten street estimates. We could quit the reporting cycle now and know how the earnings for Q3 stacked up. However, everybody gets their 15 minutes of fame or blame as the case may be.

Next week the most watched companies are listed in orange, next most important in green then yellow then everyone else. I listed a company like Black & Decker (BDK) in green because they sell tools into the retail/wholesale market and should be a good read on consumer activity. They have already preannounced better expectations. Caterpillar (CAT) should be an excellent reading of global business. I am expecting CAT to provide lackluster guidance. Over 65% of CAT's business is from outside the USA.

Apple (AAPL) reports on Monday, which is unusual for them. With ever increasing price targets and earnings estimates they are eventually going to disappoint. Friday Microsoft (MSFT) reports earnings before the open. This is a dramatic departure from the normal Thursday after the bell report. They are expected to beat the street and say positive things about Windows 7, which goes on sale next Thursday.

Amazon reports after the close on Thursday and their stock price has been relatively stagnant for the last month as though traders are unsure what to expect. Wal-Mart started a price war with Amazon last week on the price of books. Since Wal-Mart only carries a few this should not impact future Amazon earnings. Ebay (EBAY) reports on Wednesday and I am expecting some decent results. They have been changing their pricing structure and adding extra cost features and this could have produced some extra revenue over the quarter. Also, with school out many housewives use the summer months to sell kids clothes and toys on Ebay while buying clothes and toys in the next size higher. My daughter is always buying and selling clothes as her son goes through about 3 sizes a year. It always amazes me what an active market there is for kids clothes on Ebay. It appears the soccer moms turn into shopper moms over the summer.

Yahoo reports on Tuesday and YHOO stock has also been stagnant since mid September. It appears all the drama has left Yahoo and lacking a new story traders moved on to something else.

UPS reports on Thursday and will give us an update on the status of the shipping business. Based on what UPS says we can extrapolate economic health for the U.S. and to some extent the world. If the package business is picking up then there is a rebound underway.

Juniper (JNPR) reports on Thursday and will give us an idea on what to expect from Cisco several weeks from now. Actually F5 Networks reports on Tuesday and the two combined reports will be a good indication of health in the tech sector.

Several energy stocks report throughout the week including Occidental (OXY) and Schlumberger (SLB). I could not list all of the energy stocks and this week is just a trickle compared to the following week. However, after Haliburton's earnings on Friday and SLB next Friday there will be little doubt how the energy sector will fare.

Earnings Calendar

Haliburton (HAL) reported earnings on Friday that fell 61% to 31-cents per share. Although revenue was down sharply from the comparison quarter it was up compared to Q2 and the first gain in four quarters. Haliburton said it appeared the worst was over although market conditions remained difficult. Many wells are being drilled but completions postponed until prices firm. This allows firms to continue developing reserves but postpone the costly completion process until it makes economic sense. HAL hit a new 52-week high at $31 on the news.

General Electric (GE), the old faithful of earnings reporters, turned in a dud of a report. GE's Q3 profit fell -45% on a decline in orders of 18%. They beat the street on earnings through cost cutting but revenue fell sharply. Their outlook was far from exciting. GE blamed the slump on a lack of an event to offset the Olympics revenue from 2008 and because of the depressed real estate market. It was a lackluster report.

Google (GOOG) reported earnings that beat the street and garnered a $20 boost in its stock price on Friday to $550. Google has become the poster child for elevated price targets. Current targets include Canaccord Adams $700, UBS $635, Goldman $635 and FBR $680 to name a few. With only 242 million shares outstanding a good 5:1 split would probably be rocket fuel for prices. Most investors can't afford to belly up to the bar to buy a couple hundred shares at the current price. Split that price down to about $100 and thousand of investors could afford to partake in the next rally.

Google Chart

Bank America (BAC) reported a loss of $2.2 billion in Q3 and wrote off about $10 billion in bad loans. That was $1 billion more than the prior quarter. The higher than expected loan write offs from BAC, C and JPM stimulated fears that consumers are still in a downward spiral. The combined earnings reports from the major banks knocked about 7% off the Banking Index since Wednesday's close. Ironically the banks were supposed to post the strongest earnings of Q3 and instead they are proving to be the biggest disappointment.

The FDIC closed the 99th bank of the year on Friday. The San Joaquin Bank of Bakersfield CA was the last to be closed. Banks insured by the FDIC have set aside $338 billion for loan losses during the past six quarters. The FDIC has spent nearly $27 billion on bank closures so far in 2009 and has less than $10 billion left in the emergency fund.

Foreclosures are proving a hard pill to swallow for MGIC (MTG) as it posted its ninth consecutive quarterly loss. MGIC is the largest mortgage insurer and record foreclosures are crushing the insurer. MGIC lost -$4.17 per share in Q3 and much more than the $1.62 loss expected by analysts. Revenue fell more than 10%. MGIC is going to cease operations of the current company in January and start a new company in an effort to revitalize its business. Evidently the old losses and liabilities will stay with the old company and the new MGIC will be reborn. Good trick if you can manage it. MTG stock fell -12% on the earnings news. If they can succeed in splitting the company in two at year end the odds are good the current MTG will return to its lows without any new revenue to cover old losses.

MGIC Chart

Crude prices seem to be possessed. For no particular reason other than the falling dollar the price of crude has taken off over the last couple of weeks. After hitting a low of $65.21 on Sept 25th the price of crude has gone nearly vertical to close at $78.52 on Friday. Crude inventories rose slightly last week but gasoline inventories unexpectedly fell by 5.2 million barrels. Also, refinery utilization fell to 80.9% from 85%. October is the month refineries use to switch over from summer fuels to winter fuels and this was the reason for the nearly 5% drop in capacity. Also, the pace of crude imports at 8.7 mbpd is exceptionally low.

At the Peak Oil Conference last week we heard from experts from around the world that production capacity was continuing to decline although it was still more than current demand. OPEC's level of compliance with their stated quotas is shrinking every week as OPEC countries cheat on the quotas in order to capture income from the rising prices. We heard the prior week that the IEA and EIA had raised their demand estimates for Q4 and for 2010 but this should not have any impact on the current price of crude given the excess OPEC production capacity.

We also learned that China is still buying up every block of reserves they can find and using dollars to pay for it. This diversifies them out of dollars and into commodities with the emphasis on crude oil. You may have heard that Exxon had bid $4 billion for the Kosmos Energy stake in the Jubilee field. This field is estimated to hold 1.4 billion barrels of oil. Exxon thought it had completed a deal with Ghana National Petroleum for the stake in the field when China's CNOOC showed up unexpectedly with a rival bid. Kosmos had already announced it had entered into an exclusive binding agreement with Exxon but that "binding agreement" appears to no longer be binding.

This competition for reserves and production between national oil companies like CNOOC, Petrochina, Exxon, Occidental, Conoco, Petrobras, etc, is going to raise the price of oil regardless of the global production capacity. I have been warning about China for years. They are not buying up reserves and production to be an international oil production company but to acquire the reserves for their own use at some point in the future. They are NOT buying to produce and resell. They are buying to hoard and take off the market.

None of this explains the rise in oil prices last week. The initial rally came on the falling dollar at a new 52-week low but once over $75 it continued higher on short covering. Oil prices hit a new 52-week high at $78.52 at the close.

Crude Oil Chart

The price of oil is going to be a problem for the economic recovery. Economists at last week's conference believe that once oil goes over $85 the economy will begin to decline. There were many discussions on the part that high oil prices played in 2008 to accelerate the credit declines. The theory is that 90% of Americans spend every dollar they make with only a very small cushion of cash at month end. With heating oil prices hitting $4 a gallon and gasoline prices going to $4.50 the average consumer was out an extra $250-$300 every month for fuel. Since most U.S. families have two wage earners that high gasoline price was a double whammy.

The second recessionary pressure was the new credit card rules from 2007/2008 that significantly increased the minimum payment due. With an average of five credit cards and payments doubling or in some cases tripling the extra monthly outgo between credit cards and fuel bills was more than $500 per family and more than the available cash. This caused people to be late on their house payments at the same time the home equity line of credit evaporated.

The economists did not believe rising crude prices were the sole culprit for the recession but were a significant contributor. They pointed to gasoline price hikes in prior decades and the recessions that followed as evidence for their assertions.

The bottom line to this discussion is that they believe $85 oil prices will stifle the fledging rebound and push the economy back into recession.

The other big topic was the ballooning debt. Debt at a Peak Oil conference? Absolutely since they are uniquely intertwined. Rising debt produces a falling dollar and higher oil prices. Eventually the rising debt will cause inflation since the government has no choice but to print more money to keep the wheels turning. Inflation produces higher oil prices and higher oil prices will eventually produce another recession.

They say you can line 1,000 economists up side by side and still never reach a conclusion. That was not the case last week. EVERY economist, both professional and amateur, agreed the U.S. was never going to be able to pay off its rising debt. At the current 12.6% of debt to GDP it puts the U.S. in the category of a banana republic and actually worse than quite a few. People don't realize how big a $12 trillion debt really is.

There are 3600 seconds in an hour, 86,400 in a day, 31,536,000 in a year. A trillion seconds is 31,688 years. A trillion $1 bills weighs 1.1 million tons, yes tons. It would take more than 10,000 18-wheelers to transport $1 trillion in dollar bills. A trillion is a very big number and the U.S. currently owes $11,947,621,824,058 or nearly $12 trillion dollars.

If you could pay off the current $12 trillion in debt at $1000 per second it would take you 3,805 years to pay off the debt assuming there was no interest. The U.S. currently incurs $500 million a day in interest on its various debts. That is expected to quadruple over the next decade. In addition to this the U.S. also has over $56.4 trillion in unfunded liabilities to social security, Medicare and Medicaid, according to the CBO. ($184,000 for every man, woman and child in the U.S.) That means all the baby boomers who are about to retire will go from paying taxes into the system as wage earners to taking money out of the system as retirees. They will get a check every month and M/M will cover their rising medical bills. The government does not have this money because they borrowed it to pay other bills. The social security trust fund has IOUs from the government.

The economists are literally running around like a flock of Chicken Littles warning that the sky is falling. They believe this massive debt is more dangerous than peak oil. I am not an economist and I was shocked to see the fervor being expressed. They believe the collapse of the dollar is imminent. They expect the dollar index to decline from the current 52-week low of just under 75 to something in the 25-40 range. This will result in the dollar being dropped as the world's reserve currency. This has tremendous implications to the stock market, job market and your retirement plans. Needless to say I came back from the conference severely depressed. The economic landscape in our future looks more like Death Valley than the Ponderosa.

The Dow crossed over the 10,000 barrier for the 26th time this week. If it does it next week it will be the 27th time after the close at 9995 on Friday. I thought the minor decline on Friday and the rebound was bullish. After a couple days of gains the markets needed a rest. The move over 10,000 did not come without a price. Wednesday and Thursday saw higher volumes but very little movement. On Thursday the markets posted gains BUT the A/D line was negative. There were more decliners than advancers but the markets eked out a gain and volume was rising. This is NOT a good sign. Higher volumes at critical levels with internal divergence is a sign of a topping market or at least a market where the indecision is high.

I want to give the market the benefit of the doubt especially since this was an option expiration Friday. The recent rallies have been built on the backs of shorts that refuse to believe the market can go higher. However, large round numbers tend to be magnets and once there the visible target disappears. There is no direction and the troops need to fall back to regroup in order to make another charge.

This would be the perfect place to consolidate. The Dow is pressing upside resistance and nearing downtrend resistance. The SPX is facing strong resistance at 1100 and the Nasdaq is stalled at 2160. Expiration is over and Monday will be the test. In 1987 the Monday after expiration was black Monday.

If the Dow does cool we could see 9850 as support and the launching pad for the next leg higher. However, remember, this is October and the fiscal year end for most funds. There are still two weeks left in October and now that expiration has passed there is nothing preventing fund managers from making year-end changes.

Dow Chart

The S&P is facing strong resistance at 1100 and financial stocks are weakening after some of the less than spectacular financial earnings last week. Energy stocks helped push the S&P higher and they are due to ease after the big run in oil prices last week.

S&P-500 Chart

The Nasdaq is fighting resistance at 2160 and barely managed to post gains after the Intel spike at Wednesday's open. The spike took it to 2167 and that remained resistance the rest of the week. There were opening spikes over that level but the hang time was measured in seconds rather than hours. If we did get a material pullback I would expect 2063 to be support.

Nasdaq Chart

The Russell and to some extent the Nasdaq could be forming a double top. Russell 622 was solid as a rock on Wed/Thr and support should be back at 600. The Russell only managed a .2% gain for the week compared to 1.5% for the S&P. This suggests fund managers are fading the Russell as we head into the last two weeks of October.

Russell 2000 Chart

The Volatility Index (VIX) spiked to 89 back in Oct 2008 as the markets crashed and big banks failed. That was the highest level ever for the VIX. It never moved over 50 before Lehman's failure and never over 40 before that. The VIX endured 9/11, Long Term Capital Management, Russian Debt Crisis, the Asian Debt crisis and the Worldcom bankruptcy with levels under 40. The VIX traded as low as 21 on Friday and extended its longest losing streak ever. The VIX at 21 is cautionary but given the recent volatility of the last 12 months I don't believe it is flashing a warning sign. Back in 2006 it traded as low as 9.39 and for four months analysts warned of impending doom. That doom came in Feb/Mar 2007 when the markets finally corrected after eight months of solid gains.

Obviously 89 is an extreme we may not see again soon as is the opposite extreme of 9. I would simply caution that numbers under 20 suggest some very bullish sentiment, maybe too bullish. Many times over the years we have seen the markets rally into earnings, even good earnings and then experience a sell the news event. If you are holding longs today I would definitely consider using a tight stop and not be too eager to jump back into the market if your stops get hit. I believe we will move higher eventually and I will feel much better once that calendar says November instead of October.

I met an investment banker at the Peak Oil Conference that is staffing up a new energy consultancy group. He is looking for a trader to manage the firms excess cash and trade stocks, options and energy futures. If you feel like sticking your head in the lions den send me your contact information and I will make the introduction. Geographic location is not important as long as you are in the USA.

Jim Brown