A classic sell the news event knocked all the indexes into the loss column for the week. Intel may have knocked the cover off the ball but the chip sector was penalized for running up ahead of the report.

Market Statistics

It was not a fun day for the bulls as fund managers took advantage of the Intel earnings and option expiration volume to unload some of their positions that had rallied since year-end. This was not a statement about the condition of the market but simply profit taking on good news. Having the JP Morgan loan loss news and weak guidance was an accelerant to the selling but not the cause. The futures were already down well before JPM reported.

The leading tech stock reported blowout earnings by any metric you care to use but ends up losing 3% on the news. Intel posted earnings of 55-cents per share compared to already bullish analyst estimates of 30-cents. Intel posted record gross margins of 64.7% and provided strong guidance for 2010. Conventional wisdom suggests we should have been up triple digits rather down triple digits.

Actually if you watched the futures late Thursday the selling started almost immediately after the Intel spike faded in the after hours session. It was clearly a sell the news event and probably increased by the option expiration. Traders who were long options going into the Intel earnings only had one day to take profits and square up positions.

There were also some cautious comments about Intel. Some analysts believe that the 64.7% gross margins represents a peak in earnings potential because Intel said those margins would decline through Q4-2010. Those analysts are seeing the glass half empty. Intel is firing on all cylinders, has product shortages in many areas and is facing the biggest PC upgrade cycle since Y2K. So what if the margins decline a point or two? Revenue is likely to expand so rapidly that net profits are still going to explode.

A Deutsche Bank analyst laughed at the peaking talk saying Intel's Q1 guidance was conservative, chip inventories were lean and demand was improving. Alex Gauna of JMP Securities said the guidance was "nonsensically conservative", which should mean Intel will be able to continue pushing estimates higher throughout the year. Several analysts pointed out that Q1 is normally a period where reality returns from the rapid pace of holiday sales.

I don't buy the "Intel is peaking" concept making the rounds on Friday and I don't believe it had any significant impact on the Friday selling. Intel peaking does not cause 4% losses in the materials sector. A peaking Intel does not cause the Dow transports to lose 50 points when oil and gasoline prices are crashing. This was purely a sell the news event that was long overdue.

Intel Chart

The JP Morgan earnings were more problematic given the concern over potential bank losses on weak consumer and commercial loans. The banking sector had been trending down for about two months since the October highs due to loan concerns and dilution issues. On January 4th the sector exploded as new money came into the market and the Banking Index added about 15% in a little over a week. With JPM the first big bank to report the pressure was on to post strong earnings and good guidance.

JP Morgan is seen as a very well managed company and a strong bank. They said all along they did not need the TARP money and lobbied to give it back at the earliest possible moment. JPM posted earnings of $3.3 billion in Q4 and $11.7 billion for the full year. When you think back at what has happened to the banking sector in the last 15 months I think this is amazing and shows what a strong bank it is. However, even strong banks making good loans are at the mercy of the economy.

Chase Card Services lost $2.33 billion for all of 2009 and is unlikely to turn a profit this year. Chase retail services made only $97 million for 2009 after posting a $399 million loss in Q4. Chase agreed to temporarily modify about 600,000 mortgages and 89,000 have been made permanent. Still, the bank made $3.3 billion for the quarter.

What roiled the markets was a warning from CEO Jamie Diamon that he remained cautious about 2010 considering the job and housing markets continued to be weak. "We don't have much visibility beyond the middle of this year and much will depend on how the economy behaves." He also said the economy was still too fragile to declare the worst was over, though he hoped conditions would stabilize by midyear.

JPM set aside another $1.9 billion for consumer loan loss reserves but that was less than in prior quarters. JPM now has more than $32.5 billion in loan loss reserves and more than adequate for anything short of a global meltdown.

JPM Chart

The JP Morgan news riled the markets because they wanted to hear that the worst was over and crown Jamie Diamon as king of the recovery. To find out that the king of banking has no clue to the economy and the fate of the financial sector was an unthinkable course of events. If our hero Jamie doesn't know then lesser banks could still be in trouble. It was a depressing letdown for those in the financial sector. On a side note the FDIC closed three more banks on Friday.

Jamie Diamon was the only major bank CEO to speak out against President Obama's new $120 billion tax on banks. He was openly hostile that the successful banks that weathered the storm be taxed to pay back sums for other companies like AIG and GM that remain on government support. JPM would end up paying about $2 billion a year in TARP taxes as would Bank America and Citigroup. Goldman Sachs would get off light at $1.18 billion a year and Morgan Stanley $1 billion.

Bank analyst Richard Bove wrote in a note to investors on Friday "In the tradition of Hugo Chavez, the Obama administration wants to tax the rich and dishonest bankers to pay for the problems throughout the American economy, notably the losses in the automobile industry. Even though the auto companies might have been accused of being greater offenders in creating the financial crisis than the banks, the banks are labeled the villains and must be taxed to pay the funds used to bail out their competitors. This is pure Chavez reasoning."

Since GM, FNM and FRE are exempt from the tax the administration is basically rewarding the losers and penalizing the winners. The timing of the bank tax announcement was perfect. It was announced only a couple days before the big banks announced their bonus payments. Perfect timing to garner support from Main Street America and people who don't understand why the average JPM manager makes $378,599 a year. This was an excellent political move ahead of the 2010 elections. It may also explain the very cautious comments by Jamie Diamon about his outlook. Not a good week to be pounding your chest and shouting about how much money your bank made last quarter. Maybe Jamie was smart like a fox to downplay his results and caution that the worst may not be over.

The JPM results on Friday sent up warning flags for next week because next week is bank week in the earnings parade. We get earnings from Citi, MS, WFC, BAC, GS, FITB, BBT and KEY. If JPM is taking such big hits from loan losses then what about the other banks next week. This worry sent the financial sector into a dive and it will probably take some good news from more than one bank to revive interest. That 15% rally in financials since Jan 4th is going to be weighing heavily on the market next week.

On the economic front the Consumer Price Index for December rose +0.1% and less than analysts expected. Inflation is not only low but it is falling and definitely not a risk for the Fed. The core-CPI was also +0.1% for the month and only +1.8% for the entire year. The CPI numbers were distorted by the low prices for gasoline in December. That was before crude rallied from $68 to nearly $84 last week. Energy prices at the retail level fell -4.8% in December.

If there is a risk at present it is the possibility of a deflationary trend with the monthly inflation numbers hovering around zero. The high unemployment and the lack of cash available from home equities is preventing resumption of any demand for products. This was a positive report because it did not give the Fed any reason to consider raising rates.

Consumer Sentiment for January rose slightly to 72.8 from 72.5 in December. Yawn. That is the highest level since September and only a fraction below that 73.5 rebound high. The gains came from the current conditions component (81 from 78) rather than the expectations component as we have seen in the past. Analysts claim sentiment is still being constrained by the lack of jobs and weak housing market. Check back next month and this spike in gasoline prices today will be a factor. I believe we are going to be stuck in this range for several months unless the equity market suddenly breaks out and starts making new highs for several weeks.

Consumer Sentiment Chart

The NY Empire State Manufacturing Index spiked +11 points from to 15.9 in January. The headline number was only one of the major gains. The New Orders component exploded to 20.5 from 2.8 in December. Also note the continued drop in the inventory component. We are still burning though the existing inventory leftover from 2007-2008 and at the rate it is declining there should be a monster rebuild cycle once the economy finds some traction.

Empire Table

Industrial production rose +0.6% in December but it was heavily influenced by a +5.9% rise in utility output due to the cold weather. I think that negates the value of this report for December.

The economic calendar for next week is very slim with only the Producer Price Index and the Philly Fed Survey of real interest to the markets. The housing index on Tuesday may also get some airtime.

Economic Calendar

The key to next week is obviously the bank earnings but there are also a handful of tech stocks to keep traders interested. IBM on Tuesday is expected to produce strong earnings and could revive faith in tech stocks. Ebay and Google report on Wed/Thr and will be heavily watched.

As for banks the Citigroup earnings on Tuesday will probably be ignored. They are expected to do badly so any positive surprise could help. The two most watched will be the BAC earnings on Wednesday and GS on Thursday. BAC is expected to earn $3 in 2011 and a PE of only 10 equates to a $30 stock price. I would be a buyer of BAC on a dip to $15. Goldman is expected to beat the street and nobody is worried about them missing or guiding lower. The guesswork on Goldman is how much better will their earnings be?

The earnings calendar is also skinny with the tidal wave of reports coming the following with companies like Apple and Microsoft.

Earnings Calendar

Despite the credit card losses at JP Morgan, four out of six companies reporting card activity for December said charge-offs declined. JP Morgan, the largest issuer of Visa branded cards, said charge-offs fell to 7.11% from 8.81% in November. Citi, the largest Mastercard issuer, said charge-offs dropped to 9.56% from 10.29%. American Express, the largest card issuer by purchase volume, said charge-offs fell for the seventh straight month to 7.1% from 7.6%. Discover fell to 8.68% from 8.98% while Capital One saw charge-offs that rose to 10.14% from 9.6%.

Bank America was the black sheep posting rising charge-off rates of 13.53%, up from 13.0% in November. Bank America inherited quite a few of its bad loan problems from the flurry of acquisitions of failing subprime lenders over the last two years. However, they are on the right track because delinquency rates fell to 7.44% from 7.69%. Capital One delinquency rates fell to 7.44% from 7.69% but American Express was the clear winner with only 3.7% delinquencies, down from 3.9%. Obviously being more selective about how you issue cards and keeping those cardholders on a short 30-day leash has its benefits.

In the fertilizer sector CF Industries (CF) pulled its offer off the table for Terra Industries (TRA). CF said the deal no longer made sense due to the rise in valuations in the sector. Now CF is in the hot seat because Agrium (AGU) has a long standing hostile offer outstanding for CF at roughly $110 per share. CF closed at $95.43 on Friday. CF made the bid for TRA in defense of the bid on CF by AGU. Now that CF no longer has an outstanding offer confusing their value it is Agrium's turn to make a play. Do they raise the offer on CF in hopes of getting frustrated shareholders to dump the CF shares? Do they go after TRA themselves as a consolation prize? It should be interesting to see who blinks first. Agrium shares fell on the news because investors are worried they will do something stupid to force the hostile CF bid.

Barclays upgraded the sector on Thursday and RBC raised POT to a buy on Friday.

The chip stocks looked more like crumbs at the bottom of a party bowl on Friday than a robust sector leading techs out of the winter darkness. Declines of -4% or more were common as funds took profits from the +26% rally since November 1st. For example AMAT -4.3%, KLAC -4.7%, SNDK -5.4%. The SOX has support at 335 so there could still be some downside on Tuesday. A break of support at 335 targets next support at 305. That would be a buying opportunity for me. The chip sector is on a roll and a real correction in prices to anything under 320 would be a bullish opportunity.

Semiconductor Index Chart

The next biggest earnings report could be Microsoft due to the successful ramp of the Windows 7 operating system. Netbooks and cheap laptops are flying off dealer shelves and the corporate upgrade cycle has finally kicked into gear. I could see Microsoft posting some really good numbers and raising guidance. They will try to downplay guidance simply because that is what companies do when they try to under promise and over deliver.

Microsoft is struggling with resistance at $31 but was only down a dime on Friday. That suggests there are quite a few people who expect Microsoft to do well. I just hope the bank earnings next week are good enough to keep traders bullish about the market in general so that Microsoft is not fighting a negative tape when they report on Thursday the 28th. Their earnings will signal the end of the major reports and could be the next turning point in the market.

Microsoft Chart

Oil prices fell to close at $78 after trading at $83.95 earlier in the week. We closed the first trade in the OilSlick.com newsletter for a $1,250 profit when oil hit that $78 level. Subscribers already covered their subscription price for the entire year and made nearly $1,000 to boot.

Crude prices were driven lower by the warmer weather, falling demand, rising dollar and rising inventory levels ahead of futures expiration next Wednesday. If the historical cycles persist we could see oil lower next week and make a great entry point for our next plays.

Crude Oil Chart

Friday was option expiration and a major once a year event. This was LEAP expiration Friday. Options that have been in force for up to two years needed to be squared away. This causes a strong bout of extra volatility. This is especially true then there has been a major move in the markets. Every call leap written since March was probably deeply in the money and this caused a bigger than usual bout of volatility that will likely carry over into Tuesday as stock from those in the money calls moves into investor accounts.

If you bought a $60 leap call on Goldman Sachs back during the crash then you had to decide last week if you wanted to sell the leap or exercise it and own GS ($165) for $60 plus your $5 leap cost. If you think Goldman is going higher then you exercised the leap. Otherwise you sold the leap and pocketed your profits.

If you wrote the leap as a covered call a year ago then you had to decide to either let your GS stock be called away or buy back the leap for $100 and keep the stock. Either way the uncertainty going into Friday was strong and there was lots of activity.

Over 9 billion shares traded on Friday with 7.3 million in down volume. It was the heaviest volume day since December 18th.

The Dow dropped nearly 150 points at the open and exactly to support. After holding there for several hours we saw a rebound at the close to end down -101 points. The intraday high on Thursday was 10,723 and the close at 10,710. This is exactly the resistance from June/July 2006. I know that is a long time ago but old support/resistance levels never die. They fade out of recent memory but they are still there. I rarely remove support/resistance lines from my personal charts and I am always amazed when a stock or index returns to honor those levels sometimes years later.

The Dow has two patterns today. One is a megaphone pattern and the other a telescope pattern. I did not make these up, they are real patterns or basically different types of bearish wedges. In the first chart the time frame is weekly and shows the ascending wedge dating back to the March lows. The range is becoming progressively smaller and the Dow developed a new complication when it hit the 2006 resistance this week. The path of least resistance is sideways with a break out of the pattern.

We have see breaks of the bottom line more than once on the S&P on the way to where it is today. The Dow has remained in the wedge. In the second chart is the megaphone pattern, which according to Colin Twiggs, is more reliable than the telescoping wedge.

If we believe that then a break to the downside in the first chart (dash line in second chart) is not a cause for alarm. That would setup a potential bullish retest of 10,250. A failure there would take the Dow below the bottom support line on the second chart. That would be exceedingly bearish and according to Colin would target Dow 9,000.

This is where Colin and I part ways. I could easily see the Dow move sideways to down from here but support at 10,250 should hold UNLESS we are heading into a real correction. A dip to 10,250 is just profit taking and portfolio reshuffling. A dip below 10,250 is something entirely different and would be a major change in market sentiment.

Dow Ascending Wedge (Telescope)

Dow Ascending Wedge (Megaphone)

I was looking for a short-term correction a week ago that never appeared. I think Friday's dip was a combination of profit taking, portfolio reshuffling and option expiration. Is it the start of a correction? You can't really determine much from a one-day move that stops on support. If you look at all the red candles on the chart above you see that 100-point dips are pretty common and since November 1st they have been mostly one-day events. Eventually that will change but we still have two weeks of important earnings to keep some excitement in the market. After the Fed meeting on the 26/27th and Microsoft earnings on the 28th then all bets are off.

The S&P is also respecting the uptrend support but is over extended even after the Friday selling. The 6-week sideways consolidation provided a good base for the new-year rally but the index funds are no longer buying because the year-end retirement cash has dried up.

If we have another day or two of selling we could retest 1115 and that is strong support, which should hold unless we are entering a real correction. Support at 1085 would be the fallback position and the bottom of the rising megaphone wedge. A break under 1085 would likely mean we are going significantly lower. I am not expecting this kind of selling pressure until after the 28th. It can still appear but the 28th is the logical date for the earnings excitement to begin fading.

SPX Chart

The Nasdaq broke out of a bearish ascending wedge in late December and ran for +120 points in about eight days. It is very over extended but is consolidating at the highs and showing no indications of weakness despite the -28 point decline on Friday. Resistance appears to be 2320 and initial support 2280. With most of the major tech stocks, including IBM, reporting over the next two weeks I would be very surprised to see a continued decline.

The Nasdaq can remain in a sideways consolidation for several more days before breaking the pattern and 2250 should be interim support. I do believe the pattern will be broken on the Nasdaq but I also believe we are not facing a period of continued selling just yet. I think the consolidation will continue as we await the earnings from the major techs. However, if Friday was the beginning of a new correction then no pattern will be relative here.

Nasdaq Chart

Nasdaq 100 Chart

The Russell fell out of its initial uptrend wedge back in October and reformed once support appeared. After consolidating higher in November a new rally began in late December. That rally initially failed at the downtrend resistance from 2008 then once through that resistance it has been using it as support. The downtrend support, uptrend support and horizontal support from October is converging at 623-625 and should provide a strong rebound point from limited selling over the next couple days. If 623 breaks I believe we could test 570 although 600 is also a decent resting place. A break below 570 would be a change in trend but a hold over 600 would retain the bullish bias.

Russell chart

Morgan Stanley Commodity Index

I am pretty sure you understand my outlook by now. I believe Friday's dip was profit taking accelerated by option expiration and the negative comments from Jamie Diamon. I don't think it will last BUT we are overdue for a decent correction. Logically that selling should wait until after the major earnings reports between now and January 28th. After the 28th the path of least resistance may be down. I believe that will be temporary but it depends on the news between now and then.

If the earnings continue to exceed estimates and the Fed does nothing on the 27th then the rally could continue but probably not in a straight line. I think we are entering a period where the bulls will need to be cautious and where we should begin expecting more than a 3-5% dip. This is normal and not a statement on the economy. If the economic news turns bad then it may hasten the decline. If the economic news begins to improve then the decline should be limited to basic profit taking. This is more random musings than a hard prediction but even in a raging bull market we always need to be aware that a correction could appear at any moment. I just believe we are moving closer to that moment every day. I will welcome it as a buying opportunity.

Jim Brown