Intel warned on sales for Q3 and Bernanke failed to name any material change in policy but the market rallied contrary to analyst expectations.

Market Statistics

Navigating the market when actions and reactions are mismatched is always a challenge. Bernanke's speech on Friday was heralded as a make or break moment for the Fed if he did not announce some new plan. Analysts warned that a failure to disclose new plans would likely tank the market. So much for headline analysts knowing what they are talking about. Add in a revenue warning by Intel and the stock being halted and you would have expected another leg down for the market. Nope, didn't happen.

Friday did not follow anyone's expectations unless you were expecting short covering ahead of the weekend. Shorts were loaded up on expectations Bernanke would disappoint and when that did not happen on the scale they expected they were forced to cover rather than hold over the risky weekend.

Another data point that held considerable risk for the market was the GDP revision for Q2. Expectations had been for a revision down to 1.2% growth from the last update at 2.4% growth. Those expectations failed to appear although it was revised lower. The headline number dropped to +1.6% helped by a strong revision to corporate profits by +$73 billion. The majority of the decline was attributed to an upward revision to imports although some of the impact of the imports was offset by a rise in consumer spending.

According to the GDP the U.S. economic growth is continuing but at a drunken stagger rather than a sprint. The GDP is also a seriously lagging report with the period covered ending two months ago. Weak growth in Europe is weighing on the U.S. in the form of lower exports and that should get worse. Job growth remains a serious problem according to Bernanke and that will be a drag on GDP the rest of 2010.

Chart of Q2 GDP

The Final revision to the August Consumer Sentiment declined slightly to 68.9 from the first august release at 69.6. This was certainly not a major event but I would be very afraid of the next release on September 17th. The economic conditions have declined significantly in the last two weeks with the higher jobless claims and next Friday we are probably going to see another loss of jobs in the non-farm payroll report. We could see a material decline in sentiment on the 17th.

The factors impacting sentiment the most are jobs, stock market, gasoline prices and home prices. Of those factors only the price of gasoline is moving in the right direction. Weak consumer sentiment increases the risk to the economy due to weaker consumer spending.

Sentiment Chart

Next week is loaded with critical economic events. The highlights are the FOMC minutes for the August meeting, the national ISM and the Non-Farm Payrolls. The FOMC minutes will give analysts more insight into the squabbling that went on behind the scenes at the August meeting and a better idea what the Fed is actually expecting from the economy. The ISM is expected to decline in line with the regional reports but remain in expansion territory over 50.

The Non-Farm Payroll report is expected to show a loss of -100,000 jobs but it is unknown what impact if any will be seen from lingering census terminations. The headline forecast is for permanent job losses and does not include any census workers. Last month the economy lost -131,000 jobs but that included a loss of -202,000 government/census jobs and a gain of 71,000 private sector jobs. It is actually possible that we see a headline job gain if the census exodus is over. However, whisper numbers range from a loss of -50,000 to a loss of -200,000 jobs. A job gain would be a very unexpected surprise.

Jobless Claims has been a problem over the last four weeks with the prior week's number revised higher to 504,000 and last week's rate at 473,000. For the last four weeks the average has been solidly over 485,000 per week and that suggests the Non-Farm Payrolls are going to be negative.

Economic Calendar

All eyes were on Bernanke when he gave his 17-page speech Friday morning in Jackson Hole. While it is not normally a policy speech he did spell out some points that pleased the market. Essentially he took on the job as cheerleader of the economy at a time that most would find little to cheer about. Bernanke attempted to boost public confidence that the recovery still has enough staying power to survive until hiring and spending pick up in 2011.

He avoided indications the Fed was about to jump back into stimulus mode and in doing so he kept from fanning fears that the recovery is more fragile than it really is. Bernanke noted the recovery had lost some momentum but echoed the new Fed party line that growth is on track for a 2011 recovery. I said new party line because several Fed heads have stressed that point in recent speeches. The rebound point is no longer late 2010 but has moved into 2011.

Bernanke did make numerous points that were chosen to remind the market the Fed was ready, willing and able to provide additional stimulus if necessary. He said the Fed would continue to evaluate additional monetary easing and act accordingly. The issue is whether the benefits outweigh the costs. He reminded listeners the FOMC will strongly resist deflation.

He gave three solutions but stressed the Fed had plenty more at its disposal. The Fed can make additional purchases of long-term securities. They are expecting to buy $400 billion in 2011 as prior debt purchases are redeemed. By making these purchases they avoid a "passive tightening." Second the Fed can modify its communications. This means changing the "extended period" language to something less vague like "until unemployment returns to 8%." That is just an example not something Bernanke said.

A third option would be reducing interest paid to banks on reserves on deposit with the Fed. This has been discussed at length recently as a potential method for forcing banks to lend. If the Fed quit paying interest on the billions on deposit it would force the banks to withdraw those deposits and put the money to work elsewhere. Personally I think the banks would just buy short-term treasuries and continue to hold the cash in fear of a second dip.

Bernanke continued to stress that deflation was a "low risk" and inflation would remain subdued for sometime and was reasonably well anchored. That is Fedspeak for there is no inflation and we don't expect any. He calmed those worried about the U.S. by pledging to do whatever's necessary to resurrect the economy should "unexpected developments" stifle the recovery.

Overall the Bernanke speech offered something for everyone without offering any hard specifics that would roil any particular segment of the market. The stock market dropped sharply when the text was released but the dip was immediately bought even before the text could be analyzed. The initial drop was obviously a sell program timed to take advantage of any Bernanke induced sell off. The initial rebound was obviously a buy program scheduled to take advantage of cheaper prices from any sell off. The battling programs offset each other and left the Dow with about a +30 point gain.

After the speech concluded and the broadcasters had time to disseminate the text another buy program hit at 11:AM that powered the Dow to 10,100 and set the stage for the end of day short covering.

St Louis Fed President James Bullard seems to be toeing the party line and now believes there will be reasonable growth in the second half and the economy will pickup in 2011. He broke with tradition and appeared on CNBC several weeks ago for a two-hour stint and expressed various points of disagreement with the rest of the FOMC. He was pounding the table on the possibility of deflation.

In Friday's interview he was a changed person. Now he believes the economy is on track although growing slower than initially expected and it will pick up sharply in 2011. He believes the Fed has plenty of options to stimulate growth and expressed no difference of opinion with the rest of the FOMC. When questioned about deflation he said the economy still could be at "some risk" of declining prices although it is not yet a dire situation. This is a marked change over the last couple weeks and makes you wonder if he got his hand slapped by Bernanke and his peers on the FOMC for his prior comments.

The market rebound was even more unusual after Intel warned at exactly 10:AM that revenue would be less than previously expected. I though it was interesting that Intel chose to release their warning at exactly 10:AM and exactly the same time Bernanke's speech began and the text released. They were obviously hoping to capitalize on the confusion surrounding the speech in hopes of preventing a sharp decline in Intel's stock price. The ploy worked because Intel dipped to $17.81 on the news then rallied to close positive at $18.38.

Intel warned that revenue could come in as much as $1 billion below its prior guidance because of weaker than expected demand for personal computers. Their new guidance calls for revenue between $10.8B to $11.2B compared to its prior high range of up to $12B. Analysts were expecting $11.5 billion. Intel also said gross margins were going to be as much as 2% below prior estimates. With its warning Intel joined a long list of companies that have already warned on Q3.

Dell and Hewlett Packard warned last week that the back to school shopping season had been a little weaker than expected. HPQ said there was weakness in the laptop market and BTS shopping started later than normal. Several chip companies have warned that manufacturers have been canceling or delaying orders because of weak demand.

Long time chip/tech sector analyst Dan Niles said he was shorting anything with chips and he expected a continued slowdown in the economy and the tech sector. He said you could buy Apple and HPQ but only if you have enough chip shorts to offset short-term fluctuations in those longs. Dan said he expected a double dip over the next two quarters but he defined a double dip as a GDP of less than 1% growth. That seems to be a pretty safe bet with the second revision of the Q2 GDP already revised down to +1.6%. Q3 could easily be less than 1% growth.

Research in Motion (RIMM) lost ground despite the rally because of the continuing problems with India. The country in on track to shut down all the Blackberry devices in India if they can't reach an agreement on accessing the messages. Like the problem with Saudi Arabia a couple weeks ago India wants to be able to read the private emails for "security" purposes. RIMM has proposed several options but they have not reach an agreement with India as of Friday. RIMM has proposed a forum for law enforcement where selective message availability would be allowed. RIMM claims blocking the Blackberry network for all of India would be detrimental for Indian businesses and counter productive to the efficiency of local firms. There are more than one million Blackberry users in India.

RIMM Chart

Boeing (BA) stunned investors again when it announced on Friday it was delaying the delivery date on the 787 Dreamliner again until the middle of Q1-2011. The postponement was due to a delay in the availability of the Rolls-Royce Trent-1000 engine needed for the final phases of flight-testing the carbon-composite aircraft. Boeing uses both the Rolls Royce engines and GE engines in its test aircraft. This is the sixth delay Boeing has announced for the Dreamliner. The Dreamliner is 50% carbon composite and 15% titanium. Boeing has received orders for 850 planes, which can carry up to 330 people with nine abreast seating. Rolls Royce had an accident at its test site in Derby England on August 2nd when an engine blew up. This forced Rolls Royce to shut down the facility for repairs. That explosion suggests there will be some modifications to future engines including those already in use in the Dreamliner test program. Despite the news Boeing recovered from the initial dip to close up +1.84 for the day.

Norfolk Southern (NSC) completed its sale of $250 million in century bonds. These are 100-year bonds that will be due in 2105. Yes, year 2105. If you buy these bonds don't plan on being around to collect. These were added to an indenture dated March 2005. These are 6% senior notes paid semiannually. Demand was so strong that they bumped the offering from its planned $100 million to the $250 million total. NSC joins other companies like DIS, IBM, BNI, FDX, F and MOT in selling century bonds. For companies looking to lock in long term financing at historic low interest rates this is a deal. For institutions like insurance companies looking for long-term income this is a better rate than they can get on the open market. However, analysts warn that companies crowding into bonds today at these low rates are flirting with disaster.

Bond funds have seen cash inflows of $480.2 billion over the last 24 months. That is equivalent to nearly the amount of money spent by equity investors in the bubble. Treasury yields have not been this low since 1955. Bill Gross of Pimco warned investors last week that bonds have seen their best days and stocks look better now. This is especially true when almost every dividend paying S&P-500 stock is yielding more now than the 10-year treasury. More and more analysts are ringing the bell on the bond bubble and calling for an exit but every new offering either corporate or government is very over subscribed.

Fannie Mae reported on Friday that their 90-day delinquencies fell to 4.99% from 5.15% in the prior month. That was the fourth month that delinquencies declined. Hopefully that means we are over the hump but I am not holding my breath. We really won't know until March of 2011 and the start of the next buying season.

Natural gas futures expired on Friday at a contract low of $3.65. There is an excess of gas in storage and there have been no major storms in the gulf to shut down production. The excess shale gas production is depressing prices because producers can't afford to quit producing. Chesapeake shut down some production earlier in the summer in hopes of boosting prices but they could not hold out long enough to make it worthwhile.

Gas producers have leveraged themselves to the max in order to buy up increasingly large amounts of acreage. They have borrowed increasingly larger amounts of money to fund their drilling and fracturing. As long as they are punching holes at a faster rate the cash flow even at a smaller dollar per Mcf continues to flow. Because depletion of a shale well can be as much as 75% the first year they have to keep drilling to keep generating the high initial flows and generating cash to pay the bills. It is the perfect example of a hamster wheel. As long as they keep drilling the cash keeps flowing but the increased flows produce lower gas prices. This story is not going to end well. If Pennsylvania and/or New York outlaw fracturing the entire sector is going to implode when the cash flow machine stops. Meanwhile short-term gas supplies continue to increase while prices continue to fall.

Natural Gas Chart

Crude prices profited from a monster short squeeze after three weeks of declines totaling -$13. The price of crude spiked higher on two days of declines in the dollar and Friday's gains were accentuated by some serious short covering. The energy sector in general was setup for a continued decline on weak economics and was heavily shorted. Friday's rally after Bernanke and Intel sent shorts running for the safety of cash ahead of the weekend.

Crude Oil Chart

The number of Americans expected to travel during the Labor Day weekend this year will rise 9.9 percent from 2009 as some aspects of the U.S. economy show signs of improvement, travel and auto group AAA said Wednesday. Close to 34.4 million travelers will venture at least 50 miles away from home, compared with 31.3 million last year when the recession curbed holiday plans, AAA forecast. About 10.3 percent more Americans will go by car this holiday weekend, while the number traveling by air will rise by 4.6 percent.

Microsoft billionaire Paul Allen filed suit on Friday against Ebay, Yahoo, Netflix, AOL, Office Depot, Office Max, Staples, Google, Apple and Facebook and YouTube. The suit claims that Allen's Interval Research firm developed patents over Internet usage technology back in the early 1990s. Allen's suit claims the patents being violated are key to how e-commerce and search companies work. The patents described in the suit refer to technology used for such things as web browsing and sending alerts (popups) over the web. One concerns things like recommending products based on the products you previously viewed. You have seen the ads, "other shoppers bought these items as well." Two companies missing from the suit were Microsoft and Amazon. Since Amazon uses every advertising method known to man you wonder why they were not in the suit. A Google spokesman said, "This is an unfortunate trend of people trying to compete in the courtroom instead of the marketplace."

We are nearing the point in the cycle where the election will be a major factor in market sentiment and movement. Historically in a mid-term election cycle the market as reflected in the S&P declines 1% in the first ten months of the year. In the two months after the election the average gain is +4%. With hedge funds either negative or flat for the year and most heavily invested in cash there is a date between now and November 2nd that they will begin to buy in anticipation of the post election rally. Howard Present, founder of F-Squared Investments, said on Friday they are trying to build a 50% cash position going into September and they were not alone in the industry.

It does not seem to make a difference in the long term which party wins the election other than the results are better when the House and Senate are controlled by opposite parties. That recipe for gridlock is favorable to the markets and we have a good chance of that happening in 2010. That suggests the closer we get to November and the more that looks like a reality the more interest there will be in buying stocks.

Remember, part of the election cycle is the negative sentiment produced by the campaigns. The challengers will talk endlessly about how bad the economy is and why you should throw the bums out. The defenders will talk about how bad it is and blame it on the challenger's party in an attempt to poison sentiment towards the challengers. This is not a political statement, just a normal campaign process. The bottom line is a constant stream of negative campaign ads that will push sentiment lower. Eventually investors will swim to the top of the muck and see what they hope is light after November 2nd and start voting with their money and buy stocks as we get closer to the election.

The current economic conditions may not have changed on Friday and conditions appear to be declining but the Bernanke speech pacified some investors. Fears of an economy spiraling out of control may have eased with the feel good words of Bernanke saying we will do whatever is necessary to prevent a double dip or a deflationary period. The speech may have calmed the waters even though it was short on specifics and long on generalities.

Despite the calming influence there are still some critical economic events next week. Those short-term mile markers can resurrect the fear and dread if they come in sufficiently negative. While I would like to think that last weeks bounce off support was the end of the bearishness, I am far from convinced. In every bear market there are multiple rebounds from oversold conditions and Friday's buy program triggered short covering was one of those events. I doubt the bulls are ready to charge back into the market. There are significant headwinds for the economy despite the best hopes of the Fed. We will hear about some of those headwinds when the FOMC minutes are released on Tuesday.

One of the headwinds is the drop in stimulus spending. The amount of money being spent from the stimulus funds is drying up faster than ice cubes on Texas concrete in August. More than 80% of the funds have already been spent, canceled or postponed. I wrote last week that move then 40 states are suffering budget shortfalls that will mean further layoffs and service cuts. The rising jobless claims are an indication that stimulus projects are winding down. In theory the economy was supposed to have rebounded into self-sufficiency mode by now and would no longer need the stimulus money. Those "shovel ready" projects have ended but state and local governments have no money to keep those workers on new projects.

The corporate world is still in hunker down mode with the exception of the recent round of M&A activity. They are flush with cash and ready to rush into the next wave of expansion but that won't happen until there is a solid recovery. They were burned too badly in 2008 to over extend themselves again.

This leaves the market in the same shape as the corporations. Investors and funds are piling up cash for the next buying cycle but that buying is dependent on signs the economy is improving not declining. The post election rally should begin before the election but the start of that buying is also dependent in some part on the state of the economy. If it continues to appear that we are sliding into another hole then investors may wait until the polls close before taking a chance.

Art Cashin had an interesting view of the markets on Friday. He suggested the markets were being manipulated by the Dow 10,000 hat vendor at the NYSE. The Dow has crossed the 10K mark on 23 trading days so far in 2010.

With the big cap tech companies warning on falling computer sales it does not look good for the Nasdaq. The Semiconductor Index may have rebounded from a seven month low into positive territory after the Intel warning but it was short covering not a sudden rush to own chip stocks. The SOX is poised to retest that low at 310 and probably the 52-week low at 290 before the election rally begins. As the chips go so goes the Nasdaq.

Semiconductor Index Chart

The Nasdaq rallied back to strong resistance at 2150 and stalled there into the close. Ordinarily this rebound would have been bullish after two tests of initial support at 2100. The jury is still out until we see if there is any follow through to the short squeeze next week. Both dips were instantly followed with buy programs so at least one institution was bargain hunting. After Intel's warning it will be interesting to see if they are still interested in buying again next week.

Intel's warning was not an end of the world as we know it warning. For Intel to downgrade revenue by $500M to $1B when they are doing $11B per quarter is a haircut not brain surgery. When Intel upped their guidance with earnings there were quite a few analysts that scratched their heads and wondered what Intel was seeing that prompted them to raise guidance. With their warning on Friday they simply walked the numbers back down to where analysts expected them to be before the upgrade. They will still make a lot of money and the sales are still decent.

If traders take that into account then maybe chip stocks won't continue their downward slide next week. However, with Dan Niles saying, "short anything with chips" there is always a worry somebody might listen to him.

I think the key to the Nasdaq is resistance at 2160. If the tech index moves over 2160 we could see another run to 2200 but I believe it will only be a trade and not the beginning of a new bull market. Support is 2100 followed by 2060.

Nasdaq Chart - 30 Min

Nasdaq Chart - Daily

The S&P dipped to support at 1040 twice last week with a decent rebound both times. However, resistance at 1060 was a challenge until the buy program on Friday pushed the index over that level and triggered some afternoon short covering. Even though it closed over 1060 it is not out of the woods with the 1064 level acting to slow the advance at the close.

If the S&P does move higher the 1080 level should be a serious challenge. That is just far enough to remove the rest of the oversold indications and make the bulls start wondering about bailing with some profits. If the gloom and doom returns the next support below 1040 is the 38% Fib retracement at 1014 and the July lows. I think the S&P is in the neutral zone and could wander in either direction for 20 points without forcing traders to make a new trade decision. This would be a good range to wait out the payroll report next Friday.

S&P-500 Chart - 30 min

S&P-500 Chart - Daily

The Dow rallied past initial resistance at 10100 and not by a token amount like the S&P. This was a decent close 52 points over resistance. Of course it was mostly short covering of the index ETFs like the DIA, which had 25% more volume than on Thursday. Ten of the Dow 30 stocks gained over a buck with IBM, CAT and BA the leaders at nearly $2 each.

There was nothing really specific to the individual stocks but a solely a reaction to the short covering and the calming words of the Fed. Once economic reports begin popping next week we are likely to see some worry creep back into the index.

If the Dow can continue to find traction the next material resistance is 10300. The 300-point range between 10000-10300 could be a perfect range ahead of the payroll report next Friday. That does not require a major resistance breakout or a support breakdown. The Dow can wander without worry about levels as long as it stays within that 300-point range.

Dow Chart - 30 min

Dow Chart - Daily

In summary the markets rallied on Friday on short covering triggered by some buy programs and on fears of holding shorts over the weekend. How much enthusiasm will carry over into next week with a calendar full of critical economic reports is unknown. There are so many economic landmines that bulls wanting to climb the wall of worry will have to watch their steps very carefully.

The bigger question is whether the markets rally into the jobs report on expectations for a better report or sell off in advance on worries there will be more jobs lost than expected. The FOMC minutes, ISM, Challenger Report, Monster Employment and Jobless Claims will all have employment components that will telegraph numbers for the Friday Non-Farm Payrolls. Every interim report will be a landmine for the bulls to step over on their way to Friday. I am leaning towards a bad news bulls type of week where the indexes creep upward in hopes of better news. After all there is a ton of bad news already priced into the market.

Jim Brown