One third of the earnings cycle is behind us and the markets are dropping into a holding pattern with only a week to go before the FOMC meeting and the elections.

Market Statistics

Maybe I should have titled this commentary "The day volatility died" because the VIX closed at the low for the week. There has only been one day with a lower print since early May. The reason was simple. With the elections, the FOMC meeting and the year-end for mutual funds only a week away most traders have already placed their bets and they are going to watch the fireworks safely from the sidelines for the next week. The G20 meeting this weekend was also a damper on the market with currency discussions on the schedule. The dollar was flat and everyone was holding their breath over the potential for some big currency move. This convergence of events caused the Dow to trade in its narrowest range of the last six months with only a 50 point spread.

The economic calendar was light for Friday with Regional Employment and Mass Layoffs the only reports. The regional payroll report showed that 34 states lost jobs in September. On the positive side 23 states reported a lower unemployment rate. The rate can go down even when the state lost jobs if enough people ran out of employment benefits and fell off the rolls.

This is a lagging report but still notable because of the sharp decline in government employment due to the end of stimulus funding. Even with the declines the report showed a slight improvement in the overall labor picture.

The Mass Layoff report showed the number of layoff events declined for the third consecutive month. They fell from 1,546 in August to 1,486 in September. The number of workers affected fell from 150,192 in August to 133,379 in September. Manufacturing still accounted for more than 25% of the layoffs. The slowing of layoffs suggests the economy is growing but still at a very slow pace. Consumers are still using their income to pay down debt rather than pay for consumer goods. Until that changes the manufacturing sector will continue to lag.

Next week's economic calendar is active with multiple housing reports, Fed surveys and the GDP on Friday. The GDP will be the most important report for the week and our first look at Q3. Estimates have risen slightly over the last month but the whisper numbers are still in the 1.6% range. Grass grows faster than that but at least it remains positive growth.

Economic Calendar

The real news moving the market next week will still be the earnings. So far over one third of the S&P has reported and 79% beat the street estimates. Those that beat on revenue slipped to only 65%. On the surface this would appear to be a strong cycle but as we have seen from the many disasters the trading community is destroying any stock that did not have a blowout quarter. Just beating the street by a couple cents with revenue inline is good for a $3-$4 beating in your stock price.

S&P is showing reported earnings for the quarter with an increase of 26.21% over 2009Q3. Of the 158 S&P companies reported 79.1% beat, 7% reported inline and 13.9% missed estimates. Those that beat estimates posted average gains in earnings of 47.4%. Earnings misses averaged a -33.1% miss.

Earnings Calendar

The elephant hidden in that calendar is Microsoft on Thursday after the close. They are the biggest tech stock to report next week. Also important will be 3M, Texas Instruments, Merck and a ton of chip stocks. Networkers HLIT and FFIV will try to uphold the high bar set by Juniper.

We saw some good results last week that lifted individual stocks but there was also a lot of rough guidance. Very few companies were bragging about how good business would be this quarter. Most said as little as possible in hopes nobody noticed.

Winners included Amazon, Schlumberger, NetFlix, McDonalds, Ebay, T. Rowe Price and Citrix Systems. Chipotle (CMG) was the big winner for the week with a +15% ($26) rally on Friday after posting better than expected earnings. Shorts loaded up on Thursday with a $5 intraday drop and they were crushed on Friday. Earnings jumped +40% to $1.52 per share compared to analyst estimates of $1.31. Same store sales rose 11.4%.

CMG also said they had opened 67 new stores this year and were planning another 140+ stores in 2011. I have eaten at CMG several times this year and I don't see it as anything special but in the Denver area there is a Mexican restaurant on every corner. I am worried they are going to follow Boston Chicken and Krispy Kreme into disaster. Those chains thrived until they could not afford to open any additional new stores and the novelty wore off their brand. Boston Chicken disappeared as a public company in a bankruptcy and closed most of its stores and was renamed Boston Market. Krispy Kreme was a rocket ride to fame at $50 and then a roller coaster back down to trade at $1.01 last year. The company quit opening new stores and was forced to buy back those that were unprofitable once the novelty wore off.

The difference is CMG has a boatload of cash and almost no debt. If burrito sales slow down their earnings will drop but they will remain a going concern. I would not buy the stock over $200 but let them do a 4:1 split and I might dip a chip in their guacamole.

Chipotle Chart

Schlumberger (SLB) proved why it is a better investment than Halliburton when they reported earnings on Friday. Income more than doubled on an increase in drilling activity in North America. Earnings only beat by a penny but revenue was up strongly, nearly a billion dollars over Q2. They said oil and gas drilling onshore in the U.S. was growing rapidly but permits in the Gulf were still a problem. SLB said the seismic business was booming as those in the Gulf were using the down time to get a better picture of their prospects. They said business outside the U.S. was mixed with Asia, Russia, the North Sea, West Africa and South Africa was improving but North Africa and the Gulf of Guinea were soft.

Schlumberger Chart

Halliburton said the demand in North America had given them the ability to adjust pricing higher across all their product lines. There appears to be a serious shortage of hydraulic fracturing equipment and drillers are waiting in line for an appointment to fracture their wells. Comstock Resources has 26 wells in the Haynesville Shale that can't be completed because of the limited availability of pressure pumping services. Halliburton estimates that by the end of 2010 there will be as many as 3,000 wells in North America that have been drilled but not completed. There has been a feeding frenzy by drillers to produce wells to anchor leases. Most leases require drilling within a certain period or the driller forfeits the lease. These wells have been drilled but there are only a limited number of fracking crews to complete the wells.

This will continue to pressure the natural gas drilling community. If they can't complete the wells they can't start the cash flow from the gas. They have spent the money to drill the wells but are getting nothing back from their investment. They are continuing to spend money to drill more wells but the purse strings are tightening. As these wells are completed it will add to overall gas production and push prices even lower.

We will see earnings from Conoco Phillips, Chevron and Exxon Mobil next week.

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On the negative surprise side, furniture maker Leggett & Platt (LEG) posted earnings of 31 cents that missed estimates of 37-cents. The Leggett CEO said "Certain of our key markets, primarily related to residential furnishings, weakened noticeably in the third quarter. As a result sales in Q3 were lower than Q2 and that rarely occurs." They also lowered full year guidance to the lower end of the prior range. LEG shares lost -9% on the news.

The decline in the furniture business in Q3 was directly related to the end of the homebuyer tax credit and the end of the moving cycle for those who took advantage of the credit.

Now that summer is over and the buying season for homes has passed we are seeing some alarming news on pricing. The Clear Capital Home Data Index showed that home prices declined -5.9% over the last two months. The index has a high correlation to the Case-Shiller indexes so the same declines should be shown in Case Shiller over the next two months.

The senior statistician for Clear Capital said home prices are clearly experiencing a dramatic drop from the tax credit induced highs. This decline has wiped out the gains in prices seen from that uptick in sales. This is the same magnitude of drop we saw in March 2009. If this aggressive drop continues through the other indexes we could have a major hit to consumer sentiment over the next month. Hopefully it won't be enough to knock us back into a recession but it won't be pretty.

Bank of America and GMAC plan on restarting foreclosures on Monday. This will dump even more houses into the secondary market during the slow winter sales months. This will guarantee further price declines. There were 102,000 homes foreclosed in September and that was a new record.

Hewlett Packard (HPQ) released its Slate 500 tablet that has an 8.9-inch screen and runs the Windows 7 operating system. HP said the device was targeted at business customers. It can be purchased on the website today and shipments will begin in early November. On the HP website it calls the Slate 500 the "ideal PC for professionals who don't usually work at a traditional desk, yet need to stay productive in a secure, familiar Windows environment." That is obviously a jab at the iPad, which is more like an iPhone on steroids. The tablet comes with Wi-Fi but no cellular capability. It does have a camera front and back to enable video conferencing. The tablet is $799 and will have up to 64GB of storage space. You can expect announcements like this almost weekly for the rest of the year. The tablet war has officially begun.

The FDIC closed seven banks on Friday bringing the total for the year to 139. The largest was $1.6 billion Hillcrest Bank in Overland Park Kansas. The list of all the banks:

Hillcrest Bank, Overland KS
First Bank of Jackonsville FL
Progress Bank of Florida, Tampa
First National Bank of Barnesville GA
Gordon Bank of Gordon GA
First Suburban National, Maywood IL
First Arizona Savings, Scottsdale AZ

The FDIC could not find a buyer for First Arizona and they will shutter the bank and mail checks for the insured deposits on Monday. Florida, Georgia and Illinois have been particularly hard hit by closures this year. Florida has seen 27 banks closed with 16 each for Georgia and Illinois making 42% of all closures in just those three states. Only three banks were closed in 2007, 25 in 2008, 140 in 2009 and 2010 is expected to top 150 with 829 banks currently on the problem bank list.

The G20 meeting is this weekend and that prompted some profit taking in currencies and commodities over the last couple days. China hiked interest rates to avoid having to take the heat about a cheap yuan.

Timothy Geithner became the center of attention based on his comments on Thursday. Geithner said on Thursday that all the major currencies were roughly equal. That brought a storm of criticism but he was just getting started. He circulated a letter to the other finance ministers on Friday telling them to hike the value of their currencies in order to increase the value of their exports on the U.S. market.

The letter was seen as a direct attack on China and warned bluntly of the dangers of seeking "competitive advantage by either weakening their currency or preventing appreciation of undervalued currency." Let's see, just to make sure I understand. The U.S. is on a major quantitative easing program where they create artificial money with the stroke of a pen in order to lower interest rates and devalue the currency. Yet Geithner has the gall to warn other countries about doing the same thing? No wonder his letter created a firestorm of controversy at the meeting.

The Japanese Finance Minister called Geithner "unrealistic" and "difficult." He also warned "strong volatility in currency markets would be harmful to the stability of the global economy and financial system." The BRIC countries were united in their derision of the Geithner letter and said bluntly that the U.S. would not succeed in pressuring other countries to do what the U.S. was not doing itself.

Nothing was expected to result from the G20 meeting but the recent moves in currencies prompted traders to exercise caution and go flat over the weekend. When the meeting closed on Saturday there was "agreement" not to have a currency war. What did you think they would say? They have to be positive and show progress even if it is just a front. The also agreed to accept the Basel III accords when the full G20 meets in November. These rules will force banks to raise their common equity from 2% to 4.5% by 2015 and to 7% by 2019.

One of the closing statements had an interesting tone to it:

South Korean Finance Minister Yoon Jeung-Hyun said the two-day G20 meeting had laid to rest fears of a currency war between "struggling debtors such as the United States" and "exporting powers such as China." Is it my imagination or has the U.S. declined significantly in stature because of our rising debt?

Volatility died on Friday with the VIX closing a two-week low and very close to a five month low. Volume was very low at 5.8 billion shares. The Dow traded in a 50-point range and the S&P a five-point range. That was the smallest range in six months.

The problem is that everything moving the market is already priced into the market. The Fed's potential QE2 program has been telegraphed for the last four weeks with almost daily speeches by some Fed head that referenced the topic. The S&P has gained 50 points since the September 21st FOMC statement and every point over the backs of frustrated bears. As one analyst put it, "We are left begrudging the longs."

The market is convinced the Fed will act at ANY cost to insure economic growth. Analysts believe that $500 billion to $1 trillion of quantitative easing is now priced into the market. Apparently the Fed's goal is to create a wealth effect through higher stock prices. As the dollar devalues stocks go higher and investors will eventually start feeling prosperous again and begin to spend money. It may take many more months but the Fed appears committed to that goal. This is referred to as the Federal Reserve Put. If we know the Fed is not going to let the market go down it is the same as having a put protecting our longs.

I am becoming increasingly worried that the Fed may not be enough in agreement among themselves to follow through on the QE2 program. Several recent Fed speeches have warned that we should not take the Sept-21st statement literally. On the other hand Bernanke has reiterated the concept of further QE in every speech. If by chance the Fed does not follow through in their Nov-3rd statement or offers only a token amount of QE the market may react badly.

Secondly, the market has priced in a Republican sweep on November 2nd. The closer we get to the election the tighter the races are becoming. The election day is now close enough that voters are actually paying attention to the campaign ads and the democrats have a far larger budget than the republicans. By some estimates the DNC and its offshoots have some $250 million to spread around in the last week of the campaign while the republicans are closer to $100 million. With some of the hotly contested races attracting a blizzard of ads for the incumbents the odds of republicans winning some of those seats are shrinking.

How this factors into the market on November 3rd is unknown. The groundswell of republican support is shrinking but they are still expected to control the House. Will that be enough for businesses to breath easier on hopes further government taxes and regulation will be postponed for at least two years? We simply won't know until after the smoke clears but a republican sweep is currently priced into the market.

We know from the Job Openings Labor Turnover Survey (JOLTS) that the number of available jobs is growing. Employers are just not hiring yet. They have created the positions and accepted resumes but are holding off on the hiring decision. Some analysts have said they believe employers are waiting on the outcome of the election. If the outcome appears to be more taxes and regulation employers will retreat back into their protective shell. If the opposite result is seen employers could begin hiring immediately.

Did you know that the public employees union, the American Federation of State, County and Municipal Employees (AFSCME), a 1.6 million member public sector union, has become the biggest spender in the election? AFSCME has contributed $87.5 million to support democratic candidates in the upcoming election.

The market next week could be boring. It will be the last chance for funds to dress up portfolios before their Friday year-end. This is their last chance to take profits or sell losers. In theory they should have already made their year-end moves but you never know.

This entire rally has occurred while money was flowing out of stock mutual funds. That continued last week with money still moving from stocks into bonds and into emerging market funds. Retail investors have zero confidence in the rally and the market. If this trend ever changes and retail investors begin to come back to stocks it could be explosive. This would probably require an uptick in nonfarm payrolls to trigger the reversal of money flow.

Keene has been pulling his hair out trying to understand why the technicals no longer matter. He is only one of millions. Almost the entire analyst community is still in denial over the continued rally. It all boils down to the Fed wanting to create inflation and flooding the economy with cash. That overcomes technical patterns as wave after wave of cash finds a home in stocks. Bernanke wants to make it so painful to be in money markets and bond funds that people will eventually put the money to work. Don't fight the Fed.

This will also be the busiest week for Q3 earnings with Tuesday and Thursday the heaviest days. This should provide plenty of activity for the talking heads on stock TV to discuss. In reality we already know how the cycle will end but we still need to go through the motions.

The S&P climbed a whopping +7 points for the week. That is not exactly a scorching performance but it was another week of gains and another new high over that resistance at 1175. There is resistance at 1195 and again at 1210 and 1228.

I am worried that we will push through to something in the 1225 range over the next two weeks and then hit a sell the news event after the FOMC meeting on Nov-3rd. That would produce a very convincing double top anchored well back in the March 2009 lows. It may take a very strong QE program announcement to keep this from happening because all the news is already old news.

S&P-500 Chart - Daily

S&P-500 Chart - Weekly

The Dow has the same double top potential but in the case of the Dow the strong resistance at 11,200 has already been met. If we move higher to touch that again next week and can't break through then I would be even more worried of a sell the news event the following week that could begin a double top.

If we were to break through 11,200 and hold the gains it would be very bullish. Before I forget it, "don't fight the Fed" definitely applies here. The Fed's goal is to push the markets out to new highs so writing about the technicals and potentially bearish setups is probably a waste of keystrokes.

Dow Chart - Weekly

The Nasdaq chart is extremely ominous with the eight-week vertical spike approaching the Fib resistance at 2520. Like the other indexes this could easily result in a major double top. Even more so on the Nasdaq because many high profile tech stocks have made moves reminiscent of the tech bubble moves in 2000.

For instance Amazon has rallied $65 since July. That is a 50% move. NetFlix is up +$70 for a 70% move. There are others but you get the idea. There are enormous amounts of profit to be captured and you have to sell them to actually bank the profit. We could easily see a sell the news event after the mutual fund year-end on Oct-29th.

That does not mean we won't finish the year higher. If the Fed follows through on its hints we could see the markets a lot higher over the next few months but nothing goes up in a straight line even in raging bull markets.

Obviously a move over 2520 could negate my worries temporarily and would produce some serious short covering.

Nasdaq chart - weekly

The Russell posted no gain last week. There was a complete lack of direction although there were two decent rebounds from support at 690. I believe the Russell has emerged once again as a clear indicator of fund manager sentiment. On the Russell the rally stalled ten days ago at 710 and that has remained solid resistance. If we see a move over that level it would be a bullish signal and it could be explosive. The next major resistance is 740. Likewise a breakdown under 690 would be strongly negative.

Russell Chart -30 Min

Russell Chart - Weekly

The NYSE Composite Index covers more than 2000 NYSE stocks from the giants like XOM to the very small stocks just off the pink sheets. This is a broad market index and it is just a good day away from strong resistance at 7700. To complicate matters the 200-week moving average is converging with that 7700 level. This suggests moving over that resistance could be difficult. The probable scenario is a stall under 7700 until the market picks a direction after Nov-3rd.

NYSE Chart - Weekly

The Dow Transports have been remarkably strong with the price of oil over $80. However, the transports are also showing a possible double top formation if resistance at 4800 remains firm. Transports normally move ahead of the broader markets when investors believe there is a stronger economy ahead.

Dow Transports Chart - Daily

In summary I think the market will be in a holding pattern until November third. All the potentially good news is already priced in. We had the buy the rumor rally and now we are waiting on the sell the news event. I don't see how any news we might get from the elections or the Fed will be so much better that the markets explode higher. The Fed put allows money managers to buy stocks in confidence the market will not go lower but that put will eventually expire.

The Fed has been spiking the punch for two years and now they are telling us they are going to skip the punch and start passing out shots of vodka instead. Like teenagers at a keg party we don't know when to stop drinking and walk away. Why do you think casinos offer free drinks to gamblers? So the alcohol will cloud gamblers judgment and keep them investing in the tables until they are broke.

Eventually we are going to have a terrible hangover when the Fed runs out of booze and the party breaks up but a QE2 announcement on Nov-3rd will insure another year in party mode. If the announcement on the third delays QE2 for any reason, November could be ugly. I believe the Fed understands this and they will do whatever is necessary to create investor wealth and improve consumer sentiment. They have to do this or the U.S. could fall into a long-term depression like Japan's lost decade. For that reason I am still in buy the dip mode until proven wrong. Don't fight the Fed.

Jim Brown

Work spares us from three evils: boredom, vice, and need. - Voltaire