With Ireland now old news the world turned its attention to Portugal as EU finance ministers pressured the country to ask for a bailout in order to head off an even bigger contagion problem with Spain.

Market Statistics

The markets shook off the short squeeze rally from Wednesday and the Dow dropped -95 points as worries increased over the falling dominos in the Eurozone. Greece, Ireland and now Portugal have fallen prey to speculators. Next up would be Spain and the largest economy to be targeted. Eurozone finance ministers are pressuring Portugal to apply for a bailout quickly in order to prevent the damage to the financial markets that would come from a protracted delay. They also believe a quick deal could breakup the wolf pack of speculators once Portugal is no longer vulnerable.

Spain is seen to be at risk from a Portuguese default so shoring up Portugal would relieve pressure on Spain. Spain's banks have more than 100 billion euros at risk to Portugal's debt. Publicly traded banks in Spain have lost as much as 20% of their value in the last month on worries over Portugal. However, even if a bailout worked on a temporary basis there are rumors starting to surface about increasing the one trillion euro aid package that the ECB and IMF and healthy EU countries put in place when Greece was about to fail. Existing bailouts are expected to increase in size and the next countries to need help are growing progressively larger.

If Portugal quickly accepts aid, which has been projected to be in the 50 billion euro range, we could see a pause in the debt parade. It would take speculators a little more time to build a decent case against Spain and they might lose interest if the EU appears to be united about supporting any country. However, Portugal is a long way from accepting a bailout and the attached economic strings. On Friday Portugal's parliament passed a hotly contested austerity budget that contained tough spending cuts in an effort to avoid even harsher cuts mandated by a forced bailout.

Portugal's Prime Minister, Jose Socrates, said the budget's passage, which concluded many months of political bickering that at one point threatened the government's survival, removed Portugal from the crosshairs of the euro zone crisis. "I have good expectations that approval of the budget will reinforce confidence in the markets." Spreads on Portugal's debt did narrow after the budget's passage. Portugal does not have the same banking crisis as Ireland. Portugal's banks are still sound. The crisis in Portugal was in the size of the deficit and an economy about to fall back into recession. More than 50% of Portugal's GDP comes from the public sector, which means the private sector is bearing a heavy load. The crisis was not a severe problem until speculators began focusing on the debt and pushing it to levels where Portugal could not pay or continue to sell debt to finance the country. The interest rates on their debt have ballooned to over 9% for Portugal and 10% for Spain.

The real problem in the EU is not Ireland, Portugal or Spain but the credibility of the Eurozone and the Euro. As the euro plunges with every new country crisis it produces worries of a Eurozone breakup and a devaluation of the euro itself. The euro concept was sold as a strong currency backed by rigid financial rules and investors have now found out that all the rules were violated and the zone is fragmented. Greece is taking money from the ECB and IMF but they are still expected to default in Q2 and potentially withdraw from the union. By forcing the other weaker countries to accept bailouts it also forces them to live up to a new set of more stringent economic rules. If further bailouts are halted by quick action on Portugal then the union will eventually regain its financial strength even if Greece decides to secede from the union. The ECB and IMF will have stopped the deficit bleeding and put the patient on the road to recovery. If it requires amputating an appendage called Greece then that will be considered preventive medicine.

I have one question. Which EU country is going to be their Lehman Brothers? Which country failure will be the one that collapses the EU house of cards?

The worry over Portugal caused the U.S. futures to sell off overnight on Thursday and the cash markets to open sharply lower. They recovered somewhat intraday but fear of darkness brought the sellers back at the close. I would not read too much into this because volume was the lowest I have seen in years. Volume across all exchanges was only 2.7 billion shares and that was significantly lower than the 4.5 billion shares on Black Friday 2009. It was only 400 million shares above the 2.3 billion share volume for Christmas eve 2009. There was no confirmation of selling conviction on Friday but just a few stop losses getting hit by the news from Portugal.

There were no economic reports on Friday due to the holiday. Next week there is a large list of reports and some of them are critical. The regional ISM reports on Tuesday preview the national version on Wednesday. The official consensus estimates for the national ISM is for a decline to 56.2 from 56.9. I am betting we see an upside surprise instead and that would be bullish for the markets.

The Fed Beige Book also on Wednesday could be another volatility event. The FOMC appears to be in turmoil over the need for the current QE program and a positive uptick in sentiment from the Beige Book survey would increase that internal strife. Conversely if the Beige Book shows a decline in conditions Mr. Bernanke would be vindicated for his position. After a few days off for the holiday the Fed will be back in action on Monday with two different QE purchase programs. I expect them to ratchet up purchases this week in an attempt to bring rates back down and take some of the steam off the dollar rebound.

The biggest report for the week is the Non-Farm Payrolls on Friday. The official consensus is for a gain of 133,000 jobs but I am betting on an upside surprise there as well to as much as 175,000 new jobs. Last month saw a 151,000 gain in jobs. The ISM Non-Manufacturing report closes out the very busy week later Friday morning.

Economic Calendar

Stock news was pretty scarce on Friday's abbreviated trading day. There were the obligatory reports from the crowded malls where shoppers were fighting for the last "Elmo Knows Your Name Doll" and standing in long lines to be one of the first 100 shoppers and gain special discounts. By all accounts this weekend is expected to be significantly better than the same weekend in 2009. Unfortunately shares of most retailers were down in what could be a sell the news event. It is hard to tell since the market was tanking as well. Most believe the good retail news is already priced in but with four weeks to go in the shopping season I am not convinced. I believe we could still see some upside for retailers when the weekend tally is reported next week.

Del Monte Foods confirmed it was in a deal to be acquired by a group led by KKR for $4 billion. This will be the largest leveraged buyout since the collapse of Lehman Brothers. Back in 2009 the private equity guys were still gun shy and financing was hard to get. The deal was rumored the prior Friday and the stock shot up so there was only a minor gain when it was finally announced. Pre rumor DLM was trading at $14.51 and it closed on Friday at $18.83.

Rio Tinto (RIO) held an analyst meeting on Friday and announced plans to increase capex spending from $4 billion to around $11 billion in 2011. This giant increase in spending is an attempt to boost iron ore production by more than 50% over the next five years. Prices for iron ore have more than doubled from $60 a ton last year to $133 per ton today. Producers like RIO have switched from annual contracts to quarterly contracts in order to capture the higher spot prices and not get locked into a low delivery price for a long term. Rio said is was also investing more than $2 billion to grow existing copper production. They warned that worsening grades of copper ore would cause total production to decline -18% to 661,000 tons in 2010 and 2011 but it would rebound in 2012 and increase sharply in 2013-2014. RIO shares declined slightly on the downward revision on copper production. This could be a buying opportunity since lower production will mean higher prices for copper.

RIO Chart

Aflac (AFL) dropped nearly -5% on news their duck had died. Actually I am just kidding about the duck but I could find no reason for the sudden decline in the shares. A couple of writers blamed the drop on the news from Portugal but I don't see where the two are related. Insurers in general are weak but the drop in AFL was out of character with the rest of the group.

Aflac Chart

The U.S. dollar was still a safe haven play on Friday as it surged to new two-month highs. The problems in Europe is depressing the euro and investors are fleeing to the short-term safety of the dollar. This depressed commodities and was partly responsible for the decline in equities. The positive economics of the past week also helped push the dollar higher. This rally is only temporary because the QE2 chickens will eventually come home to roost.

Dollar Index Chart

FDIC Chairman Sheila Bair had an op-ed piece in the Washington Post on Friday that warned "urgent action" was needed to lower government debt and forestall the next financial crisis. Bair said the sharp increase in Federal debt, now nearing $14 trillion, "directly threatens our financial stability." She also blamed the "relentless federal borrowing" on the "unwillingness over many years to make the hard choices necessary to rein in the long-term structural deficit." She warned that U.S. Treasuries could be in danger of losing their status as a safe-haven investment in troubled times with "dire implications" for the financial system as a whole. If overseas investors eventually tire of buying our debt it could send the country into an economic death spiral since we depend on their insatiable appetite for our debt to pay our bills.

We are essentially paying our bills with our government credit card and pretty soon we are going to reach that card's limit. She said, "most of the needed changes will be unpopular, and they are likely to affect every interest group in some way." What she said is very true. We are always only one debt auction away from disaster. If the world tires of the debt stories in Europe they could just as easily decide there is no way for us to pay down that $14 trillion since we are adding to it by about $1 trillion per year. We have seen how quickly the vultures begin circling the smaller economies once some imaginary threshold is reached. How much more will they circle our obese debt in expectations of a feast once they decide enough is enough?

The only difference between Greece, Ireland, Portugal and the U.S. is we can still borrow money in the open market at a reasonable rate. That will change within the next two years according to many analysts.

North Korea warned that the U.S. and South Korea were risking war if they went ahead with their joint naval exercises beginning on Sunday. The exercises are scheduled to last four days and includes the U.S.S. George Washington carrier battle group. The exercises were planned long before the attack on the South Korean island last week. President Obama is likely to speak with China's president this weekend in an effort to have him reign in the North Korean leader's wild warnings. China wants to keep North Korea between its country and the democratic South Korea.

If north and south were joined under one democratic government supported by the U.S. it would cause China problems. Instead of Koreans trying to escape North Korea into China it would be Chinese trying to escape into a free Korea. South Korean citizens and many in the military are growing tired of the North's constant attacks without any retaliation by the South. Protests calling the government weak and lazy are being held in the South in the wake of last week's attack.

With the military exercises scheduled to begin on Sunday I would be surprised if the North takes any action. With the U.S. assisting the South any attack by the North could lead to some serious retaliation. However, attacking an irrational egotistical madman even if retaliation is justified could prompt dire results for South Korea. It is best for everyone that they give North Korea a wide berth.

The markets recoiled from the news about Portugal and the Dow lost 95 points. I warned you on Tuesday the Portugal story was coming soon. You would think the markets would have reacted better to the news since the EU story progression was so predictable. Maybe in reality Friday's -95 point decline was a minor drop compared to what it would have been several weeks ago. After all we only retraced just over half of Wednesday's point swing and ended right in the middle of our recent range.

When you compare the Russell and the Semiconductor Index the moves there were miniscule compared to the Dow. That is what you like to see in market sentiment. Bullish small cap strength is a positive sentiment indicator for the market as a whole. Having the chips stocks holding their gains and on the verge of a breakout is another plus. That makes the S&P more of a confirmation of the trend when it follows the small caps.

The range on the S&P has been 1175-1200 for nearly two weeks. Every time the shorts get squeezed to take us back to 1200 there is a news story overnight to knock us back down. Considering the frequency and severity of the stories I am surprised we have not plunged through support. I believe we still have the perfect setup for trade signals. Buying a breakout over 1200 or shorting a breakdown under 1175 makes perfect sense. For those a little more reactive you can also trade inside the trend by selling resistance and buying support.

S&P-500 Chart

The Dow has gapped open on six of the last trading days with a triple digit reversal. Despite this extreme volatility the VIX is only 22. You would think it should be pressing 30. The Dow has respected resistance and support as if they were high voltage wires. As of last week that support has been strengthened by the addition of the 50-day average.

Like the S&P the Dow has given us two clear trading signals at 11,000 and 11,200. A breakout in either direction is actionable. Unfortunately I think traders have been so burned by news reversals over the last several weeks they will be hesitant to enter new positions until we can go several days without any new headline.

Dow Chart

The Nasdaq is in stealth rally mode. If you look hard at the last six candles there is an almost imperceptible upward trend to the green candles. The close just under 2535 was right at resistance and it traded over 2540 both of the last two days. The Nasdaq is being led by the chip stocks, Internet stocks and retailers. Historically when Black Friday sales are good the retailers (9% of the Nasdaq 100) do well in the week that follows. The fascination for all things electronic this holiday season is powering the chips stocks higher despite some recent negative guidance.

This stealth rally may be about ready to go public. All Amazon has to do is report record sales over the weekend and have Google claim shopping sites were heavily trafficked and we could have an explosion higher. But, there is always the chance that the news is priced in with Amazon's +17 point gain over the last six days. How good can Kindle sales really be?

Personally my daughter and I tried to buy some of the Amazon door buster specials this weekend and were unsuccessful because they sold out within minutes of becoming available. Even though I did not get the specials I wanted I still purchased about $300 of merchandise from Amazon on Friday. Multiply that by their 70 million customer visits per month. While on the subject of holiday shopping I stopped by a Home Depot on Saturday for a $15 trash can and left with $115 of merchandise. They had so many specials stacked in the isles there was hardly any place for customers to walk. Plus there was a sales person every 20 feet asking if they could help. I bet I said, "No thank you I am just browsing" 20 times. Two weeks ago I was at the same store and could not find a salesperson to help me. The store was packed and carts were full so their advertising must be paying off.

If you are a glass half full person the Nasdaq chart looks like a stealth breakout in progress or a likely failure at resistance if you see the glass half empty. Today I am expecting a move higher if the news events would give us a rest.

Support should be 2500 and resistance 2540.

Nasdaq Chart

The Semiconductor Index has had the same volatility but the up days have been significantly stronger than the down days. Compare the last seven candles on the SOX chart to the Dow or S&P. There is no doubt that the SOX is shaking off the bad news and gaining ground on the good news. This is a strongly bullish indicator for the Nasdaq and for the broader market. The resistance line at 400 dates back to April's highs.

Semiconductor Index

The Russell lost -4 points on Friday but gained +8 for the week making the Friday decline meaningless. The Russell is testing its highs from April and early November. Compared to the lethargic Dow and S&P charts the Russell is clearly leading and that is bullish for sentiment. A break over 740 would be a strong signal that mutual funds are buying for a year-end rally and for a growth position into 2011. Support is well back at 715.

Russell Chart

In summary the SOX, Russell and Nasdaq, in that order, are suggesting there are buyers and the news is not scaring them away. By contrast the big cap indexes are locked in a trading range primarily by the drag from financial stocks and the impact of the dollar on commodities.

I don't believe a resolution of Portugal's problems through a bailout will solve the European debt crisis. I think the speculators still have to take a run at Spain just because they can. They have been so successful with Greece, Ireland and Portugal there is no reason for them not to try. I doubt it will happen immediately. I think they will have to build up some momentum before they can gather enough courage and resources to take on a larger country with a GDP of $1.5 trillion. This compares to $228 billion for Portugal, $227 billion for Ireland and $329 billion for Greece. It will take a lot more effort to run Spain into the ground than it did for the smaller countries.

For that reason I believe the immediate problems will dissipate with some resolution in Portugal. Hopefully the investing public has grown tired of reacting to these pop-up debt problems and will ignore a lingering resolution on Ireland and Portugal. After all they really don't have any material impact on our financial system. To put things in perspective the Fed will spend more on QE2 this week than the entire EU will spend on Ireland's bailout.

While I think the market impact of the continued debt crisis news should fade I also believe traders have been burned so much in recent weeks they will be gun shy about entering new positions. It may take several days of dwindling debt news before traders come back into the market. I am still bullish based on the accelerating economy but I would not add to longs without a dip to 1175 or a breakout over 1200.

Don't fight the Fed!

Jim Brown

Never worry about the size of your Christmas tree. In the eyes of children, they are all 30 feet tall. - Larry Wilde