Intel did not get any love from investors on Friday but the rest of the chip sector rallied sharply. JPM blew past earnings to power the banking sector higher.

Market Statistics

The bad news bulls are definitely in control. The negative economic news at the open was barely able to dent the indexes before the dip buyers jumped in once again. The early economics stirring the market soup was the huge jump on the Consumer Price Index. The headline number jumped +0.5% and well over the +0.1% rise in prices for the prior month. This was the biggest jump since early 2009. The core rate minus food and energy rose only +0.1% and inline with estimates.

The core rate has now risen +0.1% for two months after being flat at zero for three months. There is no inflation at the core level as long as you don't eat or use energy. For the rest of us the headline number is rising pretty rapidly thanks to those categories. Energy prices rose +4.6% in December and is now up +7.9% over the same period in 2010. Food has not really spiked yet in the U.S. but given the rise in grain prices and the impact of grain not only on bread, flour and cereal but also on beef, chicken and other livestock we are going to see prices rise.

Because the core rate remains tame for the time being there is no worry the Fed will change its strategy any time soon.

Also roiling the market was a lower than expected Retail Sales number for December. The headline number came in at +0.6% compared to estimates for +0.8%. That was still the biggest rise since July. Sales closed the year at +7.9% over their year-ago level. Unfortunately most of that growth came in sales at service stations where fuel prices were steadily rising.

Categories actually seeing a decline in sales included electronics and appliances, food and beverage, clothing and accessories and general merchandisers. The big winners were gasoline stations +1.7%, cars and parts +1.1%, furniture and home furnishings +1.0%, building materials +2.0% and nonstore retailers +2.6%. The sales at electronics stores were actually brisk but the lower per item selling prices shrank the total dollars sold although units were up. Consumers are benefiting from the flood of new products and rampant competition.

With consumers taking home a few more dollars per week this year the increase in sales should continue.

The rise in consumer spending suggests consumers are more optimistic about the current conditions and the outlook for the future but that is not what we are seeing in the sentiment reports. The Consumer Sentiment Survey for January showed a drop in the headline number from 74.5 to 72.7. That was a shock to analysts who were expecting a rise to 77.0.

The nearly -2 point drop was in the present conditions component. That component dropped sharply from 85.2 to 79.8 while the expectations component rose from 67.5 to 68.2. Given the tax bill, the cut in FICA taxes and a rising stock market you would have thought consumers would have been in a better mood. However, as I warned last month, there is a tendency for post holiday depression. Now consumers are faced with the added debt they created by using their credit cards and the joy of the season has faded. I would not put too much stock in this report. Consider it a seasonal factor.

Consumer Sentiment Chart

A positive report was the strong uptick in Industrial Production. The report showed a strong +0.8% gain in December and the biggest gain since July. If you only looked at the headline number you would be bullish. However, half of those gains came from a sizeable boost in utility company billings thanks to the cold weather. Actual manufacturing output only rose +0.4% but still a decent gain.

Business equipment, a key indicator for the economy, rose +0.6% and computers rose +1.1%. Auto sales rose steadily in Q4 and the companies have raised guidance for Q1. For 2011 analysts are now expecting a strong +5.0% growth for the year.

Next week is housing week with three different housing reports. The most important is the NAHB on Tuesday. The most important report for the week is the Philly Fed Manufacturing Survey. This is a preview of what we should expect from the January ISM two weeks later.

Economic Calendar

The big story next week will of course be earnings. This is a big week for the Q4 earnings cycle with the several of the tech blue chip companies reporting. The market is closed on Monday so there are no major reports. Apple and IBM are the big dogs on Tuesday followed by Ebay and Goldman on Wednesday and Google on Thursday. Bank America and General Electric close out the week on Friday.

The banks will produce some interest from traders but in general we already know they will beat estimates. After the JPM earnings on Friday those expectations are pretty strong. The earnings from Apple and Google will be highlights because of their exploding businesses and the competition between them. Expectations for Apple are off the charts but Google expectations are more subdued. IBM will be a key for the business sector because they are a corporate supplier rather than a consumer company. It should be an interesting week.

Earnings Calendar

Earnings for Q4 for the S&P-500 are now expected to show +32% growth led by triple digit gains in the financial sector. Quite a few of the earnings reports next week are banks. There were a couple dozen banks I did not put on the list. This should produce positive market sentiment with bank after bank beating estimates.

JP Morgan reported earnings on Friday of $1.12 that beat the street estimates for one dollar a share. That compares to 74-cents in the year ago quarter. The +47% rise in earnings came on a revival in consumer banking and lower reserves for loan losses. JPM said it could raise its annual dividend from 20-cents to as much as $1 if the Fed approves its plans later this year. Since the financial crisis the Fed requires the top ten banks to submit detailed financials for their review. If the Fed likes what it sees it could approve the dividend increase. JPM CEO Jamie Dimon said the bank would raise another $30 billion in working capital from operations in 2011 and the bank's capitalization would be well in excess of that required by the Basel accords. Shares of JPM rose sharply on the news but faded to a 46-cent gain by the close.

JPM Chart

JPM was the only major company to report on Friday. Intel reported great earnings on Thursday and opened higher Friday morning but quickly fell to a loss. Post earnings depression is a common scenario and why Option Investor almost never recommends holding an option position over the actual announcement.

Intel did set fire to the chip equipment sector. All the big names in the sector posted large gains on expectations of large capex spending in 2011. The 100% depreciation bonus in the tax bill is a huge incentive to buy equipment in 2011. KLA-Tencor (KLAC) rose +6%, Altera (ALTR) gained +6.4%, Novellus (NVLS) rallied +12% and Applied Materials (AMAT) jumped +7%. I believe there was a serious dose of short covering in some of those gains.

Novellus Chart

Hasbro (HAS) warned on Friday that 2010 sales would actually be lower than 2009 due to a slowdown in consumer demand. That caught everyone off guard since the retail sales for December just concluded three months of strong sales increases. Hasbro gave no details on why the manufacturer of action figures and Nerf toys say sales sag. Hasbro's shares fell more than -5% in early trading but recovered to close flat for the day.

Gold prices collapsed despite a continued decline in the dollar. The recovery in the euro has taken away the flight to safety trade to gold. The improving economics in the U.S. suggests the Fed will not announce QE3 and the dollar will not decline much longer. In a nutshell the QE2 trade in commodities is slowly fading. Six weeks ago could you have imagined a -2.4% decline in the dollar in four days and no rally in gold?

You may remember the metals and commodities rallied for two months ahead of the actual announcement of the QE2 plan. Now traders are getting ready for the end of QE2 in June and possibly as early as March. They may not be rushing out of their commodity positions just yet but the rush to pay ever-higher prices has ended.

Comex Gold Chart

Part of the problem in gold was the Chinese reserve hike. China raised its bank reserve requirement by 50 basis points on Friday. That was the fourth hike in the last two months and the seventh since 2009. China is trying to slow consumer prices, which have risen more than 5% over the last 12 months led by food and real estate. By raising the reserve requirement it takes more money out of the banks and makes it harder to do real estate loans. Investors are afraid China is going to tighten the screws too far and put the country back into low single digit growth. Numerous analysts believe China's inflation rate is much higher than government figures show. Some believe it could be as high as 20%. China has raised the minimum wage twice in the last six month by 20% each time. That means the inflation is rampant and the large labor pool is shrinking. China is racing towards a business cycle top but it could still be a couple years away. The decline from that top is going to be very painful for the world economy.

American International Group (AIG) is in all the headlines after it paid the New York branch of the Federal Reserve its outstanding balance of $21 billion on Friday. That cleared the way for AIG to convert the preferred stock owned by the Treasury in to common stock that can be sold in the open market. The conversion gives the Treasury 1.6 billion shares of common stock or 92% ownership in AIG.

Converting the government's $47.5 billion loan into 1.6 billion shares means the government's cost basis is around $30. With AIG at $54 that is a win for the government BUT how do you sell 1.6 billion shares? AIG and the Treasury met with bankers last week to devise a plan for a massive share offering that would take a lot of those shares off Treasury's hands. Estimates are for an offering of $15 to $20 billion. The rest of the shares would be sold into the market or in private placements over the next two years.

Just getting out of AIG does not solve the governments AIG problem. As a condition on the sale of some AIG assets the government ended up with a position in those businesses as well. The government owns $20 billion in shares of MetLife and AIA. Met bought American Life Insurance from AIG for $16 billion. AIG sold 98% of Asia's AIA in a public offering and raised $20 billion with the government retaining a stake.

There is a rush to exit AIG for one good reason. The bailouts were not popular with voters and especially the AIG bailout. The public sees AIG as a bailout of the big banks rather than AIG. The class warfare over the last two years painted the big banks as evil and only good for paying big bonuses to executives. The administration really does not want to go into the election cycle with the AIG bailout still drawing attention. Same with GM. They would rather dump the shares of both for a minor profit and be able to say, "See what a good deal this was for the American taxpayer."

The remains of the MetLife and AIA transactions will be swept under the rug and forgotten because voters don't really know about those deals and how the government is involved. We should be thankful the government bailed out AIG. The $2 trillion dollars in complex assets and derivatives on their balance sheet in 2008 would have sunk the global financial system if the government had not backstopped them and guaranteed the debt. John Q Citizen does not understand this so the administration needs to close these deals before they get too far into the next election cycle.

AIG Chart

After the close on Friday BP held a press conference to announce a joint "share swap" with Rosneft, the largest oil company in Russia. BP will give 5% of its shares valued at $7.8 billion to Rosneft and Rosneft will give BP 9.5% ownership in Rosneft. BP has a market cap of $150 billion and Rosneft $83 billion. The two companies will then jointly explore for oil in 50,000 square miles of the South Kara Sea in the Artic. Rosneft won three blocks last year in an auction where it was the only bidder.

It is obvious why Rosneft wanted to joint venture with BP. They have oil in places where they can't drill for lack of technology and BP has the technology or at least is closer to having it than Rosneft. The Russian company will get access to technology to drill in deepwater in the South Kara Sea and they can then use that technology in other fields not related to the BP deal.

BP has interest in the deal because it wants oil assets that are not controlled by the U.S. government. BP is claiming the oil spill could eventually cost them $40 billion and subject them to intense scrutiny and regulation on any operations in U.S. waters. By partnering with Russia they have a partner that is immune to U.S. asset grabs. BP has probably resolved not to add to Gulf of Mexico assets and could be looking for a way to get out of the ones it owns. If it can replace those assets with Russian oil then it may be appealing to BP.

Personally I would caution BP against dancing with the devil. The only major oil company not to be burned by Russia lately is Conoco. Shell, Exxon, Total, etc have all been the focus of heavy handed Russian tactics to confiscate their leases including their assets on the ground once the heavy work was done and production started. BP's CEO is familiar with Russian politics because he was kicked out of Russia three years ago when the partners in the TNK-BP partnership turned against him. Suddenly all is forgiven. Does that seem strange to anyone but me? Obviously there is more to this share swap than meets the eye.

BP Chart

Bookseller Borders Group (BGP) spiked +31% on Friday on rumors the company has been meeting with GE to obtain a new credit facility of $500 million to take the place of existing debt. Neither GE or Borders would comment on the rumor. In a New York Times article the chain would also ask publishers to cough up some cash to aid the ailing bookseller. Borders has not posted an annual profit since 2006. When it missed estimates in Q3 lenders cut its borrowing capacity. After Borders warned of a liquidity crisis two weeks ago several publishers cut them off and refused to ship them more books. Trouble always seems to come in waves.

DigiTimes reported on Friday that contract assembler Quanta computer is in volume production of Research in Motion's Playbook tablet. Shipments in Q1 are expected to be in excess of one million units. Motorola's new Xoom tablet will see an initial production run of 700,000 to 800,000 units this quarter as well. Tablets are about to get a lot cheaper once the dozen or so variations hit the market.

Motorola's new smartphone Atrix is rumored to have a docking station where users can attach a full keyboard. Secondly the Atrix can run a Citrix remote desktop client that lets the user use programs like Word, Excel, Power Point, etc. If the Atrix can use the XenDesktop can the other Android based Motorola products like the Xoom also feature this capability? If so this would be a big entry into moving tablets into the enterprise computing space. RBC Capital sees the tablet market at 90 million units per year by 2013.

The S&P-500 closed with a +1.71% gain for the week and stretching its streak of positive weeks to seven. That is the longest winning streak since May 2007. S&P analyst Sam Stoval warned "from a price-momentum standpoint the S&P is now overbought on both a daily and weekly basis for the first time since April." Obviously that does not prevent it from becoming even more overbought in the days ahead. Jeff Kleintop, chief market strategist af LPL Financial said "overbought market conditions and the upcoming earnings season could again contribute to a flat-to-down market."

The quote I liked the best came from an analyst whose name I did not catch. "Every technical analyst is now extremely bearish given the overbought conditions. When everyone is bearish it is time to go long." When traders are bearish they are either flat or short. If flat and the market moves higher they will have to chase stocks higher. If short you get squeezed and you chase stocks higher. Either way the odds for a continuation of the bull market are good.

As I said before I was expecting a January high around the 13th of the month. So far I am wrong. I also said last week that a break over 1280 would be a bullish signal. Thursday's close over that level was just enough to leave a doubt but Friday's close at 1292 was solid confirmation the bull is still alive. S&P 1300 is now the resistance target and baring any unexpected news from overseas we could hit that next week. Uptrend support has risen to 1275.

I have to admit I am worried about the continuation of the gains in the days ahead because the good news is already priced into stocks like Apple and IBM. For instance IBM closed at a new high at $150 on Friday. That is a $28 gain since Sept 1st. Apple closed at another new high at $348. That is a $113 gain since Sept 1st. I know there are more adjectives to describe Apple's prospects than Bayer has aspirin but eventually this stock has to rest. I mentioned last week the rumor Apple will announce a 3:1 split with earnings. That rumor is helping to power it higher. We all know what will happen if that announcement fails to appear.

With the S&P over 1280 and the Dow over 11750 you have to be bullish but that does not mean you close your eyes and accelerate into freeway traffic. Please be alert to the market, use stop losses and actually honor your stop when it is hit. It does no good to have stops if you move them down a dollar every time the price gets close. There is always another trading day if you have cash in your account.

The S&P has not tested uptrend resistance since November 5th. That is now 1300 and it could be the speed bump that jolts the bulls out of cruise control.

S&P Chart - 90 Min

S&P Chart - Daily

The Dow is confirming the S&P breakout over the latest resistance levels. Like the S&P the Dow has a ways to go before the next resistance test. The converging resistance lines at 11,900 should make that a tough level to cross on the first test. The shorter-term uptrend resistance (red) has been very consistent for the last two months in rebuking any attempts to cross. The longer term resistance in blue has not been tested since November. The combination of the two around the peak of the most earnings excitement in Apple and IBM could be a challenge.

Support is now 11,700 and prior resistance. The decline on Friday came to a dead stop at that level and was followed by a sharp rebound. That gives us a clean indicator for trading next week. As long as 11,700 holds we remain bullish. A dip below 11,700 will find secondary support at 11,600 and I would buy that level as well on the first test.

Dow Chart - 120 Min

Dow Chart - 90 Min

The Nasdaq posted a solid breakout on the strength in the chip sector after Intel's earnings. How long it can hold that strength with Apple and IBM on Tuesday is another question. Nothing suggests either company will disappoint and the excitement level is pretty high. The problem is now "Who is left to buy those stocks?" Shorts have got to be scarce ahead of Apple's earnings given their positive outlook. IBM may have a bigger short interest but I still think it is suicide to hold over their earnings. When bad news (Hasbro) knocks a stock to a 5% loss and it recovers before the day is out you have to believe the bad news bulls are just waiting for any dip. After all Hasbro is not even a high profile stock. However, Constar did not rebound so there is some selectivity.

Nasdaq 2775 appears to be initial resistance for next week and good support at 2675. That gives the Nasdaq plenty of room to run. Thursday-Friday would be the high-risk period with Google reporting on Thursday. Their earnings always seem to promote a major bout of volatility. In October they spiked $59 the day after earnings. In July they dropped -$25 at the open. In April they dropped -$32 the next day. About the only guarantee is a double-digit move. It is like playing Russian roulette with your trading account. With options expiring on Friday you might be able to get a cheap straddle just before the close on Thursday. Another double-digit move could be profitable.

Nasdaq Chart - 120 Min

Nasdaq Chart - Daily

The Russell broke over round number resistance at 800 and posted a strong 2.5% gain for the week. That came after three weeks of consolidation and suggests fund managers were waiting for the dip and it never came so they went back to buying small caps. As long as the Russell is making new highs you have to be long the market.

Russell Chart

Dow Total Market Index Chart - Daily

In summary the market continued its bullish ways ahead of potentially volatile earnings events. Like the market action or hate it you can't afford to not be long something as long as the small caps and the Total Market Index are setting new highs. There may be a resistance shadow around every corner but none seem to last more than a day or so before giving way to the bulls. I would remain cautiously long with stops in place and let the bulls do the driving.

John Mauldin had a particularly good article this weekend on the long-term problem with the Fed, QE2, Chinese inflation and the European debt crisis. He suggests Europe is going to successfully delay dealing with the debt problem temporarily but in the end it will come back to haunt everyone. Basically there is not enough money in Europe to pay off the current debt and with rates rising the debt service for those countries will become so onerous they will have no choice but to default. That default could involve $1 trillion or more in sovereign debt and will take down quite a few of the European banks. This article should be required reading for anyone planning their investments for the next 3-5 years. Article Link

Jim Brown

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Mama always said life was like a box a chocolates, never know what you're gonna get. - Forrest Gump