It was a tale of two markets last week. The Dow posted a decent gain thanks to JPM, IBM and GE, while the rest of the markets headed sharply lower.

Market Statistics

The streak of weekly gains for the Nasdaq and S&P came to an end at seven thanks to some weaker than expected earnings and guidance warnings. Apple and Google weighed heavily on the Nasdaq on Friday with Apple having its worst week since July and losing -22 points from last Friday's high. Google posted strong earnings that beat the street and garnered an $800 price target from three different brokers but still gave up -$15 on Friday.

It was a tale of the market being priced to perfection and earnings and guidance being less than perfect. When everyone is expecting Tiffany class earnings even a gift-wrapped box from Zales is a disappointment. This week has been a prime example of why not to hold an option position over an earnings report.

The only economic report on Friday was bullish but it is normally ignored. The ECRI Weekly Leading Index rose from 128.1 to 128.9 and a new high for this move. The last peak was in April at 134.7 and the low was 120.4 in July. The smoothed annualized growth rate rose to 4.1% and the fifth weekly gain. This report is only followed over the longer term. Nobody really pays attention to the weekly changes. The trend is solidly up and suggests the recovery is accelerating.

Next week has some important economic events led by the first Fed meeting of the year on Tue/Wed. With signs pointing to an accelerating economy investors will be looking tentatively towards the Fed announcement for some evidence the Fed is preparing to change its posture. They will be looking for a sign the QE2 buying could end before June. The Fed has to end the buying, change its posture and remove some of that liquidity before it can raise rates. With inflation figures rising, although still at a snails pace, the Fed has to be contemplating its next move. With recovery just starting to pickup speed I doubt they are going to jerk on the reins just yet. There have been enough question marks in the Q4 earnings so far that it is clear the road ahead is not yet free of potholes. I doubt the Fed will make any change in the statement other than to say they see signs of improvement BUT investors will be worried ahead of the announcement anyway.

The next biggest event is the Q4-GDP on Friday. The estimate is for a jump to +3.6% growth from 2.6% in Q3. Pushing the GDP higher is a strong pickup in consumer spending which likely rose close to +5% for the quarter. Auto sales are strong and Q4 retail sales excluding motor vehicles was the highest increase in more than seven years. In 2011 the budget shortfalls at the state and local level will be a drag on GDP but that could be made up by a continued acceleration of the recovery in the private sector.

There are three Fed activity reports on Monday and Thursday. They should show signs of improvement but still at a low level. The Philly Fed report on Thursday came in lower than expected and the prior month was revised lower. Let's hope that was a one-region anomaly.

The wild card is the state of the union speech on Tuesday night. Since the speech is normally more cheerleading than substance about the only drag on the market would be the announcement of some new regulatory plan or committee. The tone of the administration since the November elections has been very pro-business so I doubt there will be any negative announcements and no market impact but it remains a wild card.

Economic Calendar

The real market focus next week will of course be the acceleration in the pace of earnings. There are 128 S&P-500 companies reporting next week. The big reports of the week are AXP, MCD, JNPR, MMM, ADP, UTX, AMZN, MSFT, F, HON, CVX and COP. Let's hope they do a better job of surprising to the upside than last week's dogs did.

Earnings Calendar

Google reported earnings on Thursday night and briefly rallied +$27 in after hours to $654 before losing momentum. On Friday Google slid to close at $611. Google announced that CEO Eric Schmidt would be replaced by co-founder Larry Page in April. Schmidt is becoming the executive chairman of Google and will focus on external deals, partnerships, customers and government outreach. Schmidt helped grow Google from $100 million in revenue the year he arrived to $29.3 billion in 2010. Late Friday news broke that Schmidt will be given $100 million in stock that will vest over the next four years. I guess he needed some more stock to replace the $326.7 million in shares he filed to sell earlier this week. He owned nine million shares of Google on Dec-31st. He filed to sell 534,000 shares. Must be nice!

Citigroup reported earnings that disappointed after the company took a charge on mark-to-market accounting of its debt. Citi shares declined sharply on the news.

On Friday Bank of America reported disappointing top-line numbers and higher expenses. BAC shares continued the decline that began on Wednesday. Several other banks reported earnings that failed to impress including NTRS, STT, FITB and PNC. The weak financial sector depressed the broader market but banks saw a slight rebound on Friday. Morgan Stanley and Capital One went against the trend and rallied after earnings.

After the close on Friday the FDIC closed four banks with assets of $2.7 billion. That brings the number of failures in 2011 to seven. The banks closed were United Western Bank, Denver, Community South Bank, Easley SC, Bank of Asheville, North Carolina and Enterprise Banking or McDonough GA. The Fed's problem bank list rose from 829 to 860 in the last update. That is the largest number since March of 1993 when there were 928 on the list.

GE reported earnings on Friday and produced a big surprise and raised guidance while bragging on the recovery. Net earnings from operations were 36-cents and a +31% increase. Revenue was $41.4 billion compared to estimates for $39.9 billion. Order volume rose +12% and total order backlogs rose $3.1 billion to a record $175 billion. CEO Jeff Immelt said the economy was "getting stronger every day with the business environment growing broader and deeper all across GE's portfolio."

Immelt was also appointed to head the president's new Council on Jobs and Competitiveness, an advisory group on economic policy. The commission was established by presidential executive order and is mostly political cover for an administration wanting to appear focused on business and jobs. The commission will only meet once a quarter. How much real work can you get done meeting once a quarter? The creation of the commission will make a good sound bite for the state of the union speech but I doubt there will be a mention of the quarterly meeting schedule.

Freeport McMoran (FCX) reported earnings that rose +60% and beat the street by a mile but shares fell $10 over the last three days on lower production estimates and fears of aggressive inflation fighting in China. It is not enough to be minting money with the price of gold and copper at record historical levels. The company said 2011 copper production was expected to fall from their prior estimate of 3.90 billion pounds to 3.85 billion and gold estimates would decline from 1.5 million ounces to 1.4 million. Decreasing ore quality at the Grasberg mine in Indonesia was the culprit. Just like in the oil sector all the easy copper has been mined. New deposits have lower quality ore and require more effort to produce.

AMD reported earnings of 14-cents compared to estimates of 11-cents. That is a huge win for AMD given their past track record. They even raised guidance for Q1 but that did not prevent their stock from dropping -6% on Friday. It was post earnings depression caused by cautionary comments from several brokers and the fact the board booted the AMD CEO unexpectedly on Monday. Suddenly firing a CEO without a replacement does not inspire confidence especially in a weak and conflicted company. AMD began declining after Intel's earnings last week and the events of this week just accelerated the decline.

AMD Chart

F5 Networks (FFIV) was another stock that failed to impress and end up with a major loss for shareholders and soured the sentiment for the tech sector. FFIV said sales rose in Q4 to $268.9 million and that missed analysts of $270.6 million. They also guided higher for Q1 but the guidance was slightly lower than analyst estimates. Net income rose +90% to 88-cents and beating analyst estimates of 83-cents. FFIV was rewarded with a -$33 drop in the stock price or roughly -25%. The reason for this severe beating was the better than 100% gain in the stock since July 1st. Great expectations require great performance. Missing estimates by $1 million and change (-.0063%) was a reason to sell for somebody and another prime example of why not to hold over an earnings report.

FFIV was the recipient of multiple buy recommendations after the drop. It was almost unanimous that every broker and fund manager thought this was a buying opportunity. I would wait for a rebound back over $115 before taking the bait or a continued dip to $100 but I would be a buyer.

FFIV Chart

Schlumberger (SLB) posted better than expected earnings on Friday that rose +28% to $1.04 billion. Unfortunately shares of SLB declined after the CEO said North American activity was slowing due to the excess natural gas in the system. CEO Andrew Gould, said capex spending by oil companies was increasing thanks to the higher prices for oil but nat gas drilling was in decline in the USA. He also did not see any deepwater wells drilled in the Gulf in 2011. SLB will raise its own capex from $2.9 billion to $4 billion. Shares of SLB declined -5% from Wednesday's high.

S&P said 42 companies in the S&P-500 have reported earnings that beat the street out of 57 companies reporting. Those that beat had earnings up an average of +22%. Unfortunately expectations were for a gain of +32%. Financials were the second worst performers with an average earnings beat of +2%. Consumer stables companies were the worst with an average 24% miss.

Bloomberg reports 81 S&P companies have reported with 68 beating and 13 missing estimates. Excluding charges, gains and one time items earnings growth came in at 29.6% compared to estimates of 32%. I don't know why there is a difference in the total companies in the S&P and Bloomberg stories unless the date cutoff was different. The key is the lower than expected earnings in both reports.

The news on Thursday that China reported 9.8% GDP for Q4 and inflation at 4.6% was a downer for the equity markets. Investors are worried China will really have to tighten the screws by raising interest rates in an effort to combat that inflation. If they succeed in slowing their economy to their target rate of 8% it would be long term positive but short term negative for the global economy.

The ten-year TIPS auction on Thursday spooked the market because of the light demand. Everyone is always wondering when the debt bubble is going to be popped by a lack of interest in buying any more U.S. debt. That has not happened yet but every light demand auction renews that worry.

Gold prices crashed along with the value of the dollar and that is not supposed to happen. The problem is the worry over China's inflation cure, the hike in margin on futures contracts at the CME, worries over potential position limits and a serious need for a correction. Traders are also anticipating the end of the QE2 program as the economy improves. Gold rises on cheap money. However, rising interest rates push the value of the currency higher and that is what traders are expecting in China and several other countries. Global inflation is rising and that means higher interest rates. You would think that would mean higher gold as an inflation hedge but that brings us back to the correction problem. Gold rallied over $350 since July. It was time to rest.

Remember, when a market, stock or commodity needs to correct overbought imbalances traders will always find an excuse. A -10% correction from the highest close in December at $1425 would take us to $1282. That is only another $57 and only $6 above the 200-day average at 1276. I would buy that dip. The CFTC said net longs in gold have declined to the lowest level since July 2009. As the inflation threat rises those prior longs will be back and gold will set new highs in 2011 according to Goldman Sachs. Doug Kass believes gold will decline -$250 from its highs before finding support.

Gold Chart

You will rarely see the dollar and gold heading in the same direction.

Dollar Index Chart

America's fast food consolidation craze has ended. Companies consumed too much fat in the form of chains that were barely making it on their own and came with their own supply of future regulation problems. On Tuesday Yum Brands (YUM) said it was going to sell A&W and Long John Silvers. On Thursday Wendy's/Arby's announced it was exploring strategic alternatives for the Arby's Restaurant Group. That means a for-sale sign was just posted on the brand. Chains that have not been absorbed into a giant conglomerate are also downsizing. Roy Rogers has shrunk to only 48 stores in nine states. The margins are getting squeezed at all the low priced burger/sandwich/taco stores thanks to the 99-cent and in some cases the 79-cent value menus.

I don't think that is the real problem but a contributing issue. The real problem is the move away from high fat fast food. The government is eventually going to tax stores based on the fat and sugar content of their food. For a chain like KFC that would be a killer but KFC is a major profit center for Yum Brands in Asia. During the health care debates it was constantly mentioned that healthcare for obese consumers as a result of high fat foods was $100 billion a year. The government does not want to have to eat that expense in government run healthcare. Instead they are going to tax high fat foods to discourage their consumption and produce a revenue source to offset their impact on medical care. I believe these companies like YUM and Wendy's are afraid of what the future may bring and unsure how much the new taxes will impact sales.

The chains being sold lost their ability to stand out in the market and attract a crowd. Since YUM took over Long John Silvers their restaurants have declined to only 969 and A&Ws declined to only 328. That is out of YUM's 17,416 total stores in the USA. YUM now does the majority of its business outside the U.S. with 35,141 total stores. They open four new stores a day. You may have heard that Michelle Obama announced on Thursday a new deal with Wal-Mart to remove salt, sugar and trans fats from packaged foods. That is the first domino to fall in the new healthy food plan. Now that Wal-Mart has caved in you can bet other chains will soon follow. Late Friday Bill Clinton announced a deal with leading food manufacturers to provide healthier school lunches with less fattening components and meet science-based nutrition standards with no change in prices. This will benefit 30 million children nationwide who eat school lunches.

Apple is putting the screws to their iPhone customers again. Literally, Apple is changing out the screws on the iPhone 4 to prevent consumers from opening the phone and performing minor maintenance. You will no longer be able to change your own battery or replace a cracked screen. You will be required to take the phone to an Apple store to have it repaired. They are replacing the regular Phillips screws with something called a Pentalobe screw that requires a special screwdriver not commonly available in the retail market. However, you can already buy them on Ebay under the title "iPhone 4 Toolkit" for $5 and up. Never underestimate the power of free enterprise when corporations tell consumers they can't do something.

Apple announced on Saturday the 10 billionth download of an application from their app store. That equates to roughly 62 apps for each of the 160 million iPhone, iPod and iPads in circulation. They claim a library of 300,000 apps today.

One problem just sneaking into the news on Friday is the state bankruptcy bill. States can't file bankruptcy because they are a sovereign entity. That means if they get into fiscal trouble as 46 states currently are they have no way out. That made investing in state bonds pretty safe. However, with so many states so deep in debt there is no way they can work it out. They need a bankruptcy option. Congress is working on a proposal that would let states reduce their debt and probably more importantly their liabilities.

This is going to be a major problem for bond investors and state employees. Many states still have defined benefit pension plans. Work for 20 years and retire for life at 80% salary plus benefits. That model no longer works in the private sector but the public sector has tens of millions of people either already on pensions or arriving there soon. The states simply cannot afford to continue the plan. People used to die around 65 and now they are living to 85 or older. In a bankruptcy court the states can change the pension plans or cancel them entirely. Can you imagine the ruckus it is going to cause when states start slimming down pension plans and cutting existing debt by a large amount, say 25%. Bondholders are going to go crazy and pensioners will be picketing in the streets.

The alternative is a federal bailout and the feds don't have that much money. Secondly a bailout does not fix the problem. The pension liabilities are going to continue to grow until they consume the lion's share of the state's revenue. Unless the plans are changed and benefits cut the problem will continue to grow ever larger. I see this as a major problem for the economy and consumers. The news really has not floated to the top yet but it is coming.

Analysts claim states would not really file bankruptcy but use that ability as a threat to force concessions from unions and pensions. They can't continue to let their debts rise and right now there is no way to stop it.

The S&P ended its longest consecutive week winning streak since 2007 with a loss last week. It fell -1% on the 19th for the biggest one-day loss since November. We have been leading a charmed life and one that everybody new would eventually come to an end. The S&P dip last week could hardly even be called a dip. From the intraday high on the 18th at 1296 to the intraday low on Thursday at 1271 it was only a 25 point swing and less than a 2% move. That dip was briskly bought to push the S&P back over 1290. This is not a correction and not a bearish move. It was the equivalent of testing initial support just to make sure it was really there.

Real support on the S&P is much lower starting at 1260 and followed by the 50-day average at 1240. The tone of the market will have to change significantly in order to test those levels. Last week I said we had to be long over 1280 and that is still my thought process. I would love have a little better buying opportunity at 1260 or even 1240 but I believe that will take an external event to push us that low.

The percentage of bullish respondents to the AAII sentiment poll has declined to 52% and more in the range of reason. The percentage of stocks above their 20-day average fell from 80% to 40% in less than two weeks despite the S&P holding on to its recent gains. This kind of consolidation in place is sometimes referred to as a "rolling correction." Recent high flyers are hardest hit but those previously under appreciated stocks suddenly find buyers. It is also called a rotation cycle where investors take profits in big winners but immediately pour those profits back into those stocks they believe will be winners in the next move higher. During an earnings cycle this is very evident. Traders position themselves in the early reporters hoping for some positive news. As each report passes they move money into the next wave to report and then the next until the four-week earnings calendar comes to an end.

We had ugly earnings from banks and tech stocks and the dips were bought. We had lowered guidance from tech stocks and mining companies and investors bought the dips. Hope is still in bloom and we have a fresh batch of major companies reporting next week. There is something for everyone and I would be surprised if the market moves much lower until after next week.

The bears forget the markets can correct by moving sideways just as easily as diving for hundred point losses. It just takes longer using the sideways consolidation method but it is less painful.

I believe this would be a good environment for a sideways consolidation rather than a significant drop. The name brand analysts are predicting an S&P in the 1450-1500 range for 2011 and for investors with a long-term view there is not much difference between buying a stock here or 5% lower. Everyone would love to time the market perfectly and pick up stocks at the exact bottom but very few are lucky enough to do that more than once.

For retail traders the risk may seem daunting because retail money is scared money. Retail investors tend to jump in and out of positions and rarely time the bottom correctly. For that reason we need to worry more about the long-term outlook than what might happen over the next 1-2 weeks. If you buy a $50 stock that runs to $70 it really does not matter if you paid $48 or $52. You still made a nice profit. I believe we are seeing traders come to that realization and feeling better about adding positions despite a major dip. Of course that will cause some pain if that major dip comes but that is what stop losses are for.

I believe we should be in buy the dip mode and also into bargain hunting mode. That means when a stock we want is offered to us at a discount to its previous price we should be willing to buy it regardless of the market level at the time. A couple of examples would be FCX and FFIV. I would like to pickup FCX around the 100-day average at $100 but the drop from $122 to $108 last week put it on my radar as a potential buy. I would put in an order with a buy stop at $112 to make sure I don't miss it should a rebound occur but then follow the price lower until it appears to have found a bottom. For every $2 decline, lower your buy stop $2 until your comfortable with the price. Same with FFIV. Support is $90 but I doubt we will see it. The $30 drop was a gift. I would put a buy stop at $115 and then trail it lower if FFIV moves lower.

These are corrections in individual stocks. You don't have to wait for a market correction to establish positions. Every earnings report next week will have the potential for a stock correction.

FCX Chart

Regardless of what type of market consolidation phase we are going to experience I would expect S&P 1260 to be a strong support level given the positive market sentiment. The 50-day average at 1238 would be my worst-case level assuming Europe does not melt down.

S&P-500 Chart

The Dow completed its eighth consecutive week of gains thanks primarily to IBM. Other contributors were GE, XOM, MMM, BA and HPQ. With 14 Dow components reporting next week there will be ample opportunity for some increased volatility. Dow components reporting next week include CAT, MSFT, JNJ, MCD, T, PG, TRV, DD, VZ, BA, UTX, AXP, CVX and MMM.

The Dow hit 11,905 intraday on Friday and gave no indications of weakness. The converging lines of resistance produced a solid wall but the Dow did not shy away from the confrontation. Uptrend support from the last seven weeks is 11,800 but that should not last on any material bout of profit taking. After the spurt of volatility in the first week of January the Dow is right back in its low volatility groove and that groove will eventually fail. Nothing ever goes straight up or down without a routine pause for pressure to equalize. My target for a 2-3 day decline would be support at 11,600. That would break the short-term trend but still be well inside the longer-term uptrend channel.

Dow Chart

The Nasdaq is in trouble. The declines in Apple and Google are likely to continue given the CEO health issue at Apple and the CEO ejection at Google. At Apple there is still no word on what illness Steve Jobs is battling so obviously investors fear the worst. If the board would just tell investors it was the flu, an ulcer, an ingrown toenail or whatever then the cloud would pass and Apple could flourish. Not telling means it is an evil disease with the possibility of a negative outcome or at least that is what the rumor mill believes in the absence of the true story.

For Google the ex-CEO Eric Schmidt was the adult in the room. That adult is moving to Chairman and will still be a "consultant" to incoming CEO and co-founder Larry Page but basically the $150 billion company will be in the hands of a 38-yr old college student. Page and Brin may have co-founded Google but as college geeks, both with masters degrees and both on leave from their PHD studies, they really don't have any real world experience in managing a major company. Eric Schmidt was that calming force that faced the investor world and kept things moving forward. Investors may like Page but that does not mean they trust him to be a great manager. Google's shares could fall back below $600 as investors take some chips off the table.

If Apple and Google do continue to decline the Nasdaq does not have a chance. Together they have a $450 billion market cap and account for a substantial weighting in the Nasdaq indexes. The Nasdaq is already well off its highs thanks to AAPL and GOOG and a dozen or so other techs like CREE and FFIV with spectacular declines. It would have been worse except for Intuitive Surgical (ISRG) and its +$40 gain on Friday.

The Nasdaq fell out of its uptrend channel but has yet to test major support levels at 2675, 2650 and 2615. Those stair step increments should provide ample resting places on any further declines. If those break the next major support is 2500 but I seriously doubt it will come to that. The Nasdaq has already declined about 75 points from last week's high and another 75 points would be the equivalent of a mini correction and leave us in the vicinity of that 2615 support range.

The Nasdaq may not be the weakest index but it does have the most negatives as far as potential outlook.

Nasdaq Chart

On purely a chart basis the Russell is on the verge of a dramatic breakdown. The support from early January at 780 has failed and multiyear support at 764 is about to be tested. Should that break it would also be a break of the 50-day average and signal further selling ahead.

The Russell dropped -4.26% last week and the biggest decline of any broad market index. For reference the Nasdaq only declined -2.4%. To be fair the Russell moves faster in both directions but the ride is always scary.

I don't see any specific reason for the Russell to break support at 764 but if it did we need to take notice and be prepared because it could be a long drop. The Russell rallied faster and higher than any other index out of the August lows. There is plenty of profit at risk and fund managers may be taking advantage of the new highs on the Dow by taking profits on the small caps.

The Russell is always a leading indicator for market sentiment. A rebound from 764 would probably be greeted with excitement and large amount of relief. A breakdown below 764 would produce increased selling and a pile on by shorts. For this reason we need to watch this level carefully and plan accordingly.

Russell Chart

The Dow Jones Total Market Index, formerly the Wilshire 5000, obediently failed at uptrend resistance and fell back into the middle of the channel. That is still bullish and just a pause unless long term support at 13250 fails. The broader market is still bullish despite some spectacular problems in individual high profile stocks. When viewed in conjunction with the Russell these two indexes paint a comprehensive picture of the market. That picture is a pause for profit taking but no change in trend yet.

Total Stock Market Index Chart

In summary we could have a volatile week ahead as traders digest the full calendar of economic events, a FOMC meeting and several hundred earnings reports. This could be a pivotal week and there is risk to the downside as post earnings depression settles in. Market sentiment is still bullish but it has weakened to a more tolerable level. We should use any further weakness as a buying opportunity as long as critical levels like 764 on the Russell are not broken. In the event of a serious decline we need to step back and regroup and wait for the market to signal an all clear.

Jim Brown

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Minds are like parachutes. They only function when they are open. - Sir James Dewar