Another dip on Egypt violence and mixed earnings news was bought once again. The shallow dip despite the various bits of bad news was a key bullish indicator.

Market Statistics

The increasingly bad news from Egypt failed to hold the market down after retailers posted a big surprise for same store sales in January. Add in some positive economic spin from a Bernanke speech and the shallow dip was again bought to push the Dow to a new 2.5 year high.

Chain store sales for January were very strong with 4.8% growth compared to estimates in the +1.5% to 2% range. Most analysts had predicted a dismal January because of the number and severity of snowstorms during the month. Not only did sales come in much stronger than expected but the majority of companies reporting raised their guidance. Some of those chains were J.C. Penney, Kohl’s, Ross, TJX, Gap, Limited and Aeropostale

The spike in January sales at many chains was dramatic. The Limited (LTD) reported a 24% increase in sales compared to estimates of +6.9%. Part of that spike was due to the change in timing of a regular promotion that shifted sales into January. Zumiez (ZUMZ) saw sales rise +15.3% compared to 8.1% estimates. Dillards (DDS) saw gains of +6% compared to +1.3% estimates.

Overall sales rose +7.3% at apparel stores, +6% at luxury stores, +8.3% at wholesale clubs and +4.8% at drug stores. Chains said sales would have been even better but there was less clearance merchandise left over from strong December sales. Even with the lower inventory levels the chains estimated sales would have been 2% to 3% higher without the storms.

The excitement over the January sales was strong because January is normally the slowest month of the year. Good economic news is breaking out all over.

The ISM Nonmanufacturing Index rose to 59.4 from 57.1 and the highest level since 2005. The new orders component rose to 64.9 and a new historic high. The business activity component rose to 64.6 and also a historic high. Thirteen industry sectors reported business activity expansion in January.

The strong showing in both the ISM Manufacturing and ISM Services suggests the economy is transitioning into a mode that is self-sustaining. The employment component rose +1.9 points to 54.5 and the highest level in more than two years. Historically the services sector will produce faster employment growth than the manufacturing sector so a rebound in services is very positive.

ISM Services Chart

Weekly Jobless Claims declined from 457,000 to 415,000 last week and the drop was more than analysts expected. The prior week's surge was caused by a monster blizzard in the Northeast. This suggests next week's report could show another blip higher from the recent storm. The trend is still positive and moving lower. Within 2-3 weeks I would expect to see numbers under 400,000 on a routine basis.

The big report due out on Friday is of course the Non-Farm Payrolls. Official estimates are for a gain of +145,000 jobs. Given the severity of the recent storms the number of storms the actual number could be off the scale and a smaller than expected number should be ignored. January has the largest seasonal adjustment with a swing of more than three million jobs in play due to the termination of seasonal workers. Literally the number on Friday could be a major miss thanks to the storms. However, if the number is positive and in the consensus range it would be very bullish and suggests February could be a blowout month.

In the ADP report on Wednesday they predicted a gain of +187,000 jobs. is not publishing a number but calling instead for an "upside surprise." claims the consensus is +148,000 and their estimate is just slightly lower.

There will be a lot of noise surrounding the payroll report on Friday because of the annual benchmark revisions. Once a year in January the BLS tries to modify all their estimates for the year to match the actual data from the state employment agencies. This revision will be headline news all day on Friday.

The market got a boost from Bernanke in a speech in Washington. He was more bullish on employment and growth but he still does not believe the economy has reached enough momentum to be self-sustaining. He sees no reason to end the QE2 early AND left the door open to extending the QE program past June. This caught many analysts off guard because they were anticipating an early end to QE2 because of the accelerating economy. Bernanke said the outlook for growth, direction of the unemployment rate and inflation will be considered in making a decision to extend the QE program. Bernanke said the Fed would require a sustained period of significant job creation before the recovery could be considered self-sustaining. That pretty much guarantees the Fed will have a tough decision in June unless this recent acceleration in growth continues to gain speed.

If the Bernanke does want to continue a QE program in some form in June he is facing a tough room. There are three FOMC members who would likely vote against a new program on fears of stoking inflation. With that kind of resistance it could be political suicide to push the program through and then be held hostage by lawmakers when inflation finally roars into the picture. It will be interesting to see how Bernanke manages the transition from QE2 to QE3. Even more interesting will be watching him did the FOMC out of its monster $3 trillion hole before it can start raising rates. Actually real rates will be well ahead of the Fed funds rate since rates will rise once the Fed quits injecting money and rise again when the Fed starts selling those bonds it has accumulated.

Bill Gross was on CNBC after the Bernanke speech and he believes the Fed is not going to raise rates for at least 12 months because the unemployment rate will remain high until 2012.

Bernanke laid out the Fed's accomplishments through the QE2 program during his speech. "A wide range of market indicators supports the view that the Federal Reserve's securities purchases have been effective at easing financial conditions. For example, since August, when we announced our policy of reinvesting maturing securities and signaled we were considering more purchases, equity prices have risen significantly, volatility in the equity market has fallen, corporate bond spreads have narrowed, and inflation compensation as measured in the market for inflation-indexed securities has risen from low to more normal levels." Note that the first accomplishment listed was the rise in equity prices. Don't fight the Fed!

Evidently the message is getting out to investors. In the first three weeks in January U.S> equity funds saw inflows of $8.3 billion and global equity funds saw inflows of $7.7 billion. The markets are breakout to new highs and retail investors are moving back into the market. Investors are attracted to new market highs like moths to a flame.

The airline sector is not where returning investors should be putting new money. Since December 1st more than 52,742 flights have been cancelled due to weather or other events. That is 5% of the total of all scheduled flights. Canceled flights are expensive because they disrupt future schedules and take planes out of the schedule forcing cancellation of other flights not directly impacted by the weather. Those planes have to be reinserted back into the flight system before future schedules can be resumed. Airlines are already starting to warn about profit shortfalls and the winter is not over yet. One analyst thought the December cancellations would cost $100 million and the January cancellations could be even more expensive. Add in the rising cost of jet fuel and it is going to be a bad winter for the airlines.

Amex Airline Index Chart

In earnings news Estee Lauder (EL) posted higher than expected earnings due to robust sales during the holiday season. Earnings rose to $1.71 per share and beating estimates of $1.44. Estee Lauder raised guidance to between $3.40 and $3.60 for the full year compared to prior guidance of $2.90-$3.10. Shares of EL spiked +14% to $91.90.

Estee Lauder Chart

Coinstar (CSTR), the company behind the Redbox DVD kiosks, warned in January that earnings would be lower than expected. The stock was appropriately punished and traders began moving back into the stock last week in anticipation of a rebound with earnings. Bad idea!

Redbox reported earnings tonight that were inline with the lowered guidance but warned that Q1 earnings would also be lower due to higher inventory levels acquired for sales that did not materialize. Redbox agreed before the holidays to delay movie rentals for 28 days after a DVD title has been released. They removed older inventory early and purchased new titles but the demand never materialized. Now investors are left worrying if the 28-day rule is a killer for Redbox since online services have fewer restrictions. Why brave a blizzard to rent a couple DVDs when you can download the movies for just a few cents more?

Coinstar is now predicting earnings for Q1 of 15-25 cents and analysts were expecting 57-cents. That is going to hurt! CSTR shares dropped another $5 in after hours.

Coinstar Chart

The Las Vegas Sands (LVS) posted a decent revenue increase for Q4 but it was still short of estimates. Revenue rose +57% to $2.02 billion but short of the $2.07 billion analysts expected. Earnings doubled to 42-cents and better than the 39-cent estimate. Most of the gains came from the Macau casino despite a run of bad luck at the tables. Margins fell from 21% to 13% as a string of lucky whales pocketed some major winnings. Fortunately the house always wins in the long run and those whales will probably end up giving most of it back over the coming months.

Chart of LVS

The problem in Egypt is rapidly escalating and the U.S. is now working with Egypt's new vice president, Omar Suleiman, on a plan to force Mubarak to leave immediately. Reportedly they are trying to work out a plan with Suleiman and the Egyptian military to force Mubarak to resign and immediately begin making some constitutional reforms in Egypt. Britain is also rumored to be involved in the talks.

The crackdown on Thursday on international media appears to be an attempt to cut off news to the outside world of what is expected to be even larger riots and demonstrations this weekend. Numerous reporters and photographers were beaten and their equipment destroyed by pro-government supporters. Several were hospitalized. The government accused the reporters of being sympathetic to anti-government demonstrators.

Other countries are flying their citizens out on chartered planes by the thousands. Egypt Air has been unable to find more than one-third of their flight crews and outgoing planes are packed. Many incoming passengers have been arrested for bringing in weapons of various sorts in anticipation of joining in the demonstrations.

I believe this problem is going to be solved with Mubarak's resignation in the very near future. It has to be solved or the demonstrations are going to become much more violent. The protestors are demanding Mubarak resign by Friday but I doubt that will happen.

I believe the rally to a new high on the worsening news from Egypt is yet another confirmation the bad news bulls are in control. The morning dip was very shallow and quickly bought. Investors are worried they are going to miss further gains and they are buying anything that looks like a dip.

The S&P rallied to close right at initial resistance at 1308 for the third consecutive day at this level. Wednesday's minor decline kept it close and the S&P is poised to breakout on good payroll numbers. The key will be holding any breakout gains.

The S&P has moved more sideways than vertical over the last month as it consolidated the December gains. Each move higher was followed by several days of backing and filling but the trend has been steadily higher. Eventually this will end with a steep bout of profit taking but you have to stick with the trend. Any dip remains a buying opportunity.

S&P-500 Chart

The Dow is creeping slowly higher and stretching its gains over 12,000 but the pace is very slow. The news events are being offset by economic events and the trend remains positive. Uptrend support is now 11,850 and the volatility from last Friday looks very out of place in the two-month trend.

Dow Chart

The Nasdaq is still lagging the Dow and S&P but the pressure is building. Over the month of January the Nasdaq built a base above 2675 and is ready to use that base for another move higher assuming there is not a news event that damages tech sentiment. We have already had several high profile events over the last couple weeks and none were successful in slowing the gains for more than a day or two. Resistance is 2760 and support 2675.

Nasdaq Chart

I continue to be amazed at how the markets are ignoring bad geopolitical news. The positive economics along with the Fed's QE2 program is providing a powerful reason to be long. I believe every dip is a buying opportunity and I know full well that eventually we will see some serious profit taking. That is how the market works. When that larger dip comes it will be an even better buying opportunity. Earnings and economics are both improving and the Fed is cheerleading from the sidelines. Go Ben!

Don't fight the Fed, buy the dips!

Jim Brown

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