The Friday rebound was uplifting for the bulls but volume was light and there was no conviction. This was expected for a Friday with weekend geopolitical events a worry for buyers.

Market Statistics

Actually, Friday's rebound was better than I expected. I thought buyers would hold off until Monday because of geopolitical concerns in Libya, Algeria and Bahrain. Holding longs over the weekend would have seemed risky. However, the bears were probably thinking the same thing. Holding shorts over the weekend could have ended painfully if Gaddafi suddenly stepped down or was eliminated. I expected the markets to close relatively flat on Friday and probably rally on Monday if there was any good news.

Helping to entice buyers back into the market was a spike in the final Consumer sentiment reading for February to 77.5. That is the highest reading since January 2008. This survey was completed before the market drop and the spike in gasoline prices. This is the first time the index has risen in February since 1999. The current conditions component rose +5.1 points to 86.9. One analyst said sentiment late in the month took a sharp spike higher with the equivalent headline number for the last two weeks in the range of 81.1. With the market breaking out to new highs and winter blizzards fading I can see why. Unfortunately the next reading for March is likely to take a serious hit from the market drop, Middle East problems and the rising gasoline prices.

Consumer Sentiment Chart

The Q4 GDP was revised lower to +2.8% growth from +3.2%. Unfortunately most analysts expected it to rise slightly. The drop was caused by an upward revision to imports and a drop in government spending. However, sales of domestic products were very strong at +6.7%. That is the strongest increase since 1998. The weakness will probably be one more point to keep the Fed in play. Had it been an upward revision to 3.5% the Fed may have been more worried the recovery was accelerating too fast. The PCE price index showed inflation still tame at 0.5%.

The rapid increase in spending is depleting inventories and that suggests the manufacturing cycle will gain speed in the months ahead. The decline in inventory levels took 3.7% off the GDP number in this revision.

The economic calendar for next week is packed full of critical reports. There are three ISM reports with the national ISM on Tuesday. The ADP Employment on Wednesday will be a preview of what to expect in the Non-Farm Payrolls on Friday. Also on Wednesday is the Fed Beige Book. This is the Fed's guidance on the economic activity in each of the Fed regions. It is expected to show accelerating growth.

The ISM Services is Thursday followed by the Non-Farm Payrolls on Friday. The payroll report is expected to show a gain of +250,000 jobs compared to only 36,000 in January. Analysts expect a snap back of +125,000 jobs that were pushed into February by the blizzards and then another 125,000 new jobs created in February.

A CEO for a company that does background checks for corporate hiring was interviewed on Friday and he said the volume of checks had increased over 20% in February. Obviously that suggests hiring has accelerated. Nearly all of the regional manufacturing surveys have shown a strong bounce in the employment components and hours worked. Apparently the extension of the tax cuts and the incentives for investing and hiring are working.

Economic Calendar

In stock news Intel rallied nearly +3% after Apple said it will use Intel technology in the MacBook Pro. Intel also rallied on a report from Citigroup saying PC sales would rise in March and April. AMD rallied more than 6% because Apple will use AMD graphics in that same MacBook. AMD is trying to improve its image and capitalize on the recent error by Intel in shipping chips with a flaw. Neither company has a chart I would buy.

Wells Fargo (WFC) caught an upgrade by Goldman Sachs on Friday to buy from neutral and a price target of $38. The stock rallied +3% on the news. However, late in the afternoon WFC filed a new 10-K and warned the SEC and other agencies could be preparing charges and penalties related to its mortgage business. Wells does not disclose litigation reserves but a worst-case scenario here would be in the range of $1.2 billion. The Wells CFO resigned unexpectedly on Feb-8th and there were worries at the time there could be some accounting problems. The new CFO signed off on the new 10-K and indicated the problem was not related to disagreements over accounting matters. The 10-K announcement was released at 3:PM so there was little time for investors to learn about the event and then understand the impact. Basically $1.2 billion is painful but not a killer for a bank the size of Wells Fargo. Later on Friday Bank of America and Citigroup also filed 10Ks with the same notification of pending SEC problems over foreclosures.

Wells Fargo Chart

I am sure everyone heard about the big Boeing win of the $30 billion Air Force tanker contract. Boeing has spiked for the last two days although they won't make a lot of money on the initial contract. The real money comes on future orders from the U.S. and other countries as well as the maintenance and support contracts for decades into the future. If you are a long-term investor you might want to look at the suppliers to Boeing because they will have a faster ramp and higher profit potentials.

United Technologies (UTX) will produce the engines for the first 179 planes with four engines per plane plus spares. RTI International Metals (RTI) will produce various metal and titanium parts for the planes and that is a guaranteed profit stream for years to come. Spirit Aerosystems (SPR) will manufacture the forward fuselage. Rockwell Automation (ROK) and Honeywell (HON) will also benefit strongly from the deal. Boeing estimates the contract will create 50,000 U.S. jobs at more than 800 suppliers. An added benefit for Boeing will be new life for the 767 production line. Since the tanker uses a 767 frame this will allow Boeing to keep the line open and continue selling regular 767s for buyers who don't want the 787. Outstanding 767 backorders have declined to around 50 but some 787 buyers are considering switching back to the 767 because of the 787 delays.

Remember, this is a long-term contract for about 14 planes a year so don't expect an immediate jump in those stocks. You also need to factor in Boeing's terrible record for producing planes on time. The 787 is three years behind. The 747-8 passenger plane is already a year late and the freighter version is two years late. The new tankers will replace the KC-135 tankers that entered service in the 1950s. The U.S. definitely got its money's worth on the KC-135 purchases.

Holding the market back was the continued crisis in Libya and a return to demonstrations in Tunisia. In that country, the first one to force a government turnover, more than 100,000 demonstrators gathered to protest the new government. Their complaint was the lack of progress in scheduling elections and making government reforms. You have to admit a new government seeing 100,000 angry demonstrators only a month after a change should build a fire under those responsible for getting those changes accomplished. What it also shows is a movement towards mob rule in the Middle East.

Reportedly the entire Egyptian revolution that finally forced Mubarak out of office was started by 10 people living in a small apartment and spending 24-hour days on social networks trying to build up support for change. They formulated an idea on how to make it happen and then devoted 100% of their energy and the idea turned into a movement and then a revolution.

Gaddafi (There are 112 different spellings of the English translation of his name) is clinging to power but real estate under his control is still shrinking. The US, UN and the EU countries are all enacting sanctions against Libya over the next several days. Reports are coming out of Libya claiming thousands have been killed but they are unsubstantiated. There have been cell phone pictures of military trucks picking up truckloads of bodies and taking them to undisclosed locations. We may never know how many were actually killed. Regardless the developed nations are taking steps to make it more painful for the Libyan government to continue. Rebels are closing in on Tripoli where Gaddafi is hiding and the outcome is pretty certain.

He tried to move $4.6 billion into a personal wealth management account in London last week through an intermediary. When the brokerage found out the ultimate identity of the money's owner they cancelled the account. Now Britain is only one of a dozen countries trying to seize his assets and the assets of 28 other relatives and regime officials.

In the days to come that crisis will be resolved and then move into a new phase of rebuilding. Without Gaddafi in power the world will be much more agreeable about supplying aid and helping to get medical aid flowing and oil production restarted. The markets understand this and when the transition comes the market reaction should be quick.

The impact of the Libyan problem is of course the halt in oil production. There are differing estimates from 400K to 1.2 million barrels per day offline. Some say Libya's total production of 1.6 mbpd is offline. Nobody really knows but perception is reality. If the market thinks production has halted then prices will react to that idea.

We saw Brent crude rally to $119 on Thursday because most Libyan production goes to European refineries. Saudi Arabia stepped in and said they would produce any quality and quantity of oil that Europe needed to replace Libyan supply. Unfortunately that was another skillfully crafted lie because Saudi has no light sweet crude in the same quality that Libya produces. I wrote a complete article on this in the OilSlick newsletter on Thursday night. You can read it here: Quality or Quantity?

Regardless of when the Libyan problem is resolved we should get used to paying higher prices for gasoline for the foreseeable future. Unfortunately higher oil prices help put the "stag" in stagflation. A spike in oil prices has preceded every recession since World War II. Expensive energy will be a drag on the recovering economy. Economists claim every $10 rise in oil prices subtracts -1% from U.S. GDP. The rise from $85 to $95 will subtract 1% from Q2 GDP. Every $1 rise in crude prices costs the U.S. consumer $7.665 billion per year in added fuel expenses. That $10 rise to $95 will subtract $76.65 billion from consumer wallets and produce some serious drag on the economy.

Despite that drag economists still believe the recovery is strong enough to continue and that will offset that energy drain. However, another $10 rise to $105 will cost another $76.65 billion. A billion here, billion there and pretty soon we are back into recession again. This is not rocket science. There is not enough light sweet crude to cover the shortfall from Libya and cover increased demand from the recovery.

I am not claiming the economy is about to fall off a cliff but the seeds of destruction are being sown. How long it will take for those seeds to germinate and grow to maturity is unknown but probably before the end of 2012. Economists claim for every 25-cent increase in gasoline prices over $3 it will cost 600,000 jobs over the next two years.

The impact of the recent price hikes is easily seen in the airline sector. Jet fuel prices have risen +20% so far in 2011. They rose +11% just since Feb 15th. Jet fuel is the number one expense for airlines and it just rose 20% and that is not even factoring in the oil prices from last week. Airlines just announced the fifth fare increase for 2011. On January 1st analysts expected profits from U.S. carriers to reach $6.5 billion in 2011. Since then fuel prices have risen to $3.12 per gallon and if they reach and hold $3.15 for the rest of the year that entire $6.5 billion in profit would be wiped out and turned into a loss. For that to happen oil prices would only have to remain near Friday's close at $98.

Now translate that shift in profitability across the entire nation or even the world and you see what kind of drag oil prices will eventually be on the recovery.

I believe that once the crisis in Libya is concluded we will see prices decline but not by much. I think $88-$90 is the current floor for WTI but that is not the real price of oil. Brent is the new standard because of the technical problems at Cushing OK and the WTI delivery point. Refineries on the east coast buy Brent or oil grades indexed to Brent for their feedstocks. Refiners in the Gulf are indexed to Louisiana Light Sweet or similar and that is also tracking Brent prices. The only refiners able to capitalize on the "cheap" WTI are those mid continent refiners like TSO, HOC and CVI. Everyone else is indexed to the higher priced oil so consumers in the rest of the country will be paying Brent prices for gasoline.

The oil commentary above is for future reference. The market is ignoring the risk today. Months from now we may not be so lucky. I was actually encouraged on Friday because the market was listening to stock news not Libya news. For instance Intel rose on Citi's forecast and Apple's announcement. Stocks were reacting to stock news and not geopolitical events. The exception was of course oil stocks breaking out to new highs on contagion worries.

The contagion factor is our worst worry for next week. The new demonstration in Tunisia shows that unrest can reappear just as quickly as it faded. There were also new demonstrations in Egypt and Bahrain over the weekend. Saudi seems to have dodged a bullet so far with the $35 billion giveaway to the people but nobody knows how long it will last.

The contagion factor will be the cloud over the U.S. markets but not an active storm. Just an ominous cloud on the horizon that traders will be watching.

The U.S. economic reports should be a positive influence to offset that cloud. The Fed Beige Book should show an accelerating economy and the payroll report should show the biggest job gains since November 2005 if you don't count the three months of temporary census jobs. I think the market will react strongly to a number like that.

The current economics are accelerating as evidenced again by the highest reading in consumer sentiment in three years. There is no reason for the market not to be bullish about the current situation. We probably have another three weeks before the worry over the Fed ending QE2 starts to impact the institutional sentiment. The March 15th FOMC meeting could be the turning point. If Bernanke keeps talking about the possibility of QE3 we could see that bearish decline postponed. The offset to the end of QE2 is of course a much stronger economy. I just don't think we are there yet.

With all the Fed presidents and former Fed governors all coming out on the hawkish side of the debate last week I think Bernanke does not have a snowballs chance of getting a QE3 approved. We heard from Plosser, Yellen, Fisher, Hoenig, Kohn, Lacker and Bullard and even the dovish ones were carefully phrasing their comments to stress their concern over keeping QE2 too long. However, even inflation hawk St Louis Fed President James Bullard said the Fed "can never say never" to QE3. They are all toeing the party line despite their known views.

Lacker had an interesting comment. He said nobody believes there is an inflation problem but $4 gasoline and $4 lettuce should convince consumers that inflation is here regardless of the economic models. I have a friend who runs a restaurant. He told me on Saturday that tomatoes had gone from $16 per case several months ago to over $60 today. Cucumbers had risen to $90 per case. Some of this is related to the harsh winter weather and a freeze in the south but he said even before that cold weather the price of tomatoes had risen to $45 per case, a +300% increase. Sure glad there is no inflation yet. (grin)

Bernanke and the gang are actually benefiting from the Middle East crisis. The eventual impact to our economy plus the higher oil prices means the Fed should stay in its "extended period" mode even longer. Same with Europe's lingering sovereign debt crisis. All these events suggest Bernanke and team will not change their posture any time soon.

It was an interesting week in the markets. The S&P declined about -4% from its highs before closing at exactly the 50% retracement level for the dip. A perfect 50% rebound and pause is less common than you would think. The halt at that exact 50% level left the index poised to either fail at the perfect resistance level or use that level as support for next week.

S&P Chart - 45 min

The dip on the S&P was a textbook drop to support and immediate rebound to midline resistance. In theory the most likely direction would be down from here if you are only looking at the charts. When you take into account the rising economic fundamentals the most likely outcome would be a continued rebound.

S&P Chart - Daily

The Dow declined -408 points from a high of 12,391 the prior Friday to 11,983 on Thursday. It spent a total of 15 minutes under 12,000 before the rebound began. This was a textbook example of a short-term bull market correction to critical support and the resulting bounce.

Unfortunately that was only a -3.2% decline and that might not be enough for those who are expecting a bigger sell off as a buying opportunity. The rebound to 12,140 fell short of the 50% retracement level at 12,187, which just happens to be decent resistance.

That rebound also stalled at the first Fib retracement level and the ideal point for a failure ahead of a further decline. This is another one of those pivotal moments in the market.

While the declines to support and resulting rebound on the S&P and Dow were textbook from a bullish perspective they are also textbook examples of where a bear market rebound should fail. Volume was very light at 6.9 billion shares although advancing volume was 6:1 over declining and advancers 5:1 over decliners. There was still no conviction on the part of the buyers although given the weekend event risk I completely understand why.

Dow Chart - 45 Min

Dow Chart - Daily

The Nasdaq had the largest rebound of the big cap indexes and came to rest above the 50% retracement level but exactly at the resistance from early January. The Nasdaq benefited from the bullish call on PC sales from Citigroup and from the rebound in some of the tech names that were trashed earlier in the week. Tech bulls were eager to jump back in on beaten down techs like FFIV. Apple saw a decent bounce ahead of the March 2nd iPad 2 announcement. However, it was not because of gains in a few big techs but a broad based rebound. There were 2001 advancing stocks in the Nasdaq and 461 decliners.

The rebound to resistance could be a problem if there is not a decent rise in Asian shares on Sunday night. If the futures power the Nasdaq over that level at the open then tensions will ease. If the Asian markets are weak and the U.S. markets open lower then that resistance could strengthen ahead of the next test.

Nasdaq Chart - 60 Min

Nasdaq Chart - Daily

The most bullish index is the one we want to do well. The Russell rallied for a +2.2% gain on Friday and blew past every level of retracement resistance. Fund managers were not holding back. There were 1669 advancers and 200 decliners with 101 new 52-week highs. There was nothing bearish about the rebound in the Russell and this "should" translate into a continued market rebound next week, assuming there are no further news events to distract from the market.

Russell 2000 Chart - 60 Min

Was Friday's rally a bear market bounce or the start of a lasting rebound? If I knew the answer for sure I could sell the knowledge and retire with my own island. Unfortunately there are no sure things in the market and the Dow, S&P and Nasdaq all closed right at textbook reversal points for a bear market rebound. However, given the event risk over the weekend I would have been surprised if they had not halted there.

The key will be the weekend news events and whether they sour sentiment ahead of the open. As of late Saturday afternoon the flare up of demonstrations in Tunisia, Egypt and Bahrain could cause more contagion concerns. Those countries were throught to have been behind us but a resurgence could lead to further problems elsewhere.

Helping to produce positive sentiment on Monday is the Warren Buffett letter to Berkshire shareholders on Saturday. Buffett was bullish and said he was itching to buy with $38 billion cash in the bank. He said America's best days lie ahead. He believes a housing recovery will begin soon, He said "the prophets of doom have overlooked the all-important factor that is certain: Human potential is far from exhausted and the American system for unleashing that potential, a system that has worked wonders for over two centuries despite frequent interruptions for recessions and even a Civil War, remains alive and effective." Berkshire had a net income of $13 billion in 2010. His letter is widely read and has been known to give the market a boost.

Based on the positive economic fundamentals and the very positive internals on the Russell on Friday I think our chances for a continued rebound are good. Not assured but good. If we do roll over, a second test of support could produce a double bottom and provide for a stronger rebound. Obviously a failure of that prior support would be very bearish and suggest a much lower low. The key numbers to watch are Russell 800, Dow 12,000 and S&P 1,300.

Jim Brown

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"A fanatic is one who can't change his mind and won't change the subject." - Sir Winston Chrchill