Bad news continues to have no impact on the market as the end of quarter window dressing caused a strong rebound out of the morning dip.

Market Statistics

The Dow dipped 15 points below 12,200 this morning but the dip was quickly bought for a +93 point rebound off the lows. The Nasdaq was the strongest index with a +1% gain to 2756 and a +37 point rebound off the lows. All the major indexes closed at strong resistance and at the highs for the day.

This was a very light day economically with Consumer Confidence and Home Prices the only material reports. Consumer Confidence fell sharply from 72.0 and a three-year high in February to 63.4 in March. Higher fuel prices, the multiple crisis points in the Middle East and the nuclear crisis in Japan were blamed. It should also be noted that the market touched a two month low during the survey period.

The biggest loss came in the expectations component, which fell from a revised 97.5 to 81.1. The present conditions component actually rose from 33.8 to 36.9. Respondents that thought jobs were plentiful declined to 4.4% and those who expected an income increase declined to 15.3% from 17.4%. Those who expected an income decrease rose to 15.3% from 13.2%. Apparently something changed in the labor market for that big of a swing in wage expectations.

Those planning on buying a car fell from 12.8% to 10.9% and those planning on buying a home fell to 3.8% from 4.9%. Possible appliance purchasers declined sharply to 42.0% from 47.5%. Inflation expectations spiked to 6.7 from 5.6.

This was a very bearish report. Buying plans declined sharply suggesting retail sales are going to take a hit in March/April. The decline in the market probably put a dent in the wealth effect created by QE2 and the new market highs back in February. The market is a leading indicator of consumer sentiment and the March decline clearly impacted the survey.

Consumer Confidence Chart

The second report was the Case Shiller Home Price Indexes for January. This was a lagging report but the information weighed on the market. The 10-city index declined another -2% and the 20-city index declined -3.1% compared to December. Only two metro areas are above the levels of the prior January and eleven metro areas posted new cyclical lows. Chicago was -7.5% below the prior January, Vegas -4.4%, Miami -4.7% with Washington DC at +3.6% and San Diego +0.1% the only gainers. A couple more months of consecutive declines and home prices could set new lows for the recession. Home sales both new and existing are declining again and foreclosures are rising.

On Monday Lender Processing Services (LPS) said delinquencies over all continued to decline but foreclosures were rising. At the end of February foreclosure inventory was more than 30 times monthly demand. There was also a 23% increase in Option ARM foreclosures over the last six months and far more than any other type of mortgage. Option ARM foreclosures are currently running at an 18.8% pace. That is higher than subprime foreclosures ever reached. The average loan in foreclosure has been delinquent for a record 537 days. More than 30% in foreclosure have not made a payment in over two years.

The total U.S. loan delinquency rate is now 8.8% with the foreclosure rate at 4.15%. There are 6,856,000 homes delinquent 90-days or more.

On the positive side bank modifications appear to be working. More than 22% of loans that were 90-days past due 12 months ago are now current. That sounds like a small victory, very small.

For the rest of the week payroll numbers will rule with ISM reports a close second. The ADP employment report on Wednesday is still expected to sow job gains of +200,000 jobs. However, after the change in the employment outlook in the Consumer Confidence I am not as hopeful we are going to see good numbers. The NonFarm payrolls on Friday are expected to show job gains of +188,000.

Economic Calendar

In stock news Home Depot (HD) gained +3% after saying it would buy back another $1 billion in shares. This is in addition to the $2.5 billion previously announced for 2011. In 2010 HD bought back $30.1 billion of its stock. HD said it was going to fund the new buyback by selling $2 billion in senior notes.

I never agreed with the concept of going in debt to buyback stock but it is a recognized way to leverage your balance sheet to provide higher stock prices in the short term. If you are confident you will be producing a couple billion in free cash flow in the near future in order to pay off the notes I can understand the motivation. Otherwise the company ends up with lower earnings due to higher debt payments and that is always negative for stock prices.

Home Depot Chart

Apollo Group Inc (APOL) operator of the University of Phoenix declined -4.3% to $38 and the biggest decline since January after reporting declines in student enrollment and revenue. Apollo guided to revenue from $4 to $4.25 billion and profits of $675-$800 million. Analysts were expecting $4.55 billion in revenue and $1.1 billion in profits.

Apollo is changing the way it enrolls students in order to decrease dropout rates and student loan defaults. The government has been pressuring them because of a high dropout rate. Now they will let new students sample classes before committing to enrollment. Apollo reported a loss of $64 million or 45-cents for the quarter ending in February compared to the $92.6 million profit and 60-cents in the year ago quarter.

Enrollment fell -45% to 48,200 from a year earlier.

Apollo Chart

Amazon announced a new cloud service to allow users to store files, pictures, video and music on the web and retrieve them from anywhere. The service called Cloud Drive and Cloud Player and aims to beat Apple to the punch on this type of application. The service works with Android mobile platforms. When coupled with Amazon's MP3 store it gives Amazon a robust offering. The initial account comes with 5GB of space with a free upgrade to 20GB if you buy an album in Amazon's marketplace. If you need more space it starts at $20 per year for 20gb with options for more storage.

Amazon Chart

Lululemon (LULU) continued its upward spike after announcing a 2:1 split on Monday. Shareholders will vote on the proposal on June 8th with the split taking place "as soon as practical" after the vote. Sares rose +$4 after a strong gain on Monday as well.

LULU Chart

MolyCorp (MCP) was rocking again on Tuesday. JP Morgan boosted its price target from$66 to $74 on the rapidly rising prices for rare earth metals. The analyst said the growing shortage should continue to support rising prices in the metals. JPM has an "overweight" rating on MCP. MolyCorp is trying to boost production by +33% to 4,000 metric tons per year and they believe China will be a net importer of rare earths by 2015. There is also legislation in Congress to require the military to stockpile rare earths as a strategic commodity. That will drive prices even higher.

MolyCorp Chart

After the close Valeant Pharmaceuticals offered to acquire Cephalon (CEPH) for $73 per share. This is a +27% premium over Cephalon's closing price on Monday. This equates to $5.7 billion and will be paid in cash. Valeant said it expects to finance the full purchase price. The proposal is a hostile takeover because Cephlon's board had refused to engage in acquisition talks. Valeant said it will start the process next week to replace Cephalon's board of directors. Cephalon's shares spiked to $72.89 from $58.75 in afterhours trading.

Cephalon Chart

The S&P has rallied +5% year to date and the sector responsible for 42% of those S&P gains is the energy sector, specifically oil. The energy sector is up +15% and the oil service sector is up +21%. Brent crude is up +21% and WTI +14%.

Crude prices started to decline on Monday when the Libyan rebels were approved to sell oil to finance their revolution. That is not quite the way it was explained but you get the idea. The U.N. Security Council said the rebels were not on the sanction list. Qatar agreed to sell the oil for them but as you can imagine the devil is in the details. One of those details was a rout of rebel forces on Tuesday from recently captured ground amid a hail of artillery, tank and mortar bombardment. Turns out the Gaddafi military is not ready to give up the fight. The rebel retreat produced a realization that oil in any material quantity was not going to be shipped any time soon.

In addition to the setback in Libya the president of Syria fired his cabinet and promised to end martial law imposed in 1963 and never rescinded. Protests are increasing in Syria a country of 23 million. President Assad refuses to step down and more than 60 demonstrators have been killed.

WTI recovered to nearly $105 and Brent remains at $115.

WTI Chart

Brent Chart

U.S. gas prices as reported by AAA rose to $3.59 nationwide but both coasts are closer to $4 with quite a few cities already over $4. This is where the rubber meets the road in the form of an energy tax on the consumer and the beginnings of a serious drag on the economy.

Various Fed officials spoke over the weekend and early this week and several said the impact of high energy prices and the slowdown in government spending were strong reasons for continuing QE2 and possibly some additional stimulus after QE2 ends. Obviously not everyone was onboard with that sentiment. St Louis Fed chief James Bullard urged the Fed to cut its QE2 program by $100 billion and not wait for all the global uncertainties to be resolved before normalizing the loose monetary policy. Bullard said the policy is so lax at present it would take a long time to return to normal. Bullard thinks the Fed should taper off the remaining treasury purchases and then pause for several months before taking further steps to reduce liquidity. Bullard is not a voting member of the FOMC in 2011.

Offsetting Bullard's hawkish comments was Atlanta Fed president Dennis Lockhart. He said on Monday "I remain satisfied that the current stance of monetary policy is appropriately calibrated to the current and projected state of the economy. I see no reason to cut short the current treasury buying program short." He believes the short-term inflation as a result of high energy prices will be temporary.

The market shook off all the negative news about confidence, home prices, oil prices and Fed worries and rallied strongly out of the morning dip. Unfortunately volume was the second lowest day of the year at 6.1 billion. Monday was the worst day at only 5.8 billion. It is a clear case for lack of conviction by either side. Everyone has placed their bets for the end of the quarter and fund managers are fine tuning positions with an eye towards keeping the indexes pinned near the highs for the year until next week.

The S&P returned to 1320 and the resistance highs from Friday and Monday but could not break over that level despite the strong rebound from the dip to 1305 and the 50-day average at the open. We now have a clearly defined range that will give us a clear signal with a breakout in either direction. Stronger resistance remains at 1330 but it would take a significant news event to push us through that level. I believe fund managers will be content to just hold the indexes at this level through Friday.

S&P Chart

The Dow edged slightly over resistance at 12,250 and is now only 120 points from a new high. That would be a great headline for fund managers to end the quarter fully invested. You can bet the highly liquid large cap Dow stocks like CAT and IBM will be favored over the next 48 hours in order to keep the upward pressure on the Dow.

The morning dip below 12,200 was immediately bought and the Dow rebounded +95 points. Not bad on a day when all the economics was bad. Several analysts said they believed the bad news made it more likely the Fed would not end QE2 early and continued weakness could lead to additional stimulus after QE2.

Dow Chart

The Nasdaq was the biggest percentage gainer for the day with big cap techs PCLN, GOOG and AMZN leading the biggest gains list. Despite the gains the Nasdaq closed just barely over Monday's high and still a bout 45 points from real resistance at 2800. I seriously doubt the Nasdaq will mount a credible challenge on that level before the quarter ends.

Nasdaq Chart

Fund mangers have to hold their breath and positions for two more days before they can lock in the gains for the quarter. Any real window dressing should already be in place but you can bet they will keep the buying pressure on a few select stocks in order to keep the indexes pinned in place until Friday.

Friday is a serious risk for fund managers with the NonFarm payrolls. Nobody really expects a material decline in jobs and that is a serious problem if it appears. When traders are expecting something the reaction is priced into the market. When they are not expecting a problem and it appears the damage can be significant.

The job components in the Consumer Confidence concerns me. To get that big of a swing in confidence suggests something happened in the economy over the last three weeks that has not yet been reflected in the regional reports.

Can the bad news bulls overcome a significantly weak payroll number? After a knee jerk reaction I believe they can because it would mean no early end for QE2 and a greater chance for continued monetary stimulus. There is always a silver lining inside every cloud.

Jim Brown

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