Worries over Japan's nuclear escalation, a revenue shortage on Alcoa and a sharp downgrade on the energy sector by Goldman Sachs created some serious selling today.

Market Statistics

The markets opened ugly and never managed a decent rebound attempt. Japan raised its assessment of the nuclear accident from a five to a seven and the highest level on the accident scale. That is the same level as the Chernobyl disaster. The shock value of this news was significant but in reality nothing changed. Officials claim the current disaster has released less than 10% of the radiation released by Chernobyl. The type of radiation is also significantly different with the current disaster releasing mostly radioactive iodine with a very short half-life. I am not trying to make light of the current disaster but the news shock was worse than the actual damage comparisons.

The bigger issue for the market was a downgrade of the commodities sector by Goldman Sachs. Four months ago Goldman recommended investing in a basket of commodities including oil, copper, platinum and cotton. Those commodities have gained roughly 25% since the recommendation.

Goldman said, "Although we believe that one a 12-month horizon the CCCP basket still has upside potential but in the near term, risk-reward no longer favors the basket." The CCCP basket had a 40% weighting in oil, 20% copper, 20% platinum, 10% in cotton and 10% in soya beans. The commodities team has been considered long term bulls on the market but now they are warning it is time to take profits. Goldman noted "signs of demand destruction in the U.S." as a drag on prices. They also believed the possibility of a ceasefire in Libya could depress prices.

Goldman said the damage in Japan is likely to dent demand in copper and platinum and rising oil prices could cause a further decline in copper demand in China.

Goldman's call created a wave of selling across the entire commodity sector with metals, grains and crude prices going into free fall. Oil was hit the worst with WTI crude trading as low as $105.50 on Tuesday after trading at nearly $113.50 on Monday. Goldman pointed out that there were four times the number of speculative net longs in crude futures than were in June 2008. For every one million barrels under contract by speculators raises the price of crude by as much as 10-cents per barrel. The CFTC said last Tuesday there were net long contracts equivalent to a near record 267.5 million barrels. That suggests there is roughly $24 in risk premium in a barrel of oil. Investors accumulated the equivalent of 100 million barrels of oil between mid-February and late March on top of their existing positions. That alone added $10 to the risk premium according to Goldman.

The MasterCard Spending Pulse report for last week showed gasoline demand fell -1.8% and declined for the sixth consecutive week. Demand was down -3.0% over the same period in 2010. More than 70% of the nations major gas station chains said sales had fallen. The decline over the last five weeks was the sharpest since the summer of 2008 when gas prices hit $4 per gallon. Prices hit $3.77 per gallon on Monday.

Other analysts believe the end of QE2 will halt the decline in the dollar and we could see some firming ahead of fall as traders begin to anticipate some sort of policy tightening by the Fed. This is well down the road but the key today is the anticipation of the April 27th FOMC meeting and Bernanke press conference. Traders don't know what to expect and that uncertainty is causing them to take profits on those commodity positions supported by the weak dollar and QE2. With most of those commodities up +25% over the last couple months and clearly in nosebleed territory it would be hard to go wrong by taking profits now. Any future upside is limited and peppered with event risk.

Goldman predicted a decline in WTI crude to $99.50 and $105 in Brent. That would be a $14 decline in WTI and -$22 decline in Brent.

WTI Oil Chart

Brent Chart

Gold prices declined -$25 off their highs at 1478 on Monday to close at $1453 today. Silver hit $41.97 on Monday and an all time historic high over the $41.50 set back in 1980. It closed at $40.09 today. The CRB Index only declined about 2% after a +38% gain since August. If there is going to be a true correction in commodities there could be a lot more pain ahead.

CRB Index

The economic reports today were mostly ignored. The weekly chain store sales rose a miniscule +0.1% compared to a +2.3% gain in the prior week. The Import prices for March rose +2.7% and a significant increase from February's +1.4% gain. The spike in March was the highest since June 2009. Year over year prices have risen from +7.2% to +9.7% and the highest since April 2010. Imported oil rose +10.5% in March. Export prices rose +1.5%. Imported food and beverage prices rose +4.2% in March.

The February trade deficit was nearly flat at -$45.8 billion from -$46.3 billion in January. This is a lagging report and nobody was watching.

The Treasury Budget deficit in March was -$188 billion. Through the first six months of the fiscal year the deficit has risen +16%. Tax receipts were $150.9 billion and expenses $339.0 billion. The deficit for March was early triple the $65.4 billion deficit for March 2010. The total deficit through the first six months of the fiscal year, which starts in October, was $829.4 billion. The government is on track for a $1.5 trillion deficit for this fiscal year and slightly less than 9% of GDP. If you thought the battle between the administration, democrats and republicans over the 2011 budget was bad just wait until the debt limit ceiling debate begins after the Easter recess.

The biggest economic event for the rest of the week will be the Fed Beige Book on Wednesday followed by the Producer and Consumer price Indexes.

Economic Calendar

Cisco, under pressure to revitalize earnings and cut costs, announced it was killing the Flip Video. This was the most popular video camera in the U.S. just two years ago. The Flip was created four years ago and bought by Cisco for more than $500 million two years ago. Users love the camera and its ease of uploading and editing video. Considering the big following of the Flip Video it was a shock to most that Cisco would just announce a shutdown rather than try to sell the company.

Cisco also said it was dumping their Umi home video conferencing business. The service turned your high def TV into a big videophone for $24.95 per month. They recently cut prices to $99 per year. Now they are going to fold that unit into its corporate video conferencing business and stop selling the unit through retailers. Cisco needs to make some big changes and these small moves are not building confidence in the company. Earnings have produced some very traumatic moves on the chart over the last year as every quarter seemed to be worse than the one before. Does anyone even care what Cisco does today?

Cisco Chart

Alcoa was the first Dow component to report earnings and they beat the street by a penny but revenue was lighter than analysts had expected. Shares fell -6% on the news. Alcoa said raw materials costs had risen significantly. They also warned that higher oil prices would also weigh on future profits. They also took a significant hit on currency conversion with large losses converting back from the Canadian dollar, Australian dollar and the Brazilian Real. Alcoa reiterated expected sales gains of 12% for 2011 and that was considered positive. Overall, given the rally over the last month I believe it was mostly profit taking and the impact from the commodity sell off.

Alcoa Chart

Shares of Tyco rose over 7% after news broke they had held early talks with Schneider Electric about a possible acquisition. Schneider has approached bankers about financing a potential takeover that could create the world's largest maker of security systems. CNBC reported that the rumor about Schneider had prompted interest from other companies and the prospect of a bidding war is what spiked the stock. Other bidders could include Siemens AG (SI), Honeywell (HON) and United Technologies (UTX).

Tyco Chart

With oil prices dropping like a rock the Dow Transports gained ground and was the only sector to end the day in positive territory other than Healthcare. The airlines were flying high with UAL +6%, DAL +5%, AMR +2% and LCC +3%. I think it is a little early to be jumping on an airline stock because crude fell for two days. Even with oil at $106 at the close that represents a major problem for the airlines. The Air Transport Association (ATA) said the recent rise in jet fuel prices had increased the fuel bill for domestic carriers by more than $3 billion in Q1 alone. Jet fuel was $3.20 back on March 4th when oil was $105. The ATA says fuel at $3 per gallon would raise airline costs for the full year by more than $15 billion. Considering the industry only posted a $3 billion profit for all of 2010 the odds of a profit in 2011 are close to zero. Even if oil were to dip under $100 temporarily it appears fuel costs are going to stay well over $3 the rest of the year. I would be looking for any material bounce in the airlines as a new shorting opportunity. The airline industry as we know it is doomed as we approach the end of cheap oil over the next 2-3 years.

Airline Index Chart

Bulls should not be happy tonight. The S&P broke below strong support at 1320 and failed to produce any material rebound ahead of the close. Intraday dips are opportunities to watch market sentiment in action as buyers rush in to enter new positions at a discount. There was no rush today and those who did nibble at the morning lows likely failed to see any gains after the indexes slipped backwards at the close.

The S&P has now broken the rebound trend from early March and the consolidation up around 1333 has failed. This would appear to be a setup for a further decline. However, this was a strong news day. How much the Japanese news actually affected the market is unknown but it was the lead story all day. I think the commodity news was bigger. With a broad range of energy and commodity stocks taking a serious hit it created a major drag on the indexes. Add in Alcoa's warning about higher fuel prices and the Airline Association suggesting airlines could lose $10 billion due to high fuel prices and suddenly the market has a problem. Gone is the positive earnings sentiment from last week and now we are awash in multiple headlines on topics that are weighing on the economy and on corporate earnings.

So far 29 S&P companies have given guidance about Q1 and 13 of them said Japan would have some impact on their sales or earnings. This is just the leading edge of guidance and the tsunami is just ahead with a large number of S&P companies reporting next week. What are they going to say? Is Japan an earnings problem or not? Will fuel prices weigh on the consumer? Will the FOMC change the statement on the 27th?

There are lots of questions and no answers and that produces a fertile environment for the uncertainty virus.

The S&P dropped under my buy the dip target at 1325 and I am neutral on the market until we move back over that level. If the decline continues I would probably nibble again in the 1295-1300 range but we will have to wait until that level appears and see what is making news. Until then I am in wait and see mode. Initial resistance is now 1320, support 1305.

S&P-500 Chart

The Dow fell -148 points at the open and only recovered 30 of those points before the close. This is not a positive development. We did see the index close right on a prior support level at 12,265 but I think it was gravity and not the specifically related to that particular level.

The Dow was dragged down by a -$3.60 loss in Chevron and a -$2 drop in Exxon. CAT lost -$2.50 and MMM -1.50 to round out the top four. With a combined market cap of $750 billion in those four companies and four of the top five highest weighted companies in the Dow, I am surprised the damage was not worse.

If you compare the charts of Chevron, Exxon and the Dow they are identical. That means the majority of the Dow decline was related to the drop in crude prices and the corresponding decline in energy stocks. Does this mean a rebound in energy solves the problem? Not specifically and I would not bet on a rebound in crude with expiration only a week away. Just seeing oil remain flat at $105 would mean there is no further drag on the Dow but it would still need something in the news flow to push it higher. All I see on the horizon is the potential for negative news unless Qaddafi suddenly develops a conscience, resigns and moves to Morocco.

The JP Morgan earnings will be the Dow mover on Wednesday and hopefully they are positive. If current support at 12,260 fails we could be looking at a retest of 12,000 very quickly.

Dow Chart

The Nasdaq was hard hit with big caps of all varieties taking big losses. Williams Clayton Energy (CWEI) was the biggest lower at -$7 but it was the only energy stock in the top 20. GOOG, BIDU, SINS, MELI, AMZN, FAST and ISRG all lost over $3.

The Nasdaq broke below strong support and the 50-day average. The next material support level is 2725 with today's close at 2744. This is not a good sign and it is obviously not a result of the drop in oil or commodities. I suspect traders are becoming increasingly worried over Japan's impact on earnings and the fact the Japan problem is not yet over. Another 6.3 aftershock this week was evidence there could be even more shocks ahead and the supply chain problem could extend for an even longer period.

I have no confidence in the Nasdaq to bounce and it is entirely possible it will continue to drift lower. Initial support is 2725 and resistance 2765.

Nasdaq Chart

The Russell also declined sharply and it was not specifically due to oil prices or commodities although there are more of those stocks on the Russell than the Nasdaq. The Russell declined because investor sentiment is weakening. Like the analysis I wrote about I believe it is worry over the impact of Japan and high fuel prices on earnings. Managers also have some significant profits to capture from the March bounce and once the rally failed at 850 there has been an increasing rush to the exits.

We could see support hold at 820 but I am not betting on it. The next material support is 780 and that is a long way off with a roadside park at 800 on the way down. Let's hope that trip is cancelled.

Russell Chart

On the positive side volume was relatively light at only 7.4 billion shares and it was just over 2:1 in favor of down volume. This was far from a blowout or a capitulation event. It appears to have been a garden-variety bout of profit taking prompted by the failure to breakout last week and the overload of negative news this week. Wednesday will be the key with earnings from JPM. If the earnings are good it could lift the banking sector and that is the largest sector in the S&P. Sudden declines in energy stocks after an oil price shock tend to be limited in duration. Energy is still the sector to hold for the long run since even an oil price decline to $95 is still extremely profitable for oil companies. It also provides a higher starting level for the next rally.

Futures are up on Tuesday evening but still a lot of darkness before morning.

Jim Brown

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