The Dow has gained more than 700 points since April 18th and the Nasdaq ended the month at a 10-year high. The Dow Transports and the Russell 2000 closed at historic highs. It was a banner week despite the pressure from the Nasdaq rebalance and FOMC meeting.

Market Statistics

Earnings continued to power the markets higher with Caterpillar giving the Dow nearly a +25 point boost on Friday. Strong earnings and a docile Fed overcame a continued rise in oil and commodity prices. Bearish sentiment as evidenced by the VIX is almost nonexistent.

The economic news on Friday was mixed with a flat reading on Consumer Sentiment and a decline in the Chicago ISM. The final Consumer Sentiment reading came in at 69.8 and only +0.2 over the initial report. The minor improvement came from the expectations component with the present conditions component flat. Concerns about the rising deficit crept into the worries consumers have over the future. Fuel prices and unemployment are still at the top of the list but the recent political battles have evidently added a deficit worry to the list.

Consumer Sentiment

The ISM Chicago, formerly called Chicago PMI, fell for the second consecutive month. The headline number declined from 70.6 to 67.6. Analysts were quick to claim supply chain problems from Japan since a lot of Chicago's manufacturing is related to automotive production.

However, the new orders component fell from 74.5 to 66.3 and order backlogs fell to 62.4 from 69.6. I have a hard time believing a hiccup in parts supply from Japan would impact orders and especially backorders in the USA. I could see it slowing production but not orders. The activity in the Chicago area has been very strong so a cooling off period should not be a major concern. The decline from the February highs at 71.2 has still left the index at a high level compared to the last three years. There should be no complaints here.

Chicago ISM Chart

The ISM for the New York region was also released and the gains continued to push it to a new high. The index rose +3.5 points to 525.1 but the minor gain was the slowest rate of increase in nearly two years.

The current conditions component fell from 66.4 to 56.9. That 56.9 level is the lowest rate of growth since august 2009. The employment component fell back into contraction territory at 48.8 from 62.0. That is the first reading in contraction territory since 2009. This is yet another data point that suggests economic activity across the nation slowed sharply in April.

Two other reports were mostly ignored. The Employment Cost Index showed costs rose +0.6% in Q1 with most of the expenses related to benefits. Wage growth remains slow. However, in the separate Personal Income report for March we saw income rise +0.5% and slightly better than the consensus at +0.4%. Personal Spending rose by +0.6%. The report also showed top line inflation rising at +1.8% and the fastest since May 2010. Energy prices have risen by an average of +3.6% per month in the last two months.

On Monday we will get the national ISM report and it is expected to show a decline from 61.2 to 58.5 for April. Tuesday has Factory Orders and Wednesday the ISM non-Manufacturing.

Starting on Wednesday we shift into employment mode with the ADP report, which is expected to show a gain of 200,000 jobs. However, the Non-Farm Payroll report on Friday is expected to show a smaller increase at +145,000 jobs compared to the +216,000 gain in March. I am worried about this month's payroll numbers. We have seen consistent declines in the employment components in the regional activity surveys. At the same time the weekly jobless claims have been rising. Taken together these are not a good sign. It could be just a case of automakers doing short-term layoffs until parts return to full strength but we have no way of knowing. This report could produce a knee jerk reaction in the market but the bad news bulls could look at it as another data point that keeps the Fed on hold for a longer period.

Economic Calendar

The earnings parade will continue but the big names will be lacking. So far 323 of the S&P-500 have already reported earnings and the busiest week of the Q2 cycle is now behind us. The list below probably contains a lot of symbols you probably never heard of. After this week the number of reports will decline significantly.

For Q1 the earnings have been outstanding with the latest update showing 73% have beaten estimates and only 15% have missed estimates. The average earnings growth has risen to +22.6%. The best performing sectors were materials with +51% earnings growth, energy +35%, industrials +33%, tech +35% and consumer discretionary +15.5%.

If everything continues as expected for the rest of 2011 this should be a record year for earnings. The prior record earnings for the S&P were $88.18 in 2007. We saw that decline to $72.49 in 2008, $60.90 in 2009 and then rise to $84.35 in 2010. For this year consensus estimates are for another rise to $99.31 and a new record. If you apply a discounted PE of 14 that suggests the S&P is fully valued in the 1,400 range. Obviously for every PE increment over 14 that increases the equivalent value of the S&P by roughly 100 points. As earnings grow investors become more excited about owning stocks and the PE they are willing to support begins to rise. The median PE over the last 120 years has been 15.78 according to Robert Shiller. The lowest S&P PE recorded was 4.78 in Dec 1920 and highest 44.20 in Dec 1999.

Earnings Calendar

Starting Friday off with a bang was the earnings from Caterpillar (CAT). The company posted a +57% increase in sales and a +500% rise in earnings. To say this was a blowout quarter would be an understatement. It was good CAT posted such outstanding earnings because expectations were already high. Actual earnings were $1.84 compared to analyst estimates of $1.31 per share. Revenue increased from $8.24 billion to $12.9 billion. They are expecting record full year earnings of $6.25 to $6.75 per share in 2011 and $8 to $10 in 2012. The prior forecast was "near $6" earlier in the year. Analysts were expecting $6.30.

CAT said it expects global GDP growth of around 4% with developing countries at 6.5% and the U.S. under 3.5%. The U.S. was the soft spot for CAT and the CEO said they had not yet seen any material increase in business in the USA. The stock gained +2.77 to add nearly +25 points to the Dow. CAT said the Japan quake will cost it about $300 million in lost sales and $100 million in profits because of delays due to damage to supplier facilities. The CEO was interviewed on CNBC and he was positively beaming about the amount of business coming to them around the world. He said the next three years should be very strong. He also said the higher oil prices were not yet impacting sales.

Caterpillar Chart

Goodyear Tire (GT) also posted blowout earnings that beat estimates by 400% thanks to strong sales in North America. GT posted earnings of 51-cents compared to analyst expectations of 12-cents. Sales rose +27% to a record $5.4 billion. Shares gapped +12% higher to $18.15 and a new 52-week high.

Goodyear Chart

Two more major oil companies reported earnings with Chevron posting profits of $6.2 billion on a +23% rise in revenue. Earnings of $3.09 beat estimates of $3.00. However, the gains came from higher prices for oil rather than increased production. Nearly every oil company that has reported for Q1 has reported a decline in production. Chevron's decline was -1% to 2.76 million barrels per day.

Total S.A. (TOT) posted profits that rose +35% and said it would take a 60% stake in SunPower (SPWRA). That powered SunPower to a 34% gain for the day.

Occidental Petroleum (OXY) posted earnings that rose +45% at $1.96 per share and beat analyst estimates of $1.80. OXY was one of a select few that actually increased production for the quarter with a +4% increase and that was in spite of some shutdowns in the Middle East due to political unrest. OXY shares rose +9% on the news.

Occidental Chart

NetGear (NTGR) spiked +23% on Friday after posting earnings of 65-cents compared to estimates of 52-cents. Unlike Cisco, NetGear is expanding its product line and added 20 new products during the quarter. The new products powered sales and allowed them to raise guidance significantly for the second quarter. They now predict revenue in the $270-$280 million range and analysts were only expecting $240 million. That is a significant upgrade in a market where Cisco is canceling products and falling back to their core services.

NetGear Chart

On the negative side of the earnings ledger Deckers (DECK) reported earnings that beat the street on Thursday evening and then guided to an unexpected loss for Q2. They only beat by 2-cents with earnings of 49-cents but the Q2 loss forecast of -25 cents was a killer. Analysts had expected a 5-cent profit. Shares of DECK declined -10%.

Deckers Chart

You may remember Research in Motion (RIMM) also warned on Thursday after the close that sales of their trademark BlackBerry product were slowing. RIMM said sales of the smartphones would be on the low side of prior estimates because consumers were going for the cheaper products. That was the second major warning in the last six weeks. They did not say it but obviously sales are going to the iPhone and Android as well. The PlayBook is also being greeted coldly despite some decent ads this week. Analysts have recommended waiting for the next version or skipping the PlayBook completely. RIMM shares fell -14% on Friday.

RIMM Chart

Apple shares rallied strongly on Friday morning thanks to RIMM's bad news. Slowing sales for BlackBerry is good news for the iPhone. The morning spike was mostly short covering since traders had been shorting it into the close on Thursday on expectations for some serious selling on Friday when Apple's weighting was reduced from 20% to 12% in the Nasdaq 100. The best laid plans of mice and men sometimes go astray. Once it was evident shares were not going to roll over by lunchtime a new wave of buying appeared. Strength in the face of negative expectations is always a buying opportunity. However AAPL did decline about $5 at the close thanks to the rebalance selling but amazingly the shares ended the day with a decent gain.

I believe this is very positive for Apple and I would be a buyer of Apple shares on Monday as long as the markets are positive. I believe everyone was waiting for a dip to buy on the rebalance and they will chase prices higher next week.

Apple Chart - 10 Min

Apple Chart - Daily

If the market is open the dollar is dropping. That seems to be the new trading paradigm for 2011. The dollar declined -4% in April, -10% in 2011 and as been lower for the last nine trading days. Friday's close was the lowest since July 2008. This is not a situation that is going to change in the near future although there may be a temporary bounce in our near future.

US Dollar Index Chart

As usual the decline in the dollar helped push commodities higher again. Crude continues to press towards a breakout over $114 and the metals are crazy. Gold rallied to $1569.80 and a +$34 gain for the day. This is a new nominal high but the inflation adjusted high is much higher at $2300.

Crude Oil Chart

Gold Chart - Daily

Silver closed at $48 after trading as high as $49.56. While I believe in the silver story and think the long-term outlook is still bullish I can't help but think the short-term outlook is becoming increasingly bearish. I mentioned buying silver on a pullback two weeks ago. We got the -10% dip to $44.61 and then it roared off again when Bernanke said no rate hikes soon. However, it stalled just under $50 for the second time.

I believe the hype surrounding the silver trade has gotten out of hand. Yes, it is an inflation hedge. Yes, it is the poor man's gold and its use in manufacturing is increasing. Yes, there is a shortage today because of all the investor interest but the trade has clearly achieved bubble status.

Trading in silver has exploded beyond any reasonable level. Last Monday there were 319,205 contracts traded at the CME. That was 50% higher than the prior record set back in November. The average daily volume has tripled since last year according to the Wall Street Journal. Last Monday the iShares SLV ETF traded three times the volume of the S&P-500 ETF SPY. SLV volume was five times its daily average in Q1.

For those new to metals trading you should know they come down a lot faster than they go up. Back in 1980 when the Hunt brothers tried to corner the silver market and pushed prices to $50.50 the drop from that level was a disaster. Silver futures opened limit down for 20 straight trading days. That means the opening print was the low of the day and trading was immediately halted until the following day. That means traders could not sell their futures contracts for up to 20 days. Back then the limit was $1 per day so prices had to drop $20 before any normal trading could resume. That would be extremely painful for a futures trader. There are no limits on the CME today.

I don't know how that would work today with the various silver ETFs holding both bullion and futures contracts. I would bet in a panic the silver market today would simply implode without any limits to slow the drop. When all those traders and all that volume I mentioned above suddenly head for the exits at the same time it is going to get ugly.

Nobody knows when it is going to happen and calling tops in a particular bubble is a fool's errand. However, that $50 level and the 1980 high are flashing a warning signal. If you are long silver I would probably be taking some money off the table next week. I know puts have been recommended on the Proshares Ultrashort Silver ETF (ZSL). Just remember that any ultrashort or ultralong ETF has a tremendous bleed factor as a result of their options component. Those ETFs should only be used for short-term trades lasting days or weeks not months. There have been several studies of the various ultra ETFs and documented their underperformance when held for more than a few days. During the market crash in 2008-2009 there were ultra short funds that actually lost money rather than doubling or tripling the market decline. Be careful and read up on the best holding periods for ultra short/long funds before betting the farm on a long dated position.

Silver Chart - Daily

Silver Chart - Monthly

The market really had a good week and it is even more amazing when you consider the potential for an upset over the FOMC announcement and press conference. Instead of dwelling on the lowered economic outlook from the Fed and Bernanke's view of unemployment plus the constant stream of weaker economics the bad news bulls just kept buying stocks. They viewed the weaker economics as a sign the Fed would remain on hold for an even longer "extended period" and provide a fertile environment for equities. The outlook for the falling dollar is more of the same and that means investors have to buy stocks and commodities to offset the dollar's decline.

Of course it was also month end and there was new money hitting the retirement accounts. That money will dry up by Thursday along with earnings and we will see just how confident those bad news bulls really are. Given the +700 point rally in the Dow in the last two weeks there are plenty of traders who feel we are too overextended to add to longs. You can count me in that camp as well. Nothing goes up in a straight line so we know there is at least a temporary dip in our future.

The S&P only added +3 points on Friday and less than +2% for the week. The close at 1363 is about 10 points below initial resistance at 1373 and 37 points below strong resistance at 1400. There appears to be nothing to prevent another decent gain on Monday except its own weight. The momentum has been slowing for the last three days because of the overextended conditions. Support should be 1340 if we were to get a real bout of profit taking.

S&P Chart - Daily

The Dow is a carbon copy of the S&P with a clear breakout to new highs but extremely over extended with a 700 point gain in two weeks. The next material resistance is 12,950-13,000 but the overbought nature is going to be a problem.

Obviously nothing prevents the markets from posting additional gains. They can be irrational longer than we can remain solvent. When we can't bring ourselves to trade the current trend we have to wait for a break in that trend for an opportunity to reload.

Dow Chart

The Nasdaq performed pretty much as expected on Friday. The NDX lost about six points thanks to the rebalance at the close. The composite managed to close with a gain but it was minimal. The composite is bumping up against uptrend resistance at 2875 but Friday's performance was completely related to the rebalance.

The Nasdaq-100 ($NDX) has found support at 2400 and without the rebalance negativity next week I would expect to see a higher move using that support as a launching pad. Apple's performance on Friday suggests a decent day for techs on Monday assuming there are no critical events in the news.

Nasdaq Chart

Nasdaq-100 Chart

The Russell was the strongest index on Friday with a 0.4% gain and a new closing high. This has bullish implications for next week if it can continue to outperform. Support should be 855 if we get a decent dip.

Russell 2000 Chart - Daily

The Transports also closed at a new high but with only a +4 point gain. I am not going to draw any conclusions from that index this weekend. With crude prices at $114 and gasoline rising to $3.91 nationwide and more than $4 in 22 states the rally in the transports is temporary.

I do believe the performance in Apple suggests the Nasdaq will be positive on Monday and the performance of the Russell suggests fund managers are not concerned there is any trouble ahead.

I wish I could be that confident. I would prefer to see a 2%-3% pullback so traders could reload. There has been a lot of news over the last week and there is plenty more next week. The Non-Farm Payrolls will be the most critical and I suspect estimates will be declining all week.

I would be careful about entering any new long positions until we see some profit taking.

I have a favor to ask. Last May I was in the hospital for a week with a heart problem. I wrote at the time about the China Study, by Dr Colin Campbell, and Prevent and Reverse Heart Disease (and Diabetes) by Dr Esselstyn. I had corresponded with numerous readers at the time and received many testimonials about how those books had cured their health problems. Since then I have personally helped many of my friends improve their heart conditions and/or get off their diabetes medicine by passing around copies of those books and being an example in my own life. Since Memorial Day 2010 I have lost over 30 pounds and my last treadmill test showed no evidence of heart disease.

Here is the favor. Because of the excitement of another friend who just got off his diabetes medicine I want to build a health page with everything I have learned and make this information available in detail for others. Unfortunately I neglected to save all those emails from readers. If you have experienced better health from those books please send me another email and tell me how they helped you so I can include some additional testimonies on the health page I am building. I would really appreciate it and I know there are hundreds of readers who will benefit from your stories in their health. No names will be used.

Thank you in advance!

Jim Brown

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"Do not meddle in the affairs of wizards, for they are subtle and quick to anger."

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