Solid earnings from blue chip companies helped fuel the rally with IBM adding +80 Dow points thanks to the +10 point spike in the stock. The market also cheered positive comments by President Obama on a debt plan he could accept.

Market Statistics

Positive economics, positive earnings and positive debt limit news helped the markets to the best gains for all of 2011. What a difference a day makes! The positive economics began with a strong surge in New Residential Construction for June. Starts soared +14.6% to 629,000 from 549,000 in May. Both multi-family and single-family starts showed unexpected strength. New permits, an indication of starts for July, rose +2.6%. Completions declined slightly by -1.7% due to bad weather in May/June.

Total starts were up +16.7% year over year and the strongest gain since April 2010. Comparisons have been tough in recent months because of the homebuyer tax credit in 2010. Single family starts rose +9.4% over May and multifamily rose +30%. The flood of people moving into the rental market after losing their homes and killing their credit is powering the surge in multi-family construction.

Before you start getting really excited about the spike in starts you might want to consult the chart below. Even at 629,000 starts the pace of construction is only at the maintenance level and not yet growing.

Housing Starts Chart

New construction the only material report on the calendar for Tuesday and Wednesday is not much better. The key report for the week is the Philly Fed Survey on Thursday.

Economic Calendar

The rally was already underway when President Obama praised a bipartisan proposal by a group of senators called the "gang of six" to reduce the deficit and avoid a debt default. The president unexpectedly took the podium around 1:30 ET and the Dow promptly rallied another +80 points. The senate plan reportedly includes $1 trillion in higher taxes but is said to be tax neutral because it also does away with the alternative minimum tax (AMT) that is hated by higher earning taxpayers. Because of the tax increase the proposal will have a tough time in the House so there is really no deal despite all the backslapping in progress. Speaker Boehner told reporters before debate begin on the proposal the House needed to be responsible and see what plan B looked like.

The plan reportedly calls for $4 trillion in deficit cuts over 10 years and includes steps to slow the growth of social security payments. Unknown if that is by raising the retirement age and/or recalculating the cost of living adjustments as both have been discussed over the last several weeks. It will also cut at least $500 billion from Medicare and Medicaid. That sounds like a big number but it is a drop in the bucket. Since no politician currently in power wants to be known as the person responsible for causing a debt default and bankrupting America the odds are growing that a compromise can be reached soon and the market is celebrating that fact.

The urgency of getting a compromise passed was emphasized this morning when Egan-Jones Ratings cut the debt rating on the USA from AAA to AA+ citing the high levels of debt and the difficulty in significantly cutting spending. Egan-Jones said they were less concerned about the possibility of a short term default but more concerned about the relatively high debt to GDP and the growing possibility lawmakers would be unable to make any major reforms to slow the increase in debt. There is almost zero chance they can actually reduce the debt over the next ten years so all of this political theater is based on slowing the growth of debt. In the seven page rating analysis Egan-Jones said the U.S. debt to GDP was in excess of 100% (including entitlements) compared to Canada's 35%.

The Egan-Jones rating cut is not critical because they are one of the smallest nationally recognized rating agencies. HOWEVER, it is important because it shows the trend in the ratings sector for increased worries over the longer-term picture and not the short-term debt limit crisis. If S&P, Fitch or Moody's echoed the Egan-Jones cut it would be a very bad day for the markets. Rates would rocket higher and they would not be coming down for a very long time. We are approaching that point with every tick of the clock. A debt limit deal will kick the can down the road a ways but it will eventually happen.

We heard today that George Soros $25 billion Quantum Endowment Fund had gone to 75% cash because of volatility in the market where fundamentals no longer matter. The fund lost -6% through June and manager Keith Anderson told his portfolio managers to pullback from the market until the future became clearer. Soros said he found the current situation much more baffling and much less predictable than he did at the height of the financial crisis. He said, "The markets are inherently unstable. There is no immediate collapse, nor no immediate solution."

Louis Bacon's Moore Capital with $15 billion in assets also went to strongly overweight in cash after losing -6% through June. About 18% of asset allocation funds, including hedge funds, are overweight cash at the highest level in more than a year according to a Bank of America survey. The funds raising their aversion to risk rose to 26% in June from 15% in May according to BAC.

Goldman Sachs said volume in the 50 companies most commonly owned by hedge funds fell to 4.11 billion shares in June. This was the lowest monthly level since August 2008. Part of the uncertainty is the volatility in the global markets brought on by China's inflation fight, Europe's sovereign debt crisis and America's shrinking economics. SAIL Advisors said funds are in the uncomfortable position of facing bearish fundamentals being supported by intervening governments. Managers are being forced to resort to tactical trading by increasing shorts in bullish rebounds.

Most managers believe we are approaching a turning point where political and economic risk will decline sharply. When that happens all those funds that are heavily into cash will be forced to chase the market higher in hopes of capturing the momentum. The U.S. debt limit problem will be solved soon, famous last words, simply because it has to. There is no other acceptable option. China is seen as being close to the end of its economic tightening. Europe, Greece and the European banking system are the remaining wild cards. Fortunately they are also reaching the point where they have to hold their nose and take action as well rather than face the consequences. In theory the resolution of the majority of these variables will power a huge rush into the markets. Earnings are very strong as evidenced by IBM, Apple, etc. All we need is a little more evidence the soft patch is over and we could be off to the races.

Of all the positive earnings surprises so far this quarter the IBM earnings on Monday night were the most widely cheered. Google may have spiked +60 points after earnings but IBM was a better read on the health of the global economy. Revenue rose +12% to $26.7 billion and well over the $25.4 billion analysts expected. Earnings were $3.09 and above the $3.02 estimate. IBM raised its full year forecast to $13.25 per share and above analyst consensus. They are targeting $20 in earnings by 2015. Software sales were up +17% and hardware was up +17%. IBM signed global service agreements worth $14.3 billion and well above the $12.8 billion consensus. It was a glowing report and IBM shares were rewarded with nearly a $10 gain to a new high at $185. That $10 gain was responsible for +80 Dow points. Thank IBM for the rally today just like we thanked Google last week.

IBM Chart

After the bell Apple duplicated the IBM performance with earnings that more than doubled and nearly a $25 spike in the stock after the close. Apple shares traded briefly over $400 before settling at $393 after the regular close at $376. Apple earned +$7.79 per share or $7.3 billion compared to $3.51 and $3.25 billion in the year ago quarter. Revenue soared +82%. Analysts were expecting earnings of $5.80.

Apple sold 20.3 million iPhones and analysts were only expecting 17 million. They added 15 new countries and 42 new carriers to their network. IPad sales hit 9.25 million compared to estimates of 7.9 million. Mac sales were slightly less than expected and COO Tim Cook said that was due to some cannibalization from the iPad. Ipods were also a little light at 7.54 million compared to estimates of 8.2 million. Apple is expected to announce a new iPhone by the end of the quarter and rumors claim they have ordered more than 15 million units. Apple's guidance for Q3 of $5.50 was well below analyst estimates of $6.42 but Apple is always absurdly conservative in its estimates. It may also suggest the iPhone 5 announcement may be late in the quarter.

Apple has beaten estimates every quarter since 2003. They have beaten estimates by double digits for the last 12 quarters. Obviously if you guide dramatically lower every quarter it makes it easier to beat estimates.

There was a Wall Street Journal article today claiming several board members had been talking to recruiters about a succession plan for Steve Jobs. Reporters asked Jobs about the article and he said, "I think it is hogwash." Reportedly several directors took the initiative on their own and it was not at the direction of the board. COO Tim Cook is still seen as the leading candidate if Jobs was out of the picture.

Apple Chart

Wells Fargo (WFC) reported a +29% increase in profits to 70-cents per share and the highest ever in the bank's history. That was income of $3.9 billion on revenue of $20.9 billion. Analysts were expecting 69-cents. Part of their gains was a $1 billion boost from lower loan loss reserves. Total loans were $751.9 billion, a gain of +$766 million. Net charge-offs for the quarter fell -$372 million to $2.8 billion. WFC bought back 35 million shares during the quarter.

Wells Fargo Chart

Goldman Sachs (GS) reported earnings of $1.85 per share but that was a major miss with analyst estimates at $2.27 per share. The bank reported more layoffs of another 1,000 workers. CEO Lloyd Blankfein said Goldman's earnings had been hurt by "macroeconomic concerns" and several divisions had disappointing results as a result of Goldman reducing market risk.

Net revenues fell to $7.3 billion compared to $8.8 billion in the year ago quarter. The biggest hit to earnings came from a 53% decline in fixed income, currency and commodities trading. Despite the big miss Goldman shares only declined 84-cents but that was still a new 52-week low.

Bank of America (BAC) also hit a new 52-week low after reporting an $8.8 billion loss. Earnings were a loss per share of 90-cents compared to a profit of 27-cents in the year ago quarter. That is the biggest quarterly loss in its history after it took more than $20 billion in charges related to its mortgage business. The loss was actually inline with analyst estimates. Excluding charges BAC earned +$3.7 billion or 33-cents per share. Net charge-offs declined for the fifth straight quarter. BAC shares lost 15-cents to $9.57 and a new 52-week low.

Yahoo (YHOO) reported earnings of 18-cents and inline with analyst estimates. Revenue was $1.23 billion and a -23% drop from the comparison quarter. That is somewhat misleading since Yahoo changed the way it reported revenue to subtract the 12% of every dollar it receives from Microsoft for searches directed to Yahoo. They received $67 million from Microsoft last quarter. That payment stream ends this quarter. Net revenue of $1.08 billion was still a decline of -5%. There was nothing positive about Yahoo's earnings and the board is probably counting down the days until CEO Carol Bartz contract expires. There are 17 months left on her four-year contract. She was hired to turn Yahoo around and has been spectacularly unsuccessful. There are rumors the board has already put out feelers for a replacement. Revenue in Q3 could be less than $1 billion an Yahoo lowered guidance on earnings. Yahoo shares declined in after hours to $14.28.

Yahoo Chart

Harley Davidson (HOG) posted earnings of 81-cents that were +36.8% over the comparison quarter. That easily beat analyst estimates of 71-cents. The company said it was raising it's 2011 shipments to between 228,000-235,000 an increase of up to +12% over 2010. That compares to prior estimates of 215,000-228,000. A sharp increase in sales for Harley is a leading indicator of an economic recovery. Motorcycles are a high dollar luxury item and this bodes well for the economy. Harley shares were up 9% to a new high at $45.09.

Harley Davidson Chart

VMWare (VMW) reported earnings after the close of 55-cents compared to estimates of 47-cents. The software company reported revenue that rose +37% to $921 million beating analysts projections of $873 million. The company said corporations were more willing than in the past to sign large deals in order to get steep discounts. VMW raised Q3 revenue estimates to between $915-$940 million and analysts were expecting $898 million. VMW shares rallied +$6 in after hours.

VMWare Chart

I could keep listing earnings reports for another five pages but I think you get the picture. Those companies with good business models are reporting outstanding results while those with operational issues are struggling.

Big reports due out on Wednesday are AXP, EBAY, INTC, FFIV and UTX. On Thursday Microsoft is the last major tech to report for the week although CAT, GE, HON and SLB are notable for Friday.

Earnings Calendar

If we are not a lot closer to a debt ceiling deal by Thursday it won't make any difference how good Microsoft's earnings are.

News Corp (NWS) was all over the news today as officials were grilled by members of Parliament. The only good thing I saw in the wall to wall coverage was the lack of coverage of the European debt crisis and the emergency meeting coming up on Thursday. The News Corp coverage completely blanketed the airwaves and took everyone's mind off the real problem that will come back to haunt us later this week.

The S&P posted a very strong +21 point gain but came to a stop just under the next resistance at 1330. A breakout there would target the May highs over 1350. With Apple up strongly in after hours we should see a strong open assuming some of the companies reporting before the open don't stink up the place.

The Monday decline was completely erased and we are back on track for the earnings bounce I expected this week. That bounce may only have 48 hours to go if the debt limit discussions and the emergency meeting in Europe don't go well.

There is always the possibility for a sell the news event once the week's earnings have been absorbed into the investor consciousness and U.S. economics come back into the headlines. Late July and August are not known for market rallies and are typically weak. However, given the high cash levels held by funds it will not take more than one or two positive political events to release that pent up demand.

S&P-Chart - 30 min

S&P-500 Chart - Daily

Like the S&P the Dow has returned to strong resistance and it may take some positive results before the open in order to push the indexes much higher. The +300 point rebound from Monday's low may be just the start of a big run if lawmakers can find some compromise in the debt limit saga. Dow 12,725 would be the next resistance level.

Dow Chart - 30 min

Dow Chart

Like the other indexes the Nasdaq rebounded to a dead stop at strong resistance at 2825. However, the Nasdaq has a trump card in the Apple earnings that could create a breakout at the open on Wednesday. Nasdaq futures are up +17 points late this evening and that should hold until the open unless Europe comes back to haunt us a day early.

Nasdaq Chart - 30 Min

Nasdaq Chart - Daily

Without repeating myself too much I believe we could be poised for a breakout based on pent up demand from fund managers who have withdraw into the safety of cash. All we need to grease the rails is for lawmakers to make some significant progress on the debt limit problem, for Europe to bite the bullet and give in to Greece and for the Philly Fed Survey on Thursday to be positive and better than May, which was negative at -7.7 in May.

If funds are really that heavily into cash there could be the mother of all rallies into year-end if all the political and economic factors line up correctly. That is a very big IF but it is possible and we have not seen the bad news bulls recently. If they return then even mediocre news could power a rally.

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Jim Brown

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