Traders bought the rumors today as the Greek problem appeared to take a giant step forward towards a permanent resolution and the U.S. debt limit crisis also appeared to be nearing a breakthrough. Buy the rumor, sell the news?

Market Statistics

EU leaders agreed on Thursday to give Greece another €109 billion ($155 billion) on top of the €110 billion in the first bailout. Banks and other private investors will contribute €50 billion ($71 billion) to the rescue package by either rolling over Greek bonds they currently hold or by exchanging them for new ones with lower interest rates. They can also sell them back to Greece at a lower price. The news produced a +1.2% spike in the euro against the dollar.

The initial market reaction was positive although skeptical. The buyback with a haircut sets up the potential for a selective default by Greece but the EU leaders claim they are ready to backup Greek bonds if the rating agencies decided to take that view. The new Greek bonds would have long maturities at 30 years with a low rate in the 4-5% range. The new EU loans to Greece would be from 15-30 years in length, with an additional grace period of 10-years, at a 3.5% interest rate.

The EU leaders also overhauled the EFSF rescue fund to allow it to intervene in countries before situations became critical like we saw in Greece. The help would be in the form of a short-term credit line for struggling countries. That would be beneficial for Italy and Spain if their problems increase. The EFSF would also be able to recapitalize banks in countries that have not been bailed out. The EFSF can also buy bonds in the secondary market in order to push interest rates lower if a country's bonds begin to fall out of favor.

The new deal came about after a marathon strategy session between the leaders of France and Germany earlier in the week. It appears they finally accepted the fact the EU was going to crumble if something was not done. It appears France and Germany have adopted the PIIGS and will be their benefactors for decade to come.

This new deal on Greece and those countries following in their footsteps should eliminate Europe as a factor in our markets. EU leaders have agreed to prevent any country failures and the economic problems will now be handled by the EU rather than the public markets. The risk of default is over and Greece and the others should disappear from the headlines.

Another debt deal making headlines and spiking the market was the U.S. debt limit discussions. Around 12:30PM the New York Times said they had inside information that President Obama and the republicans were close to an agreement on spending cuts and tax increases. The Dow spiked +75 points on the news to the high of the day at 12,750. Within minutes both the White House and Speaker Boehner's office squashed that story claiming there was no deal. However, there were conflicting statements.

We found out a few minutes later the White House had actually told democratic leaders they were close to a deal but there were still some issues to be resolved. Reportedly this will be a $3 trillion deal and it will require some tax revenue changes. However, a final agreement is not expected until early next week.

What I find encouraging is that the president and Speaker Boehner have been meeting privately for hours at a time and they are NOT discussing the meetings in the press. Instead of both rushing to a microphone after every meeting they are refusing to discuss the meetings other than to say no agreement has been reached. Since they are not floating the trial balloons and not slinging mud on each other it suggests they have finally reached the point where they realize time is running out and something must be done even if it requires compromise. Boehner said he had prepared his members regarding the possibility of a compromise with the democrats and he was confident a majority of the 240 republicans would approve it. Boehner said, "We have a responsibility to act." That gives the market hope that a deal will eventually be reached and that helped push the Dow back over 12,700.

The increasing pressure by the ratings agencies is pushing lawmakers to act. S&P said today there was a 50% chance it would lower the U.S. debt rating by one notch from AAA to AA+ within the next one to three months. S&P said "EVEN" if Congress raises the debt limit in time to avert a default, it might lower the rating anyway to AA+ with a negative outlook if the debt limit deal is not accompanied by a "credible solution" on the debt level. A change to AA+ and negative watch would raise interest rates on U.S. by 50 basis points on short-term debt and 100 basis points on long-term debt.

In a Washington Post-ABC poll conducted from July 14-17th found 75% of Americans believe the republicans are too resistance to compromise and 60% felt Obama should compromise more. There are four plans currently in various states in the House and Senate. The House passed the Cut, Cap and Balance plan but it has zero chance in the Senate because it requires a balanced budget amendment. Another fallback plan put forth by McConnell and Reid where Obama would be given unilateral authority to increase the debt limit at will without any material cuts in spending is being called the Pontius Pilate Plan. Lawmakers would wash their hands of all responsibility and leave the debate. This would put the onus on president Obama and carry significant election baggage. Regardless of your political affiliation you are likely to see something ugly arrive on Obama's desk in the near future. Let's just hope it happens before the ratings agencies take action. "Laws are like sausage, it is better not to see them being made." (Otto von Bismarck, 1885)

On the economic front there was some good news with a decent rebound in the Philly Fed Survey. The July reading came in at +3.2 compared to a -7.7 in June. Analysts had expected a rebound slightly into positive territory but that exceeded those estimates of +2.0. This is significantly below the levels seen in the first quarter but any rebound back into positive territory is appreciated.

The internals were not overly impressive but there was decent improvement. New orders managed to return to positive territory after a -7.6 reading in June but the +0.1 print is hardly deserving of a standing ovation. Backorders remained significantly depressed at -16.3 and the same level as June. They have been negative for three consecutive months. However, employment rebounded to 8.9 from 4.1 and it should be noted it never went negative.

The most positive component was the six-month expectations, which rose from 2.5 to 23.7. I am assuming they expect the soft patch to be over and the debt limit crisis to have passed into the history books by year-end. About half of the survey respondents said sales had increased recently while 26% said demand had slowed. Those who saw a decline in demand blamed it on economic uncertainty and higher energy prices.

Analysts had hoped the rebound in auto production would support the regional activity but so far the NY Empire Survey and the Philly Fed have definitely been lackluster. This is only minimally encouraging.

Philly Fed Survey Chart

Jobless claims rose slightly as expected to 418,000 from an upwardly revised 408,000 in the prior week. The claims declined in the prior week as a result of the July 4th holiday and the trend to put off filing for unemployment until after a holiday week. Large declines around holidays are normal. Claims will continue over 400,000 for at least the next month because of plant shutdowns for retooling for automakers.

Jobless Claims

Economics were not the focus for traders with all the Europe news and debt discussions grabbing the headlines. Even strong earnings from major companies failed to really gain any traction in today's market. However, Morgan Stanley was the exception to the rule.

Morgan Stanley (MS) reported a net loss of 38-cents with revenue of $9.3 billion. Despite the loss it was significantly better than the 62-cent loss analysts had expected on revenue of $8.04 billion. The results included a $1.7 billion charge related to conversion of preferred shares held by Mitsubishi Financial in to common stock. Investment banking revenues were $1.5 billion, a +66% gain and the highest since 2007. Trading profits came in at $3.4 billion, a +14% gain from the prior quarter. Equity trading revenues rose +9% while fixed income revenues rose +18%. Wow, shades of Goldman Sachs style trading profits. Morgan is not normally known for making big profits in trading. Goldman only posted trading profits that declined -63% compared to Q1.

Morgan Stanley Chart

Union Pacific (UNP) posted earnings of $1.59 and only slightly higher than the $1.58 analysts expected but the stock jumped on the quality of earnings. UNP said freight revenue rose +12% for the quarter and they increased prices to push overall revenue up +16%. They would have posted significantly higher earnings except for flood related expenses of about $14 million. They also lost about $20 million in coal revenue due to the flooding.

The CEO gave upbeat guidance saying shipping volumes were likely to rise even with the economic uncertainties. He said farmers will still harvest a crop, the heat wave will drive demand for coal, automotive shipments would improve as parts shortages are erased and the Christmas holidays will still come. Farmers planted the second biggest corn crop since WWII and that will increase shipments. It was not all good news. Diesel fuel costs rose from $2.29 per gallon in 2010 to $3.29 to produce a $904 million fuel bill for the quarter and cut 2-cents off of earnings.

Union Pacific Chart

Freeport McMoran (FCX) reported profits of $1.43 per share that more than doubled the 70-cents in the comparison quarter. Analysts were expecting $1.34. The CEO said costs were 93-cents per pound and the current price of copper was $4.38. That was giving them significant margin expansion and adding to their cash hoard. FCX had $4.38 billion in cash at the end of June compared to $3.74 billion at the end of December. Since Jan-2009 the company has repaid $3.8 billion in debt. The CEO said demand in Asia was not slowing and they expected prices to remain firm for the rest of the year.

Freeport Chart

After the bell Sandisk (SNDK) reported earnings of $1.14 per share compared to 99-cents analysts expected. Revenue rose +17% but net income declined -3.5% due to lower margins and supply constraints due to Japan. Margins in the current quarter are expected to be in the 42-44 percent range. Sandisk said their growth came from the explosive sales in smartphones and tablets and they did not expect that to slow in the near future. Inventories remained lean and the outlook good. However, the CEO did guide to Q3 revenue of $1.38B to $1.43B and analysts were expecting $1.46B. It seems every major company is taking advantage of a good quarter to dramatically lower future guidance in order to hedge their bets for the typically choppy quarter.

Sandisk Chart

The big gorilla after the bell was Microsoft (MSFT). The company reported earnings of 69-cents compared to estimates of 59-cents. Revenue rose +8% to $17.4 billion and only slightly higher than expected. Bright spots were the sales of Office software, server sales to businesses and the Xbox 360 and Kinect game device. Windows sales were soft and declined slightly. Microsoft said the comparison was uneven because it launched Windows 7 in early 2010 and that inflated the 2010 numbers. Windows sales are undoubtedly suffering as the Apple iPad replaces what would likely have been laptops or netbooks running Windows systems. Apple sold 9.25 million iPads in Q2. Search engine revenue from Bing rose +17% to $662 million but the division continues to lose money as it invests in an effort to gain market share from Google. Good luck with that. Microsoft shares declined 10-cents after the report. After the June rebound I would bet on some profit taking here over the next few weeks.

Microsoft Chart

Other earnings reports that did not turn out well included Coinstar (CSTR), Acme Packet (APKT) and Ruby Tuesday (RT). Ruby declined -8% to $10, Coinstar declined -8% to $52 and Acme declined -8% to $54.75 but rebounded before the end of trading to close at $60.

So far 75% of the companies in the S&P reporting earnings have beat the street. That is a higher percentage than normal but there has also been a higher percentage of companies lowering guidance. Notable today were INTC, IR, LPL, NUE, SNDK and WHR among others.

Now that most of the big cap techs have reported there may be less interest in being long the market without a debt limit deal. I warned last week that once Thursday passed without a deal the market could become very nervous. Earnings for tomorrow include CAT, GE, HON, SLB, MCD and VZ. Those are not normally market moving earnings reports.

I am concerned that having reached its highs from early July the market may decide to take profits just in case disaster strikes and Washington egos get in the way of a material agreement on the debt limit. The problem is rapidly heading to a conclusion and any day now a big three rating agency, Fitch, Moody's or S&P, could cut the rating in an effort to be first in line and grab the headlines for themselves. Once it begins the consequences could be catastrophic.

I believe the traders will try to position themselves for a major market event on Monday. The question is "which way will they bet?" If you believe there will be no agreement by Monday you would want to take profits and be short the market for Monday's open. However, if you believe a deal is imminent then you would probably want to be long the market at Friday's close in hopes of a triple digit gap open on Monday.

Remember, President Obama said in the past a deal needs to be concluded by July 22nd (Friday) in order to make its way through both houses and to his desk for a signature before August 2nd.

The conspiracy theorist in me wonders if they are posturing for a big reveal before the open on Monday in order to kick the market to new highs so they can claim an emotional win and boost consumer sentiment. Since Obama and Boehner are being deathly quiet on the details it makes you wonder if they are planning something big.

There is a third option. If traders are so confused over the possibilities they don't know which way to bet then they will likely go into the weekend flat. I believe that is the most likely course and that would probably mean a weak Friday.

Back on Tuesday I reported that hedge funds and institutions were holding high levels of cash, as high as 75% in some cases, while they wait for some clarity on the various issues confronting the economy. One of those issues was solved today with the Greek bailout and enhanced bailout fund. If a debt limit deal appears that would be the second major cloud lifted from the market and probably a signal to put some of that cash back to work. Most hedge funds lost money in the first half of the year so they will be very eager to attack the market once the clouds dissipate. We could be nearing that turning point.

The S&P has rebounded +50 points since the Monday lows but remains below strong resistance at 1350-1360. With the major earnings reports behind us there will be less incentive to move higher given the flurry of lowered guidance. Next week is going to be a pivotal week and while I would love to see a breakout to new highs and I could make a decent case for that scenario I am worried we could see a pause in the rebound unless political events are impressive. Support is well below at 1316 and 1295.

S&P-500 Chart

The Dow looks stronger than the S&P but that is because of its narrow compensation and the gains from its major components like IBM. The blue chips have less inherent risk and fund managers may be hedging their cautious bets on a debt deal conclusion by parking money in the blue chips. The Dow is very close to a retest of the multiyear highs from May and those highs are producing a sirens call to be tested. A breakout on the Dow would be broader market positive but the Transports, Nasdaq and Russell are all lagging by a wide margin. This is a big cap rally not necessarily a market rally. Support is well back at 12,400 with new high resistance just over 12,800.

Dow Chart

The Nasdaq stalled today at 2835 and the resistance from February and June. This is more congestive than specific with the highs from May/July at 2875 and the real target. The decline in Microsoft, Coinstar, Acme Packet and others after the close and the lack of a major tech reporter on Friday could leave the Nasdaq short on fuel for a continued rally. Nasdaq futures are negative this evening and that could be a tell for tomorrow's open.

Nasdaq Chart

Despite the uneasiness over what Friday might bring we did get what appears to be a resolution of the European debt crisis today. That has been a cloud over the market for months and the resolution could play out for weeks into the future. This is a positive factor providing underlying support regardless of what happen in Washington on Friday.

CAT, GE and MCD are all Dow components so a major surprise there could benefit the broader market. I doubt it will come from GE but I will take what we can get.

Personally I tend to be aggressive. I believe a debt deal is imminent because there is no other option. For that reason I favor the long side going into the close on Friday. I would prefer to see a major dip as the herd runs for cover in order to get a better entry but even without the dip I would still favor a long position in anticipation of a Monday announcement. Remember, I am an aggressive trader. Factor in your own bias before making a decision before the close.

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