Earnings disappointments put a negative tone on the market early in the day but a late afternoon threat by the White House to veto the current Republican debt limit plan sent the markets to their lows for the day.

Market Statistics

Major blue chip companies failed to impress with earnings but after an initial dip the markets tried to rally despite the declining outlooks. However, a late afternoon threat by the White House to veto the republican debt limit bill currently making its way through the House was more than the market could stand. Sellers appeared quickly and stop losses were triggered to send the Dow to a -91 point loss to close at 12,501. It was not a good day for equities.

The economics also put a cloud over the market. The Richmond Fed Manufacturing Survey fell back into contraction territory at -1.0 for July after posting a rebound to 3.4 in June. The survey posted its most recent low at -5.1 in May. For comparison the index averaged 21.0 in the first quarter. This was a disappointing report with all components except shipments declining. However, the decline in orders and backorders suggest shipments will fall next month. More troublesome is the sharp decline in the employment component to just barely over contraction territory after several months well into expansion.

Richmond Fed Table

Richmond Fed Chart

The Consumer Confidence for July was basically flat and we should be thankful there was not a significant decline like we saw in consumer sentiment. The two surveys are conducted differently with different questions but they normally track to some extent. Confidence rose to 59.5 from 58.5 and analysts had expected a decline to 56.0. The six-month expectations component was responsible for the gain. Expectations rose to 75.4 from 71.6 while current conditions declined slightly from 36.6 to 35.7.

Buying plans were sketchy with those planning on buying a car were down fro 11.5% to 11.2% but still healthy. Those thinking of buying a home rose to 4.9% from 4.3% and appliance purchasers fell to 46.9% from 49.3%. Weighing on confidence is the weakening employment and slowly rising gasoline prices.

The weakening expectations on employment in the Richmond Survey and in the Consumer Confidence report suggests next week's nonfarm payrolls could be ugly. New job gains fell to only 18,000 in June and all indications for July suggest jobs could go negative again.

Consumer Confidence Chart

New home sales for June declined to 312,000 from 319,000 (annualized) compared to high estimates of 329,000 and consensus estimates of 320,000. Sales of homes in the Northeast fell -15.8% and declined -12.7% in the west. Sales rose +9.5% in the Midwest and +3.4% in the south. About the only good news was a sharp spike in the average selling price from $217,700 to $234,400. Analysts claim the price is more volatile because of the slower pace of sales. Months of inventory was basically flat at 6.3 months. The problem is not home demand but financing. Only the very best credits with decent cash down can buy a home today. Quite a few homes are being sold direct to investors as rental property.

The Case Shiller Home Price Index for May declined -4.5%. This is a lagging report and was ignored.

The economic calendar for the rest of the week contains several more high profile regional reports as well as the latest GDP revision. The biggest economic event is still the debt limit battle.

Economic Calendar

The morning started off badly with 3M (MMM) and UPS reporting earnings that disappointed and everything went downhill from there. Dow component 3M reported earnings of $1.2 billion or $1.60 per share compares to estimates of $1.59. Unfortunately their guidance and commentary disappointed investors and the stock was crushed. 3M said higher fuel prices and economic uncertainty was keeping consumers from spending money and slowing the economic recovery.

CEO George Buckley said the economy is currently in a "slow spot" but he expects it to recover once fuel prices decline. (Don't hold your breath George. Fuel prices are going higher not lower.) Buckley said indicators are positive for the U.S. and "most" of Europe so he remained "mildly optimistic, not for a huge growth spurt, but for gradually improving market conditions late in the third quarter." 3M's profit would have been higher except for the Japan earthquake and a sharper than expected slowdown in sales of LCD TVs. Sales of film coverings used to make LCD TVs brighter fell -22% for the quarter. As the economy entered the soft patch in May and gas prices shot higher the sales of LCD TVs declined sharply.

As a Dow component the $5 loss in MMM was responsible for more than 40 points of the Dow's 91 point loss.

3M Chart

UPS reported earnings of $1.05 and inline with analyst estimates but the stock fell sharply after the CEO said a number of factors were "creating uncertainty and undermining confidence, particularly at small and midsized companies." He said the political deadlock over the debt limit and the high unemployment were contributing to a weak U.S. economy that was seeing demand decline for domestic services and imports from places like China. He said the peak shipping season ahead of the holidays had begun but interest from countries like China had been muted. That means U.S. distributors and retailers are not ordering ahead of the holiday season. UPS shares declined -6% on the news but rebounded by day's end to -3%.

I warned on Sunday that UPS would be a critical indicator for the health of the U.S. economy and their outlook helped to sour sentiment. With the debt limit debate dragging on and the likelihood of a credit downgrade rising by the hour there is a real fear building over the weeks ahead.

UPS Chart

Another economic warning came from the steel stocks. AK Steel (AKS) reported earnings of 30-cents but analysts were expecting 50-cents. They joined U.S. Steel (X) in reporting disappointing results in warning that weakness in the current quarter would impact full year results. AKS said lower demand, higher costs and lower steel prices could further pressure prices and margins. AKS is expecting a decline in shipments in Q3. The steelmakers are expecting (maybe hoping?) demand will improve in Q4. Unfortunately Q4 is typically the period where demand slows. Last week Nucor also warned on stiffer competition, lower demand and higher prices. AKS shares fell a whopping -17%.

AK Steel Chart

Waters Corp (WAT) reported earnings of $1.08 and analysts were expecting $1.14. Waters makes lab instruments. The company guided analysts to earnings of $1.10-$1.15 for Q3 and the consensus was already $1.16 so the shares were pounded for an 8% loss.

Waters Chart

After the close Juniper (JNPR) reported earnings that missed street estimates and the stock was taken to the woodshed. Juniper reported earnings of 31-cents and that missed the analyst consensus of 34-cents. Revenue also was lower than expectations. Juniper said customers were delaying deliveries and blamed "mixed signals" for the broader economy for lower than expected sales. Juniper guided for $1.095 billion in revenue for Q3 and analysts were expecting $1.22 billion. Earnings were projected to be between 26-30 cents compared to analyst estimates of 38-cents. Juniper said demand was slowing in part due to a slowdown in government spending. They also experienced a small hiccup due to the Japan quake. Juniper shares lost $5 in after hours trading.

Juniper Chart

Paccar (PCAR) posted profits that more than doubled to 65-cents per share but analysts were expecting 68-cents. The heavy truck maker lowered full year guidance given in April from 200,000-220,000 trucks to 180,000-200,000. That is a 10% decline in volume based on the "uneven economic recovery" and supplier capacity constraints. Shares declined -11%.

Paccar Chart

On the flip side Amazon (AMZN) gained +$13 in after hours when they reported sales soared +51% for Q2. Unfortunately profits declined by -8% to 41-cents but that beat the 35-cents analysts expected. The sharp spike in sales in Q2 prompted them to guide nearly a billion dollars higher for Q3 over what analysts were expecting. The Amazon business model works on a very low profit margin in the low single digits and the Alliance for Main Street Fairness, a retail group trying to force states to collect sales tax from Amazon, took the earnings as an opportunity to protest again. It did not hurt Amazon's shares, which rallied to $227 after the earnings.

Amazon Chart

Radio Shack (RSH) rallied +20% on news it would begin selling Verizon products in September. It was fortunate Radio Shack had good news to report because earnings were terrible. The Shack reported earnings of 24-cents and analysts were expecting 38-cents. The CEO said the Q2 number reflected a transitional problem as the company changed wireless carriers. He reaffirmed existing full year estimates inline with analyst expectations.

Radio Shack Chart

Las Vegas Sands (LVS) reported earnings of 54-cents ($367.6 million) compared to analyst estimates of 43-cents. LVS reported it took in $1.21 billion of its $2.35 billion in revenue from the Macau casino and $737 million from Singapore. These earnings reversed the -$4.7 million loss in the year-ago quarter. Sheldon Adelson called the quarter "historic" he said he saw absolutely no reason, no catalyst at hand which would change this upward trend." He said the Marina Bay Sands in Singapore was on its way to becoming the most profitable casino ever and it just opened last year. The CEO said they were on track to add 6,000 rooms in Macau starting in Q1-2012 through early 2013. Shares rose about 5% in after hours.

Las Vegas Sands Chart

The earnings calendar for the rest of the week has a few more Dow components with Chevron and Exxon expected to produce some stellar earnings. Boeing also reports on Wednesday and Merck on Friday.

Earnings Calendar

The Dunkin Donuts IPO was priced tonight at $19 after being discussed in the $16-$18 range. Reportedly the IPO was over subscribed by as much as 20 times but it is tough to know how much of that hype is real. Investors and funds normally put in for 2-3 times more than they really want because requested allocations are rarely met. I would suspect this IPO could see a serious pop on Wednesday.

The lack of a resolution on the debt limit crisis sent the dollar sharply lower and very close to a new two month low. This pushed gold to a new closing high at $1620 and copper to a new three month high. Copper prices were also rising on a strike problems at Chile's Escondida mine. That is the most productive copper mine in the world. There are threats the currently striking 2,300 workers could be joined by another 7,000 contractors on Wednesday.

Dollar Index Chart

Copper Chart

Oil prices continued to tick higher with trading as high as $100.62 intraday but the black gold declined to close only slightly positive at $99.51. There is strong resistance at $100 but analysts are pretty convinced it will surge over $100 once a debt deal is reached.

Barclays said again today that crude oil will spend the next 12-18 months building a new floor OVER $100 due to rising demand in the rest of the world and declining excess capacity. Crude prices are $10 higher today than the $90 lows hit after the IEA strategic reserve release announcement in an effort to lower prices. How is that working out for them today? Those that released oil will now be forced to replace it at much higher prices.

Wti Crude Chart

Brent Crude Chart

Some earnings were good, some were bad and guidance was mostly downbeat. However, the big elephant in the room is still the debt limit crisis. I am not going to spend much time on that tonight because you can turn on any news program and get hour-by-hour updates. While I think the problem will eventually be solved I think we are moving ever so closer to a ratings downgrade even if the debt problem is temporarily solved.

The lack of conviction by lawmakers to make the hard decisions and make serious cuts in spending will not be lost on the ratings agencies. Lawmakers are the pawns of the people and the majority of the people are hooked on handouts of government-funded entitlements. Every little sound bite that touches on their government handout is immediately met with a deluge of complaints to their representative or senator. The president's suggestion last night to call your representative produced a flood of calls that were met with "all circuits busy" messages and the web servers for several lawmakers crashed under the increased traffic. That kind of response makes it even harder to make the tough decisions even though they are the right decisions. A credit card addict with tens of thousands of dollars in debt they can't pay can't get out of debt by clipping a few coupons and saving a few cents at the grocery store. The spending cuts being proposed by both parties are the equivalent of clipping coupons and saving up beer cans to sell to the scrap metal dealer.

There is no long-term way out of this problem without a lot of pain for everyone concerned. That is not the problem today but it will be the problem long-term. The problem today is not the risk of default but the picture being painted for the credit ratings agencies. They see the handwriting on the wall and realize nothing material is going to change in the near future. They don't want to cut the ratings but lawmakers are giving them no choice. I believe, regardless of the debt limit outcome, the U.S will be downgraded. Unfortunately that means all the government agencies like Freddie and Fannie will be downgraded. Multiple states will be downgraded because they can't be AAA credits if they depend on an AA credit for the majority of their funds. Corporations may be downgraded if they have significant dealings with the government. Other countries may be downgraded. Can France continue to be an AAA if the U.S. is cut to AA? There are hundreds of decisions and ramifications being decided now because of this very visible bout of congressional dysfunction. We are airing our dirty laundry in front of a world audience and the outcome is not going to be pretty.

The earnings may have given the market a negative tone but the major cloud obstructing visibility was the debt limit and the countdown clock to August 2nd and supposedly the day a default would occur. Analysts claim that has moved forward to about August 10th because the Treasury received more money over the last quarter than it expected. Who knows what is real and what disinformation is put out for our consumption to make the situation seem worse?

The S&P had rallied to the high of the day at 1338 at 2:15 when the White House implied it would veto the republican plan. That was a terminal event and the markets went into a nosedive to close near the lows of the day. The amount of uncertainty is incredible. The news flow is seriously negative and the markets reflect the news.

I believe we will see a significant rally once an agreement is reached but the size of that rally that depends on the ratings agencies. If we somehow avoid a downgrade then the rally could be strong. If we don't avoid a downgrade then it may be short as investors try to decide what the roadmap looks like for the future.

The S&P closed at 1332 and despite the three days of declines it remains very close to the early July highs. This relative strength is surprising given the seriousness of the news and the number of companies reporting lowered guidance. This relative strength is somewhat bullish for the S&P. Near term support is in the 1315-1317 range as long as disaster does not strike. However, a move below 1300 would signal a new bearish trend with risk to 1260 or below.

S&P Chart

The Dow was knocked lower by the $5 drop in MMM, which was responsible for more than 40 Dow points. Boeing, UTX and IBM were the next largest contributors to the decline. It wasn't that a lot of Dow stocks were seriously negative but those four were enough to keep the Dow from recovering.

The Dow found round number support at 12,500 but real support is slightly lower at 12,400. The blue chips should withstand the ugly headlines better than the small caps but we have to get past earnings from a few more Dow components. Fortunately Exxon and Chevron should be positive.

Unless we see a sudden and unexpected compromise in Washington I expect the Dow to test 12,400. The earnings disasters after the bell were mostly tech stocks so the Dow gets a fresh start on Wednesday.

Dow Components

Dow Chart

Despite Amazon's big post earnings spike the Nasdaq futures are negative at 8:PM thanks to Juniper and friends. However, Amazon's gains, if they hold on Wednesday, could offset those declines in other stocks.

The Nasdaq has been very strong in the face of the negative news. The Nasdaq was slightly positive for most of the day and it was not until the veto threat that it lost ground. Closing down -3 points is a breakeven day and relatively bullish given the -91 point decline on the Dow.

Initial support should be around 2830 and resistance 2860.

Nasdaq Chart

The Russell 2000 and the Dow Transports are holding above their 100-day averages but both appear fragile if the debt crisis continues. It all depends on the debt crisis but a resolution of the crisis will likely send oil prices over $100 and that would weigh on the transports.

Russell Chart

Dow Transports Chart

Investors have been anticipating a resolution to the debt crisis for the last two weeks. Nobody thought it would reach this level of severity. Unless a resolution is found quickly I fear investors are going to start abandoning ship. The level of uncertainty increases daily and nobody really knows what will happen once the ratings downgrades begin. While I would want to have some long exposure in case an agreement is reached I would also want to have some put insurance in case the downgrades begin to fall like meteorites and destroying everything the hit.

The safest play is cash on the sidelines but you would stand a good chance of missing a major move in either direction. Uncertainty is a killer but it also produces some excellent volatility if you are positioned on the right side of the trade when it occurs. A straddle/strangle on the DIA or SPY in the August options may be the winning trade. We don't know in which direction the next move will be but it may be very strong.

Jim Brown

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