For six consecutive days traders have sold the close on worries over the debt limit crisis. An 80-point intraday gain in the Dow was erased to see the Dow lose -62 points and close at a five week low.

Market Statistics

The lack of any material progress in Washington continues to weigh heavily on the markets and the worries are growing over the aftermath of an 11th hour save. The House bill was supposed to be voted on at 6:PM ET tonight but the vote was cancelled. However, Harry Reid in the Senate has said this bill would be DOA. The democrat bill put forth by Reid is also DOA and has not even been brought to a vote over the last week because even in a democrat controlled Senate there are not enough votes to pass it.

Basically these two bills are designed to do only one thing. They are designed to allow the majority in each house to vote up or down the way they believe their constituents want them to vote. Once they have covered that base and both bills die the House and Senate will come together to produce a compromise bill and avoid a last minute default. Lawmakers can go home and say we presented our bill but there were not enough votes to pass it so we were "forced" to pass the compromise bill in order to avoid a default. This is all political theater that will exact a high price in the reputation and stature of the U.S. on the world stage and likely lead to a credit rating downgrade in the weeks ahead.

The markets are struggling not only because of the debt debate but also on growing worries over the potential for a double dip recession. Earnings guidance has been lousy and nearly every company releasing earnings is reporting a sharp decline in economic activity over the last six weeks. These cookie cutter comments from CEO after CEO are adding to the bearish sentiment in the market.

The Kansas Fed Manufacturing Survey for July was released today and June's rebound was almost completely erased. The May headline declined from +14 to +1 only to rebound to +14 again in June and back to +3 in July. The index has been very volatile in part because of the parts supply problem in the automotive sector. The chart trend looks suspiciously bearish and could go negative at any time.

Note that the backorders declined -29 points from June and completely erased the June rebound. Employment declined significantly but failed to fall into negative territory. New orders declined -15 points. This was a bearish report.

Kansas Fed Components

Kansas Fed Manufacturing Survey

On the bright side the weekly jobless claims fell to 398,000 and the first time in 15 weeks they have been under 400,000. This does not necessarily mean the labor market is improving. Historically July is a very volatile month for claims due to summer vacations. If you file for a claim you have to look for work and many people would rather hold off a couple weeks and use the time for some summer outings. If the weekly claims remains under 400,000 through August and possibly returns to the lows we saw in March we should see some of the bearish economic sentiment ease.

Jobless Claims

Pending home sales for June rose +2.4% for the second monthly advance. Sales are up +19.8% YTD compared to 2010 but in June 2010 the tax credit had expired and pending sales were at historic lows. I am glad to see sales are improving but the pace is still anemic and very volatile.

The Bloomberg Consumer Comfort Index declined to -46.8 from -43.3 the prior week. This is a two-month low. It was led by a drop in the state of the economy component to -88.1 from -83.7 and a decline in buying climate to -53.2 from -50.7. Given the state of debate in Washington I am surprised those numbers were not lower.

Critical reports due out on Friday are the GDP for Q2 with an official consensus for +1.8% growth but there are plenty of whisper numbers of less than 1% and several suggesting we could see a negative number. The final GDP for Q1 was +1.91% and we are pretty certain there was a drop in activity in Q2. How much of that late June decline was captured in the GDP calculations is unknown. Anything under +1.0% would be market negative.

Also scheduled will be the regional ISM reports for New York and Chicago. The ISM Chicago was previously called the Chicago Purchasing Managers Index or PMI.

The final reading on the July Consumer Sentiment will also be reported. Sentiment declined from 71.5 to 63.8 in the initial mid month reading.

There are other signs of declines in the U.S. economy. The rates for container vessels fell -9.3% since the end of April according to the Howe Robinson Container Index. Last year the index rose +56% in the same period as demand for back to school supplies and holiday merchandise forced shipping lines to add ships to handle the traffic. Since this is the peak-booking season, where shippers normally add a surcharge on Asia to U.S. routes, this is a significant sign of trouble. Inbound container traffic at Los Angeles and Long Beach declined -4.6% in June and the first decline since January 2010. The cost to ship a 40-foot container from China to the U.S. has declined -42% to $1,600 according to Clarkson Securities, a unit of the world's largest shipbroker. Shipping companies are not only dealing with a sharp decline in demand but a sharp rise in fuel prices of +53% over the same period in 2010. There are 5,056 container ships worldwide with a combined capacity of 14.89 million containers.

Nearly every CEO being interviewed after their earnings release is saying the same thing. They claim the sharply declining economic activity over the last six weeks plus the debt crisis in Washington has forced them to raise cash to increase liquidity and to put a hold on hiring and expansion plans.

We are at that point where something positive needs to happen quickly or the fear of a problem will actually cause a problem. Perception is a stranger thing. If enough people perceive there is a problem ahead and begin taking action to protect their businesses then the perceived problem can actually turn into a real problem. I think we are rapidly approaching that level of anxiety and I don't think an instant solution to the debt limit crisis will fix it.

The odds of a credit downgrade are 50% according to S&P but analysts believe it is much closer to 100%. The debate and lack of action has revealed the emperor has no clothes. The Treasury released info today showing the U.S. only had $85 billion in cash in their accounts. They are facing $326 billion in bills in August they only have $85 billion today. To most people that would be the definition of bankrupt except that once the debt limit is raised the U.S. can immediately get a cash advance on their Treasury credit card.

I believe the world has been shocked by the intimate details that have been revealed during this debate. Does anyone really believe China would ever tell the world it only had $85 billion in cash and $325 billion in bills to pay? Obviously not. The disclosure of far too many details and the reluctance of lawmakers to pay the bills has focused the eyes of the world on us.

Moody's said today if the U.S. credit rating is cut there will be an immediate ratings cut on 177 state and local governments that depend on the U.S. government for a large portion of their revenue. That is just the tip of the iceberg. Not to beat a dead horse but interest rates for everyone are about to rise significantly.

There were some interesting earnings today. Starbucks (SBUX) reported earnings of 36-cents and beating the analyst estimates by two cents. That was a +34% increase in profits. Same store sales in the U.S. rose by +8% and international sales by +5%. Starbucks closed 900 stores since the recession and slashed costs significantly. The CEO said commodity costs had risen sharply and were expected to continue rising. Starbuck's shares rallied +2.6% on the news after a sharp drop yesterday ahead of earnings.

Starbucks Chart

Whole Foods Markets (WFM) reported earnings on Wednesday evening and they rallied +2.6% today. Profits rose by +35% and it raised full year estimates. Sales rose +11% to $2.4 billion and same store sales rose +8.1%. The company operates 306 stores in the U.S. and today the CEO said they had targeting sites for 1,000 stores. Since the most they have ever opened in a single year was 16 that target seems extremely optimistic. Starbucks closed 900 stores and Whole Foods is considering adding +700. That is a definite contrast.

Whole Foods, sometimes referred to as Whole Paycheck because of the higher prices, has definitely found a niche market. So did Boston Chicken, Krispy Kreme, etc but the aggressive expansion plans killed those retailers. Once the new wears off the wisdom of the aggressive growth strategy starts to be questioned. Whole Foods has been around for 31 years and they employ 60,000 workers or roughly 196 workers per store. That is an awfully big headcount that would climb to nearly 200,000 if the expansion plan were completed. However, the CEO said the pace of expansion would be calm with 24-28 stores in 2012 and 28-32 in 2013 and that pace would continue until they reached a saturation point.

Whole Foods Chart

Exxon, the nations biggest oil company, missed estimates for Q2. That is very hard for me to believe given the average price of oil for the quarter was $103. Exxon posted earnings of $2.34 that missed estimates of $2.50. Net income rose +41% to $10.68 billion. Oil and gas production rose +10% for the quarter to 4.4 mbpd of oil equivalent. Gas production rose +22% while oil only rose +1.1%. Exxon was hurt by lower than expected profits in their refining division. Refineries around the world and on the coast normally buy oil based on Brent prices while those refineries in the Midwest buy oil based on WTI.

The $20 spread for much of the quarter meant Exxon was paying more for oil and the crack spread into refined products was less. When oil is bouncing around at its highs the price of gasoline and diesel does not rise as fast and sometimes refiners end up selling the products for less than it cost them to refine. This is why Marathon and Conoco announced plans to spin off their refining divisions. The volatility is too extreme and the long-term profits from refining are always choppy. Exxon has said it remains committed to its integrated model and will keep its refining businesses.

Exxon recently paid $41 billion for XTO in order to expand its natural gas business. XTO now manages a U.S. resource base of roughly 76 trillion cubic feet of gas compared to 45 trillion at the time of the merger. Exxon is said to be exploring more than a dozen shale plays in search of additional acquisitions. On the oil side they recently discovered a field in the Gulf, which may have 700 million barrels of oil and natural gas.

Exxon Chart

ADP posted profits of 48-cents compared to estimates of 49-cents. Shares declined slightly on the news. The real input from the ADP earnings was the guidance. ADP said payrolls for the quarter increased +2.6% but that can be from attracting new clients rather than employers hiring more workers. ADP is in a unique position to know if existing employers are hiring or trimming the ranks. Their update for July will be out next Wednesday. Based on there analysis of the current trends they said current economic conditions were expected to remain the same through 2012. That is not a particularly uplifting forecast. By all accounts economic conditions are crummy today and remaining that way for another year would not be a bullish trend.

ADP Chart

Cliff's Natural Resources (CLF) declined -4% after reporting earnings that missed estimates by a mile. Earnings were $2.92, up +69%, compared to estimates of $3.61. The earnings miss came from some additional expenses related to their acquisition of Consolidated Thompson as well as slightly lower prices for north American coal due to a change in the product mix. They also added four million shares to the share count, which reduces the earnings per share. There were also some currency translation issues. Overall I still like Cliffs and a return to the 200-day average at $85 would be a buying opportunity.

Cliffs Chart

So far in the quarter 303 S&P companies have reported earnings. 216 companies (71.3%) beat the earnings estimates, 54 or 17.8% missed estimates and 33 or 10.9% were inline with estimates. The average earnings growth was +11.6%. That rises to +14.7% if you exclude financials.

Unfortunately I don't have a count of the number of companies that lowered guidance for the current quarter. I suspect it is a lot. I can only remember a handful that actually raised guidance but dozens that lowered guidance.

I am sure everyone has heard by now that noted analyst Richard Bove suggested on Wednesday everyone should go to cash. He believes the U.S. financial system has received a serious blow and it will not recover for quite some time as in several years. Bove is no stranger to big market calls but this one could be pivotal. He was jokingly referred to as Chicken Little in the press. He responded saying you can call me Chicken Little if you want because I really do believe the sky is falling.

That is the direction market sentiment has been moving over the last couple of weeks. UBS did a survey of high net worth clients this week and 60% said they were bearish on the economy. That was up from 27% just a few weeks ago. If you view that as a contrarian indicator it would be significantly bullish but there are far too many signs that 60% could be correct.

I am not going to spend a lot of time on the economy of the debt debate because the only thing relative for Friday's trading is the debt debate and I am pretty sure everyone has had their fill of that political theater and wish we could change the channel. Unfortunately we are stuck with it for at least three more days.

The cancellation of the House vote tonight is an ominous sign of trouble ahead. Many republicans want a bigger spending cut and they are not willing to vote for the two-step plan. Until a plan is passed by the House and killed in the Senate the final compromise battle can't begin. I believe that battle will happen this weekend and the compromise will be announced Sunday night or Monday but the leaders still have to get it passed by both bodies and that could be very difficult.

This means Friday's trading could look just like today. Regardless of the direction it will be news driven and despite being a summer Friday the volume could be large. On Wednesday 9.4 billion shares traded followed by 8.4 billion today. Internals on Wednesday were severely negative with declining volume of 8.6 billion shares vastly outpacing advancing volume of 670 million. The mismatch was not as bad today with declining 5.2B over advancing 3.0B. Normally those high volume days with 10:1 declining over advancing volume are potential capitulation days that are followed by a rebound. We saw that rebound attempt on Thursday morning but it was crushed when selling began at noon.

The market decline for the week may have farther to go but I am expecting some dip buyers to show up on Friday before the close. The odds of a debt compromise over the weekend are about 100% because there is no other option. That should spike the market from seriously oversold. However, any votes on Monday/Tuesday will be critical and we know what happens when it does not work out like the market expects. Remember the TARP vote? Everybody thought it would be approved because the financial system would crater if it failed. The vote failed and the Dow lost -700 points in one day. Lawmakers quickly saw the error of their ways and passed it and the market rebounded. A failed vote on Mon/Tue would likely get the same result.

The market is likely to make triple digit moves for the next three days but there is no way of knowing which direction on which day. Hopefully by Wednesday this will all be behind us and we can go back to worrying about earnings and the economy for our market direction. Based on what we have been hearing lately that may also create indigestion but we will have to play the cards we are dealt.

The S&P has pierced the support of the 50-day (1310) and the 100-day (1316) leaving only the 200-day as potential support at 1284. Thursday's close at 1301 is only a heartbeat above the intraday low from July 18th at 1295 and the level that started the last rebound. That 1295 level is going to be key and followed by the 200-day at 1284. A break of those levels would mean we are back to a bearish trend.

S&P Chart

The Dow blew through support at 12,400 on Wednesday and never looked back. Current support is 12,200 but with the deadlock in Washington we could easily see a retest of 12,000. Exxon -1.85 and CAT -1.70 were the biggest decliners on the Dow. It was not a flush like Wednesday but we still closed at a lower low and that is what counts. A break below 12,200 could gain speed quickly.

Dow Chart

The Nasdaq closed positive for the day but don't confuse that with a tech rally. The gains were solely the result of GMCR +14.59, PCLN +12.78, EQUIX +8.59, ZOLL +7.85, SODA +5.90, CME +5.32 and GOOG +3.72. Apple, Amazon, Netflix and F5 Networks were either negative or only slightly positive. The dead stop on the 100-day average may have been only coincidental but that is two consecutive days at that support level. A break there targets the 200-day at 2700.

Nasdaq Chart

Friday will be a news driven day with two ISM reports, GDP and the debt debacle providing the power behind the moves. I expect some buying at the close in anticipation of a weekend deal and Monday rebound. However, it will be completely news driven. If the news is still ugly then traders may elect to escape the drama and go into the weekend flat.

This is one of those market events where the best laid plans can and do go astray. Unless you have money to burn or a gambler attitude I would probably use smaller positions with tight stops if you just have to be in the market.

Jim Brown

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