The Nasdaq closed at a new 10-month low at 2341 after weakness in the chip sector and Hewlett Packard's earnings warning. Google lost $14 to close under $500.

Market Statistics

The market reporters were going out of their way to describe the damage done in the last four weeks. Statisticians pointed out it was the second worst four week period for the S&P since 1950. It was the third worst week in a year for the Dow and second worst for the Nasdaq. It is hard to believe we started the week with a triple digit rally that was testing new short-term highs on Wednesday.

Friday was actually better than I expected after watching the Dow futures fall to -200 overnight Thursday night. When the indexes rallied into positive territory at Friday's open I was shocked to some extent but pretty much realized it was just another selling opportunity for the bears and those longs who were hoping to exit before the weekend event risk.

Option expiration was one reason for the opening spike. The S&P options expire at the opening print on the S&P. This always causes some Friday volatility at the open on expiration days.

There was little to move the market in terms of geopolitical news or economics but Hewlett Packard was doing a good job all by itself. Hewlett dropped -$6 or -20% and was responsible for the loss of more than 45 Dow points. Actually since February 18th Hewlett has been responsible for a decline of more than 200 Dow points or -13% of the Dow's decline.

The actual Dow performance on Friday was not as bad as it appeared. Three stocks, IBM, CAT and HPQ, were responsible for -124 points (-72%) of the -172 point decline. Seven Dow stocks were actually positive. Those were CVX, CSCO, PG, AXP, MRK, WMT and MCD. However, regardless of how it got there a close at 10,800 is still ugly.

There were only a couple of economic reports on Friday. The Regional and State Employment report showed nonfarm payroll employment rose in 31 states in July. New York added +29,400, Texas +29,300 and Michigan +23,000 were the states with the best gains. Illinois -24,900 and Florida -22,100 the biggest losses. The data in this report is old news but it supplies detail we did not have in the Nonfarm Payroll report earlier this month. The market ignored this news.

The Risk of Recession report for July rose to 31% from 26% in June. This is also a lagging report to some extent and it is predicting economic conditions six months from now. This is the third consecutive month of increases and the 31% is the highest level since September 2010. This report is produced by analyzing all the other economic reports based on historical ranges to predict the direction of the economy. This report was also ignored.

The calendar for next week is peppered with regional Fed surveys with each taking on more importance after the Philly Fed report imploded last week. The next GDP revision is Friday and it will be a challenge to remain over +1% growth for Q2. There have been several recent reports that should have pushed the Q2 GDP revision lower. Some estimates see it close to zero. A dip into negative territory, not expected this time around, would be very detrimental to market sentiment.

The biggest event will be the Bernanke speech at the Federal Reserve conference at Jackson Hole on Friday. A year ago this week the markets were bouncing along the bottom with the Dow at 10,000, S&P 1050 and Nasdaq 2100. Bernanke took to the podium in Jackson Hole and suggested the Fed was about to launch into a major quantitative-easing program known today as QE2. The markets caught fire and a six-month rally appeared.

It would be silly to think traders are not expecting Bernanke to take the podium and pump up the markets again. In fact the majority of the market conversation, other than Hewlett Packard, revolves around what Bernanke could say or do for an encore performance.

Nobody really expects a QE3 announcement but they do expect some guidance on what to expect from the Fed. They expect that guidance to move the markets. Whether that movement is going to be a small ripple or a major tsunami is of course unknown.

With the rise in inflation in the PPI/CPI reports last week the Fed may be between a rock and a hard place with their available options. A QE3 program is not politically acceptable today. Candidate Rick Perry said it would be treasonous for Bernanke to print more money with a QE3 program. Maybe Perry needs a quick economics 101 lesson before he hits the campaign trail again.

Bernanke will probably outline the methods the Fed could use and try to talk the markets away from the cliff. How successful he is will probably determine what kind of September we will have in the market. Remember, September is historically the worst month of the year. It would have to be really ugly to be worse than the August performance to date.

Whatever happens in the market early in the week we should see some improvement on Wednesday and Thursday as traders position themselves for a Bernanke bounce. In the August 2010 speech he said, "We will do anything to prevent a second recession." Traders want to hear what "anything" means today. Beware a sell the news event if his speech is found lacking.

Economic Calendar

There was no earth shaking news out of Europe. No new bank worries and no major earnings reports. It was a summer Friday but volume at 9.7 billion was about twice that of a normal August Friday.

The big news on Friday was Hewlett Packard's astonishing earnings report and announcements. The various announcements made by HPQ caused some serious consternation among investors. HP said it was considering spinning off or selling its PC business. Since they are the largest PC maker that would be a huge breakup representing half of their $50 billion market cap. Not many companies will want to spend $25 billion for a low margin commoditized business. That suggests few bidders and a small price. By announcing it in advance of actually doing it they just hung a huge black cloud over future PC sales. How many consumers will want to buy an HP PC when the business is up for sale? Bad move by HP.

Previously CEO Leo Apotheker had publicly resisted calls for a PC spin-off saying the equipment helped HP provide a full suite of offerings to large business customers. I guess large business customers switched to buying Dell instead of HP.

Secondly they said they were closing the tablet division and getting out of the consumer devices space. With more than a million TouchPads in the channel (in retail store inventories) that was probably not a smooth move. How many consumers will want to buy a tablet from a maker that is shutting down the business? What if I need service or software upgrades? Oh, we are dropping the WebOS operating system as well. What manager would announce the cancellation of a product with 1.5 million still unsold? Sell the inventory then announce the cancellation.

Saturday evening update: HP slashed the price of the TouchPads to $99 for a 16GB model and $149 for the 32GB model and all available inventory in the U.S. was instantly purchased by frantic consumers. Even the HP website is out of stock but they will probably have some additional units when the previously announced store returns hit their distribution centers. When I heard the price cut news early Saturday afternoon I raced to call every local retailer and every one was out of stock. I called Best Buy, Costco, Staples, Office Max, Wal-Mart and Sam's Club. I quizzed several stores and they said it was panic buying after the announcement. Buyers were lined up at the registers with people buying not just one but multiples of the soon to be obsolete tablets. An Office Max worker told me they had to bring in an extra employee just to answer the phone. Google said "TouchPad" was the number one search term on Saturday. I guess you can sell anything if you give it away. That is one way for HP to avoid eating 1.5 million tablets.

Hewlett shares fell -20% to $23.59 and based on the analyst comments and expected downgrades this could be just the first dip. The obvious errors in execution by HP management does not bode well investor confidence. HP shares have declined -52% in the last six months. I wonder what kind of performance bonus Apotheker will get for 2011?

John Paulson had 23.5 million shares of HPQ on his last SEC filing. If he still owns those shares today he lost -$212 million on Thr/Fri. That has got to hurt!

Hewlett Packard Chart

With the TouchPad tablet going extinct before it ever really matured the market would seem to favor Apple. Hewlett was the deep pockets, PC relatable, big brand that was slated to give Apple some serious competition. You can bet Steve Jobs and Apple management were dumbfounded when the news broke and adult beverages were being consumed in volume all over Cupertino on Thursday night.

This narrows the field to two main competitors between Android and Apple. Android has developed some serious momentum but Apple is not conceding the fight. News leaked last week that Apple has ordered parts to construct 1.5 million iPad 3s in the fourth quarter for delivery in Q1-2012. The new iPad 3 will have a 9.7-inch screen with a 2048x1526 resolution compared to the current 1024x768 screen. There is no moss growing on Apple and they should continue to be the leader in terms of tablet technology but they can't afford to rest with Android on their heels.

Apple Chart

If Google can quickly digest Motorola the tablet wars could really heat up with a true Google tablet a couple years from now. Giving Google a manufacturing and marketing arm for computing devices could setup the eventual birth of Skynet. Let's hope their mission statement of "Do no evil" remains in force.

Google Chart

On Friday we saw a continuation of the theme for the month and that theme was to sell financials. The KBW Banking Index ($BKX) lost another -3% to close at a two year low. There was actually some good press on the U.S. banking system on Friday that stressed their higher capital levels, rising loan volumes and low exposure to Europe but nobody was listening.

Banking Index Chart

The good news was drowned out by news from Bank of America of another 10,000 workers to be cut with 3,500 in Q3. They currently employ 287,839 people and the largest of any U.S. bank. Citigroup has 260,000 and JPM has 250,000 employees. The 50 largest banks have announced cuts of more than 60,000 workers so far in 2011. HSBC announced a cut of 30,000 workers. BAC is trying to cut costs by -20% in their consumer division, which had about $30 billion in expenses in 2010. The bank has posted about $30 billion in mortgage losses since Brian Moynihan took over the CEO office in 2010. BAC shares slipped back under $7 with some analyst targets at $5. I would be a buyer of BAC once they can get their mortgage problem solved.

Bank America Chart

There was no specific news on the economy but analysts were racing each other to see how low they could go with growth estimates. Goldman cut 2011 GDP estimates to 1.7% and 2012 to 2.1%. Citi cut 2011 to 1.6% from 1.7% and 2012 to 2.1% from 2.7%.

JP Morgan cut Q4 GDP growth estimates to 1% from a prior projection of 2.5%. Even worse they slashed 2012-Q1 to 0.5% from 1.5%. JPM warned that recession risks are "clearly elevated."

Goldman also cut growth estimates on the EU to 1.9% for 2011, UK 1.5%, Japan -0.8% and China 9.3%. The downgrade virus has clearly infected the analyst community and this will not be lost on the Bernanke when he speaks next Friday.

Cutting growth estimates had a seriously negative impact on oil prices on Thursday night with U.S. WTI crude falling to $79 overnight. However, the Friday morning rally pushed it back to $83.50 before easing slightly to $82.70 at the close. The U.S. WTI contract expires at the close on Monday so expiration pressures could also have been responsible. Support at $80 should be strong. Note the stronger showing in Brent with a +2.07 gain. That contract expired last week so there is no expiration pressure there and light crude inventories are still declining in Europe and Asia.

Tropical storm Harvey made landfall in Guatemala on Saturday and that will eliminate it as a threat to the Gulf of Mexico installations. There is another storm forming south east of Puerto Rico, now called Irene and could be a challenge for the Gulf by next weekend.

WTI Crude Oil Chart

Brent Crude Chart

Another trading day is in the books and another record for gold was seen. Gold prices hit $1881 for a new intraday high and finished with a $33 gain at 1855 for a new closing high. Analysts continue to upgrade expectations with Goldman now saying $2500 with several analysts now predicting $2000 by year end with one saying $2K by Thanksgiving. Gold is up +226 over just the last three weeks so $2000 by Thanksgiving should be a snap even with a couple pauses for profit taking.

The move by Hugo Chavez to bring all Venezuela's gold back to Venezuela could be the first signs of a run on the physical metal. Venezuela has $11 billion in gold on deposit around the world. The Bank of England said it had received a request from Venezuela to transfer all the gold on deposit, currently 99 tons, back to Venezuela. JP Morgan and the Bank of Nova Scotia also received redemption requests. It is unknown how much gold Venezuela has on deposit with JPM but the bank only has 338,303 ounces of registered gold in storage or roughly 10.65 tons. Here is the key point. The gold on deposit is pledged to cover derivatives contracts and it is leveraged. If JPM has 10 tons they have probably used it to back 50 tons or more of paper pledges. Rarely does anyone ever actually redeem gold so banks can comfortably use it as a hedge and should a redemption occur they can replace it on the open market. Unfortunately there is very little physical gold on the open market today. Some analysts are worried a short squeeze on gold may be just around the corner if other major holders suddenly decide to reclaim their gold. The gold chart may look severely overbought today but a run on physical gold could quickly push it to much higher levels.

I have posted the following info before but it bears repeating. Standard Chartered PLC, a major international bank with a 150-year history and 1,700 offices, is predicting gold prices could rise to $5,000 an ounce over the next five years. Read the full report here: In Gold We Trust

Gold Chart

Actually, despite the big gains in gold the real hero for 2011 has been silver. Silver is up +39% and gold only +30%. Silver broke out over resistance on Friday to nearly $43 and the trend appears to be headed for at least $45 in the near future.

The Silver Institute recently released a report titled The Future of Silver Industrial Demand and predicted demand for industrial use would increase to 665.9 million ounces by 2015 for a 36% increase from the 487 million used in 2010. Mine production only rose +2.5% in 2010 to 735.9 million ounces. Silver investments like the SLV ETF saw a +40% increase in the amount of silver owned by 279.3 million ounces in 2010 to 582.6 million. Coins and metal demand rose +28% to 101.3 million and there were 55.6 million ounces of bullion produced. The SLV ETF increased its holdings by 1,428.6 tons in 2010 and has already added another 280 tones in 2011.

China said its net imports of silver rose nearly 400% in 2010 to more than 3,500 metric tons. They exported 1,575 MT, 58% less than 2009 and imported 5,159 MT, +15% more than 2009. China had been a next exporter of silver in the past but became a net importer in 2009 and those imports are soaring.

Silver Chart

The recession question is sure to bounce around in the markets for the next several weeks. Many firms are claiming we are already in a recession and others are warning we are headed there. Many noted analysts are critical of the idea. Abby Cohen was dismissing the idea on Friday by quoting a long list of economic facts that prove we are not in a recession. "This is not 2008" is a phrase getting plenty of headlines.

The Philly Fed Survey last week was supposed to come in at +2.0 and instead declined unexpectedly to -30. I explained on Thursday night why I thought the report was flawed. The next material report other than Friday's GDP revision is the ISM Manufacturing on Sept 1st. The July reading came in at 50.9 and only a fraction over contraction territory. Analysts warn that a reading under 48 means a recession is likely and a reading under 42 means a recession is inevitable. It is going to be a long two weeks while we tick off the days until that report.

Bottoming is a process. I have said it before but we need to constantly reiterate that truth. Bottoms are not normally made where they are expected. Actual bottoms are unexpected. They appear after everyone throws in the towel and pledges never to buy stocks again. We can see where a bottom might be forming but it will be several weeks before we know if it was the real deal.

When the market corrects there is said to be five stages of grief. Those are denial, anger, bargaining, depression and finally acceptance. Where are we on that scale?

There is another scale that has been floating around for years. The graphic below came from Barry Ritholtz. Despite the big moves in the market I don't think we have moved much past desperation or maybe panic. Obviously 400-500 point market drops are ugly and the high volume would suggest some degree of panic but I don't think we have seen capitulation even though there has been five 90% days in the last 10 trading days. I think there needs to be another big day that could qualify as capitulation and then despondency. The despondency stage is when you quit turning on the TV or logging into your computer to see what your positions are doing. You have mentally checked out of the market. The urge to buy the dip has turned into disgust that you bought the dip and were crushed by the continuing decline.

Market Cycles

The S&P closed at 1122 and the low of the day. This is only a couple points away from the August 11th low where the rebound began. That rebound has been erased and the index is threatening to make a new low. The August 9th low was 1101 so that would become the immediate target if 1120 breaks. If 1101 breaks that sets up 1050 for a complete return to the August 2010 Fed meeting support lows at 1050.

I am not predicting any specific number for next week because we are in a news driven market and there is bound to be plenty of news next week. Personally, although painful, I would love to see a retest of 1100 on Mon/Tue and then a minor rebound into the Bernanke speech.

With the S&P down the most in a four week period since March 2009 I see no future in buying puts. We are back in the oversold column and the next move to play is hopefully a bounce. The S&P is down -18% since April 29th so bear market territory is just around the corner. I would prefer to pass on that experience. Touch bear market territory? Yes. Live there for six more weeks? No.

There are analysts who believe the yield on the ten-year note will decline to 1.25% by year-end. It is 2.07% today. At less than 2% the only real opportunity to grow your money faster than inflation is in equities. That is where Bernanke will probably try to lead investors on Friday. If he can make the case for abnormally low rates for the next two years then eventually the money that would normally go into bonds will find its way to the equity market instead.

On the S&P I would buy 1120 and 1100 as short-term trades and short a break below 1100 with 1050 as the target.

S&P-500 Chart

The Dow crashed back to 10,800 thanks to the implosion in Hewlett Packard, Caterpillar and IBM. This is just above the support from the early August dip at 10,700. If sentiment does not improve and 10,700 breaks we could easily see a dip back to the August 2010 QE2 support at 10,000. While I don't believe the market fundamentals support a decline of this magnitude it does not matter what we believe. The markets sometimes develop a negative feedback loop where the declines feed on themselves rather than on the fundamentals.

I would be a buyer for a trade at 10,700 before the Bernanke speech but I would become a seller under 10,700 after the speech.

Dow Chart

The Nasdaq has returned to the early August levels and sentiment is declining. Chip companies are lowering guidance and new orders are declining. The PC sector was shaken by the Hewlett Packard news they were considering a spin-off of the PC business because the margins were so low. Lowered guidance is never good and the tech sector suffers through this problem at the beginning of every Q3. This year the advance orders for the holiday season are either lower than normal or nonexistent. This could continue to pressure tech stocks for the weeks ahead. A test of 2300 is virtually assured and a lackluster Bernanke speech could allow a dip to 2100.

Nasdaq Chart

The Russell has declined to the early August support lows but sentiment for small caps is deteriorating. Weak economics and weak earnings guidance is a one-two punch for small caps. Investors tend to put money in highly liquid blue chips with large dividends in times of market stress.

The Russell has the potential to break below 650 and could target 590 and the QE2 support low if sentiment does not change quickly. The Russell is down -24.3% from the 860 high on July 7th. The Russell is firmly in a bear market and that negative feedback loop could easily push it much lower given the weak sentiment.

Russell 2000 Chart

The Dow Transports closed at a new 52-week low but the fundamentals behind the sector are not that bad. Freight loadings are higher than in 2010 and fuel prices are declining. Coal, oil, construction materials and lumber are still strong with coal and oil rising sharply. Airlines are flying at capacity on most routes and trucking companies are reporting steady business. Obviously shipments would improve with a rebound in the economy but we have not seen a sharp decline as is indicated by the chart. This is a sentiment decline not a fundamental decline. It is however, still a decline.

Support is 4,000 and hopefully calmer heads will prevail when that level is reached.

Dow Transports Chart

For next week I expect Monday and Tuesday to be choppy. I think Friday was a "go home flat" day where everyone who bought the bounce last week gave up in disgust. Shorts were confident the downtrend was resuming and saw only negative event risk ahead.

This thought process could continue on Monday and Tuesday if there is not a sudden change in status in Europe. With nobody even close to coming up with an acceptable plan I doubt that will change but you never know. On Wed/Thr we could see some buying as shorts cover and buyers position themselves in anticipation of Bernanke rescuing the markets once again.

Volatility should continue but normally we see a decline in trading volume as we approach Labor Day. Eventually the sellers will run out of stock to sell and fundamentals will take over. Earnings for Q3 are expected to increase by +17% so no earnings recession there. The guidance may have been weaker but it still indicates decent profit growth. Eventually there will be a resolution of the current uncertainty but it may take a few more weeks before the volatility returns to normal.

Jim Brown

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"I find that the harder I work, the more luck I seem to have."
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