The markets pulled back on worries over Europe and concerns about the Bernanke speech on Friday.

Market Statistics

The problem started in Germany overnight when the DAX futures fell -4% on worries Germany would also establish a ban on short selling. France, Italy and Spain extended their short selling ban and there were worries it would extend to Germany. For European traders the inability to short on France, Italy and Spain forces them to short futures on the German DAX in order to protect their long positions on the other exchanges. The German ban never materialized and Germany's market ended the day down -1.7%.

There were other European worries on Wednesday when German Labor Party Minister Ursla von der Leyen, called for countries needing bailouts to put up gold as collateral for the loans. Finland secured additional collateral on August 16th to ensure its contribution would be repaid. However, the EU ministers are probably going to reject that deal. The problem of multiple countries asking for collateral shows it is clear they don't expect to be repaid. The bailout loans are more than likely going to be defaulted. Asking for collateral is a show of weakness in the EU plan and the individual countries. Since the eventual plan has to be voted and approved by all the countries concerned it suggests the approval may be in jeopardy. This was causing market concern all over Europe and that indirectly impacts U.S. markets.

However, the U.S. markets shook off the overseas negativity when Bank America announced Warren Buffett had purchased $5 billion in BAC preferred stock. BAC shares spiked from yesterday's close at $6.99 to nearly $9 before falling back as the day progressed to close at $7.65. This was another sweet deal for Buffett. Berkshire Hathaway bought 50,000 preferred shares at $100,000 each. Those preferred shares will pay a dividend of 6%. That may be a good deal in today's low interest market but it gets even better. Berkshire also received warrants to buy 700 million common shares of BAC at $7.14 each. If BAC returns to where it was trading in January at $15 those warrants will be worth $5.5 billion. If Berkshire executes those warrants it would become the largest shareholder in Bank America.

Buffett conceived the idea while taking a bath on Wednesday morning. Buffett called BAC CEO Monynihan with the idea later Wednesday morning using Monynihan's private phone number. Monynihan told Buffett thanks but the bank did not need additional capital. Buffett agreed and said that is exactly why he was calling because he thought the bank was a good long-term investment. With the vote of confidence and capital cloud erased it would be an even better investment. Monynihan thought it over and conferred with advisors and told Buffett on Wednesday afternoon he had a deal. There was no negotiation of the terms. Buffett got exactly what he asked for.

Most analysts believe Monynihan made a very bad deal. With interest rates so low they feel there is almost no way BAC can make money after taxes on what is basically a 6% loan. If they did not need the capital why take on that kind of interest cost? Also, the warrants represent serious dilution to existing shareholders because there is almost no possibility they won't be executed once BAC shares rebound significantly.

I believe BAC did the deal just to remove the capital cloud and they have no plan to let Buffett keep the preferred shares. Once the current cloud over BAC blows away and the bank starts posting larger and larger profits they will buy back the preferreds and the warrants. There will be a cost but once out of the current economic soft patch they will have plenty of profits to make the purchase. I believe Monynihan did the deal simply to erase the capital cloud and halt the decline in his stock price. What is it worth to improve sentiment for the bank and end the daily declines? More than 850 million shares of BAC were traded.

Bank of America Chart

Unfortunately Buffett's BAC purchase helped BAC but it failed to support the broader market. The Dow's morning rally to 11,400 was quickly sold and it declined to within 6 points of 11,100 just before the close.

Another problem for the market was a sharp rise in the weekly Jobless Claims. The weekly number spiked to 417,000. The prior week was revised up from 408,000 to 412,000. On the surface this would appear to be a worsening of conditions but the Department of Labor said the uptick was due to the Verizon strike where 45,000 workers were temporarily out of a job. The Labor Dept said they had identified at least 8,500 new filings that were related to Verizon and there were probably more. They estimated at least 12,500 were Verizon related. The uptick over the last two weeks, even though they were related to the Verizon strike, are pushing estimates for the August Nonfarm Payroll report even lower. Estimates are well below +100,000 private jobs compared to the +154,000 gain in private payrolls in the July report.

The weakening in the regional manufacturing surveys are suggesting we could see a continued rise in Jobless Claims because the employment components have been worsening.

Jobless Claims Chart

On the positive side of the economic picture the Kansas Fed Manufacturing Survey did not worsen. Given the major declines in all the recent reports this was a surprise. The Kansas headline number for August was +3.0 compared to +3.0 in July. New orders rose to +1.0 from the -5.0 in July. Backorders were less bad at -10 from -19. Even better the capital expenditure plans improved from 8.0 to 13.0 suggesting some improvement in sentiment. The hiring component improved from 4.0 to 8.0.

All of these gains were minimal but they were definitely better than the sharp declines we saw in the other regional manufacturing reports. This was good news on a relative basis.

Kansas Fed Manufacturing Survey Chart

Friday has two economic reports in the GPD revision for Q2 and Consumer Sentiment. The GDP showed +1.28% growth in the first reading but that is expected to decline to less than 1% in Friday's revision. Moody's is expecting a drop to +0.8% growth but several other analysts are expecting less than +0.5% growth.

The Consumer Sentiment fell to 54.9 in the first reading and that is the lowest level since 1980. The -19.2 point decline over the last three months was only exceeded twice in the history of the survey in 1990 and 2005. Friday's number is expected to improve slightly to 56.0.

The big event for Friday is of course the Bernanke speech and everybody with access to a microphone or a keyboard has opined on what he is likely to say. Most believe there is almost no potential for a new program to be announced. Not only is it the wrong platform but there are no programs he could announce that would not rock the boat. Most now believe he will outline the various programs the Fed could use and possibly discuss what events would force the Fed to act. With three dissenters on the FOMC the odds of a QE3 program are about zero.

The one program receiving a little bit of play is the "Operation TWIST" action taken in 1961. Basically the Fed changes its purchases of treasuries from the short-term 2-year durations to the long term 30-year in order to keep interest rates lower for a longer period. Keeping long-term rates significantly lower aids home mortgages, business loans, etc. However, Kansas Fed President Thomas Hoenig said, "I don't see any reason why it would work" to further stimulate the economy. "What is the fundamental problem? Is the fundamental problem a yield curve issue or that the U.S. and world have too much debt?" There is no problem Operation TWIST can solve.

Regardless of what Bernanke says or doesn't say his speech is the focal point for the week. The markets ran up in anticipation of some market-moving announcement and then sold off when the preponderance of the evidence suggests there is nothing he could announce that would benefit the market. He said a very weak payroll number on Sept 2nd could force the Fed to act when it meets on September 20th.

The U.S. sold $29 billion in seven-year notes at a record low yield today. This followed $35 billion in five-year notes at 1.029% and $35 billion in two-year notes on Tuesday at 0.222%, also record low yields. Interest rates do not appear to be a problem.

Doctor Doom, Nouriel Roubini, believes Bernanke will eventually announce QE3 but not at this meeting. Roubini believes we are heading into a global recession and the Fed is running out of policy bullets to slow the U.S. decline. Another QE program is the only hope according to Roubini.

Gold prices rebounded from $1705 to $1777 before easing slightly at the close. The $72 rebound came on the debt crisis worries in Europe and the sharp drop in European markets. Adding in the rise in Jobless Claims and traders bought the -$200 dip from Tuesday's high at $1917. Analysts are unsure whether this is just an oversold bounce or the beginning of a rebound to new highs. The fundamentals have not changed only the perceived risk of being long gold at $1900. Shanghai and Hong Kong both raised margins on Gold earlier in the week and that forced a minor reshuffle by investors in those markets. Investor sentiment in gold was 93% bullish last week and that has only happened once before and it was followed by a -34% decline to push investor sentiment back to 51% bullish before the rebound began.

Gold Chart

Apple shares rebounded to close only slightly negative after yesterday's announcement by Steve Jobs and his resignation as CEO. The stock traded down to $350 overnight but erased most of those gains by the close. Steve did not give any reason for his resignation other than he can no longer perform the CEO duties. Everyone assumes it is health related since he is regularly photographed entering and leaving medical offices. Steve was immediately elected as Chairman of the Board so he is not leaving Apple only leaving the day to day operations. In that position, one that has been vacant for some time, he could assume the role as Chief Visionary. Jobs recommended COO Tim Cook and acting CEO in Steve's absence, be promoted to permanent CEO and the board immediately acted on Steve's wishes.

Apple shares have risen +6,760% since Jobs was rehired as CEO in 1997. Steve grew Apple from a startup but was kicked out because of his insane focus on detail and the desire to make the absolute best products possible. He rescued Next Software and grew it to the point where Apple acquired the company giving Jobs a second fortune. Jobs gained control of Pixar Animation and grew it to the point where it was acquired by Disney and Jobs took home another monster payday. To say this many has been instrumental in some of the biggest technology innovations on the planet would be an understatement.

Apple Chart

Hurricane Irene is moving up the east coast with hurricane warnings from South Carolina all the way past New York. The storm is being compared to several hurricanes that caused billions in damage and serious loss of life in decades past. Fortunately Irene is only a category 3 at present and could weaken to a category one by the time it reaches New York. One thing it is producing is a significant amount of retail sales all up the coast from food stores and builder supply stores like Home Depot. You can expect to see a boost in retail sales for August when the numbers are reported in mid September. There is a silver lining in almost every cloud. Tropical storm ten has formed off the coast of Africa and is heading towards the Bahamas for next week.

Hurricane Irene

Tropical Storm Ten

The S&P failed at short-term resistance at 1175 and finished the day right in the middle of its recent range. Effectively the market found a neutral level where it is neither overbought nor oversold ahead of the Bernanke speech. Support is 1120 and major resistance at 1200-1205. The odds are very good one of those levels will be tested on Friday.

S&P-500 Chart

Like the S&P the Dow finished in the middle of its recent range and in a neutral position ahead of the speech. Only two components were positive and those were BAC and AXP. CAT and MMM both lost over $2.

Support is now 10,800 and resistance 11,500.

Dow Chart

The Nasdaq benefited from the +25 point rebound in Apple to also close in the middle of its recent range and just above light support at 2400. Strong support at 2335 and strong resistance at 2550. Despite today's -48 point day this was a nothing day. Traders took profits and headed to neutral ground.

Nasdaq Chart

Russell Chart

Thursday was a return to neutral for the markets. This was what the TV reporters have been calling as a risk off day. Early week profits were captured and traders moved to the sidelines to wait for the Bernanke speech. It was as simple as that. Throw in the Europe mess and rising jobless claims for economic color and a few headlines about Apple and Bank America and you have a quick synopsis of the trading day. Nothing material happened and nothing is likely to happen ahead of the Bernanke speech. After the speech is a different story.

Post speech, regardless of content, the market is likely to be volatile. Traders looking to sell the news will sell and those hoping for a dip will buy. It will be a giant tug of war and there is no telling where we will end up. Unless there is something unexpected that causes a spike in bullish sentiment I would expect we have a greater chance of a decline to support than a rally to resistance. This is August and we have people like Doctor Doom preaching recession on every channel and every newspaper. While I think they will be wrong it does not matter what I think. It only matters what the majority of traders think and that will depend on how good Bernanke does as economic cheerleader on Friday.

Jim Brown

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