The markets exploded higher as Europe offered up another plan to solve its problems but like before it was long on promise and short on details.

Market Statistics

I am sure you have heard this on the news today so I will try and make it brief. EU leaders confirmed plans to boost the EFSF to one trillion euros from its current 440 billion. They will do this by leveraging the remaining 250 billion still uncommitted by 4-5 times. Exactly how they plan to do this is unknown other than they will provide some guarantees and solicit contributions from other countries like China. Basically this is another plan with no real details on how they will make it work. Essentially they are asking the world to trust what they say rather than what they do.

Secondly they agreed to a 50% haircut for Greek bond holders. Greece has nearly 370 billion euros in debt. Only 120 billion is covered by this haircut. This will only reduce Greece's debt by 60 billion IF all the bond holders agreed. The EU statement said "we invite Greece, private investors and all parties concerned to develop a voluntary bond exchange with a nominal discount of 50% on notational Greek debt held by private investors." Does that sound like an agreement? They can't force bond holders to exchange bonds for a 50% decline in principal or it would be a default and trigger the credit default swaps. The bond exchange has to be voluntary. Does agreeing to pay 50% make it a done deal or will it be a done deal when/if all the bonds are tendered? I believe the highly praised 50% deal is not really a deal, yet.

Lastly, the EU agreed to force banks to raise tier 1 capital levels to 9%. Basically that forces EU banks to add another 100 billion in capital to strengthen them against the impact of the continued austerity and future problems with Greece. Banks can increase capital requirements two ways. They can sell shares to raise capital and further dilute existing shareholders. After the forced capital raises post recession and the very low valuations on their current stock price this is not the way most will go. The second way is to quit loaning money, call existing loans, close branches, cut employees and sell assets. Since banks normally leverage their capital 20:1 a reduction in activity sufficient to increase capital by 100 billion euros would remove two trillion in euro liquidity from the European economy. This should force the euro zone back into recession if this is the route banks take to raise the 100 billion in tier 1 capital. As part of the statement the EFSF could provide a recapitalization loan to individual banks if no other options were available. Don't look for that to happen.

Also, the EU statement said "All member states of the euro area are fully determined to continue their policy of fiscal consolidation and structural reforms. A particular effort will be required of those member states who are experiencing tensions in sovereign debt markets." What that means is that austerity will continue and nations like Italy, Spain, Greece and Portugal will continue to be faced with harsh changes and cuts in spending that will force them deeper into recession for years to come.

The EU is moving towards a change in governance. They realize they can no longer depend on individual nations to do the right thing and live within their budgets. "Being part of a monetary union has far reaching implications and implies a much closer coordination and surveillance to ensure stability and sustainability of the whole area. The current crisis shows the need to address this much more effectively. Therefore, while strengthening our crisis tools within the euro area, we will make further progress in integrating economic and fiscal policies by reinforcing coordination, surveillance and discipline. We will develop the necessary policies to support the functioning of the single currency area." In plain english this means they are eventually going to force some sort of euro wide "surveillance and governance" to enforce budgets and spending. Good luck with that!

Overall the EU plan does suggest the leaders are prepared to prevent a Lehman like scenario and that is the reason for the rebound in the markets. The worst case scenario has been taken off the table but there are plenty of weak case scenarios that will linger for years. I think we have reached a point where daily headlines from Europe will no longer control our markets but the long term implications will be with us for years and could (will) flare up again at any time. They succeeded in kicking the can way down the road but it is still on the road.

Complete text of EU statement: Click here

The next challenge for the U.S. markets will be the super committee report due out just before Thanksgiving.

The announcement of the "European solution" caused a relief short squeeze. The European cloud has been hanging over our market for so long that even putting off the day of reckoning for several months was a positive event. However, after having many hours to read the statement and realize it really did not offer an details or resolve the problem, many traders shorted the opening gap thinking the market would roll over after the news was really disseminated. Surprise, surprise! After a brief dip in the first hours of trading the market roared off again. Never underestimate the power of underinvested funds. Those new shorts were forced to join old shorts in covering and a powerful short squeeze was born. The S&P rallied +3.4% to trade over 1290 and a three month high. The Dow closed over 12,200 for the first time since August 1st.

In the U.S. we got the first look at the Q3 GDP and the headline number showed growth of +2.5% and right in line with consensus estimates. Some whisper numbers were over 3.0%. The spike in GDP from the +0.9% average for the first two quarters, was due to a +2.4% spike in consumer spending. That compares to consumer spending of +0.7% in Q2. The revised headline GDP for Q2 showed growth of +1.33% with Q1 at +0.36%. Fixed nonresidential investment (business spending) soared +14% in the quarter as companies moved to take advantage of the 100% depreciation exemption that expires at year end.

It would appear consumer spending for Q4 could be much stronger than previously expected. Good economic news is breaking out all over if you believe the first glance at the numbers. It will be revised several times over the next three months. There was clearly a soft patch in Q1 but it appears the threat of a new U.S. recession has passed. However, the GDP numbers are a lagging indicator so don't get too excited just yet.

GDP Chart

The Kansas Fed Manufacturing Survey headline number rose from 6.0 to 8.0 and the highest level since June. New orders and back orders continued to improve although very slowly. The best component was employment at 12, the same level as September and a four month high. This indicates a strong pickup in hiring. Capital expenditure plans improved for the third consecutive month with a rise from 16 to 18. This was a good report although it did not paint a picture of a rapid expansion. Slow and steady is still a plus.

Kansas Fed Manufacturing Chart

Weekly Jobless Claims came in at 402,000, a slight decline over the prior week's revised number of 404,000. The weekly claims are trending lower but the pace is excruciatingly slow. If the pace of manufacturing employment continues to expand we could see these weekly claims decline under 400K in November. However, there are normally layoffs in Dec/Jan so any dip will be temporary.

Jobless Claims Chart

Pending Home Sales plunged by -4.6% in September due to normal seasonal factors plus the impact of hurricane Irene in the northeast. Despite the decline the pace of sales is still +6.4% higher than September 2010. Recent declines in long term interest rates will help this number in the months ahead. I personally know several people who have suddenly began looking for a new home because of the low interest rates. They assume prices will be higher in the spring when the normal sales cycle begins and interest rates are not going to stay this low if the economy continues to improve.

Reports due out on Friday include the Employment Cost Index, Personal Income and Consumer Sentiment. None of those are market movers. Next week will be a challenge with three ISM reports on Monday/Tuesday and the two day FOMC meeting on Tue/Wed.

The big news today was of course the rally on the European news. Financials, commodities, materials and energy were the big winners but all sectors gained. The financial sector rallied hard because the risk of a bank failures or major losses because of sovereign defaults has passed at least temporarily. French banks saw a major short squeeze since they were deemed most at risk to Greece. BNP rallied +17%, SocGen +22%, Credit Agricole +22%, DB +15%, Barclays +20%, RBS +10%. Here at home U.S. banks also spiked sharply with Morgan Stanley gaining +17%, Citi +10%, Goldman +10%, BAC +9% and JPM +9%. It was a good day to be long banks.

Financial ETF Chart

Companies were still reporting earnings but the news was almost overlooked in light of the European rally. Citrix (CTXS) was an exception with earnings of 64-cents that beat estimates of 58-cents. Revenue rose +20% and license sales rose +28%. Citrix guided to 75-76 cents for Q4 compares to estimates of 74-cents. Guidance commentary was positive and analysts liked the earnings quality. Shares of CTXS rose +17%.

Citrix Chart

Occidental Petroleum (OXY) posted earnings of $2.17 compared to estimates of 1.95. Despite losing all its production from Libya for the last quarter the company saw total production rise to 739,000 bpd from 706,000 in the year ago quarter. They expect that to rise to 745,000 bpd in Q4. They do not expect any material restart of production in Libya because of the damage to facilities and the theft of anything not cemented into place. All vehicles, electronics, computers, spare parts, etc have all disappeared thanks to the heavy looting during six months of war. I believe OXY is one of the best positioned oil companies in the USA. Their motto is "We don't explore for oil, we produce it." They buy existing reserves and producing fields and then apply new technology to producing the remaining oil and any overlooked reserves. Using that process they actually discovered a new deposit in a 40-year old field in California that is thought to hold more than a billion barrels of oil. They are actively buying acreage in the Bakken and are in the process of expanding their operations there. OXY shares rose +$8.46 on the news.

OXY Chart

Perrigo (PRGO) beat the street on earnings but shares declined -$7.83 (-8%) on worries they were facing an uphill battle with rising generic drug competition.

Coinstar (CSTR) revenue beat estimates but it warned that Q4 earnings would be lower thanks to higher debit card fees resulting from the new financial regulations. Coinstar, parent of the Redbox DVD rental chain, said it was going to raise the price on DVD rentals to $1.20 from $1.00 to cover the additional costs on the card fees. With a $1 nightly fee a 25-cent debit card fee is a major expense. Coinstar said the fees retailers paid to banks declined on Oct 1st but the fees for small charges actually rose. Analysts believe Redbox gained customers when Netflix botched the switch to a dual subscription model.

Coinstar Chart

Time Warner (TWC) lost -8% after it reported a decline in earnings and falling subscribers to its video on demand service. TWC has been trying to increase its web-based video business but it is fighting Netflix, Amazon, Dish and DirectTV. TWC reported earnings of $1.08 on revenue of $4.73 billion compared to estimates of $1.13 and $4.95 billion.

Time Warner Chart

After the bell today Hewlett Packard (HPQ) said it would not sell its PC division. You may remember former CEO Leo Apotheker's announced plan was to possibly sell the PC division and to scrap the tablet program. The new CEO, Meg Whitman, said today that given the lost revenue and cost of removing the PC business it made no sense. Duh! Pretty much everyone other than Apotheker reached that conclusion a long time ago. HP creates a ton of cash flow from the PC business and it needs that cash flow to smooth out the rough spots in the other divisions. The PC division generates more than 33% of HP's revenue. HP is the world's biggest manufacturer of desktop and notebook computers. Analysts expect Whitman to possibly slim down HP's PC offerings to lower costs and reduce inventory components. The HP TouchPad tablet, may also come back to life but not with WebOS as the operating system. The head of the PC unit said HP was building a tablet to use the Windows 8 operating system. HP shares did not react to the announcement but was up +5% in regular trading.

HP Chart

The market rally was basically a short squeeze as those who had been waiting on the sidelines for an all clear signal raced into the market. Those expecting another disaster in Europe from the 14th summit in two years were forced to cover their shorts. Those who shorted the open on thoughts the statement was simply another failed attempt to solve the problem were also forced to cover. It was a good day for longs and a bad day for shorts. Whether that will continue is a different question.

Thursday was the last day a fund manager could change positions and have the trades settled by month end. That probably accelerated the buying since no fund manager wanted to be in cash on his year end statements after the biggest monthly gain for the Dow and S&P since 1987. How would you explain a large cash position after that run?

That settlement technicality may not be relevant to some managers and that gives them another day to pad the books. While I would be hesitant to add to positions on Friday they may not have any other options.

The rising euro crushed the dollar and that powered commodities higher. In a falling dollar environment you want to be long anything denominated in dollars. Oil, gold, copper, etc all rallied strongly. The dollar index declined a whopping -1.67% which is a monumental move in currencies. The dollar had pegged an 8-month high at the beginning of October and it has been downhill ever since. Over that same period crude oil has risen from $75 to $93 for a gain of $18. That is a monster move in a little more than three weeks.

Euro Chart

Dollar Index Chart

Crude Oil Chart

Gold and silver also spiked on the falling dollar although gold was restrained because the safe haven trade was somewhat reduced. With conditions in Europe no longer perceived to be on the edge of disaster there was less need to be long gold. However, with the potential for additional QE in Europe and the U.S. it was still seen as a good bet.

Gold Chart

Silver Chart

The S&P rallied for +3.4% and is on track for the best monthly gain since 1987. The index closed over the 200-day at 1274 and appears to be targeting the July resistance at 1350. Today's close represents a +19.5% rebound off the October 4th lows. Can you say OVER EXTENDED? However, we know from experience that some rallies continue to move higher despite overwhelming logic suggesting they should rest.

I believe we should rest. That belief and $5 will get you a cup of coffee at Starbucks. I would be very surprised to see a continued ramp higher over the next couple days but anything is possible. I do believe that once we have a bout of profit taking we will continue higher to that 1350 level before year end. That puts me in buy the dip mode. Current support is so far below today's close that it is not relative. We have to wait and see where support develops. I doubt it will be a big drop.

S&P Chart

The Dow is a carbon copy of the S&P and there is not much to be gained by a lengthy discussion of Dow levels. The two key points are the July resistance at 12,750 and prior resistance at 12,000, which should now be support. All Dow components were positive although just barely.

Dow Components

Dow Chart

The Nasdaq blew through the 200-day average and appears to be targeting the July highs at 2875 once it gets through the uptrend resistance. The Nasdaq had been lagging the other indexes thanks to the declines in Apple. On Thursday AAPL gained a whopping $4 when the Nasdaq was up +87 so Apple investors have not yet returned. You would have expected Apple to be up $20 or more on a day like today. That means on an average day or during a bout of profit taking we should expect to see Apple retest $390.

The Nasdaq looks bullish once we pause for profit taking.

Nasdaq Gainers

Nasdaq Chart

The Russell 2000 rallied for an impressive +5.2% but as you can imagine it was probably mostly short covering. The small caps did breakout but they are still lagging the big cap indexes in terms of relative performance on the charts. The other indexes are now over the 200-day average but the Russell is still below.

We need to see the Russell outperform the other indexes on a day when the shorts are not running for cover. Then we will know the rally is for real.

Russell Chart

I would NOT be a buy on Friday or Monday. We could see some more short covering or we could see some profit taking. Before committing any money to the long side I want to see what happens once October ends and fund managers no longer have any reason to game the system. I want to see the Russell outperform the other indexes when shorts are not racing to cover. I believe we will see the markets move higher but there are serious events over the next four days that could cause profit taking.

Definitely, sell too soon or at least tighten your stops to protect profits.

Jim Brown

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