The S&P rebounded from the worst Thanksgiving week since 1932 to post a +7.4% gain this week. Extreme weekend event risk kept it from being even stronger.

Market Statistics

The fear of events in Europe caused traders to take profits when the Dow rallied +126 at the open. That was the high for the day and there was a steady pattern of selling into the close as competing headlines from Europe gave traders a taste of what could happen on Monday.

We definitely can't complain about this rebound even if 750 points of the 787 point gain were on opening short squeezes. They are still gains regardless of how they occurred.

On Friday there were multiple headlines from Europe suggesting the new fiscal stability pact may not be as far along as investors had hoped. British Prime Minister David Cameron let it be known he was not favorable of a treaty change for the EU to allow more financial oversight and control of a country's finances. Britain is not part of the 17 nation common currency euro zone but still has a lot of power in the full 27 nation European Union. He said it was up to the 17 nations to get behind their currency and convince the markets they had the firepower to do it. The second thing needed was real competitiveness throughout the euro zone to ensure the currency works properly. He said both of those things do not require a treaty change.

The excitement has faded over a possible fiscal stability pact among the 6-8 strongest nations in the euro zone. Comments from Merkel show a still stiff backed German position while Sarkozy also threw some cold water on the outlook.

On the positive side the ECB said any agreement by those nations could free it to act quickly and aggressively to halt the run on sovereign debt. The IMF said an agreement by those nations could produce a cash infusion of 250-270 billion euros which the IMF would put in a trust to be loaned to the debtor nations currently in crisis. IMF head Christine Lagarde was in Brazil looking for money to beef up their current 400 billion euros in available cash. Brazil did say it was willing to contribute to the IMF in an effort to halt the crisis.

The ECB can't legally bailout Italy, Spain or any other euro zone nation. However, it can loan money to the IMF, which can then loan money to debtor nations with a long list of conditions that would force them to greater fiscal stability. It is a long way around to fix the problem but it would help when added to the 250 billion euros currently available in the EFSF.

There was a move last week by U.S. lawmakers to block any U.S. funds contributed to the IMF from being used to bail out any European country. President Obama would veto anything sent to him so that legislation was an empty threat.

The economic calendar next week is full of European potholes. Merkel and Sarkozy meet on Monday in Paris to discuss their new plan. Greece has to approve its new budget on Wednesday in order to receive the next 8 billion euro tranche of aid money and avoid a default on the 19th. The ECB will likely cut rates on Thursday. The EU leaders meet on Friday for the 15th time to discuss the debt crisis.

There is a huge potential for positive headlines as well as negative headlines and I am surprised the market did not close lower in anticipation. Ordinarily I would say the risk was weighted to the downside simply because getting that many countries to agree to anything is next to impossible. However, because of the spike in bond yields all across Europe they may have seen the light and be willing to come to some agreement. I am just not confident it will be substantial enough to actually do any good.

On the economic front in the U.S. there were only two reports on Friday. The biggest was the Nonfarm Payrolls, which came in with a gain of +120,000 jobs compared to a gain of 80,000 in October. That October number was revised higher to 100,000 and September's gain of 158,000 was revised higher to 210,000. That stretches the consecutive winning streak to 14 months since the last net job losses in Sept 2010. The economy has added 1.864 million jobs in the last 14 months. Allowing for population growth and immigration we need to add an average of 400,000 jobs per month to return to full employment by 2020. Employment growth has never been that strong for that long ever before. With U.S. austerity likely between now and 2020 I have serious doubts we are going to see that kind of employment growth.

The unemployment rate fell sharply to 8.6% from 9.0% but it was not due to a large number of new hires. The Household Survey showed a gain of 278,000 jobs but it also showed 315,000 more workers had become discouraged looking for work and had quit looking. The combination of those two numbers pushed the unemployment rate lower. The true unemployment rate or U6, which includes those working part time while they look for a full time job and those who have been out of work so long their unemployment benefits have expired, fell to 15.6% from 16.2%. The number of people not counted as being in the labor force rose by 487,000 to a record 86.5 million. That number was only 77 million four years ago. Fewer people working, more people being supported.

Unfortunately the job gains were mostly in retail and service businesses and the majority were temporary hires. FedEx and UPS hired more than 50,000 and retailers hired 50,000. Private payrolls rose by 140,000 but government lost 20,000 jobs to lower the net total.

This was a decent report but it suggests we could drop back into job losses in the first quarter as all of these seasonal workers are returned to unemployed status. Real employment is still not rising although that could change in the second quarter of 2012 if the European debt crisis has stabilized.

Nonfarm Payroll Chart

The Monster Employment Index declined to 147 for November compared to 151 in October. The decline came from a drop in help-wanted ads in more than half of the industries tracked by the index. Despite the decline, the help-wanted index is still 9.7% over the same period last year. The November reading is the lowest level of help-wanted ads since July.

The economic calendar for next week is light if you don't count the European events. The big report is the ISM Nonmanufacturing Index on Monday. The headline number is expected to rise only slightly to 53.5 from 52.9.

Economic Calendar

In stock news Western Digital (WDC) rallied over 10% at the open after raising their guidance. The disk drive maker said it had resumed partial production ahead of schedule and raised its outlook for December. Three analysts raised their ratings on WDC saying it could regain market share quickly and the accelerated production would allow them to retain some market share they had expected to migrate to Seagate. Shares of WDC ended the day with a 7.5% gain. Seagate (STX) suffered on the expectations they would not benefit as much from the flood impact on WDC as previously expected. STX shares declined -7%. With current prices for disk drives about 300% higher than three months ago those selling current production into these flood bounce prices should be very profitable.

WDC Chart

Research in Motion (RIMM) can't get a break. After rising for the prior three days on expectations of a possible acquisition bid by somebody like Microsoft, the shares were crushed for -10% on an earnings warning. The company said it was taking a $485 million charge for the write down of its tablet inventory. Reportedly the company has about 500,000 units in the channel and another two million internally. Unfortunately they are not selling at the $500 price point and analysts were told to expect a significant reduction in the sales price. Some were speculating the price would be $199 to be equivalent to the cheaper tablets on the market.

RIMM said it would ship 14.1 million Blackberry phones in Q4 and that was in the middle of its guidance of 13.5-14.5 million. Revenue will be below the prior range of $5.3-$5.6 billion. For the next quarter analysts are now projecting a decline in Blackberry sales to 12 million. There is a new equipment launch of QNX/BBX phones late in Q1 and sales are likely to decline ahead of that event.

RIMM Chart

Big Lots Inc (BIG) posted earnings of 6-cents and missed estimates by 3-cents. The reason for the miss was an 11-cent loss from Liquidation World, a company Big Lots purchased in July. Big Lots operates 1,445 stores in the U.S. and profits for the quarter fell -41.3%. BIG opened 89 stores in Canada in the prior quarter with more than 1,000 new employees. Expenses are increasing but the company continues to return money to shareholders through share buybacks. BIG purchased 77 million of its own shares last quarter.

Big Lots Chart

While on the subject of buybacks Conoco (COP) announced it would buy back up to $11 billion in shares in 2012. That represents a new $10 billion buyback approval. Conoco also said it would raise its capex spending by 15% to $15.5 billion. About 90% of that budget will support oil and gas exploration with 60% in North America. Conoco plans to focus on the Eagle Ford, Permian, Barnett and Bakken fields. Conoco has plans to sell $15-$20 billion of assets from 2010-2012 and so far $10.5 billion have been either announced or completed. I believe when Conoco completes the spinoff of its refining and pipeline assets and converts to a pure play exploration and production company it will be an excellent stock to own and a major producer with rapidly expanding production.

Conoco Chart

While on the subject of oil companies the price of oil rallied again to close over $101 on the potential for a boycott of Iranian oil. EU foreign ministers slapped sanctions on 180 additional firms and individuals as tensions increase over the Iranian nuclear program. The 27 EU foreign ministers urged the EU to extend the scope of the current sanctions and strike at the heart of Iran's financial support. Britain urged the group to accelerate sanctions after the British embassy in Tehran was sacked by a mob last week. Britain, France, Germany and Sweden now favor a ban on buying oil from Iran and the list is likely to grow. Iran's oil accounts for 5.8% of EU imports and their fifth largest supplier. Spain gets 14.6% from Iran, Greece 14.0% and Italy 13.1%. Greece is against the embargo because Iran sells them oil on credit and it is hard for Greece to get credit from anyone today.

Crude Oil Chart

Google (GOOG) is reportedly considering implementing a new one-day shipping service for retailers for a nominal fee. In order to do that it would have to offer an enhanced shopping cart to retail partners or allow users to buy directly from its search results pages. Initially this hit Amazon's shares but analysts were quick to claim it would not impact Amazon Prime, the two day shipping service Amazon customers get for free if they are Prime subscribers for $79 per year. Analysts were fairly negative on the Google idea given vast amount of complexity needed to link the service to the tens of thousands of retail customers.

Google shares have rallied strongly over the last week with a $60 gain into Friday's close. That puts Google at $620 and very close to a breakout over resistance that has held for two years. This could be a powerful breakout if it happens.

Google Chart

Zumiez (ZUMZ) shares rallied +24% after the company reported earnings that beat the street and raised its guidance. Earnings were 45-cents on a 13% increase in revenue. The big excitement came from a +8.4% increase in same store sales. That was well above the +2.7% analysts expected. Total sales in November alone increased +16.5%. Zumiez sells sports related equipment in 444 stores in North America.

Zumiez Chart

Stocks weakened after the opening spike on Friday for multiple reasons. First the +126 points the Dow gained at the open put it up more than 900 points for the week. That would have been one of the biggest one week Dow gains ever but there was too much working against it.

The jobs numbers had already been baked into the market cake after the ADP report on Wednesday predicted 206,000 jobs had been created. Nobody expected to see 206,000 on the nonfarm report but they did upgrade estimates to 120,000 to 150,000 in most cases. That meant the 120,000 actual was right in line with the increased estimates. The drop in the unemployment rate was due to people leaving the work force rather than new hires.

David Cameron, the British Prime Minister, was quoted as taking exception to the Merkel-Sarkozy plan and that was a downer for European expectations. More notably there was a rumor that Spain was going to be downgraded over the weekend by S&P. There is also that lingering rumor that France will also be downgraded soon.

With Merkel and Sarkozy meeting on Monday there are likely to be sound bites ahead of the meeting and after the meeting and who knows how that will play out as each leader struggles to claim the upper hand in the negotiations.

There was simply too much event risk for any cautious investor holding double digit profits to add to positions before the close. Most were probably taking profits off the table instead.

The Volatility Index (VIX) declined to 25.29 at the open but rose steadily throughout the day to close at 27.52 as traders bought more puts than calls. Actually any number under 30 is relatively tame and the VIX closed right at its low for the month despite the intraday rebound.

The problems for next week are many and mostly European. I won't repeat all the meetings here but there are plenty. There is also the China PPI, CPI and Industrial Production on Thursday. I don't expect any major decline but China did ease last week and that suggests they are worried about future growth. A sharp decline in those numbers could be ugly.

In the long term view there is no magic bullet for Europe. There is slim to zero chance they will come up with a master plan that works next week. We can expect this problem to remain with us well into Q1 or even all of 2012. That does not mean there won't be progress. Any crisis resolution in Europe is a multi-step process. That must be floated, discussed, changed, discussed, voted, implemented, etc and that could take a year depending on the changes.

However, we could see positive steps toward a resolution such as the fiscal stability pact by the stronger nations. There are also the strong hints by the ECB of a big increase in monetary support if that pact is enacted. The IMF could easily begin supporting the debtor nations if the stronger countries begin to contribute additional support. There are plenty of steps that could point to a solution in the works and relieve the extreme concern of a breakup of the euro zone.

That is all investors really want to see. They want to know the euro currency is going to survive and European banks are not going to fail. The EU leaders could solve that problem in principle next week with a strongly worded plan with hard details and the world would rejoice. It might take a year to complete it but as long as real progress was being made the problem would be defused.

The bigger problem for me is the sudden deterioration in earnings guidance. We are more than half way through Q4 and approaching the period where earnings warnings could surface. Since the end of Q3 the pace of guidance cuts has accelerated and is now outpacing those raising guidance by the most in over ten years. According to Thomson Reuters some sectors, like materials, have seen a dramatic decline in guidance.

On Oct 3rd the S&P earnings estimates for Q4 stood at 15% earnings growth. That has declined to 10% as of the end of November. That is a major decline and companies are beginning to report almost daily that economic activity in Europe has fallen off a cliff. Shippers, both air and water, claim traffic to Europe has declined -20%. It is pretty much common knowledge the euro zone has fallen back into recession.

The biggest worry over Europe is not a default by a country but large scale bank failures as a result of the decline in value of the sovereign debt they currently hold. The problem of liquidity was solved temporarily by the coordinated actions of the central banks last week. That is a temporary solution but the real problem is their solvency. Most European banks are already technically insolvent but banking rules don't require them to market sovereign debt to the market. If they did that today they would be bankrupt. Eventually this problem will have to be addressed in order to halt the flow of cash out of the banks. About the only solution is nationalism because no solvent bank will want to buy a chain of insolvent banks for anything other than salvage value. It is estimated there could be as much as 3 trillion euros of bad debt on the books of European banks. Most never marked down the bad mortgages they still hold.

There are worries that China is also seeing activity decline drastically. Shippers and contract manufacturers are complaining they can't get paid for products shipped into China. Real estate prices in China have fallen 30% to 50% in some areas in just the last several months and there is a panic beginning to develop. People who paid the high prices six months ago are demanding a refund of the difference. Developers have canceled orders for building supplies. There is a problem developing in China and if it were not for Europe stealing the spotlight we would be a lot more concerned about the Chinese economy.

On Saturday China's Federation of Logistics and Purchasing said on its website the November PMI fell to 49.7 from 57.7 in October. A number under 50 indicates contraction. A separate manufacturing index released by the Federation earlier in the week came in at 49.0, down from 50.4 and the first contraction since Feb 2009. The flash PMI released by HSBC earlier in the week fell to 47.7 and the lowest level since March 2009. If three different reports show contraction the odds are good they are correct. However, an economist with the Bank of America, Lu Ting, said the Chinese PMI has a history of dropping sharply in November. No reason was given.

John Mauldin had an interesting table in his weekly newsletter this week. This shows the manufacturing PMI for all the major countries. Note the majority have already slipped back into contraction territory (under 50) and the overall trend is declining.

Table from John Mauldin, Markit

I believe today that the U.S. market will ignore most of these global problems for the rest of December "IF" the EU leaders can come up with a comprehensive statement next week. Funds are under invested and as many as 75% of retail investors are invested in bonds and money markets or mostly in cash. The stage is set for a yearend rally whether we deserve it or not. It is January we really need to worry about.

On Friday the S&P rallied to beginning resistance at 1260 and just below the 200-day at 1265 before falling sharply. While it gave back all its intraday gains of +17 points it closed only fractionally negative and above current support at 1240. Considering the +7% rally for the week we should be very grateful the index did not plunge by double digits instead of just giving back its intraday gains.

Resistance remains 1265 and it should be strong. I don't know what headline could come out of Europe over the weekend to catapult us over 1265 on Monday but it is always possible. I do believe market sentiment has changed to bullish and we could see even slightly negative headlines be used as stepping stones higher. Over the last 25 years the S&P has rallied in December 80% of the time despite numerous problems in the economy and the world. New retirement money flowing into the market as well as funds chasing performance tends to push the indexes higher. Strong stocks over the last month will likely continue to be strong since they attract the hot money.

I would be cautious on any decline under 1240 but I would view the initial dip as a buying opportunity given the sentiment expressed above.

S&P Chart

The Dow came to a dead stop at downtrend resistance and the opening spike was immediately sold. This is going to be a tough hurdle to jump but once over it should attract billions in cash from the sidelines. The range from 12,000-12,200 is a mine field of resistance and it will take a strong headline to vault us over that level. Support is 11,975-12,000.

Dow Chart

The Nasdaq chart is similar to the others only it managed to close in positive territory with a +7.6% gain for the week. The Nasdaq faces resistance at the 200-day at 2675 but first it has to free itself from the clutches of resistance at 2625. We traded the entire day on Friday over that level but its influence was felt at the close when the index fell back to 2626.

The news from Western Digital about an earlier resumption of some Thailand production was a positive for tech stocks and PC stocks in general. We heard earlier last week that Intel said they were not seeing a major decline in PC sales due to a lack of hard drives so maybe this is another bullet that will end up being just a bad hangover for manufacturers and not a disaster.

Nasdaq Chart

The Russell 2000 is our canary in the coal mine and the Russell was the strongest performing index on Friday. That should suggest fund manager sentiment is improving. Or, it could be just the normal Santa Claus rally where funds buy small caps in December for expected gains in the following year. Multi-decade habits are hard to break even with all the global economic problems.

The Russell closed right at resistance and is poised to break higher on any good news on Monday. Conversely a negative headline could confirm the resistance and a lower high. A move over 750 would a strong buy signal.

Russell 2000 Chart

The Dow transports are not showing any economic weakness. They are also poised to break over the 200-day at 5,000 and break out to a new four month high. This would also be very bullish and positive support for the Dow Industrials. I would remind you that transports are strong even though oil prices are over $100. How long a breakout could last on rising oil prices is unknown but probably through the end of December if the transports can just move over 5,000.

Dow Transport Chart

As I stated earlier I think market sentiment has changed. Investors have their hopes up that the coming EU summit will produce a solid plan to resolve the European debt crisis. Unfortunately this is the 15th summit to resolve the debt crisis and they are no closer to a real solution then they were the last 14 times. Maybe they are a little closer but the cracks in the Merkel-Sarkozy plan are already showing up in the headlines. Eventually the EU leaders will get the message.

The group has been on an increasingly bumpy flight for the last two years and the captain (Merkel) and copilot (Sarkozy) have long since given up on the fasten seatbelt warning. The attendants have stowed the beverage carts and buckled into their crash seats after giving the instructions for floating seat cushions and deploying the emergency slides multiple times. Unfortunately the passengers, (EU leaders) are still in denial the flight might end badly with a serious breakup at the end of a long dive. They still believe they can talk the problem away. Talk is not going to solve this problem. Somebody needs to grab the controls and pull the euro zone out of its dive and do it quickly. I don't see that happening but I hope I am wrong.

I believe they will kick the can a little further down the road and announce a new plan to form a plan. Because it is December and fund managers need to show some gains for the year the markets will probably be satisfied with the new plan for at least the rest of December. Once into January and they realize the plan is not coming together we could be right back in crash mode again. We will have to deal with it when it happens.

Assuming there are no explosive headlines out over the weekend I would expect the market to take another run at resistance. This is a light weak for economics and for earnings so we will be entirely headline driven again. Anything is possible and volatility is probable.

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"In economics, the majority is always wrong."
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