The markets remain hostage to headlines from Europe and there is no end in sight.

Market Statistics

Continued negative headlines from Europe are pressuring the global markets and this is not likely to change for several more weeks if not months. Greece has been the daily headline but that is not the only problem in Europe.

Spanish bank Bankia was rumored at Friday's open to be planning to ask the government for an additional 15 billion euros to cover capital requirements on real estate and non-property loans. The bank's parent was nationalized about a month ago because of capital problems. Late in the day the bank actually asked for 19 billion euros ($24 billion) in support. The government already contributed 4.5 billion euros in 2010 when the Bankia Group was formed from a merger of seven savings banks. The bank posted a loss in 2011 of 2.98 billion euros.

The losses in Bankia are producing worries of similar losses in other Spanish banks and an accelerating decline resulting in other nationalizations. Investors are worried the Spanish government cannot afford to continue to pour tens of billions into the banking system in an effort to overcome the declining fundamentals. Economic Minister Luis De Guindos told banks on May 11th to come up with another 30 billion euros in capital and that was on top of a demand for 54 billion euros in February.

Spain is entering a double dip recession that will worsen problems for banks. The worst is the real estate crash that has devalued property by as much as 50% in some areas. Banks holding mortgages on those properties are in deep trouble. S&P lowered the ratings on Bankia and four other banks and warned the rising reserve requirements in the wake of the rising loan defaults would lead to further downgrades.

Spanish regional entities like Catalonia have more than 36 billion euros of debt maturing this year and no way to raise it in the private markets. The yields on Spanish debt are nearing 7% and the regional authorities can no longer sell debt in the international markets.

One analyst said "Greece is the fuse and Spain is the bomb." Spain's debt to GDP is 145%. As Greece accelerates towards its probable exit from the euro the fate of the other debtor nations including Spain, Italy, Portugal and Ireland hangs in the balance.

Spanish unemployment is 24.1% but under age 25 it is over 50%. Greek unemployment is 21.7%, Portugal 15.3%, Ireland 14.5%, France 10%, Italy 9.8% and Germany 5.6%.

Belgium's foreign minister warned on Friday that central banks and corporations are making a grave error if they do not make plans now for a Greek exit from the euro zone. Greece only accounts for 2% of the EU economy but it represents a severe contagion threat if it decides to leave the euro. The Euro Working Group told member states last week to begin making plans for a disorderly Greek exit.

French banks have significant risk to a Greek exit. Credit Agricole, BNP Paribas and SocGen have stepped up planning for the consequences of a return of the Greek Drachma. French banks have 47.9 billion euros of Greek debt, Germany 18.6, UK 11.5 and Portugal 8.7 billion. Peter Bofinger, one of the five key advisors to the German government, said Europe should renegotiate the bailout settlement with Greece as the initial terms assumed overly optimistic growth. "It is important for both sides because if you have an uncontrolled exit by Greece, it could lead to a 'Lehman moment' for Europe."

It appears the anti-bailout parties in Greece have got it right. They believe they can void the agreement and renegotiate for much better terms because the alternative of a disorderly exit is too terrible for the rest of the euro to consider. Unfortunately once they do that we will see Portugal and Ireland asking for the same deal on their bailouts. If you carry this concept a little farther we see Spain and Italy demanding support in the hundreds of billions of euros because they are too big to fail and too big to exit without bankrupting the entire euro zone. The stronger countries like Germany are in a world of trouble because they will be asked to pay the majority of the bailout bill and they have no way to avoid it. Germany may be the economic brain behind the euro body but the heart, liver and lungs have cancer and need surgery and chemo. Germany does not want to pay for all the operations but they also can't afford to deny the treatment because the unchecked cancer in any of those organs would eventually kill the entire euro body.

The cost of a Greek exit to the rest of the euro zone is estimated to be between 1-2 trillion euros from bank failures, debt defaults, business bankruptcies, etc.

This euro problem is not going away and definitely not going away before the June 17th Greek election. A new poll published Friday gave the anti-bailout Syriza party more than 30% support, widening its lead over the center-right New Democracy party from 2% to 4%. A different poll showed that more than 75% of the people don't want to leave the euro because of the financial hardship it will involve. Will they vote that way on June 17th? Nobody knows. That would require them voting for a party other than Syriza. Talk is cheap but once they enter that voting booth they have to vote for financial stabilization and austerity or exiting the euro and financial suicide. Until the result is known the world's markets will remain hostage to the headlines.

Back on this side of the pond the only material economic headline was a sharp move higher in Consumer Sentiment. The headline number for May rose to 79.3 from 76.4 in April. Consensus was for a gain to 77.8. This was a huge surprise and the highest reading since October 2007. The nearly +3 point jump was larger than the combined gain from the prior three months. Sentiment has now risen for nine consecutive months.

Surprisingly the current conditions component showed the biggest jump from 82.9 to 87.2 while the expectations component rose from 72.3 to 74.3. Present conditions are now at the highest since January 2008 and expectations at the highest since July 2007.

This sudden spurt in sentiment is amazing given the deteriorating conditions in Europe and a three week slide in the stock market. Gas prices falling to $3.71 per gallon and mortgage rates falling to a new low appear to have offset the slowdown in new jobs. Either the 2013 fiscal cliff has not yet made an impression on consumers or they just assume lawmakers will legislate it away. There is a serious disconnect between the average consumer and the financial problems the country will face in the years ahead. Don't worry, be happy!

Consumer Sentiment Chart

The shortened economic calendar for next week is full of high profile events and it could be a pivotal week for the markets. This is employment week with the ADP and Challenger reports on Thursday and Nonfarm Payrolls on Friday. The GDP is also Thursday and the consensus is a revision to +2.3% growth for Q1 but the whisper numbers are as low as +1.8%. That would be a challenge for the market.

The Chicago ISM, formerly PMI, is Thursday followed by the national ISM Manufacturing on Friday. Both of these reports could be a problem if they show material declines.

The big report for the week will be the Nonfarm Payrolls on Friday. Consensus estimates are for a gain of +175,000 jobs, up from 115,000 in April. You may remember March and April were well below expectations and a dramatic slowdown from the strong January and February numbers. If May shows a rebound or at least a strengthening then the market should be ok. If by chance there is another weak month in the 115,000 range I think the investors will express their worries over the rest of the year by exiting stocks.

Economic Calendar

We have seen some serious declines in the regional activity reports for May. The Philly Fed fell from 8.5 to -5.8. The Richmond Fed fell from 14.0 to 4.0 but the Kansas Fed rose from 3 to 9 so the conditions are not the same in all regions. This makes forecasting the national ISM for next week a tossup and that is the same with the payroll reports. Some of the regional Fed reports showed a significant improvement in the employment components. However, the weekly jobless claims are still averaging over 378,000 for the last seven weeks. That has eased to 371,000 over the last three weeks but the difference is minimal. With the heavy calendar of material reports we will remain hostage to the headlines even if Europe's news was to fade.

In stock news the Facebook IPO refuses to go peacefully into the history books. Suits are being filed daily and news is beginning to surface that explains just how big the problem at Nasdaq was at the open. It was chaos that lasted for hours and market makers could not get information on pricing or trades. Basically everyone was flying blind until after 2:PM when some normalcy returned. The major market making firms have reported losses of more than $150 million due to the technical problems at the Nasdaq. The exchange said it had reserved only $13 million for compensation on broken trades. The actual damage when the smoke clears could be 100 times that. UBS lost around $30 million. Knight Capital lost as much as $35 million. Citigroup more than $20 million. A market maker is a firm that must buy and sell a specific stock and maintain a publicly quoted price. Since the Nasdaq was not supplying prices in real time and trades were being executed as much as two hours away from when they were entered the market makers were stuck with the spread on the incorrect prices.

There will be severe repercussions to the Nasdaq for these errors. There are dozens of suits and inquiries from nearly every U.S. regulator, House and Senate committees plus the state of Massachusetts. There are multiple class action suits against the underwriters, Nasdaq and Facebook itself.

Trading in shares of Facebook has calmed with only 37 million exchanged on Friday. Shares closed at $31.90 after a spike at the close but they immediately declined to $31.34 in afterhours.

For those wishing to play Facebook options you will get your chance when they list on Tuesday. Beware! The volatility is going to be extremely high and premiums will be very expensive. I will be looking at the puts because analyst price targets are dropping like a rock with some as low as $9. There are still analysts with targets over the IPO price of $38 but they are being very quiet. The price targets range from $9 to $49. One analyst said the IPO was a disaster because it was over-hyped, over-priced, over-supplied and over owned. With a large number of banks, institutional investors and hedge funds already invested and known to be selling into the IPO there was little desire by other funds to contribute to their exit by picking up a bunch of shares. That is the equivalent of buying the top to buy shares that dozens of other hedge funds are dumping.

JP Morgan and Goldman Sachs were co-underwriters on the IPO and we found out on Friday they had actually loaned the shares to hedge fund clients to short into the IPO. Morgan Stanley did not loan shares. Shares cost 40% to borrow on Tuesday but that fell to 6% on Thursday as more shares became available. It was the 40th most expensive stock to borrow on Tuesday but not even in the top 500 on Wednesday.

At Friday's $31 close the stock still has a PE of 69. There are stories from institutional investors of Mark Zuckerberg failing to appear as promised at two road shows and hiding in the bathroom for 15 min at another when it was time for him to appear. Needless to say he is not inspiring investor confidence today.

Corsair Components, a computer memory manufacturer and Tria Beauty, a laser-hair removal and cosmetics firm, have both delayed their IPO as a result of the Facebook disaster. Expect more to follow.

Facebook Chart

Chesapeake Energy (CHK) rallied for the week on news they were putting more assets up for sale and some large investors were increasing their stakes in the company. Carl Icahn announced he had accumulated 50 million shares worth 7.56% of the company and worth $785 million. You may remember Icahn exited his CHK stake about a year ago. He had persuaded CEO Aubrey McClendon to sell off the Fayetteville Shale assets for about $5 billion. After that the promises the board made to Icahn "proved hollow" in Icahn's words and he exited his position. Shares have declined about 60% since then.

Of all the investors you want to be taking a new stake in your company it probably would not be activist investor Carl Icahn. He immediately sent a letter to the Chesapeake board saying he plans to force the breakup of the board and the installation of new directors nominated by him and some other leading shareholders. After McClendon was forced to liquidate the majority of his shares in a margin call his remaining stake is about one tenth the size of Icahn's today. I foresee a very rocky marriage ahead and an ugly divorce.

Icahn's letter to the board called them to task for not holding management (McClendon) accountable. He criticized them for allowing McClendon to cause multiple events over the past several years that were highly embarrassing to Chesapeake. At the same time they allowed the company to create a $16 billion operating cash shortfall for 2012. Icahn said he met with McClendon recently and suggested direct shareholder representation on the board. McClendon said he would consider it but the next day the board sent Icahn a letter refusing to even consider the request. The board recently said it was going to split the Chairman and CEO roles and appoint a new Chairman. Icahn said this is like having the fox chose another fox to guard the henhouse. Excerpt from Icahn letter, "We cannot stand idly by and allow this to happen. Therefore, if you continue to arbitrarily refuse the request we have made for shareholder representation, we, as activists, will immediately take whatever 'actions' we feel are necessary to protect the value of this company." That is not exactly the letter McClendon wanted to receive.

CHK announced it was putting more land up for sale in an effort to reduce that $16 billion funding shortfall. They put up 504,000 acres of oil and gas leases in the DJ Basin in Colorado and Wyoming. This is roughly 3% of their total holdings of 15 million acres. McClendon has said in February that wells in the DJ Basin had been "spotty." CHK expects to get $2 billion from that asset. Good luck with that. The acres were valued at $4,750 each in January 2011 when CNOOC of China bought a 33% stake. However, because of the spotty results Synergy Resources just paid $300 an acre in the same field in March. They are also trying to sell 1.5 million acres of leases in the Permian Basin. They are also looking for a partner for two million acres in the Mississippi Lime area of Oklahoma and Kansas.

Analysts are divided over the prospects for CHK to rise on the Icahn news or eventually decline since a proxy fight is only going to open the company up to more ridicule. After a month of gains in gas prices they fell -3.7% on Friday on a report saying at over $2.50 per mcf for gas, coal was a cheaper alternative for electrical generation. Plus gas injections into storage have been rising in recent weeks. More than 77 Bcf was added to storage last week.

Chesapeake Chart

Talbots (TLB) fell -39% on Friday after an exclusivity agreement with potential buyer Sycamore Partners expired without a deal. The deadline had been extended twice. Talbots said it remained open to the prior price of $3.05 per share but would actively explore other options. Sycamore owns 9.9% of Talbots and agreed to an exclusivity agreement in early May when it raised its offer by a nickel to $3.05. The street believes the company has already talked to multiple prospective buyers and nobody came through. Adjusted earnings last quarter were 9 cents compared to estimates for a loss of 2 cents but analysts believe the fundamentals are not good. They have closed 90 stores since March 2011 and they are on track to close a total of 110. They currently have 540 locations.

Talbot Chart

The CME (CME) announced a 4:1 stock split in an effort to attract new investors. With CME shares currently trading at $262 a 4:1 split will reduce the price to about $53. That puts it within reach of a lot more investors. However, concerns over lackluster trading volume across all exchanges has pressured prices of shares like the CME. They recently said volume was down -10% YTD. CME shares have also been under pressure since the MF Global disaster and worries over liability in that mess. CME was an auditor of MF Global and there is still $1.6 billion of client funds missing. At the CME shareholder meeting on Wednesday investors complained about the falling stock price and asked about a split.

CME Chart

In related news the CBOE won another court battle against the ISE in the long running feud over the S&P-500 index options. The Illinois Appellate Court affirmed an earlier injunction forbidding the ISE from listing S&P-500 options, which are licensed exclusively to the CBOE by McGraw Hill and the CME Group Index Services unit. The ruling also applies to the Dow Jones index options. The dispute started six years ago when the ISE tried to get approval to list the options on its electronic exchange. When it could not get approval from McGraw and the CBOE it tried to list them without any approval and the CBOE won an injunction preventing it. The S&P options are the CBOE's most lucrative product. ISE argued it was unfair since options on stocks can be freely listed on any exchange. The ISE has since been bought by Eurex, a Frankfurt based futures exchange. An ISE spokesman had no comment on future plans to continue the fight.

Google (GOOG) closed at a four-month low on Friday at $591 and $3 under the 200-day average. I mentioned this last week that a close under that level could lead to a bigger decline. The company has been holding over that level for the last two months and there was no specific news I could find pushing the stock lower on Friday. Google is very close to announcing a new Android tablet of its own. The 7 inch tablet has been seen in Google's offices and will probably be announced at the developer conference on June 25th. Next week is going to be key for Google if it remains under the 200-day average. That could prompt some funds to unload their positions. The 200-day is a key long/short indicator for many managed funds.

Google Chart

VeriFone (PAY) fell -15% on Friday after the company said it expects to report adjusted profits of 68-70 cents per share. They expect revenue between $495-$500 million. Analysts were expecting 70-cents and $502 million. The company backed full year guidance but warned the strength in the dollar had hurt profits. Some analysts suggested VeriFone was using the euro weakness, dollar strength as an excuse and the stock was punished.

VeriFone Chart

Research in Motion (RIMM) is expected to announce layoffs of between 2,000 to 6,000 as early as next week. RIMM currently has a workforce of around 16,500. This suggests RIMM has given up on growing its business and is accepting its role as a minor smartphone supplier.

RIMM Chart

The continued problems in Europe pushed the euro to another new two year low at 1.24 and the dollar index to two year high. Commodities are normally weak when the dollar rises but gold bucked the trend with a +15 point gain to $1573.

Dollar Index Chart

Crude prices were flat at $91 despite a breakdown in the talks between the six nations and Iran. The Iranian diplomat called the talks a "complete failure." A person from the six nations said the meeting was extended an additional day just to try and craft a post meeting statement that was acceptable to Iran. The final statement described "very intense" discussions but noted "significant differences remain."

An Iranian negotiator said the goodwill created since the first meeting in April has been jeopardized by "approaches that were really destructive" referring to a unanimous vote by the Senate on Monday to tighten the sanctions even further.

Iran struggled to put the talks in a positive light because all the demands of the six nations were far across the "red lines" Iran has vowed not to cross. They refuse to give up uranium enrichment. They refuse to allow inspections of military bases where testing is suspected.

During the talks Iran went back to its old strategy of misdirection and distraction. As part of the agreement they wanted conditions on non involvement in the unrest in Syria and Bahrain. They even wanted to add in restrictions on narcotics.

The final draft of the original meeting statement threw the lead Iranian diplomat, Saeed Jalili, into a fit of rage. It was "furiously responded to by Jalili [who said] if you read this statement [publicly], we are going to state the whole story was a failure, a fiasco." After a huddle the six nations agreed to an extra day of talks to construct a statement that was acceptable to Iran. It is important for Iran to save face in the region. They don't want to be seen as backing down to the six nations.

Basically Iran wanted an end to sanctions before they would agree to any nuclear concessions. They wanted language that would prevent the sanctions from being restarted on "some future pretext" like Iran not following through with its promises. The six nations demanded Iran halt all enrichment until they had proven to the world they had no secret programs to develop nuclear weapons. With 9,000 operating centrifuges that would be a tall order. Iran would have to shut down the highly secret underground facility at Fordow. There was NO agreement on anything except to have another meeting in Moscow next month.

It did not help that UN inspectors reported they had located traces of uranium enriched to MORE than 20%. The IAEA report cited a May 9th letter from Iranian officials saying the uranium they found that was enriched to 27% was an "accident" that could have occurred due to actions "beyond the operators control." A scientist at the Washington based Institute for Science and International Security (ISIS) said the new configuration at Fordo was meant to "overshoot 20 percent" at the start. Inspectors said finding the traces at 27% suggests there were enrichments even higher that were a result of the completed process. ISIS also said Iran now had enough enriched uranium to make five nuclear warheads once it was improved to 90%.

The IAEA head failed to secure an inspection agreement as promised last weekend when discussions broke down. The IAEA said satellite surveillance of the Parchin site is currently showing high traffic of construction vehicles and rivers of liquid pouring from the buildings. They suspect Iran is trying to scrub and sanitize the buildings to eliminate all traces of radioactive materials prior to agreeing to inspections.

Despite the "positive statement" that took an additional day of meetings to craft the outlook here is not good. The IAEA has enough data from observations, surveillance and insider information that Iran is not going to be able to prove they are not doing weapons research. They are not going to give up on enrichment and the July 1st EU oil embargo is going to happen. This effort to show the six nations and Iran "making progress" is a sham in hopes of eventually achieving some progress and to keep oil prices lower as we move closer to July 1st.

The six nations have the hammer with the increasingly difficult sanctions and Iran is going to have to either come clean and abandon its nuclear ambitions or go bankrupt from slowing oil sales. Civil strife is rising along with food prices as a result of the existing sanctions and the July 1st deadline will only make it worse. Oil prices should begin moving higher as we move closer to the embargo.

Crude Oil Chart

Gold Chart

The Dow has only been positive four days in May. If this continues through month end it will be the first time ever it has failed to post a minimum of five days of gains in a month. Thanks to the big rebound on Wednesday all the indexes did finish with gains for the week. The Dow was down -191 points at the Wednesday lows but rebounded to close down only -6.66 points. That rebound rescued the markets and kept them in positive territory for the week.

The S&P tested support at 1295 twice. Once the prior Friday and again on Wednesday. Fortunately both times it held. The first time it was helped by the three weeks of selling that created severely oversold conditions that were ripe for a short squeeze. The second rebound on Wednesday came on strong sales of new homes and expectations for some solution in Europe with the EU summit in progress. There was no solution and the markets declined at the open on Thursday. In the afternoon shorts covered again and volume died as we headed into the holiday Friday.

With the heavy duty economics next week and the likelihood of more negativity from Europe the 1295 level could be tested again. However, I looked at a lot of stock charts this weekend and quite a few appeared to be forming a potential bottom. Until an actual rebound occurs that pattern is just a pause in the decline but there were some encouraging signs.

The S&P has resistance at 1325 and until we move back over that level I am still bearish. There are just too many global problems to assume the market will rally. The U.S. may be the dog with the least fleas and the safe haven for any European cash but eventually that trend will be offset by the European weakness impacting our markets.

After we get past the payroll reports next week the next big challenge is the June 17th Greek election. Following that will be the June 19th FOMC meeting. If the anti-bailout party wins in Greece I would expect the Fed, ECB, IMF and BOE to announce some program to support bank deposits in Europe. I have no clue how that would happen but if Greece appears headed for the door they will have to support the banks to prevent a total meltdown in Europe. This possibility is going to weigh on the markets until June 17th.

There was no follow through on either the initial Monday rebound or the intraday dip on Wednesday. Now that we are officially in summer the volume will continue to decline. Only 4.7 billion shares were traded on Friday and it will slow in the weeks ahead.

S&P Chart

The Dow chart is similar to the S&P only it clearly shows that solid resistance formed at 12,530 and it held twice after the initial Monday/Tuesday short squeeze. The Dow came very close to making a lower low at the close on Friday. The Dow would have to break above 12,575 to confirm a move higher. A drop below 12,300 would be seriously negative for sentiment.

Dow Chart - 15 Min

Dow Chart - Daily

The Nasdaq rebounded sharply from support at 2775 but there was no follow through. It has now formed a bearish pennant formation with a breakdown due any day now. The pennant is a consolidation/continuation pattern that almost always completes with a continued move in the initial direction. In this case the continuation would be a bearish breakdown.

Current support is 2775 followed by the 200 day average at 2750. A break of those levels should setup a test of 2600.

Bearish Pennant

Nasdaq Chart - 30 Min

Nasdaq Chart - Daily

While there are some stocks showing some minor bullish indications I feel the overall market is going to be weighed down in the short term by concerns in Europe. Once the Greek election on June 17th is completed there will be more direction for Europe only because the uncertainty will be reduced. That does not mean the situation will be better because even if a pro-bailout party wins it will be a tough road that may eventually lead to further defaults.

What could change this entire scenario is the implementation of some sort of bank guarantee system like the FDIC for the euro zone. This does not exist now. That system would slow down capital flight out of the problem countries and remove some of the worries about failing banking systems. If that announcement occurs in the weeks ahead we could see a strong short covering rally in Europe and the global markets. I am not holding my breath. It will not likely happen unless the wrong party wins in Greece and they begin heading for the euro exit.

Do you play chess? If you do you know you have to think many moves ahead and consider multiple alternative scenarios in order to out play your opponent. In the stock market investors need to think many days, weeks or months ahead to be properly positioned. Investors today need to be thinking about the possibilities surrounding Greece, Europe's response, the FOMC, the election, Supreme Court rulings on Obamacare, the fiscal cliff, China's economic slowdown, U.S. debt ceiling hike in September, etc. There is a tremendous wall of worry ahead of us that may force our markets lower by the end of 2012. Noted investor Marc Faber, the Gloom, Doom and Boom Report, believes there is a 100% chance of a global recession by year end. He said there is a zero percent chance it can be avoided.

The Congressional Budget Office (CBO) believes the fiscal cliff scenario would knock -4.0 percentage points off U.S. GDP in 2013. Since estimates for 2013 GDP have already fallen to +1.8% to 2.0% growth that suggests the U.S. would be in recession at -2%. However, regardless of who wins the election the odds of any version of Congress allowing all the fiscal cliff problems to all come due at the same time is about zero. Surely rational thinking will prevail and some of the events will be postponed or extended. If not the wall of worry may collapse on us.

I believe this tsunami of major events headed our way this fall is going to pressure our markets later this summer. Maybe not next week but just as sure as winter follows summer there will be a market shift ahead. It could be subtle as each problem comes to a head but the avalanche of problems due to hit in the fall could overcome even the most optimistic investors. For this reason I expect cautious money to begin moving away from equities towards the safety of bonds as the summer progresses. There will still be peaks and valleys in the equity market but volume should slow even more than normal over the summer.

Think like a chess player and study the potential scenarios ahead as I report on them each week. Decide how they will impact your long term investments. If your time horizon is 3-4 weeks then nothing will change for you. If you have long term investments, IRAs, etc then decide how a global recession would impact your positions and take action if we see it approaching. Don't look back a year from now and say "I sure wish I had done ..." Be proactive this summer not reactive.

Enter passively, exit aggressively!

Jim Brown

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"Procrastination is still procrastination even if you schedule it for tomorrow."