Multiple earnings warnings from high profile companies combined to push the markets to seven day lows.

Market Statistics

The market decline today should not have been a surprise. I wrote over the weekend that further earnings warnings were likely to push the markets lower and we are not even into the actual earnings reporting yet. The hopium is fading and the buy the dip recommendations are disappearing from the headlines.

Europe added to the gloom with Greece saying it needs another 3.5 billion euros immediately and by the way we want to postpone our prior 130 billion euro bailout agreement by at least two years. They argued that Spain got an extension so Greece should get one as well. The same argument will be used by Ireland, Portugal and Cyprus even though Cyprus has not even received their bailout yet. Remember, Greece is not over until it is over and no amount of paper agreements will keep the country afloat until the economy hits bottom.

Italy's Prime Minister Mario Monti upped the concern for Italy after he said the country may soon need a bailout from the EU. Italy's borrowing costs are spiking and nearing the range where Italy will no longer be able to borrow on the open market and will require funding by the EU. That is a rabbit hole that once entered could take years to escape. The IMF added to the confusion saying Italy was still vulnerable to the European debt crisis and its economic decline could have a domino effect globally. Italy is the third largest economy in the eurozone and it seen by the EU as too big to bail.

Spain, the fourth largest EU economy won a delay until 2014 in reaching its deficit targets. Spanish debt yields rose on the worsening outlook.

The euro fell to new two year lows on the news above and new worries that the ESM bailout facility may not be in operation for up to three months. It was initially slated for July 1st, then July 9th, but a German high court ruling on the constitutionality of the ESM fund that was expected last week now could be delayed for up to three months.

The market had opened higher on hopes for some resolution in Europe from the second day of the EU Finance Minister meeting. They did agree to loan 37 billion euros to Spain by the end of July but the headlines went downhill from there.

The U.S. economics were not a factor with the weekly chain store sales number rising +2.0% last week compared to +0.2% the prior week. However, that period covered the July 4th holiday so sales were expected to increase.

The Job Openings and Labor Turnover Survey (JOLTS) showed there were 3.642 million job openings in May compared to 3.447 million in April. However, these are lagging numbers for the May period and were mostly ignored. The nonfarm payroll and ADP numbers reported last week were for June and closer to real time.

The real economic problems roiling the market were earnings related. Engine maker Cummins Inc (CMI) warned that Q2 and full year earnings and revenue would be lower than previously forecast due to slowdowns in the global economy. CEO Tom Linebarger said, "Order trends in the U.S. for trucks and power generation equipment have softened and demand in Brazil, China and India is not improving as we had previously expected." Earnings are now expected to be flat compared to prior forecasts for a +10% gain. The warning was significant because it impacted expectations for Caterpillar and CAT is a Dow stock. CMI shares fell -9% or -8.53 making it the second worst performer in the S&P-500. CAT declined -3.45% of -$2.87.

Cummins Chart

Caterpillar Chart

The CMI warning was a material event but the tech sector had plenty of its own problems. AMD warned after the close on Monday saying it now expects an 11% decline in sales compared to prior estimates for 3% sales growth. AMD said the warning was due to business conditions that deteriorated sharply late in the second quarter with falling sales in China and Europe along with weaker consumer demand.

AMD is not a leader in the sector so big gains are rarely expected. However, the magnitude of the warning with a -14% swing in the estimates was a wet blanket for the tech sector. AMD shares declined -11% on the news.

AMD Chart

Chipmaker Applied Materials (AMAT) warned that "demand changes" could knock 15-20 cents per share off its prior forecast of 85-95 cents per share of earnings for the full year. That is a material reduction in earnings of up to 20%. AMAT said "weaker than expected near-term demand in its semiconductor business, primarily among foundry customers" was the major cause for the earnings decline. A foundry is a factory that manufactures chips designed by others. Foundries are seeing a sharp drop off in demand because of slowing consumer demand for electronic products thanks to the problems in Europe and the slowing global economy. AMAT shares declined -2.7% on the news.

AMAT Chart

After the bell OCZ Technology Group (OCZ) reported an earnings loss of 17 cents compared to estimates for a loss of 12 cents. Shares fell -7% in after hours after a -9% drop in regular trading. The earnings were actually pretty good with positive comments from OCZ CEO Ryan Peterson saying revenue rose +54% to $113.6 million compared to company estimates of $110-$120 million. Gross margins rose to 25% from 20%. The company affirmed its full year guidance. The loss came from acquisition related problems and the discontinuance of some memory products to focus on their high demand solid state drives. (Personally I think OCZ builds one of the best SS drives in the industry. I have tested them against others and they consistently outperform. I think OCZ was caught in the negative earnings sentiment produced by AMD and AMAT. I would be a buyer at $5.

OCZ Chart

After the close Chubb (CB) said it will take up to a $240 million loss in Q2 related to storm damage and fires in 13 states. The loss would equate to between 48-57 cents per share. Shares only dipped slightly because the news had already been anticipated.

Adding to the negative market sentiment was the bankruptcy announcement by Patriot Coal (PCX). The company filed a $3.5 billion petition for chapter 11 and the CEO said dozens of the company's subsidiaries would join in the filing. The company said lower prices for thermal coal, cancelled customer contracts and rising costs pressured the company to file. Its mining operations are expected to continue through the bankruptcy proceeding with no halt to shipments. Patriot has 13 active mines and controls 1.9 billion tons of coal. The EIA said coal usage for electricity was the lowest in Q1 since 1988. The reason was the unseasonably warm winter and the low prices for natural gas. Q2 demand has increased and Q3 demand should be off the charts as more than 4,000 temperature records have been broken nationwide in July.

Patriot Chart

Earnings for Wednesday include ADTN, ITRI, TXI, NTIC and MAR. Marriott (MAR) will be the most important since it will be a window into the business and consumer environment.

The biggest event on Wednesday will be the FOMC minutes. On Monday three Fed officials laid the groundwork for a new QE program saying the U.S. recovery was too weak and unemployment far too high. SF Fed President, John Williams, currently a voting member of the FOMC, said "We are right on the edge, if economic data keeps coming in below our expectations and our view is that we are not making progress on our mandates, then I think we need more policy accommodation." Chicago Fed president, Charles Evans, said "Additional monetary accommodation is needed to more quickly boost output to its full potential level. The economic circumstances warrant extremely strong accommodation." Boston Fed president Eric Rosengren, agreed with those comments from Evans saying "I think it's appropriate to have more quantitative easing." Richmond Fed president Jeffrey Lacker again disagreed but he is the lone wolf on the Fed at this point.

Economic Calendar

The falling euro, thanks to headlines out of the EU Finance Minister meeting and the delay in Germany, caused commodities to be crushed once again.

Euro Chart

This time around the commodity sell off had some help. Futures broker PFGBest was charged with misappropriating $200 million in customer funds and the brokerage was placed on "liquidation only" status by the CFTC. That means customers of PFG can only close positions and cannot initiate new positions. This always pressures commodity prices since it removes thousands of commodity traders from actually trading. They must close existing positions and then setup a new account at a different broker then transfer funds. Unfortunately PFG clients received a notice saying that although they could close positions they could NOT withdraw any of their funds. This will put pressure on the commodity sector for weeks to come.

The CFTC claims PFGBest may have been hiding the shortfall for years. The CFTC said the company defrauded customers and lied to customers and regulators in an attempt to conceal the fraud. The CFTC just gave the company a clean bill of health in January when it did spot checks on various commodity firms after MF Global crashed. The $200 million represents more than half of PFGBest client funds so that means clients will again be out money when the dust clears. The company had setup a bogus PO Box claimed to be an address for a bank holding client funds. The fictitious bank was reportedly holding $225 million in 1,845 customer accounts when it actually contained only $5 million. The founder and Chairman of PFGBest, Russell Wasendorf, forged signatures and fabricated bank balances on the documents and simply mailed them back to the National Futures Association (NFA) in response to their request for confirmations. The scheme unraveled when the NFA moved to electronic confirmations after the MF Global disaster. Wasendorf tried to commit suicide on Monday after a well respected four decade carrier.

On Tuesday the firm's clearing broker, Jefferies Group, began closing positions on behalf of PFG's clients after the company failed to meet a margin call. Jefferies said a "substantial portion" had already been closed.

WTI Crude oil declined -1.91 to $84 and Brent fell -$2.31 to $98. Gold lost -$21.80 to $1567 and silver closed down -65 cents at $26.79. Corn closed down -2% even though the USDA published a report saying 18 states had been hurt by the drought. The USDA said 30% of this year's crop is considered in poor or very poor condition. A week ago it was only 22%. Indiana's corn is now rated at 61% in poor or very poor and 48% in Illinois.

The trade numbers out of China today also had an impact on commodity prices. China reported that import growth in June declined by more than half to 6.3%. Export growth declined to 11.3% from May's 15.3%. The vice premier said over the weekend that China would be "lucky" if it hit its full year target of +10% growth. That compares to more than 20% growth in 2011. Growth in China has fallen to its lowest level since the 2008 crisis. China's GDP declined to 8.1% in Q1 and data out on Friday is expected to show a decline to 7.3% GDP in Q2. Oil imports fell by -35.4%, steel -8.3% and copper -11.9%.

Crude prices had another reason to decline and that was the end of a strike in Norway. The country imposed compulsory arbitration on workers in the North Sea and ending a two week old strike that shutdown production of 240,000 bpd of Brent crude. Norway's fields produce about 1.6 mbpd and it will take 2-3 days to restart production. U.S. crude supplies are expected to show a decline of -1.5 million barrels when the EIA releases its data on Wednesday. That will be related to the shutdown of the oil platforms in the Gulf as a result of tropical storm Debby earlier in July.

The Dow rallied +94 points at the open but then sold off hard starting at 1:PM to lose -125 points at its lows before rebounding to close at -83 points. The better than 200 point range could be just the start of a bigger decline if the rest of the earnings cycle continues the current trend.

The S&P rallied to retest resistance at the 100-day average at 1360 at the open but then collapsed back to break below support at 1350 to close just over 1340. We now have a textbook pattern where the S&P rallied to downtrend resistance at 1375 last Tuesday on light volume and then rolled over completely to test uptrend support at 1340 today. A break of that support easily targets the lows from June at 1310.

S&P Chart

The Dow chart is similar to the S&P with a solid test of 12,900 resistance last week followed by a test of support today at 12,600. The Dow is not going to get a lot of help from earnings this week. JP Morgan on Friday is the only remaining Dow component to report. That could be a bonus or a disaster depending on how the whale trade turned out. The Dow is going to be knocked around the rest of the week by warnings made by other stocks. However, if the FOMC minutes are viewed positively on Wednesday afternoon we could have a QE3 expectation rally in the industrials. The blue chips will be seen as a safe place to park money while investors wait for the FOMC meeting on July 31st.

Dow Chart

The Nasdaq spiked to 2953 at the open but then declined more than 60 points to 2891 at the lows. The various earnings warnings and earnings misses in the tech sector are just a warm up to what may follow. Tentative support at 2900 returned at the close but it may only be temporary.

Tech stocks don't normally do well with Q2 earnings and I would be looking to sell into any tech bounce to the 100-day average. The top 20 gainers list for the Nasdaq is again an alphabet soup of symbols most investors won't recognize. However, the biggest losers list has names everyone recognizes.

Nasdaq Top Gainers

Nasdaq Top Losers

Nasdaq Chart

The markets were weak as expected for the reasons we expected. Europe, earnings and economics although the economics came from China instead of the USA. I don't see any changes in that scenario in the days ahead. Earnings will probably remain lackluster at best and U.S. economics are not expected to improve.

The wildcard here is the FOMC minutes and their impact on expectations for QE3 or some new Fed strategy. With the three Fed heads basically lining up on the side of a new QE program "if" the economy continues on its present course there will be plenty of speculators trying to get a head start on a QE3 rally if it begins to appear likely.

The PFGBest news is going to weigh on commodity prices for the next several weeks. There is nothing we can do about it and we should just resign ourselves that any good news in the sector may be ignored because of the $400+ million in limbo at PFG.

I would not be a dip buyer. I would be looking to short any short squeezes and you know there is one in our future somewhere.

Enter passively, exit aggressively!

Jim Brown

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