The Dow, S&P and Nasdaq all managed to close at three months highs thanks to short covering at Friday's close.

Market Statistics

Friday and short squeeze. It seems like those three words have been in the same sentence a lot lately. The day did not start off in positive territory after China's exports declined sharply. That caused the Dow to trade under 13,100 at the open but the dip was quickly bought. The Dow traded in negative territory until 3:PM when a small buy program triggered a flurry of short covering and the resulting +50 point jump pushed the Dow to a three-month high.

It should be noted that the Dow's range for the week was ONLY 121 points. That is the narrowest range in the last 18 months. Last August we saw ranges of 800 points. This year volatility has dried up and volume has disappeared. Volume on Friday was only 4.9 billion shares dropping the average for the entire week to 5.5 billion per day. Bank of America economist Ethan Harris called it the "sounds of silence" because so many money managers were on vacation.

The morning dip, courtesy of China, was erased quickly because of expectations for stimulus to be announced this Sunday. Weekends are when China announces policy moves. Considering the severity of the export decline I am surprised the markets did not implode. China's exports for July fell to +1% growth compared to estimates for +8% and the 11.3% increase in June. That is a dramatic decline and very close to a contraction. Exports to Europe fell -16%. Since numbers out of China can't be trusted we will never know if that 1% was a government supplied number and maybe exports are already in a contraction. Chinese imports grew by +4.7% compared to estimates for a +7% gain. The trade surplus declined to $25.1 billion from $31.5 billion and compared to estimates of $35.1 billion.

These numbers come on the back of reports out on Thursday that China's industrial output rose at the slowest rate since the recession and the inflation rate had fallen to a 30-month low. This is even more indications that China will need to move quickly and dramatically to halt the economic decline. All the major economists cut China's expected GDP for Q3 after the bad numbers for the week. China is now expected to see growth decline to 7.3% - 7.5% GDP for Q3. This is down from more than 9% in Q3-2011. Bank lending fell to $85 billion and lower than all 30 estimates in a survey by Bloomberg and the lowest level since September. The Peoples Bank of China said the "primary risk for the global economy is still the European debt crisis and the possibility Europe will trigger a double dip recession for the global economy."

On the U.S. economic calendar there was nothing major to move the market on Friday. Import prices for July declined -0.6% and the fourth consecutive month of declines compared to expectations for a +0.1% rise. Import prices fell -2.4% in June and prices are now -3.2% lower than the same period in 2011. Export prices rose +0.5%. Prices for corn, wheat and soybeans surged by double digit percentages and they are just getting started.

The Treasury Budget deficit for July rose to -$69.6 billion. The deficit is on track to end the year at -$1.14 trillion depending on how the administration defers payments in an effort to avoid another debt ceiling confrontation ahead of the elections.

The calendar for next week is much busier with several material reports. The biggest report for the week is the Philly Fed Manufacturing Survey on Thursday. That is seen as a proxy for the national ISM the first week of September.

The prices indexes, CPI and PPI, would normally be important but with inflation declining thanks to lower oil prices and slowing demand they will not be closely watched. The NAHB Housing Market Index will be scrutinized for signs the builder boom is not fading with the end of the summer outlook.

Probably one of the biggest events next week is the Cisco (CSCO) earnings on Wednesday after the close. Consensus estimates are for 45 cents with a whisper number of 48 cents. That bullish whisper number could be a serious challenge for Cisco if they just report earnings and revenue in line with estimates. I will not be surprised if they miss on the revenue. Cisco competitors are booming.

Economic Calendar

We had a busy IPO week capped by the Manchester United (MANU) debut on Friday. It was not pretty. The IPO was expected to price between $16-$20 and it priced at $14. That values the club at $2.3 billion and they raised $233 million in the IPO. The club has $663 million in debt and only had $40 million in cash as of March 31st. They sold 16.7 million shares at $14 and more than 33 million shares traded. The IPO syndicate managed to hold the price at $14 or above until the close but that level cracked immediately in afterhours trading. The odds are good it will trade lower on Monday. Manchester setup a shell corporation in the Cayman Islands called Red Football, which owns Manchester United Plc, which owns Red Football Holdings Ltd, which owns Red Football Shareholder Ltd, which owns Red Football Joint Venture Ltd, which owns Red Football Junior Ltd and Manchester United Ltd and "various operating subsidiaries." Various shareholder rights groups have issued warnings about the organization of the shell companies.

Manchester Chart

Other IPOs this week included Outback Steakhouse (BLMN) and several small cap offerings with mixed results. Bloomin Brands was the most easily recognized name.

Bloomin Brands

Peregrine Semi

Performant Financial

Yahoo (YHOO) shares declined -5% after the new CEO, Marissa Mayer, launched a strategy review that may change prior plans to return billions of dollars to shareholders. Yahoo is selling its stake in Alibaba for $6.3 billion in cash and that money was slated to be returned to shareholders in a dividend or stock buyback. Mayer is reviewing all the Yahoo business strategies with an eye towards restructuring the company for long term growth. That includes the "cash position and planned capital allocation strategy." Investors were not pleased and Yahoo shares crashed.

Yahoo Chart

Research in Motion (RIMM) rallied 6% on a rumor that IBM was looking at their enterprise services unit for an acquisition. IBM made an informal approach about possibly acquiring the division according to the rumors. The division operates a network of secure servers to support BlackBerry devices. IBM is the largest global provider of computer services to enterprises. RIMM's network generated $4.1 billion in revenue for the company last year. Analysts said a RIMM sale of that division would be a death knell for the company because the phone business was hemorrhaging customers. Most analysts believed RIMM would wait until after it actually launched BlackBerry 10 before making any structural changes. If BlackBerry 10 can't stop customers from abandoning the BlackBerry ship in favor of Apple and Android then the enterprise business will be all that RIMM has left.

RIMM Chart

JP Morgan (JPM) won a preliminary approval from a federal judge on a $100 million class action settlement with credit card customers who complained about the bank boosting minimum payments. During the credit crisis JPM boosted minimum payments for credit card customers from 2% to 5% of their account balance. Cardholders claim JPM had induced them to transfer balances from other banks into Chase card accounts. Then Chase reportedly forced them to either make higher payments or accept a higher interest rate. The bank also escalated interest rates whenever a payment was late and that led to higher payments and more defaults. Lawyers for the suit will seek to keep $25 million as their legal fees.

JPM also said it has halted its stock buyback plans until 2013. Previously the company had announced a new $15 billion buyback. That was made up of $12 billion in 2012 and $3 billion in Q1-2013. It was halted when the Whale Trade surfaced. When they announced Q2 earnings Jamie Dimon said they were hopeful of restarting the buyback in Q4. The bank announced on Friday it was delaying the restart until at least Q1-2013 because the investigation was not over and the losses were gradually increasing. Not good news for investors.

JPM Chart

Monster Beverage (MNST) shares lost -8% after the company disclosed a probe by an unspecified attorney general.

Chesapeake Energy (CHK) lost -2.6% after it said the company had received a subpoena from the SEC antitrust office. They are looking into possibly antitrust allegations over oil and gas leases. There have been allegations that companies conspired to fix bids for leases or to not bid at all. More trouble brewing for CHK.

Ubiquiti Networks (UBNT) fell -42% after earnings missed estimates. The company said the miss was due to distributors making counterfeit equipment under the Ubiquiti brand. The company said it was making good progress legally and the drain on sales should not last more than two quarters. I thought this was a strange excuse. How many distributors would make counterfeits and how many boxes could they make that it would drag sales down to $66 million when analysts were expecting $98 million?

UBNT Chart

Goldman Sachs (GS) was cut to a BBB+ from AA- by Egan Jones citing the banks weaker results, concerns over proprietary positions and the higher potential for losses. Other major issues were potential costs to comply with the Volcker Rule and a weak investment banking environment.

A study released on Friday said the costs to banks to implement Dodd-Frank could be as much as $34 billion. That is up from prior estimates at $19-$22 billion. This is another reason for a Romney rally because he has vowed to kill Dodd-Frank because of its major impact on employment. The banks are not going to just eat these costs. They will pass on what they can to customers but they will have to cut jobs, offices and expenses to make up for the rest of the costs.

The Dodd-Frank bill is 2,319 pages and regulators are only 25% through it in translating the broad meaning into laws. That 25% has created 3,826 pages of financial regulations and guidance which, according to one estimate, will take 24 million man hours a year to comply with the new laws. Banks have filed suit claiming the law is unconstitutional.

The national average for gasoline prices in the U.S. rose to $3.67, an increase of 34 cents since July 1st. The rise in crude prices, refinery outages and pipeline shutdowns were blamed for the spike. The recent fire at the Chevron refinery in California has slowed gasoline production on the West Coast. The Richmond refinery produces 15% of the gasoline used in California. Prices in California have risen 15 cents since the fire. Prices are not expected to reach the $3.94 we saw in the spring because the driving season is almost over and there is plenty of oil in inventory.

Hurricane Ernesto failed to cause any damage to the Gulf installations because it turned to make landfall over Mexico and lost strength. A new tropical storm, number 7, was heading into tornado alley south of Puerto Rico on Friday but it evaporated Saturday morning.

Gasoline Chart

Elsewhere in the commodity sector the USDA warned that the drought continued to worsen and the corn crop could be the worst in a decade. However, it could still be the eight largest crop ever. The USDA said farmers planted 96.4 million acres this year, the most since 1937. The agency cut its crop yield estimates for the third time in a month to the latest expected level of 10.8 billion bushels. If that estimate holds it would be enough to meet the world's needs and ensure there are no shortages. However, prices will rise in everything including beef, pork, chicken, food, drinks and cosmetics and almost anything that uses high fructose corn syrup. The rising cost of corn to feed livestock has prompted many ranchers to sell off herds and that will push meat prices down over the next several weeks but then prices will rise as fewer animals come to market later in the year. Corn prices sold off slightly after hitting $8.34 intraday as traders took profits ahead of the weekend.

CORN Chart

The Dow, S&P and Nasdaq have not all been down on the same day since August 2nd. The gains this week were minimal but they were still gains. There was a slow decline in the intraday highs through Thursday but the dips were bought almost instantly.

With the volume incredibly light at 4.9 billion shares on Friday it is not surprising that a minor buy program late in the day would trigger some short covering. The same week in 2011 averaged 7.84 billion shares. Traders have been reluctant to carry shorts into the weekend for several weeks now. That is strange since last Monday was the first Monday in ten weeks that actually posted a gain but there is always the danger of some overseas event catapulting stocks higher. Across the broader market on Friday there were 3139 advancers and 3192 decliners. That is about as close to a sentiment tie as you can get.

There was a serious lack of European headlines last week. We remain on ECB watch for the "whatever is necessary" move that Mario Draghi promised. Actually we are on ECB, BOE, BOJ and PBOC watch. China is very likely to take action this weekend and it could be dramatic given the accelerating rate of their economic decline. The Bank of Japan could move at any time as well.

Traders are betting on central banks all around the world acting to prevent the global economy from sliding back into recession. It is no longer just the Bernanke put but the global central bank put. The potential for the ECB to introduce literally trillions of euros of stimulus over the next couple years is approaching 100%. They may do it through the EFSF, ESM or directly from the ECB but it will happen. Spain, Italy and France are going to continue circling the drain and massive bond buying by the ECB and friends will be required to keep their debt rates in check for the coming decade. However, there may not be any significant plan presented until after the Sept 12th vote in Germany on the changes to the EFSF.

We are three weeks away from the Bernanke speech at Jackson Hole on August 31st. That is where he dropped a serious hint about QE1 beginning several weeks later. While I don't expect him to announce anything this time around there are quite a few traders betting on some revelation from above. We could see a significant letdown if the ECB and Uncle Ben don't do anything by Labor Day.

The S&P has been flirting with the resistance at 1405 all week and that is where it closed on Friday. The 1405-1426 resistance band should be strong but we have not seen any indications of a pending retracement. The narrow 13 point range for the week may prove to be a consolidation ahead of the next move higher rather than the next decline. The low volume is a key indicator that traders lack conviction. However, Art Cashin reported there were more than $1 billion in buy on close orders on the NYSE on Friday. That is contrary to the recent pattern of sell on close orders.

I mentioned last week that we would know when sentiment changed when the market rose at the close rather than sold off. Was this our defining moment or was it just caution or speculation ahead of a weekend on ECB/China watch?

Initial S&P support is 1396 with strong resistance from 1405 to 1426. Any move higher into that resistance band could be a huge sentiment indicator for the bulls. It could also be a trigger for the bears but the dip buyers are in control at present.

S&P Chart - 10 Min

S&P Chart - Daily

The Dow's narrow range of 121 points also had a pattern of lower highs but the opening dip on Friday to 13,100 was instantly bought. Dow 13,214 was the intraday high on Tuesday and should be initial resistance. However, the Dow is within range of the high close for May at 13,279.32 and that is the real resistance target. Nine Dow stocks closed negative on Friday and only one gained more than $1 and that was McDonalds.

Dow Chart - 10 Min

Dow Chart - Daily

The Nasdaq spiked above the critical 3,000 resistance on Tuesday and then used that level as support for the rest of the week. The Nasdaq was not able to equal the 3,028 intraday high from Tuesday but there was no selling either.

The last three days were very flat with a range of only a 20 point range from 3,002 to 3,022 and it closed at the high end of that range at 3,020. Dip buyers appear to be in control but resistance at 3,020 is also firm. We are just waiting for the next headline.

Nasdaq Chart - 10 Min

Nasdaq Chart Daily

The fly in the bullish ointment is the Russell 2000. The 800 level is acting as a price magnet and prevented the Russell from rebounding through minor downtrend resistance from Tuesday's high. The Russell remained in negative territory and suggests fund managers are still lacking conviction in the rally. They are putting money in the big cap highly liquid blue chips but not in the small caps. This means the Russell has again become the canary in the coal mine as the sentiment indicator for fund managers. If the Russell moves to a new low below 795 then it has risk to 765 and a level it touched just seven days ago.

Russell Chart - 10 Min

Russell Chart - Daily

The Dow Transports are still not confirming the Dow rally. The Transports did see a little short covering at the close on Friday but it was only enough to turn it mildly positive after a week of lower lows. Had it not been for the short covering Friday afternoon this chart would have a much bleaker outlook. This is a caution signal.

Dow Transport Chart - 10 Min

Dow Transports - Daily Chart

The Dow Total Stock Market Index (TSMI) finally moved over resistance at 14,550 after several days of congestion at that level. If the Friday close holds then the next test should be 14,715.

Dow Total Market Index Chart

The VIX closed at 14.74 and only .74 away from a multi-year closing low. You have to go back to 2007 to see a number under 14 for any period of time. We did dip under 14 in March on an intraday basis but it never closed under 14. When the VIX is low it is time to go BUT as we saw in early 2011 it can remain low for weeks at a time before exploding higher. This is another caution indicator.

VIX Chart - Weekly

Dow component Cisco Systems reports after the bell on Wednesday so that could be a market mover on Thursday. However, I believe the central bank put is alive and well unless somebody with a microphone develops a bad case of foot in mouth disease.

For next week we remain on central bank watch. China is the most likely to move followed by the ECB. China should not have as much impact on our markets unless they really pull out all the stops like they did for the 2008 Olympics. The ECB is the key for the U.S. markets. Eventually Draghi has to do something or his next speech will be ignored.

Lastly, U.S. treasury yields have risen for three consecutive weeks as selling in treasuries increases. Is the bond bubble about to burst? If institutions are selling bonds where is that money going? In theory it should be going into equities and maybe that is exactly why there is a strong bid under the equity market. I don't see treasuries falling completely out of favor but the gains there are limited and that could be the reason investors are switch to equities.

Ten Year Note Yield Chart

This is expiration week for options and last week is where we normally see the volatility. That did not happen so there is always the possibility it will happen early this week.

Enter passively, exit aggressively!

Jim Brown

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"Better to remain silent and be thought a fool than to speak out and remove all doubt."
Abraham Lincoln