The markets continue to set new highs and are setting up for the best January in a decade with the Dow Transports obscenely overextended.

Market Statistics

After some high profile earnings beats and misses the market is still moving higher. A major hiccup in Apple shares that knocked -$75 off the stock price could not prevent the Nasdaq from closing within 3 points from the high of the week. Many stocks that sold off on earnings found eager buyers and erased their losses by the close on Friday.

Bullishness is breaking out all over and the markets are not showing any signs of weakness. The AAII Investor Sentiment Survey for last week is now showing 52.3% of investors are bullish, an 8.4% increase over the prior week. Only 24.3% bearish and that is a decline of -3.1% from the prior week.

The rise in bullishness came from the potential extension of the debt ceiling debate until May and a string of positive earnings reports. Economics were not so bullish but nobody appeared to be paying attention.

The New Home Sales on Friday came in at 369,000 for December. Consensus estimates were for sales of 392,000 compared to 398,000 in November so the headline number was a disappointment. That was a -7.3% decline in December. I think investors were still happy because of the +20% increase in sales for all of 2012. That is the first annual gain since 2005 and the largest since 1992. However, the overall total sales were the lowest in the last 50 years.

The dip in sales in December was likely influenced by Hurricane Sandy and a couple weeks of very cold weather. Sales in the Northeast showed the biggest decline with a -29.4% drop in December compared to the -7.3% for the entire country.

The number of new homes in inventory is near historic lows so prices should continue to climb. Median prices are up +13.7% since December 2011. Analysts expect new home sales to rise to something in the 500,000 range in 2013.

New Home Sales Chart

Mass layoffs for December fell sharply from the November level as the impact of Sandy dissipated. Layoffs had jumped from 1,400 events in October to 1,749 in November with an additional 36,000 workers impacted. In December the number of layoffs declined to 1,509 events and 137,839 workers. That is a decline of -35,000 workers from November's 172,879 high. The November number was the highest since the fall of 2009. The market ignored this data because of the storm impact.

The economic calendar for last week was limited but the coming week has some very high profile events. This is the week for the January FOMC meeting plus Nonfarm Payrolls, GDP, ISM Chicago and national ISM Manufacturing. On top of that more than 20% of the S&P will report earnings.

This will be the first release of the Q4-GDP and the consensus estimate is for growth to have declined to +1.2% compared to the final reading of +3.11% in Q3. This could be a volatile number since Sandy depressed GDP early in the quarter then enhanced it with the recovery efforts late in the quarter.

The Nonfarm Payrolls are expected to be flat with a gain of +155,000. However, the weekly Jobless Claims have been dropping steadily. Last week they fell to 330,000 and the lowest level since January 2008. Continuing claims declined to 3.16 million and the lowest since July 2008.

Weekly Jobless Claims Chart

This could be telegraphing an improvement in the Nonfarm Payrolls. However, there is a trend underway by small businesses to reduce payrolls as a result of the Obamacare rules. Businesses are cutting hours to reclassify employees from full time to part time. They are also reducing employees to get under the 50 employee limit. It may be a couple months before those trends are translated into the payroll report and we may not even see it if the economy continues to recover and new jobs take the place of the disappearing jobs.

Lastly the FOMC meeting is not expected to reveal any change in the current QE programs. There has been some comments from Fed governors about ending the treasury purchases as early as Q3 but in Bernanke's latest speech he did not deviate from the stated Fed position. It will be interesting to see if the post meeting statement tries to overcome that dissension and firmly restate the Fed position. Bernanke can't have the various members of the committee spouting off about the Fed ending the program because that is counterproductive for the Fed position. The Fed is trying to hold interest rates down and those comments and the improving economy are pushing rates higher. For this reason the announcement could be more volatile than normal.

Economic Calendar

Pension and insurance funds are starting to rotate back from an extreme bond position to a preference towards equities. This is being called the "Great Rotation." These funds have benefitted from a nearly 20 year bull market in bonds and the portfolios are ripe for rebalancing. Nobody wants to be the fund that underperforms because they are only earning 2% in bonds when the equity markets are breaking out to new highs.

According to Lipper the fund flows into U.S. equity funds over the first two weeks of 2013 was $11.3 billion and the biggest since April 2000. If you include flows into equity ETFs that number jumps to more than $18 billion and more than twice the flows into bond funds. In the latest week Lipper said $3.66 billion flowed into U.S. equity funds. For all of January the Convergex Group said $15.6 billion has flowed into ETFs. Fund-tracker EPFR said there was $7 billion of inflows into emerging market equities in the first week of the year and that was the most on record. These numbers compare to the $215 billion in equity fund outflows in 2012.

Bank America analyst Michael Harnett said "their conviction in the Great Rotation remains very high." The preference for bonds has been historic. European pension funds had a 43% bond weighting and 24% equity weighting in 2012 compared to more than 40% equities in 2010.

The main point that should be stressed here is that these funds to not move in a hurry. They plan and move, plan and move and test their market outlook all along the way. As long as the market trend remains steady the rotation out of bonds could take a long time. Once the rotation builds momentum it is like the proverbial train that is hard to stop.

With the dividend yield of many U.S. equities well above the yield on bonds there is little downside for these funds to move into stocks as long as the economic forecast is for a gradual improvement.

The rotation picked up speed on Friday with treasuries getting crushed. The yield on the ten-year spiked +5.6% to close at 1.947% and an eight-month closing high. The 30 year yield spiked +3.1% to 3.133% and also an eight month high.

Ten Year Treasury Yield Chart

The S&P completed its longest winning streak since November 2004 with eight consecutive days of gains. The Dow has been up for 11 of the last 12 days and that is the best streak since 2004 as well. The Dow has gained +6% in January making it the best January since 1994. The Dow is only 268 points below its 2007 peak. Eight Dow stocks hit new highs. DIS, HD, JNJ, JPM, MMM, PFE, PG and UTX. On JNJ that high dates back to 1944 and MMM dates back to 1945.

These gains were driven by better than expected earnings from companies like Starbucks, Procter & Gamble, NetFlix and Halliburton.

So far this earnings cycle 76% of S&P companies have beaten on earnings per share according to Bloomberg. Only 67% have beaten on revenues but that is significantly better than the 47% beating last quarter. Estimates for earnings growth have done a U-turn over the last week. Estimates were over 3% on Jan 1st then dropped to less than 2.5% about a week ago. They have rebounded to +4% growth as of the close on Friday.

Guidance remains muted. Companies are not very optimistic about this quarter but the majority are positive. Saying things like "we are well positioned" or "estimates we made last quarter have not changed" may not stimulate traders but at least the majority are not warning of any business decline.

By far the biggest earnings winner for the week was Netflix (NFLX). The company reported better than expected earnings on Wednesday night and surged +$43 points on Thursday and then gained another $23 on Friday. That $66 gain started from the $103 close on Wednesday. The Netflix faithful were definitely rewarded.

NetFlix Chart

Starbucks said profits rose +13% to 57 cents per share and in line with estimates. That failed to generate excitement but news the same store sales rose +7% in the Americas was positive. Analysts were only expecting a sales increase of 5.9%. European sales declined -1% and analysts were expecting a decline of -0.3%. Sales in China and Asia Pacific rose +11%. Starbucks posted its highest revenue ever at $3.8 billion. The company operates 18,200 stores globally with plans to open +1,300 more in 2013.

I think Starbucks is a buy as long as it holds over resistance at $56.

SBUX Chart

Procter & Gamble (PG) posted profits that more than doubled as the cost cutting measures announced last year finally kicked in along with higher sales and new products. Last February P&G announced a plan to focus on its top 40 businesses, 20 biggest new products and 10 most profitable emerging markets. Apparently those efforts paid off. The company earned $4.06 billion or $1.39 per share. That was up from $1.69 billion and 57 cents in the year ago quarter. The company raised full year guidance from $3.80-$4.00 to $3.97-$4.07.

The rising sales in both the Americas and in Europe/Asia were positive for economic sentiment. Kimberly Clark (KMB) also posted higher sales and the pair of reports suggests the global consumer is improving.

P&G Chart

Halliburton (HAL) posted earnings of 67 cents that beat the street by 6 cents. That was down from the 98 cents earned in the year ago quarter. The decline came from a sharp drop in pressure pumping used to fracture wells. The number of active gas rigs has fallen to one third of their recent highs as gas prices remain low and gas production remains high. Halliburton's North American income fell -58%. Baker Hughes (BHI) reported a similar story last week but Schlumberger (SLB) reported stronger results because they have a large presence in offshore drilling.

Halliburton Chart

Oshkosh Corp (OSK) shares spiked +19% to $41.08 after reporting earnings of 60 cents compared to analyst estimates of 31 cents. That massive beat was due to an uptick in sales of construction equipment and orders for fire trucks and emergency vehicles. Car Icahn dropped his bid to buy the company in December and has since reduced his share to 4.7% from 9.5%. I bet he is a happy camper this weekend with a +19% jump in the stock price. The company was upbeat on its guidance saying "there is increasing evidence housing is poised for a nice recovery."

Oshkosh Chart

Apple (AAPL) was the biggest loser of the week with a decline of -$75 from its close at $514 prior to earnings. Revenues were strong as products jumped off the shelves. Sales were just not good enough. They also guided below analyst estimates for Q1. That is not unusual but it was significantly lower. They guided for revenue of $42 billion compared to estimates of $45.4 billion. If you take their guidance on expenses, margins and tax rates that equates to about $9.18 per share in Q1 compared to the $12.30 they made in the year ago quarter and the $11.67 analysts were expecting. It all boils down to sales. Apple sold 47.8 million iPhones in Q4. That was 29% higher than Q4-2011 but significantly below the 50 million analysts were expecting and the 56 million suggested by Verizon. Samsung sold 63 million smartphones in the quarter.

Price targets are being slashed all over Wall Street and the stock has broken through three levels of support in just two days. The $500 level is history and now everyone is hoping $400 will hold. I read two analyst updates this weekend saying the new price target for a bottom is in the $340-$360 range. Personally, I believe buyers will appear in the $400-$420 range and that will be the bottom. Even at the reduced earnings Apple is still undervalued.

Since the September high at $702 Apple has lost $246 billion in market cap. That is the equivalent of 1,230 Boeing 787 Dreamliners at $200 million each. That is more than the $235 billion market cap of GE. That is 27 times the market cap of NFLX, four times the size of Altria, six times the size of Starbucks and 49 times the size of Sears. That means thousands of funds and millions of individual investors lost a sizeable portion of their account on this decline.

Apple Chart

Next week 20% of the S&P reports earnings. However, as you can tell by the list below the size of the average company is declining and the quality of earnings normally declines in this week as well.

By the time we get to next weekend we will now how the earnings cycle will end and how many jobs were created, the GDP in Q4 and the odds of the Fed continuing QE through the end of the year.

We will also be in February and a month not normally known as a bull month. If we are going to face a bout of profit taking I would bet on the first week in February.

The key earnings for next week are CAT, AMZN, BA, QCOM, WHR, MA and the energy giants XOM, COP and CVX. I picked those first six because their earnings will tell us how the consumer and the economy are doing. Boeing will likely give guidance on the fate of the 787 grounding and it could be months. Whirlpool is a consumer appliance company rather than consumer electronics. Those earnings will relate to the strength of housing. MasterCard gives us consumer spending patterns as will Amazon. Caterpillar gives us global economic demand for heavy equipment.

Earnings Calendar

Next week Research in Motion (RIMM) will deliver a knockout punch with BlackBerry 10 according to CEO Thorsten Heins. He said it will be a Muhammad Ali thing where Ali knocked out the competitor in round 8. He said the company learned from its mistakes and they were now prepared for BlackBerry to lead the next revolution in smartphones.

Next week will be the key when they start delivering the new phones but regardless of the phone we could see a sell the news event. RIMM shares are up more than 100% since November and it would take a knockout punch to push them higher. RIMM has not delivered a knockout punch in years. Even Apple has a history of selling off on new product deliveries.

RIMM Chart

I believe the market has shown considerable strength to continue moving higher in the face of Apple's decline. Apple is a major component in the S&P and produced significant negative drag. The weighting in the Nasdaq 100 was simply too much to overcome but the Nasdaq Composite managed to close positive on Friday.

If/When Apple shares do find a bottom it will be rocket fuel for the indexes because Apple never rebounds slow from major setbacks.

The volume in the market has been steady but not strong. The average volume since January 3rd has only been 6.1 billion shares. The advance-decline numbers have not been that bullish. There has been a steady bias to the advancers but nothing material. The morning sell offs have been skewing the internals while the afternoon bias to the upside has failed to produce enough volume to overcome the morning details.

However, the new 52-week highs are growing. On Tuesday and Thursday there were more than 1,000 new highs and Friday saw 958 new highs. This meltup may not qualify as a stealth rally since the string of consecutive daily gains is starting to set records. However, the strength has been well hidden thanks to those morning sell offs.

We have reached the point where this bull market can no longer be ignored. With the Dow only 268 points from a historic high and the Dow and S&P making new five-year highs every day the money managers have to be taking action.

They can't afford to continue ignoring the new highs or waiting for a pullback. They have to be putting money to work or they are going to be left behind. When the fund rankings come out you want to be on the top of the list, not the bottom.

This is why markets making new highs tend to continue making new highs. Managers are forced to chase stocks higher today or lose customers later.

Eventually this meltup is going to lose traction. I am targeting the first week of February based on historical trends. We know the market can remain irrational far longer than we can remain solvent if we are betting against it so until proven wrong the trend is our friend.

The S&P closed over 1,500 and right at uptrend resistance. Any further gain from here targets the 1,550 level and then the historic high close at 1,565. These targets are close enough that traders are fixated on them and that could make them a reality in the days ahead. It is not safe to be a bear today as every dip is bought. That will eventually change.

S&P Chart - Daily

S&P Chart - Monthly

The Dow has extended its gains and is beginning to accelerate. With only 268 points to go before reaching its historic high the checkered flag is in sight. Initial support is close at 13,800 and real support is well back at 13,500.

This streak of 11 positive days out of the last 12 can't last forever so be prepared for a meaningful dip soon.

Dow Chart - Daily

Dow Chart - Monthly

The Nasdaq is the only major index that has not made a new high and it is entirely due to Apple's decline. The index has only gained +50 points since the gap to 3100 on January 2nd. The multiyear high close was 3,183 back on September 14th. You have to go back to November 2000 for a higher close.

Eventually Apple is going to find a bottom and the resulting rebound should power the Nasdaq higher. Let's hope the bottom in Apple comes before the markets decide to roll over for that long overdue bout of profit taking.

Current support is 3125 and then 3100.

Nasdaq Chart

The Russell 2000 blew past round number resistance at 900 but remains close enough that a retest is still possible. The Russell gained 1.3% past week and was rather subdued with the Dow gaining +1.9%. Could it be the small cap bulls are growing tired?

The Russell is over extended so a pause could come at any time.

Russell 2000 Chart

The Dow Transports are a perfect example of hyper extension. This chart is begging for a serious bout of profit taking and it is hard to understand why any investor would be buying a transport today. The transports have gained +600 points in January and they are up nearly 11% for the year. Caution is strongly advised!

Dow Transports Chart

Without any seriously negative news from Europe or China the indexes should continue the recent trend of steady but muted gains. If we were to experience a blowout on some specific news that turned into triple digit gains I would be worried about a climax top. We don't have to actually hit the prior highs on the Dow and S&P before profit taking can begin.

The transports worry me a lot. That extreme extension is begging for a bout of selling and it could contaminate the rest of the market. However, with nearly 250 companies reporting earnings this week there will be plenty to keep traders distracted. The challenges could come from within with the GDP, FOMC, ISM and Jobs.

I remain in buy the dip mode until proven wrong but beware of a sharper than normal dip.

Enter passively and exit aggressively!

Jim Brown

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"If the lessons of history teach us anything it is that nobody learns the lessons that history teaches us."