Yields at nine-month highs on the ten year treasury as money rotates out of bonds and into equities.

Market Statistics

The equity markets crept cautiously higher as they close in on the historic highs for the Dow and S&P. However there are some cracks beginning to show in the internals. Those cracks could be simply profit taking ahead of the FOMC, GDP, ISM and Jobs so we don't really want to bail out just yet.

One of the cracks today was a decline in the Russell 2000 small caps. With the Dow, S&P and NYSE all making new five year highs the Russell traded negative for most of the day with resistance at 905 proving to be a challenge. A buy program at the close turned it fractionally positive. If the Russell does continue to weaken it would be a sign fund managers are losing interest at this market level. The current rally may have already exhausted eight of its nine lives and is living on borrowed time.

Helping to dent market sentiment this morning was a major decline in Consumer Confidence for January. Confidence fell -8.1 points to 58.6 and that is the lowest level since November 2011. This was the third consecutive decline since the five year high of 73.1 high in October. The perception of economic conditions and rising tax rates weighed on the survey respondents.

The present conditions component declined from 64.6 to 57.3. The expectations component fell from 68.1 to 59.5 and the lowest level since Oct 2011. Those who felt jobs were plentiful fell -2.2 points to 8.6. That is the lowest level since September.

People who expected their income to decline rose from 19.1 to 22.9 and those expecting a raise fell from 15.6 to 13.6. That put the income index at -20.3 and the lowest level since 2009 when the recession was at its worst.

Those planning on buying a car declined from 12.2% to 10.1%. Home buying plans were unchanged and appliance buyers increased +1.6% to 47.7%.

Sentiment was dramatically lower for younger respondents. Those under 35 saw a monster -18 point decline while those over 35 were less concerned about current conditions.

Analysts claim the tax hikes were to blame for some of the decline in confidence along with the constant debate over spending in Washington. The democrat claim they are going to raise taxes again if they are forced to cut spending is a cloud over consumer spending. Lower spending means a slower economy and eventually a lower market.

Consumer Confidence Chart

The other reports out today were ignored by the market. The Business Employment Dynamics covered Q2-2012 and was a significantly lagging report. The Case Shiller home price index rose +5.5% for November compared to 4.3% in October. This was also a lagging report for the November period and investors ignored it.

The economic calendar for the rest of the week is a veritable mine field of major events. The ADP Employment on Wednesday is the first look at jobs for January. Analysts believe the ADP report will show a decline from +215,000 to +165,000 jobs. The Nonfarm Payroll report on Friday is expected to show jobs were flat at +155,000.

The Q4 GDP report on Wednesday is expected to decline from +3.1% growth in Q3 to only +1.2% in Q4. This number could have a lot of volatility in it as a result of hurricane Sandy and the reconstruction effort.

The FOMC announcement is not likely to roil the market unless there is an increase in dissenters on the Fed's current QE programs. There have been some Fed presidents speaking out against the current QE program where the Fed is purchasing $85 billion in securities each month. Analysts don't believe the Fed is going to change its program this year but there is always that risk as the economy improves. Changes to the FOMC statement will be heavily scrutinized.

Bloomberg published the results of a survey of 44 leading economists. Those economists believe the Fed will buy a total of $1.14 trillion in the current QE programs before ending or changing the program in Q1-2014. They believe it will take months of solid improvement in the economic reports before Bernanke will take his foot off the accelerator. They don't believe those reports will be out this year thanks to the tax hikes and cuts in government spending. Those two factors will cut GDP by up to -1 point and prevent GDP growth from moving over +2% in 2013. Bernanke has said he will not end the program until there are "substantial" gains in employment. In the last FOMC minutes the participants were "approximately evenly divided" between those who felt it would be appropriate to end the programs in mid 2013 and those who would continue until the unemployment target was hit. The Fed's balance sheet rose to more than $3 trillion in January and will be well over $4 trillion by year end if the QE programs are not halted. Nearly all the survey respondents and several members on the FOMC warn that the size of the balance sheet will make it nearly impossible to withdraw from the zero rare interest policy without the risk of major imbalances in rates and inflation.

The ISM Chicago, formerly the Purchasing Managers Index (PMI), will be of importance but not nearly as important as the ISM Manufacturing on Friday. Both of those reports are expected to post a decline in economic activity. If either falls back into contraction territory under 50 it could be market negative.

Plenty on the schedule and the results will be market reactive. These reports can either help push the markets to new highs or kill the current rally.

Economic Calendar

Stocks rallied once again with the Dow adding +72 points and the S&P gained +7. The Nasdaq was flat with a fractional loss. The gains were powered by earnings and not economics. Dow component Pfizer (PFE) reported earnings of $6.3 billion thanks to the sale of its nutrition business. This offset the drag on sales by generic drug competition. Excluding the sale of assets and one time fees Pfizer made $3.51 billion or 47 cents per share. That beat the street by 3 cents. Drug revenue declined -7% due to generic competition to Lipitor. The company guided for the full year to earnings of $2.20 to $2.30 and $57.2 billion in revenue and analysts were expecting $2.28 and $57.55 billion. Shares of Pfizer were +3% to $27.70 and a new five-year high.

Pfizer Chart

Eli Lilly (LLY) reported earnings that earnings of 85 cents compared to estimates for 78 cents despite a decline in sales. Profits declined -4% and revenues fell -1% due to competition from generic drugs. The patent on the drug Zyprexa expired and Cymbalta is the next major expiration in the pipeline. Including that expiration Lilly still expects full year revenues in the range of $23 billion. Analysts were expecting $22.93 billion. The earnings powered LLY shares to a new high at $54.32.

LLY Chart

Homebuilder DR Horton (DHI) reported earnings of 20 cents compared to analyst estimates of 14 cents. Net income rose from $27.7 million to $66.3 million thanks to low mortgage rates and a shrinking inventory of new homes. These results are going to be very tough for other builders to match when they release their earnings. Orders rose +39% to 5,259 homes. The contract backlog rose +70% to $1.76 billion. The CEO said DHI was in the best position it has ever been in its 35 year history. They anticipate a good selling season in the spring and put additional capital to work in Q4 to increase the number of homes under construction. They were also able to raise prices due to the shortage of inventory.

DHI Chart

Seagate (STX) crashed back to earth on Tuesday after it issued guidance for the current quarter that fell short of analyst estimates. Seagate reported earnings of $1.38 that were 10 cents over estimates with revenue rising +16% to $3.7 billion, also above estimates. The trouble came when it guided for revenue of $3.25-$3.45 billion for the current quarter that was below estimates of $3.48 billion and well below the $4.45 billion in the year ago period. That was when the Japanese drive manufacturers were offline from the tsunami and drive prices were going through the roof.

STX Chart

VMWare (VMW) reported earnings yesterday of 81 cents compared to estimates of 78 cents. Revenue rose +22% to $1.29 billion and just a fraction over the $1.28 billion estimate. However, the company said it was cutting 900 jobs and lowered its Q1 revenue forecast to $1.18 billion and below estimates for $1.25 billion. The company said it was facing a tough quarter because of a reduction in government spending and the weak economy. An expected increase in contract renewals has been pushed off until later in the year. Shares of VMW declined -21% on the news.

VMW Chart

After the bell today Amazon (AMZN) reported earnings of 21 cents compared to estimates for 28 cents. Revenue of $21.27 billion missed estimates of $22.27 billion by a whopping billion dollars. For any other company this would have resulted in a massive sell off and that is what happened in the opening seconds. Shares dipped to $249.50 from their close at $268 but the drop was short lived. Shares rebounded to close at $284 in the afterhours session for a gain of +$16 dollars. I know what you are thinking. For a company with a trailing PE of 2,892 you would expect massive investor selling on an earnings miss. Normally you would be right.

Amazon even guided for revenue of $15.8 billion for Q1 and analysts were expecting $16.86 billion. Don't worry, be happy! Who cares?

Investors liked the better than expected operating income of $405 million compared to $260 million in the year ago quarter. They liked the gross profit margins at 24% compared to street estimates for 22%. That was the highest margins in more than three years. Third party market sales rose from 36% to 39% of Amazon's business. That is inventory Amazon sells for others. Unit sales rose more than 40%. Amazon's cloud services, web services and advertising services business rose +68% from the year ago quarter. The video streaming business (like NetFlix) is also exploding higher.

Jeff Bezos said the E-book division was now a multibillion a year category that grew +70% in 2012 compared to only 5% growth in physical books. That 5% growth rate was the lowest in Amazon's 17 years as a retailer. Amazon does not disclose how many Kindles it sells but the CFO said sales would have been higher if they had not sold out of their inventory around the holidays. He said the "Paperwhite" model was the best E-reader in the line and they could not keep them in inventory. Amazon makes no money from selling the actual tablet and readers but they make a fortune from selling the electronic books. A three year old Kindle makes just as much profit as a new Kindle so there is no urgency for Amazon to press readers to upgrade.

As usual Amazon shorts were crushed once again as the stock pushed to a new high after the earnings.

Amazon Chart

The earnings calendar for Wednesday will be led by Boeing, Conoco and Qualcomm. Boeing will update on the current ground of the 787 fleet and the prospect for a solution. Since they have not yet found out what is causing the problem it could be weeks before a solution is reached.

Qualcomm could be interesting because they are the source of products for the majority of smartphones and tablets. However, Broadcom fell sharply after earnings tonight reporting earnings that beat the street by 2 cents but warned that expenses were rising. This puts the pressure on QCOM when they report. Also, the cancellation of orders by Apple could be a challenge.

So far this quarter 75% of the S&P companies already reported have beaten estimates and 67% have beaten on revenue. The revenue number is the highest percentage since Q2-2011. Less than half of companies reporting had higher revenue in Q2 and Q3. Guidance has not been stellar with less than half raising the bar on future earnings.

Earnings Calendar

Irrational exuberance continues to be the name of the game in 3M shares after they reported earnings that were in-line with estimates last Thursday. Revenues rose +1% for the year with earnings of $6.32. 3M's outlook was bullish despite the flat sales. The company is seen as a proxy for the global economic environment and apparently investors liked the story.

MMM Chart

Shares of JC Penny (JCP) rallied +9% after the company said it would hold sales on popular items tied to key events like Valentines Day, Easter, Mothers Day, etc. The spokesman said there would be fewer than 100 of these events in 2013 compared to 600 unique promotions in 2011. The company also said it was sending emails to customers alerting them to clearance items (on sale), $10 in-store coupons, 30% discount coupons, free children's haircuts and free family portraits. Is it just me or did we just see the end of "everyday low pricing" and the return of the weekly sales program? How can you have 100 events in 2013? There are not that many holidays. Shorts ran for cover and the stock posted its biggest gain since early December.

JCP Chart

Chesapeake Energy (CHK) announced after the close that their embattled CEO, Aubrey McClendon, would retire on April 1st. McClendon founded the company in 1989 and has been a lightning rod for the company in recent months. There have been numerous disclosures that suggested McClendon used the company as his personal piggybank and the stock price was cut in half as multiple investigations began. One such dealing was what he called a "Founders Well Participation Program" where he got 2.5% of every well the company drilled. He then arranged for loans on those well interests through shell companies he owned. News of his retirement gave shares an 8% boost in afterhours.

CHK Chart

Apple shares rallied for the second day with an $8 gain after they announced a new iPad with 128GB of memory. They claim this iPad will rival traditional notebooks with its speed, capacity and Retina display. The new tablet will cost $799. Some believe this is the wrong direction for Apple. With competing tablets and phones getting cheaper by the day, Apple is raising prices. Apple saw average revenue per iPad in Q4 of $467 compared to $568 in the year ago quarter. Gross margins shrank from 44.7% to 38.6%. Packing in an extra 64 GB of expensive memory will only appeal to a limited few and the increase in profit may be minimal.

Apple Chart

The strong Durable Goods number on Monday and the news on housing from D.R. Horton helped to push crude prices over the $97 level to a four month high. The durable goods report for December showed a sharp spike in orders of +4.6% compared to the prior month at +0.7% and consensus of only +1.8%. Violence in Egypt and more comments out of Iran also helped to reinforce the security premium.

WTI Crude Oil Chart

The ETF industry celebrates its twentieth birthday this week. The S&P-500 ETF, the SPY, started life 20 years ago with a total of $7 million in assets. Today that ETF has more than $123 billion in assets. The ETF industry has grown to total assets of $1.34 trillion and more than 1,241 funds. Some would say we have done ETF crazy. You can find an ETF on almost anything but there is no guarantee it will have enough volume to be a viable product.

The bond market sold off a little more on Tuesday with the yield on the ten-year treasury easing closer to 2%. This is not a rout or wholesale dumping by any stretch of the imagination. This is a calm rotation on low volume as equities head for their date with destiny at all time highs on the Dow and S&P. Quite a few analysts believe we will see another cycle of bond buying once the equity markets take a much needed rest. Once that equity retracement comes the bond groupies will use the spike in bonds to start unloading so they can buy the dip in equities.

While that story sounds likely we never know what is around the next corner. However, there is almost no scenario where interest rates stay low for much longer. The bond bubble has run its course and once the Fed halts the QE programs bonds will see a tidal wave of sellers. I would expect that most intelligent bond investors would rather get out ahead of that event but they have a few months left before the tide begins to rise.

Ten-year Yield Chart

The Dow closed about 200 points below its historic high and the S&P about 57 points. I think I heard or read at least a dozen analysts claiming we will hit historic highs either this week or next. Very few had a comprehensive guess as to what happens once those highs are hit.

Unfortunately the internals are suggesting there is trouble ahead. Across all the markets there were 3,544 decliners and 3,075 advancers. Yes, there were more decliners than advancers on a day when the Dow and S&P had decent gains. You are probably thinking it was due to the Nasdaq finishing down for the day. You would be wrong. On the Nasdaq there were 1,351 advancers and 1,020 decliners. Yes, more advancers on a down day. The advancing volume at 1,048 million shares was 43% higher than declining at 730 million.

The NYSE A/D line was negative at 1,821 decliners to 1,316 advancers. The S&P was negative with 306 decliners to 170 advancers. New highs declined for the second day but were still healthy at 868 compared to Friday's 1,045.

The point here is that market breadth is shrinking as we near the top. We are half way through the earnings cycle and guidance has not been that exciting. The markets are up 8% to 10% for the year depending on the index and we are not yet out of January.

February is not known as a bullish month. Once the earnings are past the midpoint and the late January economics are in the book we have a good chance of a decent retracement of some of these gains.

Nearly everyone believes there will be a 3% to 5% decline and then we will charge off to new highs in March. As the tax man approaches in April there is typically a sales event as investors raise cash to pay the bill.

This year we have the sequestration coming due on March 1st and the sound bites are starting to flow on that manufactured crisis. That will be followed up by the continuing resolution at the end of March.

When looking at the roadmap for the next 60 days the market direction over the next week is not that important. Stocks go up, stocks go down. We would just like to see a trend higher that lasts for more than a few weeks. I suspect that will be the case once we have some profit taking to provide new entry points.

Looking at the reprint of the 3M chart below I suspect you would not be a buyer of that chart. Multiple that by a thousand other companies that made new highs on Friday and you get the picture. Fund managers may want to be long but they don't want to by 3M or any other breakout stock without a pullback. We just have to understand this and wait for the pullback.

3M Chart

The S&P 500 inched slowly but persistently higher with a $7 point gain to close at 1,507. The index is very extended but the rate of climb over the last month has been slow. In fact it has been at exactly the pace investors would like to see the rest of the year. There has been low volatility and very few major moves. This is the perfect investment environment with nine consecutive gains out of the last ten days. Eventually this will end. Just note the red candles on the chart below. There is no such thing as an uninterrupted bull market. About once every three weeks we see several days of losses except for the month of January. Be prepared, you can rest assured it is coming.

Support is now 1,500 and the next target is the 1515 close from Dec-10th, 2007.

S&P Chart

The Dow chart looks eerily like the 3M chart. The number of days with gains has stretched to 12 out of 14 and there has not been a material dip since 13,500. The 14,000 level could be an electric fence but I think it will depend more on the economics on Wednesday than a 46 point move to 14,000. That is a large round number but the one traders are focused on is 14,164 and the historic high close from 2007. The odds are good we will reach that level in the next 8 days but I would be concerned about the market reaction once it happens.

Dow Chart

The Nasdaq is really struggling to move higher. The three points forward, two points back, movement is very frustrating for tech investors. All the other indexes are breaking out to multiyear or historic highs and the Nasdaq can barely close positive more than one day in a row.

The Nasdaq should get a boost from Amazon on Wednesday but the Nasdaq futures are only up +2 points tonight. The chip sector was a drag on Tuesday and the Semiconductor Index at 413 is far from new highs with the historic high at 1,362. You would think that all the electronic devices in the world today would be powering these companies higher but the competition on price and capability is holding profits in check.

There is the potential for a head and shoulders top on the Nasdaq if there is not a breakout soon. If the Nasdaq rolls over in the next week or so it could drag the rest of the indexes lower as well.

Support is 3,125 and resistance 3,160.

Nasdaq Chart

After spending most of the day in the red the Russell 2000 managed to slip into the green at the close. For four days now the Russell has been fighting prior resistance at 900 and it remains close enough to be clawed back on any market upset. The Russell has gained +167 points since the November low with only one material hiccup in late December. It is very over extended and due for a rest.

Russell Chart

In the dictionary the term overextended has a picture of the Dow Transports chart. I would not buy this chart with your money.

Dow Transport Chart

I am no longer in dip buy mode, at least the kind of dips we have seen recently. The opening declines have been minimal and they have been matched by afternoon gains that kept the major averages moving higher. I think we have reached the end of our yellow brick road.

I would be a dip buyer of a multiple day dip but it needs to be a decent dip of more than a couple percent. We are too close to the historic highs and the bears are getting itchy trigger fingers. We need a decent dip to suck them back into the market and then enough rebound to trigger a new short squeeze.

I would be very cautious about committing new money to the market and I would tighten up stop losses on existing long positions.

We can go higher from here but we NEED to go lower first.

Enter passively, exit aggressively!

Jim Brown

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