The worries over Europe on Monday were completely forgotten on Tuesday and the Dow regained the 14,000 level at least momentarily.

Market Statistics

Only a couple days after various news articles suggested the storm clouds over Europe had evaporated and it was clear sailing for the rest of the year a flurry of headlines upset market sentiment on Monday. In Spain the Prime Minister, Rajoy, appeared susceptible to being included in a potential corruption story that would drag him down and sink Spain again. In Italy the prior prime minister, Silvio Berlusconi was trying to implicate Mario Draghi and Mario Monti in a scandal over a bank bailout for Monte de Paschi. Berlusconi is running for reelection so he stands to gain if he can inflate the cloud over Draghi and Monti.

The European markets cratered on the sudden resurgence of perceived political instability that led to a sharp drop in the U.S. markets on Monday. Traders never let a good headline go to waste and they were looking for a reason to take profits after the spike to Dow 14,000 on Friday.

The buy the dip trade is alive and well as evidenced by the rebound today. A note from claimed investors poured $77.4 billion in new cash into stock mutual funds and exchange-traded funds in January. This easily exceeded the prior record of $53.7 billion in February of 2000. However, if you only read the headlines you don't get the meat of the story. Only $39.3 billion flowed into U.S. equity funds but it was still a record.

I have a hard time with fund flows. There are three major reporters of flows, TrimTabs, Lipper and Investment Company Institute. They all use different methods for calculating the flows and include different metrics and dates in the process. Since the periods reported cover different date ranges it is tough to know the real answer. However, all are reporting record inflows in their various reporting periods. It may not have been $77.4 billion or even $60 billion but everyone agrees it was a record.

Analysts are pointing to these flows as evidence the retail investor is coming back into the market. While I believe that is true to some extent I think the real answer is less bullish. In December we had a -50 point decline on the S&P as investors sold stocks ahead of the fiscal cliff in order to avoid potentially higher taxes. Corporations paid tens of billions in special dividends in December for the same tax avoidance reasons. Billions in year end bonuses were also pulled forward and paid in December rather than January. When the massive tax hike did not appear and the fiscal cliff was avoided on January 2nd that excess cash was immediately put back into the market. Did $60+ billion flow into the market in January? Yes, but it was the same $60 billion that flowed out in December ahead of the fiscal cliff.

I am glad to see it come back into the market and when coupled with the normal January inflows from retirement funds and 401Ks it did produce a monster rally. It remains to be seen where we go from here.

Much has been made about the potential rotation out of bonds and into equities. Trimtabs showed that $31.4 billion flowed into bond funds and ETFs in January. Apparently quite a few investors did not get the email to rotate into stocks.

Trimtabs warned that after the nine largest months of inflows the S&P declined around -1% in the 90 days that followed. The initial gains were erased in six of those nine events. The next month should be really interesting.

Economics reports in the U.S. were lackluster. The ISM Nonmanufacturing Index declined from 55.7 to 55.2 for January. That was hardly earthshaking and the market ignored it. New orders declined from 58.3 to 54.4. Backorders were basically flat at 49.0 and slightly in contraction territory. The business activity index declined from 60.8 to 56.4 and the lowest level since March 2011. Employment did rise slightly from 55.3 to 57.5 and the highest level since 2006 so the outlook by service companies may be improving.

Only eight of the 18 industries surveyed claimed activity increased in January. There were 13 with increased activity in December. Consumers are being pressured by higher taxes and higher fuel prices and that will mean lower consumer spending for services.

ISM Nonmanufacturing Chart

The U.S. economic calendar for the rest of the week is lackluster. Europe could provide some volatility for the U.S. markets on Thursday when the Bank of England and the ECB both announce their rate decisions before the market opens. The BOE is expected to remain unchanged but the ECB could actually cut rates to slow the rise in the euro currency.

Economic Calendar

The earnings cycle is definitely winding down with very few headlines today about earnings reports. On Wednesday the highlights will be Visa, Time Warner, Green Mountain Coffee and Prudential.

Earnings Calendar

One of the biggest earnings events of the day was Computer Sciences Corp (CSC). The company posted earnings of 90 cents compared to estimates for 65 cents. Revenue of $3.78 billion was only slightly higher than the $3.73 billion estimate. The company raised guidance for the full year to an average of $2.60 and consensus estimates were $2.40.

With revenue failing to grow as fast as earnings it is clear the company is slashing costs to the bone. They claim they have laid off workers and devised ways to more efficiently manage contracts. Profit margins rose in all three divisions. They are the network manager for NASA and the U.S. Navy. Shares of CSC rose +9% after the release.

CSC Chart

Disney (DIS) reported earnings of 79 cents compared to estimates of 76 cents. Revenue rose to $11.34 billion from $10.78 billion and also beat estimates for $11.21 billion. There were no real surprises. The company said it had sold out its advertising for the upcoming Academy Awards. CEO Iger said JJ Abrams would direct the next Star Wars film and it would be in theaters in 2015. Shares rose +1.60 in afterhours trading.

Disney Chart

Aflac (AFL) posted earnings of $1.24 but analysts were looking for $1.47. Revenue rose +6.6% to $6.38 billion. Aflac shares only declined about 50 cents after the report.

CH Robinson Worldwide (CHRW) posted earnings of 68 cents compared to estimates of 70 cents. Revenue rose +16% to $2.97 billion. With that much additional revenue you would have expected them to at least meet earnings estimates. Shares of CHRW were flat after the report.

Zynga (ZNGA) reported a loss of 6-cents compared to -$1.22 in the year ago quarter. Analysts were expecting a loss of only 3 cents so even though the earnings were vastly improved they still missed the targets. Shares of ZNGA rallied +4% after the report.

Expedia (EXPE) reported earnings of 63 cents that missed estimates of 65 cents. Earnings increased by +10% on revenue of $975 million. In the year ago quarter revenue was $787 million. Gross bookings were $7.53 billion. Expedia shares rose +4% on the news.

Panera Bread (PNRA) reported earnings of $1.75 that beat estimates by a penny. Revenue rose +15% to $571.5 million and same store sales rose +4.9%. Shares of PNRA rallied +$7 or +4% after the report.

Chipolte Mexican Grill (CMG) reported earnings of $1.95 compared to estimates of $1.96. Revenue increased from $596.7 million to $699.2 million. Shares rallied from the close at $305 to $327 on the strong revenue increase but then fell back to close at $303. Same store sales rose +3.8%. The challenge for CMG is rising food costs and the company has been reluctant to raise prices in a highly competitive market. They forecast slower growth in 2013 in the low single digit percentages. The lackluster forecast is what killed the afterhours rally.

The biggest stock movers were not due to earnings. S&P, a division of Mcgraw Hill (MHP) was knocked for another -11% loss to $44 after the government filed a $5 billion civil suit against S&P for fraud in its ratings practices during the subprime crisis. The government claims S&P rated subprime securities higher than practical for fear of losing market share in the highly lucrative market. The government produced some emails internal to S&P where the ratings people were laughing about how bad the products were. One analyst even wrote new words to a Talking Heads song, "Burning Down the House" and created a video of himself singing. The words basically said the subprime market was imploding. Another analyst was questioned why S&P was rating such bad paper and she said, "We rate every deal. It could be structured by cows and we would rate it." That email surfaced during the 2008 Congressional hearings.

To date Moodys (MCO) has not been sued and there were allegations the suit against S&P was retaliation against the S&P downgrade of the U.S. debt. U.S. Attorney General Eric Holder said that was preposterous. Their conduct was "egregious and goes to the very heart of the financial crisis."

McGraw Hill (S&P) Chart

Moody's Chart

Shares of Virgin Media (VMED) spiked 18% after the Wall Street Journal and CNBC claimed they were close to a deal to be acquired by Liberty Global (LBTYA). CNBC said the boards of both companies had approved the deal. No price was given for the deal, which would be funded with a mixture of cash and stock. Virgin Media is the U.K.'s number two pay TV operator. Virgin did confirm the talks are in progress.

Virgin Media Chart

Michael Dell has inked a deal to take Dell Inc private in a $24.4 billion LBO. The target price is $13.65. Dell started the company in the 1980s in his dorm room and built it into a high flyer and created thousands of Dell millionaires because of the constant rise of the stock. That all changed when the computer business started to suffer from the onset of smart phones, laptops, netbooks and finally tablets. PC sales have been declining and it is a tough market for Dell. By taking the company private he can attempt to turn the business around without having to please shareholders on a quarterly basis. The turnaround time is reportedly five years and the company will IPO again when it is complete. I wish him luck but it will take a lot more skill and effort to create a winner today than it did in the 1990s when PCs were in their prime.

Dell Chart

In past years I have reported on trades that were so large it appeared someone had inside knowledge of a pending event. Sometimes those were massive put positions on the S&P. A new trade just appeared that suggests there will be a market event in the near future. Last week somebody put on a call spread on the VIX using the April 20 and 25 calls. They bought 150,000 contracts for a net of $70 per contract. That is an $10,500,000 bet that the VIX will move over 20 over the next 60 days. You would have to be VERY confident in your outlook to risk $10 million on a directional position with the VIX at five year lows and the markets trying to break out to new highs.

Obviously there are some events in Washington over the next 60 days that could rile the market. The sequestration hits on March 1st and the president was out today begging Congress to kick the can farther down the road instead of letting the across the board spending cuts hit on March 1st. The republicans are going to extract a pound of flesh before they let that happen. You can expect further sound bites on that in the weeks ahead. Is that worth $10 million?

Next up would be the continuing resolution battle on March 27th where the existing resolution currently providing funds for the government expires. This one will be accompanied by the now routine "you can't allow the government to default, you can't not pay people" headlines. This will probably get kicked farther down the road as well but not without a toll. Is that worth $10 million?

Personally I believe we are going to see a market event over the next two months but bull markets can remain irrational far longer than the bears can remain solvent. I have launched some VIX calls in the Ultimate Investor newsletter but obviously not $10 million worth.

I would simply caution everyone to remain hedged on your long positions. There may be a more dramatic market event than most expect.

Al Qaeda posted a note on a website last week saying they were preparing to launch small and large attacks against the U.S. and France. They have made similar claims in the past with limited success but you never know when the next 9/11 could appear.

In July 2001 a reader emailed a staff writer saying "In September every market in the world is going to crash." In retrospect we believe that was someone with knowledge of the 9/11 plot. You can rest assured there are current plots in motion. Whether they are ever executed is a different question.

April VIX Call Open Interest (as of Friday)

VIX Chart

The Dow traded over 14,000 intraday but gave back -33 points in the final seconds to close at 13,979. The failure to hold 14,000 is of course a challenge. However, we have moved back to the higher ground and we are close enough that another bull rush could take us back over that level. However a drop back below 13,875 would be a bad sign and probably trigger a deeper decline.

The S&P has the same challenge with 1,515 and 1,495. The S&P actually made a slightly higher intraday high at 1514.96 and closed well over 1500 so the bullish case is still alive. It is only 4 points away from a new five year high so any positive news could produce a breakout. Unfortunately the economic calendar and the list of earnings for Wednesday are lackluster.

Art Cashin was pointing out this afternoon that the short term chart pattern could be seen as a double top if it failed to break through that 1515 level and then retreated back below 1495. If that pattern develops we could see a return to 1470. That may be the real bout of profit taking everyone is hoping for in order to launch new positions.

Support at 1495 is strong with the close on Monday at 1495.66 and the intraday low 1495.02.

S&P Chart - 90 Min

S&P Chart - Daily

The Dow has equivalent support at 13,875 to the S&P level at 1,495. A break below that level would be serious and setup a larger decline. The most likely direction is a breakout with the buy the dip mentality alive and well.

Just be prepared for this rally to stall now that the January influx of cash is over. Twenty eight of the Dow components were positive today but that old volume problem returned to haunt us. There were just over six-billion shares traded and new highs were less than half the number we saw on Friday. Advancers were 2:1 over decliners so everything was positive. Internals were just not exciting. We saw a short squeeze rebound but it was muted and that should be a cautionary warning.

Dow Chart

Plus 36, minus 50, plus 40. Nothing like a little volatility in the Nasdaq to keep tech investors on the edge of their seats. Friday's +36 point gain was erased with a -50 point drop on Monday and then followed by a +40 gain today. The entire exercise never broke out of the current support/resistance range of 3125-3185.

The good news is that Apple returned to the party today with a $15 gain and a dead stop at $460. It appears Apple is about to break out over the post earnings resistance at that $460 level and that would be very bullish for the Nasdaq. Once Apple resumes an upward trend the buyers should come back in droves.

That would push the Nasdaq to ultimate resistance at 3200 and set the stage for a new leg higher in the broader market. It is amazing how much impact one stock can have on market sentiment.

Apple Chart

Nasdaq Chart - Daily

The Dow Transports closed at a new historic high. The minor consolidation we had last week was not nearly enough to make up for the two months of gains but apparently the Transport bulls don't care. This would be my canary in the coal mine for market direction. It is seriously overextended but as long as they keep buying it the broader market will move higher.

Dow Transports Chart

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 see a convincing breakout on decent volume to confirm a new leg higher. Traders bought the dip but they could not hold the 14,000 level. It could be just a blip but look for confirmation before going all in.

Enter passively, exit aggressively!

Jim Brown

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