Friday's markets were not all that healthy to begin with but an internal email from Wal-Mart knocked -75 points off the Dow at 2:PM.

Market Statistics

An internal Wal-Mart memo from Jerry Murray, VP of Finance and Logistics said, "In case you have not seen a sales report these days, the February MTD sales are a total disaster." The Feb 12th email also said, "This is the worst start to a month I have seen in my seven years with the company." Another Wal-Mart executive, Cameron Geiger, said about the first week of February, "Well, we just had one of those weeks here at Wal-Mart. Where are all the customers and where is their money?" Both executives cited the increased payroll taxes and delayed tax refunds. Geiger called it a "potent one-two punch." An internal Wal-Mart study estimated about $19.7 billion more in tax refunds had been sent to shoppers by the same period in 2012. Tax refunds are being held up this year by the last minute changes to taxes in the fiscal cliff negotiations.

Dow component WMT dropped -$2.60 intraday but rebounded to lose only -$1.52 at the close. Other low dollar retailers including Family Dollar (FDO), Target (TGT) and Macy's (M) declined as well.

Wal-Mart Chart

Dow Chart - 5 Min

The challenge here is the gradual realization by investors that the U.S. economy is slowly sliding lower. The tax hikes and the resumption of the payroll tax as well as the sharp rise in gasoline prices to the highest level ever for February is taking a huge bite out of blue collar discretionary income. The sequestration spending cuts scheduled for March 1st are expected to remove another 1.4 million jobs from the economy in 2013 and reduce GDP by as much as a full point.

Corporate profits may be at record highs but take home pay is at the lowest point in the last five years. Corporations have learned how to cut costs and live on lower sales but the consumer is struggling. Retail sales for January rose by only +0.1% with big declines in clothing and accessories and home furnishings.

If the sequestration begins on March 1st as scheduled, and it is almost a sure thing as of today, then the GDP for Q1 is likely to be negative as well and two consecutive quarters of negative GDP is the definition of a recession.

Speaking at the G20 meeting in Moscow, Bernanke warned the U.S. economy was "far from recovering" and he reiterated his commitment to record low monetary policy including QE. Greenspan was interviewed Friday afternoon and he warned the economy could weaken further as the sequestration cuts take hold.

With the economy getting weaker it makes you really wonder how much longer QE can keep the stock market moving higher.

Friday's economic reports were mixed and that provided further confusion for traders. Industrial Production for January fell -0.1% after the +0.4% rise in December. Manufacturing production fell -0.4% with most of that drop due to a -3.2% drop in auto manufacturing.

Production would have been much worse if it were not for a +3.5% spike in utility production as a result of the cold weather. That is why the manufacturing component is material. I don't believe the headline number that includes utility production is relative. Just because a storm blows through and consumers turn up their thermostat does not mean the economy is growing. Manufacturing production is the key.

Analysts believed some details in the soft report suggested the manufacturing sector was going to rebound in the coming months. I prefer to wait for the data.

In the case of the Empire State Manufacturing Survey the data was strong. The headline number for February rose from -7.8 to +10.0. This was the first time in positive territory since July 2012 and the strongest activity since May. New orders rose from -7.2 to +13.3. You would think they were in a revival the order numbers were so good. However, the backorders rose from -7.5 to -2.0 and did not make it into expansion territory. They were only "less bad." The "average workweek" component declined -4.0 and the sixth consecutive monthly decline. With hours worked shrinking it does not normally bode well for employment and the outlook for manufacturing. However, the employment component rose sharply from -4.3 to +8.0 and the first expansion in five months.

Analysts were at a loss as to why the Empire survey spiked so sharply. They blamed everything from Sandy rebuilding to relief over the signing of the fiscal cliff deal on Jan 2nd. However, before we get too excited the February numbers typically show a bounce and then a minor decline in March. Why this happens is anybody's guess.

Empire Manufacturing Chart

Consumer Sentiment for February rebounded slightly from 73.8 to 76.3. This was contrary to the expectations for increased taxes to weigh on consumers. It is also contrary to the comments from the Wal-Mart executives saying it was the worst start to any month in seven years. The present conditions component did all the heavy lifting with a rebound from 85.0 to 88.0. The expectations component rose only slightly from 66.6 to 68.7. All I can say is that the group surveyed over the last two weeks must have been in a higher income area where the hike in taxes and higher gasoline prices were less of a problem.

Consumer Sentiment Chart

Internet E-Commerce Sales rose from $57.0 billion in Q3 to $59.5 billion in Q4. That was a +15.6% increase over Q4-2011. This was the 16th consecutive quarter of sales growth. Online retailers are responsible for 5.4% of total retail sales in Q4.

The calendar for next week has several major events. The FOMC minutes will be the most important as analysts try to determine when the Fed is going to be forced to end its QE programs. If there was a heated discussion during the last meeting about continuing or ending stimulus the market will go crazy with declining expectations. Bernanke has gone out of his way to reiterate the need to keep QE going until unemployment hits 6.5% but analysts continue to second guess him and suggest the Fed will reduce its purchases beginning this summer. The minutes will be a key event in that analysis.

There are two major housing reports on Tuesday and Thursday. Lastly the Philly Fed Manufacturing Survey is the most important of the regional Fed surveys. This one has the most correlation to the national ISM that is reported two weeks later.

There are three critical data points from Europe on Thursday and Friday and the Italian election is on Saturday. News headlines from Europe will be increasingly heavy late in the week.

Economic Calendar

Carnival Corp (CCL) declined again to close just under $37 one day after the 3,100 passengers disembarked from the cruise ship Triumph in Alabama. The first suit has already been filed alleging fraud, failing to supply a working ship, unsafe living conditions, etc. The suit wants unspecified damages for pain and suffering saying Carnival did not supply working restrooms and there was a threat of serious injury or illness because of raw sewage and spoiled food. The suit alleged the ship was a "floating toilet, a floating Petri dish and a floating hell" in various parts of the filing.

Analysts believe passengers would be better off accepting the compensation from Carnival than suing. Unless there were actual injuries it is very hard to prove damages above what the passengers already waive liability for when they sign up for the cruise. The tickets are binding contracts that limit passenger recourse. They also require all suits to be filed in Federal court in Miami. That is extra expense for the passenger and puts all the suits in Carnival's home court where cases like this have been filed hundreds of times. The odds of winning against the stacked deck of liability limitations and a court that has seen it all are very slim. Carnival will issue everyone a full refund and has offered $500 extra, reimbursed transportation to and from the cruise plus given them 100% credit towards any future cruise.

Carnival Chart

On Valentine's Day Warren Buffet said he and partner 3G Capital were buying Heinz for $72.50 a share. That was great for shareholders of Heinz but bad for some traders using accounts in Zurich, Switzerland. Heinz normally trades about 825 calls a day. The day before the deal was announced the volume in the June 65 calls rocketed to 3400. After the announcement the value of the calls rose +1,700% and generated an unrealized profit of $1.7 million.

Fast forward to Friday and the SEC has seized the accounts making the windfall trades and sued the as yet unknown traders for insider trading. The SEC said "Irregular and highly suspicious options trading immediately in front of a merger or acquisition is a serious red flag they acted on confidential information."

That is the second 3G acquisition in recent months that involved insider trading charges. The other was the acquisition of Burger King in 2010. The SEC finally filed charges less than six months ago on the BKW acquisition. A Wells Fargo broker got inside information on the deal from a 3G client.

Heinz Chart

Herbalife (HLF) shares spiked +$7 (+17%) on Friday after news broke that Carl Icahn had acquired a 13% stake. Unfortunately that gain did not stick and shares declined to post only a 47 cent gain for the day.

Icahn and Bill Ackman are locked in a no holds barred fight over the future of Herbalife. Ackman believes it is a pyramid scheme and Icahn thinks it is a great company that would be a perfect candidate to be taken private. Icahn hates Ackman and is trying to make him pay the price for taking a 20 million share short position in Herbalife shares. Icahn thinks Herbalife will become the mother of all short squeezes. He is betting on that fact with his 13% position.

Shares lost their initial gains after another hedge fund manager, Robert Chapman, said in an interview on Bloomberg that he had sold his Herbalife position.

Daniel Loeb, founder of Third Point LLC, disclosed several weeks ago his firm had bought 8.9 million shares (8.2%) after Ackman launched his high profile short attack.

There will be a big winner in this battle. If any enforcement agency takes Ackman's challenge and announces an investigation into Herbalife the shares will decline significantly. With all the information Ackman has prepared and given to regulatory agencies there is a good chance there will be an official investigation. That does not mean Ackman will win but it would help. Those agencies also have to be careful their action does not look like they are acting on the request of Ackman and allowing him to make millions in profits. That could actually keep them from announcing an investigation. Meanwhile Icahn said he is going to talk with the company about going private or doing a Dutch auction to buyback a lot of shares. That would drive up prices and trigger the short squeeze. It would also provide windfall profit for Icahn.

The 800-pound gorillas have entered the ring but the fight is a long way from over.

Herbalife Chart

The Nasdaq (NDAQ) announced Friday it planned on starting premarket trading at 4:AM ET in mid March. The move has to be approved but they expect it to happen. The Nasdaq wants to be open for trading when Europe is open in order to capture more trading volume. Currently the Nasdaq trades about 12 million shares a day in the premarket session.

Another reason to extend the hours and increase its footprint in the world markets is the drive to increase the share price. They recently held talks with Carlyle and Hellman & Friedman about taking the company private. When the share price moved to the upper $20s the talks broke down. Apparently that was more than a private equity firm wanted to spend.

The Nasdaq operates in 23 markets. They have three clearinghouses and five central securities depositories in the U.S. and Europe. They had nearly $2 billion in revenue in 2012 but their market cap is only $5 billion. They feel they should have a larger valuation given their broad business.

I believe they are still a target for an LBO, an outright acquisition or a merger. The problem is they are running out of merger partners because of antitrust concerns. Nasdaq shares have stalled at the $31 level but the company believes they should be a lot more. As long as they are trying to make that higher valuation happen the final chapter has not been written.

Nasdaq Chart

Gold declined -$58 last week to close just over $1610. This was the biggest weekly decline in three years. Support at $1650 broke because of a sharply rising dollar and what some people believe is an improving economy picture.

It also helped to have some of the biggest billionaire investors dumping their gold holdings. George Soros and Louis Moore Bacon cut their positions in the GLD ETF but John Paulson is still holding firm. He has not given up the fight and remains the largest holder of the GLD ETF with 21.8 million shares.

Soros cut his stake by 55% to 600,000 shares as of December 31st according to a SEC filing. Soros was a gold bull so his reduction in the position was a blow to sentiment. Moore Capital Management sold its entire stake in the GLD and lowered its holdings in the Sprott Physical Gold Trust as well. Lone Pine Capital and Scout Capital Management LLC both sold their entire stake in the GLD.

UBS lowered its price target for gold by -6.8% saying the signs of economic improvement in China and the U.S. "takes the shine off defensive assets."

The expected improvement in global economics and rise in equities caused an -8.3% decline in gold bars, coins and ETPs in Q4 according to the World Gold Council. However, for the full year it was up +51%.

There are quite a few analysts and fund managers who believe differently about gold's prospects. Many think the continued decline in Europe and the potential for a recession in the U.S. plus the continued QE by the Fed and other central banks will push gold back to the forefront of desirable assets for wealth preservation.

Germany's economy contracted by -0.6% in Q4. France fell -0.4%. Japan declined -3.8% in Q3 and another -0.4% in Q4. Italy fell -3.7%, Spain -2.8% and Portugal -7.2%. The ECB is predicting zero growth for the Eurozone this year and that is optimistic. China is improving but is not yet out of the woods. If by chance China's recovery did accelerate the demand for gold would also rise. China bought 202.5 tonnes in Q4.

China has been a net buyer of gold for months along with Turkey, Kazakhstan, South Korea and Brazil. Central bank buying rose +17% in 2012 to 534.6 tonnes. That was the highest level since 1964. They purchased 145 tonnes in Q4 alone, an increase of 9% over Q4-2011. It was also the eighth consecutive quarter that central banks bought gold. Germany is trying to bring all its gold back to Germany for "safety" but the New York Fed won't give it back all at once. They want to deliver it over the next ten years in small quantities each year. I smell a conspiracy there.

Russia increased its gold holdings by +8.5% in 2012. Q4 demand in India jumped +41% to 261.9 tonnes and a six quarter high.

Investors believe equities are looking good now and they are selling their gold to buy equities. With the U.S. economy on the edge of a cliff that trade is likely to reverse very soon. Long term the dollar is going to decline. It is only a matter of time. In three years the U.S. deficit will be $20 trillion. Having a 2 as the first number is going to change the outlook on U.S. debt by a lot of foreign investors.

We could easily see a dip to $1550 now that support at $1650 has broken but that lower level is very strong support. Gold has gained every year for the last 11 years. It closed 2012 at $1,675.

Gold Chart

Dollar Index

2013 may turn out to be the Year of the Cliff. You may have noticed I added several months of Washington deadlines to the economic calendar. The preferred scenario in Washington today is to manufacture a crisis and then go to war against the other party in the press. There are multiple deadlines in the next couple months and each is going to be portrayed as the end of the world as we know it if the other side gets its way. This is not going to be conducive to a positive market over the next two months.

The Dow's average range over the last 13 days has been a very narrow 1.35%. That is the lowest range since 1986. Since the 14,007 close on February 1st the Dow has lost a whopping -30 points. When you consider all the political headlines over that period and hundreds of earnings reports you would have expected a significant move. Unfortunately the indexes have risen to their levels of extreme resistance and the momentum has faded.

This normally happens when the market runs out of new buyers. There is nobody left to pay a higher price for a share of stock. Last week more than 87% of the S&P-100 were trading over their 200-day averages. This has happened four times since 2004. Typically it lasts for several months then a significant decline appears. However, in the middle of 2012 we did see some volatility and that could have delayed the next event.

S&P-100 Stocks Over 200-Day Average

James and I both look at hundreds of stock charts each weekend and compare notes. Both of us noted what appeared to be numerous stocks rolling over last week. I am talking about previously bullish charts that topped out for a couple weeks and then began to erode over the last few days. It was not a significant amount of erosion but a solid pattern of lower highs on a daily basis.

After watching the indexes trade at resistance for three weeks with minimal gains you have to wonder what is next. With all the negative economic news coming out of Europe that has to weigh on the blue chips. Most of the S&P-100 stocks and quite a few S&P-500 stocks get a large portion of their earnings out of Europe, which is currently in a recession. That is going to weigh on the earnings of those multinationals.

The Volatility Index is holding at five year lows. This is another warning that sentiment is at extreme levels and is not likely to remain there. When the VIX is low it is time to go.

VIX Chart

The AAII Investor Sentiment Survey saw bullishness decline for the third consecutive week to 42.3%. That is only down -0.5% from the prior week but the trend has changed. Actually that is good since the extreme levels of three weeks ago were unsustainable.

The S&P closed right at 1520 and strong resistance. Back at the beginning of 2013 Bloomberg asked 15 strategists to contribute their year end targets for the S&P. While 13 of the 15 predicted a move higher the implied gain was only 4.9%. That is well below the 50-year average of +7% gains and 13-year average of +9.1%. It is also the lowest forecasted gain in eight years.

Here is the catch. The S&P is already up +6.56% for the year when the average of the 15 estimates was for a gain of only +4.9%. This means to hit the year end targets the market would have to go down.

Bloomberg Average Analyst Target S&P Growth

Clearly there are far more analysts with much higher price targets and you could stack the deck depending on who you invited into the survey. However, I am assuming Bloomberg asked the same analysts as in the past in order to keep the survey sample neutral to new analyst risk.

With the GDP expected to grow only 2% for the full year and the sequestration spending cuts likely to knock off a full point and the fiscal cliff tax deal knocking off another half point we are very close to negative territory and a recession. That will impact earnings and that impacts the market. Eventually this fundamental change is going to be felt in stocks. The current "hopefulness" disguised as bullish sentiment can't last forever if the fundamentals don't improve soon.

If this continues to be the year of the cliff then every crisis will undermine market sentiment.

With the Q4 earnings cycle almost over it turned out to be a good quarter. Currently over 70% beat on earnings with 20% missing estimates. The last number I saw on revenue beats was closer to 60% and shrinking as the smaller companies report. Earnings guidance was cautious with many companies projecting a flat quarter in Q1. That is not a market lifting outlook.

The S&P hit 1524 twice last week, once on Wednesday and again on Friday. It was instant rejection each time. I believe this is actually from traders anticipating 1525 and jumping in early with their sells/shorts. The triple top on the S&P is very strong resistance and we may have run out of positive catalysts. Earnings are over and the sequestration crisis is heating up with a March 1st deadline. What event is left to power the S&P over this major hurdle?

Initial support is 1515 followed by 1495-1500. We could sustain a decent bout of profit taking and not go below 1495. The bull is not dead but he is getting tired.

S&P Chart - Monthly

S&P Chart - Weekly

The Dow has lost -30 points since the Feb-1st close at 14,007. Even with the five big swings in February the average intraday range has been 1.35% and the lowest since 1986. The bloom has faded from this rally but the petals have yet to turn brown.

Despite what appears to be a decline in sentiment every dip has been immediately bought. Friday's Wal-Mart inspired dip knocked the Dow to a -68 point loss intraday but the buyers came right back to close it with a gain.

There has been no volume surge with the average in the 6.0 billion share range. Last Monday was 4.8 billion. Volume is a weapon of the bulls and it is clearly missing. There is a bid under the market but investors are not chasing the price. This suggests any future declines will be hard fought. The initial declines will be bought and until the bears gain enough confidence to use the volume weapon against the bulls the direction may not change.

Dow Chart - 30 Min

Dow Chart - Monthly

The game changer here is the Nasdaq. Three times last week the Nasdaq traded briefly over 3200 and at 12-year highs. If Apple would just trade up for a couple days we might see a strong breakout that could energize the other indexes as well. The Nasdaq is at a critical level where a breakout could stimulate plenty of retail traders and bring new money into the market.

Nasdaq Chart - Monthly

The Russell 2000 remains in breakout mode and is the strongest index. Until the Russell fails it remains a bullish sentiment indicator for the broader market.

Russell Chart - Weekly

I don't want to be the equivalent of a broken clock and only be right twice a day. The market is over extended. Anyone that has been trading longer than a year understands this. We are due for a decent correction. However, markets making new highs tend to keep making new highs contrary to the best predictions of the analyst community.

I believe as long as the trend is not broken we stay with the trend. However, I would tighten up your stop losses and be prepared for a decent dip that could be next week or next month but we know it is coming.

The market will pick an excuse and all of a sudden stocks will be sold and everybody will be wishing they had stop losses. Bull market corrections are normally short, sharp and scary. Be prepared and profit from it.

Don't fight the Fed and the other global central banks. Currently there are 17 central banks that are either practicing QE or some other type of stimulative monetary policy.

Enter passively and exit aggressively!

Jim Brown

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"It is better to be out wishing you were in, than in wishing you were out."
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