The major indexes finally broke above recent resistance and moved further into new high territory.

Market Statistics

Despite some negative economic news this morning traders came back from the long weekend in a buying mood. This may have been a residual effect from the February option expiration on Friday but we won't question any move that accelerates the breakout.

The negative news came from the NAHB Housing market Index for February, which fell rather than advance as analysts had expected. The headline number declined from 47 to 46 and analysts were expecting a further rise to 48.

There were several declining components. The traffic of potential buyers component declined from 36 to 32 and the lowest level since September. Builders can't blame it on Sandy because the sub index rose from 36 to 41 in the Northeast. Business improved in that region. However, in the South the sub index declined from 51 to 44. Sales declined in the south and increased in the Northeast so it was not a storm related problem. Sentiment in the Midwest and West were basically unchanged.

Available homes declined to a 4.4 month supply and the lowest level since 2005. One problem remains the lack qualified buyers. Equifax reported that 82% of mortgage applications were from borrowers with credit scores over 700. The Senior Loan Officer Survey showed the requirements for borrowers with high scores actually eased slightly but tightened even further for those under 700.

Builders also complained about rising costs for building materials as their most significant problem. More than 75% stated that was a problem. More than 42% complained about the impact from Obamacare and expected insurance costs to rise this year and next.

NAHB Chart

The calendar for Wednesday has the Producer Price Index, New Residential Construction and FOMC minutes as the highlights. The Producer Price Index is likely to show increasing costs at the producer level. At least that is what we hope to see. The Fed is worried about falling prices and a return of deflationary pressures.

The residential construction report should show a decline in the rate of building and you can blame that on the various winter storms.

The big news will be the FOMC minutes at 2:PM. These will be scrutinized for signs of weakness in the Fed's resolve to keep the $85 billion a month in QE purchases flowing. The various Fed governors seem to be having a war in the press on their views towards keeping the QE in force as the official FOMC statements have said.

This is the real stumbling point for Wednesday. However, even if there are signs of active dissension among the Fed members it may only generate a temporary dip in the markets. Traders are in buy the dip mode and at this point they are hoping for dips to buy.

Economic Calendar

In earnings news Dell reported after the bell and beat estimates slightly. Dell reported earnings of 40 cents compared to estimates of 39 cents. Revenue was $14.31 billion compared to estimates of $14.12 billion. Nobody really expected Dell to post any results that were much different than estimates because of the battle over the LBO transaction. If the numbers had been worse there would have been a suspicion Dell was trying to make things look worse to increase the prospects of the deal being accepted. If they had reported strong numbers then shareholders would have pressed for an even higher price.

Dell said it was not giving future guidance because of the LBO transaction. Dell said the majority of sales came from the enterprise group with the consumer sector falling to less than 20% of sales. Sales overseas were terrible. Sales in Europe, the Middle East and Africa fell -14% and the Asia Pacific region declined by -9%. The America's saw sales decline -10%.

More than 20% of shareholders not in the Michael Dell LBO group have come out against the transaction. The terms of the deal require more than 50% of the non Dell Group shareholders to vote for the deal. Most analysts now expect the price to rise into the mid $14 range in order to get the deal done and they expect that to happen. The shares are already up +40% since the deal rumors began at $10.

Dell Chart

Herbalife (HLF) reported earnings of $1.05 compared to estimates of $1.03. Revenue was $1.06 billion compared to estimates of $1.05 billion. However, if that is the only headline you read you missed the real news. Herbalife bought back four million shares of stock in the quarter or 4% of the outstanding shares. That is why HLF was able to beat the street earnings estimates. This is a tactic IBM made famous years ago. The analysts base their estimates on the outstanding shares at the end of the prior quarter or in this case 108 million. Herbalife ended the quarter with 104 million and that increased their earnings per share by +4 cents. Without the buybacks the earnings would have been $1.01 and -2 cents below estimates.

The company also revealed the SEC had begun an inquiry into its "business and financial operations" in December after Ackman went public with his claims the company was a major pyramid scheme.

There was no conference call today. That call will be held at 11:00 on Wednesday and you can bet there will be a lot of very pointed questions.

Herbalife Chart

Red Robin (RRGB) reported GAAP earnings that more than doubled to 45 cents compared to 20 cents in the year ago quarter. Adjusted earnings rose to 59 cents compared to analyst estimates of 46 cents. The restaurant said more people visited the restaurants and they spent more than the prior quarters. Same store sales rose +1.4% at its 339 stores. The company said it expects this to rise to 2.5-3.0% in 2013 and it expects to open 20 more stores.

Red Robin Chart

Some healthcare companies plunged today after the Centers for Medicare and Medicaid said new reimbursement rates would be lower than expected. Humana (HUM) receives nearly two-thirds of its revenue from Medicare Advantage. A comment period lasts until March 1st with the final decision due out on April 1st. Humana said in a SEC filing that payments would be flat to slightly down. "The company believes the base rates would result in a mid-single-digit decline in its benchmark payment rates."

Other companies including Universal American (UAM) fell -6% because it received 75% of its revenue from government programs. UNH, AET, CI and HNT each lost more than 1%. eHealth (EHTH) continued its plunge from Friday with another -17% drop to close at $16 after missing on earnings and guidance. Analysts are concerned the company may not survive the coming changes in the sector as a result of Obamacare.

eHealth Chart

Humana Chart

Need staples and printer paper? Office supply giants Office Depot (ODP) and OfficeMax (OMX) are discussing a possible merger with an announcement later this week. The companies are discussing a stock swap that would combine the companies and allow them to compete with Staples (SPLS).

OfficeMax and Office Depot both have a market cap of $1 billion each and Staples sports a $10 billion cap. The merger came from talks begun after activist fund Starboard Value LP became the largest shareholder in Office Depot. The merged company would have about $18 billion in revenue compared with $25 billion for staples. The merged company would see as much as $580 million in savings by combining the warehousing operations and closing duplicate stores. OfficeMax rose +21%, Office Depot +9% and oddly enough Staples rose +13%. I am assuming that is because there would be fewer competitive locations.

OfficeMax Chart

Michael Kors (KORS) announced a secondary offering of 25 million shares after the close. Michael Kors will sell 3.0 million of the shares he owns personally as part of that offering. That will reduce his stake to 4.8 million shares. The announcement came after the shares hit a new historic high at $64.84 at the close. That is a 300% gain since it IPOed in 2011. The company reported blowout earnings last week including a +41% rise in sales in North America. Sportswear Holdings Limited, a private equity firm and KORS largest investor will sell 19.7 million shares or 62.9% of its stake. A children's trust for CEO Jim Idol will sell two million shares. The company itself will receive no proceeds from the offering since all shares are being sold by individual owners. Shares of KORS declined about $1.50 in afterhours.

KORS Chart

The market rally seemed to find some traction today but that may run into trouble soon as a result of gasoline prices. Retail gasoline prices have risen for 33 consecutive days gaining +45 cents over the last month and +15 cents in the last week to hit $3.75 today. Gasoline is now over $5 at some stations in California and over $4 in a lot of stations on both coasts. The rise in prices is the result of refinery closures amounting to about 500,000 bpd. Several refineries have closed over the last year after the owners were unable to sell them. Hess was the latest to close its refinery in New Jersey and announce it was going to sell the rest of its refining network. The refinery incurred operating losses in two of the last three years.

Refineries are struggling with new environmental regulations and a weak forecast for gasoline refining profitability. Refineries forced to use water borne crude index to Brent prices, primarily costal refineries, are at a disadvantage to refineries able to access WTI crude or the cheaper Bakken crude.

BP's Whiting Indiana refinery went down in November for a $4 billion upgrade and should have been back up by now but BP is now saying it will be offline until July or later. BP is upgrading the plant to refine the cheap Canadian oil sands crude. It currently has the capacity to process 80,000 bpd of Canadian crude and that will increase to 350,000 bpd while the total capacity will remain 405,000 bpd. The loss of that much refining capacity is producing a shortage of gasoline.

Gasoline prices are at the highest ever for this time of year with crude prices just under $97 for WTI and $117 for Brent. Bank America said today that Brent could rise to $140 in 2013 and average $100-$130 a barrel through 2015. Technicians claim Brent could be setting up for a sprint higher after trading volume declined to 23% below the 100-day average. The spread between Brent and WTI increased to $23.18 on February 8th and declined today to $20.82. This premium to WTI is what causes the gasoline prices on the coasts to be significantly higher because the coastal refineries are forced to buy crude indexed to Brent.

Historically every $10 rise in oil prices reduced GDP by 0.2 points because higher gasoline prices reduce consumer spending. The Wal-Mart email last Friday claiming sales were off to the worst start in February in the last seven years was one sign the rising gasoline prices are already hurting consumers. There are other factors like the resumption of the payroll taxes but higher gasoline prices are a bigger drag. With prices up 45 cents a gallon over the last month the normal tank of gas is costing $10 more and two car families this could be $120 to $150 a month in additional expenses. This may be a temporary ceiling but prices will rise again when driving season begins this summer.

Gasoline Futures Chart

The VIX hit a new six year low at 12.03 intraday. There is a complete lack of fear as evidenced by the VIX. Last week the speculative longs in the VIX futures fell by -16,222 contracts to 104,284 according to the Commitment of Traders weekly update. At the same time the speculative contracts in the Russell 2000 futures hit an all time high.

As I have shown many times in the past the VIX can remain low for a very long time. The VIX spent the majority of 2005-2006 well under 13 with the last quarter of 2006 seeing a dip under 10.

VIX Chart

There is no fear in the market. The last thee week average intraday range in the Dow was the smallest since 1986. Despite the sequester deadline on March 1st and the expiring budget resolution on March 27th we are seeing no fear over those issues by traders. Even permanent bears like Nouriel Roubini have given up on calling for a bear market. More than $37 billion in new cash flowed into the stock funds over the first six weeks of 2013.

The average daily price move for the S&P-500 has fallen to 0.43% in 2013. That is down from an average of 1.08% over the last five years. That is the steepest decline since the 1930s according to Bloomberg. The last time the average was this low was 1995 at 0.38% when the S&P gained +34%. Bloomberg research shows stocks gain an average of 17% during years when the gyrations are so small. The data goes back to 1928.

The largest contributions to mutual funds in nine years are powering these gains. Analysts now believe it is not a rotation out of bonds but a transfer of funds out of money market accounts.

We are living in a goldilocks market. The economic data is just right to keep the Fed writing $85 billion in QE checks every month and there does not seem to be any end in sight. The negative GDP in Q4 could be followed by another negative quarter in Q1 but nobody seems to care.

Europe is in recession but the euro is near seven-month highs. Despite the Fed's massive QE program and marginal economics the U.S. Dollar is at two month highs.

Traders have been conditioned by the various political events over the last two years to expect a solution. Political crisis after crisis in the U.S., Europe and China have gone from "pending disaster" to just another speed bump in the road. Greece was going to leave the eurozone. Spain was going to fail. Italy was on the verge of collapse. China was headed for a hard landing. The U.S. was going to default on payments as a result of the debt ceiling. None of these things happened and that has made traders immune to the headlines.

Traders may not believe the markets are going to shoot higher and funds are reluctant to go all in with bets on equities but there is no alternative. Bonds don't work for returns and Treasury yields are at 10 month highs as selling increased in the bond market.

Fund managers and retail traders may not be irrationally exuberant but they are definitely buying the dips. Every minor bit of volatility that causes a dip is being instantly bought. The Wal-Mart email on Friday caused a -67 point dip in the Dow but traders instantly jumped into the gap and the Dow recovered to close positive for the day.

That Wal-Mart dip failed to raise the premium on WMT options. At the money march calls are only 84 cents and puts are 94 cents. There is no volatility in the market and premium sellers are seriously challenged to find any options worth the risk.

Energy has been volatile with crude prices fluctuating $3 over the last week but options on energy stocks are very cheap. With OXY at $84.71 on Friday the March $85 in the money put was only 97 cents. The same is true in the banking sector. JP Morgan was up +57 cents today at $49.46 but the March $50 calls are only 70 cents. This is very cheap for an at the money call option.

Options on ETFs are even cheaper. The Financial ETF (XLF) at $17.92 is showing a March $18 call for 20 cents and the $17 put is 6 cents. Granted the XLF is not a fast mover but at these prices this is the equivalent of a free trade.

Something will appear in the future to upset this applecart but as is the case with most corrections there will be no advance warning. Traders will seize on one headline and it will become the excuse to sell and the house of cards will come tumbling down. Today I don't know that that headline might be. The FOMC minutes on Wednesday could be a bump in the road but traders have shown they are suddenly immune to shocks.

The S&P spiked suddenly higher today after being stuck at 1520-1525 for the last week. This breakout over what had become strong resistance is very positive. That is a new five year high and it is only 35 points below a historic high. Support is now well back at 1515. This was a bullish event.

S&P Chart - Daily

The Dow gained +53 points to close at 14,035 and that was the high level seen back on February 12th. This is not a breakout by the Dow but it appears to be a nice setup for a breakout this week. If the S&P and Nasdaq continue their run the Dow will catch fire as well. Support is back at 13,950.

Dow Chart - Daily

The Nasdaq finally caught up with the other indexes and broke out over strong resistance at 3200 to a new 12 year high. This is a major event for the Nasdaq and should draw new cash into the market. It was helped by a +$14 gain by Google and a new all time high at $806. Apple was not a drag but also not a help with a fractional 17 cent loss to close at $460. ISRG, AMZN, NFLX, FSLR and RRGB were big gainers that helped Google support the Nasdaq.

I view the Nasdaq breakout as VERY bullish and especially so if the tech index can post back to back gains.

Nasdaq Winners and Sinners

Nasdaq Chart - Daily

The Russell 2000 Small Cap Index sprinted higher with a +9 point gain. This continues to be the sentiment indicator for fund managers and it is very bullish but definitely over extended.

Russell 2000 Chart - Daily

For weeks analysts have been waiting for a 3-5% pullback for profit taking so the markets could begin a new leg higher. That dip never came. Many investors forget that profit taking can also come in the form of a period of consolidation as well. The market does not have to sell off for traders to exit old positions and enter new ones. When there is a strong underlying bid the selling is met with buying and the indexes move sideways until the stock available for sale is exhausted.

I believe that is what we saw in early February. The major indexes stalled and went sideways for three weeks and every intraday dip was immediately bought. When the dips ended on the 8th the volume slowed and the intraday ranges shrank to almost nothing. This was the final equalization between buyers and sellers and Friday's Wal-Mart dip was the last straw. Having the Dow recover 75 points in only a few minutes on a Friday afternoon was evidence the buyers were out in force.

Today's breakout on the Nasdaq, S&P, Transports, S&P-400 and Russell should be a signal to those still on the sidelines to jump on the train or get left at the station. OR, it could have been the climax spike that signals the start of a significant correction. I believe it is the former and not the latter. I hear that train whistle blowing.

Enter passively, exit aggressively!

Jim Brown

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