The S&P slowly moved closer to the next obvious target of 1600 but fell -3 points short.

Market Statistics

After a major gap down at the open as a result of negative economic news the window dressing was applied in volume and all the major indexes crept back into the green. It was the 15th consecutive Tuesday gain for the Dow and a new record. The S&P struggled to reach the 1600 level but failed as traders were actively shorting every attempt. If a breakthrough ever comes there could be a really big short squeeze.

The morning economics shocked investors when the Chicago ISM for April fell into contraction territory for the first time since July 2009. The headline number fell from 52.4 to 49.0. This was a 3.5 year low. Analysts were expecting a minor decline to 52.0.

The internal components were grim. New orders were basically flat at 53.2 but backorders plunged from 45.0 to 40.6. That is the lowest level for backorders since September 2009. Inventories dropped to 40.6 as well. Employment fell from 55.1 back into contraction territory at 48.7 indicating manufacturing companies are laying off workers.

Supplier deliveries fell from 58.0 to 47.9. That means lead times are the shortest they have been since the recession. Faster deliveries represent a shortage of orders at parts suppliers and suggests the economic weakness is widespread. Confirming that fact was a -10 point drop from 61.0 to 51.0 in the prices paid component. Weak prices mean weak demand.

This data point is even more troubling because it comes from an area that is largely driven by auto manufacturing. Since auto sales have been robust this suggests other areas outside of autos must have been even weaker than what this composite report suggests.

The negative surprise sent the Dow down -84 points to 14,734 before the rebound began.

Chicago ISM Chart

On Monday the Texas Manufacturing Survey fell deep into contraction territory for April at -15.6 from +7.4 in March. That broke a five month string of positive gains. New orders fell from +8.7 to -4.9. Backorders fell deeper into contraction to -7.9 from -5.6. The only bright point was a rise in the employment component from 2.6 to 6.3. Employment is a growing economic center because of its low tax rates and broad employment base. The sharp decline in the headline number is a worry.

On the positive side the Consumer Confidence for April jumped +6.2 points from 61.9 to 68.1. That is the highest level since November. This reversed a -6.1 point decline in March. The rebound was due totally to a jump in the expectations component. Expectations jumped from 63.7 to 73.3. The present conditions component was basically flat with a minor gain from 59.2 to 60.4.

The buying plans were also flat with those planning on buying homes declined from 10.8 to 10.6, homes flat at 5.6 and appliances declined from 47.2 to 46.6. However, those that felt jobs were hard to get rose from 35.4 to 37.1.

Analysts believe the negativity surrounding the sequestration caused confidence to decline in March. Now two months later the world has not ended so consumers are feeling better about the future. The new highs in the equity markets and an eight-week decline in gasoline prices contributed to the improved mood.

Consumer Confidence Chart

The weak labor market is helping employers keep costs low. The Employment Cost Index for Q1 saw only a +0.3% rise in total employee compensation. That was slightly lower than the +0.4% gain in Q4 and well below the +0.5% gain in the prior three quarters. Employee benefit compensation declined from 2.5% to 1.9% compared to the same period in 2012. However, benefits now compose 30% of employee compensation.

We saw in the Personal Income report on Monday that wages rose only +0.2% in march compared to +1.1% in February. The savings rate was 2.7% and the lowest level since 2007. Employees are being forced to spend everything they make to live. These are confirming indicators that employment is weak and we could see a disappointment in future payroll reports.

The PCE deflator, the Fed's preferred indicator of inflation, actually declined -0.1% in March to a year over year rate of only +1.0%. This is very low inflation and gives the Fed no reason to halt its QE programs. There is no inflation in the system.

There are three major economic events on Wednesday. The FOMC announcement is a major event but it is not expected to move the market because the results are already baked into the market. The Fed is not expected to make any changes to their positions and their economic outlook may have worsened, which would suggest no changes in the near future.

Over the last week several Fed heads actually said they thought the Fed should accelerate the QE purchases to offset the currently declining economics. That pushed analysts to extend their timelines for future changes. In a survey of 46 analysts the consensus believed the Fed would not begin tapering purchases until March 2014. They thought purchases would end in July 2014 and rates would not rise until May 2015. QE in 2014 was expected to reach $632 billion compared to the $1.02 trillion in 2013. Obviously nobody has a crystal ball but shifting the dates that far into the future suggests the QE is here to stay well after Bernanke ends his term as Fed chairman in January.

After Bernanke said he would not attend the annual Fed summit at Jackson Hole where the chairman always gives the keynote address the rumor mill went into overdrive. We can expect those rumors to accelerate in the months ahead if Bernanke or President Obama don't disclaim them soon. Fed Vice Chairman Janet Yellin is expected to take over as Chairman if Bernanke does not continue. If Yellin was not the successor the markets would probably take it very badly. She is a known commodity versus the appointment of somebody outside the current Fed system like Tim Geithner. He is constantly rumored as the alternate choice as an Obama buddy. Geithner has repeatedly said he is not interested but you never know once the arms are twisted.

The next Fed head is going to have a very tough task in unwinding what will be a $4 trillion plus Fed balance sheet without crashing the markets and the economy. The Fed has never successfully unwound a stimulus position and it has never had a stimulus position this big. The potential for disaster is extreme.

The second report for Wednesday is the ADP Employment for April. Expectations are for a gain of +170,000 jobs. That is even higher than the +158,000 from last month that was such a disappointment. If jobs actually rose in April it would be very market positive.

The third report is the ISM Manufacturing. After sharp declines in the regional manufacturing reports there is a strong potential for a negative surprise. The Chicago ISM caused an 85 point decline in the Dow this morning. If the national ISM comes in severely negative I would doubt the dip buyers would show up in volume. There might be an initial rebound but a negative national ISM would seriously impact market sentiment towards a possible recession. On the flip side the whisper numbers are already negative so maybe the bad news is already priced into the market.

Economic Calendar

The dollar index fell to a two month low on the negative Chicago PMI. However, precious metals failed to rally significantly so worries over a potential recession remain weak. The bond market saw some buying with the ten-year treasury getting a bid and lifting yields off five month lows.

Oil prices declined -1.44 on worries over falling demand if manufacturing was weak. WTI had risen nearly $9 over the prior two weeks so that was a minor bout of profit taking.

Dollar Index Chart

Ten-Year Yield Chart

Apple (AAPL) shares continued their rebound with a +13 gain after demand for their bond offering exceeded $40 billion. Apple said it was selling $17 billion in various term bonds at an average yield of 2.4%. That is the largest non-financial bond sale in history. Apple stock is currently yielding 2.8% so investors have their choice of investment vehicles. Apple shares have risen +$57 since the $385 low on April 19th. The recent gains have supported the Nasdaq and pushed the index to a new 12 year high today.

Apple still has to battle investor concerns over new products, lower prices and falling margins but for the time being the lure of $100 billion in stock buybacks and dividends is pushing shares higher.

Apple Chart

Amazon (AMZN) halted its slide at least temporarily with a +$4 gain on no news. I suspect this was a combination of the drop being overdone, critical support reached and Apple inflating the indexes and tech ETFs, which lifted all the stocks in those ETFs. This chained response to ETF buying and selling is becoming more pronounced as ETF volume increases. Many funds are now buying and trading ETFs rather than single stocks.

Amazon could help itself with a decent stock split so the average investor could buy shares again. Apple, Google and Amazon should all consider a split.

Amazon Chart

Earnings from Dow component Pfizer (PFE) caused a drag on the index after the company missed earnings and warned on guidance. The company reported adjusted earnings of 54 cents that missed analyst estimates by a penny. Revenue declined -9% to $13.5 billion and missed estimates of $13.9 billion. Revenue from Prevnar declined -10% to $846 million. This is the biggest selling vaccine in history with $4 billion in annual sales. This is for ear infections, meningitis and pneumococcal infections. Pfizer blamed the drop on seasonal buying patterns in some countries. The company is struggling with more than a dozen former blockbuster drugs now off patent and suffering from generic competition. Revenue from Lipitor declined -55% in Q1 to $626 million. In its prime the drug produced revenue of $13 billion annually.

Pfizer blamed generics and the yen and euro for the guidance warning. Currency fluctuations are expected to knock $900 million off full year revenues. The new forecast calls for revenue of $56.3 billion on average and $2.19 on average for earnings.

Pfizer shares rallied early in the month on news of a "breakthrough" FDA label on the breast cancer drug Palbociclib. The drug is in late stage testing and apparently the FDA is excited.

Pfizer Chart

The Dow got another boost from IBM with the stock in stampede mode after dropping more than $25 last week. IBM rallied +$4 on Monday and another $3.39 today. IBM announced today it had authorized a $5 billion stock repurchase plan in addition to the one already in place. This brings the total in outstanding repurchase authorizations to $11.2 billion. IBM plans to request additional share repurchases at the October board meeting. IBM bought back $2.6 billion in shares in Q1. The company also hiked its dividend by +12% to 95 cents. This is the tenth straight year of double digit increases in the dividend. IBM crashed last week after the first earnings miss in eight years and being hit with an 8.3% one day drop in price. Today's gain added about 30 points to the Dow, which closed up only +21 points so thank you IBM.

IBM Chart

In the "wonders never cease" department the Semiconductor Index closed at a new two-year high. Despite numerous earnings misses and guidance warnings the semiconductor stocks are trading at new highs. You can thank Intel, Applied Materials, Broadcom, Lam Research and Nvidia. Despite the decline in PC sales the rally in phones and tablets has powered the sector higher. Not all the components were positive I scanned some of the 30 components and there were some ugly charts in the mix as well.

Semiconductor Index Chart

The S&P set a new inrtaday high at 1597.57 today. The old high from April 11th was 1597.35. The difference in those numbers at 0.22 points should give you some idea of the battle raging at the current market highs. The high on Monday was 1596.65. When a 1600 point index is only able to increase its high-water mark by fractions of a point you know there is some serious selling pressure.

Since the November dip the S&P has been posting steady gains with only three brief pauses to take a breath. After the minor pause in mid April the index is back at the highs and struggling to break that early April resistance. The 1600 level has taken on a life of its own as the assumed target but it is far from guaranteed.

With all the press about the potential for a "Sell in May" event you would think investors would be hedging their bets here and taking some money off the table. There is no evidence of that and the quick rebound from the morning dip shows there are plenty of buyers waiting on the sidelines.

We could easily see a break over 1600 and some obscene short covering if that happens. While I am not predicting a breakout the possibility exists. If the ISM manufacturing did not disappoint and/or the FOMC announcement confirmed QE well into 2014 the market could get a second wind and move higher.

We have to allow for the impact of window dressing. The moves the last several days could have been helped by month end portfolio enhancements. It is not unusual to see cash come into the market in late April once the taxes have been paid. Investors have been holding back funds for taxes but once the bill is paid any remaining funds go back into the market. Once into May this cycle will end.

After the morning dip we can call 1587 initial support followed by 1578. Longer term support is so far below at 1540 it is hardly worth mentioning in this commentary.

S&P Chart - Daily

S&P Chart - Daily

After two weeks of solid body punches by stock after stock missing earnings and guiding lower the Dow earnings parade is over. The Dow is headed back up to retest that 14,865 level that was so tough in early April.

On April 11th the Dow closed at 14,865 and a new historic high. On each of the following two days the exact high for the day was 14,865. That new high close had become rock solid resistance. The Dow is headed back for a rematch and should be able to do so without any pesky earnings from Dow components.

The Dow was helped a lot by the strong performance in IBM the last two days. Can IBM keep up the pace or is it due for a rest.

We know the Dow is seen as the market even though it is only 30 stocks. However, this week the attention should switch to that 1600 level on the S&P.

Watch 14,865 for a breakout.

Dow Chart

The gains by Apple, Google and Amazon helped lift the Nasdaq to a new 12 year high but they had a lot of help from stocks I bet you don't recognize. Heartware (HTWR), Chart Industries (GTLS), Alliance Holdings (AHGP) and Multimedia Games (MGAM) all posted strong gains on earnings beats. However, you can add all of them together and they don't even come close to the impact on the Nasdaq relative to Apple. This was a large cap rally by the generals with a lot of support by the troops.

Initial resistance on the Nasdaq is now 3345 followed by 3365. The Nasdaq is already in short covering mode so any further move higher by the S&P will only intensify the buying in tech stocks.

Winners & Sinners

Nasdaq Chart

The Russell 1000 Big Cap Index closed at a new high at 886.89. The sell off from the prior week to a two month low has been forgotten. If the Russell moves higher this week we should assume fund managers are not leaving for the summer and dips should still be bought. This is surprising strength by big caps. The Russell 1000 is the 1000 largest stocks in the Russell universe and includes the Dow and S&P stocks.

The Russell 1000 actually has room to run, market permitting. Resistance is well above at 900-905.

Russell 1000 Chart

Russell 2000 Chart

Unfortunately, using the same scale on the Russell 2000 Small Cap Index the difference between the indexes is easily seen. Small caps actually lost -0.5% for the month of April and they have been struggling. The high close set back on March 14th at 953.07 has not been touched in April but the gains this week have helped. The Russell 2000 should be watched carefully for signs of fund manager flight once we are into May.

Russell 2000 Chart

I can't emphasize enough the importance of the next three days in the market. There are numerous economic events that could crystallize sentiment either positively or negatively. However, all of these events are known. As Donald Rumsfeld would say these are "known knowns." The rebound from the morning dip in the face of these high profile events was very telling. It tells us investors are unafraid of the reports ahead. That may come back to haunt them but we have to play the cards we are dealt. This is a liquidity driven market and until events turn so negative investors can't ignore them or the liquidity flow stops the market could continue higher.

Everyone knows about the "Sell in May" cycle but nobody seems to care. Is this the return of "Irrational exuberance?"

Enter passively, exit aggressively!

Jim Brown

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