For the third consecutive day the indexes bounced back from intraday losses to return to resistance. This market refuses to drop.

Market Statistics

Nearly 50% of S&P 500 corporations have missed on revenue for Q2 and China keeps lowering the bar for economic growth but the U.S. equity markets remain strong. The Dow dropped -147 on Friday to 15,405 before rebounding to close with a +3 point gain at 15,557. The S&P dipped -14 points to 1676 mid morning before rebounding to close +1.4 points higher at 1691. The last three trading days have all produced lower lows but the buy the dippers are rushing into the gap to pick up bargains.

There are 5 things powering the market.

1. Q2 earnings were not that bad. I laughed to myself when I typed that since expectations were cut in half over the last two months. If you set the bar low enough anyone can beat it. More than 69% of the 246 S&P companies reported so far have beat on earnings and 49% missed on revenue. Apparently that was good enough for investors.

2. European PMI suddenly rebounded to an 18-month high at 50.4 on the composite index and a 24 month high of 50.1 on manufacturing. The PMI Output Index hit a 25-month high at 52.3. European equities are up +8% for the month. Suddenly Europe is no longer a headwind but is turning into a global positive.

3. U.S. economics remain weak and the Fed is not likely to taper QE this year. The consensus estimate for the GDP on Wednesday is expected to fall from +1.78% growth in Q1 to +0.4% growth in Q2 according to Moody's and very near contraction territory. The Fed is not going to taper QE with the GDP this close to zero.

4. Some funds are still chasing performance with new money flowing in thanks to the new market highs. Those new highs are a strong advertisement for equities over cash or bonds. Individual investors are also putting new money in the market.

5. Bonds are still being sold although not quite as fast as we saw earlier in the week. Some of that bond money is making its way into stocks and that is providing some upward momentum in equities. said more than $80 billion flowed out of bonds and bond funds in June. Outflows in July have continued but at a lesser rate. However, equity funds saw inflows of $8 billion in the first two weeks of July. We can assume both those trends are continuing.

Economics on Friday were positive. The final reading for July on Consumer Sentiment was 85.1 and a six-year high. New market highs and rising home prices do wonders for consumer sentiment. The Fed induced wealth effect is alive and well and the Fed is counting on this to lift the economy. Consumers with a positive outlook tend to spend more money and consume more things. Seeing your investment statement balance rise every month is very good for sentiment.

The current conditions component rose from 93.8 to 98.6 and its highest level since July 2007. The expectations component declined slightly from 77.8 to 76.5 but the change was minimal. Another component showed that 68% of survey respondents expected interest rates to rise compared to 55% in June. That is the highest level since August 2006. Respondents also expect the inflation rate to rise to 3.1% over the next year.

Next week is going to be a huge week for economics with Jobs, GDP, ISM and the FOMC meeting. The first look at the jobs picture will be the ADP report at 8:30 on Wednesday. Expectations are for a gain of +179,000 jobs compared to +188,306 in June.

At the same time the Q2-GDP will be released and the Moody's estimate is for +0.4% growth compared to +1.78% in Q1. This is a material decline and should not be good for the Fed's "moderate growth" forecast model. In this case it would be another "bad news is good news" headline since it would keep the Fed from changing existing QE policy.

Later on Wednesday the FOMC rate decision will be announced and "no change" is the expected result. That will depend in some part on the ADP and GDP reports. I believe Bernanke will not want to make a policy error here when he is so close to retirement. It makes more sense to leave the current policy alone until the economy supplies real proof it is improving. There may be some false urgency on the part of the Fed to make a change simply because they Fed has never been this deep into a stimulative policy in its history. They don't really know how they are going to exit and all the outside analysts are warning of a pending disaster when they do change policy.

The ISM Manufacturing on Thursday is the report on the national manufacturing outlook. The index rebounded out of contraction territory to 50.9 in June and expectations are for a further improvement to 51.4. That is really a shot in the dark since the regional surveys have been very inconsistent. Order backlogs were well into contraction territory last month at 46.5 and that suggests July activity should have been weak. I would not be surprised to see a decline in the ISM instead of a gain.

Lastly the Nonfarm Payrolls for July will be released on Friday. Estimates are for a gain of +175,000 jobs compared to +195,000 in June. The Nonfarm numbers have been revised significantly higher for the last several months. July was well into the Sequestration process so there could be a negative impact to the jobs numbers. The full time, part time skew to avoid Obamacare penalties was also evident. More than 240,000 full time jobs were lost in June and +320,000 part time jobs added. In the Nonfarm numbers a part time job counts as much as a full time job so a person could lose their full time job and take two part time jobs to pay the bills and that is shown as a net gain of +1 job.

Economic Calendar

After the July FOMC meeting Bernanke only has four meetings left in 2013 before his term ends in January 2013. His last meeting will be January 28-29th. President Obama will not nominate a successor for Bernanke until September according to an administration official. The September meeting is on the 17-18th so I would expect it after the meeting.

The two leading candidates are Fed Vice Chairman Janet Yellen and former Treasury Secretary Lawrence Summers. About a third of the 54-member Senate Democratic caucus signed a letter praising Yellen and encouraging Obama to nominate her. Obviously she is a democrat and she was Chair of the White House Council of Economic Advisers under President Clinton. Yellen was also president of the San Francisco Fed. She received a doctorate in economics from Yale and taught economics at Harvard.

Yellen is considered to be a dove and is more concerned about low employment than higher inflation. She would be expected to keep rates low for the foreseeable future until employment accelerated or she was forced to combat rising inflation.

President Obama nominated her to be Vice Chairman of the Fed in 2010 for a four-year term that expires in Oct-2014. On Friday Nancy Pelosi said Yellen is "extremely talented" and "it would be great to have a woman" as the Chairman of the Fed. Senator Barbara Boxer said Yellen is an "outstanding candidate." Also, "She has tremendous experience and the right temperament and I think it would be great to have her" as Chairman. With this sudden burst of overwhelming support from the democrats it would appear Yellen is leading Summers in the nomination race.

On Saturday president Obama proved he was a politician in an interview with the New York Times. He said he had narrowed the field to several outstanding candidates but he has yet to make a decision. He said he wants a chairman that understands the Fed's dual mandate to promote maximum employment and price stability.

The president said,

"When unemployment is still too high, and long-term unemployment is still too high, and there is still weak demand in a lot of industries, I want a Fed chairman that can step back and look at that objectively and say, 'Let's make sure that we are growing the economy, but let's also keep an eye on inflation.' If the markets start frothing up, let's make sure we are not creating new bubbles."

Mr. President, as long as you are wishing for the impossible why not wish for peace in the Middle East and a new form of nuclear fusion that runs on seawater.

Janet Yellen

Friday was a big day for earnings moves. Expedia (EXPE) fell -27% to $47 after profits declined by a third as a result of increasingly intense competition. The company reported earnings of 64 cents compared to estimates of 81 cents. Bookings rose +13% overall, +23% international and +7% domestic. They blamed the short fall on sluggishness in Europe, higher marketing costs and increased competition from PCLN and TRIP. They may be reconsidering that spinoff of TRIP now that they are a competitor.

Expedia Chart

Outerwall (OUTR), formerly Coinstar, operator of the Redbox DVD kiosks, reported earnings of $1.91 and revenue rose +4% to $554.2 million. Analysts were expecting 99 cents and $564.9 million. The company lowered revenue guidance slightly but still roughly in range with previous estimates. They lowered earnings guidance for Q3 to a range of $1.36-$1.51 and analysts were expecting $1.63. The company said DVD rentals declined -11% for the quarter but they expect that to reverse later in the year because of a heavy movie release schedule this summer. The Q2 earnings had a bunch of credits and charges and Q3 will have charges as well. I think the various charges along with the lowered guidance was confusing for investors and the stock was crushed for a -13% loss. After ten months of decent gains it was due for a pause.

OUTR Chart

Amazon (AMZN) shares pulled off an amazing rebound after posting a loss instead of a profit for Q2. The company reported a second quarter loss and weaker international growth Thursday evening and was down as much as -$17 in afterhours trading to touch $286. On Friday shares exploded higher to close at $312 for a gain of +8.61 and a new historic high. Anyone shorting the earnings miss was really surprised.

Amazon Chart

Starbucks (SBUX) rallied +7.6% on blowout earnings. The company said it saw +30% sales growth in the Asia-Pacific region and outstanding sales in China. The coffee seller opened more than 500 stores in China in the last year. They expect to open their 1,000th store in China before year end. The company expects China to be the second largest coffee market behind the USA in 2014. That is amazing since China is traditionally a tea drinking country with that beverage accounting for 54% of drink consumption. In 2012 the average Chinese person drank 2 cups of coffee per year compared to 134 cups for the global average.

Starbucks earnings jumped more than 25% to 55 cents compared to estimates for 53 cents. Revenue of $3.74 billion also beat estimates. Operating margins improved from 14.9% to 16.4%. Global same store sales rose an astounding +8% compared to estimates of +5.8%. Starbucks credited the expanding menu of bakery items, teas and juices for the +9% same store sales increase in the USA. The company raised full year guidance from $2.12-$2.18 to $2.22-$2.25

Starbucks raised 2014 guidance for revenue to increase +10%-13% and to open 1,400 new stores. 600 of those will be in America, 100 in Europe and 700 in China-Asia Pacific.

Starbucks Chart

The earnings calendar for next week is very busy with hundreds of companies reporting. However, the majority of blue chips have already reported leaving the list with only a handful of the largest corporations. The earnings quality only goes downhill from here as the average company size decreases with each passing day.

On the bright side the smaller companies are focused more on U.S. business and have less exposure to the weakness overseas and the currency translation problems. Several of the international blue chip companies reported about a 2% impact to revenue from currency issues related to the strong dollar.

Earnings Calendar

The violence in Egypt is increasing rather than decreasing as it appeared a couple of weeks ago. More than 1,000 were injured and up to 160 killed this weekend as security forces tried to disperse Morsi protestors in Cairo. Morsi has been moved from house arrest to a prison and detained over newly discovered links to the Palestinian militant group Hamas and for allegedly plotting attacks on jails and police stations during the 2011 uprising. Those charges may or may not be true but they are definitely convenient and allowed the military cover for moving him to the heavily fortified prison.

The Egyptian military said more than 30 million people flooded the streets in Egypt over the last couple of days. Morsi supporters claim it was 36 million. What is clear is that the confrontations are not going away and they are intensifying. It is very possible we could see a complete meltdown in Egypt and that possibility should keep oil prices high.

In Libya more than 1,000 inmates escaped from a Benghazi prison as protestors stormed political party offices across the country. The growing unrest is being fueled by the more than 100 militias that were born in the overthrow of Gadhafi. The weekend protests started after an activist critical of the Muslim Brotherhood was killed. Thousands of protestors gathered in Tripoli and demanded the dissolution of Islamist parties. Protestors stormed Brotherhood offices and parties affiliated with the Brotherhood and destroyed furniture, computers, etc. A military colonel and three security officers were killed on Saturday. The military is not strong enough to enforce order as they typically have to rely on the militias for help in enforcing laws. They don't want to anger those militia alliances. With a million people running around with guns captured during the revolution to unseat Gadhafi, Libya is a powder keg set to explode. Unlike Egypt, Libya is a large produce of oil at 1.6 mbpd.

These events have not had any material impact on the U.S. markets to date but should these countries spiral farther downward into outright civil war it could affect the entire region and cause substantial turmoil in the Middle East and Northern Africa. Oil production would be severely impacted with prices rocketing higher. American alliances would be brought into play and that is a dangerous road we don't want to travel.

In the "can't make this stuff up" category Spain's Secretary of State for Energy drafted a royal decree to tax solar power. Failing to pay your sun power tax carries fines up to 30 million euros. If you want to buy some cheap solar panels for your roof the payout on your investment just went from 10 year to 33 years. The tax is meant to keep solar electricity prices higher than state run utility prices. That way the state utilities can keep hiking prices and citizens are stuck paying the bills.

Are you scared of dying or investing? According to a new Nationwide Financial survey of potential investors with at least $100,000 in investible assets, 83% fear another financial crisis and 62% fear the stock market. That compares with 58% who fear death and 57% that fear public speaking. The closest category to the 83% was fear of skydiving at 81%.

The IMF warned that tapering of QE by the Fed could "reignite" the euro debt crisis. The tapering of stimulus by the U.S. Fed risks reigniting the euro zone debt crisis and pushing the weakest countries into a "debt-deflation spiral." They said this would raise borrowing costs in the euro area, further complicate monetary policy and potentially damage area-wide demand and growth. I would bet Bernanke can't wait until his term ends in January. It appears he does not have to worry about just the U.S. economy but the entire world. The new Prince George Alexander is in danger from Bernanke and doesn't even know it yet.

Italy's economy is declining faster than previously predicted. Italy's central bank revised the 2013 estimate for GDP from -1% to -1.9% and it will probably be revised lower next quarter as well. Italy declined by -2.4% in 2012. S&P cut Italy's credit rating to BBB and two notches above junk.

Thomas Lee, chief equity strategist at JP Morgan raised his year end S&P target from 1715 to 1775. That puts him at the top of the analyst scoreboard until someone picks a higher target. It also suggests another 5% upside over the next six months if his guess comes true.


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Bank of America said last week that professionals have been net sellers of the equity market since late June. In fact they claim institutions have never sold as much stock as they have in the last four weeks. At the same time BofA Merrill Lynch said retail investors have been rushing into the market.

"On a four-week average basis, net sales by institutional client groups are the largest in our data history. Private clients have been net buyers of US stocks since early June. The private client net buying streak is currently the longest since late 2011."

Is the real great rotation the passing of liquidity-driven stocks from the hands of smart money to the dumb money once again? The psychology of "missing out" on the great bull market is forcing cash into equities. This is completely different than irrational exuberance since they are reluctantly chasing prices rather than rushing to buy a hot market.

JP Morgan said it was thinking about getting out of the market for physical commodities like aluminum, gold, silver and oil. The bank has made a huge fortune in physical commodities for years. However, there have been a lot of rumors of late that banks warehousing precious metals were double, triple or even quadruple dealing and perhaps the gold you thought you owned was not really there. Banks, especially JP Morgan, own physical gold and silver. They also store it for others. However, while the gold is in their warehouse they can "lend" it to others in a variety of ways. As rumors ballooned over the last few months about physical gold shortages the price of physical gold (coins, bars, etc) shot up but the price of paper gold (ETFs, futures, etc) dropped sharply. Investors no longer wanted to hold paper. They wanted the real thing and stood in line around the world, sometimes hundreds of people long, to buy coins and bullion.

Art Cashin stepped into the maelstrom last week when he pointed out that conspiracy theories were exploding and futures prices appeared to be reacting to the news. He showed that backwardation, that is spot prices being higher than future prices, was not being acted on by investors. In theory if spot gold was $100 higher today than the September futures contract you could sell gold today and buy the futures and lock in a $100 profit minus expenses. Art pointed out that nobody was doing that. That suggests there is doubt there is really gold in storage to back up that contract and be deliverable when the contract expires.

The biggest conspiracy theory around is related to JP Morgan. Hardly a week goes by that some analyst is posting charts showing the amount of gold JPM claims to have versus the actual registered gold in their vaults. Nothing ever comes from the stories and rumors but when the New York Times published an article about it last week those rumors multiplied again. The NYT hinted there was manipulation of metals prices by the big banks and the price of gold rocketed higher by $45 on Monday. JP Morgan made about $1.5 billion from their physical commodities business in 2012 and they are suddenly thinking of getting out of that business. Could there be another whale trade debacle in gold about to surface?

Beware September. August may be the worst month of the year for the markets on a historical basis but at least Congress is not in session. They take August off and return to their own states for the month. When they return in September the budget battle will begin. President Obama is reportedly preparing another $1.6 trillion tax increase to overcome the sequester and pay for all the new programs he is requesting. The House is warning they are not going to raise the debt ceiling, which was hit last month, until there are significant and substantial cuts in spending. This confrontation ahead of a midterm election year could be a disaster for the markets as threats of a government shutdown battle QE tapering for the headlines.

The markets seem to be ignoring the headlines and the very busy economic calendar for next week. The potential for a market disruption is significant given the GDP, ISM, FOMC and Nonfarm Payrolls. Instead of selling off on these worries the Teflon market rebounded to close at the highs of the day. It was as though the market makers refused to let the indexes close negative for the week on fear the retail investor would quit buying. The Dow gained +15 for the week and the S&P +1.65. That was just enough to keep the weekly winning streak alive.

The S&P dipped below initial support at 1680 but only barely with a rebound from 1676. Upward momentum has definitely slowed but the dip buyers are alive and well. Resistance remains 1700 with the S&P touching just over 1698 twice last week before the sellers hit the tape. The risk is a decline to 1650. Mary Ann Bartels from BofA-ML said on Friday that is the real risk level. As long as that level holds the year end targets will be intact. Should 1650 break it would require a new look at the data and potentially a target reset.

Short interest on the S&P-500 is at the highest level since January. On a contrarian basis that is bullish.

S&P Chart - Daily

The Dow dipped to 15,400 on Friday and critical support for the last three weeks. The Dow has traded in a narrow range from 15400-15600 for the last three weeks without any material volatility. Thursday and Friday were the biggest intraday declines since July 2nd. The late day rebound from the -147 point loss to a +3 point gain amazed everyone given the relatively weak earnings and events next week.

If support breaks at 15,400 there is risk to 14,900-15,000. Once the bloom is off the rose we could see a few petals fall before buyers step back in. With earnings peaking we are going to be a headline driven market and we could have some ugly headlines next week.

Resistance remains 15,600. Note the very short candles on the chart for the last two weeks.

Dow Chart

Despite some very bad earnings from companies like MSFT, INTC, ORCL, etc, the Nasdaq has also held in a very narrow range from 3575 to 3610. Forward momentum has died but there has been no selling. The index is consolidating its gains. Some analysts believe it is in distribution mode where institutions are slowly liquidating their positions to retail buyers. The next move will be key. If the Nasdaq breaks out to the upside it could upset the best laid plans of many hedge funds that have gone short or back to cash.

Support is 3575 and a breakdown there could retreat back to 3500 or even 3400 if the summer doldrums hit us hard.

Winners and Sinners

Nasdaq Chart

The canary in the coal mine actually coughed last week. The Russell declined by -6 points on Friday when the blue chip dip was being bought. This could be a sign fund managers are moving new money into the highly liquid stocks in case they have to exit quickly. This would mean fund manager sentiment is weakening. Obviously a couple of weak days do not make a trend but it "bears" watching.

Support is 1,040 with resistance 1,054. We saw a couple intraday spikes over that resistance but they were immediately sold. Watch the Russell carefully. If we see a dip under 1,040 it could be a sign of a pending collapse.

Russell 2000 Chart

I remain very cautious about the overall market and the outlook for the next 6-8 weeks. The market has shown an amazing resilience to almost any kind of headline but eventually this trend will end. This is a critical week for economic events and after three weeks of sideways movement we should see a market direction appear by Friday. Let's hope that direction is up.

Enter passively and exit aggressively!

Jim Brown

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"There is a time to go long. There is a time to go short. And there is time to go fishing."
Jesse Livermore