If you are expecting a logical response to the government shutdown don't look in the stock market.

Market Statistics

Portions of the government shutdown at midnight last night and the markets rallied. While that may seem like the opposite of conventional wisdom there is some validity to it. Actually going into shutdown has changed the characteristics of the negotiations. As the hostility heats up and the mudslinging shifts into high gear there is a greater chance of a compromise. With the debt ceiling coming up for debate only two weeks from now there is suddenly a good possibility the two problems could be merged into one big settlement.

When the market opened it was running on comments from various lawmakers saying it would be a very short term shutdown lasting a day or two. By late afternoon that idea had faded and 10 minutes after the close news started to break that the republican leadership was now thinking it could be a week to ten days. While that means we will be inundated with shutdown headlines for far longer than expected it also means there is an even better chance there will be an omnibus settlement that could include the debt ceiling. That is bullish if it works out that way but there are a lot of potholes in the path between now and a grand bargain.

Another positive for the market was the outlook for QE. The longer the shutdown lasts the longer it will be before the Fed actually tapers QE. The shutdown is harming the economy because of the uncertainty and the million plus government workers not getting paid. Companies may hold off on capital spending because they don't know what the environment will look like when the dust settles. Who knows what grand bargain the House and Senate may end up with after all the arm twisting? If it drags on very long the AAA credit rating for the U.S. could be in jeopardy.

You would have thought the Washington headline war was already over. The Nasdaq soared to a new 13 year high at 3817 and broke out of a two week consolidation range. The Russell 2000 also broke out to a new high at 1086 after punching through solid resistance at 1080. The Dow and S&P both posted gains but remained well off their September highs. The Nasdaq and Russell have been the leaders to the upside and that was very evident today.

The economics were also favorable although mixed once again. The biggest positive was the ISM Manufacturing Index. The ISM headline number rose from 55.7 to 56.2 and the highest level since 2011. The estimate was for a decline to 55.0. The gain was a surprise to everyone. However, the new orders component declined from 53.2 to 60.5 but order backlogs rose slightly from 46.5 to 49.5. The employment index rose from 53.3 to 55.4 and that is positive for the job outlook. That is only the third gain this year.

This was an update report and it suggests the ISM Services report will also surprise to the upside.

The Construction Spending report was not released because of the government shutdown.

The Texas Service Sector Survey for September declined from 16.7 to 14.0. The revenue component declined sharply from 13.6 to 8.9 and that suggests the index could fall in October as well. However, the employment component fell sharply from 7.5 to 3.7, a 50% decline. Companies are still hiring but at a much slower pace. Retail sales also fell sharply from 21.1 to 16.5. The expectation component fell from 27.5 to 23.5. Texas was the hot spot for business in the U.S. but maybe that trend is slowing.

The annualized vehicle sales for September declined from the 16.1 million pace in August to 15.3 million in September. Last month had two less selling days because of an unusual calendar but estimates were still higher at 15.9 million. Even at the lowered pace that is still higher than the 14.94 million pace for September 2012. The pace of auto sales fell from 8.0 million to 7.7 million. Light truck sales declined from 8.1 million to 7.6 million.

Domestic manufacturers saw their market share rise slightly from 44.6% to 45.0%. The three major Japanese automakers saw market share decline from 34.5% to 31.4%.

The economic calendar for the rest of the week is cloudy. The Nonfarm Payroll report on Friday has been postponed because it is a government report. Other reports that will be postponed until after the shutdown will be the Factory Orders for August, oil inventories and natural gas inventories. The reports produced by private agencies like the ISM Services and home prices will be released on schedule. The ADP Employment report on Wednesday will be released on schedule.

Bernanke will still speak at 3:PM on Wednesday and three of the Fed dwarves, Williams, Powell and Fisher, will still speak on Thursday.

As you can imagine what little stock news there was quickly became lost in the storm of shutdown headlines. One headline that stayed on the top of the news was the massive sell off in gold. Somebody, probably a big hedge fund, dumped a massive amount of gold futures in the market. Between 8:30-8:40 more than 23,000 contracts of the December gold futures were dumped on the market. This was more than $1 billion in gold futures.

Gold prices imploded from yesterday's close at $1,326 to hit $1,282 intraday and a decline of -$38 for the day. This completely flushed any weak holders and it may actually be a capitulation event in the gold market. It may take a couple days for the echoes of the drop to fade away but it was a major event. Strangely the total volume for the day of the December futures was 119,700 contracts compared to the daily average of 159,000. That is a significant shortfall given the massive move. The drop probably would not have occurred if the contracts were parceled out over the entire day rather than dump them all at once.

That strange trade could have been a major player bailing out OR it could have been a major player trying to crush the market. It could have been JP Morgan dumping futures to raise money for a massive settlement for its mortgage sins but I doubt it since JPM traders are smart enough to sell the contracts in small amounts to avoid impacting the price.

Several analysts theorized that the expectations for a short shutdown simply negated the Armageddon trade. I think they were drunk at the time since the shutdown could actually morph into an Armageddon event where gold as insurance would be a plus.

Whatever the reason for the massive drop it will be interesting to see if buyers appear now that the weak holders have been flushed.

Silver declined -50 cents in sympathy with gold and volume was also below normal. Silver broke below the 100-day average at $21.52 that had been support for the last month. After trading as low as $20.63 it rebounded strongly in the last hour to close at $21.15.

Under Armor (UA) rallied +4% on an upgrade from JP Morgan to neutral from underweight. Yes, I said +4% on an upgrade to neutral. The analyst said in conversations with retailers they found the space allotted to active wear growing significantly. Macy's said it was doubling the square footage over the same period in 2012. Nike (NKE), Under Armor and North Face were the brands being expanded. There was a strong push into space allocated for women's active wear. That is a portion of the sector that has previously been under served by retailers.

Apple (AAPL) shares rallied +$11 after Carl Icahn had his long awaited dinner with CEO Tim Cook and pressed him for upping the share buyback to $150 billion. That is twice what Apple has already planned. Icahn said Apple could borrow money at 3% and take advantage of the depressed share price to organize a monster share repurchase that would benefit all shareholders. I am not holding my breath. Icahn may be a billionaire but Apple has a market cap of $450 billion. Even if Icahn bought a billion dollars in Apple shares he is just 1/450th of the outstanding shares. Icahn said he can't promise they will take his advice or that the stock will go up but he did promise he was not going away. That implied threat to Cook and the board will at least make them think about upping the buyback.

Chicago Bridge and Iron (CBI), a current play in Option Investor and the OilSlick.com newsletters announced today it was forming a joint venture with China Power Investment Corp (CPI) to build nuclear power plants in China. CBI will include the provision of engineering, procurement, construction management, commissioning, project management and technical support services for new plants developed by CPI. China is planning on approving 30 new plants by 2020. They have approved four new plants so far in 2013. CPI is one of the largest state-owned power companies in China and one of three nuclear plant owners and operators.

CBI has 50,000 employees and is the most complete energy infrastructure focused company in the world. They are the provider of choice for the LNG industry and they have several major developments under construction and several more in the bid process. They were just awarded an engineering bid for LNG work by Russia on Friday. CBI shares have recently broken out from a three-month consolidation and closed at a new high today.

The markets rocketed higher on Tuesday for multiple reasons. I already explained how the expectations for a short 1-2 day shutdown caused buyers to appear. We have had so many critical events pass silently away that the prospect of a 1-2 day shutdown and then a successful budget agreement was just one more crisis that turned into a buying opportunity. The "everything is going to work out" mentality took hold again.

When the futures began spiking overnight the shorts got scared and the result was another major short squeeze. After declining continuously since the high on September 18th on fears of the dreaded shutdown the shorts were overloaded and ready for a massive drop. Surprise! It did not quite work out as they expected and the squeeze was on.

This was also the first day of the month when new retirement contributions normally hit the market. Fund managers apparently applied those funds to what has been working for them for the last several months. That is small caps and tech stocks.

The White House may have been preaching Armageddon against the republicans but investors were tuning out the hostile headlines. The news after the bell that the shutdown could last 7-10 days took the bloom off the S&P futures and turned them negative. The House tried to pass targeted spending bills to support parks, veterans and the municipal government for the District of Columbia but before the votes had even been taken the Senate and White House said they were doomed. The increasingly hostile environment now has analysts wondering if everything will work out after all.

Normally when the House approves a bill and the Senate modifies it they appoint a conference committee that meets to work out a compromise. The House appointed a conference committee to conference the budget differences but the Senate members refused to attend.

In theory this is when the two sides should be hiding out in a conference room working out their differences. Instead they are firing off increasingly hostile sound bites and the situation is not improving. This may turn the shutdown rally into a one day wonder.

The S&P bounced off 1680 twice on Monday and then rallied to test resistance at 1695 today. There is significant resistance from the close at 1694 and 1705. An announcement the two sides have come to an agreement could easily propel the S&P well over that resistance but continued hostility could force a retest of support at 1680.

We should not apply too much emphasis to technical analysis of the charts tonight. This is a headline driven market and until the headlines turn positive the S&P should have a tough time pushing higher.

The Dow was the weakest index again with a gain of +62 points or +0.4%. The Dow struggled with resistance at 15,200 and would have performed even worse except for a +30 point gain in the last five minutes of trading. There were big gains in JPM, IBM, AXP, DD and DIS and GE in the last 5 min.

The Dow declined to a three-week low on Monday and was heavily shorted. Despite that the rebound was lackluster.

Support is 15,100, 14,880. Resistance 15,200, 15,275.

The Nasdaq exploded higher after touching a two week low at 3734 on Monday. The index gained +46 points to close well over prior resistance at 3800 and we are in blue sky territory at 13 year highs. Unless there is a disaster in Washington we should see higher highs. There may be some temporary profit taking and there is always headline risk but the strength of the move today was pretty amazing.

Support should now be 3800 followed by 3750.

The Russell 2000 also broke out to a new high at 1087 and easily overcoming prior resistance at 1080. With the small caps in breakout mode after a dip to 1061 on Monday this rally could have legs. I keep thinking the October fiscal year end for funds will eventually force some profit taking but there is no indication of that today but the month is young.

The market is being driven by headlines and assumptions that everything will work out. Rarely does that work out as expected but investors appear committed to that prospect. It is hard to project market direction when fundamentals don't matter.

More than 100 S&P companies have issued guidance for Q3 earnings. S&P said 65 have warned, 25 have issued positive guidance and 16 guided in line with estimates. That is nearly a 3:1 ratio of negative to positive. Earnings are expected to grow +3.1% and revenue +4.0%. While that is not bullish it is still a positive trend in earnings growth. It is not enough to justify the markets breaking out to new highs.

I expected a buying opportunity when the debt ceiling debate heated up. We are not there yet but the market does not appear concerned. If a grand bargain is struck it should produce a continued gain in equities. However, if whatever compromise is reached in the coming days only deals with the continuing resolution on the budget we could see a sell the news event.

Enjoy the gains but keep your finger on the exit trigger.

Enter passively, exit aggressively!

Jim Brown

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