The shutdown is turning into a showdown with participants solidifying their positions as the deadline for action approaches.

Market Statistics

The budget battle shut the government down last week but the headline topics are slowly changing to encompass the debt ceiling as well. As the battle lines on the budget begin to blur and merge with debt ceiling talking points the potential for a grand bargain increased. At this point the president would make a major mistake by accepting a deal today that only solved the budget battle while knowing an even bigger battle is only two weeks away. It is incumbent on the president to package the two battles into one solution.

The House on the other hand may want to speed up the resolution of the budget battle and end the shutdown before taking up the problem of the debt ceiling. By ending the government shutdown the public interest will fade. The House has a much stronger argument for forcing spending cuts as part of the debt ceiling. By separating it into two different battles the republicans would likely stand to gain more ground.

The Debt Ceiling has been raised 16 times since 1993 when it was $4 trillion. It is currently $16.7 trillion. BOTH PARTIES have used the debt ceiling raises as tools to extract concessions from the other. This is not just a republican tactic. The party in control tends to use it to their advantage. There is absolutely ZERO truth to the claim by the president that the debt limit has never been used before to extort concessions from a sitting president. There is also ZERO truth to the claim that hitting the debt limit will force a U.S. default on its debts. The government takes in over $250 billion a month and debt service is between $30-$45 billion depending on the month. The default sound bite is simply a scare tactic used by whichever party is in control at the time. The government can prioritize payments to debt service although the current administration has rejected that option because it would take away one of their Armageddon style sound bites. Since much of the debt service payments would go to China that option may not play well on Main Street.

The market rallied on Friday despite further hostile sound bites from House and Senate leaders designed to be the lead in sound bites on the news shows over the weekend. The market rallied on three things. First, investors know the countdown clock is ticking and the longer the shutdown remains in force the greater the potential for a favorable resolution.

The second reason for the market rebound was short covering. When an agreement could be announced at any time traders were hesitant to hold short positions over the weekend. Nobody currently short wants to wake up on Monday morning and see S&P futures up double digits on some weekend resolution.

The third reason was bargain hunting. With the Dow at a four-week low and testing round number support at 15,000 this was a good spot for bargain hunters to begin nibbling at stocks. The Nasdaq is back just below the high for the week and the S&P honored support at 1680 for five consecutive days.

With the government shutdown the Nonfarm Payroll report was postponed for the first time in 17 years so there were no material economics to move the market. FYI, the BLS completes the Nonfarm report on the Monday prior to the Friday release. That was Sept 30th and prior to the shutdown. They give the report to the president on the Thursday prior to the release so his staff can prepare the administration talking points. There was no reason why the report was not released other than the decision by the administration to withhold the data and cause the market grief. Other government agencies like the Energy Information Agency went ahead and released their reports.

The ADP Employment on Wednesday became the proxy for the missing Nonfarm data. The ADP report showed +166,000 jobs created in September compared to estimates for +180,000. That was definitely in the Goldilocks range for continued Fed QE. However, the August number was revised down from +179,000 to +159,000. That makes the ADP report a miss and a decline and that suggests the Nonfarm data may also be lower than expected.

It was shutdown headlines all day Friday and the public is already tiring of that repetition. The government shutdown and life as we know it in the U.S. did not end. For the typical trader their mind was already turning to the Cowboy - Bronco football game on Sunday.

The economic calendar for next week is lackluster other than the FOMC minutes. Many of the reports will not be released but nobody is sure which ones. Some offices have said they will produce reports for several weeks using a skeleton staff while others are actually shut down. The nongovernmental reports like the Moody's Business Confidence and NFIB Small Business Survey will still be released.

The FOMC minutes is by far the biggest economic event for the week. The Fed surprised everyone last month when they did not announce a taper. Analysts will be scrutinizing every word in the minutes for a clue about future actions.

I believe they can search all they want and it will make no difference. With the government in shutdown mode the Fed is not going to announce a taper in the near future. According to analysts the government shutdown is removing -0.03% from the GDP per week but that number will grow the longer the shutdown lasts.

Next week is the start of the Q3 earnings cycle with the big names on Friday with JPM and WFC reporting.

With no taper on the horizon the market is free to rally in the fourth quarter because of diminished Fed fears. The president has not yet named his replacement for Bernanke but he has been talking about it a lot. That keeps the topic fresh and makes it appear that he is diligently searching for the right candidate. I could never make it in politics. Talking around a topic to generate interest without actually saying anything is an art. Knowing which topics to talk about and which to dodge is a science.

Tropical storm Karen is heading for the Alabama/Florida coast but winds have slowed to 40-45 mph. This is going to be a large thunderstorm by the time it hits the coast on Sunday. There is a slight chance of strengthening on Saturday night but forecasters are downplaying that potential. Louisiana and Mississippi could receive a light brush by the storm as it moves to the northeast this weekend. APC, XOM, BP, CVX, EPD, MRO and RDS.A were evacuating Gulf personnel ahead of the storm and shutting in some production to be safe. The region south of Louisiana is home to the majority of Gulf production. The Gulf of Mexico provides 23% of U.S. oil production and 5.6% of natural gas production. More than 45% of the refining industry is found surrounding the Gulf.

The storm's passage is close to the Louisiana Offshore Oil Port (LOOP) and the only U.S. port capable of offloading ultra-large crude carriers. The LOOP is still functioning but maintaining a close watch on Karen. We saw a sharp decline in oil imports three weeks ago when there was a flurry of storms in the Atlantic. This storm, although mild, will probably delay imports again. Tanker drivers will not want to fight the storm and will wait outside the storm's path until it blows over.

Crude prices rose slightly on Friday as traders speculated on the potential for a drop in production.

Tropical Storm Karen's Path

Have you got a potbelly? After the Friday IPO of Potbelly Corp you may be wishing you had one or at least a few shares of Potbelly (PBPB). The company owns Potbelly Sandwich Works and operates 280 company owned stores in the 18 states. The company sells sandwiches similar to Subway but warm and toasty according to their menu. Their IPO was warm and toasty after pricing at $14 it traded to nearly $34 before fading to close at $30.76 and a +120% gain.

Cherry Hills Mortgage Investment Corp (CHMI) was not as successful as Potbelly. The stock priced at $20 and never traded at the IPO price. CHMI topped out at $19.20 and then faded to close at $18.50. It is rare that an IPO does not trade at the IPO price at least briefly on the first day. The company will use the $130 million in IPO proceeds to buy mortgage servicing rights and mortgage backed securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae.

Sotheby's (BID) auction house said it adopted a poison pill two days after activist investor Dan Loeb's Third Point hedge fund acquired a 9.3% stake. Loeb wants to replace the management because of weak financial results and losing market share to Christie's. The poison pill activates if any one investor acquires more than 10% of Sotheby's shares. Sotheby's poison pill allows every existing shareholder owning less than 10% of the shares to buy $400 in common stock for $200 if an activist investor acquires more than 10% of the outstanding shares. That investor would not be allowed to participate thereby diluting him significantly. Loeb reacted with hostility to the plan and said he would acquire additional shares and once he had a board seat he would lobby for the replacement of the Chairman/CEO, Bill Ruprecht.

Tesla Motors (TSLA) shares fell from $193 to $168 after a video of a burning Model S went viral on the Internet. The car ran over a large metal object on the highway that punctured a three-inch hole through quarter-inch armor plating surrounding the battery compartment of the car and caused a short circuit of the batteries. The individual was not injured.

On Friday Tesla CEO Elon Musk said even after the firefighters punctured the batteries protective cover to extinguish the fire, it never reached the passenger compartment.

Musk released emails between Tesla and the car's owner, who is currently an investor and owns Tesla shares. The owner said the response from Tesla has been fantastic and far beyond what he could have expected. The company gave him a loaner model as a temporary replacement.

Musk pointed out this was the first Model S fire ever. He also said the fire ratio for a Tesla was once every 100 million miles driven compared to once every 20 million for a gasoline car. In the U.S. there are 30 vehicle fires every hour. Musk said the fire risk in a Tesla was significantly less than someone driving around with a gas tank filled with explosive liquid.

People beat up Tesla for only selling an estimated 21,000 cars in 2013. They should remember it took Toyota 8 years to grow Prius sales from 50,000 units to 250,000 units, a fivefold increase. Tesla expects to increase sales five times within two years.

TSLA shares rebounded nearly $8 on the news.

You probably heard that Twitter is going to launch a $12 billion IPO. We don't know what the symbol will be but it is not TWTRQ. That belongs to Tweeter Home Entertainment. The stock was halted on Friday after a rumor broke that this was related to Twitter. The stock rose +1500% intraday. Yes, +1500%. Of course it was only trading for a penny prior to the rumor. Somebody made a lot of money because 14.4 million shares traded hands compared to the average daily volume of 61,000 shares.

Priceline gained +13 on Friday after Lazard raised its price target to $1200. Note to CEO Jeffery Boyd, "It is ok to split your stock." There are only 51.5 million shares outstanding.

BlackBerry (BBRY) was back in the news on Saturday thanks to a Reuters article. Reuters said the company was in talks with Google (GOOG), Cisco (CSCO) and SAP AG (SAP). Reuters also listed Intel (INTC), LG Electronics and Samsung as parties to the talks. Private equity firm Cerberus has previously expressed interest according to Bloomberg. Reportedly the company has requested preliminary expressions of interest from potential buyers by the end of next week. BBRY shares closed at $7.69 on Friday.

Lockheed Martin (LMT) said it was planning to furlough 3,000 workers on Monday as a result of the government shutdown. The number of workers furloughed will increase each week until the shutdown is over. Some workers are prevented from working because their jobs are in government buildings that have been closed. Boeing (BA) also said it will begin "limited furloughs" next week. The Aerospace Industries Association said tens of thousands of defense workers are being forced off their jobs with no pay. BAE Systems and United Technologies (UTX) are also planning furloughs. As many as 15% of the 34,500 employees at BAE could be sent home. More than 1,000 BAE employees in the U.S. have already been laid off. UTX said a further extension of the shutdown could put 5,000 workers at risk.

Goldman Sachs believes there will be a grand bargain where the budget resolution and the debt ceiling will be combined together in a single solution. However, they do not believe it will happen before October 12th and more than likely it will be somewhere around the Oct 17th deadline set by the Treasury. They view that as a 60% probability. They also said there was the remote possibility that the budget issue could remain unresolved even after the debt ceiling had been dealt with. Goldman gave this a 30% chance of occurring.

There is also a decent chance that Congress might vote to suspend the debt ceiling until some future date. This is different that voting to raise it but only in the minds of lawmakers. They can still say with a straight face they did not vote to raise the debt ceiling. In theory this would appease low information voters that don't really understand what happened. You see most voters actually believe what politicians tell them.

Lastly, Congress is scheduled to go on recess the week of October 13th. It is amazing to look back and realize how many seemingly insurmountable hurdles were resolved in the days just prior to a congressional recess.

The president tried several times last week to force the stock market lower. In multiple sound bites he warned investors that "this shutdown is different." Prior government shutdowns have had little impact on the market with stocks rising in the month following a resolution. Analysts believe the president would like to see a plunge in the markets that would weaken republican resolve and allow democrats to win the battle.

Meanwhile lawmakers will spend the weekend looking for cameras and microphones to jump in front of and get their 5 minutes of weekend fame. There appears to be no urgency to solve the problems so next week could be a duplicate of last week only there will be less interest from the public. The lack of an actual calamity breeds complacency.

The shutdown and debt ceiling are only two of the challenges for the market. The third one is the earnings cycle. S&P Capital IQ said earnings growth estimates for Q3 are +3.3% and revenue is expected to increase +4.1%. Both of those numbers are better than Q2. However, there is a fly in the earnings soup.

FactSet reported that 82% of companies giving guidance have reduced expected earnings. That is the most for a quarter since they began keeping records in 2006. Thomson Reuters said that companies have reduced estimates over the last two quarters the most since 2001.

Somebody is wrong or the comps are so lackluster that even reduced earnings guidance is still +3.3% growth. With Q3 earnings beginning this week we will see pretty quickly over the next two weeks how this quarter is going to play out. Estimates for Q4 finally dropped into the single digits for +9.7% growth. I would definitely bet against that level coming to pass.

The market does not seem worried about Washington or earnings. The Dow was the only index to decline significantly at -185 points while the Nasdaq actually gained +26 points for the week. The S&P lost -3 points but that is hardly a material loss.

The S&P tested strong support at 1680 every day last week with an intraday plunge to 1670 on Thursday before recovering to close at 1679. Friday short covering and hope there might be a deal in Washington over the weekend pushed the index to a gain of +12 on Friday.

I view the solid support at 1680 as the red line for the market. As long as the S&P does not close significantly under that level the longer term market sentiment is still bullish. The short term sentiment is just reacting to the headlines and trying to scalp a few volatility trades.

The Dow continues to be the weakest index despite the +76 point gain on Friday. The Dow has lost ground repeatedly since the high on September 19th. The 15,000 level is round number support that almost failed on Thursday with the Dow closing at 14,996. Friday's rebound was simply short covering and probably some light bargain hunting.

The Dow is oversold but could become even more oversold with a drop to 14,880 and strong support. Since the headlines next week are not expected to be conducive to a change in sentiment I think we have a good chance of seeing that 14,880 level.

The Nasdaq plunged from the 13-year high of 3819 on Wednesday to 3753 on Thursday. That was a dramatic shift in sentiment but driven entirely by the Washington headlines. On Thursday afternoon and Friday the index recovered almost all of the drop to close at 3807 and only 12 points from a new high.

What this showed us is the strength of the support at 3750. That level has been tested numerous times over the last two weeks and held each time. Even the monster gap open lower to 3734 on Monday was immediately bought to close back at 3771.

Bullish sentiment for tech stocks is very high all things considered. Resistance remains the recent high at 3819 but I think that will be broken.

The Russell 2000 is the twin of the Nasdaq. There is solid support at 1065 and solid resistance at 1080. Several excursions outside that range eventually failed. The Russell closed at a historic high of 1087 on Tuesday but then gave back its gains to retest 1065 on Thursday. There has been volatility but the dip buyers are alive and well.

In normal Octobers the seasonal volatility usually occurs between the 19th and 28th as fund managers restructure portfolios for the October 31st fiscal year end. This year and this October are far from normal. How much of that seasonal trend we will see this year is unknown.

What we do know is that many fund managers are behind the curve and have failed to keep pace with the market gains. That could mean they are willing to hang on until the last minute in hopes of a Washington resolution producing one last climatic bounce. However, even if that happens there is a good chance we will see at least a brief sell the news event in the days that followed.

In the contrarian view some believe the fund managers have already shifted out of their losers and took profits in winners to cover those losses when the markets hit highs back in August. They believe the decline in late August was the portfolio restructure cycle.

Since nobody knows for sure we simply have to dance with the trend that brought us to this point. We should continue to remain bullish and view any Washington generated dip as a buying opportunity. Who knows, maybe earnings will be stronger than expected because the bar has been lowered too much. Time will tell.

Enter passively and exit aggressively!

Jim Brown

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"I believe there are no good stocks or bad stocks; there are only money making stocks. So there is no good direction to trade, short or long; there is only the money-making way to trade."
Jesse Livermore