Since Wednesday's low the Dow has rebounded +3.5% on hopes for Washington solution.

Market Statistics

After declining -990 points from the October 18th high at 15,709 to the 14,719 low on Wednesday you would expect a serious oversold bounce on unexpected news. That +3.5% bounce put the Dow into the green for the week but the Nasdaq was not so lucky with a loss of -16 points.

With the deadline for disaster only a week away the market was seriously oversold but rapidly getting even more oversold as the week progressed. Wednesday afternoon's trickle of news about possible negotiations triggered a massive short squeeze in the futures Wednesday night and the Dow gapped open +190 points on Thursday. Anyone wanting to buy the negotiation rumors from Wednesday evening would have gotten really bad fills at Thursday's open as shorts raced to cover. This was one of those rallies where you had to be long when the news broke rather than actually buying the news after it happened.

On Friday another meeting with Senate republicans at the White House failed to produce any concrete results and the markets started to fade after 1:PM. However, when faced with the choice of going into the weekend short those traders covered at the close.

With a congressional recess scheduled for next week I suggested last Tuesday we had a pretty good chance of a resolution. Quite a few major political events have been magically resolved just before a congressional vacation. That is not playing out this time.

As of late Saturday all the proposals put forth by the House and Senate this weekend have failed. Even a "reasonable" bill with bipartisan support by republican senator Susan Collins failed in the senate. The bill would have funded the government, given federal agencies discretion in how they spent money under the sequestration and the medical device tax under Obamacare would be repealed with the revenue replaced elsewhere.

Speaker of the House, John Boehner, said Saturday afternoon the president had rejected two proposals and had gone back into "I will not negotiate" mode. If nothing happens before Monday we are likely to have a really bad day in the market with only three days before the debt ceiling deadline. At this point even if the senate did launch something on Sunday it would be Tuesday at the earliest before it could be passed.

There was not much in the way of economics to move the market on Friday. Washington headlines and bank earnings were the big news.

Consumer sentiment for October declined from 77.5 to 75.2 and the lowest level since January. This was no surprise. With all the negative headlines out of Washington I am surprised sentiment did not fall even further.

The present conditions component was unexpectedly flat at 92.8, up from 92.6 in September. The expectations component was the big loser with a drop from 67.8 to 63.9. Apparently consumers believe all the scary headlines about the results of a U.S. default. If they actually knew what a default would do the sentiment number would be half the current level.

The calendar for next week is peppered with some critical reports but all attention will be on Washington and whether or not there has been a resolution to the debt ceiling.

However, ONCE an approved bill is sent to the president the focus will immediately shift back to the economic reports and more importantly for next week it will shift to the Q3 earnings cycle.

The Fed Beige Book and the Philly Fed Manufacturing Survey are the two reports that will draw the most attention. The Philly Fed headline number is expected to decline from 22.3 to 15.0. If the headline number does decline it will be further insurance against a QE taper at the October FOMC meeting.

The Q3 earnings cycle begins in earnest next week. The S&P earnings estimate declined from the +3.5% growth they were expecting two weeks ago to +2.9% as of Friday. There were a lot of earnings warnings last week and more are expected. Guidance is going to decline for Q4 because of the impact of the government shutdown.

Micron (MU) reported earnings on Friday of $1.51 per share but that included a onetime gain of $1.31 from the acquisition of Elpida Memory. Excluding the onetime gain Micron earned 20 cents compared to estimates for 24 cents. Micron benefitted from higher prices after a fire at a plant owned by Hynix reduced available DRAM supplies in the market. Because of the shortage analysts expected Micron to post higher profits. Shares of Micron declined -8.6% on the earnings miss.

Wells Fargo (WFC) reported earnings of 99 cents that beat analyst estimates of 97 cents. Revenue declined slightly from $21.2 billion to $20.5 billion. Wells suffered from falling loan originations but they still created more than $80 billion in new loans in Q3. That was down from $139 billion in Q3-2012. The CFO said credit quality had improved significantly and loan losses had declined from $2.4 billion to $975 million. Shares declined $1 at the open but rebounded to end the day flat.

JP Morgan (JPM) posted a loss of $380 million or -17 cents per share but the reason for the loss was a monster reserve for legal problems. The bank took a $7.2 billion charge for litigation issues to bring its total reserve for legal issues to $23 billion. JPM has had a tough time with regulators recently and the bank is trying to wrap up all the outstanding issues as soon as possible to avoid a continuing drain on earnings. JPM is currently the focus of 12 different probes by regulators. In September the bank held discussions with all the parties and tried to come up with a settlement of all issues. A settlement number of $11 billion was rumored in the market.

The bank said fixed income trading was very slow in Q3 with profits down -2% from Q3-2012 and -17% from Q2. Revenue from equity trading rose +20%. Mortgage banking revenue fell -45% as loan originations declined sharply.

Earnings estimates for retailers are being revised lower after several reported lower than expected same store sales. Gap stores (GPS) reported September sales declined -3% for the worst month since June 2012. Banana Republic sales fell -5% and Old Navy fell -2%.

The miss by The Gap pushed the industry-wide same store sales index to only +0.4% for September compared to expectations for +3.1%. That is the weakest month since August 2009 when it fell -2.9%.

Sales at apparel retailers have been dismal. An announced 30% off sale at Urban Outfitters was upgraded to a 50% off sale to unload sluggish fall merchandise. The Buckle (BKE) said sales declined -4.5% compared to estimates for a +1.2% gain. L Brands (LTD) said sales rose only +1% instead of the +2% estimate. Cato Corp (CATO) said sales declined -3% and Zumiez (ZUMZ) fell -0.6% with estimates for a +0.3% gain. J.C. Penny reported a -4.4% decline in sales but that should be no surprise. Low dollar discount store Stein Mart reported a +5% rise in sales.

Costco (COST) missed earnings on Wednesday of $1.40 compared to estimates for $1.46. Revenue was more than $1 billion below consensus at $31.77 billion. They reported same store sales growth of +3% that was below estimates. YUM Brands (YUM) also missed earnings and reported lower sales growth. Their results were impacted by the continued chicken scare in China. Family Dollar (FDO) beat earnings estimates by two cents at 86 cents but warned Q4 earnings could be 70 cents compared to estimates for 76 cents. Same stores sales were flat compared to estimates of +2%. They guided to sales to decline -2% to -3% for Q4 compared to +6.6%. The CEO said the current retail environment was more challenging than expected. Competitor Dollar General (DG) posted sales increases of +5.1% so not everyone is feeling the pinch.

The weak retail sales all across the sector with only a few exceptions suggests Q3 was a tough quarter. That should translate to weak earnings across the board for retailers and other consumer stocks.

I would be hesitant to load up on any stock ahead of earnings because those that are missing the estimates are getting hammered.

Energy companies are also expected to post earnings declines because of weak demand, tough comparisons and slowing production. Chevron (CVX) warned that Q3 profits would fall below Q2 profits because of lower profits from refining and marketing and a loss from foreign exchange rates. They gained +$300 million in Q2 from currency fluctuations and they expect to lose a similar amount in Q3. Refinery maintenance and unplanned outages also hurt Chevron profits. Their oil and gas production in North America declined but international production increased slightly.

It is getting harder and harder for these giant oil companies to offset falling production in older conventional fields with new production from unconventional sources. Chevron shares dipped to long term support at $115 on the news. As a long term investor I would personally be a buyer here because Chevron has some monster gas projects in Australia coming online in the next several years.

On Wednesday evening Men's Warehouse (MW) officially rejected the $2.3 billion acquisition bid from Joseph A Banks (JOSB) at $48 per share. The stock soared from $35 to $44. The company announced a shareholder rights plan that would be triggered if any activist investor acquired more than 10% of the shares or a passive investor at 15%. The plan would give every shareholder of less than 10% one new share for every share they owned. The plan expires on Sept 30th 2014 unless cancelled by the board before that date. The board said it would consider offers that fairly valued MW and at this point the JOSB offer did not.

Shares rose again on Friday after a Stifel Nicolas analyst said an eventual deal between the two retailers could still happen. The analyst said after meeting with both companies the deal still made really good sense and the benefits to the combined entities could prove significant. Based on a takeout basis the analysts said MW could be worth $52 or more. He said JOSB management remains committed to a deal.

What goes around comes around. The co-founders of BlackBerry, Mike Lazaridis and Doug Fregin, are gearing up to make an offer for the company. Together they already own 8% of the outstanding shares. While they claim to have a plan for "stabilizing and reinventing" the company they don't have the $5 billion or more that would be required to beat the tentative offer of $4.7 billion at $9 per share already on the table. While that is not a firm offer it has provided support for the shares. The founders hired Goldman Sachs to help them "explore" a bid for BlackBerry. In English that means track down financing. That may be a very large task. Many of the big private equity funds including Blackrock and KKR have already passed on the company. Writing down nearly $1 billion in inventory on your new flagship product is not exactly awe inspiring.

Gold prices plunged on the prospect of a debt ceiling deal in Washington. Gold declined -$36 at 8:42 to $1259.60 when more than 34,000 contracts of the December futures were traded in two minutes. The orders were for the equivalent of 3% of the gold mined annually. The CME halted trading temporarily to allow for stop loss orders to catch up with the price. This is called a Stop Logic event. It allows the computers time to price match many of the orders triggered by the sudden drop. A fund or funds evidently decided the Armageddon trade was over and it was time to bail on gold. Some analysts are now saying we could see a retest of $1200 after a real debt ceiling deal.

Crude prices declined -$1.27 after the International Energy Agency (IEA) said non OPEC production could rise a near record amount of +1.7 mbpd in 2014. The new production is expected from the U.S., Canada and Kazakhstan. The IEA release caused the spread between WTI and Brent to increase to $9.26 and the widest in four months. U.S. crude production rose to a 24-year high at 7.83 mbpd on Sept 13th.

OPEC supply declined -645,000 bpd to less than 30.0 mbpd for the first time in nearly two years thanks to strikes in Libya and civil problems in Syria, Egypt. Global non OPEC output is expected to rise to 56.4 mbpd in 2014. Demand is expected to rise to 92.0 mbpd according to the latest IEA projections.

Another Chinese official called on the U.S. to solve the debt ceiling problem ASAP. Gang Yi, deputy governor of the Peoples Bank of China, was speaking in a panel discussion at the IMF meeting in Washington. "They should solve this problem as soon as possible" because "it was adding budget uncertainty to the global economy." Going further he said, "The Federal Reserve should carefully manage a reduction in its massive monetary stimulus." And, "What we need is an orderly, well communicated tapering." The China Daily newspaper is also blasting "the astonishing failure" of the U.S. Congress. The paper said, "It is pitiful that the US is now putting the fragile world recovery under renewed threat with its mind-boggling political infighting."

I guess it makes more sense to have China's premier just tell his citizens what to think and supply fictitious economic numbers to make them feel like their country is succeeding in the world. No country is perfect but at least we elect the people in Washington so we can blame ourselves when they do something stupid.

The market was very oversold and I expected a short squeeze if negotiations turned positive. I did not expect the squeeze to run this far on hope rather than facts. Obviously traders are convinced a deal will get done and they no longer wanted to be short ahead of the debt ceiling deadline on the 17th. That is probably a valid decision but like everything the market over reacted.

The S&P rebounded +57 points from Wednesday's low to come to rest at strong resistance from 1700-1705. The dip to strong support at 1650 was textbook even though shorts were hoping for 1630.

Now we wait for a deal to get done and that should be very soon or the market is going to revisit that 1650 level even faster than it did the first time. The most likely scenario is another temporary deadlock over the weekend followed by some last minute shouting and then a cram through of a modified bill on Monday or Tuesday. Assuming that scenario comes to pass we should see the markets return to an uptrend.

I see the 1680 level as short term support on any negotiation deadlock on Monday with 1705-1710 as resistance from July.

The Dow rebounded so strongly it is now at a post shutdown high. The index rallied over resistance at 15,200 on Friday and then used that prior resistance we support at the close. The weekend short covering on Friday pushed the index back over the 50 and 100 day averages. However, after rebounding +517 points and with no deal in Washington we could see a serious retracement of those gains. Support at 15,200 will likely to broken at the open depending on the Sunday night headlines.

Possible support levels are 15,025, 14,950 and 14,880. Upper level resistance would be at the 15,300 and 15,400 levels.

The Nasdaq did not recover all the losses from earlier in the week but it came close. The index bounced from exactly 3,650 and strong support on Wednesday to close at 3,792 on Friday. The index has strong resistance at 3,795 and just over the high for the day. Should that resistance be broken the next level would be the prior closing high at 3,818.

The Nasdaq should breakout once the Washington deadline is resolved. With some major tech earnings next week there is always the worry that companies like Intel or IBM could miss and warn and sour sentiment for the entire sector. At the 3,800 level the Nasdaq is priced for perfection. The index is up +25% for the year and we are headed into the fiscal end for stock funds on Oct 31st. Any bad news could turn ugly very quickly.

The small caps came back very strong to punch through resistance at 1,080 and then use that level as support during the afternoon dip. The index is only 3 points from a new closing high and that represents very positive market sentiment.

We did see a major sell off early in the week that was completely reversed to close with a gain of +6 points for the week. I doubt anyone would have expected that when the index was trading at 1037 on Wednesday. That is almost a +50 point or +4.5% rebound in only 3 days.

The magnitude of the rebound was of course due to some serious short covering but that was not the only motive factor. Funds were buying small caps again.

The only near term resistance is the prior high at 1,087.43with short term support at 1,080 and 1,065.

Once the Washington problem is solved the market will quickly focus on earnings. The earnings calendar for next week can be found here:Earnings Calendar

Partial highlights include YHOO, INTC and SCHW on Tuesday. On Wednesday we have BAC, IBM, AXP, SNDK and EBAY. On Thursday there is GS, ISRG, COF, GOOG, CMG and ATHN. Friday closes the week with MS, SLB, HON and GPC.

China may also weigh on the markets on Monday. On Saturday we learned that China's export growth unexpectedly declined by -0.3% in September compared to expectations for a +6.0% gain. That is the worst performance in three months. Exports to Southeast Asia declined to a 17-month low. Analysts believe this is related to a weakening in the global economy as a result of the QE taper talk. Unwinding QE is going to be very destructive to foreign exchange rates. Emerging markets could implode when rising rates in the U.S. cause capital flight from those risky markets. With China's exports falling sharply the GDP number on Thursday evening could surprise to the downside as well. Current estimates are for +7.8%, up from +7.5% in the prior quarter. Since China has cut back on building ghost cities it is harder to keep that GDP growing.

The late week rally was based on wishful thinking rather than actual progress. Market direction next week will again be based on headlines and the timeframe for action is short. A lack of any meaningful progress on Monday could be very detrimental to the market but once a deal is accepted we should breakout to new highs on the Nasdaq and Russell.

Everyone needs to understand that a last minute deal in Washington is probably going to be short term and we will revisit this shutdown-debt ceiling scenario again in the near future. A deal now is merely an agreement to negotiate again before the next deadline.

Despite all the press about the government shutdown this is the 18th since 1976. Shutdowns happen regularly. This is not a shutdown but a slim down. More than 83% of the government is still working. Only certain agencies are shutdown. The debt ceiling has been raised 53 times in the same period. On 27 of those debt hikes there were special conditions attached to the debt limit increase that had no relevance to the actual debt ceiling. There were things like women's rights, voter rights and cigarette taxes to name a few.

The American Enterprise Institute said last week that 60% of the 77 debt limit increases since 1962 came with democrats attaching conditions to the hike. Only 15% contained republican led conditions and 25% were divided with joint conditions. There is NO precedent for a president to refuse to negotiate on the debt limit since it has been happening routinely since 1962. In a negotiation nobody ever gets 100% of what they want. The parties negotiate and both sides give up something. That is how government works.

This debt limit problem is going to be played out over and over again in the years ahead. The government needs to borrow another $700 billion over the next 12 months. It will need to borrow another $7 trillion over the next ten years and probably more if Obamacare does not sign up enough young people and high earners to subsidize the premiums and health care for everyone else. Over the next 20 years the debt could rise by another $15 trillion because we borrow additional money every month to pay the interest on the current debt. It is like getting a cash advance on your credit card to make the credit card payment every month. Every trillion in new debt is going to produce another debt ceiling fight until the country eventually crumbles under the insurmountable debt load. It is only a matter of time.

Enter passively and exit aggressively!

Jim Brown

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"A speculator must concern himself with making money out of the market and not with insisting that the tape must agree with him. Never argue with it or ask for reasons or explanations."
Jesse Livermore