Market Wrap, Saturday, 04/04/2009 Best Four Weeks In 70 Years by Jim Brown Click here to email Jim

HAVING TROUBLE PRINTING?

Over the last four weeks the S&P is up +23% and the Nasdaq +24%. Bears are in denial and the bad news bulls are in control.

Market Statistics

The Non-Farm Payrolls for March showed the economy lost -663,000 jobs and pretty much inline with estimates. Those estimates had started to tick up as the week progressed with an average high in the 717K range. All that gyrating was unnecessary as the original consensus was right on the money. The -663K March job losses followed a -651K loss in February. In this report January job losses were revised higher to -741,000 from the prior reading of -655,000. The five-month average is now -666,000 jobs per month.

The unemployment rate rose +0.4 to 8.5% and the highest since 1983. 13.2 million people are now unemployed and the highest level since records were started in 1940. That counts people who are freshly out of a job. If you add those who are working part time out of necessity until they find a full time job, totaling 9 million and twice year ago levels, and those out of the labor force but still willing to work the unemployment rate rises to 15.6%. The government chooses to only report those freshly out of work because it makes the numbers seem not so bad. The manufacturing sector lost -161,000 jobs, construction -126,000 and services -358,000. During the first quarter manufacturing and construction together have lost nearly a million jobs. Job loses total three million workers over just the last five months. The high unemployment creates a forced spending freeze by those out of work.

I spoke with an analyst on Thursday and he believes the worst of the job losses are over. The economy has not materially worsened in Q1 and companies are now down to their core employment. It would take another major economic blow to force companies to endure another round of layoffs. The nonessential and unskilled workers are the first to go followed by staff reductions in the mid level ranks and managers who have ceased to improve. Now the companies will be forced to cut skilled individuals they spent millions to train. These come with larger severance packages and extended benefits so keeping them on the payroll for another year is sometimes cheaper than firing them. Nearly everyone expects a recovery over the next year so companies should be toughing it out for the next six months.

Non-Farm Payroll Chart

The ISM Non-Manufacturing Index declined for the second month with a -0.8 point drop to 40.8. This is still well above the historic low at 37.4 set back in November but well into contraction territory. The service sector normally declines later than the manufacturing sector and the ISM services is now approaching the 36.3 level we saw on the ISM manufacturing index on Wednesday. That index has risen for three consecutive months from its low of 32.9 in December. The employment component for the services ISM fell -5 points to 32.3 from 37.3. This was the biggest decline in any component and matches the decline in the non-farm payrolls. The record low of 31.1 was set in November. The only services sector to rise in March was real estate.

ISM Non-Manufacturing Chart

Those were the only two reports on Friday and they caused a wide spread depression in the markets at the open. Fortunately the bad news bulls are feeling frisky this spring and traders bought the opening dip just like they did on Wednesday. This is a buy the dip market and bears are in serious denial and continue to short the bad news only to have those shorts eliminated within hours of being entered.

The bad news next week will probably be limited to downbeat earnings reports. The economic calendar is devoid of any material reports other than the FOMC minutes on Tuesday. The Fed has done such a good job with their post meeting statements the minutes are almost an afterthought. They still produce volatility but there is little we don't already know.

Economic Calendar

The earnings calendar is also light with only a couple names you might know. Alcoa officially kicks off the earnings cycle on Tuesday and expectations are for a second consecutive quarterly loss as the price for aluminum declines along with demand. Alcoa is expected to report a loss of 57-cents on revenue of $4.08 billion. Alcoa has rallied about 60% over the last three weeks on what I believe is bad news already priced in to the stock. This is one of the most widely known horror stories of the recession. Prices were exploding two years ago and Alcoa could not produce aluminum fast enough to keep up with demand. They opened new mines, added shifts and expanded plants. Just as those efforts began to shift into high gear the global market imploded leaving Alcoa running at full speed and going nowhere. There is also a takeover premium on Alcoa with several potential suitors being mentioned over the last several weeks.

Bed, Bath and Beyond (BBBY) will also report on Tuesday with earnings of +44 cents. This would be down a third from the comparison quarter but investors are flocking to the stock as a retail survivor after Linens and Things closed their doors. The stock is up +28% since March 1st.

Mosaic will report on Tuesday and this will be a key report. With global credit tight there is a problem shipping massive amounts of fertilizer overseas. The major companies, POT and MOS, have cut production and are benefiting from the lower cost of raw materials. It will be interesting to see if they can pull out a win with their earnings in a bad market. Once the global rebound begins these companies are again going to be bursting with profits but we have to get past their earnings first.

Chevron reports on Thursday and they are expected to show losses caused by the sharp drop in natural gas prices. That Burlington purchase several years ago looked great when natural gas went to $12 but today's $3.80 gas is going to seriously crimp their earnings. Regardless of their earnings this will be our first real view inside the energy sector for this quarter.

First Week Earnings Calendar

The financial sector got a major boost from the relaxation of the mark-to-market rules. The conversion to mark-to-make believe accounting will now be accepted on first quarter financials although FASB said the official rule change will take effect in Q2. This issue is not yet over but the bank stocks appear poised to break the bounds of gravity and move over current resistance.

Goldman issued a report on Friday saying the FASB change will not prevent bank shares from falling because bad loans are increasing at a 3% annual rate compared to a 2.5% rise in earnings before their loan loss reserves. Goldman says U.S. regulators may force the top twelve U.S. banks to write down another $1 trillion in loans based on values set in FDIC auctions of failed bank assets. This is twice the amount they have already written down. The FDIC said loans may only be worth 32-cents on the dollar compared to the 84-cent average currently on the books of the major banks. Some of the FDIC auctions got as little as 2-cents on the dollar. Loans have not been written down as strenuously as the mortgage backed securities and subprime mortgages. The bank loan portfolios are still relatively undamaged by the write down rules but with the accelerating delinquencies the hammer is about to fall.

If the FDIC and Treasury forces banks to write-down or sell these loans into the TALF program it could cause another capital raise cycle similar to the one we saw in 2008. Maybe worse because I doubt there are many deep pockets left that are willing to buy billions in bank stocks under those conditions. However, the change to mark to make believe is going to give quite a few banks some relief from the government pressure.

All those mandated mortgage rescue programs are failing. Mortgages modified in Q3 failed at a faster pace than those revised earlier in the year. Q1-2008 mortgage revisions saw a 41% delinquent rate after eight months while Q2-2008 loans had a 46% delinquent rate. John Dugan, U.S. Comptroller of the Currency, said credit quality continues to decline across all types of mortgages even prime. Prime mortgages delinquent by more than 60 days doubled in Q4. Prime mortgages are considered the least likely to fail and account for 65% of all mortgages. The percentage of borrowers who skipped making the first payment of a modified mortgage rose significantly in all categories except prime loans. Q4 first-payment defaults on subprime mortgages rose to 4.4% in Q1.

Fannie Mae (FNM) said their refinancings in March more than doubled to $77 billion. It is amazing what kind of activity 4% money can generate. The MBA mortgage report for last week showed that 79.1% of all applications were for refinancing with the 30-year rate at 4.61%.

The top 19 banks are undergoing their Treasury mandated stress tests and the results will be out by the end of April. Those that fail will be given six months to raise additional capital or be forced to take money from the government at terms already laid out for the banks. Given the recent retroactive rules you can bet any bank in trouble is already pounding the private capital market in an effort to beat the deadline. Nobody will want to be labeled a bad bank because they failed the stress test. This will be the ultimate scarlet letter on their forehead.

Capital One (COF) caught two credit downgrades from Fitch and Moody's on Friday and still posted a minor gain. The ratings downgrades came on worries that the declining credit quality would pressure earnings because of delinquencies in the COF portfolio. Several analysts contradicted the calls saying COF was handling the credit problems and considered the stock a buy at these depressed levels.

Research In Motion (RIMM) ignored all the naysayers and posted blowout earnings and dispelled the notion that the iPhone was a BlackBerry killer. Margins are rising and so are subscribers. RIMM now boasts 25 million subscribers, and this is the killer statistic, up +80% from just a year ago. There is no recession in BlackBerry sales and they keep releasing new models that are creating a feeding frenzy among the BlackBerry faithful. RIMM boosted Q1 guidance from 88-cents to 97-cents and well over the 82-cents analysts expected. Revenue is expected to be a roughly inline with the $3.4 billion analyst estimate but margins have risen to 44%. RIMM said inventory at the carriers is at the lowest level they have seen in a long time. The +23% after hours jump on Thursday to resistance at $60 held all day Friday but I am betting we could see some profit taking next week.

RIMM Chart

Halliburton (HAL) gained a buck Friday on takeover speculation. Currently at $17 and down from the $55 highs last summer the energy giant is no longer a giant in market cap. HAL is valued at slightly over $15 billion today and well under their $55 billion market cap of last year. Exxon was the rumored suitor and they could buy Halliburton out of cash on hand. Call options on HAL normally trade about 7,500 contracts per day. On Friday they traded over 75,000 contracts.

The big outrage for this week is the possibility of healthy banks using the TARP money to buy toxic assets from weaker banks. Is there anything wrong with using the government money to make a profit? Isn't that why they have it in order to do deals and make loans? If a bank was smart enough to avoid the bad deals on the way up I see no problem with them profiting from the bad decisions of others. Pawnshops do it all the time. Maybe that was a bad analogy. I believe if they want to buy a toxic asset they expect to profit on then it helps everybody. An asset may be toxic at 85 cents on the dollar but it might be a buried treasure at 35 cents. If a bank turns a profit while using TARP money then the bank gets stronger and the government gets their money back and a profit. I don't believe they should take their talents, TARP money, and bury it because they fear the government is a strong taskmaster and may scold them for taking risks. In the bible the servant who took the master's talents and made money was rewarded while the servant who buried the money until the master returned was punished.

The S&P posted the best four-week gain since 1933 at +23% and the Nasdaq saw its best ever four-week gain of +24%. The S&P added $1.3 trillion in market cap over that period. If you stacked $1.3 trillion in $100 bills the stack would be 820.6 miles high. A $1 billion stack is 3,333 feet high or 2.5 times the height of the Empire State Building. When you hear that the government has announced over $13 trillion in stimulus you can visualize a stack of $100 bills 8,206.3 miles high. Maybe you can visualize it but I can't. While I am on the statistic binge, AIG lost $61.7 billion last quarter or $7,757 per second, 24 hours a day, 7 days a week for 92 days.

I have to admit the gains were impressive. This has been a rebound to remember and despite accumulating four consecutive bullish weeks the market sentiment is still overall bearish. It appears we have stumbled into one of those reluctant rallies where nobody believes it and the shorts just keep adding fuel to the fire.

If you remember just four short weeks ago, it now seems a lot farther away than that, and the market prophets were predicting Dow 5,000 and Nasdaq 1000. The entire financial sector was going to implode and bread lines were expected to form outside the NYSE. Suddenly when things seemed darkest a rebound appeared borne on the back of a monster short squeeze. Every pundit advised selling the rallies because it was just a bear market bounce. Every rally that was sold bounced even higher in the days that followed despite all the talking heads on TV expressing their skepticism. Meanwhile the reluctant rally continued and shorts continue to give back their profits from the long descent from the 2008 highs.

Every news event threatened to scuttle the rally with dozens of reasons why this was the new catastrophe. The bad news bulls just put their head down and moved forward. Fund managers who believed the hysteria over lower lows ahead stood idly by and watched the market run away from them. As the quarter ended they found themselves chasing stocks to appear more intelligent than they really were when statements were printed. Surely once the quarter was over reality would return in the form of a correction or at least some profit taking. The market open on April 1st dipped sharply for about 15 minutes then resumed the upward trend despite warnings from analysts that the market was overbought.

I agree the market looks overbought from a technical perspective and should be due for a rest. Unfortunately for the bears a market in rally mode tends to ignore the technical aspects and trade more on emotion. The emotion today is denial on the part of the bears. After eight long months of market decline they can't grasp the concept of a change in trend. Surely the next bounce is a new entry point. Surely the market can't go up for five weeks in a row on top of a four-week record. Actually it can and it can go for another four weeks if the conditions remain the same. The bears will continue to short the rallies and the bulls and fund managers still in cash will continue to buy the dip. The key difference to this scenario today compared to six months ago is the bulls have the upper hand. The bears have lost their edge and the bulls are gaining power. Every move over a higher resistance level convinces a few more investors to come back into the market. It started with a trickle like a levee with a minor leak. That trickle grew to a stream and the bears are losing the battle.

Despite the 23% gains over the last four weeks there has not been a lot of excitement. The cheerleaders are notably absent because the overall sentiment is still bearish. The Volatility Index is still over 40 and stubbornly refuses to weaken. This is evidence of the bearishness because investors are keeping the volatility high with their put buying. If nobody bought any puts next week it would drop to 20 within hours. When you see it fall under 40 you know the bears are giving up.

If the bears give up the velocity of the rally will slow. We need the bears to be forced to cover shorts on every rally in order to keep prices moving higher. Once everybody moves to the same side of the rally boat the boat will capsize. I know it sounds strange but that is the way markets work. There needs to be enough panic to force movement. Panic to get out or panic to get in because your fund is not invested and your performance bonus is evaporating.

I personally believe quite a few investors have looked six months into the future and they see an economic recovery despite the current news of falling production and rising unemployment. Q2 is not expected to be as bad as Q1 and several analysts have said publicly the Q2 GDP could be fractionally positive. That would be a huge change in sentiment and investors are buying that news today. The bearish scenario about bank failures and new lows is growing quiet as signs of spring sprout in the market. The nuclear winter is drawing to a close and the frozen credit markets are starting to thaw.

None of this means we are not going to have a 500-point drop next week. We are bound to have some serious headline risk from those left to warn about upcoming earnings or those actually reporting like Alcoa, BBBY and Chevron. The headline risk is there but it is old news. Everybody knows the plot and like the cult classic Rocky Horror Picture Show everybody knows the dialog by heart.

The bear market rally crowd is growing silent and that is a dangerous sign because it means there will be fewer short squeezes driving the gains. If you look at the internals for the last couple weeks the up days have been on much higher volume with a much more lopsided advance to decline ratio. The down days have been on mediocre volume and fairly normal declines to advances. Many of the up days have been 90% days where up volume is the vast majority of the volume. For instance Thursday saw 11.6 billion shares on the upside and only 1.4 billion on the downside. The 13.152 billion shares total was significantly over the 9.9 billion shares that traded on Friday. Strong volume on the big up days and light volume on the consolidation days. This is textbook market action.

This leaves me in buy the dip mode and I anticipate I will stay there unless there is a dramatic market event. For Monday that dip support would be around 7800 on the Dow. The rising support trend line is very clear. Should that fail the next major support level would be 7500. That would be the ideal entry point for the next push higher but I would be very surprised if we saw that level again. Never say never but I would be surprised.

Dow Chart - Daily

Dow Chart - 60 min

The S&P-500 is the bear bait this weekend. The Friday stall at 845 and six-month downtrend resistance would appear to be the perfect entry point for the bears. I hope they take the plunge and knock it back to support at 780 once again. That would be the ideal entry point for the next leg higher.

S&P-500 Chart - Daily

The Nasdaq remains the leader of the pack and closed over resistance at 1600 on Friday. This is bullish and one more decent move higher and we could see it catch fire. That 1600 level was key resistance. The tech stocks continue to find buyers even when the semiconductor billings fell 30% last week. The bad news bulls are alive and well and very close to breaking out of the corral. This could be the trigger for the next squeeze higher. The bears have got to be scared if they are still short at this level. On the downside RIMM closed right at resistance on Friday and could see some profit taking from the +24% spike. This could produce some drag on the Nasdaq on Monday.

Nasdaq Chart - Daily

To recap I would continue to buy the dip and the bigger the dip the better. There is only one economic event of note next week and that is the FOMC minutes on Tuesday. Earnings warnings will continue to present headline risk but RIMM proved there is still an economy and certain segments are doing just fine.

Jim Brown

"The problem with socialism is that eventually you run out of other people’s money."- Margaret Thatcher

If you watch CNBC's Fast Money you know that the host, Dylan Ratigan's contract expired last week and he is no longer on the show. After searching far and wide they came up with a replacement once his current gig is over. Unfortunately we learned he was not an active trader and just talked a big game. That should qualify him as the new host but getting permission to film from prison could be a tough challenge for CNBC.

New Fast Money Crew