Market Wrap, Tuesday, 04/14/2009 Earnings Surprises by Jim Brown Click here to email Jim

HAVING TROUBLE PRINTING?

Now that the Q1 earnings cycle has begun in earnest the number of surprises are growing and many are unpleasant. Traders hoping for bank like earnings elsewhere are being disappointed.

Market Stats Table

The economic reports this morning were mostly ignored because the earnings from companies like Intel were feared much more than stale economic news. However, like the fertilizer it is the economics continue to pile up in the path of traders. The Producer Price Index (PPI) fell sharply in March by -1.2% due mostly to the drop in food prices. If you remove the volatile food and energy prices the core prices remained flat at a +2.6% year over year rate. Finished energy goods fell -5.5% helped by a -13.1% drop in gasoline prices.

Prices for finished good fell for the fifth consecutive month. A budget squeeze at home is depressing sales for meat and dairy products and prices for those items. Overall consumer foods prices fell sharply at a -10.1% annualized rate. Prices for core intermediate goods fell -7.7% at an annualized rate. The falling prices will eventually pass through to the consumer and there are no signs of inflation at any point. This suggests the Fed is clear to continue their quantitative easing policy.

Retail Sales fell unexpectedly by -1.1% in March. That was the official headline but I don't know how many people were actually expecting a sales gain. The official consensus estimate was for a gain of +0.4% but I doubt many analysts were actually expecting a gain. The biggest declines came from electronics and appliance stores, apparel stores and gas stations. The only gains came from drug and grocery stores. Core sales fell -0.8%.

The drop in sales wiped out the trend of gains we saw over the prior two months. Those sales were supported by gift card redemptions and colder weather stimulating clothing sales. Warehouse clubs, super centers, drug stores and restaurants showed gains. Almost every restaurant I visit frequently has published new menus with higher prices over the last 90-days. It appears their response to falling sales was to raise the average ticket price. Economic reports due out on Wednesday include Mortgage Applications, Consumer Price Index, NY-Empire Manufacturing Survey, Industrial Production, Housing Market Index and the Fed Beige Book. The Beige Book is the most important of the group. Last month the Beige Book showed that conditions deteriorated in ten of the 12 Fed districts. Philadelphia and Chicago reported weak conditions but unchanged from the prior month. For March we know consumer spending is going to be lower and tourism is practically nonexistent. Nonfinancial service businesses are slowing rapidly. Manufacturing has slowed to a crawl and businesses are trying to liquidate inventory rather than replenish. This report could be a serious shot of stimulus to the market if several districts reported an uptick in activity.

After the bell today the real earnings parade began with Intel earnings. Intel posted earnings of 11 cents and crushed the street estimates of 3-cents and said PC sales had bottomed. We should all run outside and set off fireworks in celebration, right? Not so fast. Intel posted the strong earnings due in part to a monster tax decrease rather than a surge in sales or margin. The effective tax rate for the quarter was 1% compared to estimates of 27%. This is due to some favorable rulings on some prior tax issues and it not repeatable. Gross margin fell to 46% and well below the 53% we saw in Q4. Intel's revenue was roughly $7.1 billion and about $100 million over analyst's estimates. Intel traded sharply lower in after hours.

There were several problems besides the sharp drop in gross margins. Intel said financial results for Q2 were too hard to predict and withheld any guidance. This frustrated traders after the "PCs have bottomed" comment. All Intel would say was that revenue would likely be flat with the first quarter and margins in the mid-40s as a percentage of revenue. Sales of the Atom chip for notebooks declined by $219 million, -27%, due to what Intel called an inventory overhang at retailers. I believe traders would have been less irritated over the drop in margins if Intel had given some specific guidance even if it was going to be weak. Investors don't like being told "we don' know what is going to happen." Intel's CFO Stacy Smith said "There is still a lot of uncertainty out there and it creates a wider range of potential outcomes than normal." Intel also said it was cutting back on CapEx spending and that is not good for those companies that sell to Intel.

Chart of Intel

Johnson & Johnson (JNJ) also reported earnings and beat the street despite a drop off in global sales. Net income was $3.5 billion or $1.26 per share. That matched the earnings from Q1-2008 and was +4 cents over analyst's estimates. The difference was in stock buy backs. JNJ only bought back $500 million in Q1 out of a total of $8.6 billion already announced. This suggests either JNJ is expecting its share price to drop or they are saving cash for a rainy day. JNJ shares gapped higher at the open but declined to close only fractionally positive due in part to the -137 point drop on the Dow. JNJ said it had four prescription drugs, each with potential sales over $1 billion a year, which could be approved by the FDA between April and August. It does not appear there is a recession at JNJ.

Railroader CSX Corp, (CSX) reported a Q1 profit that was -30% lower than the comparison quarter but still beat the estimates. Earnings of 62 cents were well above analyst estimates of 51 cents. The 30% drop in revenue came on falling shipments in all categories except agricultural products, which were flat. Railroads depend on raw materials shipment in the energy sector, metals, ores and the homebuilding sector for their bread and butter traffic. Transportation of cars and parts fell -53% from a year earlier. Metal shipping volume fell by 48%. CSX said it had cut expenses by 17% to cope with the slowdown in volume. Lower fuel costs also helped. CSX said it paid an average of $1.39 per gallon for fuel in Q1 compared to $2.82 a gallon in the comparison quarter. CSX shares rallied +6% in after hours.

Ebay announced after the close they were going to spin off Skype. They paid $2.6 billion for the company in 2005 and later had to pay bonuses of $530 million because production goals were hit. Skype has been a headache for Ebay since day one. They were forced to take a $900 million write-down in 2007 after using Skype in auctions never caught on. Investors have complained and Ebay has been unable to monetize that purchase even with their tens of millions of Ebay customers. Skype was created by the same people that created the music sharing website Kazaa proving once again that lightning can strike twice. Ebay has been faced with an ugly market over the last year and had to postpone any decision on Skype in hopes of better times ahead. Skype is successful with more than $551 million in revenue in 2008. That was up +44% from 2007. Ebay said Skype would generate more than $1 billion in annual revenue by 2011. The IPO is slated for a 14-month roll out. That gives Ebay time to hype it and time for the market to rally higher to more realistic valuations. No price was stated for the Skype offering.

The clear winner today was Denderon Corp (DNDN) with a +123% gain. DNDN said results of its prostrate cancer drug Provenge showed extended survival rates and would aid FDA approval for the drug. DNDN rallied to $22 from its $7.32 close on Monday but gave up some of its gains to ONLY finish up +124% at $16.99. Can we get a do over here and turn the clock back about 24 hours?

DNDN Chart

The loser for the day was Goldman Sachs with a $15 loss (11%) to close at $116. Goldman reported better than expected profits on Monday got a sharp boost in price but the dilution from $5 billion secondary offering is already hitting the stock. The offering price is $123 and once the price fell below $123 the drop accelerated. There is also an investor uprising over the new accounting plan at Goldman. Their year-end was Nov-30th making the Q1 period Dec through Feb. They announced they were switching to a calendar year end and that leaves the December data orphaned in accounting hell. That stub month contains $1.3 billion in write-downs and an after tax loss of $780 million. Did it help them in Q1 to leave out those losses? Sure but in the long run it is immaterial. Goldman is currently leveraged 22 to 1 and still has counterparty risk. They have received $12.9 billion in payoffs from AIG, which were funded by taxpayers. All of these factors plus the 10% dilution by the stock offering pushed GS back to close at $116 and well off the $131 high on Monday.

Goldman chart

Companies on tap to report earnings on Wednesday include ABT, AMR, ASML, INFY, MBWM, BTU, PJC, PLCM, PGR, UNB, LSTR, KMP and LAKE to name a few. The pace picks up on Thursday with a lot more names you would recognize like GOOG, JPM, HOG, NOK, PII, LUV, UTEK, PH, CY, FCS, BAX, AMLN and BIIB. Of course next week is crazy with nearly 500 companies reporting.

Is the rally over? Now that we have actually arrived at Q1 earnings and as evidenced by the Intel disappointment does that mean the rally is over? There is a quote by a famous market analyst from decades ago that goes something like "Trying to pick market direction based on facts is a fools errand." The market is not a rational being but is driven by the individual decisions of millions of investors and several very large funds. Without those funds cooperating the market is going to move slowly if at all.

That suggests the answer to the rally end question depends on whether those massive funds believe we are going higher. So far the little bit of profit taking we have seen is just froth. The semiconductors are still moving higher although at a much slower pace. After Intel's conflicted earnings who knows which way the chips will move. If PC demand has bottomed then chips should do well despite the drop in Intel's stock price.

The Dow has plenty of room to pull back to initial support at 7800 followed by 7500. Both levels should offer considerable support and allow for the market to digest some negative earnings guidance.

Dow Chart

The Nasdaq has stalled at resistance at 1650 and Intel's drop tonight should start the Nasdaq brothers off on a negative footing on Wednesday. There are no major tech stocks reporting on Wednesday. With Google reporting on Thursday and expected to disappoint it is entirely possible we could see further weakness in techs ahead of that report. Support is 1550 and then 1500 and either level would be greeted by buyers currently waiting on the sidelines with cash burning a hole in their pocket.

Nasdaq Chart

The S&P 500 broke over long term downtrend resistance on Thursday's massive short squeeze but failed well under the next resistance level at 875. Strong support remains 780 and it would be a great entry point on any serious profit taking.

SPX Chart

We need a real bout of profit taking over the next couple weeks. Everybody is questioning the rally and without some profit taking it will be tough to get new money into the market. Nobody wants to buy a +25% rally unless they can get a decent retracement first. This means the markets are likely in limbo until the next event. It is hard to believe that event will be better than expected earnings by a host of S&P companies but it is also hard to believe that anyone is not expecting some earnings disappointments. This produces directional confusion and not enough volume to move the market in either direction for very long. I would love to see a major earnings blowup by a couple of blue chip firms that would knock 400-500 points off the Dow. That would clear the air and bring back the buyers. One major negative today was the large increase in volume to 12.1 billion shares but this is an option expiration week. You would expect volume to rise when you have the double threat of major earnings events and expiration in the same week. However, I am still in dip buy mode and that is 7800 and 7500 on the Dow and 800, 780 on the S&P.

Jim Brown