Market Wrap, Saturday, 04/18/2009 Going and Going and Going by Jim Brown Click here to email Jim

HAVING TROUBLE PRINTING?

The markets are doing their impression of the Energizer Bunny as they stretched their rally gains to six weeks. Bulls are hesitant and bears are in denial but the result is still a higher market.

Market Statistics

Friday had only one material economic report and that was the April Consumer Sentiment. The survey posted a 61.9 number and well over analyst estimates of only 57.5 and last month's reading of 57.3. Friday's reading was the highest level since September's 70.3 spike. The improvement in the equity markets was credited with improving sentiment as well as the multi-decade lows on home interest rates. Despite the strong improvement it remains in the narrow range dating back to April 2008 with the September spike an unresolved anomaly.

The expectations portion of the index rose +5.4 points to 58.9 and the present conditions component rose to 66.6 from 63.3. This was a strong month and this is just the first reading. There is a distinct feeling that the worst may be over in the labor markets. The non-farm payroll report has failed to produce higher levels of job losses and the weekly jobless claims are starting to improve. April's sentiment gains could be the light at the end of the tunnel suggesting the economy is about to begin a rebound.

Consumer Sentiment Chart

Next week's economic calendar is devoid of any material event. There was nothing for me to highlight as something to watch. If these reports were cancelled nobody would care with the possible exception of the two home sales reports. Next week will be entirely focused on earnings rather than economics.

Economic Calendar

The earnings calendar for next week is extremely crowded. There are over 500 companies reporting and quite a few major earnings events. This is the biggest week of the quarter for S&P earnings. On Monday Bank America reports and all eyes will be on them to see what they say about TARP, the stress test and the Countrywide and Merrill Lynch acquisitions. This BAC earnings report and Wells Fargo earnings on Wednesday is where the rubber meets the road for the financials. Wells has already guided higher so BAC is going to be the banking focus.

Also reporting on Monday is IBM. I did not single them out n the list like MSFT and AAPL because they function in a different market. Their services division is still exploding and they deal with corporate clients much more so than Apple although Microsoft also benefits from corporate clients. IBM is expected to beat their earnings despite the global slowdown. This suggests we could see a negative reaction if IBM surprises to the downside.

On Tuesday we have Capital One (COF) and hopefully they have their consumer credit problems under control. However, we saw from Citi on Friday that credit card delinquencies have risen to 10.18%. COF has a lower class of credit and could have added exposure if consumer credit quality is still declining. If by chance COF makes some positive statements it could be explosive.

Yahoo reports after the close on Tuesday and traders will be looking for signs of change now that the new CEO has several months behind her at the helm of Yahoo. Will there be news of a deal with Microsoft? Carl Icahn was talking up the benefits on Friday of selling search to Microsoft. Baidu said last week that Internet ad sales began improving in late January. Did they improve for Yahoo?

On Wednesday Apple Inc (AAPL) reports and there is some concern that iPhone sales could be slowing. We saw exploding sales of the BlackBerry when RIMM reported but commentary from the Apple front line has been sparse lately. We know that Mac sales have been rising but were they hit by the economic downturn? I was answering reader email this week about the Market Monitor and I had far more questions about porting it to a Mac than ever before. It appears Apple has its foot in the Microsoft door and is pushing hard. Ironically the virus agencies reported this week about a first ever botnet Trojan called MacBot, which is infecting previously safe Apple Mac computers. It does not appear to have infected the stock, which closed at a new six-month high at $123 on Friday.

Ebay will be the second most watched stock on Wednesday when they report after the bell. There is some concern that auction volume is dropping because buyers no longer have any discretionary funds. On the flip side there should be more auctions because consumers are scratching to find some extra cash to help stretch the unemployment checks.

Wells Fargo also reports on Wednesday but they already guided higher so the fireworks should be muted. Dow component Boeing also reports and news of further delays in the 787 project could be a problem. The 787 is already two years behind. As of the end of March Boeing had backorders for 3,589 planes from 737s to 787s. On April 6th the Pentagon said it wants to cancel purchases of the C-17 transport plane and the Future Combat Systems program. It also wants to terminate the CSAR-X helicopter and the TSAT satellite and the prototype model for the airborne laser. All of these problems could surface in the Wednesday earnings report.

Thursday has Microsoft, Amazon and UPS. Amazon is on fire and continues to add more sales even in a troubled period. The Kindle is back ordered and Amazon is kicking butt in the Internet retail sector. The company that took so much heat over its Internet model when it went public is now becoming the go to retail shopping name. There is almost nothing you can't buy at Amazon.

Microsoft is expected to say that PC sales are still in the tank and they only made 39 cents per share instead of the 47 cents they made in Q1-2008. Research firm IDC reported this week that sales of PCs fell -7.1% for the quarter and 99% of those would have had a Windows operating system. MSFT did not offer a forecast for the quarter so there is a potential for a small surprise since everyone is predicting the worst.

The earnings from UPS and YRCW on Thursday will give us the health of the shipping business as a proxy for the economy. YRCW has already announced they were scaling down operations to save money until the business environment improved.

On Friday the announcement with the most interest will be Ford. This odd man out automaker, which is not embroiled in the GM/Chrysler saga, is gaining market share and could surprise everyone with Q1 profits. On the oil front Schlumberger (SLB) also reports and as one of the major service companies in the oil patch should give us some color on the health of the energy sector. Elsewhere in the energy sector Conoco Phillips, National Oilwell Varco and Occidental report on Thursday and Halliburton on Monday.

Earnings Calendar

Earnings last week did not excite investors. Intel and Google reports were met with confusion and lots of volatility in the stock price but no real surprises. Citibank reported earnings on Friday that were actually earnings instead of a loss for the first time in more than a year. Citigroup earned $1.59 billion in Q1 compared to a loss of $5.11 billion in Q1-2008. Quarterly revenue almost doubled to $24.79 billion from $12.44 billion a year earlier. These were the best earnings since the second quarter of 2007. The biggest hit to Citi was $10.3 billion in credit costs. There were $7.3 billion in net credit losses, mostly from consumer accounts, and a $2.7 billion increase in loan loss reserves. The better than expected news was met with a yawn and Citi gave back -9% for the day.

Citigroup chart

Citigroup is expected to finish dead last in the 19-bank stress test. The preliminary details are to be released on April 24th by Turbo Tax Tim after the Treasury has flip-flopped several times on releasing the details. The details of the test will be released on the 24th but the results of the tests will not be released until May 4th and then only in parts. This is one of those thorny problems that Turbo Tax Tim has created for himself. If 15 banks pass with flying colors and four are on life support then disclosing the names of those four could be fatal.

Seven regional banks have already returned nearly $500 million in TARP funds but the Treasury will not let the major banks return the money. JP Morgan said on Thursday they could repay the $25 billion it received in TARP funds immediately upon approval from the government. Goldman Sachs claims it can repay the $10 billion it received and Ken Lewis, CEO of BAC, said on TV two weeks ago BAC could pay back the billions it received once the government said ok.

Most analysts believe the stress tests will show the need for an additional $100 to $300 billion in capital for troubled banks and if there are no failing banks in the test results the validity of the test will be questioned. The test was designed to inspire confidence and that means somebody has to fail to make it believable.

GE also reported earnings that fell -35% but were better than analysts expected. GE profits fell to $2.8 billion do mostly to declines in the financial services and media businesses. Revenue fell -9%. Helping GE reach its profit goals was a $1.2 billion tax benefit at GE Capital. Overall the GE earnings were lackluster and the stock finished up only 12 cents. GE is not normally an earnings standout. They typically report right inline with expectations and analysts and investors alike rarely get excited.

Late Friday MGM Mirage (MGM) reportedly made a progress payment of $70 million towards the construction of the CityCenter project. MGM paid its $35 million share and the $35 million share for its partner in the project, Dubai World. The $8.7 billion project has been on shaky ground with rumors that MGM may file bankruptcy. The two partners have another $200 million payment due in two weeks. The WSJ posted a story that claimed differences between the two companies had been resolved and the project would be completed. There were no details. MGM is under threat of bankruptcy with Carl Icahn and private equity firm Oaktree Capital Management pushing them towards bankruptcy in order to restructure the more than $13 billion in MGM debt. MGM is suffering from a sharp drop in gaming revenue as a result of the recession. This came after MGM borrowed money for several acquisitions and building projects. Kirk Kerkorian, the majority MGM shareholder, would have to approve any deals struck by the company and any bankruptcy plan.

The markets finished Friday with gains of only 2-5 points across the major indexes. This was an option expiration week so the odds of a lackluster day on Friday were strong. Stocks were pinned at their max pain strikes and the day was an exercise in patience. The gains for the week averaged just over 1% but still managed to make it the best six weeks for the Dow since 1938.

The VIX finally broke below support at 40 and appears headed back to normal territory for a bull market around 20. The breakdown in the VIX is a key road sign for the rally. It suggests traders are losing their fear of another breakdown in the broader market. As long as investors were buying puts to protect their portfolio the VIX refused to fall. This is a key point in determining market direction.

VIX Chart

Until now the bears have been in denial and the bulls were not convinced. Every dip was bought and recent shorts squeezed yet again but there was no market conviction. As late as last week market analysts were still predicting another decline. Market sentiment was still overall bearish despite the five weeks of gains.

In fact stock mutual funds saw combined outflows of $5.2 billion for the week ended on Wednesday according to TrimTabs.com. This was a reversal of the minor inflows of $3.8 billion the prior week. We just finished the best six weeks in the markets since 1938 and mutual funds had outflows of $5.2 billion? This does not make sense for a bullish case and accurately depicts the overall bearish sentiment.

It is clearly a case of rally denial by the bears and by the investing public. As a contrarian this would normally be a strong bullish signal for me. Unfortunately I still feel there is trouble ahead. The earnings last week were better than expected for the most part but only better than some seriously reduced estimates. Those estimates had been reduced so drastically that only a snake could slither under the bar. Any positive uptick in business immediately pushed companies to a better than expected result. Many are doing this with tax refunds because business was so bad they overpaid and are filing restated forms to get refunds. GE capital got a $1.2 billion windfall from taxes to boost their earnings.

It appears the rest of the earnings cycle could follow this trend. Technically they will beat but fundamentally they will still be ugly. The banks have already played their trump card of surprising the street and other sectors yet to report now have a higher standard to uphold. I don't think it is going to happen.

However, I am not preaching doom and gloom today. I am only saying the lackluster earnings expected next week may not be enough to maintain the current rally. The velocity is slowing and as evidenced by the money flow there is considerable reluctance to buy the 28% rebound.

I have been preaching the "reluctant rally" for several weeks. The bears are in denial and fund managers are lightly buying the dips just to make sure they are not left completely behind. As more and more people catch on to the breakouts in the major indexes the rally should gain speed. However, it will not truly gain upward velocity until we have a serious dip for profit taking. There needs to be an event that really sucks in the remaining bears and the bulls can convince themselves it is safe to buy. A "normal" 10% decline would be ideal but there has been nothing normal about this bear market or this rally.

What event is going to cause this decline? Will it be another bank failure? I doubt it because the 24th bank failure of 2009 occurred after the close on Friday and it didn't even trigger a meaningful headline.

Will it be the stress test results on May 4th? That has possibilities. If the stress test is real and there are some big banks still in serious trouble then there could be a real dip in our future. However, what if there are no major problems in those 19 banks? Sure there have got to be some valuation issues but if none are in trouble then that could be the all clear sign everybody is looking for.

For years I have recited the mandatory paragraphs about the "sell in May and go away" strategy. The Stock Traders Almanac has been hyping this strategy since its discovery in 1986 and it is a very valid strategy in normal years. In theory traders capture the gains from the Q1 earnings cycle then move to the sidelines until October when they return to buy the dip. Historically this has produced massive returns. If you had started with $10,000 in 1950 and invested in the Dow from Oct-31st to April 30th you would have nearly $600,000 today. If you invested that same $10K in the market from April 30th through Oct-31st you would have lost about $2,000. The strategy is so simple that it has a lot of followers. If you used the MACD timing method used by the Hirsch organization to tweak this strategy your $10K account would now be worth about $1.5 million since 1950.

It does not take a rocket scientist to understand the ramifications here. The summer months have typically been lackluster and funds rotate out of portfolio positions heading into October so they can reload in November. If John and Jane investor have given up on stock picking and focus on ETFs as many investors do now, they can step aside very easily and go play with the grandkids for the summer without having to watch the markets.

Here is my key point for 2009. I don't think we are going to have a sell in May event. The 50% bear market drop has altered the plans of almost every investor. Most are underwater and will not want to sell their losing positions and risk missing a summer rally that would help them get well. Since everyone believes the bear market lows are behind us there is no downside to staying invested. Funds are not going to sell because they loaded up in March and they can weather any choppy markets headed into the second half of 2009.

Remember the economy is expected to recover late in 2009 and early 2010. This means stocks are still cheap today and they are expected to rally into that recovery. Why sell now?

I am sure there are some profits that need to be captured. After a 28% rebound I know there are some trading profits at risk. However there is a lot more money still waiting on the sidelines than there is invested in pure trades. That sideline money is waiting for a real dip to buy.

You may have noticed that every small dip we have seen has been instantly bought when it appeared to lose downward velocity. Cash is waiting and it is running short on patience.

We need that 10% retracement to properly load the boat. A 10% drop on the Dow would only be to 7300 but I have serious doubts it will ever happen. There are simply too many people who missed the rally boat and they can't wait for a chance to jump in.

A Dow drop to initial support at 7800 would only be 4% and a drop to even stronger support at 7450 would only be 8%. I would be extremely surprised to see that 7450 level retested but I could easily see 7800 over the next couple of weeks. If the Dow continues higher instead the next material resistance is 8350. At that point we could move into consolidation mode with several weeks of sideways action between 7900-8350 in place of a major correction. If money continues to chase prices higher then that is more likely than a retracement back to 7800.

Dow Chart

The S&P chart is much more bullish than the Dow. The S&P moved up to stall on Friday at 875, which just happens to be very strong resistance. However the minor decline at the close to 869 was very encouraging. The S&P is on the verge of a major breakout over 875 and should that happen it would negate everything I said about profit taking in the prior paragraphs. Once the S&P clears that resistance the money could come flying off the sidelines in hot pursuit of runaway stocks. I know that is a lot of speculation but the S&P chart is rapidly improving. Initial support is 820.

SPX Chart

The Nasdaq is a picture of the S&P only from several days in the future. The Nasdaq closed at a new five month high on Friday at 1673. Any move higher from here will be in clear breakout mode and could light the rally candle once and for all. This is going to be a critical week for the Nasdaq with a lot of big name earnings but even bad earnings has not slowed it in recent weeks. Just another 20-30 points on the Nasdaq chart is going to change the outlook considerably. That sideline money looking for a 10% correction may have to be contented with a 10-minute dip.

Nasdaq Chart

The Russell 200 chart is also a carbon copy of the S&P only a couple days into the future. The late January, early February resistance highs at 475 are behind us with the Russell close just under 480 on Friday. Small caps are leading the blue chips and this is a sign that fund managers are not planning to sell in May. They would not buy small caps if they were planning on selling them a couple weeks later. At this point in the market cycle this is a long-term hold.

Russell Chart

To recap, I am still in buy the dip mode. The bigger the dip the better but I would buy any dip that loses velocity quickly. The bank stress test is the only event I see on the calendar that could alter investor perceptions and I think there is more upside risk than downside. It is still possible that we could have some stinker earnings but so far the poor results have only impacted the stock in question. The bad news bulls are participating in the stealth rally and hoping to lure the bears out into the pasture one more time where they can be trampled in the next stampede. Buy the dip.

Jim Brown