Market Wrap, Tuesday, 04/21/2009 Volatility Dip by Jim Brown Click here to email Jim

HAVING TROUBLE PRINTING?

After Monday's -289 drop and today's +127 point gain it would appear that traders don't know how to react to the flurry of conflicting earnings reports. The dip on the BAC credit quality was bought but not in the kind of volume needed to convince the bears.

Market Stats Table

There were no economic reports today to rile the market. The Risk of Recession for March came in at 45% compared to 47.5% in February. That is a report they need to trash. It never got above 60%, the high back in November, and we have the worst recession in progress in nearly 30 years. The real GDP in Q1 is expected to decline at 4.3% annualized and somewhat better than the -6.3% decline in Q4. If anything the recessionary conditions are improving and still pointing to a recovery into positive territory later this year.

This is a very light week for economics with only the FHFA Home Price Index and MBA Mortgage Application Survey on Tuesday. Neither are market movers. The weekly oil and gas inventory will also be released and crude inventories are expected to rise by another 3.0 million barrels according to Platts. Gasoline inventories are expected to have declined slightly but not enough to impact prices. Crude inventories are at 19-year highs and this should continue to pressure prices until demand returns. Several OPEC nations are already lobbying for another production cut when OPEC meets in May.

Prices were very volatile on Monday with a drop from $50 to $45 and that drop continued this morning to an intraday low of $43.83 before a rebound to close at $46.64. This was NOT in relation to the amount of oil in inventory or some new production outage somewhere. It was due to the expiration of May futures at the close of trading today. Those traders who were long the futures in hopes of a bounce as summer driving began to increase demand were rewarded with a continued lack of demand and they were forced to sell before expiration. June futures closed at $48.48 and about $2 higher than May. If anything the news was bullish for oil prices with depletion increasing worldwide. Mexico reported that production volumes for March fell by 6.6% and that drop was not voluntary.

Crude Oil Chart

The market moving news today was testimony by Turbo Tax Tim Geithner to a TARP oversight committee. Geithner said "indicators generally suggest improvements in confidence in the stability of the system and some thawing in credit markets." He also said "the vast majority of U.S. banks are adequately capitalized. He was quizzed on repayment of the TARP funds and why the big banks were not being allowed to return the money. He said return of the TARP money may have restrictions and the banks would not be allowed to return the money unless they could prove they no longer needed government help and were able to increase lending. He said available credit was more important than returning the TARP funds. Geithner also said that most banks have more capital than they need suggesting the worst was over for the financial sector. However, banks are still hoarding cash because they are afraid to lend and put themselves at risk. Let's hope the worst is over because the TARP has already chalked up a $104.5 billion loss from the money it loaned. Geithner's comments about over capitalization were credited with producing the market bounce.

Shorts were quick to pile on the financials on Monday's drop and they were treated to another news squeeze after the Geithner comments. Regions Bank rose +36%, Key Corp +31%, Citigroup +26% and Bank America +27%. The Banking Index rebounded +8%.

Earnings were the big news of the day and a trend is beginning to appear. That trend is better than expected results and some improving guidance from some. Caterpillar reported its first quarterly loss in 17 years. The company was hurt by falling sales and the cost of laying off thousand of workers. CAT is the largest manufacturer of heavy equipment and they said the global slowdown was worse than expected. The drop in sales was so large that it over shadowed the sharp decline in commodity prices like steel. The official earnings was a loss of 19-cents but that included 58-cents per share of layoff expenses. Ex items CAT beat the street by 4-cents with earnings of +39-cents. Revenue fell -22%. CAT said they experienced the biggest decline in sales since the 1930s. CAT said the stimulus package will have minimal impact because the amount of stimulus actually spent on construction was a very small percentage of annual construction spending. CAT guided investors for a $1.25 full year profit. This was down from prior guidance of $2.50.

Cat chart

US Bancorp (USB) recorded a profit of 24-cents per share, down -61% from 62-cents in the comparison quarter. This did beat analyst estimates of 20-cents per share. Revenue actually rose to $3.88 billion. Net charge offs nearly tripled to $788 million and rose to 1.72% of total loans. USB shares rose +20.9%. USB has also gone on record as wanting to repay the TARP funds as soon as the government gives them approval.

USB Chart

IBM reported earnings of $1.70 per share, a gain over the $1.64 in the comparison quarter. This beat analyst estimates of $1.66 per share BUT this beat was a manufactured number. IBM has a history of making massive share buybacks whenever their earnings are going to come under pressure. By reducing the number of shares outstanding it raises the earnings per share and gives investors the illusion that IBM is doing better than analysts expected. IBM also gave full year guidance of $9.20 per share.

IBM Chart

Coach (COH) shares spiked +15% after reporting earnings of 38-cents that beat analyst estimates of 36-cents. Revenue fell less than -1% and same store sales fell -4.2% but profits remained firm but down from the 46-cents seen in Q1-2008. Coach also initiated its first quarterly dividend of 7.5-cents.

COH Chart

Dow component Merck (MRK) disappointed investors with earnings of 74-cents after items and analysts were expecting 78-cents. Merck also reported some setbacks for several major drugs and investors punished the stock with a -7% drop. Merck affirmed earnings estimates of $3.15 to $3.30 and a revenue decline of as much as 7.8%. On the flip side MRK is buying Schering-Plough (SGP) and Schering reported earnings that nearly tripled, at least on paper. Schering posted profits of 56-cents compared to analyst estimates of 47-cents. The earnings in the comparison quarter were 17-cents but they included a monster charge for an acquisition. Merck is paying $41.1 billion in a reverse merger making SGP the surviving company. That will occur in Q4.

United Airlines (UAUA) cut its Q1 loss to $4.45 a share and less than the $4.55 loss in Q1-2008. Quarterly revenues fell -22%. United suffered from a 30% decline in premium seat traffic as more travelers decided to sit in coach. Delta (DAL) reported a loss of 96-cents per share and said it was going to start charging $50 to check a second bag beginning July-1st. Delta is trying to recover $100 million in annual revenue. Fuel costs increased +35% to $1.9 billion despite the drop in jet fuel prices. This was due to losses on their hedging program related to the drop in crude prices.

After the close Yahoo (YHOO) reported earnings of 8 cents compared to analyst estimates for profits of 8-cents. Earnings fell nearly 80% as advertisers drastically cut spending on online ads. Yahoo said it would cut an additional 700 jobs over the next couple weeks. Yahoo currently employs about 13,500 workers and has cut about 1,600 over the past year. Yahoo said revenues would continue to decline in Q2 to something in the $1.5 billion range, down from $1.8 billion in the comparison quarter. The new CEO declined to comment on rumored discussions with Microsoft about selling the Yahoo search platform. Playing the obvious CEO card she said Yahoo was reluctant to part with the search business. Obviously she is not going to say, "Would somebody please take this turkey off our hands." She has to say Yahoo wants to keep it otherwise the price will decline sharply. Yahoo shares rose +8% in after hours.

Yahoo chart

AMD posted a bigger than expected loss of 66 cents but after items that rose to only -62 cents. That beat analyst estimates for a 66-cent loss. Sales fell -21% to $1.18 billion. AMD gave lackluster guidance for lower Q2 sales and expressed concern that the market may have bottomed. However, the CEO, Dirk Meyer, said it was difficult to predict. "The second quarter is normally the weakest of the year for chip sales, I've heard some say we have hit bottom. I don't know how someone could say that for sure in the current economic climate." Profit margins fell to 35% and analyst Ashok Kumar said that was about 5% below expectations. AMD only exists to keep Intel from coming under increases monopolistic scrutiny. Intel has provided money and technology to AMD to keep them afloat. AMD shares fell slightly in after hours trading.

Capital One (COF) announced a loss of 39-cents per share compared to analyst estimates for a loss of only 8-cents per share. Revenue fell -26% to $2.88 billion. Analysts were expecting $4.17 billion. COF warned that credit losses were escalating and they were setting aside some more money for reserves. Charge offs are now expected to be more than the $8.6 billion previously forecast. The charge off rate is now 8.4% of outstanding loans. COF said as long as job losses continue to mount their credit quality would continue to decline. COF typically made loans to less than stellar credits and now they are paying the price. COF bought Maryland based Chevy Chase bank for $520 million in Q1, which increased the COF deposit base by $14 billion. This was a good deal for COF at a time when capital is critical. Money on deposit is as good as gold in the capital structure. However it did not help COF stock prices in after hours with a drop of more than $1.

Earnings overall this quarter have been "less worse" than expected. 60% of companies reporting have beaten the severely reduced estimates. Financials earnings to date have only declined -25% compared to estimates of -37%. Meanwhile the consumer discretionary sector earnings are down -114% and energy -61%. Both of those are worse than analysts were predicting. Over 70 S&P companies have already reported.

On Wednesday we will get earnings from AAPL, EBAY, ATI, BA, MCD, MO, MS, NVLS, QCOM, TROW, WFC, WLP and YUM to name just a few.

Coming up on Friday the first details of the financial stress test will be revealed and despite Geithner's comments today it is still a worry for investors. Analysts believe that the government's reluctance to allow banks to repay the TARP funds is to protect those banks the stress test is going to highlight as still in trouble. This is why I don't expect any real details about the results of the test to be released next week. Pointing out which banks other than Citigroup are still on life support would be severely negative for those banks. As long as the government can keep up the ruse by forcing all the big banks to keep the TARP money it clouds the issue on who is actually still in trouble. I heard one analyst say today that Morgan Stanley was in trouble and they have always been thought of as mostly immune from the current financial disaster. It shows how nobody really knows who is still living with a financial IV feeding tube. Talk is cheap. Having Jamie Dimon claim they would really like to return the TARP money immediately is a great sound bite. However, if Geithner has told everyone privately they can't give it back until 2010 then the sound bite is just a tool to prop up the banks stock price.

Emulex (ELX) finally found some loving after years of being ignored by tech investors. Unfortunately they don't want the affections of their new suitor. Broadcom (BRCM) made an unsolicited bid of $9.25 for the company and that represents a 40% premium to yesterday's share price. Emulex recently turned down an offer from Broadcom and immediately adopted a poison pill provision to ward off future advances. Broadcom said it had asked a Delaware court to invalidate recent changes in the company's bylaws meant to hamper the sale of the company. Broadcom reported a 19-cent per share loss for Q1 and a 24% drop in revenue. Shares were hammered for a 6% loss on the combined news.

Be careful what you ask for. On Sunday I suggested a drop back to Dow 7800 would be a welcome event that would give reluctant traders an opportunity to enter the market. The 7791 low at the open this morning was a perfect test of support and the Geithner comments were fuel for the rebound. Shorts were squeezed again and volume was decent at 10:2 advancers to decliners on 12.6 billion shares. It was not as powerful a rebound as I would have hoped but it was still a rebound. In our pessimism gone wild earnings cycle the analysts are being caught with their estimates around their ankles. Monday's drop on the Bank America news was only a brief return to the ugly days of 2008. Overall the earnings cycle has been better than expected and the recent economics are improving. Projections to return to growth in the later half of 2009 are expanding. Home Depot and Lowe's were upgraded today on the improving housing market. For traders expecting six more weeks of winter after dismal results from this earnings cycle it appears they should be breaking out their spring wardrobe. The view may not be so bright you have to wear shades but the clouds are definitely starting to clear.

The key for the rest of the week will be that 7800 support level on the Dow. As long as that level holds the buyers should begin to return. We could still endure a 10% decline back to the 7500 range and still maintain a bullish bias. I continue to believe those two levels represent a buying opportunity for bargain hunters. Resistance remains 8200-8400 and it probably won't fall easily.

Dow Chart

The Nasdaq dropped to initial support at 1600 as if an electro magnet was switched on at the open. The +45 point rebound intraday did not make up for the 65-point loss on Monday but it definitely took us out of harms way and the threat of breaking that 1600 support level. AAPL, EBAY, NVLS and QCOM will headline the tech earnings on Wednesday and investors may be cautious ahead of those afterhours reports. Resistance is still 1650 to 1685 and the bullish trend is still intact.

Nasdaq Chart

The S&P would be my cautionary index tonight. It fell further than I expected to 826 and rebounded less to close at 850. Initial support at 840 was broken but we did not approach the strong support at the 820 level. I believe the S&P was hurt by the drop in crude prices and therefore energy stocks, which are the second biggest sector in the S&P. The lack of a really decent rebound, although +2.1% was not bad, worries me slightly.

S&P-500 Chart

Offsetting my concern for the S&P was a whopping +3.9% jump in the Russell after a strong bounce off initial support at 450. This was a huge sentiment win and I believe the confirmation that Monday's dip was a one-day event. It also gives us a clear level for concern. If a second retest of 450 fails then I would turn short term bearish. Until that happens I believe Tuesday's rebound was a sign that bargain hunting funds are alive and well.

Russell Chart

The next problem we will have to worry about is the financial stress test details on Friday and the actual results on May 4th. Regardless of how the news is released or what it contains there is sure to be a volatility event attached. The best news would be to have 2-3 banks noted as still needing the TARP funds but not in danger and the other 16 banks overly capitalized for the foreseeable future. If Geithner gave the vast majority of the banks his blessing and told them to go forth and loan then I believe the markets would celebrate wildly. Continue to buy the dips until we are proven wrong.

Jim Brown