Market Wrap, Saturday, 05/02/2009 Swine Flu, Stress Tests And More! by Todd Shriber Click here to email Todd

HAVING TROUBLE PRINTING?

It was another action-packed week for the markets. Trying to cram all the news into a confined space is a lot like listing all the ingredients on the front of a cereal box and telling people there's also a prize inside. The major indices shook off news of swine flu and delayed bank stress test results to continue their march higher with the Dow, Nasdaq and S&P 500 all finishing the week up at least 1.5%. Those are modest numbers, but let's not scoff at the fact that April was a banner month for the market.

Market Statistics

By any account, last week could've been a disaster with headlines of swine flu swirling around before Monday's open, sending the futures lower. Obviously, this wasn't welcome news for pork makers and Smithfield Foods (SFD), the largest US pork producer, finished the week down about three percent. We also noted in the Market Monitor that travel-related stocks, most notably airlines and hotels, suffered at the hands of the swine flue news. Proving this is a resilient market, shares of Starwood Hotels (HOT) and Wyndham Worldwide (WYN) both finished the week higher on solid earnings announcements.

Investors with the foresight to have purchased shares of CVS Caremark (CVS) and Walgreen (WAG) enjoyed a profitable week as shares of the drugstore operators surged on swine flue concerns. Both stocks finished the week up more than five percent.

Much like Monday, Wednesday could have been a dire day on news that first quarter GDP looks to be far weaker than previously thought. Estimates had called for a contraction of -4.7%, but Wednesday's advance reading showed a decline of -6.1%. Logically, many investors would think this would be a terrible day for the markets. Mr. Market had other ideas and turned in his best performance of the week. Go figure. Even bad news these days can be good. Have a look at the chart below to understand just how dire recent GDP performance has been.

GDP Chart

The news spigot was flowing in full force on Wednesday as substantial declines in nonresidential and residential construction spending were reported at 44.2% and 38%, respectively. Adding salt to the wounds was a report that software and IT spending fell nearly 34%. These are annual figures. Another decline in spending that flew somewhat under the radar was, get ready for this, cue the drum roll please, government spending.

Most investors were probably under the impression that Uncle Sam was going to spend us back to prosperity. In fact news reports said state and defense spending fell almost four percent annually. So all this bad news makes one wonder how Wednesday turned out to be such a dandy day in the markets. Look no further than our friends at the Federal Reserve.

It seems that the Fed's decision to not change interest rates, meaning to not raise them since they can't get any lower, was met with open arms. Bernanke and Company seemed to take painstaking efforts in their policy statement to not give the market reason to move lower and they were right on the money, literally. The S&P closed Wednesday up 2.1%.

Thursday's news catalyst was that Uncle Sam is diversifying his investment portfolio, adding an automaker to his holdings that already include mortgage companies, banks and an insurance firm. Chrysler, in a move that likely shocked no one, said it will declare bankruptcy. President Obama seemed to favor the move and then proceeded to chide hedge funds that hold 30% of Chrysler's debt for rebuffing a Treasury Department plan to keep the company out of bankruptcy.

We wondered if any of those hedge funds were the same ones that contributed so faithfully to Obama's presidential campaign, but that's a story for another day. One of America's most storied companies is probably gone for good, at least in the fashion that we knew it, only to be picked apart by an Italian automaker. It appears the only winners here are members of the UAW.

Again, the market seemed to shrug news of Chrysler's bankruptcy and Thursday's declines were really nothing to lose sleep over.

What would a weekly market review be without news from the banking sector? A pleasant surprise and/or incomplete. We cannot accommodate our loyal readers on either front as those stress tests keep rearing their pesky little heads, but before we touch on that, let's recall some of the news from Bank of America (BAC), the gift that keeps on giving when it comes to headlines.

Earlier in the week, Calpers, the California pension fund for state employees, said it would oppose the reelection of all 18 Bank of America board members, including Chairman and CEO Ken Lewis. Calpers holds nearly 23 million Bank of America shares, so this isn't the old lady at the Teldar Paper shareholder meeting in "Wall Street" getting up to voice her concerns. When Calpers voices displeasure regarding the management of one its holdings, it's time to take note. In spite of the sway that Calpers holds, Lewis and his cronies were comfortably re-elected though Lewis had to abdicate his role as chairman. He will remain CEO.

On Friday, a government source said results of the bank stress tests would be released sometime on the afternoon of May 7, not May 4 as originally planned. Regardless of the release date, it is already widely speculated that at least two of the 19 banks included in the test, Bank of America and Citigroup (C) will need additional funding, maybe in the billions of dollars, to continue operating. Citi is already essentially a ward of the government and one analyst report said Bank of America may need as much as $70 billion more in taxpayer funds. That would be nearly $14 billion more than Bank of America's market cap as of Friday's close.

Heading into next week, investors will certainly be circling Thursday on their calendars as the day to watch. The Fed's action on the stress test front has been curious to say the least. Keep in mind they are testing the ongoing financial viability of the 19 largest US banks. We're talking Goldman Sachs (GS), JP Morgan Chase (JPM), Wells Fargo (WFC), et al. here, not he local credit union. Further delays in releasing the results will only serve to spook the market and investors will likely deduce, logically so, that the news is going to be grim.

Previous news reports said that the banks would find out the results on May 1 giving them a few days to contest the findings. Or as one administration official put it, "...the banks have the right to go back and make their case to the regulators. . . like they're the guy complaining about their grade in class..." We couldn't come up with a better analogy ourselves.

The ultimate result here is likely to be something along the lines of banking Darwinism. Investors have suffered mightily from holding shares of weaker names like Bank of America and Citi. Their patience is worn thin and their appetite for risk has waned. Bad news from any of these companies will likely lead to a sell-off of Titanic proportions. On the other hand, the strong will survive. They always do and the market generally does a fine job of separating the men from the boys. To be sure, there will be winners among "The Gang of 19." The entire sector may be punished on May 7 or it may not. Even it is, investors will find their way back to strong stocks like Goldman, US Bancorp and a few others.

In "The Godfather," Tom Hagen says the Don wants to hear bad news immediately. Investors in bank stocks likely feel the same way and the government shouldn't delay these results any longer. If the news is bad, get it out and let the healing begin.

Don't worry if the banking sector isn't your cup of tea as the week of May 4 offers plenty more than banking news. There will be several other market catalysts. The Institute for Supply Management (ISM) releases its non-manufacturing data for April on Tuesday. March was the sixth consecutive month of contraction and the graph below paints a dismal picture. Readings of above 50 are considered good, March came at 40.8 and April's number is unlikely to be in the vicinity of 50. Friday's Manufacturing ISM rebounded strongly for the fourth consecutive month but still fell short of the expansion level over 50. The Services ISM on Tuesday is expected to be a lot closer to a breakout.

Friday's Manufacturing ISM

Tuesday's Services ISM chart

On Wednesday, oil and gas inventories will be released by the Energy Information Administration (EIA). During the week of April 24, crude oil stockpiles in the U.S. surged to 4.1 million barrels, far exceeding the estimate of 1.8 million barrels.

According to Moody's, the report isn't likely to be a market mover because crude stockpiles have been on the rise for months, but the price of crude has held steady at $50. Moody's notes, and we agree, that the focus is on the equity markets and the performance of oil and gas-related stocks. ExxonMobil (XOM) and Chevron (CVX) have already reported first-quarter results, but Transocean (RIG), one of the largest deepwater drillers, and natural gas giant Devon Energy (DVN) both report on Wednesday.

The oil patch, particularly stocks like Transocean, could be a compelling space for investors going forward. Currently, supply outstrips crude demand in the U.S., according to Moody's. That's fine, that's fair, that's true. That doesn't explain why the price of crude has held steady in the $50 range and weak demand currently belies what will eventually turn to growing demand from the U.S., China and others in the future.

Transocean has $1.1 billion in free cash on its balance sheet. Rival Schlumberger (SLB), which received a favorable write-up in Barron's on Saturday, has $1.65 billion in free cash flow. National Oilwell Varco (NOV) has $1.25 billion. Now all these companies don't do exactly the same thing, but we bring them up because their stock prices are intimately tied to the price of crude. They share other important traits in common. In addition to the robust free cash flow each sports, Transocean, Schlumberger and National Oilwell are dominant players in their respective markets. They are extremely well run companies with the ability to acquire smaller competitors with depressed stock prices to gain even more market share.

These are simply equities that benefit when the price of oil rises. With the price of crude relatively low right now, at least compared to last summer's prices, explorers put projects on hold, idle rigs and certainly don't initiate new drilling endeavors. All of that is bad news for the companies we've highlighted here. It's a simple equation: The higher the price of oil is, the more companies will explore for it and the higher rates of exploration means high stock prices for services firms like Transocean.

The point here is this: Oil demand may be slack right now. Emphasis on the last two words of the prior sentence. Here in the U.S., politicians would have us believe there is a way to practically eliminate the need for crude oil altogether. As such, there is a rabid drive to "go green" and invest in green stocks. We're all in favor of being better stewards of the environment, but it is foolhardy to believe an industrialized economy can survive without oil. Yet, the U.S. doesn't invest in building up reserves with American crude. This is lack of action will once again prove to be a drain on the economy.

Hybrid cars are great ideas, but even their tires are made from crude oil. So the lower demand is temporary and represents a fine opportunity to pick up some good stocks at discounts. We'll stand by our earlier picks as three nifty stocks with potential for nice capital appreciation. As wise man once said, you never really kill demand, you simply delay it.

All right, and this is sure to evoke a sigh of relief, we're off the oil soapbox and onto more pressing near-term concerns. May 5 is the first Friday of the month and we all know what that means: Unemployment data is released by the fine folks at the Bureau of Labor of Statistics. By now, we all know the story of economy's ability to shed jobs and it seems most economists expect the shedding to continue into next year. That said, the jobs report is the epitome of the "not as bad as expected so the market rallies" report.

We're not going to go out on a limb here and make a call as to how many jobs were lost in April (remember February and March revisions will accompany the April numbers), but if the number is in the neighborhood of, say, 500,000 the market is likely to rejoice and finish the week on a strong note. For a full view of the coming week's economic releases, see the calendar below.

Economic Calendar

Earnings season continues this week and many of the marquee names that step into the earnings confessional are energy names. In addition to Devon and Transocean, Chesapeake (CHK), another natural gas giant, reports on Monday. Dow component and media conglomerate Disney reports after Tuesday's close. Mickey's comments on theme park performance will be a good barometer for just how much consumers are ailing.

After the bell on Wednesday, Cisco Systems (CSCO) reports, which means we'll have the privilege of seeing eponymous CEO John Chambers on CNBC early Thursday morning. Chambers is generally candid on his conference calls and during interviews and since Cisco's customers are mainly Fortune 500 companies, his sentiments about the rest of 2009 will be quite telling about the overall state of the US economy. Also keep on eye on former market darling Nvidia (NVDA), which reports on Thursday.

If soft commodities are your thing, Archer Daniels Midland (ADM) reports on Tuesday and fertilizer maker Agrium (AGU) reports on Wednesday. Fertilizer makers Potash (POT) and Mosaic (MOS) have already reported first-quarter results, as has agriculture play Monsanto (MON) and the numbers weren't pretty, so we shouldn't expect anything less from Agrium. That said, the company has received a couple of bullish media calls recently, so the focus will likely be on 2009 and 2010 guidance as the market has probably already factored in a dismal first quarter.

Friday promises to be an action-packed day. In addition to the unemployment number, Beazer Homes (BZH), Petrobras (PBR) and Toyota (TM) all release profit results. Any remotely positive commentary from Beazer or Toyota combined with a decent jobs report could catapult the market higher, sending investors cheering into the weekend.

This doesn't mean the news from Petrobras will be glossed over and nor should it be. Petrobras is basically the ExxonMobil of Brazil except for the part where Petrobras is actually making significant new discoveries. Brazilian stocks were once high-fliers, but the bear got his claws into them the way he did every other sector, knocking them from their previously lofty perch. The reality is Brazil is still a compelling growth story and its oil king is worth keeping an eye on.

There is an array of other earnings releases next week. Check the calendar below for additional names to put up on your screens.

Earnings Calendar

One more event that we should note that has the potential to move stocks on Monday is this weekend's Berkshire Hathaway (BRK.A, BRK.B) shareholder meeting. A record 35,000 attendees flocked to Omaha to hear Warren Buffett opine about his holdings and where he thinks the market is headed. Last year was Berkshire's worst since Buffett took over in 1965, leading market watchers to ponder if the Oracle of Omaha has lost his touch.

It may not be a matter of Buffett's touch being gone as much wondering if buy-and-hold investing has gone the way of the dodo bird. At the very least, buy-and-hold investing has seen better days. Of course, American Express (AXP) and Wells Fargo, two long-time Buffett favorites, did Berkshire no favors in 2008, nor did an ill-timed purchase of a massive chunk of US Bancorp stock. Buffett's comments on recent Berkshire purchases of General Electric (GE), Goldman Sachs and Tiffany (TIF) shares also have market-moving potential.

With two months of solid gains behind the market, this stands to be a pivotal week. Can the Dow make headway toward the important 8,500 level or will just tread water and stay above 8,000. If the Nasdaq can hold 1,720, good news out of Cisco could send the tech-laden index higher, possibly past resistance at 1,735, a level it hasn't touched since late 2008. And can the S&P 500 finally get enough steam behind it to break 888? A close above that number could be the bullish confirmation need to lure more buyers into the market and turn the two-month rally into something more significant.

Dow Chart

Nasdaq Chart

S&P-500 Chart

Russell 2000 Chart

Not to put too much emphasis on the coming week's market action, but it could be a deciding factor in whether the old adage "Sell in May and go away" plays out. It wouldn't be surprising to see the market's tread lightly going into Thursday's release of the bank stress test results, which will make Friday's trade the judge and jury on the week's performance. We expect somewhat choppy trade until the bank news on Thursday afternoon with the major indices hovering around the levels at which they closed last week. Needless to say, we expect to occupy this space with some exciting news next weekend.

Todd Shriber

Editors note: Todd is a new contributor to the Market Monitor and I asked him to fill in for me this weekend while I was occupied with the website move back to Denver. I think you will agree he did an excellent job. I am very glad to have him on the team.

Jim Brown