Stock Market Report for Week of July 20, 2008

WHERE THIS MARKET IS HEADED

As you can see from the charts above we had a mighty bounce last week but the question on everyone’s mind is, ‘will it last?’ With as many fundamental problems as this economy has its doubtful. The best approach to a bounce like this is to watch it for a rollover and a chance to enter new bearish positions at the best possible prices.

With all the hubbub last week surrounding plummeting oil prices and a government bail-out of the Fed, everyone sort of forgot to look at the inflation numbers—but they should have because they’re huge.

The Consumer Price Index (CPI) launched 1.1% in June to an annualized rate of 7.9% and the PPI is up a whopping 9.2% year over year. Energy was cited as the main culprit which in turn passes on increases to just above everything else. Energy has not ceased to be inflationary just because oil fell $18 from its highs last week. $129 oil will continue to push prices higher and odds are good it won't stay as low as $129 for long.

The Fed would love to stand pat with the economy as weak as it is but these latest numbers may force their hand. Fed Funds Futures rose to a 62.2% chance of a rate hike at the August 5th meeting fueled by hawkish comments out of several influential members of the FOMC. Minneapolis Fed President Gary Stern told Bloomberg on Friday that "headline inflation is clearly too high and could feed through to core prices." He went on to warn that the Fed could not wait for the economy to stabilize before raising rates--Stern is a voting member of the FOMC.

Former St. Louis Fed President William Poole warned that the Fed should act "sooner rather than later" to begin tightening interest rates. Poole said it would be better to take "a milder hit now in order to reduce the risk of a much bigger hit later." Poole stressed that we are running a "substantial risk" of inflation being more difficult next year (now that’s an understatement). He also said the current data does not justify that we are in a recession.

Piling on the telegraphing of a potential rate hike Kansas Fed President Thomas Hoenig made hawkish comments after touring a manufacturing business in Colorado where every single component had risen sharply over the last year. Hoenig said it reinforces his concerns about needed action to combat inflation. The Fed likes to let the market know what it is going to do ahead of time. With comments like these the news isn’t so devastating when its released—and right now these particular governors are telling us we could easily see a rate hike when the Fed meets again in two weeks.

With a good percentage of the regional banks already in trouble and construction of single-family homes falling 5.3% in June to a fresh 17-year low ANY kind of rate hike is going to smack this economy to the canvas. Especially considering The four-week average of continuing unemployment claims climbed by 16,500 to 3.14 million last week---the highest level since February 2004.

Of course the FOMC meeting is still two weeks away and traders have more immediate concerns. We’re smack-dab in the middle of earnings season and the reports are coming hot and heavy. The Nasdaq blasted higher by 150 points in just three days last week before a slew of nasty earnings reports Thursday knocked the index down a notch to close the week.

Google plunged a whopping $52 closing at 481.50 logging its biggest percentage loss ever after disappointments on revenue spoiled the bullfest. Google warned the slowing economy had people clicking fewer ads—another strong signal the consumer is in trouble.

Microsoft (MSFT) fell -$1.88 or -6.8% for its worst loss in two years after giving weak guidance about its software sales. Microsoft said spending would be higher but revenues would be lower. Acceptance of the Vista operating system continues to be slow and many companies are now planning to wait for the next Windows release before committing to any changes.

AMD posted a loss of $1.19 billion or -1.96 per share compared to a loss of $600 million in the comparison quarter. That was way worse than analyst's estimates for a loss of 52 cents. Revenue was also light. AMD lost -13% but for a stock below five bucks that doesn’t amount to much—and neither does AMD’s prospects.

The big news in the tech space this week is Apple (AAPL). The stock crashed over six bucks back to support at $165 on Friday ahead of earnings on Monday. Apple is expected to post strong results despite the recent flurry of high profile disappointments. Keep in mind their recent sales success of the 3G iPhone will not count in this earnings report—it will be next quarter. Apple is expecting to earn about $1 per share on revenue of $7.2 billion for Q2. Analysts are a bit more optimistic with expectations for $1.08 and revenue of $7.34 billion. Apple’s earnings after the bell Monday will go a long way toward determining the Nasdaq’s direction this week. In addition Yahoo reports on Tuesday which should give some further indication of advertising growth on the net and a potential new chapter in the company’s ongoing takeover drama.

The other big story last week was oil dropping over $18 from Tuesday's high of nearly $147. Crude closed at $128.88 on Friday for the biggest weekly drop in history. Various support levels were broken with ease and Friday's close suggests more downside immediately ahead.  There are several fundamental reasons for the fall but on a technical basis oil was grossly overextended with a classic double top at $147.

The biggest fundamental reason is demand is dropping almost daily. Plus there was news of an apparent cooling of Iranian tensions last week. On Tuesday comments were being made about a meeting between the UN and Iran's nuclear negotiator this weekend. On Thursday the U.S. said they were sending an official envoy, William Burns marking the first official meeting between the U.S. and Iran since the hostage crisis in 1979. On Friday Condoleezza Rice said the U.S. has no "permanent enemies" and is open to negotiations with anyone. She said Iran was "a difficult and dangerous state" but "We have been very clear that any country can change course." Many analysts have claimed over the past months that the growing tensions between the Israel, Iran and the U.S. were responsible for as much as $40 in the price of oil. Unbelievably, the U.S. also suggested it might consider opening a diplomatic mission in Tehran (you’ll be seeing that about the same time George Soros speaks at the Republican National Convention).

Just a word of warning on the continuing fall in oil—don’t expect the Iranians to cooperate in-spite of any potential sanctions that may be on the table. They are just buying time until the US selects a new president and as soon as the markets figure that out—and a hurricane warning or two hits the wires—you’ll see oil blast through the roof just as quickly as it dropped.

Probably an even more influential sector in the markets right now however is the financials. The Financial Select SPDR (XLF) plunged to an all-time low on Tuesday before earnings by Wells Fargo (WFC) sparked a huge short covering rally. Wells Fargo beat the street and raised its dividend at a time when others are cutting them. WFC has a large mortgage component and their great results were a welcome surprise to a beaten down sector.

Add up the news from last week and we’ve got an announcement of government backing of Fannie and Freddie, the elimination of naked shorting capability and an upside earnings surprise from Wells Fargo and you’ve got all the ingredients for a short covering sprint that was practically straight up. The XLF rebounded 25% from its low Tuesday to Friday's high. The question is—will to continue?

There are several regional banks reporting earnings next week that might not paint quite as rosy a picture as Wells Fargo. Wachovia reports on Tuesday and expectations are not good. Washington Mutual also reports on Tuesday and their subprime credit portfolio could be a strong negative. Plus we’ll hear from Bank of America Monday and their new acquisition, Countrywide Mortgage. The key of course is forward guidance but with the real estate market consistently putting in new monthly lows AND the unemployment rate on the rise how rosy could the outlook be for banks holding the majority of their assets in home mortgages? There is also particular concern in the financials if there is a chance the Fed may be raising rates in two weeks.

So—we’re smack in the middle of earnings season with high profiles reports batting the averages both ways, the Fed is telegraphing a rate INCREASE just as earning will be winding down, the price of oil has plunged but holds the potential for a powerful bounce, and the financial sector rocket blasted higher last week breaking clean above its downtrend channel—the question is…

HOW DO WE MAKE MONEY ON IT?

We’ve got two new high potential plays lined up this week and even though one is bullish and the other is bearish they both have something in common—they are both playing off of extremely short-term overextended positions. Stretch a rubber band far enough and the bounce back can be extreme—as we witnessed this past week on the XLF.

We’ve got two new positions that are both like wrist-rocket slingshots pulled all the way back and ready to fire—and when these things release the right options can make us a fortune VERY quickly.

We’ve got two potential cannon shots lined up on a market ready to explode our way—so let’s get to it…

For more information on the Pearly Gates trading newsletter subscription click on
http://www.cashflowheaven.com/products.