WHERE ARE WE NOW

First let me toot my own horn for a moment, something I do very infrequently. My last post, which was on Walmart was not only timely but right on the money. The stock hit its closing high the next day, 51.75 and went south consistently hitting its low two days ago at 46.32. I took my profits a little early, but I'm not complaining. My post prior to that was also pretty good and timely in laying out the bull case for the overall market. Although it saved me a lot of money, I didn't profit quite as handsomely. It serves as a good starting point to review where we are now.

One of the points I was trying to make then, was how remarkable the stock market rally was in light of all the economic weakness. In that regard, not much has changed, and in fact the economy has deteriorated since then. Back then I argued that the first revision in 2nd qtr GDP, up to 2.9% from 2.6% is what swept away all economic concerns and accelerated the stock rally. Similarly, when the Dow declined 6 days in a row from 10/26 to 11/03, it was the strong rebound in the ISM services index and the large revisions in non-farm payrolls for the prior two months and corresponding drop in the unemployment rate, that once again swept away economic concerns and reignited the rally.

Now however, I believe the rally is running on fumes, and here is why:
Not only was 2qtr GDP revised back down to 2.6%, but 3rd qtr came in at 1.6%.
Auto sales have declined further to 16.1 mln in Oct from 16.6 in Sep and manufacturers have cut production further in the 4th quarter because they are choking on inventories.
Existing home sales and prices continued to drop. Sales to 6.18 vs 6.3 in Aug, prices another 1.9% vs a 3% drop in Aug.
New home sales showed an uptick has they have for the last several months but then is revised away in subsequent data. Prices, however showed a steep drop from 239,000 in Aug to 217,100 in September.
The ISM dropped to 51.2 in Oct vs 52.9 in Sep.
The Democrats have indeed taken the house and Senate.
Walmart sales have been below the low end of forecasts for two months and not at the high end as the were in Aug.
It's hard to be bullish about $60n oil, when most of my working life $40-$50 oil was looked at with aghast.
Eventually, the top line rules. You can continue to generate earnings for a while as the top line slows down as many companies have, but eventually they have to follow.
Technically and sentiment wise the market is extremely overbought. Barchart's momentum indicator shows 79% of stocks are over their 100 day ma and 71% are over their 200day mvg. Newsletter writers are at their most bullish since May.

Those betting on a soft landing are now bucking the trend. We have all been told, the trend is your friend. They economic trend is now down and bulls are trying to catch the bottom. If you are bearish be just as careful and do not try to catch the top. In momentum markets like this, the last 10% in time can be very large in amount. Like Barry Ritholtz said recently on his blog thebigpicture.com you can be early being long, you can even be early going to cash, but the death of a money manager is being early going short. Or as I heard said once, the canyons of wall street are filled with the corpses of those who where right but too early.

Conclusion: Its to late to get in or but more. Its time to scale out and prepare an exit plan. What will be the straw that breaks the camels back? It could be and ISM reading below 50, a drop in auto sales below 16mln units, a further decline in home sales or prices, a renewed climb in oil prices, and actual decline in Walmart SSS, or many other things. Or as John Mauldin discusses in his e-letter of 8/26, fingers of instability, it could be some seemingly trivial event, the market not acting well after a good news item, one bad earnings or Christmas sales report. So as usual, we wait for a fundamental, technical or sentiment signal to ell when to hit the exit door. Time is drawing near.

WALMART

There has been a lot of hoopla over Walmart the last two days. Well why not. They had their two day annual meeting giving them a chance to strut their stuff. Let me say at the outset, I didn't listen to their entire webcast of the meeting, so maybe there are some hidden pearls of wisdom I missed. Based on the news and analyst reports I read, I was not impressed. Of course I've been a bear on Walmart for sometime. I also sat out the recent rally from 42 to 52 but was not short. Back to the meeting. They said they were going to slow down new store expansion to a 7% increase in square feet from 8% and cut and plan to keep cap ex equal to their increase in same store sales growth, about 2-4%. This meant an increased focus on profits and their return on invested capital. Wow-wee! The bulls are trying to equate this with McDonalds turnaround of a couple of years ago. They also cut new store opening's to almost zero not a paltry 1% and pushed more of existing and new product through their existing distribution. They increased store hours, started accepting plastic for payment, introduced new products like premium salads and coffee. Walmart is also trying to increase traffic by remodeling stores and hiring a new lead ad agency among others. But they are of course always trying to increase sales and have not been too successful lately. McDonalds was coming off a low base after a couple of horrific years, Walmart is not. McDonalds after going astray had more potential and easier fixes. Adjusting their menu for more mature tastes and staying open longer and accepting credit cards were almost no brainers. They money they saved from stopping new construction they were able to put into huge share buybacks and dividend increases. Walmart plans do not include anything on that scale.

I think Walmart has terrific management. Their problem is the macro environment has just overwhelmed them. They are so large, that it is and will continue to be the largest influence on their performance. One thing you never hear mentioned, is sales growth versus inflation, probably because most retailers have sales at least equal to inflation, otherwise their unit sales would be dropping. So it was with Walmart, in 2000 same store sales were7.7% vs inflation of 2.7%, in the recession year of 2001 the SSS were 5.1% vs inflation of 3.4%. In 2002 inflation dropped to 1.5% and their SSS increased to 6.1%. Inflation was 2.4% in 2003 and their SSS were 5% . In 2004 the inflation dropped to 1.8% and SSS fell to 4%. In 2005, the trouble began, inflation went up to 3.3% and SSS dropped to 3.3%. After inflation they had zero increase in sales. The pattern continued in fiscal 2006. Inflation was 3.5% and SSS increased 3.6%. Only because they have opened new stores equaling about an 8% increase in sq footage that they have been able to show any decent profit growth. That 8% plus 3% SSS have given them the 10-12% total sales growth the last couple of years. No surprise last years EPS growth was 11.2%. It is no wonder they would take a very slow incremental approach to slowing new store growth. Why are they doing it at all? Last year SSS growth actually increased for the first time in 6 years, only marginally 3.6% vs 3.3%, but total sales growth fell nevertheless to 9.9% from 11.2%. They're getting less bang for the buck. Increase new stores by 8% and have total sales growth decline. Secondly, like a lot of companies announcing slowing capex, like Amazon yesterday, they see the slowdown coming and don't have to look any further than their own numbers. Hope the money saved and put into share buybacks can make up the difference.

A final word on gas prices. Walmart, like stocks in general , really took off on the lower gas prices helping their sales. They even said in their webcast that lower gas prices will help them. Yes, if they stay there for 6 months to a year, but a one month drop, even as large as its been, its effect has been over-rated. To prove that point, not widely reported, but they mentioned that SSS in October were only up 1% so far, well below their 2-4% estimate.

THE BULL CASE

With this mornings GDP release, a revision to 2.9% from 2.5% for 2nd quarter growth, the bulls have strengthened their case. Nothing stops the resilient U.S. economy from chugging along at it's potential of about 3 %, and along with it, corporate profits and stocks.

A weaker housing market, well it's only 6-7% of the economy anyway. Weaker year over year auto sales, well we are really a service oriented economy now anyway. The industrial side has shriveled to about 15% and autos are a fraction of that. Higher interest rates, the Fed has paused and the interest rate cycle has peaked, and bond yields are falling. In addition, that bugaboo, oil prices, have also peaked and are falling, now below $70, adding support to consumer spending.

A potential Democratic victory, taking the House and Senate, well that's too far away to worry about. Inflation worries, the Fed has told us it will moderate as the year progresses, not to worry. A soft landing is in the cards, haven't you heard. That's why the market as acted so well even in the face of bad news, and the latest GDP proves it.

In addition, we have valuations at levels not seen in years, robust corporate share buybacks, and M&A activity being propelled by bigger and bigger pools of private equity. WMT sales were at the high end of forecasts, last months retail sales were better than expected and auto sales were over 17 million units.

Technically, we are breaking out to new highs, and sentiment as a contrary indicator is as bearish as we've seen in sometime, close to where we have seen big rallies in the past.

So if I were a bull I'd say, put that in your pipe and smoke it.

THE BEGINNING OF THE END

Could this be the end of another Fed is done rally? This Fed is done rally has been a little different from the rest. If you recall the initial spike after the Fed announcement was transitory. They did pause, but their words did not indicate that they would stay paused. It was not until the release of the PPI and CPI which were weaker and gave credence to the idea that they would stay paused that the market really took flight.

Why might then this be the beginning of the end? Well, one reason is that volume has been pretty tepid throughout this rally. Secondly, the consumer confidence figures released by the University of Michigan were weak again, around the levels of the last recession. Finally, the Ford production cuts to levels not seen since the 80's are pretty ominous.

In the short run, liquidity and sentiment rule. In the long run sales,production,inflation i.e. fundamentals determine sentiment. Homes are not selling, autos are not selling, inventories are piling up. The growth rate of retail sales are slowing. When Ford says they are going to cut production 20% for the rest of the year, it is not a transitory event. Just like high oil prices it will have slow but grinding effect on the economy.

How about this. The rally was propelled by a CPI a tenth of one percent lower than expected. A large drop in car prices was a big factor. Ford cut it's price on the Expedition SUV $4,000. It cut prices because sales for SUV's are falling off a cliff. Have we got the cart before the horse?

NEVER MIND

Wednesday's rally on FedEx earnings, FedEx being a bellwether, was quickly reversed on Thursday's, weaker leading indicators. I think by now everyone agrees the economy is going to slow, and the market is fighting about how much, how soon. Today, the takeover of Kerr-McGee, helping energy stocks of course, was offset by earnings warning of City National Bank blaming the yield curve. So the market overall is kind of sideways.

Next week doesn't look that great either, with new and existing home sales probably showing weakness, potential earnings warnings, the Fed raising rates with the potential for more hawkish rhetoric and the consumer sentiment indexes being a toss up. We will see if month end window dressing can save the day.

UP UP AND AWAY

What I believe the market is telling us today, is that in spite of higher rates and oil and a slowdown in housing, if you stay away from homebuilders and automakers, earnings are good, and projected to stay good. Most companies are doing very well and think they will continue to do so in spite of the gloomy macro economic background. That's the spin today and can continue to be until the next bad economic number or earnings warning.

In my view it's a bear market bounce, but it can carry further. We are up about 1 1/2% today and it could go another 1 1/2-3% . At that point I'd certaintly start putting out some shorts again.

Life is so much easier as a bull. The market went up for four months and gave up all its gains in May. That is typical. Markets fall faster than they rise. In this example, everyone wound up at zero returns, but the bear had one month of bliss and four months of agony while the bull enjoyed the reverse, four months of bliss and one month of agony.

NEW HIGHS

Well the S&P set a new intraday high today after another big rally on the Fed minutes. The market and earnings tell us in spite of all the potential negatives it's all good. Oil averaged roughly $62 this quarter and another quarter of double digit earnings are unfazed. Bond yields are up 75 basis points and that hasn't been much of an issue either, except for slowing housing a little. The Fed tells us the economy can handle a housing soft landing though. We obviously haven't reached a tipping point yet.

It looked to me like the run to new highs today was to blow out the stops at the 5yr highs and it is not uncommon for highs to be made right around option expiration day, which is tomorrow.
A tipping point is close I believe because even though oil is not at an inflation adjusted high, it is higher on an inflation adjusted basis than anytime but once. And even though the 10yr yield is low by 80's standards, an index of inflation adjusted oil and inflation adjusted 10yr yields I deep has never been higher except for the early 80's. True stocks began their long bull market about then but they were propelled by the Regan massive tax cuts, and the trends in inflation and interest rates were sharply down albeit from much higher levels. Today both are moving higher. Perhaps even more important, back then we were much less leveraged. Total government debt of GDP was half of what it is today and the consumer debt ratios were 20% lower with a savings rate of 10% versus 0% today.

A tipping point could come tomorrow or wait until the dangerous months of Sep and Oct. Obviously the Fed raising rates 15 times has been good for the market as it implies robust fundamentals. It;s when they are thinking of easing that we need to be worried.

WANT TO KNOW WHAT HAPPENED TODAY

Seems as if everyone one on CNBC is perplexed by what happened to the rally today.
Here is what happened. The market opened higher. The S&P traded as high as 1314.07. The five year high was 1315.93 reached the week of 5/25/01 on a spike. Bonds also initially traded higher and then reversed. The high yield on the 10 yr was reached the week of 6/18/04 at 4.88%. When the bonds broke through that ceiling decisively on their way to 4.95% and the S&P at 5 year resistance, you can bet trading models picked that up all over the world and hence program selling began. That doesn't even take into account that the market was ripe for profit taking on weak fundamentals of higher oil prices, and lackluster retail and auto sales.

POSITIVE SPIN

Let's try to put a positive spin on all the things I worry about. After all to climb a wall of worry is a good thing. My worries fall primarily into three categories, the economy, geopolitical, and the market itself.

Economy-
Interest rates- we are in our 4th year of rising rates, but don't worry they are still historically not high, so the market can still move forward. Hey I heard it on CNBC.
yield curve - Its flat to inverted but this time is different Bernanke told me so.
Housing is slowing down, along with prices, but the Fed said the economy can withstand a housing slowdown.
Sales- they have been weak, as stated in housing, autos , and most recently retail sales, but we are not at a danger point yet.
International rate hikes- Both the ECB and the Bank of Japan have snugged up monetary policy and as a result global liquidity is being reduced. The tightening is occurring from such a low level that it's not a problem.

Market-
We are overbought, but I guess we can get more overbought.
Mutual Fund cash is at record low levels so buying power is lacking. But,the little guy is coming back into the market.
Leadership- Some of the bellwethers have been shot down, Google and Intel to name two.
Others will emerge.
Insider selling is very high, especially in semiconductors. The little guy is buying.
NDX short interest is at very low levels, not much buying power left from short covering.
The little guy is buying.
Volume is low. It will pick up as soon as we break through the highs.
Block trades are way off signaling a lack of institutional participation, but you guessed it , the little guy is buying.
This is one of the longest periods ever without at least a 10% correction. So what.

Geopolitical-
Iraq- deteriorating into civil war. I remember when we turned over more responsibility to
ARVN the South Vietnamese regulars. It was the beginning of the end. Maybe it will force us out of there sooner.
Bird flu- the northern migration of wild birds should bring it to our shores soon. Think of all the pharmaceutical stocks that will benefit.
Iran- no end in sight to that confrontation. At least it's not in the headlines every day.
Trade - Senator Schummer is in China trying to get them to revalue their currency and threatening to slap a 27% tariff on their imports if they don't. If he does, that will thrash the dollar which will be extremely good for multinational earnings.

MCDONALD'S

Earlier this week McDonald's reported February sales. Same store sales were up 4.7%, total sales up only 3%. Sofar this year SSS were up 5.7% in Jan and the 4.7% last month, This is the best back to back SSS increase since 2004 but the stock didn't react, and in fact has been acting week for a month. What gives? Total sales growth has been slowing significantly and persistently throughout 2005. Read my posts on 1/25 and 8/15/05 for background. It is now picking back up but the stock gets no benefit. Analysts have the first quarter earnings at .48 a share, about the same as last quarter, although last qtrs .48 included .015 impairment charge for South Korea, but was fairly clean otherwise. 2005 quarterly numbers have been a quagmire to sort out because of impairment charges, repatriation of overseas profits, large tax benefits, etc, making it easy to obfuscate the underlying trends.

To make .48 last quarter, they had 5.235 billion in revenues, which by the way was the first sequential revenue drop in a 4th quarter since 2002. With two months under our belts and total sales growth was 4.2% in Jan and 3% in Feb yoy. Total revenues are always a bit higher than the sales numbers they announce monthly because they do not include affiliated restaurants like Boston Market. So lets assume next month totals sales spurt to 5% and avg 4% for the quarter, throw in another 1% for Boston Market and say total revenues will be up 5% forma year ago. Last year's 1st qtr revenues were 4.8 bil, so a 5% increase would take them to 5.04 bil. Bottom line, I don't think they are going to make their numbers. They could miss by 2 cents. They sold some Chipolte shares and took a capital gain but that was offset with some further impairment charges. They also bought back a lot of share this quarter which will help and they could sell more Chipolte shares, but I think the street would see through that. In any event we will know in early April as they always pre-announce earnings with their monthly sales release. As an aside, I saw on Bernie Schaeffers website that the Mar 37 1/2 calls had large open interest, probably due to the earlier hedge fund interest in McDonald's. They look to expire worthless now.

The markets rally over the past month that recaptured the highs of the beginning of the year was largely driven by lower oil prices. Most other rallies over the past several months were driven by the Fed is almost done mantra. Today we have a real trifecta weighing on the markets. Bond yields are at their highs for the year, oil is back over $62, and retail sales were softer. I won't go into it now, but final demand is critical to the economy, asset prices, the bond conundrum, exchange rates, etc. In that regard we saw evidence this week that it is faltering. New home sales, resales, auto sales, and today retail sales are all showing sign of softness. The housing market we've known about for a while, auto sales were already weaker last month but were obfuscated by fleet sales. Yesterday both GM and Ford said they were trimming production next quarter, so they don't see the softness going away any time soon. Walmart gave forward guidance of 1-3% for sales this month, not great either. One month does not a trend make, but it is time to keep our eyes open for the often predicted consumer slowdown.

FACTS TO CHEW ON

Consider this. On 10/13/05 the market low, S&P500 @ 1170, oil was at $63 and the 10yr note was at about 4.5%. At the market high on 1/11/06 S&P500 @1295, oil was at $64 and the 10yr note was at about 4.5%. In between we have had weak economic stats and strong, good earnings and bad. If oil, bond yields, don't matter and we've had 4th qtr GDP at 3.8% and 1st qtr GDP at 1.1%, high profile earnings misses by INTC,GOOG, YAHOO, upside surprises by XOM, BA, CAT, what's driving the market? It seems to me nothing moves the market like perceptions over Fed policy. It was perceptions of further tightening that drove the market down in September, and after Fed minutes were released on the first trading day of the year, it was perceptions that they were almost done that pushed the market up to 1294. So the lesson seems to be ignore the noise and watch how the market feels about the Fed.

JOBS

Wednesday's blog was somewhat prophetic. I said the market moves is bursts and I thought the next one would be down. I didn't think it would come so quickly. The move was surprising considering, auto sales and retail sales were very good. There was a lot of fleet sales in the auto numbers and a lot of gift card redemptions in the retail sales. I would suppose that is why they weren't taken seriously. The payroll number today was negative for the market, but the bond market rallied significantly. It's getting harder to read the tea leaves. Next week is a light data week and earnings are tapering off. We have Treasury auctions, which will be interesting in light of the fact that if prices hold here, buyers will have a negative carry. The Iran situation will also be front and center, so oil we be important. The last few days have seen a good sell off in both oil and gold. Both were overbought and up at resistance. I hope we have significant corrections so we can buy them again.

GOOGLE?

In spite of the fact that Google is down 35 pts and 7 out of 10 of the largest NASDAQ stocks are negative, the index trades around flat as I write, not bad at all. However the negatives continue to pile up. Oil is approaching $69, the bond market is down again with lots of supply coming next week, with Intel, 2 out of the big 3 have reported punk earnings, housing stocks are weak as both the MBA survey fell 5% and the NRA index of pending sales fell 3%. Lately I've also noticed a correlation, which makes sense, between housing stocks, retailers and the bank index. They are all weak today. Mortgage lending and home equity loans have been a big source of bank profits, and of course we all know how dependent retailers are on home prices.
The character of this market this year and maybe longer has been long periods of little volatility and then big bursts up and down, ala the first day of the year and the big swoon on Jan 20th. I think we are headed for another swoon, it is just a question of what sends it over the edge. If you would have told me about Google beforehand, I would have said that would have been enough. Maybe oil touching 70 or a bad auction next week . Stay tuned.

PINS AND NEEDLES

The market sits on pins and needles as well it should considering the surge the market got at the release of the last Fed minutes. My instincts tell me they will try it again. It is a perfect opportunity to squeeze the shorts as we are not far from the highs and a move above would run the stops. This time around I don't think it will be longlived. The fundamental background is quite different. Oil is near its highs. Real estate the locomotive of the economy the past few years is softening. Auto sales due out tomorrow, which bounced back in December but were blamed for the poor showing of GDP, are expected to show weakness. Finally, their is considerable doubt aver the strength of the consumer this year. Earnings, with the exception of Exxon, have also not blown anyone away particularly among the dow stocks. Greenspan the market's security blanket is also gone. Time to sell the rallies I think.

WALMART

In addition to Exxon's record profits, helping the market as well is Walmart saying it's same store sales will come in at the high end of it's 3-5% estimate at 4.7%. No doubt this is due somewhat to the redemption of gift cards, as they said sales were greater than expected last month. However, at 4.7% this is the best month they have had since a 5.9% showing in Mar of 04. Since last month was so dismal at 2.2% perhaps averaging the two months together is a more accurate picture of the underlying trend, and that comes in at 3.45%.
Walmart has been a weak stock since Feb of 04. Last week it got one upgrade and one down, by major firms. We all know that the low end consumer in the current economic climate is being hurt the worst, Walmart's bread and butter. What is not well appreciated is that prior to last month, they had been running positive comparisons in same store sales to last year for the past six months. This year may be the first year in 4, that they beat last years same store sales growth, albeit only marginally.
The question is, in a slowing economy, will they attract more move down consumers from higher end stores to make up for the shortfall in purchasing power of their traditional customer base. So far so good. Stay tuned.

BOUNCE

As I mentioned a couple of days ago, good earnings from CAT and HON in the dow was just what the doctor ordered and we had a triple digit increase in the dow. The market had a great rally to start the year and the bulls don't want to give up on it. Who can blame them. Every bit of good news is seized on with fervor. We will now pretty soon how this earnings season has come in, but of the 20 dow stocks that have reported, the bad still outnumber the good. Only 4 could characterized as unequivocally good. Not to say that is definitive, because some like AA and PFE are higher than when they reported because of favorable news flow, like higher aluminum prices and new drug announcements. The overall tone however is that the dow will be a lagger and revenue growth is hard to come by.

This morning, the lower than expected GDP report at 1.1% vs 2.8% expected is so far not doing much damage. To my mind, however, this is one more factor starting to deteriorate. Ten year yields are creeping up, the Fed is going to raise rates again next week, housing is slowing, the auto industry is in trouble and oil is getting close to $70 dollars again. Nothing is more lethal to the economy and the market than the combination of higher rates and energy. We have just to look back to Mar of 2000 to see what such a combination did.

MCDONALDS

Reading the footnotes of Mcdonalds press release, 2004 earnings had one time charges of .14 cents per share so the 1.79 reported for the year was 1.93 operating earnings adjusted. 2005 had one time benefits of .06 per share, so adjust the 2.04 reported down to 1.98. That's growth of 3%., a lot different than the headlines ballyhooed on the news wires and CNBC of "McDonalds profit jumps 53%, or McDonalds stock soars on 4th qtr earnings. What's more, revenue DECLINED sequentially. The 4th quarter had the slowest total sales growth in YEARS, averaging 2.5% vs 6% for the 3rd qtr and 6.3% 2nd qtr. Currency is starting to hurt them. Where are the analysts and reporters? Does anyone look behind the headlines any more.

DOW LAGGARDS

One reason the market has given up it's gains this year is the action of its generals. My count says we've had 14 Dow stocks report. All but three have been miserable. UTX is up two points on good earnings and AXP is slightly higher than when it reported. PFE loss was less than expected so it is trading higher. AA Alcoa's reported a fall of 16% in net income on higher energy costs. DD warned of a 200 mil revenue shortfall and issued very weak guidance. Big daddy INTC missed earnings badly and got clobbered. IBM earnings were OK but revenue was light and it is now trading lower. JPM had trading revenue disappoint and it has rolled over. GE was not impressive and its stock has traded consistently lower since reporting. C missed earnings by 2 cents and trading lower. MMM issued weak guidance and is down over a point. JNJ was light on sales, trading lower. MCD don't get me started, said their earnings were great but if you deduct one time factors from the comparisons, I think they were weak. MCD is up 1/4.

The good news is that most of the bad news should be out of the way for the remaining 16. Earnings for the rest should not be so lopsided. CAT, BA, HON should be good. As always forward guidance will be key. Good luck trading.