DRIVE OUR EAGLE MATERIALS (EXP) PUTS TO A SWEET THREE-DAY FORTY-EIGHT PERCENT PROFIT!

This past week the markets drifted up and then down settling very close to where they started--but there was still enough volatility to...

DRIVE OUR EAGLE MATERIALS (EXP) PUTS TO A SWEET THREE-DAY FORTY-EIGHT PERCENT PROFIT!

That was a nice win and it materialized quickly--unfortunately we also got stopped out of our Ralph Lauren (RL) puts only to see the stock plunge right after the stop was hit--which shows the lack of conviction in RLs move higher. We also took an early exit on our MGIC Investment (MTG) calls as the stock continues to drift lower in a market with few reasons to keep climbing.
With the major earnings announcements just about over this is an excellent time to take a look at...

WHICH WAY THIS MARKET IS HEADED

The markets have had a good run but if they trend much lower the climb from early July will be over as a new downtrend asserts itself.

Aside from economics we are heading into a very weak period seasonally. Earnings are almost over and there were only 7.5 billion shares traded on Friday, and just barely 7.06 billion on Wednesday. This was a month end week and there should have been much more volume from funds squaring positions. Low volume means higher volatility which in our case can be extremely helpful--especially if it's to the downside.

The markets rallied strongly in July with gains in the 7% range across the board. The rally sounds impressive but the markets hit eight-month lows on July 2nd making a big oversold bounce relatively easy.

Earnings created a lot of excitement but now that they are nearly over and the market is struggling at resistance the outlook is tipping toward the downside. The focus is turning from earnings back to economics and the big reports this week could easily tip the markets onto a new multi-month trend lower.

For example the China PMI coming out tonight could be a big market mover. The consensus estimate is for 51.1 with 11 estimates from 50.0 to 51.7 according to Reuters. However the whisper number is below 50 and into contraction territory. The June number declined to 52.1 from 53.9 in May. You may remember the major market decline when that big June drop was announced. China's Shanghai Composite index closed at a nine-week high on Friday so their market is primed for a big fall if the number disappoints.

Keep in mind it's China that everyone is depending on to pull the world out of recession but it's the developed nations that dictate demand for China's goods--not the other way around. By the time you read this the number will likely already be released and it wouldn't be surprising to see a dip below 50 which would be extremely bearish for Monday's open.

The Nasdaq dropped back to support at 2225 on Thursday and Friday and rebounded both days to the 2250 level--an impressive recovery given the multiple downgrades to the chip sector. The SOX declined -6.2% from its Tuesday high thanks to the downgrades and guidance issues from several chip companies. The summer is not normally kind to tech stocks and the chips are leading techs lower.

Economics reasserted themselves Friday with the GDP revision a major force driving the markets lower at the open. The headline number on the GDP for Q2 fell to 2.4% compared to prior estimates of 3.0%. Dropping more than a full point was a shock to economists but the bigger surprise was the revision to the last three years of quarterly GDP estimates.

The BEA revisions show that the recession was much deeper than previously thought (at least what the economists thought). The revision showed that the bottom of the dip was a whopping 6.8% drop in Q4-2008. The revision also moved the severity of the dip backward by a quarter from previous estimates.

The GDP numbers for Q2 are just the first estimate and will be revised monthly. Until the labor market improves there will only be minor GDP gains. The 16% of U6 unemployment is going to be a drag on growth for at least another year. With this much unemployment the risks are high for a double dip recession regardless of how many analysts promise it won't happen.

Moody's is revising their Q3 GDP estimates lower and may cut them to less than 2%. They are worried about the declining inventory cycle and the potential for low job creation now that the stimulus impact is fading. Governments are going to reduce spending by about 1% of GDP in the last half of 2010 as a result of stimulus money drying up. Moody's believes as many as 500,000 government employees from all levels could lose their jobs.

There IS growth out there but it's slow--the ISM New York improved slightly from 458.9 to 463.1 in July. The current conditions component fell from 69.3 to 58.4 while the expectations component fell only 2 points from 69.6 to 67.5. However both of those components are at their lowest levels since August 2009. The Financial Regulation Reform bill probably weighed on sentiment in the New York area.

The Chicago ISM, also released on Friday, showed an improvement in activity. The headline number rose to 62.3 from 59.1 and the highest level since April. Analysts speculate this is only temporary and related to GM's decision to skip the retooling process this year and keep plants open and thereby boosting output. This additional demand probably impacted activity at all the parts suppliers and boosted the Chicago numbers.

The minor improvements and revisions in various economic reports produced a positive week in the critical ECRI Weekly Leading Index. The index rose slightly from 120.7 to 121.1. That is not an earth-shattering move but there is a definite uptick in the chart after 16 weeks of a predominately down trend. However, the annualized growth rate inched lower again to -10.7%.

The WLI is likely to make a major move after the jobs report this Friday so stay tuned.
The economic calendar for this week has two important reports. The first is the national ISM Manufacturing report on Monday which is expected to be flat. A flat report may not produce a market crisis but any material decline or improvement is sure to create a big move in the absence of earnings distractions.

The big report for the week is the Non-Farm Payrolls on Friday. The official consensus estimate is for a loss of 75,000 jobs. The unofficial estimate is for a loss of 150,000 jobs--Ouch!

However the census data will cloud the picture again---Morgan Stanley believes the headline number will be a decline of 50,000 jobs but net of the census a gain of +135,000 jobs. That means they are expecting census terminations of 185,000 positions.

This payroll report is going to be critical for market sentiment for the rest of the quarter as it will be looked at as a true read on whether the economy is improving or declining. Most of the weekly regional reports have seen the employment components improving even as the overall production components decline. This is going to be a tough report to predict and the market will probably be hesitant ahead of the news. There is a Fed meeting two days after the payroll report providing another potential market mover.

Jobless claims continue to hover in the 460,000 range and while they are down from the peak over 640,000 in early 2009, they are stubbornly refusing to return to normal in the 320,000 range. A high level of layoffs is still happening and until that improves everything from consumer sentiment to consumption to GDP will continue falling.

Meanwhile earnings have been fairly upbeat--seventy five percent of the 336 S&P-500 companies who have reported beat the street on earnings per share. Only 64% beat on revenue expectations but that is still a strong number. Q2 profits have risen more than 45% from those who have reported. Obviously that number will go down as the smaller companies announce but it is still way ahead of the 26-30% that was being predicted just four weeks ago. This has been a very strong earnings cycle. Unfortunately that early cycle boost to the market has run out of steam.

The earnings calendar for next week is still busy with more than 350 companies reporting. However the quality of those reporters is declining and the market is now left focusing on some key economic reports--the question is...

HOW DO WE MAKE MONEY ON IT?

We've got two high potential plays lined up this week and they are both bearish.

The first is on a high-priced restaurant chain that just reported same store sales that were essentially flat--not a good sign considering the lows of a year ago should have been very easy to beat. Holders of the stock agreed and began selling immediately but it looks like this downtrend is just getting started!

Our next play is also bearish and it's on a stock that historically plunges after earnings and they are coming up within the next few days. This one has HUGE potential as we can buy some extremely well-placed September puts for right around .50 cents giving us some tremendous upside potential. If this thing performs like we thing it will you'll be sweeping up at the mint!

We've got two great plays lined up on a market ready to move so let's get to it...

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