This past week the markets took off to the upside
like a tree squirrel chased by a starving Doberman…
AND WE USED THE OPPORTUNITY TO ENTER TWO SUPER
HIGH POTENTIAL SHORT POSITIONS!
Now I know the bulls are almost giddy with
enthusiasm that ‘the worst is behind us’ but there are some compelling
reasons why we may not be off to the races quite yet—what we saw last
week will likely end up being a sweet shorting opportunity.
Now I admit our timing wasn’t perfect---the market
continued higher after taking our positions--but the good news is our
timing doesn’t need to be perfect. Because once this market hits the
tipping point--likely this week--we’ll see another plunge quickly adding
value to our existing positions.
But for now the markets are heading higher—and to
get an idea of how far they might climb—and how to take advantage of
it--let’s take a good look at…
WHICH WAY THIS MARKET IS HEADED
The charts above show a powerful rebound in play
right now which is virtually all Fed induced—because the fundamentals
are still pretty scary.
Earnings season is in full swing with over 700
companies reporting next week and so far the numbers haven't been too
great. Earnings for the S&P for Q4 now
stand at a negative -20.5% as of Friday--on October 1st the estimate was
for a gain of +11.5%.
Financials are
continuing to drag down the S&P with a -104% drop in profits for the
quarter and a loss of $2.5 billion compared to sector gains of $55
billion in profits in Q4-06.
Tech stocks have
been the strongest sector with earnings gains of 25%. Overall companies
have been reporting earnings about 26.6% below estimates, again mostly
due to the financials.
Standard & Poor's is expecting some $250
billion in red ink from the banking sector for the fourth quarter
related to subprime and collateralized debt obligation (CDO) losses,
with the next round likely to affect smaller banks and other financial
institutions. But the problems don't stop there.
Problems in the
credit markets have dramatically affected new home sales, which were
reported last week to have fallen to an annualized rate of 604,000
units-- the weakest pace since the spring of 1993. The current sales
rate of 604,000 is less than half the peak of over 1.4 million units in
October of 2006. The median price just reported was down by 10.4% from a
year ago and inventory of homes on the market rose to 9.6 months of
supply. Amazingly this horrible news did not slow down the buying in
homebuilder stocks with the sector now sporting a two-week rally.
With so much of our
economy affected by the residential real estate sector the GDP for Q4
just reported on Wednesday fell to +.64% from the +4.91% rate in Q3.
That is a massive 87% plunge and shows the nearly instant impact from
the subprime crisis as it bled over into the corporate bond arena.
The 4-point drop in
the GDP was a strong incentive for the Fed to cut rates at Wednesday's
meeting. The majority of the indicators suggest the economy began
dropping even faster in December so analysts worry that the decline into
Q1-08 has already put us into a recession.
Another troubling indicator is the sharp spike in initial unemployment
claims to 375,000 for the prior week. Rising unemployment is probably
the strongest indicator of a pending recession and that fear was further
reinforced by the Employment Report.
The Employment
report on Friday showed a loss of 17,000 jobs in January. If this is not
revised in the March release it will be the first month of job losses
since August 2003. The report blind-sided economists as official
expectations were for job gains of 75,000-100,000 jobs.
Meanwhile all was
not well even the strongest sector--technology. Global semiconductor
billings fell -3.6% in December with the decline marking the 3rd
consecutive month of slowing sales. Chip sales were still up +3.2% for
the year but slipping fast. Demand for consumer devices remained strong,
+14% for PCs, but over-capacity problems are flooding the market and
forcing prices down.
The current
champion of tech--Google (GOOG)--was hammered on Friday for a -$48 loss
to close at $515 after disappointing on earnings Thursday night. The
news of the MSFT/YHOO deal just added to the Google plunge. The company
posted earnings of 4.43 per share compared to analyst expectations for
$4.44 per share. Investors are used to Google beating estimates by a
mile so the fall from grace by even a penny was a gigantic shock.
Plus the
combination of Microsoft and Yahoo will create a serious competitor for
Google. Current stats indicate the merger would give Microsoft a lead
over Google in eyeballs and potential advertising audience. Reportedly
Microsoft and Yahoo have been in discussions for the last 14 months and
Microsoft described them as frustrating so when Yahoo declined to a
4-year low Microsoft decided to go hostile and make them an offer the
shareholders couldn’t refuse. The merger news is credited with boosting
the entire tech sector but one has to wonder if there isn’t more
underlying buying pressure at work here because this type of news is a
one-time event.
The final piece of
serious economically damaging news is the bond insurers. The major
rating agencies reiterated their current negative outlook on Friday. The
current consensus of opinion suggests a settlement needs to be reached
on ABK/MBI before the end of February or the sector is going to cave in
completely.
The bond insurance
sector imploding has such major negative consequences on the financial
markets that at last count there were eight major banks in talks to bail
out the insurers. Reportedly a downgrade to junk status on MBI/ABK would
cause between $75 billion and $150 billion in further write downs by the
major banks coming close to doubling the damage already done by the
collapse of the subprime sector.
The problem is the $1.3 trillion in CDOs written over the last 3-years.
No one seems to know their actual value today but based on the Merrill
CDO buyback they could be worth less than 50% of their original selling
price. Since banks have only written off about $100 billion in value
this suggests a failure to rescue the insurers could result in much more
massive write-downs in the future.
The problem is so potentially severe it has drawn help from several
agencies, including the New York insurance regulator which is currently
attempting to put a bail-out deal together. The Washington Fed is also
involved along with the New York Fed, the Presidents Working Group on
Financial Markets otherwise known as the Plunge Protection Team (PPT)
started by Reagan after the 1987 crash, and the Treasury Dept. This bond
insurer situation has the potential to be worse than the Long Term
Capital blowup in the late 90s which is why so many government
heavy-weights are trying to fix the problem.
As far as the stock
market goes the current rally is directly counter to what the
fundamentals are telling us--but it may have some sticking power. Every
major selling attempt since the Societe Generale January 23rd
low has been met with strong buying. The bad news is being discounted
bit by bit and there are signs we see a lasting rally at some point
soon.
With increasing government involvement the odds are getting better that
the bond insurer problem will be solved without a major catastrophe. The
financial sector rallied +11% for the week and the housing sector gained
+13% in-spite of every devastating statistic we just discussed—this is
bullish price action in the face of some pretty daunting news.
The Fed has finally begun to realize how dire the situation is and has
already bailed out homeowners and CDO owners. Their unprecedented 125
basis point cut in just over a week is a clear sign they are trying to
rescue the economy by bailing out homeowners. Cutting rates to the bone
would allow the majority of homeowners in serious trouble with resetting
ARM loans to quickly escape the debt trap and convert to a low interest
conventional mortgage---30-year rates were already down to 5.15% last
week.
Many of the 1.2
million homes expected to foreclose in 2008 may now escape and the Fed
is not done according to the futures, which are now close to pricing in
another 50-point cut when they meet again on March 18th.
A 2.5% Fed Funds
rate would put mortgage rates under 5% and could potentially complete
the rescue of the housing sector, mortgage sector and the economy. That
$1.3 trillion in CDOs written over the last three years would suddenly
recover in value and help solve the problem of the bond insurers.
Although these radical rate cuts are devastating the value of the dollar
the Fed has decided it is the lesser of two evils—and in the short term
they are probably right.
If we can avoid a recession the global economy will catch fire again
because the only reason there is a global slowdown right now is because
of the U.S. subprime crisis and the resulting slowdown in the States. If
the Fed successfully re-inflates housing and manages to solve the bond
crisis we’ll will be off and running again—and that may be the reason we
saw so much buying last week in a market flooded with bad news—the
question is…
HOW DO WE MAKE
MONEY ON IT?
Regardless of
whether January marks the true bottom of the market or not we’ve got
upward momentum right now—and it’s a smart trader that goes with the
flow--which is why both of our new trades this week are bullish. Plus
we’ve got the downside pretty well covered with our existing positions
so two new plays on the other side only make sense—especially these two
new trades...
Our first play is
on an oil producer and refiner that recently got hit on lower
earnings—but a closer look has investors convinced the bottom is in and
margins are expanding. The chart tells us this is an excellent time to
jump aboard as the stock rocketed higher Friday on BIG volume—and it
won’t take much of a move to make us a bundle on the right calls—calls
we’ll be buying first thing Monday morning.
Our next trade is
on a key player in commodities infrastructure turning in a whopping
116% earnings increase at their last report. With a brand new 2 for 1
split behind the stock and one of the best looking charts out there
we’ll be taking a ride on this upward bound escalator first thing Monday
for what looks to be a very profitable ride.
We’ve got two nice
plays lined up and a market that wants to move—so let’s get going…
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