The markets seemed to fall off a cliff toward the
middle of last week and investors everywhere are wondering if we’re
going into a massive free-fall or if this market is finally ready to
find a bottom—to help answer that question let’s take a good look at…
WHICH WAY THIS
MARKET IS HEADED
The S&P-500 broke
below January's low close of 1310 finishing the day at 1293 and well
under previous support. Now that the Jan lows have been broken this
index looks like it’s heading to the 1225 support level dating back to
Jun/Jul 2006—and by the way things have been playing out it’s liable to
happen sooner rather than later.
The Nasdaq traded
below its January lows at 2202 hitting 2186 intraday---the rebound was
weak but still managed to close up 30 points by the end of the day on
what looks to be short covering. If the 2200 level cracks for good next
week then the next target is 2000. The five Nasdaq heavy weights--MSFT,
INTC, AMZN, EBAY and GOOG all look weak—not a good sign if you are
looking for a bounce.
The big question
everyone is asking this weekend is whether the markets are nearing a
capitulation low—unfortunately for the bulls that doesn’t look to be the
case. The VIX only rose to 28 on Friday---a level it has seen many times
over the last four months. It is far from an extreme like the 37 we saw
back in January.
Volume was far from
extreme with only a slight gain over the prior week. Friday's volume was
8.2 billion and well below the 12 billion or so we saw back in late
January. The advance decline line was only 8:5, in favor of decliners.
There was an imbalance but definitely no extreme.
Only about 12% of
stocks were at 52-week lows on Friday. The internals are certainly
bearish but far from extreme. There has been no capitulation and no
extreme increase in volume. The sell-off has been orderly and more like
a buyer boycott than extreme selling.
There has been a
lot of debate over whether or not we’re in a recession and Friday
morning’s employment report should have settled the issue once and for
all. Economists were expecting a gain of 25,000 jobs for February and
instead got a devastating loss of 63,000 jobs. The consumer is
completely tapped and their biggest asset—their homes—have been falling
in value like dead weights. All that could bad news could conceivably be
sustained if employment stayed strong but this latest report tells us
the last leg of this three-legged stool just got kicked out.
February's 63,000
job loss was the second consecutive month of losses. January's 17,000
loss was revised lower to -22,000. If you remove the +38,000 jobs added
to government payrolls the private sector lost over 101,000 jobs for the
month. The decline in jobs is a clear signal of the onset of recession
and one that has been nearly flawless for the last 60 years. We have
never escaped a recession after three months of job losses—so far we’ve
got two months down and one to go.
The only thing that
kept the markets from completely imploding Friday morning was the action
by the Fed just as the report was about to be released. The two-step
approach reflected the Fed's efforts to break the frozen credit markets.
The first step was to increase the Term Auction Facility (TAF) to $100
billion from $60 billion. They also committed to extend the TAF for an
additional six months. They relaxed the rules to cover any bank and
almost any collateral. In step 2 they will offer $100 billion in
addition 28-day loans to member banks. Although further loosening of
lending to banks initially appeared bullish traders soon realized it
meant the Fed wasn’t likely to lower interest rates again before the
March 18th meeting—and by the sounds of things even that may
be up in the air.
Fed speakers have
been hitting the podium all week with warnings about the potential rise
in inflation brought on by aggressive rate cuts. The Fed may be trying
to warn investors that the pendulum was swinging back to inflation fears
and away from worries about slowing growth AND the resulting halt to the
current rate cut bias.
For example Kansas
City Fed President Thomas Koenig said in a speech on Friday that,
"excessive rate cuts risk adding to inflation and create further asset
bubbles." Furthermore Fed Vice Chairman Donald Kohn said at a Bank of
France seminar in Paris, "Policy-makers must be mindful of the
uncertainties surrounding the outlook for commodity prices and the risk
that past or future increases in these goods could yet embed themselves
in higher long-run inflation expectations and a persistently faster rate
of overall price increases." This is the kind of talk that halts
interest rate cuts in their tracks.
Noted inflation
hawk Dallas Fed President Richard Fisher warned the markets not to
expect continued rate cuts saying the Fed needs to be careful and take a
steady measured approach to the new economic events---and Fisher is a
voting member of the FOMC. Earlier this week the futures were showing a
strong chance of rates cuts totaling 100-points by April 1st. With the
Fed's action on Friday those chances have now dropped to only 50-points.
The market has yet to price in this change in bias despite the -146 drop
in the Dow.
Because the specter
of spiraling inflation is so critical for future rate cuts the key
economic report this coming week is the Consumer Price Index (CPI) due
out on Friday. The CPI is important because of the sudden uptick in
inflation talk among Fed officials. The CPI gives us a look at the rate
of inflation at the consumer level—and if it shows continued higher
prices the market and the Fed aren’t going to be happy.
In addition to the
threat of inflation keeping a lid on the Fed every new rate cut pushes
the US Dollar to new lows. This drop in the dollar is continuing to
power commodities—one glaring example is oil rising to another new
intraday high at $106.54. Every $1 increase in oil is an additional
$5.23 billion energy tax on U.S. consumers making it that much tougher
to avoid a recession—and that much tougher to get out once we’re in.
Goldman Sachs
raised its average expected oil price to $95 for all of 2008, $105 in
2009 and $110 in 2010. Those are averages for the full year but their
high end of the range is now expected to be $135 with possible spikes to
$150-$200 if additional supplies do not come to market or if we suffer a
major disruption in some producing country. You may remember that
Goldman shocked everyone two years ago with their $105 super spike
projection—but we’ve hit it already and odds are good we’ll see their
new projection as well. Better park the Suburban and break out that
ten-speed.
In addition to
everything we’ve just talked about the next round of financial earnings
are due out the week of the 17th—just a week away. Odds are
very good there will be more big write-downs.
The Fed also meets
in seven days to discuss interest rates and with a 75 point cut priced
into the market there is plenty of room for disappointment. In addition
to that we’re closing in on earnings warning season. There is plenty for
traders to be worried about right now but we could still see a reaction
bounce this coming week—the question is if we do get one can it last
through the CPI report on Friday? And the more important question is…
HOW DO WE MAKE MONEY ON IT?
We’ve got two great
plays lined up this week and they are both bearish.
Our first plays is
on a semi-conductor company that really bounced recently on some good
news—unfortunately for share holders everything tells us this bounce is
VERY temporary—in fact we expect a big reversal most likely on
Monday—but not before we’ve had a chance to buy some super
high-potential puts close to the open Monday morning!
Our next play is on
one of the huge multi-national manufacturers—this one has a chart that
just screams ‘short’ and we’re paying attention---with some well placed
puts first thing Monday!
The kind of
movement we’ve seen over the past few days can make options traders rich
if you’re on the right side—and with our current plays we are—so let’s
get started…
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