Speaking of markets turning on a dime that’s
exactly what happened Friday—to find out what’s dead ahead and where the
opportunities are let’s take a good look at…
WHERE THIS
MARKET IS HEADED
Both the SPX and the Nasdaq are looking pretty
bearish here—the SPX dropped 37.57 points in the last five days and the
Nasdaq plunged 80.74 for the week. It looks like investors are getting
pretty nervous over how earnings might play out and Friday looked like a
good time to bail—especially with the bombshell General Electric’s (GE)
dropped Friday morning.
GE posted earnings
of 44 cents compared to analyst estimates of 51 cents—a devastating
downside surprise considering how well GE usually hits their estimates.
The company blamed the implosion in the financial markets after the Bear
Stearns collapse for their stumble as they were unable to conclude some
critical asset sales because the market had gone back into gridlock.
GE lost a lot of
credibility using the too well-worn credit markets excuse and the size
of the miss. If it was really a one-time event then why did they lower
their full year earnings estimates to between $2.20 and $2.30 per share
from their prior guidance of $2.42? It appears GE has more wrong under
the hood than what they admitted to during their announcement.
GE is considered a proxy for the entire economy and
their surprisingly poor earnings rattled investors with the stock
crashing $4.70 for the day-- the largest single day loss for GE since
the 1987 crash and single handedly knocking 36 points off the Dow. It
was GE's dramatic failure to meet earnings estimates that calls into
question the capability for the rest of the stock market to meet
theirs—that fear sums us the dramatic turn in investor sentiment on
Friday.
Unfortunately it’s not just investor sentiment that
has turned south---the Consumer Sentiment number for April also reported
Friday, fell a startling -6.3 points to 63.2---a 26-year low. The
expectations component fell -6.7 points to 53.4 and current conditions
fell -5.8 points to 78.4 while inflation expectations spiked to 4.8%
from 4.3% in March.
The decline in sentiment is not only consistent
with a recession but at these levels and acceleration it looks like a
severe recession with a headline number already below what we saw back
during the 1990 downturn. In fact the last time sentiment levels were
this low was the 1981-1982 recession.
Rising food and energy expenses were seen as the
biggest drivers and it makes sense since they hit consumers so close to
home. Talk of $4 gasoline in May and $5 by the end of the summer is
causing a panic among house holders whose budgets are already stretched
to the breaking point. Add in the plunging housing market and nearly
impossible loan requirements and it’s not hard to imagine a 26-year low
in sentiment.
Since the consumer makes up approximately
two-thirds of the US economy a downturn in consumption affects the
economy directly. The Fed Beige Book on Wednesday will give us a good
look at economic conditions in all 12 Fed regions. Last month’s report
showed conditions were worsening in almost all regions and all
components. Odds are good this report will be significantly worse given
the recent change in posture by the Fed—the question of course is
whether the FOMC can justify continuing to lower rates in the face of
rapidly rising prices.
We’ll get a good
idea of those rising prices this coming week with the two main inflation
reports---the Producer Price Index (PPI) and the Consumer Price Index
(CPI). The PPI is Tuesday and will show us how rising energy prices are
filtering through at the producer level. Expectations are for a rise of
0.5% to 0.8%. With oil hovering around $110 the odds are good there will
be a sharp increase in those products related to crude—which is just
about everything. The CPI on Wednesday is also expected to show a sharp
increase of 0.3% to 0.5% with last month’s zero gain an anomaly.
We’ve got a whole
lot of earnings reports this coming week with Intel on Tuesday a
critical bellwhether for the tech sector. They continue to say business
is good but then turned around and lowered expectations for the quarter.
IBM reports on Wednesday and they will be just as important as Intel if
not more so since they deal directly with large corporations--if their
guidance tells us corporations are slowing their spending then look out
below. We’ve got two more tech biggies with EBay on Wednesday and Google
on Thursday.
There are several major banks/brokers also due to report next week and
including JPM, USB, WFC, MER, C, AMTD and ETFC. These major financials
will be heavily scrutinized for new write-downs. Analysts expect
cautious guidance, higher delinquencies, and the need to raise more
capital. Assets that cannot be valued by normal means because they are
not currently trading will be assigned a value based on what they think
they are worth rather than an actual market value. An independent
analysis of the financial sector was released on Friday suggesting that
up to 200,000 jobs could be cut by year-end due to falling profits.
FedEx CEO Fred
Smith warned on Friday there was currently "no growth" in the U.S.
economy and UPS lowered its guidance last week due to higher costs and
falling volume—both of these package shippers are good indicators of the
overall economy and their sentiments are echoed by current earnings
expectations. As of Wednesday Q1 earnings for the entire S&P were
expected to fall by -13.2%. That was 2% worse than three days earlier
and -5% worse than ten days before. After the GE news that forecast has
probably fallen to a decline of more than -15%.
By this time next
week we’ll have a pretty good indication of how earnings are going to
play out with major reports from the two largest sectors---the techs and
the financials. If GE, with a spotless balance sheet, can't get
transactions financed then banks and brokers with major counterparty
risk are probably having an even tougher time. The Fed's massive
programs to increase liquidity may have partly solved the problem and
the markets will be riveted to news out of the financials—especially
derivative laden JP Morgan (JPM) on Wednesday.
Even amongst some
pretty daunting economic numbers traders are looking hard for a bottom
and thought they found one a couple of weeks ago--but they got a big
surprise with GE and there may be more on the way this week—the question
is...
HOW DO WE MAKE MONEY ON IT?
The markets took a
big turn for the worst Friday and traders are skittish—the path of least
resistance looks to be lower and we’ve got two ripe downside plays lined
up to take advantage of it.
Our first play is
on an industrial powerhouse with tentacles in multiple sectors of the US
economy—very much like GE. With GE the best run of the big conglomerates
you can bet this company isn’t doing a whole lot better—and their chart
confirms we’re not the only one with suspicions. The stock broke a
month-long uptrend on Friday on sizeable volume after hitting major
resistance on Thursday. Now the stock looks to be heading for a whole
new leg to the downside—one we’ll be taking advantage of first thing
Monday morning.
Our next play is on
a company that is being hit by both a slowing economy AND rising oil
prices. The stock took a big turn south this past week when they
admitted business is worse than originally thought, but that looks to be
just the beginning. With the stock price hovering over seventy dollars
per share there is plenty of potential downside—especially with earnings
just eight trading days away!
We’ve got two new
high-potential put plays and a market heading south—so let’s get to it…
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