In Cashflow Heaven when it rains it pours—profits
that is! This past week some outrageous volatility blasted us out of
every open position we had for some eye-popping gains…
RH DONNELLEY (RHD) DIPPED BELOW OUR AUTOMATIC
EXIT SELLING OUT OF OUR JAN 40 PUTS FOR A NICE FOURTEEN PERCENT GAIN!
MEANWHILE DIGITAL RIVER (DRIV) BROKE THROUGH
OUR PROFIT TRIGGER FOR A MUCH MORE ENTICING FORTY-EIGHT PERCENT WINNER!
ALSO ON THURSDAY FLOWSERVE (FLS) ROCKETED
STRAIGHT UP CATAPULTING OUR DECEMBER 95 CALLS TO A SUPER-JUICY
NINETY-FOUR PERCENT PROFIT!
AND FINALLY CAPTAL ONE FINANCIAL (COF)
COLLAPSED THROUGH SUPPORT THIS PAST TUESDAY DRIVING OUR DECEMBER 55 PUTS
TO AN OUTRAGEOUS ONE-HUNDRED-SEVEN PERCENT WINNER!
To top it off we didn’t have a single loser so now
our options accounts are stuffed to the rafters with fresh, tradable
cash! Cash we’ll be putting to good use this week with two new plays
just researched and ready to go. Before we get to them though let’s take
a good look at…
WHICH WAY THIS MARKET IS HEADED
As you can see the
S&P-500 broke through resistance at 1485 and ran to the downtrend line
from the October highs. This resistance line is strong since it is also
a congestive zone dating back to May—it would take a lot of good news to
power the index much higher from this point. A lower high here could be
a failed bear market rally and lead to a retest of the lows.
The Nasdaq broke
above horizontal resistance at 2700 but just barely and still has tough
resistance just overhead at 2720--the Nasdaq is just not that
encouraging. The Nasdaq 100 on the other hand is much more bullish and
finished well above the same relative resistance as the composite--2050
on the NDX--and the pattern is a lot cleaner. The NDX appears to be
poised to make a real break higher but has not yet completely broken
free of that 2120 resistance. The message here is that the large caps
are still more popular and that tells us investors still have recession
fears—and for good reason.
The markets went
nowhere on Friday despite the jobs report coming in ‘just right’.
Friday's nonfarm payrolls came in at a gain of 94,000 jobs in November
and suddenly most of the tension in the market evaporated. October's
gains were revised slightly higher by +3,000 but September was cut by
more than half from 96,000 to 44,000. Those revisions gave us a net gain
of only 45,000 jobs in Friday's report. The headline gain and the net
gain was just enough to dull the immediate threat of recession but not
too hot for the Fed to keep from cutting rates on Tuesday. Despite the
surprise +170,000 job gain in October the trend in payroll growth is
definitely down, just not steep enough to cause a selloff.
The relatively weak
breakouts you see in the charts above warn of potential weakness ahead.
When an index breaks key resistance by only a handful of points it is
only a tentative win and must be followed up quickly with conviction or
be doomed to retest support. On Friday we had the perfect jobs report
and the markets did nothing. True, the markets may be waiting for the
Fed but the Jobs Report should have kicked up some action and instead we
had the lowest full day volume since October 12th—not exactly
what bull markets are made of!
The market cheerleaders tell us the minute the Fed cuts we’ll charge
straight up with reckless abandon—but Friday’s action and the charts
above tell a different story. The truth is the Fed rate cut is already
priced in—and probably a .50 point cut at that. The Fed telegraphed it
for two weeks and then the last week's relatively bullish data made them
likely wish they had kept their options open. The Fed now has to cut at
least a quarter or risk an immediate market selloff—even so it’s
doubtful that a quarter point will be enough to keep the markets
trending higher next week.
The Fed will have
to walk a real tightrope on their guidance and whatever they say may not
be enough to pacify the market. The reason is the market already bought
the Fed rate cut talk and even with stronger economics last week the Fed
funds futures are still indicating a 152% chance of a quarter point cut
and a 35% chance of a 50-point cut. The Dow has rebounded +900 points in
two weeks on rate cut hopes and anything the Fed does is going to be
anticlimactic.
If past psychology
is an indicator any spike higher next week should be seen as a shorting
opportunity.
The economic
calendar for the coming week only has three material events--the FOMC
meeting on Tuesday, the Producer Price Index on Thursday, and the
Consumer Price Index on Friday. The price indexes are expected to show
even more hikes caused by food and energy but the core rates are likely
to be flat and not give the Fed any reason to hold off on cutting. The
headline PPI is expected to jump sharply to 1.6% from 0.1% in October.
The CPI is expected to rise less by only .7% compared to the .3% in
October. The Fed will have that info before we see it later in the week
so all eyes will be on the Fed and the individual price indexes will be
mostly ignored in the aftermath of the Fed decision.
The highlight of
last week had to be the President's "Teaser Freezer" plan to slow down
the subprime crisis to non-panic levels. Just the announcement of a plan
sent financials and builders soaring even before the real details were
revealed.
A closer look at
‘The Plan’ tells us it’s mostly high profile posturing to calm the
financial markets and give the appearance of action. According to
Friday's most recent projections the freezer plan would only apply to
about 90,000 to 150,000 of the 1.2 million mortgages that will reset in
2008. Those other million plus mortgagers are still stuck with the same
problem they had last week and that is a monster reset in their
immediate future. What the plan did do was improve sentiment across the
sector and the actual details of its execution will probably get lost in
the shadow of the next big story to hit the wires. The short term effect
has been great but there is still going to be a whole boatload of
foreclosures in the first half of next year and when the markets truly
acknowledge that fact it won’t be pretty.
Merrill Lynch cut
three major credit card firms to sell on Friday indicating that the
recovery of the financial sector may be a little premature. The
companies downgraded were American Express (AXP), Discover (DFS) and
Capital One (COF). The analyst wrote that economic news was worsening
and the risk of a consumer recession was all but certain. Merrill puts
the risk of recession at 65%--they warned that weakness in the consumer
sector was going to be much worse than expected.
The report further
warned that housing also had broader implications than currently being
discounted. They said Capital One was the most at risk due to their
client mix and was currently 15% over valued. Discover was reportedly
24% over valued and at risk given 60% of their business is domestic.
Discover is expecting charge-offs up to 4.75% but Merrill thinks it
could be much worse if the recession appears. They were more positive on
the American Express business model citing their greater exposure to the
international market. The analyst thought increasing risk to AXP would
come from falling real estate values of their big spender cardholders.
Risk at AXP was calculated at a 14% downside to the current price.
The bottom line is
that in spite of a well published government ‘rescue’ program last week
and a substantial upward spike in the markets we’re not out of the woods
yet and chances are good we’ll see a ‘sell the news’ event potentially
starting Tuesday if the Fed only cuts .25 basis points—and that is
likely all they will do—the question is…
HOW DO WE MAKE
MONEY ON IT?
We’ve got two plays
lined up this week and they are both bearish.
The first one is on
a drug maker the FDA is targeting hard. Earnings fell off a cliff at
this company’s last announcement and the news keeps getting worse.
Friday the stock sold off hard on huge volume telling us this one has
further to fall—a slide we’ll be riding for some potentially very
generous put profits starting first thing Monday morning.
Our next play is
also bearish and it’s on a company with the misfortune of being involved
in several of the weakest sectors in the economy right now—and their
recent earnings report underscores the fact. The stock gave us a perfect
shorting opportunity this past Thursday and Friday with a spike higher
that is already rolling over. We’ll be buying the right puts first thing
Monday for what looks to be a sweet ride to the downside.
The markets partied
hard last week but the hangover is coming—and we’ve got two nice plays
lined up to take advantage of it…
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