One of the big keys to the current market is to
remember that winning profits on the downside can be even faster than on
the upside--because markets tend to drop faster than they rise—this past
week provided a great example with the post Fed drop on Tuesday.
Will the markets continue to plummet or are we
ready for a bounce? To get a better idea let’s take a good look at…
WHICH WAY THIS MARKET IS HEADED
As you can see we had some major technical
break-downs this past week that look extremely bearish for the markets
going forward. There isn’t a whole lot to hang a bullish charge on right
now which means these indices are liable to test their recent lows—the
SPX at 1405 from November 26th and the Nasdaq down at 2545
from the same date.
A lot of market
watchers are shaking their heads and wondering why with all the
recessionary data out there right now the Fed didn’t give the markets
what they wanted with a big .50 basis point cut and a lot of market
friendly language to go with it.
The reason is
obvious now—the Fed had access to the price index data before they made
their decision and they could see the numbers were pointing toward much
higher inflation. Now that both of those reports have been made public
we can see the same inflationary dangers.
On Thursday the
Producer Price Index (PPI) spiked +3.2%---the second highest reading
since the inception of the report back in 1947! Year over year inflation
spiked from 6.0% to 7.7%---the highest level since 1981.
The largest
contributor to this spike was a 14.1% jump in energy prices—while the
core rate--even after taking out food and energy--rose by a larger than
expected +0.4%. No wonder the Fed only cut by .25 points—in fact if they
hadn’t practically promised the markets a cut going into the meeting
they probably wouldn’t have acted at all.
Producer prices
came in high but the inflationary numbers didn’t stop there--the
Consumer Price Index headline number on Friday spiked +0.8% for the
largest increase in more than two years. After 5-months of +0.2% gains
the core rate rose +0.3%, marking the biggest rise since January. Over
the last 3-months the top-line CPI has risen at an annualized rate of
5.6%--way above the Fed’s target of 2%. The Economist's food-price index
is now at its highest since it began in 1845, having risen by a whopping
one-third over the past year!
The biggest problem
for the market last week was these new inflation revelations. Since the
Fed can't ignore the signs they are nearly locked out of any future rate
cuts if the current trends continue. The next meeting is Jan-29/30th and
the Fed will have nearly two months of additional data before they have
to decide again. This makes the inflation component in any future
economic report critical for Fed direction—and market direction.
The biggest news
next week will be earnings reports by the major brokers. Goldman Sachs
reports earnings on Tuesday, Morgan Stanley reports on Wednesday and
Bear Stearns on Thursday.
In addition to the
financials we’ll see earnings that could substantially affect the Nasdaq
from ADBE, ORCL, PALM and RIMM.
The key as always
will be forward guidance and it’s the financials that will likely have
the most influence on the overall markets. We’ve already heard from two
major players this past week and the news has not been good--which could
be a preview of this coming week.
On Friday Citi-Group
said it would move its seven troubled investment funds back onto its
balance sheet. These funds hold a lot of mortgage investments and have
$62 billion in assets or $49 billion excluding cash and cash equivalents
and $58 billion in debt. In taking these funds back onto their balance
sheets it guarantees the funds will probably not go under, and will help
create transparency for future dispositions. The new CEO, Vikram Pandit,
probably got a blank approval from the board on almost any amount of
housecleaning needed to bring Citi back into favor on Wall Street—so far
so good.
The problem is
taking these funds back could put Citi into a capital squeeze. Bank
America analyst John MacDonald warned Citi capital reserves could drop
to 6.8% by year's end. Regulators prefer banks remain above 6% and a
level they feel is safe. Citi has $2.36 trillion in assets and while a
failure is not expected there is concern.
Besides these
separate funds Citi has $55 billion in direct exposure to subprime
mortgages. $43 billion of that is exposure to CDOs. Citi has already
said they would write down $11 billion of this debt in Q4 due to
decaying credit quality. CIBC World Markets said Citi would have to sell
about $100 billion in assets to raise cash and probably cut its 54-cent
dividend. The dividend cut is already being priced into the stock--Citi
(C) lost nearly 10% for the week.
The reason we’ve
spent this time dissecting Citigroup is because they are the largest
bank by assets in the United States and may give us an indication of
what we’ll be seeing when the major brokerages report this coming
week—the subprime mess is far from over.
Another one of the largest banks in the country—Bank of America warned
on Wednesday that end of year results would be "quite disappointing."
The CEO announced that current write-downs of $3 billion from bad debt
would not be enough and larger losses were still ahead—Ouch!
BAC lost 6.5% for
the week despite being named by Inside Mortgage Finance as the largest
mortgage loan originator for the first nine months of 2007. BAC
originated $110 billion in mortgage loans for the first nine months
beating both Countrywide and Wells Fargo.
In just Q3 BAC
loans jumped +27% over the same period in 2006 mostly due to the
problems at Countrywide with people looking for a secure lender to
handle their loan. Since Bank of American has been picking up so much of
the slack in the mortgage market a tightening at the firm is likely to
make mortgages in general that much harder to fund going into 2008.
This increased tightening comes at a tough time in
the real estate market. On Monday, the National Association of Home
Builders will release its housing market index, a sentiment survey of
builders. On Tuesday, the Commerce Department will report on housing
starts and building permits for November.
Economists expect housing starts to fall 3.3% in
November to a seasonally adjusted annual rate of 1.19 million from 1.23
million in October. Starts have fallen to a level that's off about 50%
from the peak--and are continuing to head lower. There is a lot of
inventory that needs to sell before prices stop going down and new
housing starts turnaround to the upside.
We’ll get the ‘Risk of Recession’ report Monday at
10:00am ET giving us an idea of how much the credit crunch and falling
housing market is affecting the economy. The last report pegged the risk
of recession at 47%--and any increase above that--especially to over
50%--is likely to spark another rush for the exits.
Last week was likely a turning point in the markets
with many traders realizing the Fed may be finished with their
accommodating monetary policy. When the Fed refused to cut 50 points and
failed to issue a strongly worded statement this past Tuesday market
support instantly disappeared and stocks plunged lower. Add in the
earnings warnings, sector wide downgrades, additional subprime
write-downs, recession warnings and sharply rising inflation and there
were few reasons to buy last week--and lots of reasons to sell.
By the looks of Friday’s close that sentiment is
likely to carry over into this week as well.
There are basically eight trading days left in 2007
plus a couple half days with very little volume. Holiday trading always
decreases dramatically in the week before Christmas and mutual funds are
going to quit trading as volume slows. As long as traders were counting
on a year-end rally there was still buying interest—but now we’re likely
to see tax selling more than anything and a squaring of positions before
next Friday’s quadruple witching. If current support levels break this
week—and they very well may—the markets could turn down fast. But even
if support holds it’s hard to make a bullish case for the rest of this
month—the question is…
HOW DO WE MAKE MONEY ON IT
We’ve got two plays lined up this week and you know
they are both bearish.
The first is on a mid-size regional Bank that just
confessed to a greater exposure to subprime losses than investors had
originally thought—and they’re not out of the woods yet. The stock just
broke below key support on Friday and by the looks of the chart it’s got
quite a bit more to go—a ride we’ll be jumping on with some well placed
puts first thing Monday for what looks to be some extremely generous
downside profits!
Our next play is on a major retailer that is
rolling over from a fairly high stock price. In spite of what has so far
been a better than expected holiday shopping season it looks like
traders are trying to get out early before the January hang-over sets
in. The stock just rolled over forming what looks to be a bearish
double-top with plenty of downside ahead. With the right trailing-stop
this play is primed for some huge profits as the stocks downtrend
accelerates!
We’ve got two great downside plays lined up on a
market pointing due south—so let’s get to it…
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