Option Investor
Market Wrap

Market Meltdown or Explosion?

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        WE 9-14           WE 9-7          WE 8-31          WE 8-24
DOW     9605.51 -   .34  9605.85 -343.90  9949.75 -473.42  +182.39
Nasdaq  1695.37 +  7.67  1687.70 -117.73  1805.43 -111.37  + 49.79
S&P-100  558.58 +  4.69   553.89 - 23.51   577.40 - 29.31  + 12.84
S&P-500 1092.54 +  6.76  1085.78 - 47.80  1133.58 - 51.35  + 22.96
W5000  10104.44 + 37.95 10066.49 -448.60 10515.09 -433.32  +188.32
RUT      440.73 -  4.46   445.19 - 23.37   468.56 - 12.25  +  5.16
TRAN    2676.49 - 36.65  2713.14 -100.27  2813.41 - 40.98  + 29.74
VIX       34.60 +   .24    34.36 +  6.51    27.85 +  5.56  -  4.45
VXN       63.84 -  1.61    65.45 + 12.59    52.86 +  5.16  -  4.32
TRIN       3.28             1.25              .71              .70
TICK       +100             -113              -74              351
Put/Call   1.01              .84              .82              .56

The damage has been done to lives and buildings. The damage to the stock market has yet to be seen. When the NYSE opens for trading on Monday it will not be without problems. Still the almost superhuman effort to reroute communications, occupy temporary office space, install and configure new computers, servers, routers, etc, will be tested under fire at 9:30 Monday morning. There is likely to be outages, bad ticks and massive failures as record volume hits the boards. Still America will be back in business but it will not be business as usual.

There is a huge difference of opinion as to what will happen on Monday morning. There is a group of analysts that think the markets could easily drop 8-10% at the open, rebound slightly and then fall off the cliff to extreme levels. The bullish camp think that Americans have put on their red, white and blue trading caps and will rush in to buy America on sale on Monday and create a very strong patriotic rally. Reality will likely be something in the middle of both those extremes.

The Fed is building a fortress around the U.S. stock market and the American financial system. They have injected almost $215 billion of liquidity into the system in the last three days. $90 billion of that was funding for foreign banks to prevent a cash drain as funds are shipped around the world when the markets open for business. The Fed Funds Futures are showing almost an 85% chance for a 100 point rate cut in the next 30 days. The educated bettors are expecting a 50 point cut before the market opens on Monday with another cut at the October 2nd meeting if the markets are still in the tank.

The Fed action, if it comes, will provide a boost to the market, temporarily. Because it has been telegraphed all week much of the impact has already been dulled. Heaven help us if they do not cut or only cut a quarter.

The biggest problems will come from the change in the world as we know it. Airlines for example are literally on the verge of bankruptcy from the already 50% drop in revenue over the next 90 days. Reservations are being cancelled daily, and new restrictions on travel are being added as well. The CEO of Continental said on CNBC that most airlines would not survive the next 90 days without intervention. The government is trying to rush through a $2.5 billion grant to keep them liquid over the next two weeks and then a $12.5 billion loan guarantee to prevent them from bankrupting over the next 90 days. Air travel as we know it has changed. The airline sector as we know it will likely change over the next 90 days as well. Expect smaller carriers with lower reserves to experience problems and become prey for the giants.

The -50% drop in airline bookings will also impact hotels, restaurants, retail and the service industry. Consumers were already losing confidence in the economy as evidenced by the huge drop in the sentiment numbers on Thursday. The University of Michigan sentiment dropped to 83.6 from 91.5 in August and was far below the 90.8 analysts expected. This is what the Fed has feared for some time. Fueling this drop was the spike in jobless claims to 431,000. With a head start down the recession hill any pull back by consumers because of the fear of terrorism could grease the skids not only in the U.S. but globally as well. The state department has issued a strong caution for overseas travel and the bombs have not even started falling. Without the U.S. tourist as well as tourists in general there will be serious problems with the global picture.

Local economists are painting a gloomy picture. First Union said on Friday that the drop in retail, restaurants, hotels and travel would be enough to push the U.S. economy into a full blown recession. The economist for Bank One was also negative about the possibility of avoiding a global recession. In reality market fundamentals have worsened. Before the attack the fundamentals were terrible and the markets were tanking as companies warned on a daily basis. Now that the fundamentals for a major portion of our economy have literally been cut in half how can the markets react positively?

General Electric was the first major company to warn based on the attack. They said losses in their reinsurance company for claims on the WTC would knock four cents off their earnings for this quarter. AIG also said they would lose -$500 million for their part in the claims. These are only the first of many warnings but these warnings may be seen as one time charges instead of normal operating and therefore ignored. It still sets a tone for the markets that is negative. Ford said disturbance in supply lines would cause it to make fewer vehicles and they would miss earnings estimates. Multiply this by hundreds of companies and you can see what lies ahead.

Contrary to all the negative issues I mentioned above there are also many positive benefits to the economy. The amount of replacement hardware for the ground zero businesses will be substantial but it will still only be a blip on the screen long term. What will help is the change in business climate nationwide. Many corporations will see the devastation and complete destruction and start thinking about what would happen if that happened to their building due to terrorism, fire, flood, hurricane, tornado, earthquake, etc. It makes you feel very vulnerable. There will be a rise in orders as thousands of companies beef up their disaster recovery plans. The security sector will undergo a complete makeover and literally hundreds of thousands of people could find employment there over the next year. As the counter attack progresses it will heighten awareness and increase the security level for all America.

This wave of capital spending will take some time to be seen in sales and profits but it will happen. It will not happen in time to help the markets next week. What will help us next week is the relaxation of the buyback rules by the SEC. They normally prevent companies from buying back their stock in volume on the open market. This prevents companies from manipulating their stock price. With the relaxed rules companies have more freedom to buy larger amounts. Cisco has already announced a $3 billion buyback to begin next week. AIG, even after announcing a $500 million loss, has approved a 40 million share buyback. This will put a floor under their shares. CSCO at $14.47 could put out a blanket order for millions of shares at $13. This would allow some market movement but limit the downside. AIG at $74 could put in a limit buy at $69.75 and basically support the stock in a very bad sector while giving themselves a little breathing room.

Monday is likely to be historic in more ways than one. Many analysts think we could easily see the biggest volume day ever. Some have said we could actually see four billion shares on the NYSE. While I doubt the four million mark it will be very heavy. The best guess for direction is a strong dip at the open followed by a patriotic rebound but ending negative for the day. The war between the bears and the bulls could be waged for most of the week. There is likely to be a struggle to rally which will end with the realization of the recessionary facts. Sentiment has taken a serious hit on top of the drop from the prior week. Earnings will continue to fall through the fourth quarter and any bounce from a new wave of capital spending will not be seen until next year.

The Dow is going to face a challenge from Boeing, GE, GM, JPM, AXP, C, WMT and DIS. Boeing is rumored to be at risk to drop -15% to -20%. JPM, C and AXP could easily drop -10% to -15%. The Dow, which closed at 9605 last Monday, could easily hit 9300 or even 9000 on panic selling. The European/Asian markets have fallen close to -10% on the news and could fall more in advance of our market open on Monday. A 5% drop on the Dow would put it at 9124. A 10% drop would see 8644. The markets were already severely oversold from the prior week and even a 5% drop from here may be too much of a temptation for investors to resist.

That is of course if there are any investors willing to buy the dip in front of a huge unknown. With comments in the media today that Bin Laden has over 10,000 trained soldiers at his disposal across several countries, the battle is shaping up to be long and arduous. Up to 50,000 reservists have been approved to be called into active duty. This is bound to weigh on investors and consumers. The threats of revenge are already being made by the Taliban and they have the resources to carry it out.

This will not be a couple cruise missiles launched in the night. This is going to be a sustained conflict with a good possibility of a ground war. Russia spent years and lost thousands of soldiers in Afghanistan. It is a very rough terrain and not conducive to a quick conclusion. Benjamin Netanyahu called the attack the "wake up call from hell." The threat has always been there but their technical ability to act on it was lacking. He said they are capable of changing the direction of history if they are not stopped soon. This type of information is being absorbed by investors and it will weigh heavy on the markets.

I would love to tell you that the market will do thus and so on Monday and have you plan your trades accordingly. Unfortunately there is no human being with the ability to predict what will happen. We have spent the entire week producing special reports and analyzing the possibilities. We have received some great emails from our readers about these efforts. The sector analysis, trading tips and sentiment pieces were our efforts to equip you to make the right decisions on Monday.

We have had some very successful put plays recently. Many of them could have been very successful on Monday as well. Because we do not want to look like opportunists trying to profit on the tragedy we are dropping all of them this weekend. BA, PGR, TSG, JPM, AIG, ACF and MER. How you continue to play these is of course up to you. We have been asked by many to suggest some plays that we thought would benefit from the money shuffle that will occur. We tried to find a couple politically correct companies that were not directly impacted but would benefit from a longer term outlook. We chose ATK, Alliant Tech Systems and NBR, Nabors Industries an oil driller that focuses on the lower 48 states. We also suggested a couple plays on the QQQ and DJX to benefit from any major dip and rebound. We will resume a regular play pick schedule on Tuesday after the smoke clears.

If you are not in the markets currently I would be very careful attempting to trade them on Monday. Those readers who are long options and have seen time value evaporate over the last week would do well to monitor those positions closely. The Options Clearing Corp will not change the expiration date. Remember, for every holder of a long option who is wishing for another week of time to hopefully recover value, there is another writer of that option that wants it to expire worthless. Do not expect relief in that direction.

I apologize! Apparently many readers took my comments from Thursday night incorrectly and not in the spirit given. I apologize for the misunderstanding. I fully support Bush and realize that plans for any military operation must be fully developed before being put into operation. That was never in question. The point I was trying to make was the tone of the delivery of every speech by Bush was so soft and lacking in emotion that I feared the leaders of the rogue nations would read it as weakness. I wanted to see him speak more forcefully and with passion. I never suggested he simply start flinging bombs with reckless abandon. The various speeches on Friday were delivered with much more confidence and determination. It was encouraging. I seldom use this venue to make political statements and I apologize for any misunderstanding.

Check out the great strategy sections and special reports in this weekends edition of the newsletter. New articles as well as the articles from earlier in the week are being repeated and summarized for your trading education. Profit from it!

Definitely, enter passively, exit aggressively!

Jim Brown

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