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Market Wrap

Katrina Rally

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The Katrina Rally continued today as September op-ex week kicked off, with the Nasdaq providing upside leadership in what was a mostly choppy, sideways session that saw the Dow close fractionally green and the S&P fractionally red. Bonds and energy futures declined, also extending their post-Katrina trends.

Volume breadth was mixed for most of the session, with declining NYSE shares roughly even with advancing shares, while on the Nasdaq, advancing volume held better than 2:1 for most of the day. Volatility rose despite the narrow range and firmness of price, and overall volume was solid on the exchanges while well below average on QQQQ.

Daily Dow Chart

The Dow has been rising from its Katrina low in the 10330 area in a daily cycle upphase that still has room to run, adding 4.38 points today to close at 10682.92. Trendline resistance is above current levels, in the 10775 area, and the Dow has been in a steady rise. The decline in oil has doubtless been supportive as well. Beyond the higher trendline resistance and strong oscillator picture, however, price is at confluence resistance going back to the July-August highs, and is at 20-day Bollinger resistance as well. Combined with the topping action in the weekly cycle (not shown), there's good reason for bulls to be cautious and close on their stops at current levels.

Daily S&P 500 Chart

The SPX kept everyone guessing today, printing a doji star at the top of Friday's tall candle, losing .92 for the day to close at 1240.56. Like the Dow, it's been in a steep daily cycle upphase, most of the gains produced by 4 strong up days, the first of which launched the Monday following Katrina's arrival. That upphase is closer to overbought than that of the Dow, and as with the Dow, the weekly cycle rollover suggests that we should not see the previous high for the year exceeded, for long or by much, if at all.

Daily Nasdaq Chart

The Nasdaq was the only index to finish with more than a fractional gain, adding 7.32 to close at 2182. This gain left a doji star as well, but at new highs for the move, its daily cycle indicators just now approaching overbought territory. Price exceeded upper Bollinger resistance intraday, closing right on it, with confluence resistance extending from here to 2200. Bears need a break below 2175 on a closing basis to break the daily cycle uptrend.

Daily TNX Chart

The Fed's open market operations on Friday were via 7-day repos, leaving no expiries for today. Just before 10AM, the Open Market Desk announced an overnight repo of $4.75 billion, all of which was a net add to its dealers' accounts, and equities lurched higher on the announcement. The stop-out rate was below 3.5, and with the next policy meeting fast approaching next week, time is running short for the Fed to begin walking up demand to the presumed 3.75% target. The longer that the Fed continues adding with the stop-out rate in the 3.5 area, the less likely a 25 bp hike becomes.

This is a difficult issue in the wake of Greenspan's Jackson Hole comments 2 weeks ago and the subsequent arrival of Katrina a day later. Presumably in recognition of the impressive rallies in energies and housing, Greenspan stated with rare unequivocal clarity that the Fed would seek to tighten in order to avoid stagflation. The arrival of Katrina, however, provided an external, non-discretionary tightening. Since then, the Fed has been generous via temporary repos as well as permanent additions to liquidity. Just today, there was another coupon pass in the amount of $1.1 billion following coupon and TIPS passes last week. The Fed's response to Katrina has been to add generous amounts of liquidity, and the equity markets have responded favorably so far. The need for money now seems to be outweighing inflationary impact of that money on energy and other asset prices.


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Prior to next week's meeting, there is the September 15th meeting on derivatives called by the Fed prior to the arrival of Katrina to address back office delays and errors in the processing of derivatives trades. There's no way to know whether or how the agenda for that meeting may have been affected by the hurricane. I discussed this meeting several weeks ago when it was first announced, but it's potentially very significant given the massive numbers in play via the derivative markets.

The Treasury auctioned $28 billion in 13- and 26-week bills today. Foreign central banks participated strongly, taking $11 billion of the total. The 13-week bills sold for 3.45% with a yield of 3.529% and generated 2.15 bids for each awarded. The bid-to-cover was less on the 26 week bills at 1.96, which sold for 3.67% at a 3.791% yield.

Ten year notes sold off today despite the temporary and permanent open market operations and the declines in energy futures, with the ten year note yield rising 4.6 bps to close at 4.169%. 4.14%-4.16% has been significant confluence in both directions, and was cleared today. The daily cycle upphase points toward next resistance at 4.2%, and then 4.25-6%, followed by 20-day Bollinger resistance at 4.3%.

Daily Chart of Crude oil

There was confusion over the weekend as OPEC was reported to be planning another increase to its production limit, this latest one by 2 million bpd to be announced at their September 19 meeting in Vienna. OPEC subsequently denied the report, but crude oil futures opened in the red on Monday just the same. These production limit hikes have been greeted with a yawn in the past, as they are little more than symbolic gestures- until the Saudis (or anyone else) can begin announcing verifiable capacity increases, these announcements will continue to be treated by the markets as mere talk. Furthermore, the loss of refinery capacity in the wake of Katrina has cost an estimated 38 million barrels of oil products this month, and worse yet, it has demonstrated the lack of capacity and fragility of infrastructure worldwide.

As Don Coxe has noted in recent comments, the continued push for tighter environmental controls has resulted in a trend of smaller refiners failing to maintain their facilities. As deadlines for compliance with stricter measures arrive, smaller refiners have had an incentive to simply abandon their installations. Katrina has exposed this consequent lack of spare refining capacity, particularly in Europe, which is a longer-term bullish factor for the price of refined petroleum products.

Over the weekend, estimates for Katrina-related repairs continued to fly fast and furious. Montpelier RE (MRH) described the hurricane as "a significant net loss for us," and estimated its impact at $450 million - $675 million for the company. Grand totals continue to come in the $100-$200 billion mark, and Congress has already authorized $62.5 billion in various aid and assistance. AON said today that the hurricane will likely be the largest loss ever, worldwide, for the property reinsurance industry. That company expects that the storm will impact future renewal negotiations. However fast or slow the Federal government's disaster response may have been, the allocation of contracts has gone through expeditiousl- Reuters reported that Shaw Group and HAL subsidiary Kellogg Brown and Root, both clients of lobbyist Joe Allbaugh, the President's former campaign manager, have already been signed up.

Crude oil has dropped to pre-Katrina levels from a high of 70.85, its daily cycle indicators in a bearish divergent downphase. It may strike some as odd that the destruction of so much infrastructure and shut-in of so much production would result in lower prices for crude oil and higher prices for equities. As Joe Granville said, "News is for suckers," and Soros has said that the key to successful investing is to identify and ride the trend whose premise is false while it is profitable. On a fundamental basis, the destruction of refining capacity results in a higher demand for finished petroleum products and a reduction in demand for inputs (such as crude oil). Beyond the short term, however, it's difficult to find anything bearish for the price of even crude oil. While the financial press attributed the decline in prices today to expectations of lower demand on slowing economic growth, it's worth noting that a great deal of consumption has little to do with economic output- consider much of suburban motoring as an example.

For the day, crude oil finished at a 5-week low, -.75 or 1.2% at 63.325. Unleaded gasoline closed -4.4% at a 2-week low of 1.8737 per gallon.

EBAY was down over 3% this morning on news that it has agreed to pay $1.3 billion in cash and $1.3 billion in stock for the Luxembourg VOIP provider, Skype. It intends to use the acquisition to add free web telephone calling capability to its online auctions. Skype, a private company, expects revenue of $60 million for 2005 and more than $200 million in 2006 and has a member base of 54 million callers. It expects to double that within a year. This is EBAY's largest acquisition to date, larger than its acquisition of Paypal. EBAY rallied later in the morning, however, to close +.83% at 38.94.

Oracle (ORCL) announced that it will be purchasing Siebel (SEBL) for $10.66 per share in cash in a $5.85 billion deal that will make it the largest CRM software provider in the world. Net of SEBL's $2.24 billion in cash, the deal is worth $3.61 billion, a 16.75% premium to Friday's closing price. ORCL expects the acquisition to be accretive to earnings by 2-3 cents in 2007. SEBL gained 12.71%, closing at 10.29.

In other news, ORCL's founder and CEO, Larry Ellison, announced that he will pay $100 million to charity to settle an insider trading suit, if ORCL's board approves it. On top of the $100 million will be a payment of $22.5 million to the lawyers who brought the case on behalf of shareholders. Yahoo reported that Ellison had sold approximately $900 million in ORCL stock in January 2001 at an average per share of $30.76. Less than 2 months later, the company issued a profit warning, causing the stock to fall to $16.88. In the wake of these announcements, Moody's placed ORCL's long term ratings on review for a possible downgrade. ORCL closed +1.58% at 13.49.

Overnight, it was reported that Northwest Airlines (NWAC) and its striking mechanics reached an impasse and broke off talks. NWAC announced that it intends to begin hiring permanent replacements for the striking union members tomorrow. DAL got slammed to below $1 per share as the WSJ reported that the beleaguered airline could file for bankruptcy protection this week. Marketwatch reported that DAL is trying to reach a deal to obtain $1.7 billion of debtor-in-possession financing from a group led by GE, $1 billion of which would be used to pay off a loan from GE. GE rose strongly all day, finishing +.50 at 34.47. NWAC lost 4.89% to close at 3.31, DAL lost 22.73% to close at .85, and GE closed +1.32% at 34.43.

This is set to be a heavy week for economic data, starting with tomorrow's release of the Trade Balance, PPI and Treasury Budget. On Wednesday, it's Retail Sales, Industrial Production and Capacity Utilization. On Thursday, we get the Empire State Index, CPI, Initial Claims, Business Inventory and Philly Fed, followed by the Current Account, Michigan Sentiment and Chicago PMI on Friday. With the convergence of so many macro factors potentially impacting the markets, including the energy rallies (and their post-Katrina declines), the authorization of relief aid and the Treasury and Fed machinations to accommodate it, and the grief at the consumer level caused by high gasoline and natural gas prices (compounded by negative savings for the first time in decades), the usual uncertainty in the markets has a sharper edge than usual. At this point, it's easy to imagine the Fed either raising or lowering the overnight rate next week, or leaving it unchanged. It's just as easy to imagine any of these 3 possibilities causing the markets to rally, tank or trend sideways. In the presence of uncertainty at these levels, it's key to stick to your trading plan and above all, respect your stops.

I personally have doubts about the markets' ability to sustain equity and bond rallies in the presence of natural gas prices above 10 and crude oil above 60, and all those other commodities that central banks cannot make more of. These doubts are further fed by the toppiness in the weekly cycles and the approaching tops in the daily cycle upphases. But general trends have to be respected, and if the Fed is going to liquefy to accommodate the various current pressures, then traders have to be prepared to follow the prices higher, wherever they may be. Jim's maxim "enter passively, exit aggressively" comes to mind. We'll be there tracking it for you in the Market Monitor.

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