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Market Wrap

Going For A Bakers Dozen

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The Fed raised rates by +25 points for the eleventh straight time and indicated that at least one more was in the cards and probably two more for a bakers dozen of 13. This means the Fed rate by year-end is destined to be 4.25% and exactly where many feel is neutral territory. Greenspan will have moved rates back to neutral just in time for him to retire in January and leave his successor in control of his own fate. If he left rates too low or too high they could blame Greenspan for future events. At 4.25% he avoids both the extremes and fades off into history with his legacy intact.

Dow Chart - Daily

Nasdaq Charts - Daily

SPX Chart - Daily

The markets were mixed in their anticipation of the Fed action with many hoping for a Katrina pause. Many others were hoping for the rate hike to assure everyone the economy was ok and then a change in the language saying they were going to pause after today until the real Katrina impact is known. Neither side got their wish and despite the lengthy language in the Fed statement about the impact of Katrina the Fed kept the "measured pace" language indicating there were more rate hikes ahead in Nov and Dec. The Fed said the impact of Katrina would be material in the short term but would not be persistent with an uptick expected in 2006 and beyond as the rebuilding effort kicked into high gear.

The markets were already shaky after Monday's plunge and +7% spike in oil prices. The September curse is in play and the Katrina excuse is starting to get a lot of air time. Companies as diverse as mattress companies (TPX) and Estee Lauder (EL) are using Katrina as a reason to warn. Actually they are saying the high gasoline prices associated with the Katrina event are changing consumer buying habits and keeping consumers out of the malls. Still there was good news with Proctor and Gamble (PG) affirming sales for the quarter at the high end of estimates. Of course if you think about what items displaced evacuees are likely to buy while waiting to return home the vast majority are the consumer items PG sells like toothpaste, shampoo, razors and other personal items.


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Despite the spike in the dollar value of gasoline sales from higher prices the weekly chain store sales fell -2.1% for the week. This was the largest decline since late 2003 and shows the real impact of high energy prices on consumers. This was the seventh consecutive weekly drop in sales. An ICSC survey in early September found that 59% of consumers are reducing their discretionary spending as a result of high energy prices. The biggest drop in spending came from households in the lower income range. This bodes ill for the holiday season if energy prices continue to remain high.

New residential construction fell for the second consecutive month but are still tracking for better than two million homes for the year. This is likely a seasonal reduction in starts simply due to the advent of fall. Starts should pickup again in advance of the spring selling season. We are also going to see a jump in starts several months from now when the actual rebuilding begins in the hurricane area. The homebuilders are taking it on the chin as they face higher rates and higher costs for materials. Builders LEN, TOL, HOV and KBH are imploding and there seems to be no end in sight. The amount of profit built up in those stocks over the years is being quickly extracted and the charts are very ugly.

Hurricane Rita, the 17th storm of the year and the 9th hurricane continues to gain strength as it heads into the Gulf. The projected track puts it dead center on the heavy refining areas in Texas and forecasters are now expecting it to be at least a category four storm by landfall. The farther south it hits the better and a shift to the north hits the other 50% of Gulf oil fields that were missed by Katrina. A hit on Beaumont/Port Arthur, right on the Texas-Louisiana border would hit another 25% of our refining capacity. If this storm gains strength as expected and hits the oil fields the impact to oil prices or more specifically gasoline and natural gas prices would be enormous. 5% of our refining capacity is still offline and will be out for several months. 54% of oil is still shut in from Katrina as is 30% of gas production. Oil companies are already evacuating platforms ahead of Rita and more than 1000 workers were targeted for removal today. Whether Rita hits dead center or not it is impacting our oil supply as each rig is shut in when workers leave. Fears of another Katrina hitting Texas sent oil prices up +$4 to $67.30 on Monday but much of that move was short covering as bears got squeezed by the sudden appearance of Rita. Crude pulled back intraday today to $64.80 but rebounded when Rita was upgraded to a category two hurricane around noon. It closed around $66 for slightly more than -$1 loss but compared to Monday's jump this was a mere pittance. After the close crude rose to $67.50 on a Rita severity warning from Accu-Weather. Rita is expected to gain strength tomorrow and make landfall sometime late Friday or early Saturday. This weekend hit will leave oil traders with no choice but to protect themselves against a Katrina like weekend disaster. As long as Rita continues to gain strength oil prices should continue to rise into Friday's close. A shift to a more northerly direction should send them back to the $70 levels seen post Katrina. Continue to buy the dips until the trend changes.

Crude Oil Chart - Daily

Oil and gas inventories due out on Wednesday should show a much better picture of the post Katrina levels. We are nearly a month past the Katrina hit and the impact of SPR releases and IEA contributions should be known. There is no credible estimate of inventory levels because we simply don't know how the products are flowing into the system. A build in inventory levels could send prices skidding despite the potential hit from Rita. OPEC concluded their meeting in Vienna and kept their stated production ceiling at 28mbpd but said they would offer two million extra bbls to anyone who wanted it. This was purely smoke and mirrors since nearly everyone in OPEC is already pumping more than their quota to reap the rewards of $65 oil. If they had more oil they would already be selling it. The only oil available is the sour crude in Saudi and they can't give it away due to the reduction in refining capacity. Talk is cheap in the world of OPEC. They have no interest in seeing oil return to sub $60 levels given their falling production rates. They want to milk every dollar possible before production slides even further. This is not like in the past where excess oil drove prices down and high prices produced fear in OPEC of increased exploration and drilling elsewhere. They know demand is on the verge of exceeding supply and they need not fear a price collapse.

Hugo Chavez was on TV on Monday saying he had more reserves than anyone on this side of the planet and bragging about his recent deals with China. He was offering his oil to anyone who wanted it but left the U.S. out of the picture. He neglected to mention that most of his oil has the consistency of cold honey and is very hard to refine. This is why he has an excess of oil and very few countries want it.

Natural Gas Chart - Daily

The real crisis this time around is the natural gas crisis. The October contract for natural gas hit a new all time high on Monday at $12.70. The December contract and soon to be the current contract hit $13.80. These levels are twice the prices seen last September and are still rising. With 30% of Gulf gas still shut in and that number likely to rise as Rita approaches the outlook for the winter heating season is very bleak. Consumers seeing heating bills double from prior levels are going to be hoarding pennies to pay the bill. It is only going to get worse from here as demand increases. Several analysts are calling for $20 gas before year-end. Companies benefiting from this include CHK, SWN and ECA. Coal companies BTU and FDG are benefiting from the rush to burn cheaper coal rather than expensive gas. Buy the dips on these companies!

Oil is not the only commodity moving higher. Gold continues to hit new highs, $469 on Monday, and copper hit a new all time high at $1.75 today on the potential demand for the Katrina recovery. With 400 lbs of copper in every new home the demand is going to be huge. With every commodity soaring it amazes me that the Fed feels inflation is under control. Of course they qualified that with "excluding energy prices" inflation is only +2.1% year to date but what do we do that does not need energy in some form? The Fed still believes the energy surge is just another bubble that will burst and fade from memory.

The markets are beginning to crack under the weight of energy and the flood of earnings warnings with the Katrina excuse. I have been expecting the decline so it was no surprise to me. Commentators said today's drop was due to the Fed statement but I think we would have dropped regardless of what they said. The current economy is weakening as evidenced by recent economic reports. The giant sucking sound from Louisiana is the sound of $67 billion in Federal funds being pumped from the treasury for things that are not benefiting the broader economy. Until the rebuilding effort begins we are at risk for earnings. Unfortunately First Call raised their estimates for Q3 today to 18.2% for the S&P-500 from just over 17% just last week. On the surface that appears bullish but the only reason the S&P has earnings at all is the energy stocks. First Call said energy earnings for S&P stocks should average over +70%. That is a tremendous supporting factor for the S&P.

Despite that support the markets still collapsed on Monday with the average energy stock up well over a buck with many up $3 to $4. The SPX fell -10 points on Monday before a late buy program rescued it from disaster as it broke under 1230. Today the SPX fell -15 points from the morning high of 1236 to close at 1221. This put the SPX back into a sell signal once again in my book.

One factor that may work against the drop scenario is the Semiconductor Book-to-Bill, which came out tonight at 1.05 and the first time over parity in more than a year. Bookings rose to $1.1 billion and the highest level since Dec-2004. However, it is still well below the levels seen in all of 2004, which averaged $1.5b per month. Tech bulls should fixate on this 1.05 number and attempt to rally the techs starting with the chips. The SOX closed at its lowest level since late August at 466 after surging to near 475 at the open. As is typically the case the bulls caved in just before good news appears.

SOX Chart - Daily

A rebound in the SOX on Wednesday and a Rita induced surge in energy stocks could blunt the September selling we are seeing but that might be just wishful thinking. It is something we need to watch if the markets do not act as we expect on Wednesday. The Dow closed at 10484 and is closing in on the early September support at 10450. Just below is the late August support at 10350. Both are still well above my original September target of 10250.

The Nasdaq has given back -56 points in just a week and is closing in on critical support from late August at 2120. If the Semi B-T-B tonight produces a bounce I would be looking at getting out of any remaining long positions on that bounce. My worst case target for the Nasdaq is still 2050.

I am still looking for a continued decline into month end. This is unfortunate since a broad market decline still drags down or retards my energy stocks. Even a helium balloon is forced lower in a down elevator. I believe we are in that down elevator and while there will be some remarkable standouts the end result is still lower lows before September is over. As we saw on Monday even surging energy stocks could not keep the averages in the green so adding a chip rebound may not help either. Right now cash is king because there is a buying opportunity ahead. This is the period where we need to spend more time reviewing charts than buying options. Look for those stocks with high relative strength to the market. That means stocks that are going up while the market is going down. QCOM would be an example in the chip sector. In the energy sector we saw UPL, STR, SWN and several others bucking the profit-taking trend today. While other sectors are going to be posting earnings warnings the energy sector should begin giving guidance soon and their outlook should be strong and market friendly. As always, enter any position passively, long and short, and only when the price comes to you. Be ready to exit aggressively if the trend you expected changes suddenly. September volatility is in full bloom and triple digit swings are always possible.

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