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Market Wrap

Quadruple Waiting

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Quadruple witching turned into quadruple waiting on Friday. After 30 min of record volume at the open the rest of the day turned into a very slow and lackluster day in the markets. After Wednesday's high volatility rebound traders were hoping for a continued move higher. What they got was a flat Thursday and a dreary Friday. Quadruple witching and an S&P rebalance at the close failed to provide any momentum in either direction.

Dow Chart - Daily

Nasdaq Chart - Daily

Friday's economics were about as lackluster as the markets. The Consumer Price Index (CPI) had a headline number at +0.4% that doubled estimates for only a 0.2% rise. Helping to push the headline number higher was a sharp +0.9% jump in energy prices. The core rate of inflation came in at +0.2% and right inline with expectations. Core CPI for the full year is now 2.7% and well above the Fed's inflation target but well under the cyclical peak of 3.6% seen last May. Energy prices are up +14.7% on an annualized basis and continuing to push prices higher on a broad array of goods. This was a positive report despite the headline number being higher than expected. The continued moderation in the core CPI should keep the Fed on the sidelines for several more months.

Industrial Production spiked +1.0% to an eight month high and completely reversed the -0.3% decline in January. Capacity utilization rose +0.6% to 82.0 and a six-month high. While this may sound like the rebound is picking up speed the gain instead was due to very cold weather. The utility component rose +6.7% for the month as cold weather produced a heavy demand for electricity and natural gas. Natural gas utilities saw demand jump +11% for the month while electric utilities rose +5.9%. I did not hear anybody in the mainstream press pointing out these facts as they reported on the surge in Industrial Production all day on Friday. The headline number would have shown a slight gain even without the utility component thanks to gains in autos, auto parts, computers and electronics.

The constant chatter in the news about the subprime loan implosion knocked -2.5 points off Consumer Sentiment for March taking the headline number back down to 88.8. That is the lowest level for sentiment since the 85.4 in September. There were declines in both the present conditions and expectations components. Fear of falling housing values and the difficulty of refinancing current subprime loans helped drag the index lower. Rising gasoline prices also put a crimp in consumer attitudes.

The calendar for next week is very sparse and weighted heavily to the housing sector. There are three housing reports, which will be scrutinized heavily given the subprime meltdown. The Fed begins a two-day meeting on Tuesday and is expected to leave rates unchanged through July assuming there is no material economic change in the coming months. Still, the Fed announcement at 2:15 on Wednesday will provide additional market volatility as analysts try to second-guess the announcement language.

Economic Calendar

The quadruple witching event produced record volume on the NYSE for the first 30 min. This was due primarily to the expiration games on the S&P as market makers tried to pin the opening tick to 1400 so as many options as possible would expire worthless. Looks like they did a good job since 1397.51 was the high for the day on that opening settlement spike. At the close volume spiked again as the quarterly S&P rebalance occurred. Companies with large buyback programs like Exxon and Pfizer bought back enough stock during the quarter to change their S&P weighting. Funds indexed to the S&P had to reduce their holdings in these stocks to remain in balance. Some of that rebalance occurred at the open as well. For instance Pfizer traded nearly 11 million shares on the opening tick as fund managers took advantage of the S&P expiration games to sell into the opening spike. Exxon traded nearly 9 million shares on the opening tick. Hewlett Packard (HPQ) announced the biggest stock buyback in history at $8 billion. This is in addition to the $3.3 billion remaining on its prior $6 billion repurchase plan.

The subprime problem continued to take center stage with several lenders seeing stock gains for the second consecutive day. IndyMac Bancorp (NDE) released an announcement saying they were a Prime/Alt-A lender not a subprime lender as they had been characterized in the press many times recently. NDE said only 3% of its $90 billion loan portfolio is subprime paper. This does not even rank them in the top 25 in the country. S&P just upgraded the NDE portfolio from above average to "strong" and the highest level available. At the same time a different S&P analyst cut NDE to a sell with a price target of $26 but that is only -$2 below their current price. NDE said that despite their portfolio being strong they still expected defaults to rise from the current 0.63% to as much as 1.5%-2% by years end. This shows how the current default rate in subprime is expected to move up the credit ladder as standards toughen and adjustable rate mortgages continue to reset.

Bear Stearns, a major loan securitizer, posted earnings of $554 million for an increase of +8%. An S&P analyst said BSC still had exposure to the subprime problem but like any other problem there was money to be made for those quick to react. BSC could end up producing record revenues in the distressed debt sector as those companies in trouble sell off loans for substantial discounts to raise cash. S&P believes that the subprime problem has been blown out of proportion and this could be an opportunity for aggressive banks.

Accredited Financial (LEND) said it was going to sell $2.7 billion in subprime loans at a discount to free up cash so it could cover margin calls. LEND jumped +15% on the news. Fremont General (FMT) gained +20% after Credit Suisse boosted its credit line by $1 billion.


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Builders continued their plunge last week as fears of slowing sales and excess existing home inventories from foreclosed loans weighed on the sector. Nearly every day some builder repeats the familiar refrain that it may be too soon to call a bottom and the recovery will not be robust. The Center for Responsible Lending expects 2.2 million people to lose their homes either by forced sale or foreclosure. Adding those homes to the current inventory surplus will push prices lower. Add in the stricter lending policies we have today and to go into force on Sept-1st and that takes another 500,000 or more buyers, up to 25% of the buying pool, out of the market. Falling home prices will make home equity loans more difficult to get. Home equity loans have been the backbone of consumer buying since 2001. We have already seen how consumer confidence/sentiment has fallen on worries about falling home prices. High risk loans known as exploding ARMS, piggyback loans, liar loans (stated income) and no doc loans accounted for 47% of the total loans written in 2006. According to the IRS nearly 60% of those borrowers overstated their income by more than 50%. That means when the payments get tight they do not have the income to make up the difference.

Greenspan made news again on Thursday when he said the subprime shakeout will worsen. He said the mortgage defaults would spread to other areas of the economy, especially if home prices decline. Is Greenspan having a late life crisis? What do you suppose is prompting him to suddenly see himself as a harbinger of doom? Somebody needs to remind him that he is no longer in power and his comments are having a negative impact on the markets.

Private equity group Blackstone shocked Wall Street by saying it was planning on going public. Since Blackstone has made a career taking public companies private it was a shocker to think they would want to take on the regulation and reporting restrictions of a public company. Blackstone has purchased 85 companies for something over $150 billion in the last ten years. The two partners who started the firm with $200,000 each stand to make billions with a successful IPO. The value of the company could be as high as $30 billion according to some analysts. Not a bad return on your $200K investment. Hedge fund Fortress Investment Group (FIG), which made news with its IPO in early February, traded as high as $37 on opening day and has traded as low as $23.34 last week. That 33% haircut suggests the bright flame of IPO interest fades quickly once reality returns. As a public company they will quickly find the quarterly earnings reports may produce a crisis of confidence since investors are quick to judge a company's entire worth on their most current set of numbers.

The flow of deals has had a positive impact on the market since it indicates continued bullish sentiment. The CBOT was the target of a $9.9 billion unsolicited bid from the Intercontinental Exchange (ICE) that threatened to derail the current deal between the CBOT and CME. As long as M&A deals continue to be announced the long-term outlook for the market should remain bullish.

Wal-Mart said it cancelled plans to start a bank after months of contentious debate. Various groups feared Wal-Mart would severely dent the banking system with its low cost approach to everything. I think it would be a good idea to have Wal-Mart start a bank. Maybe it would eventually drive down the outrageous fees most banks currently charge.

April Crude Oil Chart - Daily

Oil prices continued their seven-day slide to close at $57. The OPEC meeting has come and gone and there was no effort to change production targets. Nobody expected it but evidently some traders were hoping for some production cut comments. Gasoline continued to hold at multi month highs ahead of the coming driving season. With falling oil prices and rising gasoline prices the refiners are going to be printing money.

Stock traders are not printing money and likely are seeing erosion in their accounts. The Dow set a new five-month low at 11940 on Wednesday followed by a sharp rebound to 12185. Unfortunately that 12185 level held as resistance on Thursday and Friday's decline took us back to support at 12100. This is likely to be weak support after last week's dip. That is unfortunate since the dip to 11940 was the last material support point dating back to early November. I would bet today that we are going to see that support broken. The dip to 11940 was a lower low than the March 5th low at 12039 and sets up the very real potential that we will need another dip to establish a bottom. As long as each dip continues to set a lower low that bottom has not formed. Traders are now looking for a retest of the prior low that does not penetrate as a sign that buyers have gathered to form a bottom. The dip to the Dow lows was a -6.6% retracement off the 12795 high. I am beginning to believe that we may see a full 10% correction and that would take us to 11515. We are approaching the place on the calendar where earnings warnings for Q1 will begin making news. Given the current softness in the markets a few key warnings could give us that last little push we need to break below 12000 for real.

The Nasdaq is in better shape than the Dow with Wednesday's dip to 2331 still above decent support at 2325. This would be the next real test for tech stocks. We are seeing some strength in semiconductors despite disappointing guidance from Texas Instruments. This would suggest there is buyer interest in techs but everyone is just cautious. At the Nasdaq low last week the index had fallen -7.9% from its high. A 10% retracement would take it to 2277 but that would require a break of that strong support at 2325. A break there could further sour sentiment, which could setup a potential target of 2200.

The S&P traded as low as 1364 last week before rebounding to find new resistance formed at 1395. I could see the S&P respect that 1364 level because there are several support zones from 1364 to its Friday close just over 1385. The Russell and the NYSE Composite are continuing to show a more bullish chart than the other indexes. Neither declined as low in relative terms as the Dow, Nasdaq and S&P and both held up better on Friday. I still don't see evidence of new fund buying but funds are not bailing on the small caps and that is a bullish point for the overall market.

S&P-500 Chart - Daily

Russell-2000 Chart - Daily

The biggest challenge is the break of the 100-day average on all of the indexes. Because I am using the Russell as our sentiment indicator the movement around this average is more critical. The Russell first broke below the 100-day at 785 on March 1st. It has fought to climb back over that level but has been unsuccessful. For me this is the sentiment indicator to watch. A break above it means the small caps are being bought again and fund managers are coming back into the market. A further move below that level is consolidation as long as it stays above 760. A move below 760 means more trouble ahead.

The housing sector will be front and center next week and even with positive reports there is likely to be more subprime news to push builders lower. As always the 2:15 release of the FOMC announcement on Wednesday will provide volatility but there is a possibility for a change in the statement. Given the Greenspan comments Bernanke may want to polish the statement slightly to produce a more positive spin. That could give added support to the indexes but you may need a secret decoder ring to decipher the message.

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