The market reminds me of one of those Abbot and Costello skits where Costello is running around in circles yelling, "which way did they go, which way did they go?" Market pundits are acting the same way today when discussing the fate of the markets. Which way will it go? That is anybody's guess and everybody has one.
Dow Chart - Daily
Nasdaq Chart - 90 min
The economics today were mixed but the reports were not those highly watched by traders. The Manpower Employment Survey showed employment expectations for Q4 had softened somewhat in the U.S. to show 18% of employers were still expecting to add workers. This is down from 22% for Q3 but still positive. Overall 26 out of 27 countries were still showing positive hiring trends. This is anticlimactic after last week's employment report but still another building block for the bull's global growth scenario.
The Job Openings and Labor Turnover Survey (JOLTS) showed that new jobs rose to 4.82 million in July from 4.74 million in June. Separations fell to 4.48 million from 4.54 million. Although hiring increased in July over June it fell for the 3rd straight month compared to the same period in 2006. The year over year decline started in May with a loss of -1.7%, followed with -4.9% in June and -6.3% in July. This confirms some of the weakness in Friday's employment report but is still showing a positive overall trend. However, this is a trailing report and a month behind the August jobs last Friday. As a trailing number it garnered little investor interest.
International Trade came in flat with the consensus at a deficit of -$59.2 billion. That was about -$250 million below the prior two months. No excitement there. Chain store sales rose +0.3% for the week on continued back to school buying. This was only a tick over the +0.2% rise the prior week. No excitement here either. Actually the next economic item of interest will be the Fed meeting next Tuesday. The rest of the reports for the week are lackluster at best.
A report released Monday by the National Association for Business Economics put the growth of GDP at +2.0% for the year. This was a downward revision from the +2.2% estimate in May. If this level of GDP growth comes to pass it would be the weakest annual growth since the +1.6% in 2002 as we came out of the 2001 recession. Expectations for growth for 2008 were also lowered to 2.8% from 2.9%. 60% of the survey respondents said recession was their biggest fear, not inflation.
The bills are flying fast with potential congressional solutions to the subprime problem. The Fed says 2.5 million mortgages will reset by year-end at a higher rate. Schumer authored a bill today that would raise the mortgage cap for Fannie/Freddie loans to $625,000 from its current $417,000 cap. This would also give Fannie and Freddie an additional $145 billion in loan capacity. Regulators have opposed giving them additional limits due to accounting problems in the past and Greenspan's warning that a collapse of either or both could bankrupt the economy. In 2001 F&F held 80% of the existing mortgage backed securities. That number has been reduced to 44% at the end of 2006. The big brokers and hedge funds picked up this slack when F&F were forced to limit their purchases. This is how the subprime balloon was born.
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The banks/funds saw how profitable restructuring and repackaging the loans could be and went wild. Now they are paying for that excess. Realty Times reported that 33% of loan commitments were cancelled in August with subprime loans representing 56% while the gold standard on the other end of the credit spectrum, prime conforming, represented 16%. That is a key metric because it represents commitment cancellations on the equivalent of a gold credit. This was due to the gridlock in the credit markets and lenders simply could not get the money to close the loan. Lenders are scared and had pulled back from the market due to increasing foreclosures. Foreclosures rose +9% from July to August and +97% from August 06 to August 07. The FTC warned over 200 lenders on Tuesday that current mortgage ads may violate Federal law by giving a deceptive picture of mortgage terms. Duh, you think? I looked up one ad a couple weeks ago that claimed a 30-year $350,000 loan for $750 a month with no negative amortization. Since that is impossible I wanted to find the catch. The catch was the first payment only was $750 and the next 359 payments were at 7.25%. The FTC sent notices to media outlets as well warning them about running the deceptive ads. I expect to see a lot fewer ads over the next few weeks.
Meanwhile lenders are still under water and sinking fast. Washington Mutual (WM) CEO, Kerry Killinger, said on Monday, "the combination of rising delinquencies, higher foreclosures, more housing inventories, increasing interest rates on many mortgages and greatly reduced availability of mortgages due to limited liquidity is creating what we call a near perfect storm for housing." Obviously this is a CEO of a company suffering behind the scenes trying to survive a sudden cutoff of access to capital. There was no chance to wean themselves away from their financial diet of constantly increasing loan volume. It was stopped instantly when the plug was pulled and now they are struggling to maintain life support. WaMu gets one-fourth of its income from subprime credit cards and when times get tough those borrowers don't pay the bills. Defaults are said to be rising all across the credit card spectrum. This puts WaMu in the middle taking hits from both sides, home loans and credit cards. Killinger said WaMu was raising its loan loss reserves by $2.2 billion to cover pending defaults.
Countrywide has seen mass infusions of cash over the last month and announced layoffs of 13,000 workers. They sold $11.2 billion of loans to an investor group and $2 billion in convertible stock to Bank America. This week they are back in the market looking for another bailout. It was reported that Countrywide is working with Goldman Sachs to find another buyer similar to the Bank America bailout. Reportedly JP Morgan, Citigroup and several hedge funds have expressed interest and a deal could be announced later this month. Countrywide shares fell to $16.86 and under the $17 convertible price negotiated by Bank America. On Monday we saw that two major investors had bailed on CFC and cut their stakes considerably. AllianceBerstein LP owned 63.8 million shares on July 31st, 10.7% of CFC. They had cut their stake to 23.8 million shares in August. Barclay's cut its 48.6 million share stake in half to 24.4 million shares. There were some buyers sneaking in under the Bank American cover. Legg Mason said it boosted its stake to 53.4 million shares from 50.2 million. LMM LLC raised its stake to 4.5 million shares. With Bank America having a "matching offer" provision there is not likely to be an entire buyout of CFC but there are definitely some bottom fishers out there who would take a piece of the risk if they got favorable terms. Because Countrywide has come back to the equity markets so quickly it suggests they are in worse trouble than the street thought just a couple weeks ago. We could easily see some additional layoffs in the near future. Countrywide is not going under but they could be in major trouble requiring a larger multibank bailout. Countrywide services $1.4 trillion in mortgages and that equates to 19% of all securitizations. That servicing produces a solid income stream and first look at any new borrowing from those same customers. If you have a mortgage with CFC and want to move to a new home the majority of customers would call CFC for a new loan. This servicing business plus the giant loan origination arm has great value for someone like Bank America or another major bank. The biggest problem facing CFC is the margin calls on defaulting loans. As every defaulted loan is put back to CFC they have to come up with the cash and in the present market they can't immediately resell those defaulted loans. After the market closed CFC issued a statement saying, they don't comment on market rumors and reiterated its earlier statement regarding cash and liquidity needs, "The Company has already taken decisive steps to address funding challenges." For us that translates into "please quit selling our stock."
Countrywide Chart - Daily
The economic news is not all bad, as we have seen from several individual companies this week. Intel (INTC) raised its top line revenue estimates by $200 million and said its profit margins would be at the high end of estimates at 52%.
Home Depot (HD) revised its estimates higher saying earnings per share were only going to decline 7-9% for fiscal 2007 rather than the 12-15% previously forecast. Much of that came from the 290 million share buyback last month. If you reduce your outstanding shares by -15% then your earnings per share will rise. It was a positive press release if you only read the headlines.
Western Digital (WDC) raised their estimates to between 61 and 65 cents on revenue up to $1.65 billion. Prior estimates had been for 43-47 cents. This revision on stronger than expected sales followed Seagate's upgraded guidance last week.
Surprisingly on a blowout day in the markets Apple (AAPL) lost -1.22 even though a Piper Jaffray survey of Apple and AT&T stores showed iPhone sales were soaring. Reportedly the price cut on the 8GB model spiked sales by +300% or roughly an additional 27,000 phones per day since the announcement. The analyst said the spike clearly represented a surge that is not sustainable but estimated sales would level out at a 50% increase. Despite the media whipping Apple took when they announced the price cut I think it was the right move. It is not really about the price today. It is about grabbing market share. There are dozens of smart phones coming out from all the major manufacturers. Apple knows an iPhone buyer today will be more likely to buy a newer iPhone 2yrs from now once they hook them on the features. IPhones are not the best bang for the buck in terms of features and performance but they do have a lot of sex appeal for young and old buyers alike. Apple is being forced to compete against the new generations of smart phones and they are handicapped by the slow AT&T network and very few available applications compared to some other open architecture phones. I hear you cannot even change the battery yourself and have to take the phone to the store. That kills the idea of having spare batteries for long trips. All of these problems are starting to weigh on Apple now that the initial buzz has died.
OPEC surprised everyone with a novel announcement. For background their official quota for the 10 OPEC countries with a quota was 25.8 mbpd. They were actually producing 26.7 mbpd or 900,000 barrels over their stated amount. This was quota cheating by the couple of producers who actually had spare capacity but the official quota was 25.8 mbpd. They announced after the meeting they were going to raise "production" by 500,000 bpd, not quota. When the Kuwait Oil Minister was asked after the meeting he said production would rise to 27.2 mbpd for the OPEC-10. By confusing the terms quota and production it gave the appearance they were only raising slightly but in effect they were legitimizing the 900,000 already being produced. When you add in production from Iraq and Angola, countries not under the quota system, the total production as of November 1st will be 30.8 mbpd. This is only a hair under the maximum production last year at 31.4 mbpd in Q4. Many wonder if they could even duplicate that amount today although their claimed capacity is about 34 mbpd. They said the increase would be effective Nov-1st but you can bet it will be flowing down the pipes tomorrow. If you are already going to cheat on existing quotas then an increase in production targets is a free chance to print even more money by cheating even more. With OPEC raising their output and promising to add more if needed you would expect oil prices to move lower. They did for about 30 min before rocketing off to near a new closing high at $78.25. That surprised the heck out of me and quite a few other futures traders. Analysts were all over the wires saying higher prices were nearly insurmountable now with supplies so high and OPEC raising production. Evidently somebody large did not believe OPEC and the shorts who loaded up ahead of the meeting were blown out again. Wednesday's inventory report may be the last hurrah for prices if crude posts a gain in inventories. Gasoline demand should be slowing dramatically and refineries will begin taking capacity offline and switching to winter fuels. This will allow inventory levels to build. There are no storms on the horizon for the next ten days so it will all be up to the inventory report to move the price. Estimates are for a drop of -2.5 million barrels in crude and -750,000 barrels of gasoline. Refinery runs are expected to drop up to a full percent to 91.1%. The IEA monthly oil report is also do out tomorrow and it is expected to be bearish given their recent warnings on supply. Could be we will see $80 before $70 even though there is no fundamental justification.
October Crude Chart - Daily
All eyes are on the FOMC meeting next week on Tuesday the 18th. Now it appears the earnings for Lehman (LEH) has been changed to the 18th as well. Bear Stearns (BSC) has also moved to the 20th along with Goldman Sachs (GS). Yahoo's earnings calendar was originally listing LEH/BSC on the 13th as well as commentators on CNBC. Either Yahoo was wrong or those companies changed their date until the following week. Maybe it takes longer to add up losses than profits? That is going to make it a little harder to game with the cheaper September options, which expire on the 21st. Goldman remains a buy in my mind ahead of their earnings. They have a legendary trading desk and 61% of their revenue comes from trading. If they saw this credit crunch coming they could have blowout earnings from getting in ahead of the drop.
The Fed decision is becoming cloudier than it appeared on Friday. Some Fed speakers are more hawkish than others but the trend still appears to be slightly in favor of a rate cut. Mishkin had the following comments on Monday.
In my view, an increase in [financial] uncertainty is an important part of what we have observed recently and stems from heightened concerns about the value of financial securities related to certain types of loans, about who is holding these securities, and about how a revaluation of these securities might affect the balance sheets of various financial intermediaries. Consequently, investors have become less willing to put funds into various financial markets, particularly into the more opaque segments of those markets.
As best we can tell thus far, the imprint of these developments on economic activity appears likely to be most pronounced in the housing sector. However, economic activity could be affected more severely in other sectors should heightened uncertainty lead to a broader pullback in household and business spending. That scenario cannot, in my view, be ruled out, and I believe it poses an important downside risk to economic activity.
This would appear to show sincere concern about the ongoing impact of the credit crunch and a good possibility this will translate into a rate cut next Tuesday. We will get a much better view of how those securities are going to be priced and handled on balance sheets when LEH/BSC report earnings.
Janet Yellen said in a speech in San Francisco that falling home prices and rising joblessness could cause "significant" risks to consumer spending and the current turmoil in financial markets has added "appreciably" to downside risks for the U.S. economy.
It sounds a lot like the Fed heads are lining up on the side of a rate cut. However, Dallas Fed President Richard Fisher had a different view. He said, "Amidst this clamor and drama, some might have lost sight of our economy's great resiliency," and "Our economy seems to be weathering the storm I am generally encouraged by what I have heard and seen so far." Doesn't sound like a rate cut from Mr. Fisher. Of these speakers only Mishkin is a voting member but his outlook was definitely the most forceful in favor of a rate cut. The Fed is now in their blackout period prior to the FOMC meeting and there will be no further comments on the economy until after the meeting.
Bernanke spoke this morning in Germany and said nothing. He expertly avoided any comments that could be construed as relative to our current environment. His speech was taken as bullish overall and the market rally picked up speed once it was over. The Dow gained +180 points and added to yesterday's rebound. The low on Monday was 13024 and almost exactly the same as the low seen on Aug-28th at 13035. Support at a higher low appeared to hold and Friday's drop was almost erased after two days of trading. The Dow still has solid resistance at 13400 but the bulls appear to be winning the battle. Of course we have seen quite a few triple digit moves recently that were erased the following day. I think that may change once the Dow gets back over 13400. It has been nearly a month since the August 16th low and there has not been a serious attempt at a retest. Many think that is a good sign. As I type this traders on the floor of the NYSE are singing God Bless America at the closing bell. That also means the 6th anniversary of 9/11 has passed uneventfully with no repeat attacks. That could also remove a cloud over the market given the Osama video late last week. The reasons to sell the market are dwindling with all the bad news priced in and support is holding.
The Nasdaq appears even more bullish with its second higher low since the August dip. Tech stocks continue to outperform the broader market and we are seeing upgrades almost every day. JP Morgan reiterated their overweight on Ebay today on the +6.1% rise in new listings since August 22nd. August 22nd was the anniversary of their rate hike last year. Ebay is currently running a discounted listing program through the end of September and a JP Morgan analyst said this was a winner for Ebay and should guarantee his year-end estimates of +5% growth. Listings had declined -6.4% year over year prior to August 22nd. These kinds of upgrades are hitting all across the technology spectrum with JNPR, CSCO, BRCM recent recipients. If this trend continues we could see the Nasdaq retest recent resistance around 2625. We saw the Nasdaq briefly spike above that level on Sept-4th but could not hold it. The next time could be the charm.
The S&P-500 is still stuck in its recent range with no prevailing trend. 1440-1480 has contained 90% of the trading since the August low. Resistance at 1490 is going to be the area everyone will be watching if this rally continues.
SS&P-500 Chart - 45 Min
Russell 2000 Chart - Daily
The Russell remains the weakest link but today it was the biggest gainer with a +1.61% gain. I don't know if it was the heaviest shorted and therefore got the biggest bounce from short covering or we are just starting to see buyers return. The Russell is rebounding from a lower low on Monday at 760 making this a +22 point rebound so far. The close at 782 is right in the middle of the recent congestion range and still well below the very strong resistance at 800. It is too early to draw conclusions but today's action was bullish.
For the rest of the week we are waiting on the Fed and while today's rally was very broad it was on light volume. In addition to the Fed meeting next Tuesday and earnings from financial stocks we are facing the "Sell Rosh Hashanah, Buy Yom Kippur" period. The Stock Traders Almanac has tracked this as a historical cycle for years. In theory many traders sell/close positions going into the religious holiday and focus on their families and faith instead of the market. In theory this produces a sell signal and a buying boycott until the holidays are over and traders return to work. This year Rosh Hashanah is Sept-13th and Yom Kippur is Sept-21st. Seven of the last eight years have seen losses heading into that period. Average market gains from Yom Kippur to Passover are +7.1%. Over the last 16 years the Dow has gained +9.1%. Passover begins on April 8th in 2008.
That leads us into another sell cycle where mutual funds reposition portfolios
ahead of the quarter end and ahead of any Q4 rally. September tends to open
strong and then weaken into month end. So far September has been anything but
strong with more down days than up. Let's hope the historical trend has been
reversed this year. I am market neutral tonight although there are signs of
bullishness in the market. It may be just buying the rate cut rumor ahead of the
Fed or buying because
all the bad news is already baked into the cake. Buying is
buying regardless of the reason but we need to make sure the trend continues for
more than two days.