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Market Wrap

Yesterday's News

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After what was already a bad day on the markets yesterday, the post-market revelations by Morgan Stanley, AIG and Cisco sent futures lower. By this morning, ES and YM futures had recovered and were moving above their fair values, indicating a positive open. Would yesterday's revelations turn out to be yesterday's news, over and done, as those futures indicated, or was more weakness to come, as the NQ futures hinted?


The overnight recovery in futures proved somewhat remarkable, given the 3.19 percent loss in the Nikkei 225 and the scarier 4.85 percent loss in the Shanghai Composite. Even the NQ futures had bounced far off their overnight low although they remained well below their fair value. The USDJPY, a currency pair that often correlates with U.S. equity performance, was also climbing well off its overnight low of 112.02, even carving out and then confirming a bullish inverse head-and-shoulders formation.

Perhaps some market participants anticipated that Federal Reserve Chairman Ben Bernanke would rescue markets when he testified about the economy this morning. Perhaps some anticipated that, if the Bank of England and ECB held rates steady again this morning, the assumption would be that our FOMC would be more likely to do so, too, perhaps firming up the dollar. Both central banks did hold rates steady.

BHP Billiton's (BHP) offer for Rio Tinto (RTP) generated some excitement in the markets, but few anticipated that Ford (F), reporting today, would add to the excitement. Most analysts reportedly believed that F was in the worst shape of the big three automakers. F did something unexpected, however. It beat forecasts. Perhaps more importantly, the company forecast "substantial year-over-year improvement" in the fourth quarter.

Same-store sales trickled in during the pre-market session. Costco (COST) beat expectations as did Target (TGT) and a few others, but headlines on this number called October figures bleak and noted that these were the worst chain-store sales figures in more than a decade. Wal-Mart Stores (WMT) missed, as did Limited Brands (LTD), American Eagle (AEOS), Chico's (CHS), Zale, and Nordstrom Inc. (JWN).

Ultimately, none of that mattered. Market participants riveted their attention on the testimony of Federal Reserve Chairman Ben Bernanke before the Joint Economy Committee of Congress. While article writers and television commentators offered widely varying impressions of Chairman Bernanke's particular worries, level of concern, and grasp of the problems, markets offered a clear reaction. They dove during his testimony and the question-and-answer session and didn't stop for a while after he finished.

By early afternoon, CNBC commentators were noting that it was beginning to feel like the middle of August again, that there was a fear that credit markets would freeze up again. It appeared that yesterday's news, that from August, was again impacting our markets after all, and not in the way that futures had suggested this morning.

Comparisons to August must have alerted bulls to take a look at that disastrous day in August when markets plunged to their August lows. What happened that day? A massive bounce carried indices right back up to their starting places, starting the rally that carried into October. Yesterday's news played out again today, with indices rallying from their intraday lows to close near their opening levels.

Some pointed to a statement by British Petroleum's (BP) CEO who said oil should be $60-80.00 in the medium term as providing relief. Some just thought it was time for a relief rally. Many reasons have been and will be offered for the afternoon bounce, but technical reasons for a bounce also show up when charts are examined.


The downside target for a confirmed head-and-shoulders formation was nearly met on the SPX and Dow.

Annotated Daily Chart of the SPX:

If the SPX were just approaching a downside target, the bounce attempt might have been expected and somewhat predictable. What happens next, though? Will another bounce like that on August 16 (far left side of the chart) begin now?

Notice some characteristics of that August 16 candle. It was followed by the third candle of a morning-star reversal signal, a tall green candle that eclipsed at least half (and more, in this case) of the first candle of the three-part pattern.

However, today's stop under the 200-sma and -ema leaves some concern as does the fact that there was even a confirmation of a bearish formation and a hitting or near hitting of its downside target. While I do think it's possible that we'll see a sharp rally over several days, the climate is so bad that I can't predict that will happen. Even if the SPX pierces the 200-sma and 200-ema's tomorrow, it could find resistance there again on a daily close.

The SPX has now begun establishing a descending price channel off the October high, and while that channel persists, I believe the environment remains a sell-the-rallies one. If the SPX manages to get past the 200-sma and close above it tomorrow, then 1490, 1498.86-1500 and especially the confluence of moving averages from 1509-1515 remain obvious places to watch for rollovers.

What if there is no tall green candle tomorrow? That looks more immediately bearish.

Annotated Daily Chart of the Dow:

Annotated Daily Chart of the Nasdaq:

Like the SPX, the Nasdaq's strong bounce couldn't bring it back above what might be key resistance. It looks to me as if the Nasdaq was forming a head-and-shoulders formation and just fell through the neckline before it could even form the right shoulder. The TRAN used to do this quite frequently. If this is true, the Nasdaq hasn't even begun to meet its downside target, which would be near the 200-ema and -sma's.

Traders should of course be careful of rollover potential near the 50-sma, especially since it converges with other potential resistance. If the Nasdaq can close above those averages and maintain a rally, the 2750 and 2777-2800 zones should be watched for rollover potential.

Annotated Weekly Chart of the SOX:

Annotated Daily Chart of the RUT:

Annotated Weekly Chart of the TRAN:

Is the neckline at about 4687 on a weekly close, as I've drawn it, or higher, at about 4867 on a weekly close? Perhaps it's lower. In any case, the TRAN flirts with a confirmation of this formation, a formation none of us other than rabid bears want to see confirmed. The TRAN has been known to confirm such formations and then turn around and zoom up, invalidating them, so any conclusion reached on a presumed confirmation should be adjusted if the TRAN should quickly reverse course. In particular, it's possible that the TRAN could fall to about 4500 and then rise up into a new right shoulder, with the current presumed head-and-shoulders being nothing but the head formation. As can be imagined, however, even a drop to only 4500 wouldn't be fun if the TRAN dragged other indices lower, too.

Today's Developments

Federal Reserve Chairman's Ben Bernanke's address to Congress' Joint Economic Committee was one of the highlights--or should we say, lowlights--of the day. Bullet points from his address included his reference to continued upside risks to inflation and downside risks to growth. The weaker dollar and spike in crude costs contribute to inflation risks, he warned, but he believes that it will remain in a range that will maintain price stability in 2008. Those who wanted hints that the Fed would soon cut rates again were likely disappointed, but treasuries certainly acted as if rates would be cut. Bonds moved higher and yields lower.

Chairman Bernanke acknowledged the "significant pressure" to financial markets caused by "investor concerns about the credit quality of mortgages." He blamed a "decline in underwriting standards . . . as well as softening house prices." He believes that delinquencies will continue to rise but feels that there's little evidence so far that the housing weakness has spilled over into the economy. He did acknowledge that the subprime problem has resulted in the issuance of "few securities backed by subprime mortgages" since July. That's a bit of an understatement.

As a separate Federal Reserve release that occurred while Chairman Bernanke was speaking was to prove, those types of securities dropped the most in nine weeks last week. However, Chairman Bernanke seemed to believe that once this all worked through the system, "a healthier financial system" would result in "the medium to long term."

He mentioned the actions meant to help homeowners in trouble with their mortgages or likely to be in trouble soon. He wants lenders to work with borrowers, and says that the Federal Reserve has issued statements asking lenders and mortgage servicers to do that. He specifically mentioned NeighborWorks America, a nonprofit that attempts to help distressed borrowers, and other such initiatives. He mentioned statutory changes that could lead to the "modernization of programs administered by the Federal Housing Administration (FHA)." The Federal Reserve intends to address unfair or deceptive mortgage lending practices.

Although he believes that the housing slump will impact consumer spending, he doesn't want to take an alarmist view on how the decline in housing might impact consumer spending. Growth should slow "noticeably," in his words, in the fourth quarter and remain sluggish in the first half of 2008. This slowing of growth is a slowing from the 3.9-percent pace of the third quarter, not the much hotter rates seen last year and earlier this year.


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However, he asserted that those downside growth and higher inflation risks are still balanced much as they were at the time of the October FOMC meeting. He believes that the economy is resilient and that recent data have supported that belief. He's not particularly worried about the statement yesterday that China might diversify some of their dollar holdings into stronger currencies. He warned that net increases in taxes were not a good idea at this time.

The Fed's job is to keep banks sound, the Fed Chairman asserted, of particular concern to some on a day when evidence accumulates that banks may suffer some of the fallout from the subprime mess. That fallout comes from evidence seen in the commercial paper report detailed later in this article. Chairman Bernanke listed the Fed's actions since August to calm the turmoil in the financial markets.

Not all questioners were reassured. During the question-and-answer session, questioners addressed the weak dollar, the risk of recession and other worries. Some appeared to think Fed Chairman Bernanke entirely too complacent.

Some financial writers agreed. Others wrote of his fear that inflation would strengthen while the economy turned lower and said that he portrayed an economy that was in a precarious and perhaps even perilous position. Certainly the picture of a slowing economy and rising inflation is the antithesis of the Goldilocks scenario.

A third view was that Fed Chairman Bernanke was trying hard not to worry anyone and to keep all options open while data was reviewed. Some thought that the FOMC could be characterized as weak and indecisive because of that attempt to keep all options open.

Listeners appeared to filter his words through their own concerns or preconceived opinions and come up with varying impressions of what was said and the Fed's grasp of the problems and the solutions. With such varying views, some subscribers might prefer to read Bernanke's address. It can be found on the Federal Reserve's website, at this link.

The market's reaction wasn't varied, however. Market dove the whole time Fed Chairman Bernanke was speaking and that dive didn't stop immediately afterward, either. Many recently high-flying big caps were hit particularly hard, with CSCO one of those, of course. I watched the SPX and OEX today and noted that by many measures I watch, such as Keltner channel performance, the big-cap OEX was underperforming the broader SPX.

Other than Chairman Ben Bernanke's testimony, today's slate of economic events was lighter than that seen on many Thursdays. Weekly initial and continuing claims began the day at 8:30 EST. Initial claims dropped 13,000 to 317,000. The four-week average rose 2,000 to 329,750, influenced by several weeks of rising claims. This four-week average is considered more reliable than the volatile weekly numbers.

Continuing claims fell 4,000, with the four-week average rising 16,000. While job growth has slowed, these figures suggest that firms are mostly standing pat, not laying off workers they might need later, either. The insured unemployment rate stayed at 1.9 percent.

The next report was more important. Last week, I reported that the outstanding level of commercial paper had dropped for the twelfth week in a row. Make that thirteen. Outstanding commercial paper fell by $15.6 billion. Even worse, asset-backed commercial paper declined by 3.4-percent for the week ending Wednesday. This was the largest decline in nine weeks, bringing the total decline to 29 percent or $338 billion. These are short-term loans that are backed by credit cards, mortgages or other receivables. This illustrates that investors still aren't interested in these asset-backed securities, and it backs up that feeling some mentioned that it felt as if the credit market might be about to "lock up" again. I'm not entirely sure the Fed agreed with this sentiment, since it did not fully replace the repos, the temporary market operations, that matured today. It left a net liquidity drain of $7.250 billion, accepting only $32.750 billion of the $162.050 billion that was submitted today.

This decrease in the outstanding level of commercial paper is not good news for banks, with balance sheets that will be impacted when the issuers of these asset-backed maturities must rely on banks for their funding needs. Typically, companies can issue commercial paper to pay for their obligations, including operations. Chairman Bernanke mentioned this in the Q&A session, saying that it would be in the interest of banks to disclose as much as possible the hits they were taking.

This information came on a day when Standard & Poors reduced to negative its outlook on Morgan Stanley (MS). The prior rating had been stable. Another financial, Anthracite Capital (AHR), reported today, and an accompanying statement proved interesting on the day when Chairman Bernanke was urging banks to disclose the way that the credit crunch was impacting them. AHR is a REIT that invests in real-estate assets in the U.S. and internationally.

AHR beat expectations. In its statement, however, the company said that although the "Company continues to have no direct exposure [to sub-prime residential assets], there has been an overall reduction in liquidity across the credit spectrum of commercial and residential mortgage products." The company detailed its strategy of match-funding assets when it could and maintaining adequate cash to meet any margin calls on assets that are not match-funded. If those assets declined significantly, the company noted in its statement, lenders could call in all or a portion of those loans. The company was careful to point out its limited percentage of commercial mortgage-backed securities that were not match-funded and to say that "approximately 40 [percent] of the Company's recourse borrowings are unsecured term debt which does not permit lenders to call any portion of their loans."

The Department of Energy released the weekly natural gas storage figure at 10:30. Natural gas supplies rose 36 billion cubic feet, meeting the prediction of MF Global.

During the day, October's Chain Store Sales were released. Costco (COST) said same-store sales rose 9 percent, with analysts expecting a rise of only 5.7 percent. Target's (TGT) same-store sales also beat expectations, buoyed by electronics and healthcare sales. WMT, however, reported sales that climbed only 0.4 percent, missing estimates, and said November sales would come in between flat and a two-percent rise. Sales at both Wal-Mart and Sam's Club sale contributed to the miss. Warm weather has hurt sales of coats and other items, this retailer and others reported. WMT began a stepped-up promotion program more than three weeks ago, but some industry watchers expect its promotion and those of others to cut into margins.

About two-thirds of retailers missed estimates. The International Council of Shopping Centers (ISCS) has been cutting its forecasts for October sales. Originally, it had forecast gains of 2.5 percent but has since lowered that forecast to 2 percent for stores open at least a year.

One of the most important earnings reports today was Ford's (F). The company reported a $0.19 a share loss, with analysts predicting a much larger $0.46 loss. The company lost $2.79 a share a year ago. The analysts I heard talking about F before its report hadn't expected management to offer predictions, especially good ones, for the fourth quarter, so F's prediction of "substantial year-over-year improvement" in that quarter might have been a surprise.

Toll Brothers (TOL) reported preliminary results for the fourth quarter and the full year for its home-building revenues. Home-building revenues decreased 36 percent year over year for the fourth-quarter and 24 percent for the full year, as compared to full-year 2006. Contracts and backlogs declined more than 30 percent in both the fourth quarter and the full year.

Several companies reported after the close. Qualcomm (QCOM) reported after hours today with the shares dropping after that report. Earnings were a penny better than expected and revenue higher, but the company said that it's in a dispute with Nokia Corp. and won't record royalty revenue from Nokia's sales after April 9, 2007 until a court or arbitrator awards damages or the disputes are resolved. The company projected first-quarter earnings of $0.50-0.52 when analysts had been predicting $0.52. Priceline.com (PCLN) fared better in after hours after reporting.

Tomorrow's Economic and Earnings Releases

Tomorrow's economic events begin with the 8:30 release of October's Import and Export Prices and September's International Trade balance. Import and export prices are expected to rise 1.0 percent. The trade balance is expected to widen to $58.2 billion from the previous $57.6 billion. Typically, these numbers don't impact trading unless they're big enough to change the GDP estimates.

November's Consumer Sentiment will be released at 10:00. I've been saying lately that Consumer Sentiment may regain some of the importance it once held if we worry that consumers are pulling back on their spending enough to impact economic growth. Perhaps Chairman Bernanke's discussion of the impact on consumers will indeed bring more focus to this number.

No companies of major importance report tomorrow.

What about Tomorrow?

Equity markets are overdue for a relief bounce, of course. Will it continue?

Volume was strong today. Someone was accumulating, absorbing that volume, or prices wouldn't have bounced. Someone with lots of money was doing the absorbing because only big money can produce strong volume.

But will the accumulation last? Even big money can be wrong. Tomorrow will give us a better look at whether it might last as long as a few days, but I don't believe we'll know even then if it will last longer. My belief for a while has been that we're in a sell-the-rallies environment, and I've said that in recent Wraps. I still don't see evidence that it's otherwise. So, adept scalpers can continue to scalp both directions, but others should be careful.

Even if it's a sell-the-rallies environment, bears should be particularly careful tomorrow as relief rallies can be brutal, especially in a high-volatility environment. The VIX should be watched.

Annotated Daily Chart of the VIX:

What do the intraday charts show for some indices?

Annotated 30-Minute Chart of the SPX:

Notice how the supporting Keltner lines, those under the SPX's current level, still slant strongly lower? Keltner support is not strong when it descends that way. As may be obvious, prices can slide down along that descending support.

Annotated 30-Minute Chart of the Dow:

Annotated 30-Minute Chart of the Nasdaq:

Be careful about long positions on a security in breakdown mode. Keltner channels were originally designed to identify such situations for the express purpose of trading such breakdowns (or upside breakouts), as such strong momentum movements can sometimes lead to strong trending moves.

Annotated 30-Minute Chart of the RUT:

So, what do I think? I think all signs point to a several-day rally. In any other environment, I would not only think that would happen, but I would believe it. This isn't that kind of environment, however, so I'm not at all certain that today's signs will produce that kind of follow-through. We definitely, 100 percent saw potential reversal signals form today, with confirming volume patterns, but potential reversal signals aren't always completed, just as formations aren't always confirmed or their targets met when they are. My problem this time is that traders who thought all the subprime mess was yesterday's news have learned otherwise.

My advice remains the same regardless. Until proven otherwise, only those who know what they're doing and can afford the risk (mentally and financially) should consider long trades here. Your risk from sitting on the sideline is that you won't participate in the monster relief rally that I fully anticipate will occur at some time or another. This just might or might not be that "some time or another," and at this point I believe the risk of a rollover at any time outweighs the risk of not participating in a relief rally that will drive up to some as-yet-unknown level and keel over again.

If you've ever traded the forex (currencies) markets, you'll understand what I mean when I say that you can fully participate in a good trending move like the one we've seen this week, and then get chopped to pieces trying to anticipate the reversal and get on board for that. Been there and done that. So, for all but the gunslingers, watch for rollover potential until the market proves to you that the environment has changed.

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