On Thursday, when it appeared the Fed might cut 50-points, the strength in the ADP employment report created doubt and began to remove expectations of that move from the forecast. The markets started to waffle and the Fed fears began to circulate. Finally, we got to Friday and the Labor Dept nonfarm payrolls were just right, not too hot and not too cold. Traders breathed a sigh of relief and the Fed funds futures continued to project a cut. The bears can now go back to sleep and let the bulls have their holiday party.
All week the focus was all about the jobs report and the impact it would have on the Fed. Too hot and the Fed would not cut. Too cold and a cut may not rescue us from a recession. The interim reports were confusing with the Monster employment index on Thursday falling to 183. The tone of the report was decidedly bearish with the annual growth rate falling to 4.6% and the lowest on record. Online hiring in all regions fell in November. Only three of 23 occupational categories and two of the 20 industries showed an increase in job openings. This report set the stage for an ugly report from the labor dept on Friday but that stage was quickly demolished when the ADP report hit the wires.
The ADP employment report on Thursday showed there were 189,000 private sector jobs created in November. That was nearly twice the rate of October and four times the analyst November expectations for 50,000. Suddenly the estimates for the government report were soaring. Last Sunday the estimate was for 65,000, by Thursday afternoon it was 75,000 and by Friday morning that number had jumped to 100,000. I heard one analyst on TV that said we could see as much as 200,000. That would have been a nightmare for the Fed. By Thursday's close the conflicting reports had analysts everywhere grabbing onto the ADP report as the lesser of two evils.
Friday's nonfarm payrolls came in at a gain of 94,000 jobs in November and suddenly all the tension in the market evaporated. October's gains were revised slightly higher by +3,000 but September was cut by more than half from 96,000 to 44,000. Those revisions gave us a net gain of only 45,000 jobs in Friday's report. The headline gain and the net gain was just enough to dull the plaintive wail of the recession bears but also not too hot for the Fed to recoil in shock. Despite the surprise +170,000 job gain in October the trend in payroll growth is definitely down, just not steep enough to cause alarm.
Nonfarm Payroll Chart
The Fed should still be on track to cut rates on Tuesday although it is almost a guarantee now that it will only be a 25-point cut. The Fed would probably like to skip this meeting after the subprime fix, ISM and jobs numbers but they have already talked themselves into a rate cut bias through a dozen Fed speeches the prior week. Once they convinced the market that they were ready and vigilant to take on the probabilities of a recession they were committed to at least one cut. Now the focus turns even more to their statement. If it sounds like a one and done then the market will not react kindly. They need to at least tease readers with the potential for another cut in late January. There have only been hints of inflation in the recent reports and the Fed will have the most current look with the PPI and CPI reports next week.
The economic calendar for next week only has three material events. That to me is the FOMC meeting on Tuesday, Producer Price Index on Thursday and Consumer Price Index on Friday. The price indexes are expected to show even more hikes caused by food and energy but the core rates are likely to be flat and not give the Fed any reason not to cut. The headline PPI is expected to jump sharply to 1.6% from 0.1% in October. The CPI is expected to rise less by only .7% compared to the .3% in October. The Fed will have that info before we see it later in the week so all eyes will be on the Fed and the individual price indexes will be mostly ignored in the aftermath of the Fed decision.
The highlight of last week had to be the President's "Teaser Freezer" plan to slow down the subprime crisis to manageable levels. Just the announcement of a plan sent financials and builders soaring and that was before the real details were revealed. Now the big question on everybody's mind is "when did Hugo Chavez replace President Bush." This is the United States of America where contract law is the cornerstone of business in every form. If the President can just arbitrarily sign away contract terms then our form of government has turned into something you would see in Russia or Venezuela.
Fortunately that has not happened regardless of what you hear in the media. Many cries about damaging the investors holding the mortgages were heard when the proposal was aired. Those poor investors with billions invested in subprime debt. Don't you just feel so sorry for them? I would think that any plan that resulted in a payout of the mortgage rather than a 20-30% loss due to foreclosure would be preferred even if it lengthened the term of the deal by a couple years. Let's face it everybody knows those houses are going to be flipped just as soon as real estate prices firm and the mortgages are going to be paid off. But everyone is still worried about the violation of contract law.
Ahh, but that is just the point. Those subprime contracts that covered the slicing and dicing of millions of mortgages contain some interesting provisions but even if they did not have those provisions there is nothing in the plan that would break the contract. Why, because the plan is totally voluntary. Secondly the servicers are restricted from taking this teaser freezer action if it violates any servicing agreement. Black and white, if it violates the terms then forget it. Now the really interesting part. Most of the servicing agreements allow for "maximizing returns of the pool." That means servicers can take whatever action they want to take to maximize returns even if that includes modifying the loan terms. According to the American Securitization Forum (ASF) only about 30% of the existing agreements limit loan modifications. Some of those would even allow the freezer plan. So, we don't have to feel sorry for those poor investors that bought millions in subprime paper. They will eventually emerge reasonably whole. Just envision Scrooge McDuck in his vault sitting on millions in cash and your pity for the investors will probably disappear.
The teaser freezer is mostly a smoke and mirrors event anyway. According to Friday's most recent projections the freezer play would only apply to about 90,000 to 150,000 of the 1.2 million mortgages that will reset in 2008. Some place the number slightly higher but these are the numbers making the rounds. Those other million plus mortgagers are still stuck with the same problem they had last week and that is a monster reset in their future. What the plan did do was improve sentiment across the sector and the actual details of its execution will probably get lost in the shadow of whatever the next big event will hit us in 2008. For starters that will be the Olympics and the elections. If the roster of candidates gets any bigger we may have to hold our own election Olympics here in the U.S. just to weed out the contenders.
The investors who bought Chrysler are probably wishing they could give it back. A serious case of buyer's remorse must be settling in with problems mounting on a daily basis. Chrysler LLC said on Friday the company would lose $1 billion or more for 2007. Analysts felt the update was a warning there were more job cuts ahead on top of the 25,000 already announced. Chrysler also said they were going to idle the Warren Michigan and north St Louis truck plants during the month of January and a plant in Mexico for two weeks to try and stop the massive buildup of truck inventory around the country. $3 gas has caused a lot of buyers to reconsider new truck purchases in favor of better mileage cars and dealers report over flowing truck inventories. Chrysler also said they were recalling nearly 600,000 trucks for transmission problems. I bet that is not going to be cheap.
Merrill Lynch caught a bad case of the recession flu and cut three major credit card firms to sell on Friday. Those were American Express (AXP), Discover (DFS) and Capital One (COF). The analyst wrote that economic news was worsening and the risk of a consumer recession was all but certain. Merrill puts the risk of recession at 65%. They said the weakness in the consumer sector was going to be much worse than expected. The report said housing also had broader implications than currently being discounted. They said Capital One was the most at risk due to their client mix and was currently 15% over valued. Discover was reportedly 24% over valued and at risk given 60% of their business is domestic. Discover is expecting charge-offs up to 4.75% but Merrill thinks it could be much worse if the recession appears. They were more positive on the American Express business model citing their greater exposure to the international market. The analyst thought increasing risk to AXP would come from falling real estate values of their big spender cardholders. Risk at AXP was calculated at a 14% downside to the current price. Another reporter thought the Merrill analyst had been drinking too much of the bearish Merrill Kool-aid. Merrill has been mired in the subprime crisis losing billions as defaults rose and the repercussions reached all the way to the ousting of the CEO. The hallowed halls at Merrill appeared to have turned into a bear cave and the reporter thought the analyst was being overly influenced by the negativity.
The Sci-Fi channel has been running a new Wizard of Oz mini series over the last week. You know, where Dorothy is transported to a land where unbelievable things happen. I felt like I had been transported there on Friday when I heard the unbelievable news about United Airlines (UAUA). They announced they were going to pay shareholders a $250 million special dividend of $2.15 per share on Jan-9th. Let's see, crude is over $90 a barrel, capacity is rising but load factors are not and Delta just announced this week they could turn in a loss for the quarter. Airlines have been in short the bounce mode for as long as I can remember and suddenly UAL is flush with money. Their 17,000 flight attendants reacted angrily to the plan after enduring harsh wage cuts to help the airline restructure. Now that the airline has emerged from rough times they are giving stockholders a holiday gift but the attendants did not even get a lump of coal. Actually UAL is healthier than I thought when I discovered doing research they had generated $2 billion in operating cash flow so far in 2007 and had $4.2 billion in unrestricted cash. That caught me by surprise. Made me wonder if they had been hauling more than passengers on north bound flights from South America. However they did it I am impressed they are not bleeding cash like the rest of the sector.
On a side note I heard this week the Coast Guard said that year to date they had confiscated a record 355,000 pounds of cocaine bound to America from all points south. According to the Coast Guard that has a street value of roughly $4.7 billion. Sonny Crocket would be proud.
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Careful with that TV Guide next week. You may want to check it for hidden threats like incorrect feature times or missing pages. Gemstar-TV Guide (GMST) agreed to be acquired by Macrovision (MVSN) for $2.8 billion. Macrovision shareholders were highly aggravated because they thought MVSN paid too much for a 54-year old magazine company that has been losing money and subscribers. Gemstar does license various types of digital channel guides as well. Gemstar shareholders were ticked because the board sold them too cheap. At $2.8 billion that is only 10% of the Gemstar market cap just 7-years ago. You may remember Gemstar bought TV-Guide for $14 billion in 2000. The Gemstar shareholders need to get a grip on reality. Analysts say the lack of innovation at TV-Guide had it slated for the trash bin of history and MVSN should be seen as a savior at this point. Subscribers have fallen from 8.2 million in 2005 to a reported 3.3 million last quarter. The former Gemstar CEO was found guilty of fraud in 2006 and the company had to restate millions in revenue. Analysts hated the deal in general and wondered what actual Gemstar asset MVSN wanted and why they did the deal. MVSN has 760 employees and $200 million in annual revenues. Gemstar has 1600 workers and $571 million in revenues. The current Gemstar CEO and CFO plan to leave the company once the deal is done. MVSN CEO Fred Amoroso could not answer questions with any specifics when questioned on a conference call. When asked why they bought TV-Guide, Amoroso said he didn't know much about publishing and needed more time to assess how TV-Guide would fit into MVSN. Duh! You just paid $2.8 billion for a magazine and you don't know what you are going to do with it? Kaufman Brothers analyst Todd Mitchell doubts TV-Guide will be part of MVSN and the magazine itself will probably be spun off as soon as the deal is completed. Now that is an IPO I would avoid. GMST lost -16% and MVSN was hammered for a 21% drop.
A better deal for shareholders came from IMAX Corp (IMAX) after they announced a new deal with AMC to install 100 digital projection screens in AMC theaters. That doubles the IMAX penetration into the U.S. market. IMAX stock jumped +58%.
Smith & Wesson (SWHC) was gunned down to the tune of a -29% drop after lowering their earnings estimates for the second time in six-weeks. The primarily handgun manufacturer has been trying to introduce a new line of long guns and apparently shooters don't like them. Inventory has ballooned at major retailers and one chain cancelled a large order due to the glut. The glut led to production cuts, plant shutdowns and a layoff of 100 workers. Better keep any loaded guns away from the CEO.
For the last couple weeks Research in Motion (RIMM) has been getting whacked after an analyst said he thought the new Palm phones were outselling the Blackberry. Evidently Palm did not get the message and slashed their guidance on Friday. They said the larger than expected loss would be due in part to the delay of a product launch. Palm did not say which product but analysts speculated it was a wider release of the 755p Treo currently available only through two carriers. Analysts were quick to downgrade Palm calling it "obviously disappointing financially" and a "further decline in fundamentals and estimates." There was also talk of a write-down on this inventory that may not sell if it is late to market and misses the holiday season. Citi analyst Jim Suva cut PALM to a sell. Another analyst joked that PALM may be going to zero if management does not improve. PALM lost -13%, RIMM only lost 23-cents and is still holding over support at $100. I still believe this is a buying opportunity with a stop at $95. PALM earnings are Dec-18th and RIMM earnings are on Dec-20th.
Crude continued its Jekyll and Hyde performance with nearly a +$5 move on Thursday and better than a -$3 intraday move on Friday. The January contract has six trading days left and volatility is definitely increasing. There was nothing on the news front to move the price other than momentum players reshuffling their portfolios prior to year-end. Profits are not profits until they are turned into cash and we could be seeing some oil profits taken to offset losses in other areas. Current support is $88 but some analysts are suggesting we could see a drop back to much stronger support at $80 before the year is out. Because of year-end shuffling volatility is likely to increase as the contract expires on Dec-18th.
Non-economic events next week include the start of the earnings cycle for the brokers with Lehman (LEH) leading off on Thursday. This flurry of broker earnings will disclose any further problems from the subprime problem and the lingering credit crunch. Goldman is next on 12/18 and BSC 12/20. Morgan Stanley should be the same week but has not yet announced a date. If any of the brokers report a material loss not previously disclosed it could get ugly again. GE is also holding an analyst meeting on Tuesday, 3M on Wednesday and UTX and HON on Thursday.
Financials are probably as close to a bottom as they are going to get and those with high short interest are rebounding sharply. For instance, Corus Bankshares (CORS) was up +30% for the week. Last week 64% of the float was short. That would be an extreme example but there are plenty of bears turning tail and heading for the sidelines in both banking and homebuilders. Toll Brothers (TOL) had 19% short interest last week. Bear Stearns 20% but Lehman only 7%. That suggests traders in Lehman are expecting positive earnings rather than a new disclosure. Bear Stearns however is still attracting traders expecting more bad news.
The markets went nowhere on Friday despite the Goldilocks jobs report. It was clear that everyone was either comfortable with the jobs numbers ahead of the Fed or dumbfounded and not knowing which way to jump. I prefer to think the bets have been placed and everyone is just waiting for the Fed. The Dow stretched its rebound from the Nov-26th low at 12725 to hit 13667 on Friday. That is a monster 942-point move in nine days. I view the +5 point hesitation on Friday as potentially bullish. This was a perfect chance for profit taking and nobody took the bait.
The Dow rallied right to strong resistance at 13665 on Friday and recoiled only slightly to close at 13625. That resistance has been in play since early June. After a +900 point rally it only makes sense we should pause here before the Fed.
Dow Chart - Daily
The Nasdaq is far less clear but it has decent resistance just overhead at 2720. The Nasdaq Composite is not encouraging to me. I see this minor break over 2700 as more of a failed breakout than a real break. However, the Nasdaq 100 is showing a slightly more bullish posture. The NDX is well above the same relative resistance as the composite (2050 on NDX) and the pattern is a lot cleaner. The NDX appears to be poised to make a real break higher but has not yet completely broken free of that 2120 resistance. Gravity is still a controlling force.
Nasdaq Composite Chart - Daily
Nasdaq-100 (NDX) Chart - Daily
The S&P-500 broke through resistance at 1490 and ran to the downtrend resistance from the October highs. This was the perfect place to stop since it is also a congestive resistance range dating back to May. A lower high here could be a failed bear market rally and lead to a retest of the lows. I am positive on the S&P only as long as it stays over 1490 but I still lack conviction.
S&P-500 Chart - Daily
The Russell had a decent week but is still not showing any real strength. There is solid downtrend and overhead resistance at 800 and little buying power. The Russell had only 35 stocks making new highs on Friday (2.4%) with the S&P Small Cap index only showing 2.2% making new highs. The only index with a worse reading was the Nasdaq at 2.1% (65 highs). Comparatively the S&P-500 had 7.5% and the S&P MidCap 4.8%. There is simply no strength in small caps and that is why the Nasdaq Composite is so weak. I would love to sound the bugle for the bulls but I don't see it in the internals.
Russell-2000 Chart - Daily
I believe these false breakouts warn of a potential weakness ahead. When an index breaks key resistance by only a handful of points it is only a tentative win and must be followed up quickly with conviction or be doomed to retest support. On Friday we had the perfect jobs report and the markets went numb. I understand they are waiting on the Fed but this should have polarized somebody into action and instead we had the lowest full day volume since October 12th.
I know the conventional wisdom is that we are waiting on the Fed to bless the markets with a rate cut and the bulls will charge into the year-end with reckless abandon. I wish I could sign up for whatever drugs they are selling in the trading rooms in New York. After 12 hours of research and writing Friday evening I am leaning solidly into a sell the news event.
I believe the Fed rate cut is already priced into the market. They telegraphed it for two weeks and then the last week's data made them wish they had kept their proverbial mouths shut. They have to cut at least a quarter or risk a very bad market reaction but I doubt that will be enough to hold off the selling.
Jeff Macke said it best on Friday. He called it the GIG factor in referring to the Fed statement. The first paragraph in the statement is about Growth, second Inflation and third is Guidance. Whichever paragraph they emphasize is the one that determines market direction. If they only cut a quarter point they have to guide to a further bias towards rate cuts. That means the growth paragraph will have to be weak. They can't emphasize inflation or they can't cut rates. This means they should say growth is weak, no surprise there, but also change their bias to further cuts. That may be the paragraph they choke on. With last week's economic data they may not want to change to a bias towards more cuts and that will poison the market.
You can spin this 90 ways from Sunday but the real point is the Fed will have to walk a real tightrope on their guidance and whatever they say may not be enough to pacify the market. Why, because the market has already swallowed the program hook, line and sinker. They bought the Fedspeak the prior week and even with stronger economics last week the Fed funds futures are indicating a 152% chance of a quarter point cut at Friday's close and a 35% chance of a 50-point cut. Traders have completely ignored the possibility the worst is over and the recession talk was just smoke. While I would love to see the markets charge off after the announcement and not look back until January I think that is a very slim possibility. The Dow has rebounded +900 points in two weeks on rate cut hopes and anything the Fed does is going to be anticlimactic.
The odds of a sell the news event are very strong but there is always that slim possibility of a market miracle. The NYSE may not be on 34th Street but Bernanke could come to the rescue. I just doubt he will don a red suit and call himself Kris Kringle. He may have delusions of power but he is already being called a one-term chairman by many. How he handles this credit crisis could be the key to his future. He could do worse things now than cut rates. In fact anything other than cutting rates now could seal his fate when the new administration takes power.
Contrary to popular opinion the Fed does not lead in periods of change. The market leads and the Fed follows. The Fed is rarely if ever ahead of the market or the economy. They always want to see months of confirmation before making a move. Many times the individual members seem afraid to take a stand lest the inflation monster sneak up and bite them on the ass when they are not looking. Inflation is always considered their biggest enemy but they won't even mention the dreaded "R" word in public. The market wants them to pay attention on Tuesday, see that core inflation is dead, take aim at the recession potential and blow it away with a 50-point cut. Unfortunately I doubt it will happen and a lukewarm, backpedaling, post meeting Fed statement will be sold faster than Macrovision after announcing they were buying Gemstar. Since market conditions will change hourly before the Tuesday announcement we need to simply deal with what the market gives us and not what I think will happen today. This week the plan will be to honor that 1490 support on the S&P. Buy dips back to 1490 but reverse to shorts should that level fail.
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