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Market Wrap

Tale of Two Markets

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There were two markets today. The one before the 2:30 sell program and the one after 2:30. In the morning market the Dow rallied +67 points to 12900 before the Countrywide bankruptcy scare pushed the Dow to -79. Once Countrywide denied the rumor the Dow rebounded +110 points from its lows to 12870. The bulls were gaining confidence and the bears were starting to cover their shorts. Three days at support at 12800 without a credible attempt for another selling event. At 2:30 that changed with a monster sell program that knocked -300 points off the Dow without breaking a sweat.

Dow Chart - Daily

Nasdaq Chart - Daily

The daily dose of economics had nothing to do with the market weakness. The only report of note was the Consumer Credit for November, which increased by $15.5 billion to $2.505 trillion. That gain was only 7.4% on an annualized rate and not a big jump. It should be noted that any loans secured by real estate are not included in this number. That means anyone borrowing against their home equity to make ends meet will not be listed here. You would have thought the subprime problem would have caused debt to spike much higher as consumers started leaning more heavily on their credit cards. This was the largest gain since the +$20 billion in August. The trends suggest auto sales will be pressured in 2008 by credit quality and reluctance of consumers to add to debt until the housing sector recovers.

The holiday buying binge continued last week with consumers breaking out those gift cards and hitting the malls with their returns. Chain store sales were up +0.4% for the week ended on Saturday. This was not enough to support year over year growth and that slumped to the weakest level since June. Cold dry weather in much of the country supported demand and stores were able to dump much of their clearance merchandise. Nationwide the EIA said unleaded gasoline rose +6 cents to $3.16 per gallon and that will continue to weigh on consumer budgets.

Bear Stearns (BSC) contributed to a gap open this morning with news that Jimmy Cayne is stepping down as CEO, a post he held for the last ten years. He will be staying on as Chairman and that was still a negative according to some analysts. With Cayne staying on as Chairman they doubted Bear Stearns would make the radical changes necessary to renovate the company. Alan Schwartz, currently the president of BSC is expected to succeed Cayne as CEO. BSC initially opened higher but ended the day down -$5 at $71.17 and a new 4-year low.

BSC Chart - Daily

CFC Chart - Daily

Countrywide Financial (CFC) fell to another decade low at $5.47 losing -28% today when they reopened for trading after a flurry of rumors. The NYSE halted trading in Countrywide after several analysts speculated they would have to file bankruptcy if they did not get a $4 billion infusion of cash over the next couple weeks. Their loan volumes are falling and their foreclosures are rising. The foreclosures require Countrywide to repurchase the defaulted loans and that sucks up any available cash and credit Countrywide has left. Countrywide instantly denied the bankruptcy rumors but the selling persisted. There was also a report in the New York Times that Countrywide falsified documents in the bankruptcy of a Pennsylvania borrower.

The subprime saga took another turn downward today with a Morgan Stanley downgrade for bond insurers Ambac Financial (ABK) and MBOA (MBI). Morgan said the companies were beginning to realize sizeable losses on their portfolio of insured securities, Refunding income has slumped sharply and use of insurance on municipal bonds has slowed dramatically. I don't know how the outlook for these companies could get any worse. MBI fell -21% to $14 and ABK lost -17% to $19.55.

Citigroup (NYSE:C) lost another 4% after a Merrill analyst said Citi will take a $16 billion write-down for Q4. He doubled his estimate of a loss for Citi from 73 cents to a whopping $1.43 per share. The analyst said recent declines in portfolio quality in the BSC and LEH earnings reports suggests Citi is also experiencing major declines. Citi reports earnings on Jan-15th.

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E*Trade Financial (ETFC) shares fell to an all time low after the Egan-Jones Rating Co. lowered its rating on ETFC to CCC from CC. The company said E*Trade is desperately in need of financial support, which if it does not receive shortly, might render it unsalvageable. Customers are pulling cash out of E*Trade at a record pace on fears the broker is going under due to subprime losses. Citadel Investment Group is putting $2.55 billion into ETFC but that will not be enough to save it according to some analysts. Analysts fear the account drain at ETFC will reduce its revenue stream to levels incapable of covering expenses and capital reserve requirements. If E*Trade capital fell to a point where it began receiving margin calls from the exchanges it could be a shock not only to E*Trade viability but to the entire system. E*Trade said last month it would no longer publish reports of customer activity and balances and that is a clear indication that things have gone from bad to worse.

The chip sector plunged even lower today after American Technology Research downgraded the sector citing weak demand for chip-making tools. Channel checks reflect weak bookings for Q1 with orders expected to decline by -10% for the quarter. Stocks hit by the downgrade included AMAT, KLAC, NVLS and LRCX. The SOX lost -2.6% to close at 361.

Shares of restaurant chain Brinker (EAT) fell more than $2 after KeyBanc cut the stock to an "underweight" with a price target of $15. The downgrade came after Brinker said on Monday that earnings would suffer due to a -2.1% decline in same store sales. Consumer budgets are simply being compressed to the point where big-ticket meals are being shunned in favor of fast food or home cooking. I wrote about this in my oil report this year and the potential for restaurants to close by the thousands as gasoline prices move over $4 in 2008 and $7-$8 by 2010. Consumers are going to be severely hurt and so will these consumer service businesses.

The damage is not limited to high dollar restaurants but low dollar sales are also suffering. Family Dollar stores (FDO) said sales would fall by 5-6% in the current quarter due to a shift in the retail calendar and due to customers being more restrained in their spending. The company said cash strapped consumers were cutting their discretionary spending in a trend FDO did not expect to improve in the near term. This is probably a good indicator that Wal-Mart is also going to miss estimates or warn since they are primarily a blue-collar store where budget conscious shoppers try to stretch their budget dollars.

KB Homes (KBH) said today their Q4 loss rose to $772.7 million or $9.99 per share. KB said deliveries fell 22% and the average selling price fell 12% to 247,800. Order backlogs fell -40% and the cancellation rate rose to 58%. Analysts were quick to point to the results as evidence of continued pain in the sector and a continued housing recession. Meanwhile the National Association of Realtors monthly forecast projected home sales would increase by 1% in the second half of 2008. Somebody is wrong and I hope it is the analysts.

It was not all bad news with several companies guiding higher for various reasons. Leap Wireless (LEAP) spiked +18% to $40.16 on a strong boost in Q4 subscriber numbers. LEAP said it added 152,000 net subscribers in Q4 and that was well above the prior range of expectations from 70K-130K. The churn rate at 4.2% was also lower than many analysts had expected. LEAP provides a flat rate wireless service with no credit checks or required term contracts. The customer is month to month and therefore can leave as quickly as they came. However, LEAP deals mainly with people with credit problems not able to get service with the other networks and that limits consumer options. Given the rate of mortgage and auto loan defaults due to the housing recession LEAP may be gaining a lot more customers in the future. There was also strong insider buying of LEAP stock in December.

Comcast Cable (CMCSA) announced a faster cable coming to your home soon. The cable will allow downloads of 160 megabits per second and allow complete downloads of HD movies in four minutes. They are upping their library of HD movies on demand to 1,000 this year and will up that to 6,000 movies in 2009 with more than 3,000 in HD. The announcement made at CES was full of additional features too plentiful to list here including a home phone like an iPhone with viewable voice mail, phone directory, weather forecasts and sports data. CMCSA lost 38 cents on the day but that was due primarily to the closing sell program.

SSeagate Technology (STX) gave an interview at CES that was so bullish the stock should have spiked several dollars in price. The CEO said he could not imagine a more bullish environment for disk storage. He said nearly everything we touch now has a disk drive. Our computers, cars, set top boxes, cameras and dozens of other consumer devices. They are even making add on drives up to one terabyte for people who want even more video storage capability for their DVR. He said they were getting requests from dozens of firms every month to develop a drive for a specific consumer application. STX lost 86 cents on a morning downgrade by Caris & Company. I would be a buyer here on any strength when the market finally recovers.

He is back and ready to rumble. That would be Starbucks founder Howard Schultz as the new CEO of Starbucks (SBUX). With the McDonalds announcement they were going to put 14,000 coffee bars in nearly all their stores it was another challenge for the sinking SBUX chain. SBUX had slipped to a multiyear low at $18 on slowing same store sales and rising competition. When McDonalds made their announcement SBUX fired the current CEO Jim Donald and immediately hired Schultz to take on the new competitive challenge. The stock jumped 10% on the news. Schultz said there was a continuing opportunity overseas and SBUX was just beginning to capitalize on it. His long-term plan is to have 40,000 stores, up from the current 15,000 in 42 countries. However, he does plan to close some non-performers. McDonalds is going to be a big threat but Dunkin Donuts is still the strongest competitor.

Gold prices spiked $18 to 884 intraday and a new historic high. That is of course if you don't allow for inflation. The 1980 high was $875 and adjusting for inflation would put that number around $2,150 today. The falling dollar, rising inflation fears and rising geopolitical tensions all contributed to the spike.

Apple (AAPL) announced some new computer models today including some that use pairs of the new Intel quad-core 3.2ghz chips producing a workstation with extreme speed. They also bumped the power of the rack-mounted server called the Xserve. Since Steve Jobs is typically the announcer of all new Apple products it looks like Apple is clearing the board of all the routine new announcements before MacWorld to allow Jobs plenty of time to lay on the hard sell on whatever new and unique products they are going to announce to the world. AAPL stock fell another $6 on the market implosion to close at $171. My ideal target for an entry would be around $165 but I am starting to get antsy here at $170. I think Apple will rebound into MacWorld but we need to wait for the market to find a bottom before taking more than a nibble at AAPL stock.

So what caused the market implosion? Reporters everywhere are blaming AT&T. The CEO of AT&T was speaking at a Citigroup investor conference at 2:PM. He said "We're experiencing softness on the consumer side of the house related to the economy." He went on to say that the home wireline business was seeing an increasing number of disconnects from nonpayment. It was not a significant number and would have no impact on their earnings. The wireline business only accounts for 20% of their revenue and is easily offset by the gains being made in other areas of their business. He said the home telephone is the first thing to be cut when finances are hard but the wireless service was the last thing to go as a result of a shrinking budget. With a million foreclosures in progress it makes sense there would be a lot of disconnects but that should not be news to anyone. I have a hard time believing the AT&T comments were the cause of a -300 point drop in the Dow. Several analysts suggested it was due to telecom being thought of as a recession proof business and having those thoughts proved wrong. Still, I don't buy it.

The first blurb on the AT&T story did not hit the print wires at 3:33PM. Bloomberg first broke the story about 2:42 on their website. The selling in AT&T started at 2:30. The timing fits but the severity is wrong. For an event that made no difference to AT&T earnings a concentrated drop of that magnitude (-$4.50) makes no sense. Even if the event was related to AT&T then it should have only impacted AT&T and maybe the other phone companies. What we have here is simply an attempt to place blame for an event normal reporters don't understand.

Dow Chart - 15 min

I looked at intraday charts on over 100 stocks. I looked at Dow stocks, drug stocks, tech stocks, integrated oils, oil service, steel stocks, miners, engineering stocks, solar stocks, etc. Every single stock in every sector sold off sharply at exactly 2:30. If this was an AT&T related event it would have taken time for the contagion to spread to the other sectors. It would have started with telecom and then spread if it was related to AT&T. It did NOT spread. It was instantaneous across all sectors and predominately large caps. This was a monster sell program that fired at exactly 2:30. Within minutes trailing stops were hit across the board and that triggered follow on sell programs and sell stops by retail traders. Traders who had setup their exits just in case the Dow broke 12800 and the S&P cracked 1400 were ready to push the button with those levels were hit. In a suddenly falling market you sell first and ask questions later. Selling in a market already on the edge is very easy to trigger and that is what we saw when that program fired this afternoon.

Now, what should we do? The Dow came to a stop at 12600 and the S&P 1390. The Nasdaq cracked support at 2500 and closed at the low for the day. It is not a pretty picture regardless of what caused the breakdown. Sometimes the reasons why become less important than the fact that an event occurred. We have broken support on all the major averages and the event started as the averages neared the highs for the day. Anybody buying the dip over the last two days was flushed. There were three attempts to buy last week's dip and it appeared the bulls were going to be successful on the third try at 2:25 this afternoon. Now those bulls are traumatized given the sharpness of the drop and the strong break of support. I would expect quite a few are going to wait on the sidelines now to see what the future holds.

S&P-500 Chart

The Nasdaq has fallen -10.5% since the holiday highs and has now fallen for eight consecutive days. The Dow closed 200 points under its consolidation range and below support that held for the last eight months. Even if we want to be bullish we have to respect the market breakdown regardless of the reason. On Sunday I suggested exiting your shorts from the 1490 resistance failure when we reached 1400. I suggested buying any bounce from 1400 and if 1400 failed we load up for another potential bounce from 1380. On today's crash 1400 was only a 10-minute pause in the decline. Brave bulls tried to buy the touch of support but were steamrolled by the next wave of selling. That leaves us flat under 1400 and looking for 1380 as our next bounce point. I see nothing new on the economic horizon and Alcoa reports earnings on Wednesday. MacWorld begins next week. This would be my recommendation. Buy a bounce at 1380 or a breakout over 1400. Short a break of 1375 with no visible support until 1250. It could get really ugly if something does not change soon. This has been the worst 5-day start for any year in recent history. If the Fed announced at 5 min before the open tomorrow they were cutting rates another 50 basis points it would be an entirely new market by tomorrow's close. I am not holding my breath.

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