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Market Wrap

NBER Speaks; Former Member Bernanke Follows

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Never heard of the NBER? It's the National Bureau of Economic Research. Reuters says that this organization "determines when the business cycle enters recessions and recoveries," a statement repeated this afternoon by Fed Chairman Bernanke who was once a member.

NBER's president, Martin Feldstein, spoke at a forum this morning hosted by the Hamilton Project. Reuters identified this group as an economic research group that is led by Robert Rubin, former Treasury Secretary. Feldstein told the Hamilton Group that recession "is more likely than not," but that it's not yet a certain thing.

Some have been wondering if we were already slipping into recession. Fed Chairman's Bernanke's statements about NBER later in the afternoon added much credence to NBER's assessment of the current state of the economy. During the question-and-answer session, Fed Chairman Bernanke said that the NBER didn't "even think about" getting together to decide on whether a recession had occurred until "six months after the event."

Our country is not the only one dealing with the twin worries of rising inflation and a softening economy. This morning, the European Central Bank and Bank of England voted to hold their interest rates steady. The ECB's decision was expected, but economists had been split on their predictions for the BOE. The situation in the U.K. echoes that in the U.S. in many respects, so the BOE's decision was closely watched. Central bankers in the EU and the U.K. weighed inflation fears against evidence that discretionary consumer spending was plummeting. The BOE decided against easing. Our futures weren't celebrating that decision during the pre-market session.

If the BOE could turn its face from suffering retailers, couldn't our FOMC do the same? The situation was hammered home by U.S. retailers issuing December same-store sales reports today. The reports were dismal for the most part. American Eagle Outfitters (AEO), Hot Topic (HOTT), Men's Wearhouse (MW), Limited Brands (LTD), Pacific Sunwear (PSUN) and Stein Mart (SMRT) lowered earnings guidance. Wal-Mart (WMT) reaffirmed its guidance, and some sources pegged it as beating expectations while mentioning how rare that was in this reporting period. Costco (COST) also performed well, as did Target (TGT).

Retailers don't constitute the only suffering group, of course, either here or in other places across the globe. U.S. financials figured in the news all day, with COF being blamed for pushing futures lower in the morning and BAC/CFC speculations credited with pushing prices higher in the afternoon.

Capital One Financial (COF) announced that it would take a $1.9 billion fourth-quarter provision for loan losses for the fourth quarter and trimmed its earnings forecast for the year. COF noted that increased loan delinquencies and legal reserves led to that provision.

Citigroup (C) and Merrill Lynch (MER) reportedly are negotiating with foreign investors for more capital infusions, to the tune of $10 billion and $3-4 billion, respectively. As had first been speculated a couple of Thursdays ago, Citigroup (C) may also slash its dividend. Market watchers expect its board to meet Monday to discuss the dividend as well as other measures.

Late in the afternoon, a surge higher was supposedly prompted by speculation that Bank of America (BAC) would acquire Countrywide Financial (CFC), but it was in the earlier, gloomier period during which market participants awaited Federal Reserve Chairman Ben Bernanke's speech on the economic outlook. He spoke before the Woman in Housing and Finance and Exchequer Club in Washington, D.C. Even before he began speaking, however, his prepared remarks hit the airwaves. Pundits interpreted his comments as leaving little doubt that the FOMC will cut rates, and cut them aggressively. The first response was an enthusiastic one, but one soon tempered by his somber words about the economy.

Mentioning restrictive lending practices by banks and a recent worsening of the economic outlook, Fed Chairman Bernanke concluded that financial market concerns were hindering economic growth. The strain caused by the credit markets is significant, he said, and may pose a considerable risk. Although the economy still grows at a moderate pace for the moment, he asserted, the FOMC remains alert for signs that the weak housing market is spilling over into other sectors. The housing and financial markets could further strain the economy.

During the question-and-answer session, he responded to a question about the "R" word by saying that "the Federal Reserve was not currently forecasting a recession." The Fed is forecasting slow growth.

"In light of recent changes in the outlook for and the risks to growth, additional policy easing may well be necessary," Fed Chairman Bernanke said in his statement. Not only was the Fed prepared to ease rates, it was prepared to take "substantive additional action as needed to support growth."

In his speech, he summarized the history of the current difficulties. He detailed the process by which "banks, too, became subject to valuation uncertainties." That process included a number of factors, including poor underwriting, fraud and abusive practices and a flawed premise in the first place, among other reasons. That flawed premise was "that house prices would continue to rise rapidly."

The subprime problem resulted in a broadening of problems. Borrowing has become tougher for all, not just "nonprime borrowers." Lending rates rose over "certain benchmark rates," he noted, probably referring to the often-noted worries about lending rates that stayed stubbornly above LIBOR for so long. Uncertainty attaches to the value of financial and other assets, particularly structured credit products or asset-backed commercial paper. Banks have been reluctant to lend money to "firms and individuals." Balance sheets for banks had been "swelled" by the various products "for which well-functioning secondary markets no longer existed." These worries have been tackled on these pages before and are not new to our subscribers, but Chairman Bernanke's face and voice seemed somber as he listed these concerns.

The Fed has certain powers through its discount window to impact liquidity, the Fed chairman noted, but two problems are that some financial institutions have been reluctant to approach the discount window because of a perceived stigma and the actions taken there "could tend to push the rate below the Federal Reserve's target rate." He went on to say that those concerns had been largely overcome.

He mentioned the Fed's term auction facility (TAF) actions, including $60 billion in term repos to be auctioned in January. Our Fed's actions have been matched to some degree by coordinated actions by other central banks, including the European Central Bank and the Swiss National Bank. Some market watchers question how much liquidity the Fed is really injecting with those auctions and whether some of that presumed injection isn't instead a churning of various components of the monetary base. However, Chairman Bernanke said that as a result "term premiums in the interbank market and some other measures of strains in funding markets have eased significantly, although they remain well above levels prevailing before August last year." He noted that the TAF may become a "useful permanent addition to the Fed's toolbox."

Despite these efforts and their moderate successes, concerns remain. There's still "considerable uncertainty about the appropriate valuation of complex financial assets" and about the losses that our financial institutions might yet incur. Many would agree. The Fed chairman noted during the question-and-answer session that 400,000-450,000 interest-rate resets may be expected per quarter in the next year, and that although not all those with loans being reset would be in trouble, some would. Some market participants have begged for financial institutions to come clean about their losses, but others would argue that it's not possible yet for those institutions to know how much their losses will mount..

The labor market weakness poses a threat, Fed Chairman Bernanke said. Signs exist that high energy and food costs may finally be spilling over into core inflation measures, something that most of us will agree happened long ago.

Those who would like to read Fed Chairman Ben Bernanke's prepared comments in their entirety can find them at this link.

Soon after the Fed Chairman spoke, further speculation that the Bank of America Corp. (BAC) was seriously considering an acquisition of Countrywide Financial (CFC) surfaced. CFC surged although the WALL STREET JOURNAL article was far from definitive. The deal could "occur very soon," as soon as the end of this week, although it wasn't "clear how quickly a deal might be struck." The deal could also "be delayed or fall apart altogether." That covers just about every possibility, doesn't it?

After relentless selling and a year's beginning that's been characterized as the worst since 1932, markets were ready to bounce, however, and they did. Let's look at charts.


Annotated Daily Chart of the SPX:

This view was a daily one. The weekly one provides some insight, too. The SPX's weekly chart currently displays a candle that's springing up on a long lower shadow from support, with the body of the candle just above the red trendline seen on the daily chart. Such candles can be reversal signals, needing to be confirmed by the next week's performance. Equity bulls want to see that long lower tail left tomorrow with a weekly close above that trendline. If not, I'd certainly factor in vulnerability to that lower blue trendline and maybe even to 1345.

Many looking at charts tonight will also be aware that the weekly chart shows a potential head-and-shoulders formation with a neckline at this week's low. Equity bulls don't want to see that confirmed.

Still, although there's enough concern for some teeth grinding tonight, that's not a picture without hope, is it? It provides hope for a rally or perhaps some choppy consolidation over the coming weeks between the 1386-1466 zone.

There's reason for concern, too, though, and other charts shown later in the article provide even more reason for concern. Let's see what the Dow's chart shows.

Annotated Daily Chart of the Dow:

The Dow's weekly Keltner chart (not shown) suggests that until and unless the Dow begins producing weekly closes above about 13150, it's got vulnerability down to 12325. That's not a happy thought, but it's not predestination, either.

In this climate, we need to be aware where vulnerabilities might lie. Without panicking, we need to assess the risks in our trading portfolio and make appropriate plans. If you went long Dow or DIA calls on the test of the August low, for example, keep that vulnerability in mind. You might not automatically abandon a profitable play, but knowing the vulnerabilities would urge you to exercise caution.

With that vulnerability in mind, how will you react if the Dow rolls back through this week's low tomorrow? Will you jump out and then watch what happens if 12325-12400 is approached? What if the Dow charges right up to the midline of that declining channel tomorrow and stops there? Will you elect to stay in your play over the weekend? Instead, will you take partial or full profits and then see what develops next week? There's no right or wrong choice. If you've got one contract of a deep ITM March Dow or DIA call and a trading account of $100,000, you might make a different choice than someone with a $2,000 account and five contracts of OTM expiring-next-week January calls.

Annotated Daily Chart of the Nasdaq:

So far, these charts have provided hope for at least at least swing trade possibilities as indices stabilize and move up through these descending channels. Bounces occurred right where expected. Although I kept charts as simple as possible, RSI also often hit sub-30 levels, as sometimes happens in so-called "oversold" conditions. There's reason for cautious planning and awareness of risks and vulnerabilities, but also some degree of hope that indices will rise at least up to the midlines of those channels.

It's difficult to assign much hope to the next two charts, however, seen in a weekly view.

Annotated Weekly Chart of the SOX:

That SOX weekly chart looks ugly. While the RUT's doesn't look as ugly, it presents some reasons for concern. Viewed on the RUT's weekly chart, that descending price channel seen on the SPX, Dow and Nasdaq charts becomes a potential broadening formation. Such formations are often characterized by only two tests of the top rising trendline.

Annotated Weekly Chart of the RUT:

That annotation should have read that broadening formations are "potentially" bearish formations. If you were trading in 2003, you saw some broadening formations resolve to the upside.

No new weekly downside Keltner target has been set for the RUT, and so far, the RUT has sprung up from this test of the weekly 200-sma and -ema's as well as of the broadening formations support.

Bulls don't want to see a rollover tomorrow and a weekly close beneath those benchmarks, however. Keep in mind that a weekly Keltner target would not likely be reached in one swift dive lower, if it is reached at all. I see vulnerability to 675, however, if the RUT does fail here.

With the TRAN's chart, hope is renewed again.

Annotated Daily Chart of the TRAN:

The TRAN's chart is a daily one, but the weekly view would have provided an insightful look, too. This week, the TRAN punched through the weekly 200-sma and -ema's, at 4144.24 and 4227.31, respectively, managing a close above both so far. Equity bulls want tomorrow's close above both, too, to end the week. The Keltner weekly chart suggests that if the TRAN closes the week below 4298 and particularly below 4211, it sets a potential eventual downside target at 3251. I don't even want to think about that.

Today's Developments

Today's economic calendar was a busy one but not a particularly important one other than the confirmation from retailers that December was a weak month. December's Monthly Chain Store Sales were released, but market participants had already gotten a look at retail sales over the holiday season. They didn't expect much cheer, and they didn't get it.

In addition to the retailers mentioned in the opening paragraphs, Charming Shoppes (CHRS) lowered its fourth-quarter outlook. Abercrombie & Fitch (ANF) and Signet (SIG) announced that December's same-store sales declined. AnnTaylor Stores and Macy's saw declining sales. Some retailers blamed the calendar, noting that the post-Thanksgiving shopping week was in November in 2007, rather than in December, as it sometimes is.

In a bit of good news, Aeropostale (ARO) said same-store sales rose 12.2 percent in December, far above the 3.7 percent that Thomson Financial said analysts expected. The company raised EPS guidance for the fourth-quarter.

The International Council of Shopping Centers (ICSC) said retailers would report a gain of about 1 percent in December, down from the group's original 1.5 percent estimate. That would be the weakest December performance in five years. According to ICSC, profit estimates for retailers for 2008 may be at least three percentage points too high. The news appeared to be mostly factored into prices. The RLX, the Retail Index, continued higher from yesterday's spring off 360.

The Labor Department released initial and continuing claims at 8:30 am ET. Initial claims dropped 15,000 to 322,000, reaching a two-month low. The drop was unexpected and welcomed, although weekly figures are volatile. The four-week moving average dropped more modestly, by 3,000 and to a one-month low. Year over year, initial claims have risen seven percent.

Continuing claims fell 52,000 to 2.7 million. However, the four-week moving average on this number rose 17,000 to 2.7 million, the most in more than two years. Year over year, continuing claims have risen 10 percent.

November's Wholesale Trade appeared at 10:00. The Commerce Department reported that sales rose faster than inventories in November, pushing the inventory-to-sales ratio down to a record 1.07 low. Sales gained 2.2 percent, but inventories rose only 0.6 percent. That ratio sounds great, but higher crude costs were responsible for the higher sales. Petroleum sales gained 8.9 percent. That's the biggest jump in two years.


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The Federal Reserve updated its weekly figures for outstanding commercial paper. This release has assumed great importance in the current market environment. If you're not familiar with commercial paper, the Federal Reserve provides an explanation. According to the Federal Reserve, commercial paper is issued mostly by corporations. It consists of short-term promissory notes that mature up to 270 days, although most mature in about 30. The money raised is used to fund transactions.

A troubling trend had begun since the credit crunch appeared, with outstanding commercial paper dropping. Companies found it difficult to place that commercial paper during the worst of the credit crunch.

Outstanding commercial paper rose for the second week in a row, according to the Fed's figures. It grew $14.5 billion, more than the previous week's $13.2 billion increase. On a seasonally adjusted basis, asset-backed paper--that backed by mortgages, for example--grew $4.8. That's good news, too, although the change is far less than the previous week's $26.3 increase. If not seasonally adjusted, asset-backed paper dropped by $0.500 billion. It had increased $8.3 billion the previous week on an unadjusted basis. Over all, the news was good, but perhaps tempered a bit by the smaller increases and the decrease in asset-backed paper when not seasonally adjusted.

The Department of Energy was last on the slate with its update on weekly natural gas inventories. Natural gas inventories dropped 171 billion cubic feet.

CIBC's World Markets Chief Economist Rubin addressed concerns about another part of the energy complex. He predicted today that the world will see $150.00/gallon crude within the next four or five years. He predicts that demand will soar in countries such as India and China, but that consumption will drop in the U.S. as consumers drive less due to the cost of gasoline.

Not all the news today was of the doom-and-gloom variety. Worries about gasoline costs didn't hamper the transports in early trading. The TRAN powered higher right away, led higher by Boeing (BA) after an analyst had good things to say about the company's order backlog for airplanes. Airline shares were also helped after a letter from the chairman of Delta's (DAL) pilot union to union members heightened speculation that Northwest Airlines (NWA) might be a merger target for DAL. That speculation fueled more rumors about which other airlines might be ripe for the picking. Not all analysts believed the NWA/DAL speculation, but there's nothing like a little M&A speculation to add cheer to a gloomy market.

Further M&A news circulated. Leveraged-finance specialist GSO received an offer from Blackstone Group (BX). BX believes that the expertise of GSO Capital, founded by former Credit Suisse First Boston executives, will help BX finance deals. And, of course, the BAC/CFC afternoon news was the M&A speculation of the day.

Various company spokespersons were quoted today, saying that their companies or sectors wouldn't be adversely impacted by a slowdown. Verizon's (VZ) COO Strigl said that VZ will see only a minimal impact from a slowing economy. Bad debt in consumer business has increased only slightly, Strigl noted, contradicting the warning of consumer weakness that AT&T's CEO issued earlier in the week.

Tomorrow's Economic and Earnings Releases

Tomorrow's releases begin with November's International Trade figures and December's update on Import and Export Prices, both released pre-market. Market watchers believe the trade deficit may have widened to $58.6 billion from the previous $57.8 billion. The ECRI Weekly Leading Index comes next, at 10:30, and December's Treasury Budget follows last, at 2:00 pm ET.

What about Tomorrow?

The daily and weekly charts viewed earlier in the article suggested that many indices were set to spring up at least to 10-sma tests if not to the midlines of their descending price channels. We know, however, from our longer-term views and Keltner charts that vulnerability to lower values exists and we have some idea where those vulnerabilities are. We know from our own experience of the markets in recent months that they're weak and that market participants--either shorts or longs--are easily shaken out in this environment. That sets up the potential for some wild action.

We also know that anyone who has hopes that our markets will avoid further steep declines will view this week's closes as pivotal. Will markets climb or even steady? Let's look at some short-term charts to see what they're showing.

The 7-minute charts have been better predictors of SPX action, but I know that many of you may not have the ability to view 7-minute charts. I'll stick with the 15-minute charts.

Annotated 15-Minute Chart of the SPX:

Nearest resistance is at 1428.27 on a 15-minute close. RSI is near neutral, not giving much of a prediction.

These Keltner lines are dynamic and will change after the first few minutes of trading. However, the SPX often climbs by bouncing from the 15-minute 9-ema on 15-minute closes and descends by getting knocked back from it on 15-minute closes. The aqua-colored line is the 120-ema, the basis line for these channels, with the short-term action bullish above it and bearish below it. Most people can put those two ema's on their chart to watch. That won't provide you with the targets, but it does provide with information that's useful.

A 15-minute close below the pink 45-ema sets a potential downside target of 1384, something bulls don't want to see happen. The vulnerability to 1370-1375 is visible on this short-term chart, too, in the form of that lower channel line, so those hoping for more gains don't want to see that 45-ema violated on a consistent 15-minute closing basis.

Annotated 15-Minute Chart of the Dow:

A bounce and consistent 15-minute closes above the black channel line early tomorrow morning sets up a potential upside target near 13089.

The vulnerability to lower prices, to 12569 and then 12436 is shown by the lower channel lines. Consistent closes beneath the pink 45-ema would set up a potential target at the lower black line.

Annotated 15-Minute Chart of the Nasdaq:

Annotated 15-Minute Chart of the RUT:

Fifteen-minute closes above about 720 keep that upside target in play, although 725-ish resistance must be faced. Bulls would want to see consistent 15-minute closes above and bounces from the 9-ema. Consistent 15-minute closes beneath the pink 45-ema set a new downside target near 697.

I was disappointed, however, when I viewed these 15-minute charts as a group. As I studied them, I saw that it would be all too easy for prices to roll back down through those 45-ema's and set up new downside targets, bringing those vulnerabilities back into play. The upside move appears more tentative than it looks on some daily charts.

Today is the Thursday before option expiration week. That's often been a day of crazy trading conditions, a day when a week's high or low is followed by a reversal into option expiration week. Just about the time we start noticing such a pattern, it changes, and it's possible that yesterday's drop was the low that will be reversed into next week. The TRAN's confirmed morning-star reversal signal suggests that as a possibility. Anyone who wants to see the values of pensions, IRA and 401K's maintained wants markets to steady and avert a deeper carnage.

The effort to reverse U.S. equities is certainly visible. The weakness and uncertainty in the markets is just as palpable.

We see the efforts the bulls are making, but markets can roll over again in a heartbeat. I have been expecting a relief rally. All chart signals say it's time for such a rally, and Wednesday's strong volume washed out at least some weak hands. However, in my opinion, that was not capitulation volume or stopping volume, as one source calls the kind of volume that's indicative of "the" market bottom. Maybe we had high enough volume yesterday to be indicative of a short-term or even intermediate-term bottom, but I keep speaking in terms of vulnerabilities and they're still very real.

So, what do I personally think? Bullish plays might be the best short-term choice right now, but I wouldn't trade them unless I were a trigger-happy cowboy or cowgirl type, and I'd keep my finger on the trigger, ready to get out at any moment. Protecting your profits is the most important task you have right now. I believe that what we're seeing now is likely to be just a relief rally and that more weakness exists in our future, but whether that weakness occurs after a few day's climb up to some 10-sma or November low or whether it occurs after prices scream higher all next week or even after months of chopping between support and resistance, I don't know.

Trade carefully and give careful consideration tonight to whether you really want to go home with a position over the weekend. Assess your risks and lighten them if they're too heavy. Are you long a bunch of stocks and does that worry you in this market environment? Do you want to take profits or collar them? If you don't know what a collar is, ask one of us or consult your broker.

If you're not sleeping well, your risks are either too heavy or you're not sure you trust yourself to pull that trigger and keep losses moderate. Neither is a good situation because each promotes emotional responses. This market is crazy enough and volatile enough to do the impossible, whatever it is that you think is impossible, so make plans to protect profits whenever you have them and keep losses as small as is possible. That goes to bears who might get stomped over in a short-covering rally as well as to bulls who might get chewed up in a steep decline.

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