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After watching the Asian and European markets implode for two days we finally got our chance to show what we could do. The Dow plunged -464 at the open amid rampant pessimism and expectations for a repeat of the 1987 crash. The Nasdaq lost -118 before the short covering appeared. Compared to some of the Asian markets our drop was tame. Several of the Asian markets were down over 10% for the week at some point on Tuesday. A 10% drop on the Dow would have been more than 1000 points and knocked us back to Dow 11,000.

The Fed stopped the drop this morning by announcing a surprise 75-point rate cut taking the Fed Funds rate down to 3.5%. They also cut the discount rate by 75 points to 4.0%. This was the first intermeeting rate cut since 9/11 but I don't know how you could really call it a surprise. Traders expected a 50 point cut all last week. After the weekend implosion around the globe most thought 50 points would not cut it any more and it appears the Fed realized that more was needed if only for the sentiment effect. The Fed statement said it was "in view of a weakening of the economic outlook and increasing downside risk to growth." And, "broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets." The statement also said "appreciable downside risks to growth remain. The Fed will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks." This is Fedspeak for we will cut again if conditions continue to decline. The Fed Funds futures are pricing in another 25 points at the Jan-29th meeting and an 80% chance of another 50 point cut. The vote was not unanimous with William Poole voting against the rate cut saying conditions did not justify a cut before the regular meeting next week. This does not bode well for the chance of another cut next week.

There were economic reports this morning but they were ignored in light of the market turmoil. The Chicago Fed National Activity Index (CFNAI) fell to -0.91 in December. This was a multiyear low in contraction territory and activity continues to suggest the country moved very close to recessionary levels at the end of Q4.

The Richmond Fed Manufacturing Survey fell to a -8 in January. This was down from the -4 seen in December. Order backlogs actually improved slightly to -12 from -19 but shipments fell to -17 from -10. The six month outlook posted the biggest positive gain to 31 from December's 24. It is unknown why manufacturers feel better about conditions six months out but it is possible they are assuming the recession will be brief. Tomorrow will be light with only the Mortgage Applications and Oil inventories.

After the bell Apple and Texas Instruments reported earnings and traders were hoping a couple of good reports would be the boost needed to continue the market rebound on Wednesday. Apple (AAPL) posted earnings that soared +58% over the same quarter in 2006. Unfortunately those earnings were completely ignored after sales of iPods slowed to 22.1 million units compared to estimates of 24.7 million and Apple warned of drastically lowered profit expectations for the current quarter. Apple is normally conservative on their guidance but recession fears and slowing iPod sales evidently forced them to be more conservative than normal. Apple said they expected to earn 94 cents in Q1 compared to the Wall Street average estimate of $1.09. AAPL lost $20 in after hours trading to close at $138. That equates to a $14 billion drop in market cap lost after the close.

Apple Inc Chart - 90-min

Texas Instruments (TXN) reported earnings that rose +13% and said sales had reversed a yearlong decline. Earnings were 54 cents compared to estimates of 52 cents. TXN also guided slightly higher for Q1 to a range of 43-49 cents compared to analyst estimates of 45 cents. TXN said the company was well positioned if there is an economic slowdown and was pretty optimistic about future profitability. TXN rose a buck in after hours to close at $30.

Earnings due out tomorrow include EBAY, MOT, QCOM, SYMC, UTX, PFE, COF, ATI, EAT, COP, TER and about 120 others.

Research in Motion (RIMM) had rallied to a +1.50 gain in regular trading after a past downgrade over slowing sales was debunked by another firm saying channel checks show increasing sales instead. RIMM also showed off its BlackBerry enhancements at the Lotusphere 2008 event. Unfortunately RIMM was crushed after the close on the Apple news and gave up about $5 before buyers appeared.

Oil prices fell over the weekend on recession fears and profit taking to $86.11 before buyers rushed in to scoop up the bargains. Crude returned to trade back over $90 before the close. This was also the last day of trading for the February contract. The March contract became the current month and it was trading at $89 after the close. If a U.S. recession appears and the rest of the world catches it from us then oil demand and prices will decline for several months until the economic slump is over.

March Crude Chart - Daily

The global markets imploded over the long weekend. You already knew that unless you were camping out with polar bears and playing in the sub zero weather. With the Dow futures down -550 before the open there were fears we would follow some of the global indexes into oblivion. India's Sensex fell 11% on Tuesday before triggering circuit breakers in time for calmer heads to prevail. It finished well off its lows. The Australian market, the ASX 200, suffered its worst loss ever of -394 points or -7% with more than $95 billion evaporating from investor accounts. The Nikkei fell -752 points, Shanghai -354 and the Hang Seng lost -2061 points. Those were single day drops!

Fear was rampant before the open of the U.S. markets. Those trading on margin were in terror of major gap down open wiping out their accounts. Fortunately the Fed came to the market's rescue but that may only be a temporary Band-Aid on the problem. The Apple warning tanked the U.S. futures but the Asian markets still appear poised to open higher. That would be a good sign given their very oversold conditions but there are still serious concerns plaguing the market.

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The panic produced a serious dip but in retrospect it was less than two days of the intraday ranges we have been seeing for 2008. The Fed rate cut caused some instant short covering and that took us to 11:AM and then the music died. All the major indexes returned to initial resistance and stopped dead in their tracks. There was no follow on buying and there was no additional short covering after the 11:AM stall. In fact every weak attempt to move above that 11:AM level was met with additional selling as bears reloaded their shorts.

The three sectors performing the best on Tuesday were finance, retail and homebuilders. Those were exactly the three sectors with the highest short interest. Banks and homebuilders stand to gain the most from an accelerated Fed rate cut scenario. Financials make more money when rates are cheaper and they are directly responsive to the Fed moves. Homebuilders will find more buyers if mortgage rates continue to fall and that could not have come at a better time ahead of the spring selling season. Retailers have been hammered on worries over shrinking consumer cash. The Fed move provided a sentiment lift for consumers even though the rate cut would have little if anything in the form of help for consumers. All three sectors were up on short covering not because conditions suddenly changed.

If you look at the market internals it is not a pretty picture or a picture that suggests we are going to rocket off of Tuesday's low for a week long rally. If you look at the new 52-week lows that is the highest level since 1998. That volume number is also a record level. If the markets had recovered all their losses and posted gains for the day with increasing buying all afternoon I might have a different opinion.

Internal Snapshot

I believe the Apple earnings guidance is a clear indication that the next three weeks is going to be ugly. The vast majority of earnings reports are still ahead and I think we can expect weak guidance from nearly every report. It's a recession stupid! Every company will guide lower just in case the recession does appear. Earnings estimates are going to fall and every report is going to further sour investor sentiment.

According to late reports it still appears the overseas markets are going to open big but that does not mean the gains will hold. Just like our market saw short covering at the open on the Fed cut the overseas markets are going to spike on follow through to our minimal losses. The key to Wednesday's trading is whether the global markets hold their gains. If they do post significant rebounds then the U.S. markets could continue higher. Unfortunately it may be just a bear marker rally. Nothing fundamental has changed and the technicals still look terrible.

The Dow fell to 11634 intraday crushing the support at 12000. Before day's end it recovered to close at 11971 and nearly recovering that support level. This is not strong support and all the longer term technical indicators are suggesting we will eventually see a retest of the July-2006 lows at 10750. In every bear market there are many rebounds from oversold conditions but they eventually fail. Until the fundamentals of the market and the economy recover and sentiment improves I think we should be skeptical of any bounce.

Dow Chart - Daily

The Nasdaq support at 2340 failed and unlike the Dow the Nasdaq failed to return anywhere near that support. With the Apple profit warning and falling iPod sales that suggests tech earnings guidance is going to be a three-week plague for the tech index. I would not be a buyer here until we are back over 2340 or manage a successful retest of 2000.

Nasdaq Chart - Daily

S&P-500 Chart - Daily

The S&P-500 chart is similar to the Dow except the S&P has already violated the March-07 lows and appears headed straight down to a retest of 1225. The financial stocks may be 21% of the S&P but they were unable to push it back to positive territory despite the strong short covering in those stocks.

I left you on Sunday with a recommendation that we watch Russell 675 as the key level for deciding to be long or short. The Russell fell 25 points to 650 intraday BUT returned to 675 and ONLY a -1.61 loss for the day. I would like to think that fund managers suddenly decided to buy small caps on the dip but I think it was more a case of small caps being the most heavily shorted. Some of those shorts covered but others reloaded at 675.

Note in the chart above that Russell 675 is strong resistance and every attempt to move higher was immediately hit by strong selling. For the rest of the week I would recommend we continue to watch the 675 level as our long/short indicator. To avoid having to make that decision 2-3 times per day I will suggest we remain short under 670 and long over 680. That gives the warriors 10 points to battle for control. Once a winner breaks out of that range we will hop on for a ride.

This may not be a market where everyone should be invested. If this kind of volatility makes you seasick then stay on shore until the waves subside. The Volatility Index (VIX) spiked to 37 on Tuesday and the same level we saw at the August bottom. Some are calling Tuesday a bottom because of the VIX spike. I remain doubtful and remind everyone that it can go higher and in bear markets it normally does. In the major averages look for a retest of the Tuesday lows and a failure there means the Fed rate cut band-aid has failed. It does not mean it will not be effective long term but only the sentiment bounce has been over powered by negative news.

Jim Brown
 

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