Option Investor
Market Wrap

Raise Or Call

Printer friendly version

The bets have been placed and traders are now looking at the big dog at the table for a signs of a flinch. Will the Fed play out its bluff, check or raise the bet? Last week the odds of a 25-point cut were well over 300% and a 50-point cut right at 100%. With several positive economic points this week and numerous comments from CEOs that the U.S. is not headed for a recession the odds of a 50-point cut had fallen to about 74% intraday on Tuesday. There are actually many analysts suggesting that they may not cut at all. Given the uncertainty and the conflicting signals the continued market rally was amazing.

Dow Chart - Daily

Nasdaq Chart - Daily

The positive economics were led by the Durable Goods orders for December, which soared with a +5.2% jump. The consensus estimate was only for a gain of +1.6% and November orders were only +0.5%. This was a blowout report with gains strong across the board. Core Capital goods orders jumped +4.4% after declining for two months. Shipments rose +2% and backorders rose +2.5%. A 138% jump in military aircraft orders helped push the overall numbers higher. Nearly every category posted sharp gains. You would think these strong numbers would mean the economy was doing ok but we really need to see the ISM on Friday for a broader look at the manufacturing sector. Analysts are still expecting the ISM to post the seventh consecutive drop and the second month in contraction territory with estimates around 47.

The weekly Chain Store Sales Index number fell -1.2% to 482.6 and the lowest level since Dec-15th. This caused the ICSC to lower its projections for sales growth to flat or slightly negative for the month. Energy, both gasoline and home heating costs were blamed again as pressuring consumer budgets. The average gasoline price was $3.03 per gallon over this reporting period.


The Most Profitable 4 Letters in Trading

Master them with Hotstix QQQ Trader. We'll show you exactly when to buy and sell the QQQQ and turn you into a master trader who knows how to cut your losses, nail short term gains and rack up some incredible profits.

30-Day FREE Trial:


The last Consumer Confidence reading for January was 87.9 and only slightly below the 88.6 posted in the earlier reading. This was only 0.1 above the cycle low of 87.8 seen in November. The index component for those planning to buy a home remained at its cycle low of 2.5 and well below the double-digit levels seen in the boom. A key point for both consumer confidence and retail sales is the jobs report due out on Friday. As long as job growth continues even at a slower pace the level of confidence will probably hold at this level. Once the press starts shouting about job losses confidence will fall quickly.

News that will impact confidence was the S&P/Case-Shiller monthly home price index released today. Nationwide the 10-city composite index fell another 2.1% in November. Since the peak in prices the national average through November has declined -8.6%. Phoenix, San Diego, Miami, Tampa and Las Vegas have all declined more than 14% from their peaks. The homebuilders are rebounding like there was a bottom in prices but the Case-Shiller Index is not yet showing it. However, this index is a trailing number 90 days old when published.

Home Price Declines

On Wednesday the two major events are the Q4-GDP at 8:30 and the FOMC rate decision at 2:15. The Q4 GDP is expected to be in the 1% range and any positive number should not be a disaster. The FOMC announcement is going to be the key. I called it D-Day on Sunday and nothing has changed. However, there was a survey being discussed today that suggested the Fed would not cut rates after knowing about the SocGen futures dump and the rebound in the markets from last week's lows. That would be very ugly for the markets because they have priced in a full 50-point cut. Other analysts suggested that the Fed would go ahead and cut 25-points just to make it appear they were not fooled into cutting last week for the wrong reasons. Most analysts feel even a 25-point cut would be met with selling.

The earnings have been flying fast and furious and the majority of the guidance has been negative. I reported on this possibility over the last couple weeks. With all the recession worry it is a free guidance cut for firms reporting. With everyone lowering guidance just in case we do have a recession it gives them the possibility of beating that guidance if the recession does not appear or does not impact their specific sector. It is a win-win scenario and everybody is taking advantage of it.

Countrywide Financial (CFC) posted a $422 million loss or -79 cents per share in a quarter they had previously expected to post a gain. Analysts were expecting a loss of 32 cents. The $422 million loss was substantially less than the $1.2 billion loss in Q3. A Bank of America official said the loss was inline with their due-diligence and showed that the mortgage business was improving. The loss came from reclassifying some loans it held for investment as credit quality declined and from a $907 million loan loss reserve on loans in default. Countrywide said 34% of its subprime loans were in default and $2.9 billion in loans are now classified as non-performing. That means foreclosure is imminent. Countrywide said it had renegotiated 81,000 loans in 2007 to avoid a default. Currently it has $400 million in properties where foreclosure has already occurred. The company has $8.8 billion in cash and spent $84 million on advertising in Q4. Overall this was a positive earnings report and did not show deteriorating conditions but just further challenges that need to be handled.

In a surprising move bond insurer Ambac declared a quarterly dividend of 7 cents per share. Ambac (ABK) is possibly on the verge of going under and it still declared a dividend. That is serious chutzpa. Moody's has placed its AAA rating on "review for possible downgrade" and S&P placed it on "credit watch negative." Fitch already cut them to AA and has now put them on "rating watch negative." It is almost a sure bet ABK and MBI would already be several notches lower if it were not for New York regulator Eric Dinallo pleading on the rating agencies to hold off until he can somehow structure a bailout. He is trying to come up with $15 billion in emergency capital to keep them afloat. Numerous analysts feel he has no chance of pulling it off given the massive credit problems saying the move is simply too late in the game. If the rating agencies follow through on their downgrades it will be lights out for the firms. Shares of ABK and MBI continue to be buoyed on hopes a bailout materializes but the clock is ticking.

Another company shocking traders after the close was Lehman Brothers (LEH). Lehman raised its dividend 13% and said it authorized a stock buyback of 100 million shares. The buyback will cover nearly 20% of its outstanding shares. At today's closing price that equates to about $6.25 billion. This was a real shock since most financial companies are going out for additional capital and this combined move suggests Lehman is out of the woods and in very good financial condition. The announcement was late in the after hours session but shares gained $2 before the session ended.

Yahoo (YHOO) reported earnings after the bell and beat the street by 4 cents posting 15 cents instead of 11 but that was the end of the good news. Yahoo said it was going to take a charge of $20-$25 million to cover the 1000 layoffs Yahoo will make by mid-February. Yahoo guided lower for the current quarter and for the full year. YHOO fell -10% in after hours trading. Analysts felt Jerry Yang's broad-brush strokes and few details on how he is going to turn the company around suggested there was serious trouble still brewing. Yang said "we will continue to face headwinds in 2008 but should exit stronger and more competitive." Those were not very promising words.

Meanwhile Google lost $5 ahead of their earnings on Thursday. Google was the recipient of an upgrade and a price target of $755 but it did not help lift them off their $550 close. Google is expected to report a 40% increase in earnings and a 54% jump in profits. That translates to something around $4.44 per share and $3.44 billion in revenue. Google is somewhat recession proof because more than 50% of their earnings come from outside the States.

Valero (VLO) reported earnings of $1.02 per share that beat analyst estimates of 64 cents by a mile. Profits were down over the comparable quarter due to the higher price of crude but were still very strong. VLO earned $1.1 billion for the quarter. Revenue jumped to $28.7 billion, up from $18.8 billion in the same quarter last year. The decline in profits on a percentage basis came from shrinking margins as crude prices rose. The prices received for refined products did not rise as much as crude prices. Margins in Q4 were $9.91 per barrel compared to $11.53 in the comparison quarter. Valero will make a profit when other refiners won't because of their ability to process heavy/sour crude. Their investor relations contact told me several weeks ago that they normally process about one-third heavy crude, one-third medium crude and one-third sweet crude. This insures them the lowest input prices in the market place as the lower grades of crude sell for $8-$12 per barrel less than sweet crude. Valero refines 3.1 million barrels per day.

3M (MMM) beat the street by 2-cents and projected a 10% increase for all of 2008. The report was notable because they forecasted easing commodity prices ahead. 3M said copper and wood pulp should continue to decline but steel prices were still rising. "We see more tailwinds now in commodity purchasing than we do headwinds" according to CEO George Buckley. MMM closed positive for the day with a minor gain. They were one of the few companies that did not guide lower.

Baidu (BIDU) does not report earnings until Feb-13th but they are down -$60 over the last 3-days. Shares fell -$20 on Tuesday after Canaccord Adams slapped it with a sell rating and a $265 price target. After the loss BIDU closed at $270. The analyst was positive about its prospects for market share gains in the Chinese search market but said expenses were rising ahead of those future gains. Canaccord was also the company that upgraded Google with a $755 price target.

Polaris (PII) surprised analysts with a +16.4% jump in profits. Sales in Q4 were up +21%. They beat the street by 3 cents and guided slightly lower for 2008 but still projected sales gains. Polaris and Harley Davidson are seen as the canary in the coalmine in terms of consumer sales. As long as consumers are still buying high dollar toys we should not be in a recession. PII gained +82 cents for the day. Harley Davidson (HOG) posted disappointing earnings last week and was crushed by sellers. Sales fell -5.3% and inventory rose +22%. Harley tried to compensate for slower sales by raising prices and it bit them in the tail pipe.

EMC shares fell -6% on Tuesday despite posting better than expected earnings. EMC also guided above analyst estimates. The challenge for EMC was the earnings miss by VMware on Monday. VMW lost -$28 on Tuesday to close at $54.70 after predicting only 50% growth in 2008 compared to 88% in 2007. Expectations were off the charts and their guidance brought them back to earth with a hard landing.

SanDisk (SNDK) closed near its 52-week low at $25 after posting earnings that beat the street by a nickel. The problem was in the guidance. SanDisk projected Q1 revenue from $775-$875 million when analysts were expecting $1.1 billion. One analyst cut his target price by 50% saying the extreme oversupply of NAND chips was not easing.

Also after the close homebuilder Centex saying its loss widened citing fewer sales and falling prices. CTX posted a loss of $975 million from continuing operations or $7.94 per share compared to a loss of $242 million and $2.02 per share in the comparison quarter. The loss included $554 million in charges for land defaults. Revenue fell 30% to $1.91 billion and home sales fell -20% with an 11% drop in selling prices. Traders were not surprised and shares fell only a dollar in after hours.

Earnings for tomorrow include AMZN, BA, MO, MRK, UPS and SBUX.

Apple Inc (AAPL) rose +1.48 on a reiteration of a buy from Piper Jaffray and a price target of $250. Apple blog AppleInsider reported that Steve Jobs sent a memo to employees saying hang in there and they would recoup their losses in the stock.

Crude oil rose again to $91.65 at the close of regular trading and has continued to rise to $92.50 overnight as we approach the OPEC meeting on Friday. Crude was rising on thoughts that OPEC is not going to add to production and hopes the Fed would cut rates and help avoid a recession and drop in demand.

The markets have performed the obligatory pre-Fed ramp right to resistance as traders place their bets ahead of the announcement. There is almost no scenario that will guarantee a continued rally but then anything is possible. The Dow has risen right to resistance at 12500 and volume has dried up. Volume across all exchanges barely broke 7 billion shares both days this week. Traders are clearly waiting on the Fed and there is a tremendous potential for a disappointment. The Dow has support at 12150 and assuming the Fed at least cuts a quarter point that support should hold. The next material resistance is well above at 12900.

Dow Chart - 30 Min

Nasdaq Chart - 30 Min

The Nasdaq can't get any traction to move off support at 2325 and struggled to close positive today. Were it not for the +96 point Dow gain the Nasdaq would still be sitting on 2325. There was no buying interest and almost no volume. With Yahoo's earnings challenge after the close there will probably be less buying interest tomorrow. 2375 is resistance.

The Russell-2000 has risen exactly to resistance at 705 and like the other indexes did it on very light volume. The small caps are giving no indication that mutual funds are loading up prior to the Fed decision. It appears more likely that shorts are closing positions just in case buyers appear on the announcement.

Russell-2000 Chart - 30 Min

S&P-500 Chart - 30 Min

The S&P rose to a dead stop at just under 1365 and decent resistance. I was actually surprised to see it move this high after the Friday decline to 1330. I have to admit I was leaning to the downside over the weekend and I am amazed that traders still buy the ramp into Fed announcements. More often than not they produce a sell the news event. That event can happen on the announcement or the following day. We know the volatility is going to be huge and nobody knows where the market is going to be 48 hours later.

I am not going to recommend a bias today because the GDP and FOMC are two huge news events that can do strange things to market sentiment. There was an article on CNBC early Tuesday about short interest on the S&P being at a six-year high not seen since Jan-2002. While that should be an indicator of market sentiment it is also a powerful market mover to the upside should some event cause a sudden interest in buying. All that high short interest would need to be closed and the resulting short squeeze could be very strong. With financial stocks improving, as in Lehman's announcement, and the Fed trying to put a bottom under the housing sector, there is a good chance the lows are behind us. I don't want to recommend a bias before the FOMC announcement but after Friday's ISM and Jobs report I think we will be ready to go directional again.

Jim Brown

Market Wrap Archives