Option Investor
Market Wrap

Caught in the Vortex

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If you enjoyed trading the last two days, I've got a vacation suggestion for you and your family, the Howlin' Tornado at the Grapevine, Texas location of the Great Wolf Lodge. This ride washes rafts out into a huge funnel-shaped enclosure, swinging them from one side to the other of the funnel before slinging them into the downspout.

I'm not associated with the Great Wolf Lodges and have never visited that resort, but I think I know how the riders must feel. Trading since the FOMC announcement has felt like being caught in that ride: helplessly washed from one side of the vortex to another, trying to hang on, screaming all the way. MBIA's (MBI) earnings and a couple of economic reports provided the screams. Reassurances by MBI executives about the company's position and New York Governor Spritzer that progress was being made on a plan to help the bond insurers added the thrills. Unfortunately, no one is sure yet where that vortex is going to set us down.

Let's look at charts. Feel free to use your imagination and experience that ride vicariously whenever you feel you might be going to sleep. You just might be about to be washed out into that vortex with your positions.


I decided to show a weekly rather than a daily chart of the SPX so we could gain a more balanced outlook. This vortex has been scary so far, but what's really happened?

Annotated Weekly Chart of the SPX:

The daily Keltner chart, not shown, predicts that as long as the SPX maintains daily closes above the rising 9-ema, now at 1359.57, it sets a potential upside target at 1399.33, but it's a long way down all the way to 1359.57 and a daily close below it before we know that potential upside target is erased.

Annotated Daily Chart of the Dow:

The daily Keltner chart suggests that as long as the Dow is producing daily closes above the 9-ema, now at 12,441, it maintains a potential upside target near 12791-12846. Again, as with the SPX, it's a long way down to a daily close beneath that rising 9-ema, though, and you might want closer stops than that.

Annotated Daily Chart of the Nasdaq:

On the daily Keltner chart, not shown, the Nasdaq has met its current upside target. It would need sustained daily closes above 2400 to set a new one. For now, bulls want to see sustained daily closes above the 9-ema, now at 2366.

Annotated Daily Chart of the SOX:

Annotated Weekly Chart of the RUT:

Annotated Daily Chart of the TRAN:

Today's Developments

Today's releases proved numerous, so I'm going to cover them as briefly as possible. In some instances, I'll provide links to the government or other sites, so that subscribers who wish to delve deeper into the reports can do so.

The day's releases began with the Monster's January Employment Index. The index fell nine points, the third straight month of declines. Year over year, the index has declined nearly five percent. Twenty out of 23 occupational categories declined. Monster pegged January's decline on a combination of seasonal trends and further slowing in the U.S. economy.

Other highlights from the report detail the sectors that eased. Those included the financial, retail and sales, and leisure and hospitality sectors. Monster pointed to sharp declines in the arts, entertainment, and recreation and accommodation and food services as showing lower household spending and consumer confidence.

The healthcare sector showed the strongest growth. Among industries, the mining industry was the only category to show increases. The West South Region was the region showing the strongest year-over-year growth.

That report was followed by the Weekly Initial and Continuing Claims and the 2007 fourth-quarter's Employment Cost Index. If the Labor Department's weekly initial and continuing claims proved reassuring last week, they were anything but reassuring this week, and they slung equity futures around a bit in that vortex. Initial claims rose sharply to 375,000, jumping by 69,000. However, balancing this rise was the puzzling decline by 51,000 in initial claims that had been seen in the late December period. Also, the Labor Department pegged the jump on adjustments made due to the Martin Luther King holiday. The four-week moving average, considered a much better barometer, rose 10,250 to 325,750.

Market participants weren't interested in balance or reading details, however, particularly with the tomorrow's important Employment Report looming. Equity futures weakened as the report was released. Continuing claims rose 47,000 to 2.72 million. The four-week moving average of those claims dropped, however, by 9,500 to 2.71 million.

In a separate release, the Labor Department reported that the employment costs index (ECI) rose 0.8 percent in the fourth quarter. This was in line with expectations. The full-year 2007 increase in employment costs was 3.3 percent, equal to the 2006 increase. Wages rose 3.4 percent for the full year, more than 2005's 3.2 percent rise.

A study of the components showed wage costs increasing 0.8 percent, with that rise equal to that seen in the last three quarters. Benefit costs rose 0.9 percent.

The ECI is rumored to be important to the Fed as the FOMC seeks to balance inflation pressures against downside risks from the economy. This number did not go the way that market watchers would have preferred, increasing worry that the Fed would have difficulty continuing the rate-cutting trend.

Other departments were busy with releases today, too. The Bureau of Economic Analysis presented its reports on December's Personal Income and Personal Spending. Personal Income rose 0.5 percent while Personal Spending climbed 0.2 percent. Prior rises had been 0.4 percent and 1.0 percent, respectively. Expectations were for 0.4 percent and 0.1 percent increases.

Core personal consumption expenditures (PCE) rose 0.2 percent, with the number at 2.2 percent for the past twelve months. December's number was in line with expectations and prior numbers, but that keeps the number for the past twelve months above the Fed's perceived comfort zone. In addition, some economists feel that the real income is too low to sustain spending. Those who would like to read today's Bureau of Economic Analysis' complete reports can find them at this link.

January's National Association of Purchasing Management-New York (NAPM NY) was the next on the slate of economic events for the day. The association headlined its report with the words "Activity Down, Pessimism Up." The Current Business Conditions component dropped to 47.9, below the benchmark 50. The Six-Month outlook fell to 44.2. NAPM-NY termed this the lowest that outlook component had been since November 2005. Prices Paid and Quantity of Purchases indices fell. The association said companies participating in the survey blamed concerns about recession, drops in consumer discretionary spending and market downturns, among other causes. Those who would like to read the report in its entirety can find it at this link.

Chicago's PMI, the report on manufacturing from the NAPM-Chicago, stood at 51.5 for January. This was well below the prior 56.4 and also below the forecast 52.0-52.5. The January number sank to just above the 50 that benchmarks the difference between and expanding and contracting environment. The New Orders index plummeted to 44.7 from its prior 56.7. This dropped the index into levels not seen since the spring of 2003. The Prices Paid index jumped to 81.7 from the prior 67.4. This district's report is considered predictive of the ISM, and it wasn't predicting good things. Those who would like a more detailed view of the report can locate it at this link.

The less-watched Kansas Fed Manufacturing Survey also showed an easing in expectations for future factory output coupled with rising price indices. The report mentioned a "large jump in raw materials prices for food, chemical, and machinery producers."

The Department of Energy released natural gas inventories today. Those inventories dropped by 274 billion cubic feet, more than the 260 bcf's that were expected.

Information relating to the housing industry was also released. Freddie Mac's weekly survey on mortgages revealed that rates rose last week in concert with the rise in yields on treasuries. A 33-year fixed-rate mortgage averaged 5.68 percent, up from the previous week's 5.48 percent, but still well below the year-ago level of 6.34 percent. Freddie Mac's chief economist noted that a rate cut such as those provided last week and this week sometimes don't immediately impact long-term rates.

Today, in testimony before Congress, the FDIC's Chairman Sheila Blair warned that the mortgage industry needed to move faster to modify loans in risk of default. She also warned that credit problems were expanding beyond the subprime sector, saying that a better solution for both homeowners and lenders might be to forgive part of the debt.

The Federal Reserve released its weekly figures on outstanding commercial paper, an important gauge of whether companies are able to place commercial paper to fund their operations and development plans. If you're not familiar with the number, the current climate dictates that we want to see increases in outstanding commercial paper, suggesting that companies were successful in obtaining funds this way. Seasonally adjusted, outstanding commercial paper increased $4.1 billion last week. Seasonally adjusted, the non-financial foreign paper was flat and asset-backed paper dropped $1.1 billion, but all other categories rose. Not seasonally adjusted, it fell $0.6 billion.


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In the weekend Wrap, December's Semiconductor Billings was listed as being due today, but that number had not been released as this report was edited and submitted and my information suggested that it was actually released January 17. December's Book-to-Bill ratio rose to 0.89 from the previous November final number of 0.82. That means that, over a three-month average, "$89 worth of orders were received for every $100 of product billed for the month," according to the North American Semiconductor Equipment Industry press release.

As numerous as the various economic reports might have been, MBIA's (MBI) earnings report perhaps proved even more important. Although much of the early morning weakness was blamed on the sharp increase in initial jobless claims, shock over MBI's headline numbers must be assigned some responsibility, too. The company will take $3.5 billion in write downs, resulting in a $2.3 billion fourth-quarter loss. That's a loss of $18.61 per share. I kept checking that number to make sure it was right, going to several sources. It seemed that it must have been off by a decimal place, but all sources listed the same thing.

The write downs mainly resulted from a devaluation of CDOs or collateralized debt obligations. Rising delinquencies and defaults led to further write downs, including $100 million placed in reserve against potential future losses. Analysts had forecast a loss of $2.97 per share.

The MBI chairman and chief executive officer and its chief financial officer attempted to clarify the company's position. The CEO pointed out that the successful conclusion to its capital plan will more than offset the effect of the write downs on the company's capital position. He reportedly has said that MBI will be able to meet all requirements to maintain its AAA rating. The CFO asserted that the company could cover its needs for a two-year period with the cash on its balance sheet.

As most market participants know by now, the company is scrambling to maintain its AAA rating, with both Moody's Investors Service and Standards & Poor's already reviewing its ratings along with those of other bond insurers and Fitch Ratings already cutting FGIC Corp's rating yesterday. As Jim Brown has detailed in other Wraps, MBI's failure to maintain that rating would result in cascading difficulties for banks and other entities, including municipalities whose bonds companies such as MBI have insured.

In the afternoon, a Reuters report reported that the Federal Reserve Bank of New York's president, Timothy Geithner, was closely watching the efforts to formulate a rescue package for bond insurers AMBAC Financial Group and MBIA Inc. His efforts should not be construed as interference with or participation in the New York Insurance Department's efforts to formulate the rescue plan, articles asserted. Those efforts are led by New York State Insurance Superintendent Eric Dinallo.

Although MBI initially dipped to a new week's low, it didn't stay there. It climbed through most of the day, closing at $15.17, just off the $15.87 high.

Other reporting companies included Bristol-Myers (BMY), MasterCard (MA) and Procter & Gamble (PG). All companies were deemed as beating expectations in various articles.

In addition to economic and earnings reports, some attention focused on the progress of the stimulus package. The Senate Finance Committee has reportedly made some changes in the House's version, changes that some economists worry will stall the progress. Those changes reportedly include raising the maximum income individuals or couples can earn and still qualify for the rebate and lowering the rebates.

After hours, Google (GOOG) reported. Fourth-quarter profit rose 17 percent and revenue climbed 51 percent, but its results were deemed disappointing. Earnings of $4.43 a share were below the expected $4.44 a share, and net revenue of $3.39 billion was below expectations of $3.45 billion. Google reported that it had hired 889 new employees in the fourth quarter, down from the 2,000 new hires in the third quarter. Although the pace slowed, some remain concerned about the hiring pace. Also of concern was a note from analysts with Stifel Nicolaus suggesting that the European Commission will file a statement of objection to Google's intended acquisition of DoubleClick. As I type, GOOG trades at 526.96, down significantly from its 564.30 close, but that can change by the next day's open.

Currently, Google is believed to be bidding in a government auction for the "C block" of the nationwide wireless spectrum. Today, the bidding reached a $4.6 billion minimum needed for open-access rules to be applied to that chunk, a move Google wanted. All bidding is anonymous, so it's not known for certain that Google is involved in the bidding, but the size of the block and its cost make it likely that only large corporations such as Google, Verizon or AT&T would be bidding.

Tomorrow's Economic and Earnings Releases

Tomorrow's January Employment report, also variously known as the Unemployment report and the NonFarm Payrolls report, will prove important. It will be released at 8:30 am ET. Wednesday's ADP report suggested that the current estimate of 57,500 will be too low, but the ADP number has proven wrong in the past and today's initial claims number questioned the strength shown in the ADP report.

Some presume that the FOMC had this NonFarm Payrolls information at hand when making its decision on Wednesday. However, I caught a discussion on television this week in which a former FOMC member avowed that only the chairman was given prior information, and only at 4:00 pm ET the day previous to the announcement. He suggested that the Fed would not have had tomorrow's numbers but would have the ADP's Wednesday release, of course.

December's Construction Spending, January's Consumer Sentiment and January's ISM will all be released at 10:00 am ET. January's ISM may be the most watched of the three, although I still believe consumer sentiment and spending figures will gain prominence as we worry about recession.

The expectation for the ISM is for an easing to 47.0 from the previous 47.7. A big surprise either direction could impact markets, so plan your early trades accordingly.

The ECRI Weekly Leading Index should be released at 10:30 am ET.

What about Tomorrow?

Annotated 15-Minute Chart of the SPX:

If the SPX should gap higher tomorrow morning, know in advance how you'll treat a test of the upper channel resistance. As should be obvious by now to anyone not rendered unconscious over recent weeks, pullbacks can be sharp and can come out of nowhere. If you don't have a plan in mind, you may be too late.

Annotated 15-Minute Chart of the Dow:

Annotated 15-Minute Chart of the Nasdaq:

Annotated 15-Minute Chart of the RUT:

When you're drawn into a vortex or hop on a ride like that Howlin' Tornado in Grapevine, it's silly to predict the last direction you'll take before you're deposited on the ground again. Similarly, it's silly to make too many predictions about what's going to happen next in the markets. That's what's being sorted out, and these volatility-powered swings indicate that everyone is trying to figure it out with a lot of emotion-based trading going on while they do. For now, I would always remain aware that another big swing might come at any time, particularly another big swing to the downside. I absolutely would not go into the weekend this weekend with more risk in my portfolio than I was able to comfortably endure, either to the upside or the downside. Study charts and determine likely support or resistance levels and have a plan in place before those levels are touched. Sometimes you have seconds to exit or enter a position before the move begins and begins sharply.

My opinion? I believe that markets are trying to chop their way a bit higher before they roll over again, but I do believe they will roll down again. I'll be waiting if they do, to see how far they go and whether the downside momentum has waned. I felt fairly confident today that the SPX was perhaps just undergoing a 10-sma test and that it might close back above it by the day's end, but I have no confidence at all that there won't eventually be a deeper thrust down. When will it come? That's the thing about bear flags and amusement park rides. You just never know.

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