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Market Wrap

Confidence Crashes, Market Rallies

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Consumer confidence fell to a 5-year low of 75 in February for a -12.3 point drop from the January level of 87.3. The prior low was 61.4 set on a 2-month drop in March 2003 when the U.S. invaded Iraq. In that period confidence fell from 80 to 61.4 and back to 81 over a 2-month period. Excluding that invasion dip you have to go back to November 1993 to find a lower level for consumer confidence. The expectations component for February fell to 57.9, a drop of 12 points and to a level below the 2003 invasion dip. The present conditions component dropped 14 points to 100.6 for the largest component drop. Deterioration occurred in every component and every category. Gasoline prices, rising employment, falling home prices, continued recession talk and the drop in the equities were given as the reasons. With confidence numbers at 15-year lows the odds are good this is impacting consumer buying trends and this will increase the chances of a recession. This could be a self-fulfilling prophecy where worry over a potential recession actually creates that recession.

Consumer Confidence Chart

Consumers who own homes have more to be worried about if the S&P/Case-Shiller Monthly Home Price Index released today is any indication. Home prices in the 20-city index fell another 2.2% in December pushing the year to date drop in prices to -9.8%. Prices fell in all 20 cities and the rate of decline accelerated in many. This is the largest decline in the 20-year history of the index. It should also be noted that December is the worst month of the year for home sales and those desperate to escape the pressure of escalating mortgages probably depressed prices with panic sales. January may provide us with signs of a bottom but that would be pure speculation today. Realtors are reporting a dramatic uptick in shoppers in February and that should result in price stabilization. Continued rate cuts by the Fed should continue to rejuvenate the housing sector as the buying season gets underway.

S&P/Case-Shiller Home Price Index

Producer Prices as shown in the Producer Price Index (PPI) headline number rose +1.0% in January and more than double what economists were expecting. The inflation spike pushed the trailing twelve-month number to 7.7% and the fastest rise since 1981. Finished crude goods, those with an energy component, rose +4.0% for the month and 24% for the trailing twelve months. These numbers represent an extremely large amount of inflation in the manufacturing pipeline and a threat to the economy. However, if recessionary actions like those seen in the consumer confidence depress buying the producers will not be able to pass these increasing cost through to the consumers. Prices will fall as excess supply competes for available purchasers. At least that is the theory and exactly what the Fed has been hoping for in their latest speeches.

On the positive side of the economic ledger was the Richmond Fed Manufacturing Survey. The index remained in contraction territory with a headline reading of -5 but there were positive changes in the components. The headline number itself was slightly improved from the -8 low in January. Shipments showed the most improvement from -17 to only -4. New orders declined only slightly to -5 from -3. One component that weakened considerably was order backlogs, which fell to -21 from -12. This was the third consecutive month for the headline number to be in contraction territory but it was not as negative as many expected.

For the rest of the week the GDP revision on Thursday and the PMI on Friday are the key reports. Another potential problem will be the Bernanke testimony on both Wednesday and Thursday. With the inflation numbers spiking Bernanke could make some comments about shifting the Fed's focus to inflation rather than growth and the market would not react favorably to any changes in the Fed posture.

Fed Vice Chairman Donald Kohn made some comments today that dampened the markets fear of inflation and fear of the Bernanke testimony. Kohn said he remained open to further rate cuts but admitted high food and energy prices might be passing through to core inflation. Gee, thanks for the heads up Don. He said the recent cuts might not prevent a period of continued economic weakness due to the lag time for changes in monetary policy to impact the economy. Kohn said it was essential for the Fed to take into account the possibility of unfavorable developments as a result of policy changes. The balance of the speech favored a rate cut bias but there were plenty of qualifications that would let the Fed out of the rate trap at the March 18th meeting. Dallas Fed president Richard Fisher was also in the headlines today cautioning again that the inflation was a rising concern. He joins Richmond Fed president Jeffrey Lacker in the inflation hawk camp and both will probably vote against a rate cut in March. Their votes are not enough to prevent a cut but the rising urgency in their voices could begin to sway other Fed voters.


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The signs are growing for another bout of stagflation and Bernanke is sure to be questioned about it at his testimony this week. When slowing growth is accompanied by rising inflation consumers cut back on spending, businesses cut back on expansion and slash costs and the cycle produces a feedback loop that stifles the economy. So far employment is still stable at 4.9% and well off the 8.5% we saw in the early 1980s when we had the last bout of serious stagflation. Inflation rates were also well into the double digits and more than double our rates today. This may be a serious dip in our current economy but it is nowhere near the problems in the late 70s and early 80s. The Fed can still focus on growth while keeping a watchful eye on inflation. As I have said before all they need to do is slash rates quickly to revitalize the housing market and let everyone escape the mortgage reset squeeze. That would solve the home price problem, credit problem and subprime problem over a 6-9 month window. Then they could reverse the process once the crisis eased. The current crisis was created when rates were 1% for a long time after 9/11 and the housing bubble expanded out of control. They can fix it by cutting rates to relieve the immediate pressure and then go back to rate hikes as usual in 2009.

The market rally today can be credited to Dow component IBM. They surprised the market at 11:AM with a new $15 billion stock buyback and raised full year guidance to more than $8.25 per share. IBM spiked +4.30 on the news and that equates to about 35 Dow points. IBM bought back $18.8 billion in shares in 2007 and they expect to spend $12 billion of their new $15 billion allotment in 2008. IBM stock buybacks are expected to continue after they projected earnings in 2010 to be as much as $11. The buyback energized traders since it suggests IBM feels their stock is undervalued.

Google (GOOG) needed to make some announcement to prop up its stock price. Google was down over $40 intraday after Internet traffic checker ComScore Inc said paid clicks were down -7% in January. Google had 532 million paid clicks in the U.S. in January and that represented a -12% drop sequentially. That rate was flat from 2007 and suggested the paid click business was declining despite increasing use of the Internet. Search volume rose +39% year over year but paid clicks declined. UBS and the Bank of Montreal cut their price targets on Google from $690 to $590 with Google now trading at $463. That is well off the $747 high back in November. Maybe Google should spend more time trying to improve their Internet business and less time trying to buy up all the solar panels and wind farms in California and land a new robotic rover on the moon.

Google Chart - Daily

Home Depot (HD) said earnings could fall -24% in 2008 as the housing slump continues. Home Depot reported earnings that missed estimates and posted its first ever annual sales decline. Net income fell to 40 cents per share from 46% in the comparison quarter. Rival Lowe's (LOW) reported a 33% drop in Q4 profits and same store sales fell -7.6%.

Starbucks (SBUX) said 7,000 stores would be closed at 5:30 PM today for three hours of employee training. They are reportedly training employees to make the world's best espresso in an effort to recover some of their falling market share and revitalize the menu. In reality it was just a big publicity stunt. Announcing a new espresso formula would not have qualified as need to know news all across America. However, announcing you are closing 7,000 stores for three hours got the event reported on CNBC, FOX, CNN and the local news channels. Not a bad idea but it remains to be seen if it will help their falling sales. Meanwhile Dunkin Donuts captured some of the news value by announcing they would offer 99-cent latts on Tuesday afternoon to compensate for the Starbucks training shutdown.

On Friday CNBC rocked the markets when they aired a report by Charlie Gasparino that a bailout was imminent for bond insurer Ambac (ABK). Shorts in financial stocks rushed to cover and the Dow rebounded over 200 points in the last 30 minutes. CNBC advertised its market moving story over and over. Today they tried to do it again. They aired another "breaking news alert" at 3:30 with Gasparino supposedly reporting breaking news that the Ambac bailout was done and being reviewed by the rating agencies before being announced to the public. Every 2-3 minutes during/after the alert the personalities continued to report the spike in Ambac and the market despite the market declining into the close. It was a failed attempt to manipulate the market and hopefully somebody in an enforcement capacity was watching.

A few minutes after the close they aired an interview with the new MBIA CEO Joseph Brown. I actually thought that interview was credible. Had they done that one 30 min before the close they could have gotten their market moving event without a complicated setup and phony news. The MBIA CEO was extremely frank and positive on the outlook for MBIA. Reportedly they will not need to raise any more capital. The $3 billion they already raised along with $2 billion in cost savings, dividend cuts and the shutdown of some divisions would be more than they need to continue business as usual. Brown said MBIA did not have to do any business over the next year and still would have plenty of capital to pay all expected worst-case claims. He answered all the sharply pointed questions being fired his way and never wavered in his statement. I believed him and I believe MBIA (MBI) may be a decent buy today. If he was shading the facts or outright lying then the SEC now has plenty of evidence to hang him. If Ambac really does announce a deal this week then the sector could find a lot of buyers very quickly. Moody's and S&P reaffirmed MBIA's AAA rating today. Fitch also has an AAA rating on MBIA. S&P did keep MBIA on negative watch until they know how the rest of 2008 is going to shape up but should the housing market find a bottom the subprime exposure will decrease.

The Ambac deal reportedly being pitched to the rating agencies contains capital infusions and a line of credit from a consortium of banks trying to save their AAAsses. They know if Ambac loses its AAA rating those same banks will lose tens of billions in additional write-downs. What was new today was news that there were some banks without exposure to Ambac willing to put up capital along with some private equity firms. If these companies without exposure are willing to invest capital then there may be light at the end of the Ambac tunnel. That would be very market positive if it comes true.

Oil closed up +1.68 at $100.88 and gold returned to test resistance at $950. Unfortunately both of these were due to the 1% drop in the U.S. dollar to its LIFETIME lows against a basket of other currencies. The close at 74.75 was due to the increasingly negative inflation/recession news and expectations that the Fed will cut rates again.

U.S. Dollar Chart

The markets closed today with their best 3-day rally in 2008. It has been a combination of short covering due to the improving MBIA/Ambac saga and short covering ahead of the Bernanke testimony. Dow component IBM provided additional market fuel with their announcement and managed to return the Dow to initial resistance at 12,700. Since the 3:PM low on Friday of 12,155 to today's high at 12,734 the Dow had gained nearly 600 points. That is not a bad 3-day run but now all the good news is potentially priced into the market. Traders are counting on a positive announcement on the bond insurers and positive rate cut words from Bernanke. Should either of those fail to appear or even worse turn negative that 600 points could be erased even quicker than it was gained. Bernanke's Wednesday testimony at 10:AM is going to be the biggest hurdle the bulls have to cross to keep the rally alive. With the Dow holding just below resistance it may take more than a veiled reference to future rate cuts to power it higher.

Dow Chart - Daily

Nasdaq Chart - Daily

The Nasdaq gained nearly 100 points from Friday's low but continued declines from several of the big caps is a huge weight on the index. The Nasdaq chart is the weakest of the three major indexes and if not for the help to techs from IBM's guidance upgrade the Nasdaq could have finished the day in the cellar. It is trading at the upper end of its range but without any material investor conviction.

The S&P actually broke over initial resistance at 1365 but then stalled at 1385 and a level that has been a curse many times in the past. This is just below the late January highs and a level that could be tough to cross without any new motivating event. The rebound in the financials is the powering force behind the spike with financials 21% of the S&P-500 index. Negative news from the Ambac deal discussions or Bernanke comments could tank those financials and the index on a moments notice.

S&P-500 Chart - Daily

The Russell also returned to resistance at the top of its recent range and the +40 point 3-day run was impressive. It remains to be seen if that resistance at just over 720 can be broken without some new confidence-building event.

On Sunday I suggested watching S&P 1365 as key resistance and a breakout over 1395 as confirmation any rally had legs. The 1365 resistance level was broken on the IBM news today but the close at 1381 is well below that key resistance high from Feb-1st at 1395. I would continue to watch those levels as key indications of market direction.

Jim Brown


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