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Warnings, Rumors and Fed Heads

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What a day for market moving events. We had profit warnings by companies like Intel and Staples, conflicting comments by a handful of Fed heads and our daily Ambac rumor. Shorts were celebrating in the morning as Bernanke suggested mortgage holders cut principle on mortgage loans and Intel soured the semis with a bearish outlook. By 2:30 those same shorts were on the run again after the afternoon Ambac rumor hit the wires. The Dow rebounded from its -220 lows to close down only -45 after the Ambac rumor was squashed just before the close. What a day!

Dow Chart - Daily

Fortunately there were no material economic reports to further complicate the picture. Wednesday has a full calendar with the Challenger Employment report, Productivity, Factory Orders, ISM Services and the Fed Beige Book. The big report is still the Non-Farm payrolls on Friday. We already saw the ISM fall back to contraction territory at 48.3 on Monday and the reports for the rest of the week are expected to be more of the same. The employment component for the ISM at 46.0 was not as weak as many had feared and that took some of the bearishness out of the expectations for the payroll report on Friday. The official estimates are still holding for a gain of 25,000 jobs but the whisper numbers are still in negative territory.

The big shocker in the economic realm this morning was a speech by Ben Bernanke. In the speech he suggested mortgage holders reduce the principal on loans to keep homeowners from letting them foreclose. I was astounded he would suggest this and there was an audible rumble of dissent from the bankers in the room when he said it. The idea is to give the homeowner an incentive with the lower loan balance to remain in the home and hope to have some equity when they finally sell it. If you are a mortgage banker the concept of cutting the principal 10%, say from $200,000 to $180,000 on a loan in trouble is nearly unthinkable. The drop in mortgage payments would be minimal and would do little towards actually letting the homeowner off the hook. Secondly it would limit the banks eventual recovery if the loan finally went into foreclosure. Banks are open to cutting interest rates to the bone or doing payment workout promotions to give the homeowner breathing room but receiving less interest is significantly different than cutting principle. The first option simply means less revenue and a potentially longer payout. The second option to cut principle is an immediate loss on their balance sheet and does little to solve the problem. I think Bernanke hurt his credibility significantly with the suggestion. This comment may come back to haunt him for years to come. Mortgage bankers fired back saying writing down the initial loan amount may help now but it would set a precedent if the value of homes continued to fall and balances went underwater again. Are we going to be forced to write the loan down again? Bankers would rather take their lumps up front if it goes into foreclosure and let PMI make up the difference. Arbitrarily cutting the loan balance would probably not be covered by PMI.

This same option was floated last month by the Office of Thrift Supervision with a suggestion that banks receive a warrant for the amount of the reduction. That warrant could only be exercised if the house eventually sold for more than the value when the balance was cut. That is even more unwieldy since the homeowner would actually not receive any benefit if the house value went up. The bank still gets the money and the homeowner gets only a minor break on the payment.
Fed Governor Frederic Mishkin sent a strong signal to the markets suggesting that Fed officials are poised to cut rates even more because the economy still faces significant downside risks from housing and the labor markets. Mishkin gave some bleak assessments of the current economic direction saying falling housing prices would lead to further slowdowns in consumer spending. He said the FOMC would face serious challenges in handling the problem but they would act in a timely manner as needed to guard against downside economic risks. JP Morgan Economist Michael Feroli called Mishkin's housing assessment "almost unredeemably bleak. I think this is the most forceful argument that we've seen that the decline in housing prices can be self-feeding," Feroli said. Mishkin was very optimistic on inflation saying, "inflation should wane over the next few years, as product and labor markets soften and the rise in food and energy prices abates"
CContrasting Mishkin's comments was bearish news from Dallas Fed President Richard Fisher. He said the Fed must choose to fight rising inflation even if it means faltering growth. "Containing inflation is the purpose of the ship I crew for, and if a temporary economic slowdown is what we must endure while we achieve that purpose, then it is, in my opinion, a burden we must bear, however politically inconvenient." He is an inflation hawk and is dead set against further rate cuts.

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Fed Vice Chairman Donald Kohn told lawmakers yesterday that challenging market conditions will likely hurt earnings and consumer lending. Since the start of 2007 more than 45 of the worlds biggest banks have taken write-downs of more than $181 billion according to Kohn. He said he was worried about the liquidity of the nations 50 largest banks given their write-downs and future expected losses.

All of this bearish Fedspeak has sent the chances of further rate cuts much higher. The Fed Funds Futures are now projecting a 163% chance of a 50-point cut, a 100% chance of a 75-point cut and a 75% chance of a full 100-point cut. Several analysts interviewed on Tuesday said the Fed was likely to cut 50-points this week and another 50-points when they meet on March-18th. There is a 100% chance that the Fed rate will be 2.0% after the April 30th meeting.

The financial sector was not celebrating the rate cut chances with continued downgrades pushing the sector back to 52-week lows. Citibank estimates were cut again by Merrill and the CEO of the Dubai Investment Capital said a continued bailout of Citi would require additional foreign investment. Citi fell to a nine-year low on the warnings. Citi denied the need for outside capital but other analysts were echoing the Dubai claims. Citi has already written down $18 billion in loans and Merrill said they would have to write down another $18 billion in Q1. Goldman cut its Q1 estimates for Citi from a profit of 15-cents per share to a loss of $1 saying they made a mistake in the model that produced the earlier estimate. The WSJ said job cuts at Citi, currently announced at 24,000 would grow to 30,000 as a result of the continuing losses.

Intel warned after the close on Monday that profit margins on flash memory chips was lower than expected due to a rapid decline in chip prices. Intel and the tech sector declined on the news pushing the Nasdaq to 2221 intraday. That decline was reversed when AMAT and CSCO released positive news to the market. AMAT said it received its biggest private company order ever totaling $1.9 billion. The order for an unnamed private corporation was to supply and install equipment for multiple solar factories outside the U.S. with much of it going to China. AMAT said this order was five times bigger than any order it had previously received. This triggered a rebound in some of the chip stocks and a couple solar stocks. Trina Solar (TSL) posted earnings that tripled on strong demand for solar-power systems and higher profit margins. TSL rose +$1.75 on the news and further helped halt the selling in chips.

Late in the day Cisco CEO John Chambers said at a conference that he is more comfortable with the company's long-term growth rate than he was on the last conference call. He said there would still be short-term bumps in the road but he expected the slowdown in growth to be shallow. He said, "nothing has changed in Cisco's guidance", implying that the recent economic downturn had not impacted Cisco's sales. Cisco does generate a lot of its income from overseas and that is compensating for any weakness in America. CSCO rebounded sharply from the afternoon lows and helped push the Nasdaq back into positive territory.

About the same time as the Champers comments we got the normal breaking news alert on CNBC that an Ambac deal was imminent. I don't know what Charlie Gasparino is going to do for a market moving alert effort once the Ambac deal gets done. Within minutes he was back on the air with the daily qualification that it may not happen and "sources" said there was still a lot of work to be done. It did not matter to CNBC, ABK had already popped +$2 or +22% on the news. They got their bounce and on to other stories. Reuters quickly posted a story saying there was not going to be any announcement according to "a person briefed on the matter." We need to start assigning deep throat like names to these sources. The Financial Times reported that Ambac had decided not to split the two business units and keep the CDO business with the municipal bond business. Personally I don't think anybody will know anything for sure until a formal announcement is made. This is just headline spamming by the various news wires.

Another tech story that was not widely reported was a strong guidance upgrade by Seagate Technology. (STX) Seagate said a better than expected product mix and fast acceptance of its new industry leading products would produce earnings in the range of 68-72 cents. Analysts were expecting 63-cents per share. I reported on Seagate back in January and suggested it was a strong buy given their earnings and sales guidance back then. STX had risen +20% since mid January. Their new 15K.6 SAS drives have 61% less power requirements and a 28% increase in speed over prior models. The standard 250GB SATA-II drives are selling for $69 online and are well worth it.

Office Supply store Staples (SPLS) cut its 2008 sales and profit outlook for 2008 and expects the economic weakness to linger throughout the year. Goldman Sachs analyst Matthew Fassler said North American same-store sales trends had slowed meaningfully and more than we expected. Barnes & Noble (BKS) missed estimates and was downgraded by several firms. BKS had raised its profit estimates but analysts said the outlook was too aggressive. A JP Morgan analyst said it was aggressive because of difficult comparisons and softening sales trends. The analyst pointed out that book sales soften during election years. JPM cut them to sell, Credit Suisse cut them to neutral.

Tax preparer Jackson Hewitt (JTX) was knocked for a 30% loss of $6.61 after they said earnings had fallen on a slow start to tax season. A Goldman analyst said the numbers were far worse than even his bearish estimates. On investor minds was the report of much slower tax filer traffic. I guess if you can't make your mortgage payment then filing your taxes early is not really a priority.

Apple Computer or Apple Inc as they are now called held their shareholder meeting today and the star CEO was under fire. AAPL stock was up +153% in 2007 but down -40% in 2008. Shareholders wanted to know what Steve Jobs was going to do about it. He was questioned on whether Apple would spend some of its $18 billion in cash on stock buybacks or a dividend and Jobs said no deal. Shareholders also said no deal to runaway pay and voted in a "say in pay" proposal. Apple is the first major company that found shareholders disgruntled enough to pass the initiative. Approximately 40 companies have seen the proposal make the ballot but then fail on the vote. Jobs said Apple was making plans to enter India and China with the iPhone but would not say when it might happen. Jobs stuck to the 10 million phone estimate for 2008 despite the slowdown in consumer buying. AAPL rose +2.89 on what was considered a successful but uneasy meeting. Thursday is the software meeting where Apple will lay out its roadmap for the various iPhone products.

Google reported its vice president of global operations had deserted the "do no harm" company to join Facebook as its COO. Sheryl Sandberg worked at Google for six years and prior to that was chief of staff at the Treasury Department under Clinton. The 38-year old Sandberg will now report directly to 23-year old Facebook founder Mark Zuckerberg. That ought to be an interesting working relationship. I am sure she walked from Google with more stock options than she can spend so the Facebook project is probably more a thrill of a new challenge than a desperate need of income. With Google hitting a new 52-week low of $435 today she better cash those options quick.

Crude Oil Chart - Daily

Crude oil prices hit $103.95 and a new all time high on Monday but declined to close at $99.20 today. The drop in crude came with heavy selling in all commodities but there were extra reasons for the drop in crude. OPEC ministers meet tonight in Vienna to discuss production rates for the next 60 days. Almost every oil minister has said over the past week that there will not be any increase in production. No surprise there. At the same time they appear to have agreed in advance not to cut production despite the buildup of supplies. President Bush implored them today not to cut oil production and indirectly increase the recession in North America. Today almost all analysts and ministers have said the only avenue left for OPEC is to leave production at current levels and strongly describe the rising inventories around the world. They cannot or maybe should not cut production in the face of rising prices and a slowing global economy. They don't need any additional negative press but then sticks and stones, etc, maybe $100 oil is worth it. OPEC tends to dance to a different drummer so despite the overwhelming sentiment about no change in production anything is possible. On a side note Exxon (XOM) has an analyst meeting at 9:AM tomorrow and there are several major items on the table including a possible boycott of Exxon by OPEC. Venezuela is pressing OPEC to cut off Exxon because of the XOM/VZ battle. Volatility could be huge.

At its lows today the Dow had fallen over 220 points to a low of 12032 and right at the bottom of the range seen since Jan-22nd. It is still well above the January lows of 11634 but still at critical support. The sentiment was extremely bearish and it appeared on the surface that we could easily have been down -300 in just minutes. With internals declining by the minute and shorts loading up for the express trip back to those January lows the market was ripe for a news related short squeeze. The combination of the comments from John Chambers and the daily breaking news alert on Ambac put fear back into the shorts and the squeeze was on. The Dow rebounded +175 points and the Nasdaq +40 to close barely positive. Initial support remains 12,000 and resistance is hundreds of point above us at 12500 and not relative without an Ambac deal.

The Nasdaq, even with the rebound, is looking very negative. The new six-week low today at 2221 had all the signs of a breakdown until the Cisco and Applied Materials news produced the squeeze. There was limited follow through to the squeeze overnight so there is no indication if there will be follow through at the open. This could be just another rally to short but I am not recommending it today.

Nasdaq Chart - Daily

S&P-500 Chart - Daily

The S&P-500 declined to its January closing low of 1310 and like the Nasdaq looked a lot like a major breakdown in progress until the afternoon news hit the wires. The afternoon recovery allowed a lot of traders to breath easier but it may only be temporary. Support is 1310 with the January lows at 1275 as a fall back position.

The charts on all the major exchanges look very ugly. But, as they say it is always darker before the dawn. I am still cautious about this week given the declining economics and the Non-Farm Payrolls on Friday. I think traders are going to be cautious about going long until after that report. There are strong expectations that the Fed could hit us with another intermeeting rate cut. Because everyone expects it the lack of an announcement is negative. The Fed could wait for Friday's jobs report before making a move. If jobs suddenly improved then the cut would be off the table until March-18th. That is a lot of indecision and the Fed Beige Book tomorrow afternoon is only going to further cloud the issue. We also have the daily Ambac news. If they ever announce a resolution and a successful bailout plan the markets are likely to rally hard. With hundreds of billions in Ambac debt on their books the financials are struggling with what they are going to write down when they report earnings in two weeks. If the Ambac deal is announced prior to that then they can value that debt higher. If it does not get done then expect some major additional write-downs. The window is closing on both the banks and rating agencies and something needs to happen very soon. That would be a major positive for the market and could be the trigger to the end of the credit crunch. That is the wild card for me as it has been for the last four weeks. Without an Ambac deal I expect the markets to continue to trend downward. Internals have been declining for the last five days and volume increasing the last three. Tuesday was the largest volume day since Feb-7th and most of it was declining. With a deal we could have a monster short squeeze similar to the one started on Feb-22nd. I am still an observer on equities and a short on oil (USO) assuming OPEC does not do anything stupid like cut production.

Jim Brown
 


 

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