Option Investor
Market Wrap

Arrival of the Summer Doldrums

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Economic news was lackluster, stock news was nonexistent and inflation worries coupled with rate hikes worries depressed the market. I could stop there and you would have an accurate picture of today's market. Volume was low and even the oil traders lost interest. The presidential candidates were doing face time on CNBC and taking their opening shots at each other as the next stage of the campaign begins. It was enough to make me want to go mow the yard in the 90-degree heat instead of watching the market. Can we just fast-forward to September?

Wilshire 5000 Chart - Daily

The economic reports today were lackluster. The Manpower Employment Survey was surprisingly resilient with 31 countries of the 32 surveyed retained either an optimistic outlook or actually rebounding in many cases. Only one country, Spain, showed a negative outlook. Several counties weakened measurably but are still showing growth. The biggest takeaway from the Manpower Survey is expectations for a continued weak job market in the U.S. in the third quarter. The baseline forecast calls for a continued minimal loss of jobs at the rate of 40,000 per month through September. Employment is expected to rise to 6% in early 2009. While this may not sound optimistic the expected level of job losses is well above historical norms in the hundreds of thousands per month for similar economic recessions.

The JOLTS report (Job Openings Labor Turnover Survey) showed hiring rose to 3.5% in April. This is a lagging report. Hiring activity improved in April and separations were only slightly higher. This produced a net improvement of 319,000 hires and the best pace since October. In April 4.78 million workers were newly hired while 4.47 million left their jobs. Hiring in the west was especially strong and separations also declined. That suggests the housing related losses are reversing.

The weekly Chain Store Sales index spiked +1.7% last week according to ICSC. Large gains in the first week of June are common as summer shopping kicks into high gear but this was larger than the typical spike and the strongest since Feb-2nd. Sales were said to have benefited from hotter weather and the tax rebate checks. The national average for unleaded gasoline hit $4.04 on Tuesday and will continue to drag on sales despite the rebates. Year over year gasoline is up +97 cents from the same period in 2007.

I am sure those three economic reports made everyone want to run out and buy something but it was not stocks. The problem for me is a lack of market drivers for the next several weeks and a major pothole in our immediate future. The June FOMC meeting begins on June-24th and from all appearances the Fed is desperately trying to warn investors that rate hikes are coming. Bernanke said on Monday that the worst was over in the financial markets but he also said the Fed would "strongly resist" any surge in inflation expectations. This along with similar statements by other Fed speakers is a clear indication that inflation is now its top priority and we could see rate hikes begin at the June meeting. Comments about reduced downside risk and aggressive Fed action helped to send the dollar higher. Treasuries were sold hard the yield on the 2-year rose 53 points in the last two days. This is a move reminiscent of the early 1980s. The ten-year yield closed at a new high for the year at 40.99. All are clear signs of inflation fears. Fed Vice Chair Donald Kohn will speak at a Federal Reserve conference on Wednesday as well as ECB board member Jurgen Stark. Fed governor Randal Kroszner, Cleveland Fed President Sandra Pianalto and St. Louis Fed President James Bullard will all speak at different conferences. All speeches will be dissected for signs of a coming rate hike.

The biggest report for the week remains the Consumer Price Index on Friday and the market are not likely to rally much ahead of that inflation information.


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There was no conviction in the markets by either buyers or sellers. The financials rebounded in the morning but rolled over again in the afternoon. Lehman lost another 7% to close at $27.30. That is below the $28 on their secondary offering. Bank of America is down -10% in three days and only managed a +0.02 cent gain. WaMu (WM) rallied +0.44 cents after being hammered for a 17% drop on Monday on fears it could lose another $27 billion over the next three years. With financials still tanking the broader market is not going higher. Even the drug stocks closed lower again.

Apple was lone standout with a +$4 gain to $185 after getting pounded on Monday after their iPhone announcement. AAPL fell $10 intraday on Monday to $176. Some of that drop was blamed on Steve Jobs gaunt appearance. Jobs is a survivor of pancreatic cancer and many thought he looked too thin and unhealthy and worried his cancer may have returned. Investors worry that without Jobs there is no Apple. There is no announced succession plan at Apple and given his cancer background that is suddenly troubling. Apple was slow to respond to queries about Jobs health but eventually said it was a "common bug that was responding to antibiotics." Critics suggested that only a "bug" would not have made such a dramatic change in his weight and looks since the last big product announcement. Jobs concealed his cancer from the board for five months before he announced it last time. There is a precedent here to hide negative health info.

The new iPhone is going to make it tough for the unlocking industry that sprang up when the iPhone began selling. Roughly one third of iPhones sold never made it to the AT&T network and ended up overseas. This was a revenue hit for AT&T and Apple, which participates in the monthly revenues. The old iPhone was only marketed in 5 countries. The new one will be available in 22 countries on July 11th and 70 countries by year-end. Apple and AT&T are working on a penalty for users who buy iPhones and don't activate them within 30 days as another way to profit from those that are unlocked. Unlocking phones other than the iPhone is still a big business. Uniquephones.com unlocks 10,000 British cell phones of all kinds every day. European travelers with an unlocked phone can use local prepaid service plans and not be hit with the massive roaming charges on remote networks. The new iPhone will cost $199 for the 8GB model and AT&T is planning on subsidies of up to $270 per phone to induce customers to buy the resource hog. They feel they will recover that subsidy over the life of the contract from the monthly service and download fees. AT&T said the front loaded subsidies would knock 10-12 cents off earnings in 2008-2009. Citigroup has a buy on Apple and raised the price target to $287 from $248. Lehman raised its price target to $248 from $202 and cut estimates on AT&T to $49 from $54. S&P raised Apple to a buy from hold and boosted the price target to $210.

Even oil traders found an excuse to leave the market today. Crude closed at $131.35 and about $8 below Friday's high. There was a lot of news in the oil sector with something for traders on both sides of the market. Saudi Arabia announced a meeting on June 22nd for global producers, consumers and oil companies to discuss high oil prices and what to do about them. They also announced an immediate increase in production of 500,000 bpd to 9.45 million barrels per day. They said in addition to the 500 kbpd they would provide additional oil to anyone who needed it. They are clearly trying to retard high prices because they fear the consequences. High prices cause demand destruction and lower demand causes much lower oil prices. They would rather demand and price remained constant. Prior periods of demand destruction took several years for demand to return to prior levels. That cost OPEC billions of dollars in income. Once you buy an economical car it cuts your consumption for years to come. They would rather you continue to drive your gas-guzzler with slightly lower prices.

July Crude Futures Chart - Daily

The IEA cut demand growth estimates by 110,000 barrels per day in Q3. That may sound like a lot but you have to put it in perspective. That is a drop in GROWTH not demand. They expect demand to grow by 1.5% in Q3 to 86.34 mbpd up from 85.07 mbpd in 2007. That is still growth of 1.27 million barrels per day. They expect oil prices to average $132.67. The EIA cut its estimates for non-OPEC production growth to 310,000 bpd from 570,000 bpd in the April estimate. The EIA said output would be lower from Russia, Norway, Mexico and Brazil. For 2009 they expect demand to rise another 1.3 mbpd with non-OPEC output lagging with only a 1.1 mbpd gain. They warned that delays in projects could push that number lower and prices higher. They also said current spare capacity has fallen below 2 mbpd for the first time since 2006 as demand increases and supply declines in many countries.

The CFTC launched a taskforce to formally investigate the implications of large speculators. The 25-person board will make policy recommendations to the CFTC focusing on the role of and possible need to rein in index trading and trading on foreign exchanges. However, the fox is in the henhouse. Members of the board will include representatives from Morgan Stanley, Goldman Sachs and JP Morgan. They are some of the largest energy traders on the planet. The Nymex announced yesterday that margin requirements for energy trading would increase as of the close of business today. For the miNY crude contract that increase was roughly $500-$600 depending on the class of customer. Members were slightly lower than retail traders. For the majority of people trading the miNY crude contract the $600 increase in margin is not going to slow them down. For major players with thousands of the big contracts in their portfolio the $1000+ increase in margin could cause them to knock a few contracts off their position but I doubt it will be material. The decline in oil prices today was probably due to the Saudi meeting, news of the 500 kbpd increase in production and the unknown about how the margin requirements would impact open interest at today's close.

New Margin Requirements for Front Month Contracts

The markets are oversold but they can't mount a credible rally. Every rebound is sold. There is really no reason to be in the market as we head towards the FOMC meeting on the 24th. We are moving closer to the earnings warning cycle and we could begin to hear warnings from the early reporters over the next two weeks. Nobody is expecting earnings to improve. The CPI could spell rate doom on Friday. The financials begin reporting next week and to say traders were afraid of the unknown would be an understatement. We have options expiration next week and that will increase the volatility. Once past expiration the volume will really slow for the rest of the summer. There is simply no compelling reason to be invested given the recent market weakness.

Dow Chart

The Dow has declined to test support at 12200 on each of the last three days. So far that support has held but the Dow is looking very weak with exposure to 11725. Initial resistance is 12350 followed by 12600. Ironically AIG was the second biggest gainer on the Dow today and the two biggest decliners were XOM and CVX. We just can't get everyone moving in the same direction at the same time.

The S&P has tested weak support at 1350 this week and the rebounds have been weak. The continued drop by the financials and now with the oil sector joining the decline there is little to expect from the S&P in terms of market support.

SS&P-500 Chart - Daily

Nasdaq Chart - Daily

The asdaq is right on the verge of breaking support at 2440. This has held for the last five weeks but it is starting to look weak. I reported last week that 50% of the Nasdaq gains had been on RIMM, AAPL and GOOG. We need those leaders to run again if the Nasdaq is going to avoid breaking support at 2440. There is fear on Apple about Steve Jobs health and the news is now out on the 3G iPhone. Going to be tough to gain in a down market. RIMM is probably going to follow AAPL rather than lead it. I am expecting the Nasdaq to decline without some news item that creates a short covering spark.

The Russell has been my beacon of hope and I hate to keep repeating this in every commentary. Russell 730 has been our decision point and it declined over 30 points from last week's high to a dead stop at 730 today. The trend is still up but I believe we are setting up for a failure. I would be short under 730. It is as though all the life has bled out of the markets over the last week and the lack of any credible attempt to rebound from the various support levels suggests traders are tired of fighting the tape. The summer doldrums will arrive with the expiration of options on June 20th and without a summer earnings surprise we are probably range bound for the rest of the summer.

Russell 2000 Chart - Daily

Ford investors flocked to Kirk Kerkorian's offer to buy 20 million shares for $8.50. More than one billion shares were tendered in a massive show of disgust. With Ford shares at $6.12 it is not surprising the response was overwhelming but shares were over $8 when the initial tender offer is made. Now everyone wants out of the automakers at any cost. I wonder if captain Kirk is regretting his offer of $8.50?

Jim Brown

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