Option Investor
Market Wrap

Women and Children First

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The markets are so confused and liquidation so heavy it appears we should be heading for the basement bomb shelter. Many sectors are getting crushed for absolutely no reason. Prior favorites are now cursed and those previously out of favor are almost out of business if you measure them by their stock price. Analysts had thought that the removal of the Fannie/Freddie cloud would release the financials and homebuilders to rally but that lasted about 30 minutes once the market opened. There is a serious undertow in the market and we are approaching the worst week of the year historically. Is it time to grab the wife and kids and camp out in the basement?

NYSE Composite Chart - Weekly

Economic reports on Tuesday failed to tell us anything we did not already know. The Job Openings and Labor Turnover Survey (JOLTS) improved only slightly but the downward trend in employment is still intact. In July 4.1 million workers were hired and 4.3 million left their jobs. Job openings declined by -100,000 to 3.4 million. On a trailing 12-month basis there were 17% fewer job opening than the same period in 2007. This report simply confirms the Jobs Report we got last Friday. The Manpower global employment survey also released today showed net employment had weakened but remained positive for the fourth quarter.

Job Openings Chart

The Pending Home Sales report for July showed sales declined -3.2% over July 2007. This is the smallest rate of decline since December 2006. However, as we move farther into the housing downturn the comparisons become easier. In July of 2007 pending sales were down -14.7%. Sales are improving but we are moving out of the summer selling season and into the dark days of winter where home shoppers are more concerned with staying warm and planning family events for the holidays. Spring of 2009 is where all the mortgage news and pent up buying should come together.

Pending Home Sales Index Chart

There are no material economic reports on Wednesday. The Oil and Gas inventory report will probably be the highlight as we start to see the impact of shut in production in the gulf. Nearly all the gulf production was shut in last week and that is 1.4 mbpd of oil. Plus the Louisiana Offshore Oil Port or LOOP was unable to offload tankers due to lack of power and lack of tankers. As of today 77.5% of oil is still offline and 64.8% of natural gas. The LOOP did restart under generator power but capacity was limited. The installations in the gulf only returned a minimum number of staff because hurricane Ike was originally projected to hit the oil patch south of New Orleans. They did not want to be faced with another expensive mass evacuation. When Ike turned west to target southern Texas the oil patch started to breathe easier but late Tuesday the track started to turn north once again. Ike cleared the northern coast of Cuba late Tuesday and is entering the gulf where it will gain in intensity. The next 12 hours will be critical for determining its track with more accuracy.


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OPEC met on Tuesday but as of 6:PM there was still no official word on their plans. There were plenty of unofficial comments including some from the OPEC president that no official changes were expected in production. The key point everyone stressed was an enforcement of quotas. With OPEC currently pumping 574,000 bpd more than their quotas just dropping back to the quota level would be a significant cut. Other estimates have OPEC producing 1-1.5 mbpd over quota. Several members also said they fully expected a cut would be needed at the December meeting because of the rising inventory levels. Crude prices fell to $102 and their lowest level since April on the OPEC news and the new storm track on Ike.

Chart of Oil

Storm Track for Hurricane Ike

The biggest news of the day was the implosion in Lehman (LEH) on news the talks with Korea Development Bank ended without a deal. Lehman stock fell -41% to $7.90 on the news. That is a new decade low. The problem appears to be reluctance on Lehman's part to accept the market value of its assets. They said bids for its Neuberger Berman asset management division were $2 billion less than expectations. Lehman's market cap dwindled to $5.1 billion on today's drop. Nearly 400 million shares were traded or 60% of the outstanding shares. Bank analyst Richard Bove reiterated his $20 target saying the company was now so cheap nearly anyone could afford it. Possible suitors named by Bove were Blackstone, Blackrock, HSBC and an unnamed Japanese bank. Bove said Lehman had $25 billion in assets that were currently being valued at 20 cents on the dollar and that was way too low.

Bove also lowered his earnings estimate to a loss of $3.17 per share from a loss of $2.32 per share. There were some expectations that Lehman might preannounce earnings to remove the pressure from the stock. Their official earnings date is Sept-18th. Several analysts said Lehman appeared to be in a death spiral and given their unexplained stock drop it was unlikely any other firms were using them in counterparty transactions. Well after the close Goldman Sachs, Citigroup and Morgan Stanley all said they were still doing counterparty trades with Lehman. You wonder if they are still trading because they want to or because they can't liquidate the positions? Capital opportunities for Lehman was drying up faster than a snowflake in July. They still have the Fed window available to them and they continue to claim they don't have any liquidity problems. Bear Stearns said the same thing two days before they were taken over. You can bet the Fed is in contact with Lehman on a daily basis. S&P put Lehman on credit watch negative citing "heightened uncertainty" about Lehman's ability to raise capital. A flurry of management departures over the weekend suggested to Bove that there were no deals imminent and people were fleeing Lehman so their name would not be tied to any future failure.

LEH Chart

Apple Inc (AAPL) lost another $6.50 to close just over $150 after CEO Steve Jobs hosted the new product announcement party today. The refreshed iPod line included the classic, which now comes with 120GB at a price of $249. Apple cut the price of the iPod Touch to $229. This is a touch screen iPhone without the phone and Jobs said it was the most popular game platform in the market today. The new iPod Nano will come in an 8GB version for $149. Jobs also announced an update to iTunes and a software update for the 3G iPhone that is supposed to fix the dropped call problem and extend battery life. The price cuts across the board and the new iPod products were widely anticipated. Jobs started the meeting with a line from Mark Twain highlighted on the floor to ceiling screen. "The rumors of my death have been greatly exaggerated." He was referring to the constant rumors about him being in poor health. In an interview with CNBC later Jobs said he was fine with no problems other than needing to gain 10-15 pounds. The drop in Apple stock was more of a market issue rather than a disappointment about the announcement. There was a letdown from a lack of a big new product but the market was the culprit.

Apple Chart - Daily

Attention Microsoft, Yahoo closed at a new multiyear low at $17.60 on news the Yahoo/Google deal announced in June was coming under increased Justice Dept scrutiny. Justice has hired a prominent anti-trust litigator to consult on its probe in the deal. Also, the Association of National Advertisers (ANA) is calling on Justice to block the deal saying the combined joint venture would control 90% of search advertising. This appears to be another opening for Microsoft to step up and do a deal for significantly less than they offered last time. Google closed at $418 on the news.

YHOO Chart - Daily

On Monday Yellow Roadway CEO Bill Zollars warned, "The economy has softened further impacting volume levels and pricing." "After a solid second quarter, the current quarter started slowly and has progressively weakened. We do not see signs of the economy improving in the near term." This warning along with the Lehman drop was a primary reason for the early morning drop and the continued weakness in the markets.

The bear market in commodities and materials picked up speed. Nucor (NUE) dropped -10%, US Steel (X) -13%, BHP Billiton (BHP) -9%, ANR -13%, BTU -8%, MOS -12%, POT -9%, MEE -19%, FLS -9% and WLT -12%. There was nothing specifically impacting those sectors other than continued worries about a slowing global economy.

More importantly it appears the markets are still undergoing the same forced liquidation we saw last week. The only difference is a sharp increase in volume and a huge imbalance of sellers. Volume was nearly 12 billion shares and skewed 10:1 to the downside. In normal markets this could be considered a potential capitulation event. 400 million of that volume was Lehman but the selling increased sharply across nearly all sectors.

Market Internals Summary

The Semiconductor Index (SOX) collapsed again with another -3.5% loss and another five year low. JP Morgan said in a research note this morning that "deteriorating demand will bring about a correction in semiconductor earnings estimates over the next 4-6 weeks." Semiconductor analyst Christopher Danely also said, "We expect almost every semiconductor company we cover to lower estimates as a result of the correction." Danely said current consensus earnings assets are at least 9% too high. Danely offered the following list of warnings as reasons for his concerns.

Samsung: Lowered expectations for second half due to macro slowdown.
Nokia: Warned it will lost market share in Q3.
Cisco: Said recovery in communications market not likely until at least first half 2009.
Ciena: Lowered guidance on lower spending by telcos.
Dell: Lower margins due to weak pricing in Europe.
Compal: Lowered Q3 guidance on weakness in Europe, U.S.
Richtek: Lower-than-expected guidance on weak PC demand.
Realtek: Lowered guidance on weaker-than-expected back-to-school.
Taiwan Semi: Below seasonal Q3 guidance on weakening semi demand.
MEMC: Q3 update noted that semi demand was weaker than expected.
Ingram Micro: Cited weak demand in Europe, Asia so far in Q3.
Corning: Cut guidance on excess display panel inventory.

After the close Texas Instruments updated it's forecast but did not change the midline. Prior forecasts were for 41-47 cents. They narrowed that range to 42-46 cents leaving the almost exactly same midline of 44-cents and inline with analyst estimates. TXN spiked $1 on the news as a few shorts covered in a thin market.

Semiconductor Index Chart - Weekly

The Dow fell a whopping -280 points and erased nearly all of Monday's gains. The Dow closed just over 11200 and appears likely to retest the July lows of 11000. I find it hard to believe that we will suddenly rebound on Wednesday but as always anything is possible. The extremely lopsided internals show us to be very oversold but I think the continued rally selling is telling us there is more weakness ahead. The opening short squeeze spike on Monday was huge but it was quickly sold as was the closing ramp. Today's market never tried to rally. It was open season for sellers right from the opening bell. The Dow is tied securely to the health in the financials and without a Lehman buyout I doubt they are going to suddenly recover.

The Nasdaq fell harder than the Dow and closed at a new two-month low at 2214. Support is 2200 and given the volume imbalance on the Nasdaq there were no survivors. Down volume was 2.4 BILLION shares and up volume was a miniscule 153 MILLION shares. That is not a misprint, 153 million with an "M". That 16:1 imbalance was still going strong at the close.

Nasdaq Chart - Weekly

There is a growing rumbling in the analyst community that a large number of hedge funds are in trouble, not just one or two. Remember the leverage example I gave on Sunday. What we are seeing is the unwinding of that leverage. European bank HSBC reported a survey today of 12 fund firms that manage a total of $4.2 trillion dollars in assets. The survey found that those fund families were rapidly moving to cash and bonds and away from stocks. I can't even imagine the amount of leverage $4.2 trillion in funds controls. Unwinding it could take months and the deeper it goes the faster it may go. As funds see assets dwindle the urgency to exit increases.

I had hoped on Sunday that the financial short squeeze would last more than one day. When we started hearing of funny accounting and two lawmakers announced separate hearings on who, what, when and why the government had to take over the firms the market sentiment turned sour. Remember, it was just a month ago the government got authorization for $25 billion to bail out Fannie/Freddie and the quote from Paulson was "we may never need it." Now they are talking $200 billion. Lawmakers want to know exactly what happened and how the government intends to get itself out of this mess. What was thought to be a financial market rescue on Sunday now appears to be an anchor. Historically we are in the worst month of the year for the markets and next week is historically the worst week in September. Based on today's collapse I am afraid to see what the next eight days might bring.

Jim Brown

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