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Confidence Implodes, Market Explodes

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The Consumer Confidence report for October showed confidence fell an astounding -23.3 points from 61.4 in September to 38.0 in October. That was the third largest single month drop on record and 38.0 is the lowest level of confidence on record. The market responded with a +900 point rally. Confused?

Market Stats Table
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The majority of the drop came from the expectations component, which fell from 61.5 to 35.5. The present situation component fell from 61.1 to 41.9. The survey questions showed 38.3% of responders felt business conditions were bad, 37.2% thought jobs were hard to get and 19.7% expected their income to decrease. Assessments of job market conditions are the lowest since the early 80s and the income outlook is the worst since 1978. On the positive side 4.4% were planning to buy an auto, 2.7% were planning to buy a home and 25.9% were going to buy an appliance. These were only slightly lower than prior months but still show the consumer is harboring dreams of improving their life style.

Consumer Confidence Chart
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The Richmond Fed Manufacturing Survey declined for the sixth consecutive month to a low of -26. This was the lowest level on record. Shipments declined to -24 and its lowest level since Dec-2001. New orders fell to -35 and the lowest level on record. Unfilled orders fell to -40 and the lowest since June 2001. Layoffs accelerated and manufacturers are cutting shifts and closing plants. This was a very ugly regional report. On Monday we will get the ISM report, which is a national report of the same data. If the ISM reflects the same declines as the Richmond Fed and last week's Philly Fed, which declined -42 points to -37.5 and the largest monthly decline on record, then the U.S. is in serious trouble and the recession bears will be mauling the bulls for weeks to come.

Richmond Fed Chart
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Despite the record bad news above there are still some reports left in the week. On Wednesday the Durable Goods report could give us some more bad news after a -4.5% decline last month. The GDP on Thursday could take all the wind out of the market's sails if GDP fell deeply into negative territory. Given how badly the recent economic reports have been I think it would be incredible if it remained positive. However, the various economic reports only turned sharply lower in late September and early October. That may have been too late in the third quarter to have had a really drastic impact on the quarterly GDP. It will definitely be a market mover when released at 8:30 on Thursday.

The Fed will announce its decision on interest rates at 2:15 on Wednesday and the consensus is for a 50-point rate cut to 1.0%. However, analysts are really mixed on the possibilities. Some want an even bigger cut to try and get the banks to lend money again. Cutting the Fed rate to 1% or even zero as some are suggesting will not make banks lend money again but it will make banks more profitable. That alone would be a strong positive. The Fed has said repeatedly that cutting the interest rate would not solve the banking problem but we all know it would be a positive boost to banking sentiment. Also, lower rates would help solve the recession problem. Bernanke needs to reflate the economy and a strong dose of inflationary interest rates is the best medicine for that ailment. It would be almost impossible for the Fed to say they were worried about inflation over slowing growth. They would love to be confronted with some signs of inflation today. Regardless of the decision we can expect a strong does of volatility at 2:15 tomorrow.

There was a monster short squeeze today and I am not talking about our markets. Shares of Volkswagen soared to $1,256 (EU $1,005) and a +100% gain over the prior day's close. The super spike came on news that Porsche had raised its stake in VW to 42% and had options to take its stake up to 74%. Since the German state of Lower Saxony owns 20% of the shares that would leave only 6% of the outstanding shares available to trade. VW has been heavily shorted by hedge funds as a way to raise money on what they thought was obviously over inflated values. VW was trading prior to the spike at 21 times 2009 earnings and better than twice its peers. Hedge fund Greenlight Investors said they were shorting VW on valuations and there were dozens of funds in the same trade. Many were shorting VW and going long Porsche in a pairs trade. That trade was already killing them with Porsche falling 50% since July and VW rising. Hedge funds continued to talk down VW thinking the global decline in auto sales would eventually take its toll on prices. When Porsche said on Monday they had options to raise their stake to 74% all those hedge funds went crazy. With only 6% of the stock left to cover shorts the funds created a super short squeeze as they all tried to cover using the same shares. VW spiked from a $60 billion euro market cap to $290 billion intraday as VW spiked +425 euros to 1,005 euros on the news. At the same time hedge funds were told by banks they had to put up more capital to remain short shares of VW. Funds found they could not even hold on in anticipation of the spike collapsing. The exchange said VW could be removed from the exchange if the float fell under 5% and that pushed the demand for shares even higher. After VW became the highest company in the world by market capitalization at $290 billion euros at the height of the spike, reality returned. VW declined at the close to only a +19% gain but the damage to hedge funds could last forever. It is rumored that several funds lost billions in the squeeze although it lasted only one day. Total hedge fund losses were projected to be $30 billion on the trade.

Hedge funds are not having a good month. Literally hedge funds are down on average about -8.4% so far in October. If the month ended here this would be the second largest monthly loss since 1990. The average hedge fund is down -19% for the year. Two of Citadel's largest funds, Wellington and Kensington, are down over 30%. Rumors over Citadel's health have roiled the markets several times over the last several weeks. Citadel had over $30 billion under management. Citadel has been forced to respond to rumors several times. On Tuesday Citadel said it was business as usual and it had not asked the Fed for capital and the Fed was not reviewing its books as rumors suggested. Goldman Sachs, Morgan Stanley and Citigroup were all forced to deny they had exposure risks to Citadel. Citadel said it had $10 billion in available credit and 30% of their assets were in cash or treasuries. Still the rumors about hedge funds in trouble continue to pressure funds with withdrawals. November 15th is the next deadline for notices that investors want to withdraw their funds on Dec-31st. Without a strong market rally over the next two weeks I would expect another flood of redemptions for year-end. A healthy market would erase much of that withdrawal interest. You may remember the comments from Roubini about 30% of hedge funds going out of business that I wrote about on Sunday. Today George Soros warned that half to two-thirds of funds could go out of business. All of this hedge fund news had me thinking about the overall hedge fund concept. I thought hedge funds were supposed to be "hedged" to lessen losses in down markets and maximize results in bull markets. What happened to the hedge in hedge funds?

Crackpot to rock star to outcast in two short years. Boone Pickens has made a round trip on the rocket to fame. Reportedly 50% of the investors in Picken's energy fund BP Capital have asked for their money back. Despite stellar gains over the prior two years that rocketed Pickens to fame in the investing world his fund has run up some serious losses of over $2 billion since June. A few weeks ago Pickens moved the fund to almost entirely cash until the volatility in energy subsided. Pickens owns about 20% of his fund and has reportedly lost $400 million so far this year. He will be the first to tell you that the selling is not due to long-term fundamentals but a specific short-term decline caused by the global recession and credit crisis. With hedge funds collapsing they were forced to sell anything of value and that was a lot of commodities and equities. A year ago Pickens was in high demand on the news circuit with a herd of photographers and reporters following his every move. Were it not for his appearances for the Pickens Plan his calendar would be blank today.

Whirlpool (WHR) lost $4 to $46 after announcing it was cutting 5,000 jobs and closing plants due to slowing sales. Whirlpool announced earnings fell -7% for Q3 on lower global volume and higher costs. They cut the forecast for the year and announced price increases. "The global credit crisis had a profound negative impact on what was already a weakening and very fragile global economy" according to CEO Jeff Fettig. "Declining home values, rising unemployment and very low consumer confidence levels will likely prolong a negative demand environment at least through the middle of 2009."

GMAC announced today it was no longer going to make auto loans in seven European countries. GMAC said it will no longer originate retail loans in the Czech Republic, Finland, Greece, Norway, Portugal, Slovakia and Spain. GMAC said ongoing problems in the credit markets as well as rising country risk prompted them to cease loan originations. GMAC said a shortage of capital in those markets also contributed to the decision. GMAC also said it would be more conservative on other loans it was still writing in other European countries. Earlier this month GMAC said it was cutting back on writing higher risk and longer-term loans in North America. GMAC has also moved to severely limit any leases it writes in the USA. GM dealers have also complained that new GMAC guidelines are so restrictive that it is virtually impossible to sell cars.

Citigroup and Morgan Stanley, JPM and MS, GS and MS, GS and C or even C and JPM. Those were some of the merger rumors making the rounds on Tuesday. In an effort to stop some of the speculation Citigroup said it was not currently in talks with anyone although it had received some interesting offers. Leading the rumors are continued declines in MS, GS and JPM on continued fears of counterparty risk and equity dilution. Morgan and Goldman were forced to tell the market this morning that they had not seen any material trading losses in recent days. Although banks are supposed to be healthier after the various government bailouts these four firms are still under attack. Just to illustrate in the real world the underlying concern that another shoe is going to drop I have a story to tell. I have accounts at JPM/Chase and US Bank. I have multiple accounts both business and personal at US Bank with some over 15 years old. Almost everybody in my USB branch knows me. I was transferring some money for a large purchase this week and I went to JPM/Chase and got a cashiers check for $15K to take to my USB branch in the same parking lot. I deposited the check in USB into an account that had roughly $7,000 in it already. I asked for a cashiers check on that account for $16,000 to be made out to the seller I was working with. USB refused to give me the check. I pointed out that I just gave them $15K in a cashiers check that I brought from the Chase bank next door. Sorry. I appealed to the branch manager and he looked at the check and said no. "If it was another bank I would give you immediate credit but we have to hold checks from Chase for three days." I was shocked but he said it was "orders from corporate." I transferred money from another account inside USB to solve my problem but that comment from the USB manager bothered me all day. If USB does not trust cashiers checks from Chase then there are some major problems still lurking in the banking sector.

Crude oil gained +1.43 to $64.50 and gasoline prices have fallen to a national average of $2.68 and as low as $1.86 at stations in Texas. Energy firms BP and Occidental reported strong profits but lowered forecasts. Of course that is not surprising since oil prices have fallen more than 50% from their highs. It would be hard for firms to duplicate Q2/Q3 performance. Valero said it was scaling back spending by 33% this year and cutting its 2009 budget. Valero said it was going to build up its cash position, buyback more stock and increase dividends. Conoco said they were going to maintain capex at $15 billion in 2009. Conoco has it right. Develop resources and acquire assets today while prices are low because they won't be low forever.

Sell the news? When the Fed announces their rate decision on Wednesday there is a good possibility of a sell the news event. It is not that the market does not want to the rate cut but the cut has already been priced into the market. There are lingering market problems but with the S&P trading with a PE of just over 10 it is also very undervalued. A 50-point rate cut would lower the rate on loans on everything from special purchases to home loans. That is exactly what the Fed needs to do to blunt this recession. A rate cut tomorrow would put us at the lowest rate in more than four years. Other countries have hinted at coming rate cuts and the U.S. has the opportunity to lead. Hopefully the Fed will act aggressively rather than cautiously. Whatever they do the market will probably see a sell the news event but hopefully it will be short lived.

The markets rallied an average of +10% today on no news. It was time for a rally as I pointed out in my Sunday commentary. Mutual funds accounting for 75% of all mutual fund investments have a Friday year-end and the selling should be over. Now is the when they are in window dressing mode to make those year end statements as appealing as possible. Maybe I should say "less ugly" instead of appealing since investor decisions for next year will be made on which fund lost the least instead of who made the most. Next week starts the best six months of the year for the markets and funds want to be positioned for any continued rally. They can always bail out again next week once their year-end has passed and investors won't know they went back to cash. Whether they do that or not depends on the rest of this week and next week. Those eight days are going to be the key to market health for the rest of the year.

Today was a great day for the Dow with nearly an 11% gain and a close back over 9000. Considering the analysts on Monday projecting a retest of 7500 this was a major reversal. Obviously everyone reading this article should know it was one monster short squeeze but we can still enjoy it. This was the 2nd largest Dow point gain and the 7th largest percentage gain in the Dow's history. Major Dow gainers from the list below were energy stocks XOM and CVX along with IBM. These are highly liquid blue chips that funds can exit in a heartbeat if things turn bad again.

Dow Components Table
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The Dow rallied nearly 900 points to close back over 9000 but still remains well under strong resistance at 9250 and 9500. Getting additional traction after a 900-point spike could prove tricky but not impossible. Most traders will be leery of buying that big of a bounce so I expect some selling as profits are taken and buyers jockey for position to buy the next dip. At least I hope they buy the next dip. I would love to see a higher low instead of a lower low as our next inflection point.

Dow Chart - Daily
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The Nasdaq exploded past 1600 after testing support at 1500 several times over the last three days. Nasdaq 1500 was the support low after 9/11. The Nasdaq has plenty of room to run before hitting resistance at 1800 even after today's +143 point 9.5% gain. However, slight downtrend resistance at 1640 may slow it initially. The resistance at the 130-period exponential, average HL, on a 30 min chart tends to be very reliable as you can see on the second graphic. Ignore the gain for the day on both charts courtesy of Qcharts.

Nasdaq Chart - Daily
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Nasdaq Chart - 30 min
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The S&P-500 rebounded back over 900 to close at 940 and a gain of nearly 11%. The next major resistance is 980 and 1020. Once over 1020 it should be clear sailing until 1200. Oh that we should be so lucky! Support at 850 and the October 10th low was solid and was tested several times over the last four days. I would love to think this bear market rally will stick but we have to assume it may not at least initially.

S&P-500 Chart - 90 Min
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The Russell rebounded a strong +34 points but was the worst performer of the major averages. The problem is strength and liquidity. Until fund managers are confident about going long the market the Russell will move slowly. Fund managers will favor the highly liquid large caps like XOM, IBM, etc where they can enter and exit quickly in volume. The small caps will be the biggest movers once managers feel the selling is over.

Russell-2000 Chart - 90 Min
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I said on Sunday that I thought the worst was over and we would see some window dressing this week. I did not expect a 10% squeeze in only one day but that is proof on how severely we were oversold. We saw another major rally of 900 points back on Oct 13th and those gains were erased in only two days. I believe this one is different and although we may not go straight up I don't think we are going to give back all of these gains. The calendar is in our favor as well as signs of lending among banks. If the Fed acts responsibility on Wednesday and cuts rates without a scorched earth policy statement and the GDP on Thursday is not a GDD or gross domestic decline then maybe we can get back to business as usual and value stocks on their fundamentals and not which bank is failing this week.

Jim Brown

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