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Market Wrap

Don't Breath Yet!

HAVING TROUBLE PRINTING?
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The Dow completed its third consecutive day of gains for the first time since mid September. Buyers are holding their collective breath in fear these gains are just a temporary relief from the selling. If this is you please don't breath yet!

Market Stats Table
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The market opened weak after Treasury Secretary Paulson announced a new round of incentives and the GDP revision came in weaker than some expected. The GDP revision for Q3 fell to -0.5% from the -0.3% with revisions to consumer spending and exports. This report shows that the economy is firmly in a recession and the next revision could be even lower. Over the past year the GDP has increased only +0.7% and the slowest rate since Q4 of 2001. Retail sales of domestic products fell -1.4% in Q3 compared to a rise of +4.4% in Q2. Personal consumption expenditures fell -3.7%, a downward revision from the initial 3.1% drop. Corporate profits fell -3.8% at an annualized rate in Q3 and have now fallen for five straight quarters. Business fixed investment fell -5.6% and the largest decline in almost four years.

The Richmond Fed Manufacturing Survey came in very negative at -38 compared to October's reading of -26. This is the lowest reading since the report began back in 1993. Shipments fell seven points to -31 and new orders fell 13 points to -48 and by far the lowest reading since the report began. This was an extremely bearish report showing how sharply demand has fallen. Demand from export markets has also weakened indicating the recession is impacting countries worldwide. The current tight credit market is slowing sales of big-ticket consumer items.

Richmond Fed Manufacturing Survey Chart
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Other reports included the Case-Shiller Home Price Index, which showed home prices continued to decline in September. On a year over year basis prices in the top ten markets fell -18.6% compared to -17.7% in the prior month. The FHFA Purchase Only House Price Index fell -7% year over year compared to -5.9% in the prior month. As the southern states slide into recession the price of homes accelerated lower.

Surprisingly Consumer Confidence rose from 38.0 to 44.9 in the final reading for the month. Most analysts had expected a further decline but the drop in gasoline prices was credited with the rebound. You may remember the initial November reading fell -22 points and the largest drop in history. That decline was obviously overdone and probably contained some census anomalies. The majority of the rebound came in the expectations component, which rose from 35.7 to 46.7. This could also have been a residual impact from the election with some people thinking the new president will improve conditions quickly. With gasoline falling under $1.80 per gallon in much of the U.S. and predictions of continued drops this has got to help build confidence in consumers who were paying over $4 just a couple months ago.

Consumer Confidence Chart
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The economic calendar for Wednesday is busy ahead of the Thanksgiving holiday. The most notable reports are the Chicago Purchasing Manager Index (PMI) and the Kansas Fed Survey. The Kansas Fed Manufacturing Survey is expected to mirror the Richmond Fed report we saw today. The PMI is going to be an advance indicator of the National ISM report due out next week. None of these reports are expected to be positive so the bulls will have plenty of economic bricks to add to their wall of worry.

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The Federal Reserve announced some new programs today designed to address mortgage rates and consumer loans. The new program called the Term Asset-Backed Loan Facility or TALF will provide $200 billion for top rated consumer loans including student loans, auto and small business loans. By providing a backstop for these sectors the Fed is indirectly funding new lending by banks. Auto sales have fallen to their lowest level since the 1980s because of the lack of financing. The Fed is trying to break the gridlock in the consumer-lending sector. The negative to this announcement is the delay until February before the program will become active.

Another Day, Another $800 Billion
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The Fed also announced it will purchase debt issued by Fannie and Freddie to boost the availability of home loans and lower the costs of credit for homebuyers. The 30 year fixed mortgage rate is poised to move under 6% by as much as half a point. The Fed is going to purchase $100 billion in Fannie and Freddie debt through competitive auctions that will begin next week. They also plan on buying $500 billion in mortgage-backed securities backed by Fannie/Freddie to free up the securitization market. This program will not begin until closer to year-end but Fannie Mae spreads narrowed significantly on the announcement. If the government would just say it was backing all new debt issued by the GSEs they would not have to buy these mortgages back and the pair could borrow money today at nearly zero interest. It would be cheaper for the Fed and the taxpayer. The Fed is rapidly reaching a point where their balance sheet is going to be over extended as well. Globally the bailouts are reaching $7 trillion.


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Tech stocks took a hit today after Cisco said it was going to shutdown its U.S. and Canadian operations for the last week of December because of slowing sales. An analyst with UBS first reported the mandatory shutdown and Cisco confirmed it later in the day. They will close for four days in the last week of the year as part of a broader effort to trim $1 billion in costs amid slowing in IT sales. CSCO fell -6% to $15.42. Analog Devices (ADI) reported earnings and warned on Monday after the close. ADI said current quarter earnings would be less than expected due to weak demand and rising inventories. ADI said it cut capex-spending plans to $55 million from $157 million. ADI lost -7%.

The impact of the Cisco plant closure was felt across the entire tech sector with the Nasdaq off sharply intraday and the only major index to close negative after the late afternoon bounce. Hewlett Packard (HPQ) lost -6% to $33.42 despite affirming estimate on Monday.

Google rallied +24.61 or nearly +10% on news they would significantly cut their workforce of 10,000 contractors. Google's permanent workforce of 20,123 is augmented by the 10,000 contractors as a way of not incurring long-term employee liabilities. Google co-founder Sergey Brin said the force would be reduced through vendor management, converting some to regular employees and through some other approaches. Google has been on a massive cost cutting binge of late suggesting they are also seeing a drop in ad spending. An analyst at Merriman Curhan Ford said keyword prices are down %5 to 30% and click through rates on ad listings are declining as well. The analyst put a sell rating on GOOG with a target of $200-$240. I suspect there is going to be some serious volatility around their next earnings release.

Miner Rio Tinto PLC (RTP) lost -$40 or -27% after BHP Billiton (BHP) said it was dropping is $66 billion takeover bid. This acquisition battle has been running for nine months and would have been the largest takeover ever. With the credit market meltdown BHP ran out of options and had to abandon its bid. The drop in commodity prices over the last nine months also help kill the deal. The deal was worth $150 billion when it was announced with an offer of 3.4 BHP shares for each RTP share. As commodities crashed so did BHP's stock price from $95 back in May to less than $25 last week. After BHP said it was going to drop the bid their stock soared to close at $37 today.

After the close today Fitch raised its rating on Morgan Stanley to stable from negative suggesting the worst may be over for the sector. Goldman Sachs (GS) became the first bank to sell FDIC insured debt with a $5 billion note offering. The amount was initially in the $3 billion range but there was so much interest they raised the total. This should be the first in a wave of borrowings with JPM and MS next up on the list. With the FDIC insuring the debt it takes out the risk and there is plenty of cash waiting on the sidelines for a safe investment. The notes will yield $3.367% and about 2 points over treasury debt. With recent non-insured borrowings going in the range of 7.25% more than comparable Treasury debt this is a major breath of fresh air for the major banks. This FDIC insured debt program announced in October has created a huge demand and analysts estimated there was as much as $1.4 trillion in the system that would qualify for refinancing under the FDIC program. That much paper leaving the commercial market and being repackaged under an FDIC seal of approval would create a serious vacuum in the non-insured market place with buyers all lining up at the FDIC product window. Reportedly there is $500 billion in debt expiring by next June that would be eligible for refinancing under the FDIC umbrella. Hopefully the buyers of this debt actually read the rules that the FDIC guarantee was only temporary.

I caught a lot of flack for my comments in the Sunday newsletter about Friday's dip to Dow 7500 being a buying opportunity. I got a ton of email thinks to the "email Jim" link on the commentary. It looks like the readership has turned into a bearish horde rather than a nation of bulls. That is quite a change from prior years when less than 10% of our readers would consider buying puts. Actually I think that is an evolutionary leap for readers. Maybe everyone should go back and read those last two paragraphs from Sunday again. I was not suggesting backing up the truck but nibbling at some opportunities and looking for some gold nuggets in the charred rubble of the market. My feelings have not changed. I think the bottom is behind us but that feeling could change any day if we get a new dose of bad news. I believe that even if we do move lower there are quite a few good stocks that are very attractive and I doubt would drop much more even it there was a new low in our future. There is never a guarantee that the worst is over or a direction is cast in concrete but I do believe than good stocks bought today in small quantities will be worth a lot more this time next year.

Dow Chart
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Technically the Dow has come to a dead stop at resistance of 8500 and I was very surprised at the closing rally today. I thought sure we would have to pull back and digest those gains from the biggest two-day rally since 1987. The fact we rebounded to close positive today is a very bullish sign but that resistance is still solid. A move over 8500 could really attract some volume. I can't tell you how many times I have heard "short the rally" or "I sure would not buy it after a +1000 point bounce." Obviously shorting bounces has been a very profitable strategy for months now and I have to admit buying a 1000-point bounce sounds crazy. However, I think we are approaching a point where we need to look at the markets in a different light. Eventually one of these rebounds is going to stick and I don't want to be kicking myself for the next 1000 points while repeating shoulda, woulda, coulda. If the investing public has all turned bearish, as it would seem from my emails, then the bottom may definitely be in. Whenever sentiment is 100% in one direction we should run in the opposite direction. Look for a move over Dow 8500 as confirmation the bulls are climbing that wall of recession worry. That would equate to 865 on the S&P.

The Nasdaq is the anchor the Dow must drag higher. With the continued warnings from tech stocks about slowing sales and weak chip demand I am surprised we saw any rebound this afternoon. That rebound gave us a new support level of 1430 so that is the level I would watch for a failure of the current rebound.

Nasdaq Chart - 120 Min
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Russell Chart - 120 Min
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The Russell was my hero today with the largest percentage gain of any index other than the Dow Transports. The Russell closed at a new five-day high at 443. You know what I am going to say next. If the Russell is being bought then funds are moving back into the market. It was a small gain and probably more short covering than outright buying but it was a bullish close. We are moving into the Santa Claus rally cycle where in theory fund managers buy small caps to prepare for the January effect. Personally with all the volatility we have had over the last two months I think all the normal cycles are shot for the year. I would just keep watching the Russell for a clue to market direction. A +6 point gain may not sound like much but that came after a +70 point rebound in the prior two days. ANY move higher from here would be bullish. Likewise a move back below 425 would be a cause for alarm. As you can see in the chart the long-term resistance is still ahead making the current rebound suspect until that long-term resistance is broken.

Have a Happy Thanksgiving!

Jim Brown

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