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Market Wrap

Light In The Tunnel?

HAVING TROUBLE PRINTING?
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Massive job losses and the highest unemployment rate since 1993 drove the Dow to a -257 point loss at Friday's open. The bad news bulls returned with a vengeance at the close to push the Dow to a +259 point gain. Could that be a light just ahead?

Market Statistics
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The big news on Friday was a horrendous employment report for November. The economy lost 533,000 jobs and well more than the consensus estimate of 300,000. That was the largest monthly job loss since Dec-1974. That was not the end of the bad news. September was revised lower to -403,000 jobs from -284,000 and October was revised to -320,000 from -240,000. The net result was a new loss of -732,000 jobs over those previously reported over the last 90 days. Over the last three months the economy has lost 1.256 million jobs. We are finally moving into job losses equivalent to a normal recessionary period. This was the 6th largest monthly job loss since 1939 when records were started.

The unemployment rate rose to 6.7% and a rate not seen since Sept-1993. Building and manufacturing lost 163,000 jobs in November while the retail sector lost 91,000 in a period normally bullish for retail. Losses in service producing industries hit -370,000 and more than doubling the -153,000 loss in October. The average workweek declined to 33.5 hours and the lowest on record. This suggests employers are cutting hours rather than cutting valuable employees. The labor market has fallen to its worst level in decades and much of that drop was in just the last 90 days. This suggests the Q4 GDP could be even worse than the -5% commonly being reported. This was a very ugly report and the market should have fallen much more than the -257 drop at the open. However, some are claiming the sharp 200-point decline on Thursday just before the close was in anticipation of a very bearish jobs number.

Jobs Chart
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The only other economic report of note was the Mortgage Delinquency Rates for Q3. The national delinquency rate on all loans rose to 6.99% and nearly 60 points higher than Q2. For prime mortgages with a fixed rate the delinquency rate rose to 3.3% and prime adjustable rate mortgages rose to 8.2%. Compared to subprime numbers those were great. Subprime fixed rate loan delinquencies rose to 18.0% and adjustable rate mortgage delinquencies rose to 21.3%. The slowing economy, rising job losses and falling home prices are making it impossible to trade out of an underwater mortgage. These are record numbers for delinquencies although foreclosures have slowed slightly with the various government programs. Still nearly 1 of every 10 loans in the U.S. are either delinquent or in foreclosure. Mortgage rates fell -51 basis points this week to 5.5% for a fixed rate making it the largest swing in the last decade. Rates have not been under 5.37% in 45 years. Holders of ARM loans should benefit from the sharp drop in rates. The government is talking about offering 4.5% fixed rate loans for purchases. This will pressure the private sector to lower rates as well. Consumers are racing to take advantage of the lower rates. The weekly application report showed applications more than doubled last week with refinance applications up +200%. Applications to purchase homes rose +38% over the prior week.

Delinquent Mortgage Table
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For next week there are plenty of economic reports but only one of specific interest. That is the Producer Price Index (PPI) for November. Even the PPI is not likely to be market sensitive given the falling price of commodities and prices in general. There is really nothing on next week's schedule that could come close to the bad news the market got on Friday.

Economic Calendar
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On the news front the grilling of the automakers droned on without any resolution. However, Chrysler raised the ante when the WSJ reported they had retained Jones Day to prepare a bankruptcy filing. This could be a well-played bluff or the reality of falling auto sales coming home to roost. It is a well-known assumption that any one automaker falling into bankruptcy would prompt the other two to quickly follow suit. A bankruptcy gives the company the ability to break union contracts, supplier contracts, leases, pensions, etc. It is thought that automakers not going though bankruptcy would have a much harder time competing when their costs would be drastically higher than a company emerging in a streamlined mode from bankruptcy. Friday was the perfect day to play that card because it puts some worry into the lawmakers currently arguing over bailing out the automakers. In a survey taken last week 52% of prospective car buyers would not buy a car from a company in bankruptcy. However, if all three took the plunge at the same time that would remove some of the stigma. Late Friday around 9:PM news sources were reporting that Democratic leaders and the White House reached a deal to provide between $15 billion and $17 billion in aid. That is far less than the $34 billion requested but Democrats believe it is enough to keep them in business until after Obama takes office on Jan 20th. Lawmakers are planning on pitching a new bailout plan to the new president immediately upon him taking office. Evidently the Chrysler news did the trick. Was it a well-played bluff or reality?

Hartford surprised the market with a better than expected forecast for 2008 and said its balance sheet was more than sufficient to withstand any continued market declines. Hartford (HIG) stock soared +102% to $14.59 on the surprise short squeeze. All of the insurers rallied strongly on the news. Also helping was news that regulators were meeting in Texas this weekend and could come up with a plan to ease regulatory guidelines for reserves held to back their variable annuity products. This would help the insurers avoid additional capital raises and would be bullish for the sector. PRU gained +7.80, MET +5.64 and LNC +5.15.

Bank of America and Merrill Lynch shareholders both approved the acquisition of Merrill by BAC. It was a shotgun merger and given the current environment the Merrill shareholders are probably glad they got something besides cat box liner material out of their shares.

The Federal Reserve bought $5 billion in Freddie/Fannie debt on Friday as it began its $600 billion in announced GSE bailouts. The Fed is going to buy $100 billion in debt and $500 billion in mortgage backed securities in an effort to lower mortgage rates. Dealers submitted $12.9 billion of debt into the auction and the Fed bought the lower end of the maturity range from 1 to 2 years in length. As the program expands the Fed is likely to buy across the entire range of debt in order to push rates lower.

The most amazing statistic from last week came from the energy sector. The price of oil closed at $55.19 on Friday before last Saturday's OPEC meeting. This Friday it traded as low as $40.50 for a -26.6% drop. Given the prior $100 drop over the last few months this additional $15 drop in one week is nothing short of amazing. Actually it is incredible. OPEC did not act but made it clear they would in two weeks at the Dec-17th meeting. Unfortunately that is not the problem. We are still seeing massive liquidation by funds and institutions. Complicated hedges are being unwound on a daily basis as analysts talk about $25 oil and $1 gasoline. The world has gone mad as the fear of the recession has surpassed the actual impact of the recession. Just like every bubble is built on irrational expectations and greed, every crash is based on irrational expectations and fear. Every prediction by a major analyst is repeated thousands of times until another analyst jumps in the spotlight with something even more bearish and the actions are repeated. It is a massive game of whispers, gossip and unknowns. Nobody knows what demand will be in six months. Heck, nobody really knows what demand is now. Everyone is afraid the soaring unemployment will result in bread lines around the world and people will be living in their cars not driving them. All of this crap is simply not true. Even if demand temporarily fell another million or even two million barrels a day it is not the end of the world.

All of this hysteria over falling oil prices is doing much more harm than good. Projects are being cancelled or put on hold all over the world because the current price of oil does not support new projects to produce $50, $60 or even $75 oil. Every project that goes inactive adds several years to the date when it will eventually produce oil. We are already talking about projects that total over 3 mbpd of potential production. That production is what would have delayed the onset Peak Oil. By putting them on hold the world is becoming increasingly at risk of even higher oil prices. The recession will be over in 6-9 months and demand will explode at these low prices. Unfortunately when a project is cancelled or mothballed the workers move on to other jobs. The equipment is sent to other locations and pipe and supplies are diverted elsewhere to be used on other projects. When the decision is made to reactivate the project all those assets will need to be acquired again and that could take years in the case of rigs and workers.

The current drop in oil prices is the worst thing that could happen to the energy sector. We are duplicating exactly what happened 10-years ago this month. The price of oil crashed because of a political battle inside OPEC and Saudi Arabia flooded the market and pushed the price down to $10 a barrel to force other OPEC nations to face reality. Around the world rigs were mothballed by the thousands and eventually cut up for scrap steel. Tens of thousands of experienced oil field workers were laid off and either retired or went into other professions. These were experienced workers that could not be replaced. When the price of oil eventually began to rise again those workers were no longer available. The rigs had been scrapped and there was nobody left to man them even if they were still around. This led to a boom in the oil equipment sector where companies ended up with multiyear backlogs for new rigs. Day rates for existing rigs exploded. New workers had to be hired and trained at great expense. The result of the oil crash meant every new rig and crew now cost up to ten times as much to operate as the older rigs and hands. This meant the cost of producing a barrel of oil soared to levels today of $50, $60 or even $75 a barrel. Those fields cannot be produced today because they are not profitable and will eventually be shut in if prices do not change quickly. In 1998 thousands of producing wells were plugged because they were not profitable. Most were not reopened even at $145 a barrel simply because there was no time or money to do it. We lost millions of barrels of production because of low prices. The same thing is happening today. This oil crash will eventually turn around and when it does the moves are going to be dramatic. Enjoy your $1.50 gasoline today because it is not going to last forever.

Crude Oil Chart
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Tired of the winter cold? Wish you had sold your stocks before the July crash? I heard a marketing gimmick today that is sheer genius. Elite Island Resorts came up with a killer marketing ploy. Because of the recession they have about 50% of their rooms in places like Antigua, Grand Cayman, Palm Island, Nevis, St. Lucia and Tortola going empty. Empty rooms still cost the same for debt service and overhead but generate no revenue. Elite hit on the perfect way to fill their rooms and make a profit. A weeklong Christmas vacation for a family of four costs $650 a day all inclusive of literally everything. That equates to $4550 for the week. They are willing to give you a week at one of their resorts in exchange for $5000 of stock at July 17th prices. Google was $534, Goldman $177, Citigroup $17. You give them $5000 of stock at July 17th prices and you get the room. That is 9.3 shares of Google at the July 17th price. That is only $2649 at Google's price today. Get the picture? They are allowing you to trade stock at one third to one half of its July 17th price in exchange for an EMPTY ROOM. For Elite that is a killer marketing deal. They are planning on holding the shares for 18-24 months and the odds of them making a profit are about 100% in most cases. What a deal, trade stock for an empty room and provide a killer vacation for the seller. Kudos to Elite for thinking outside the box. Link to description

This was a crazy week in the markets. Triple digit moves were the norm like Friday's 550-point swing. The biggest move was the -600 point drop on Monday to 8150. That established our support for the week and that support held. The drop on Monday was due to several news factors as well as simply being in a new month after a +1000 point rebound. It was profit taking, sell programs and news events. More importantly it did not establish market direction for the week. The markets actually shook off Monday's drop to trade higher for eight of the last ten days. Thursday's closing drop was a serious sell program, possibly several concurrent programs and now that we know what the jobs report held we can guess why somebody was moving to the sidelines. Friday's opening dip of -259 Dow points produced a temporary dip just below support at 8150 but it was short lived. The bad news bulls raced to buy the market and another short squeeze developed. In the internals table below I think we are seeing continued evidence of rising bullish sentiment. Volume was decent every day and it did not increase on the down days. Actually Monday's 600-point loss was the lowest volume day of the week.

Market Internals Table
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On Tuesday I recommended buying dips to Dow 8150 and that worked well on Friday. The close on Friday was the high of the week after Monday's opening drop. We still have plenty of overhead resistance between our close and 9000 and we are not out of the woods yet. I continue to hear stories about traders leaving for the year. So many people are fed up with the volatility and have decided to move to the sidelines until a trend develops. That may be a good plan for some but I still want to nibble on the dips. By the time a real trend develops we could be a thousand points higher on the Dow and many stocks up +20% from their current levels. Dow 9600 is the real trend breaker level. That was the resistance high back on Nov-4th. Once over that level we should see some additional interest from buyers.

Dow Chart
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Believe it or not the Nasdaq also closed at its high for the week. After being the scapegoat for all the tech warnings we saw firm support at 1400 and a close just over 1500 on Friday. This is far from being bullish but it is far less bearish than we were seeing two weeks ago when it looked like 1300 was just a pause in the downward trend. If the Nasdaq can move over 1500 on heavy volume the retail tech traders should get that wishful gleam in their eyes and start shopping again. We could still see a retest of 1300 but that possibility becomes more remote every day we stay over 1400. More people will start believing the bottom is behind us and begin placing bets. Real resistance is 1800 but that is so far away you can barely see it from here. Let's wish for a few more small steps before we start worrying about the big numbers.

Nasdaq Chart
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The S&P looks like the Dow but there were several important tests of support at 815 that did not waver even a little bit. Strong resistance at 900 but like the Dow and Nasdaq as long as 815 continues to hold we will eventually move higher. The 30-day average is the next resistance challenge. Given our recent volatility just holding within the prior week's range was amazing. The price action was not particularly bullish but closing at the high after a rocky week is never a bad thing. I would look to buy the dip to 815 and go short below that level.

SPX Chart
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The Russell did not exhibit any special characteristics different from the Nasdaq and S&P except it did not close at its high. The Russell only missed by two points and that is close enough in my book. 460 continues to be short term resistance and that is exactly where it closed on Friday. I would look for a move over 480 as a sign funds are buying small caps again. Today I am neutral on that point. There was buying interest a little earlier in the day on the Russell than the other indexes but that could have just been short covering. We have two weeks left on December options and next week could see some pre-expiration settlement pushing the small caps higher. The dip buy level on the Russell is support at 420.

Russell Chart
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Contrary to anything you might have read above I am slightly more bullish overall because buyers seem to be shrugging off the bad news. (No Rodney, I am not on drugs) Since Nov 21st I have been suggesting we bargain shop and begin picking up some good stocks on sale. I specifically said not to back up the truck but be picky about what you buy. You may not be happy 2-3 weeks from now but 12-18 months from now you should be very profitable. I have never seen a bear market this violent and of course a financial crisis this bad. I think both are in the final stages and will soon pass. The Fed meets in 7 trading days and they are likely to cut rates again. Before then the Fed and the Treasury will be spending money like crazy to slow the economic decline. I am hearing -5% to -8% for Q4 GDP but that is just speculation. We will not have a clue until well into 2009 and those numbers are published. If by chance it is not as bad as analysts expect the recovery could come sooner and be led of course by the markets. On Monday the markets will probably be controlled by the bailout of the automakers. As of early Saturday there are still some details to be worked out but it appears it will pass. That could stimulate some relief buying on Monday. The auto industry directly employs 250,000 workers and probably another 250,000 indirectly. They are too big to fail, especially considering the paltry $34 billion they need to survive. The financial stocks have benefited from bailouts in the $1.4 trillion range making the $34 billion automaker bailout chump change.

I am working on the end of year renewal special but there are still some details to be ironed out. Please be patient.

Jim Brown

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