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Market Wrap

Thanks For Nothing

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After three weeks and unending hours of airtime the Senate failed to pass a bailout for the big three automakers. Three weeks of posturing in the bright lights of TV cameras provided hours of face time for politicians but not a dollar of relief for automakers.

Market Statistics
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Asian markets plunged on Friday after a procedural vote killed the bailout measure late Thursday night. US markets opened down sharply but rallied back to positive territory after the White House said it would consider using TARP funds for interim relief. On Friday GM hired a bankruptcy firm to advise them on how to proceed if the government does not bail them out. The Bush administration said it would act to prevent the "precipitous collapse" of the U.S. auto industry. Obama sent an urgent request to the White House seeking intervention for the automakers. Republicans don't want to be blamed for giving the automakers a bailout when the business models are clearly flawed. White House press secretary Dana Perino said, "Under normal economic conditions we would prefer the markets determine the ultimate fate of private firms." The eventual format of any long-term bailout proposal will rest on Obama's shoulders once he takes office. The Bush administration will only give them enough to survive until March. GM said it would close all its plants for a month and cut Q1 production by 250,000 vehicles in an effort to save money and reduce inventories.

Competing for headline space on Friday was news that longtime Wall Street figure, Bernard Madoff, had been arrested for running a $50 billion Ponzi Scheme. In A Ponzi scheme initial investors are paid off from new cash generated from new investors. As long as the company continues to generate new cash from signing up new investors the fraud can continue. Once the cash flow stops the house of cards implodes. Madoff started his securities business in 1960 and was a former chairman of the Nasdaq. The fraud was conducted as a quasi hedge fund he ran from a separate floor of the building where his brokerage is based. He supposedly managed pools of money for investors rather than act as an actual hedge fund. Madoff told senior employees and his two sons on Wednesday that the company was insolvent and had been for years and estimated losses are expected to be around $50 billion. Madoff said he planned to turn himself in next week but first wanted to take the remaining $300 million and give it to employees, family and friends. The sons immediately called the FBI. In a form filed with the SEC back in January Madoff said the firm had up to 25 investors with $17 billion under management. Madoff was released on a $10 million bond. The SEC filed separate charges saying it was a stunning fraud and virtually all the assets of the hedge fund business were missing. Madoff's other securities business, Bernard L. Madoff Investment Securities has more than $700 million in capital and is a market maker in 350 Nasdaq stocks. It remains to be seen to what extent the separate hedge fund Ponzi scheme will impact his other business. This was part of the problem. Because he was a market maker he cleared and accounted for his own trades. That removed a level of detection from the process.

Aksia LLC, a New York based adviser to hedge fund investors, urged clients last year not to invest with Madoff's firm. The tip off came when they learned Madoff's accountants were a firm with three employees and a 13-by-18 foot office. There was a secretary, one active accountant and a 70-year old partner who lived in Florida. Obviously there will be a lot of charges filed against numerous people for accounting irregularities, securities fraud, etc, before this is over. Even though SEC documents, obviously in error, only claimed $17 billion under management, Madoff said it was actually over $50 billion and there were no assets. The end came when several hedge fund clients demanded $7 billion of their money back on Dec 1st and Madoff had no money to pay them.

This is a major reason for the sharp market sell off on Thursday afternoon. Madoff's fund had been supplying consistent 8% returns for years but in recent years those returns had risen to the low double digits and nearly every small hedge fund or fund of funds had money invested with Madoff. When the news broke it created a panic on Wall Street that $50 billion in investments had disappeared. Many funds are going to be forced to disclose to investors that their money is gone. This is going to accelerate hedge fund redemption requests as nervous investors seek to regain control of their remaining money. The $50 billion scheme may rank as the biggest fraud case ever and is sure to attract a lot of attention as further details are revealed.

On the economic front there was some good news with Consumer Sentiment for December rising to 59.1 from 55.3 in November. That 55.3 level in November was 28-year low. The present conditions component surged +11.9 points to 69.4 on the strength of lower gasoline prices while the expectations component remained nearly unchanged at 52.4. The 12-month inflation expectations fell to 1.7% from 2.9% in October and readings around 5% back in May through July. Despite sentiment at multiyear lows this was a slightly bullish report indicating consumers are starting to believe that conditions are improving.

Consumer Sentiment Chart
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Producer prices (PPI) fell for the fourth consecutive month with a -2.2% drop due to falling demand. Energy prices continued to decline and that is filtering through the system with an 11.2% drop for the month. Core inflation remained only slightly positive at +0.1%. With producer prices falling rapidly we should see a drop in consumer prices (CPI) when they are released next Tuesday.

Next week has several major economic events. The biggest is FOMC meeting on Tuesday. The Fed is expected to cut rates from 1.0% to 0.5% on its way to a zero rate sometime in Q1 of 2009. This rate cut is widely expected so the absence of a rate cut would be market negative. On Wednesday the Philly Fed will begin the regional manufacturing reports for December. All expectations are for results to be flat to down for December.

OPEC meets on Wednesday and expectations are for another production cut of 1.5 million barrels per day. OPEC is under the gun with many OPEC nations now pumping crude for less than it costs them and less than their budgetary requirements. Russia is not an OPEC member but they budgeted income of $75 per barrel for 2008 and $95 for all of 2009. Their budget is being crushed by oil prices in the mid 40s and this is same problem with Iran and Venezuela. They are drastically underwater and need prices to rise. The hype will be huge as we near the meeting. This will produce some extreme volatility with crude contracts expiring on Friday.

Ecuador said on Friday it was going to default on a $31 million interest payment due on Monday. Ecuador produces 500,000 bpd of oil and the drop in value has killed their ability to make their debt payments. This is a preview of what we will continue seeing by oil producing nations until prices rise.

Economic Calendar
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I also added the Goldman Sachs earnings to the calendar for Tuesday because all eyes are on the firm as an indicator for the sector. Goldman may post the worst quarter in its history with losses nearly every business area. If Goldman reports a smaller loss than expected loss it could be positive for the banking sector. It would be hard for them to surprise on the downside given the negativity so I view the event as a possible market catalyst.

I had surgery on Tuesday and spent the last three days in bed watching stock TV. The negativity was amazing. You would think the normally bullish biased reporters had taken a Jekyll and Hyde pill and changed their stripes. The markets actually did fairly well given the abundance of gloomy outlooks. Every dip was immediately blamed on the news events of the last hour as if investors were just waiting for the next sound bite to bail from their positions.

I was encouraged by the tech stocks and especially chips. Intel closed at the high of the week and the Semiconductor Index (SOX) was very close to its highs. This is even more amazing since the chip sector will see a decline in revenue for 2008 for only the fifth time in the last 25 years. According to Gartner Inc, the chip sector is on track to post revenue of $261.9 billion, down -4.4% from 2007. Also according to Gartner 2009 is going to be considerably worse. They said the recession will cross two calendar years and could be the first back-to-back years of revenue declines. Prior decline years were 1985, 1996, 1998 and 2001. Gartner said it may be too early to buy the group since 2009 estimates are likely to be cut significantly after Q4 earnings results. Evidently investors are willing to take that chance and are buying chips today as the base for a tech portfolio for 2009.

The Nasdaq announced at 8:PM on Friday it was re-ranking the Nasdaq-100 as of the market open on Monday Dec-22nd. Stocks added to the NDX include ADP, FSLR, LIFE, ROST, MXIM, ILMN, PPDI, ORLY, URBN, JBHT and XCRX. The following 11 stocks will be removed from the index. AMLN, CDNS, DISCA, LAMR, LEAP, LVLT, PETM, SIRI, SNDK, VMED, WFMI. Expect increased volatility in all 22 stocks next week. Here is another list of stocks that deserve your attention. RBC Capital put together a list of stocks most likely to benefit from Obama's infrastructure stimulus program. Some of these are not your normal big name stocks and I thought you might benefit from seeing the list. EME, FLR, GWW, FAST, PWR, CAT, JEC, TEX, VMC, ESLR, FCEL and SI. With stocks rebounding on continued horrible news it is tough to form a bearish perspective. When bad news is no longer capable of holding stocks lower it is time to start looking for stocks to buy. We had some horrible news last week but the VIX lost ground all week. Jobless claims hit 573,000 for the week and the highest level since 1982. That is pretty significant news and the markets shook it off. The Senate voted to allow the big three automakers to go bankrupt and the markets rebounded from triple digit losses to close positive. Bank of America said they were cutting 35,000 jobs and the banking sector closes higher. The bad news bulls are back and they are buying the dips. Unfortunately they are not buying in heavy volume and they have not been able to move over strong resistance.

However, there was a really positive move on Friday. The Dow rose +0.25%, Nasdaq +1.4% and the Russell gained a whopping +3.81%. If you read my commentary often you already know I believe the Russell's health is the thermometer for the broader market. Nearly a +4% gain on the Russell on Friday is very bullish for sentiment. I only wish it had been on heavier volume.

I was frustrated the Dow did not manage to break over 9000 on Tuesday but I guess I should be happy that it closed flat for the week given the highly negative news. Support on Friday was 8400 with 8200 as the backup from the prior week. If the lows keep rising eventually we will break over that resistance at 9000.

Dow Chart
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The Nasdaq also failed to break over strong resistance at 1600 but like the Dow it found support at a higher level of 1500 on Friday. I already pointed out that bullish techs in the face of negative chip sales is positive and December is normally a positive for tech stocks. No complaints here.

Nasdaq Chart
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The S&P was a carbon copy of the Dow with support at 860 well over the prior week's support at 820. The S&P spent three days knocking on the door over 900 only to implode on the Madoff news, negative BlackRock comments and the outlook from Jamie Dimon the Chase CEO on Thursday. Those three events occurred almost simultaneously Thursday afternoon and the implosion was instant. The S&P lost over 50 points from the Thursday high to the Friday low but still rebounded to close fractionally higher for the week. This was far from bullish but not bearish either.

S&P Chart
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The Russell closed well off its highs for the week but the +3.81% gain on Friday was critical to sentiment. There was a survey released on Friday on best sectors coming out of a recession and the small cap growth stocks were number one every time. Small cap growth won out over small cap value putting the bullseye on the Russell 2000 for aggressive investors. Initial resistance is 480 with a close at 467 and a definite patter of three higher lows since Nov-21st. The Russell continues to tell me the bottom for 2008 is behind us. However, if the Russell can't move over 480 by Christmas then it suggests an early January market drop.

Russell Chart
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The last couple weeks of the year are normally bullish as year-end retirement money is put to work. That could be what we are seeing today and holiday sentiment could continue to push the indexes higher until Christmas. After Christmas I am worried. I am worried we are going to see some selling once the calendar turns over to 2009. We could see some traders try to front run selling in the first week of January by taking bearish positions after Christmas. I believe any January dip will be bought but it could be a substantial dip. I would urge caution about holding longs over the holidays.

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2008 has been a very tough year with record volatility, record market moves and the biggest financial crisis since the great depression. This has been an extremely tough year to make money or just keep what you had when the year started. If you are reading this you are well ahead of most traders. You have waded neck deep through the valley of risk and are now ready for the reward.

We have seen major companies fail or be sold for chump change like Lehman Brothers, Merrill Lynch, Bear Stearns, Wachovia, Washington Mutual, AIG, Fannie, Freddie and Countrywide Financial. If I had listed those firms in January 2008 and told you they would either fail or be nationalized by the end of 2008 you would have thought I was crazy.

Crude prices soared to $147 in July and traded as low as $40.50 in December. This kind of volatility has never been seen before. Commodity funds were wiped out. Over a trillion dollars in commodity value was erased. Dozens if not hundreds of hedge funds will have closed their doors by the end of next quarter.

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Jim Brown

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