The potential for a Dubai debt default roiled the global markets with fears there may be more financial monsters left under the bed.

Market Statistics

There were no economic reports on Friday but had there been you can bet they would have been ignored. The storm cloud spreading outward from Dubai was not a hurricane but it was definitely rocking the global boat. Basically the government of Dubai has an investment vehicle called Dubai World. Dubai World is run by Dubai's ruler, Sheikh Mohammed Bin Rashid Al-Maktoum. Dubai World had borrowed billions from more than 70 lenders around the world. Dubai World develops projects all over the world and recently the scope of their projects has moved from the ridiculously extravagant to obscenely extreme. Dubai World has $3.52 billion in bonds due on Dec-14th from it's Nakheel unit. Dubai World has more than $60 billion in debt and now it can't pay its bills. Since it is a quasi-governmental entity run by the country's ruler this reflects badly on the ability of the country of Dubai to pay its own bills. That $60 billion number is based on a filing in late 2008. Analysts said it could be as much as $90 billion today.

Dubai World is not bankrupt but they are asking for a six-month moratorium on paying their debts so they can restructure their finances. This is a totally reasonable step for almost any company but being owned by an oil rich nation causes enquiring minds to wonder how deep the distress goes in Dubai and whether this same virus has infected nearby oil producers in the middle east. Actually Dubai does not have any oil of its own but is surrounded by oil rich giants. Dubai tried to use this geographic opportunity to create a booming business and resort community as a hub for that oil rich region. Dubai is now the most populous city in the United Arab Emirates.

Some people believe this financial problem is specific to the Dubai World entity. Over the last decade the people running Dubai World have gone off the deep end in over spending on projects that are beyond belief. One reporter called Dubai, Vegas on steroids. For instance Nakheel Properties, a subsidiary of Dubai World, developed the man made islands Palm Jumeriah, Palm Deira and Palm Jebel Ali with plans to construct other island complexes called The World and The Universe. Construction on the 300-island World complex was halted in early 2009 and the developer committed suicide. The Palm Deira was planned to be eight times larger than the Palm Jumeriah but due financial problems the construction was reduced in size then halted. Rumors have been spreading for months that the Palm Jumeriah island is sinking back into the Persian Gulf.

Palm Jumeriah

Palm_Deira

Currently under construction and scheduled for completion in January is the 2,684 foot tall Burj Dubai skyscraper in Dubai. This is almost twice the height of the World Trade Center towers at 1365 feet. It has 160 floors compared to the prior 110-floor record for the WTC towers. Office space rents for $3,500-$4,000 per square foot. Maybe I should say "was" renting with the Dubai economy in a shambles they may not be renting any today. The budget for the project was $4.1 billion. As if this was not big enough there were plans to build the Nakheel Tower to be the world's next tallest building with a target height of 3,500 feet. Plans for the tower were suspended several months ago due to financing problems.

Burj Dubai

Another Dubai World (DW) project is the Las Vegas City Center currently under construction. DW is doing this in conjunction with MGM Mirage (MGM) to develop an 18 million sq ft project costing approximately $11 billion. DW provided joint venture funding for the project. The original estimate was $4 billion but design changes and cost overruns common to DW projects has pushed it higher. The center is expected to open for business in December and both DW and MGM have issued statements saying the current DW problem will have no impact on City Center because the project is already fully funded. The $11 billion project is just another example of how DW spending was out of control.

Las Vegas City Center

In 2007 90% of the population of Dubai was made up of foreign workers. However, with the Dubai economy in free fall due to the global recession and the 50% drop in oil prices the worker population is either fleeing or being fired. Over 1500 work visas are being canceled every day. When your visa is cancelled you must leave the country within 30 days. Many of these workers were promised years of work with a decade of development ahead. Most bought homes in hope of profiting from the economic boom.

With the boom now busted and 50,000 workers a month being kicked out of the country the economy is in ruins. 50,000 workers consume a lot stuff and generate a lot of economic activity. Remove that many per month over the last two years and there is not a lot of activity left. Real estate prices have crashed up to 50%. Luxury vehicles are being sold for half of their value 12 months ago. The workers leaving the country can't sell their property because they owe more than it is worth so it becomes abandoned.

Dubai still has a debtor's prison. If you can't pay your debts you go to prison until your relatives pay them for you. Earlier this year newspapers reported there were more than 3,000 cars abandoned at the Dubai Airport, left by debt ridden foreigners who were fleeing the country to avoid going to prison. Many cars had notes of apology along with maxed out credit cards left inside.

The Abu Dhabi Central Bank floated a $10 billion bond offering back in February to help the government of Dubai pay its debts. Abu Dhabi bought another $5 billion in Dubai debt this week. The Royal Bank of Scotland (RBS) was the biggest underwriter of loans to Dubai World with HSBC Holdings also having a large exposure. RBS arranged $2.3 billion in DW loans since 2007. HSBC has $17 billion in loans in the UAE that could be impacted by a default in the region. British banks in total have more than $49.5 billion in loans to the UAE.

Deutsche Bank said Dubai borrowed more than $80 billion in a four-year construction boom and that boom has gone bust. Commercial property values are down -50% from their 2008 peak. Over 1,000 projects have been halted and construction terminated. Anyone holding a loan on one of these projects is in serious trouble. Arnab Das, head of market research and strategy for Roubini Global Economics said, "Central banks around the world may have stabilized the financial system but you can't make all the excesses disappear and Dubai had a lot of excesses." Abu Dhabi Commercial Bank has a large exposure to Dubai World and that is not the first problem they have had in the region. Two Saudi Arabian families defaulted on loans earlier this year totaling more than $610 million. This DW problem is further confirmation that being in the middle of an oil empire does not guarantee financial success.

After laying out all the problems and players in this scenario I am going to tell you I don't think this is a real problem. The Arab Monetary Fund (AMF) based in Abu Dhabi, will meet over the weekend and I suspect they will work something out. Even if Dubai World imploded completely the total risk is more like $20 billion than $60-$90 billion. That is a lot of money but it is manageable. Dubai World is likely to get a serious tongue lashing from the AMF and have to agree to some serious restrictions but the AMF and Abu Dhabi will bail them out in some form. It is one big distantly related family of sorts and a problem with DW hurts everyone else in the region get development loans. I suspect we will have some news by Monday that puts the market at ease.

You may not realize that the news on Dubai World broke on Wednesday but nobody in the U.S. reacted to the news. It was only after Europe and Asia crashed on Thursday that U.S. investors started paying attention. Europe crashed because the majority of loans to Dubai World and the UAE in general came from European banks. Some of those banks were down more than 10% on Thursday. This rippled out to other overseas markets on Friday and the U.S. played catch up on Friday. I believe the U.S. decline on Friday was just a knee jerk reaction to the two days of European/Asian declines.

Next week is a big week for economics. There are four ISM reports with the national manufacturing index on Tuesday. The Fed Beige Book is on Wednesday with another economic view of the various Fed regions.

Friday is the big event with the Non-Farm Payroll report for November. The official consensus estimate is for an improvement to a loss of -145,000 jobs from -190,000 jobs in October. However, the whisper numbers are improving. Morgan Stanley is expecting an improvement to a loss of only -90,000 jobs and a +100,000 revision to October. That is extremely optimistic compared to the majority of analysts. However, we saw new Jobless Claims fall to only 466,000 last week. That is the lowest level since 2008. Unfortunately that headline number is after the seasonal adjustments. The actual behind the scenes number was 543,926 but who is counting. This chart shows that claims have been declining since March but appear to have accelerates lower over the last month.

Weekly Jobless Claims chart

Weekly Economic Calendar

Friday was not only Black Friday for retailers but Black Friday in the markets. The market was only open for half a day but it was ugly. The Dow dipped to -230 at the open but quickly rebounded into the -80 range before sinking again at the close. The opening was a knee jerk reaction to declines in Europe/Asia but the closing dip to -154 was a dose of caution settling in before the weekend.

Investors were seeing the dollar spike higher, gold and crude implode and equity markets extremely erratic. Cautious traders moved to cash to wait for the smoke to clear. I wish the markets had closed lower because I believe this is a buying opportunity.

Gold prices fell from $1195 on Wednesday night to $1130 on Friday morning. This was due to a monster short squeeze in the dollar after a flight to quality started it moving higher. You would have thought gold would be a hedge against negative news but the dollar rebound was too strong.

The Dollar index dipped to a 15-month low at 74.17 and a 14-year low against the Euro. This is when gold hit $1195. When the dollar began to rebound almost vertically to almost 75.60 the gold/dollar hedges evaporated. Most equity traders don't realize that a full 1.50-point move in the Dollar Index is almost unheard of for one day.

If you are shorting dollars you are dealing in pips not points. In the EURUSD currency pair a pip is .0001 and it is worth $1 to the trader. A move in the dollar index is not exactly correlated to the EURUSD because it is a basket of currencies but works in this illustration. The dollar index moved from 74.170 to 75.575. In a currency trade that would be roughly the equivalent of $10 for every .001 point move. That move was 1,405 x $10 or $14,050 per contract. (I am just using the dollar index as an illustration because everyone can get this chart on their home PC without a currency futures subscription.) If you were long/short 5-10 contracts you made a lot of money or lost a lot of money if you did not stop out.

If you were a money manager in some sort of hedge trade where you were short the dollar and long gold you would probably not be playing with just 5-10 contracts but 500-1000 or even a much bigger number. This was a monumental move and when paired with gold futures the contraction in position value was huge. You had a $65 drop in gold prices equal to a $6,500 move per full size gold futures contract. If you were short the dollar and long gold it was a rough 24 hours. I really suspect the monster moves were more short covering than anything else.

Dollar Index Chart

Gold Chart

Crude oil was almost an identical chart to gold with a huge drop from $79.92 on the 23rd to $72.39 on Friday. The Friday intraday spike was almost entirely from the dollar rebound. Those playing the oil hedge rather than the gold hedges were equally surprised. Obviously there was no change in the fundamentals of oil overnight. It was purely a currency related move. That drop to $72.39 would have been a great dip to buy. I have been worried over putting on any long trades on oil stocks over the last few weeks because of the repeated tests of support at $76. The speed with which crude recovered from the dip has put me at ease. This would have been the prime opportunity to settle at a lower level but buyers rushed into to dip.

Crude Oil Chart

Other than the Dubai news and the moves on currencies and commodities there was very little news in Friday's shortened market session. Reports from the retail sector claim there were bigger crowds swarming stores on Black Friday than in 2008. In our local Toys-R-Us the checkout line was three-hours long. In the local Super Wal-Mart customers had been sitting on the floor next to the roped off sections for most of Thursday to be there when the specials started on Friday.

Interviews with Best Buy managers around the country said crowds were larger than last year because products were priced cheaper. Managers said they hoped sales held for the next three weeks so they could go into the holidays with empty shelves rather than lots of excess inventory. Hewlett Packard netbook computers for $199 appeared to be the hottest sellers along with big screen TVs.

All the online retailers are gearing up for cyber Monday. That is where all the shoppers this weekend made note of items they wanted to buy and will go shop online from work on Monday. I cruised some websites Friday and several were barely limping along. It took 30-45 seconds for some Micro-Center pages to load with the current bargain specials. NewEgg.com, my favorite electronics seller, actually had some pages fail to load due to "server too busy" and others were very slow. Amazon pages loaded quickly in 5-10 seconds but Ebay pages became increasingly slow as Friday night arrived. All those service delays tell me that business is going to be much better than most analysts had expected. That assumes of course that it wasn't just people looking for Black Friday specials online.

I am actually cautiously bullish for Monday but we do need to realize that the Dubai event is not over. Dubai reminds us that there are still problems in the world and that could prompt money managers to take profits. The markets were making new highs last week and Dubai was a spot on a map. By next Friday it could be just a spot on the map again but there is always the possibility of a domino effect. The beginning of the subprime crisis started small. Finance companies that most people had never heard of began to experience higher loan losses. Small flags were raised but nobody expected the eventual crisis as the falling dominoes got progressively bigger.

Do you remember the Thai Baht crisis in 1997 that led to the Asian Contagion and came close to a global financial meltdown? Who knew the Thai Baht currency could cause a global meltdown? Thailand decided to float the baht and cut its peg to the dollar. Ho-hum you say? The currency imploded and Thailand exhausted its reserves trying to support it. When they finally ran out of reserves they devalued the currency and the impact cratered economies all over Asia. People forget that Thailand was already deep in debt because of real estate problems before they devalued the baht. The real estate domino was the first to fall and nobody outside Thailand heard it. Asian markets crumbled, Asian currencies plummeted in value and it took years for the problems to go away. The IMF had to bailout Thailand with a $20 billion program, part of $40 billion in total, in an effort to stave off a global meltdown. It was not until 1999 that Asian economies began to recover.

Just like the Thai Baht was the first domino to fall in the forest there is always the possibility that some event will appear suddenly today that exposes another new wave of problems that threatens to tank the financial system. Is it the Dubai default? I doubt it but I would have said the same thing back in 1997 about the Baht. My initial comment would have been "What is a Baht and why do I care?"

I think the wiser brother, Abu Dhabi, will bail out the wayward sibling just like they have many times in the past despite some comments to the contrary on Friday. Dubai has actually been an embarrassment to the rest of the UAE community with its obscene excesses. Dubai captured the world's attention as the wild child. Now they are back to the family begging for another bailout. I think it will happen but I expect some strong words and restrictions. However it happens it should put the markets to rest. Unfortunately it may take a few days for the fear to go away.

As for the major indexes the Dow came to rest right on decent support at 10,300. The news reports of crowded stores and better than expected sales should help smooth tensions. I would love to see the Dow begin to move higher from the 10,300 level but I would not be unhappy to see a further decline to 10,200 and a rebound from there. That would allow some further clearing of positions and give new buyers a better confidence to enter the market. Dow 10,200 is also stronger support.

Dow Chart

However, the S&P is giving me some cause for concern. The S&P declined to support at 1085 and then rebounded very slightly to close at 1091. The S&P has been struggling to move over 1100-1110 and hold the gains. 1110 has been rock solid resistance and I was hoping the historically bullish Black Friday session would make that low volume break over 1110 and give us a head start for month end next week.

S&P 1085 is going to be a critical level. Any further weakness next week has got to hold that 1085 level or we could be in for some falling dominoes of our own. There is still a lot of profit at risk from the March rebound and money managers on a calendar year end may decide that taking profits now in the face of global uncertainty is a wise, bonus saving, move. Let's hope that does not happen.

S&P-500 Chart

The Nasdaq is also giving me a cause for concern. The velocity of the 2009 rebound has slowed and resistance at 2200 was rock solid and prevented a return to even the midline of the uptrend channel. The Nasdaq has been trending down for the last seven days and although it closed back in the channel and slightly above the 50-day average it still appears in danger. The dip to 2113 and a three-week low was scary. A further weakening would target a return to support at 2035. Unfortunately I believe a decline to that level would not stop there.

I want to believe in the Nasdaq and on the strength of the big cap techs to power higher but I am not feeling the love here. When coupled with the weakness in the Russell it makes me question whether there is an upside possibility. Let's hope this overall weakness is temporary and news of holiday buying revives the chipmakers and stocks like MSFT, APPL, AMZN, EBAY and RIMM. A strong report about Hewlett Packard computer sales would not hurt either.

Nasdaq Chart

The Russell 2000 chart is ugly. The Russell closed on exactly the low of the day and exactly on support. The Russell lost the most of any major index at -2.52% and closed on the lowest tick of the day. This is not a bullish event. I would love to see a miracle on Monday and something pull the markets higher but the Russell is telling us there may be further weakness ahead. It may not be next week but baring a miraculous recovery in the markets I think the Russell is the leading edge of the next decline. There are of course 1001 things that could reverse it and I would be thrilled. I think we should watch the Russell next week as our coalmine canary and a signal to exit quickly if the canary drops dead.

Russell 2000 Chart

Despite the big moves in the markets the volume on Friday was only 4.5 billon shares across all exchanges. This was the LOWEST daily volume in over a year. It does not invalidate the big losses but it does make you wonder if we will see a big move on Monday as traders come back to work.

Monday is month end and typically the last day and the first two days of a month are slightly bullish. Hopefully there will be some good news out of Dubai and that weight will be off our shoulders. I told you earlier that I was cautiously bullish about Monday given the knee jerk action in low volume on Friday and higher expected month end volume next week. The Nasdaq and Russell will have to hold their ground for any positive sentiment to be effective.

I feel like the market is that repeat delinquent and the principal has given him one more chance to improve his grades or be kicked out of school. Next week will be that one more chance for the markets. If the market can escape the week without flunking the Nasdaq and Russell classes then maybe there is hope. A break under 575 on the Russell would be a failing grade. The Nasdaq has a little more room with a break under 2100 a serious infraction. I want to be cautiously bullish but only above those levels.


Option Investor is twelve years old this weekend. It is also the tenth anniversary of our Year End Renewal Special. We launched the first newsletter on the Sunday after Thanksgiving 1997 and the first EOY special on the Sunday after Thanksgiving in 1999. That calls for a double celebration this Sunday! Are we going to break out the party hats and crack open the champagne? Nope! Not at Option Investor. Feel free to do it on our behalf but our idea of a celebration is closing a winning position.

We are going to celebrate by announcing the Tenth End of Year Renewal special but you saw that coming. So I don't bore you with repetition you need to go here to see the details. I don't know about you but 2009 was so much fun I know you can't wait to see what the markets bring in 2010.
Click here for the 2009 Renewal Special Details

Happy Birthday!

Jim Brown