It would sure be nice if we could just step away from the markets for the rest of the week and start over again on Monday with Korea, Ireland, Portugal and the Fed only a bad dream in our past.
It is hard to decide which entity caused the most trouble today and there was a lot to choose from. Overnight events in Korea and Ireland sent futures spiraling into the red overnight and conditions never got better.
North Korea attacked a South Korean island by firing scores of artillery shells that destroyed house, killed two and wounded more than 20 people. This was one of the biggest attacks by Korea since the war ended in 1953. South Korea fired back and scrambled jets to target the guns.
The island is just across the border from North Korea. The leader of South Korea warned of an immediate and devastating response if the North attacked again. The U.S. administration promised to defend South Korea if needed. The U.S. has 28,000 troops in the south as a peace-keeping force.
Korean Island Under Attack
Most analysts believe this is just a cry for attention from Kim Jong-il as he fades from relevancy. He is in ill health and is passing the leadership to his 20-year-old son. This could have been a teaching exercise as well on how to deal with the south and gain concessions from the world powers. He has made a practice for decades of creating an event to get everyone all excited and worried about war and then he promises to be good if the major powers will give him something in return. Kim is an expert in political blackmail using brinksmanship as a tool. You may remember the north sunk a South Korean naval destroyer and killed 46 sailors about a year ago in an unprovoked attack by submarine.
North Korea created a fuss last week when they took a noted scientist to see their previously undisclosed uranium processing plant with 2,000 active centrifuges. This was another "in your face" effort to attract attention.
The exchange of fire of about 100 artillery rounds each crushed the won and sent the dollar higher. South Korean stocks declined sharply. However, in past attacks by North Korea the impact on the equity markets was fleeting with a recovery almost immediately. Everyone knows it is just a game with the North and neither country wants to go to war. The North has overwhelming military force positioned on the border and could inflict significant damage on South Korea in any conflict. They know they would eventually lose but they are prepared to play the mutually assured destruction card if the U.S. and allies attacked.
Problems in Ireland flared up again as citizens protested the austerity budget the country was going to have to enact in order to get the bailout. The prime minister defied calls to resign saying the national interest required he press on to unveil a four year austerity package on Wednesday. There were riots in the street and analysts expect them to increase once the plan is announced. The government is expected to cut the minimum wage, social and welfare spending. They will also cut the number of government workers, add a new property tax and raise income taxes.
The banking sector in Ireland is under serious pressure despite the promise of a major bailout by the IMF. Some major Irish banks have reported that deposits have declined from 15-17% since the first of the year. Analysts believe a multi notch downgraded of Ireland's debt could occur at any time.
Portugal is now expected to be the next target by speculators once the Irish bailout is completed. Lawmakers in Portugal are bracing for what they know will be the required budget cuts and austerity measures. Portugal's deficit is not 9.3% of the GDP and well above the 3% limit for EU countries. The official debt is claimed by the government to be a whopping 86% of GDP but most analysts believe it is actually much higher and well over 100%. The most recent estimate is 112%. It seems public accounting standards in the EU countries is mostly smoke and mirrors and we saw in Greece their official numbers were well below the real numbers discovered by Eurostat.
Portugal still operates under the post revolution labor laws where unions rule. Laying off workers is nearly impossible and requires large compensation payments. Workers can refuse changes in their duties and hours. Civil servants can't be fired except in cases of extreme misconduct, which leads to bloating of the government rolls. Productivity is less than two thirds of Spain and educational levels are among the lowest in Europe. The minimum wage is 475 euros per month and the government has legislated prices and rates on almost everything in order to keep costs low and affordable on that wage. That means there is no incentive to build or manufacture anything since companies can't sell or rent for a profit. Even the Portuguese don't like their own country. A Canadian researcher claims nearly one million citizens have left Portugal in the last ten years.
I described the problems in Portugal in depth so once Ireland's fiasco is over you will understand why the focus is shifting to Portugal. Next up after Portugal is Spain.
The 90 billion euro bailout for Ireland was good for about 48 hours of calm. EU lawmakers don't seem to be getting much bang for their buck these days. It turns out the Irish government had been secretly negotiating with the EU for weeks over a bailout despite their constant public statements to the contrary. The continued country-by-country bailout process is producing increased worry that the euro is toast and the Eurozone is doomed. As the countries in need of help become larger and more costly there is a real fear that the rescuers will be in need of a rescue themselves. If Spain, the fourth largest EU economy, does require a bailout it would wipe out the rest of the 750 billion euro bailout fund and leave the union in dire straits.
This chain of bailouts, severe budget cuts and the associated civil disturbances are causing investor flight from the EU. This is pushing up the U.S. dollar at a time when the Fed would like it to be falling. OR, at least that is what the public Fed was saying. In the FOMC minutes from the November meeting there was some serious opposition to the QE2 program. Several members worried that it would negatively impact the dollar and raise risks of inflation. Others did not believe any further QE programs would have any impact on the economy.
The Fed went ahead with the QE2 program because many on the Fed were worried that slow growth and high unemployment could lead the country back into recession. The Fed was so concerned that they held a secret meeting in October where they discussed things like fixing an inflation target, fixing a price on 10-year notes and having Bernanke hold routine press conferences to counter rumors and update analysts on the current conditions.
The Fed cut its estimates again for economic growth. They cut GDP estimates for 2010 to 2.45% a decline of -0.9% and raised unemployment estimates by +0.25% to 9.6%. They cut 2011 estimates to 3.3% a decline of -0.55% and raised unemployment by +0.5% to 9.0%. They raised GDP estimates slightly for 2012 to 4.05% but added +0.65% to unemployment and pushing it to 7.95%.
The Fed disclosed it was aware their message to the markets and to consumers was being lost in the translation. Few consumers understand Fedspeak. For this reason having Bernanke hold regular press conferences would probably not be beneficial. However, the Fed needs to improve its communication skills. That is harder to accomplish than you would imagine because a lot of what the Fed does it does in secret. Too much information could be harmful to our health. What did come out of the FOMC minutes is a Fed that may be contemplating some even more drastic measures to build a fire under the economy. One thing mentioned continually now is charging banks a fee to deposit money at the Fed. Currently the Fed pays the banks interest on money on deposit. This would force the banks to lend money or face a decline in profits.
Nobody was watching the economic reports today but there were several key releases. The GDP estimate for Q3 jumped to +2.5% from 2.0% in the last update. This was up from a +1.7% rate in Q2. The increase came from upward revisions to consumer spending, exports and state and local government activity. Corporate profits rose by $44 billion in Q3. Import growth slowed as the dollar declined and that added to GDP.
The Core PCE Price Index rose by only +0.8% on an annualized basis in Q3. This is the Fed's preferred inflation measure and the miniscule gain continues to suggest deflation is still more of a threat than inflation. Q4 GDP is expected to suffer from a decline in stimulus spending but be helped by a surge in hiring in Oct/Nov.
The Richmond Fed Manufacturing Survey rebounded for the second consecutive month with a headline number of 9.0. This is the highest level since August and a gain of +4 points over October's 5.0 reading. The new orders component rose from 8 to 10 and the employment component surged from 4.0 to 10.0. CapEx spending plans jumped from 16.0 to 24.0 indicating manufacturers were starting to feel more comfortable about expanding. This was a very strong report.
Richmond Fed Chart
The regional and state employment numbers for October showed that employment rose in 41 states and DC. Only six states posted a decline in hiring. The states with the most hiring were Texas at +47,000, New York +40,600 and California +38,900. Nevada still had the highest unemployment at 14.2% followed by California at 12.4%.
Unfortunately existing home sales for October posted a -2.2% decline to 4,453,000 units on an annualized basis. That was still slightly higher than the consensus estimates but not a material improvement. All four regions posted declines with the South falling the most at -3.4%. Compared with year ago numbers sales are down -26%. That is distorted because of the tax credit sales in 2009. Sales normally decline in the fall as colder weather the holidays discourages house shopping. Strict mortgage credit requirements are still blamed for the lack of sales. The pendulum has swung too far in the opposite direction from the pre recession credit bubble.
Corporate profits hit a record in Q3 and that is positive for the market in the future. Total adjusted profits rose +2.8% on a quarterly rate. This represented a seventh consecutive quarterly increase and a +67% gain over that period. Wage growth also rose. Total compensation in the second quarter, the latest complete numbers, showed that salaries and wages rose +6% on an annual basis and more than twice the initial estimate. The Q3 estimate is now over 3%. Higher income increases spending and promotes higher corporate profits. Despite the current weakness in the market it appears conditions are improving and should produce a rally once all this geopolitical mess passes.
With Thursday and Friday government holidays the rest of the week's economics will be squeezed into Wednesday. The only material report is the Kansas Fed Manufacturing Survey. If the geopolitical fires are still burning all these reports will be ignored.
About the only news in the stock world was the gain in Hewlett Packard after their earnings on Monday. HPQ shares rose +94-cents on a really ugly day. Other gainers on the NYSE were CF, CRM, PPD, BIG, DG, AGP and CMG. Leaders on the Nasdaq were SODA, JOBS, OPEN, SQQQ, MDAS and TSLA.
I heard somewhere that Tesla Motors has a short interest in the stock of more than 64%. Those shorts just keep pushing it higher even on the bad days. Tesla is up nearly 100% from its IPO price despite having sold only 1200 roadsters.
The SEC and FBI are expanding their probe in what could be the biggest insider trading case ever. Hedge funds MFS, Citadel, SAC Capital, Wellington Management, Level Global Investors, Diamondback Capital Management and mutual fund company Janus have all admitted to receiving information requests and/or visits from the FBI. The general complaint seems to revolve around paying for what could be considered inside information. Things like paying farmers near a plant in China to count the number of trucks leaving the plant. Another fund paid people to stand outside a casino and count the number of people entering. That fund multiplied the number of visitors by the known average loss to get an idea on how much the casino was taking in on a daily basis. Is that wrong or just some smart private research. We have no idea where this probe will end or when but many are saying it would be tough to get a conviction on those kinds of research.
The Dollar Index spiked almost a full point today as the flight to safety from the Eurozone debt debacle and the Korean attacks had investors moving money in large amounts. The spike in the dollar put it at two-month highs. This would be a likely place for it to fail if there were not some many problems in Europe. With Ireland unveiling the new austerity plan on Wednesday there is no telling what will happen.
Dollar Index Chart
Obviously South Korean stocks were hit hard and the EWI ETF declined -5.4%. If you want to play the rebound you could use SKM, KEP, SHG, PKX or LPL.
In the U.S. markets the S&P fell back to support from last week at 1175-1180 and could be poised to rebound. However, traders don't like this daily dose of geopolitical surprises. I am worried that trading for Thanksgiving week has come to a screeching halt. Actually I am hoping it will be a halt and not a serious breakdown. If support at 1175 breaks we could be in for a complete change in market sentiment.
Like the S&P the Dow has respected its current range for the last week. We are however right on the verge of a serious breakdown if the geopolitical events don't begin to fade soon. The flash crash killed investor confidence and it was just starting to really solidify in late October but China, Ireland and Korea have now put a serious dent in that confidence.
If the Dow breaks support at 11,000 it could start a chain reaction of profit taking now instead of waiting until year-end or the first couple weeks of January. Individual investors have a lot of profits stored up in the market and now we are right back where we were a week ago with the rally erased.
The Nasdaq closed below 2500 once again and that is a key sentiment threshold. The damage was slight but it is still a worry. The -25% retracement level held last week and I would like to hope it would hold again but the S&P and Dow are leading the market down. It may not be up to the tech stocks to rescue the market once again.
I have been a dip buyer to S&P 1175. I am still going to buy it tonight but with a lot more caution. Sentiment has been damaged and this normally bullish week is struggling. I had a reader email me today asking if this was the year of opposites where normal trends were all reversing. I am not at that point yet and I think we are just in the grip of a lot of bad news. Unfortunately I don't see that news ending soon. Ireland is going to have more problems on Wednesday when they release the new austerity budget. Korea is a wild card and China has been very quiet this week. Who knows what new problem could suddenly show up to cause trouble? When the bulls are charging this kind of news is ignored. This week the bulls are obviously confused and for good reason. Buy the dip but do it cautiously!
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