The quadruple expiration failed to cause any volatility and the markets traded flat ahead of the weekend event risk.

Market Statistics

Index options, equity options, index futures and single stock futures expired peacefully on Friday but the damage was done earlier in the week to leave the markets down an average of -3% and the first weekly loss in three weeks.

The obligatory opening spike was instantly sold and the indexes faded quickly but with the exception of the Dow they managed to hold onto minimal gains. Trading was lackluster despite strong volume of 9.0 billion shares. The extra volume came from the option expiration and from the normal quarterly rebalancing of the S&P-500 and the Russell indexes.

The big news for the day came from ratings agency Fitch. The agency affirmed the AAA rating on France but said it could downgrade the country over the next two years. Fitch also warned it was placing Spain, Italy, Belgium, Solvenia, Ireland and Cyprus on ratings watch negative to be completed by the end of January. This suggests those countries will have their ratings lowered. Fitch said the change was due to Europe's failure to find a comprehensive solution to the crisis. S&P and Moody's both downgraded Belgium earlier in the week.

Fitch said without a full solution the crisis will persist, "punctuated by episodes of severe financial market volatility that is a particular source of risk to the sovereign governments of those countries with levels of public debt, contingent liabilities and fiscal and financial sector financing needs that are higher relative to rating peers."

Fitch also said,"A comprehensive solution to the euro zone crisis is technically and politically beyond reach." All the ratings agencies were disappointed with the EU plan announced last week. They said that is fine for the next crisis but it has no relevance to the current crisis. "Of particular concern is the absence of a credible financial backstop", "This requires more active and explicit commitment from the ECB." The agencies understand that without a lender of last resort with an active bailout strategy the problems of the individual countries will continue to get worse.

The worry all day on Friday was the potential for an S&P downgrade of European countries after the close. They downgraded the U.S. back on Friday August 5th after the close. The worry of specific and numerous S&P downgrades has troubled the market all week. They said they would review their ratings immediately after the EU summit concluded and analysts believe the result of that review could be announced any day now. S&P placed the ratings of 15 nations on review for a possible downgrade on Dec 5th. Moody's said on Dec 12th it will review the ratings of all EU countries because the Dec 9th summit did not produce "decisive policy measures." Late after the bell on Friday Moody's downgraded Belgium two notches from AA1 to AA3 with a negative outlook.

I think it is pretty obvious there will be downgrades to euro zone countries. The market is slowly factoring it in but nobody really knows how bad they will be and who will be affected. It is tough to fully price in an unknown.

Without spending too much time on Europe it is clear the plan to make a new plan was not well received. What they did right is being ignored. The dollar swap lines announced two weeks ago is relieving temporary liquidity problems. The ECB announced three year loans to any bank at very favorable rates. These two actions should act to reduce the pressure on the European banking system until Europe finally comes up with a plan that works. Unfortunately those actions don't have any impact on excessive sovereign debt. They only help the banks deal with the daily cash drain as customers continue to withdraw money to put under the mattress.

The ECB three year loans carry an interest rate of 1%. They also said they were going to relax the collateral rules currently set at A-. That means the banks put up loans, notes, bonds, etc rated at least A- as collateral for the loans. If the ECB relaxes those rules enough to allow sovereign debt with a slightly lower rating then the banks would have a sudden windfall. They could borrow three year money from the ECB and then buy short term sovereign debt currently yielding 3% to 6% and put that same debt up as collateral for the loan. Pay attention, this is a critical point. The ECB can't loan money directly to a country. However, if they are willing to loan to banks using sovereign debt as collateral it would be a major change in sentiment. Suddenly there would be a market for that high yielding sovereign debt. New debt sales would be heavily bid and yields would go down. Banks would make the spread and that would provide a strong infusion of cash. This is a very subtle change in stance by the ECB and it could be a game changer. It would be the ultimate carry trade and the possible end to the rising yields on sovereign debt. The new collateral guidelines are expected to be announced next week and be effective immediately. This is effectively a new version of quantitative easing by the ECB and there is no limit on the loans.

This would in theory expose the banks to "Private Sector Involvement" or PSI. You may remember that private holders of Greek debt are going to get a 50% haircut or worse. You may also remember the major comment from the EU summit. "We will never do a PSI haircut again. That was a bad idea and it won't happen again." (paraphrased) Was this a signal to the banks so they would jump back into the sovereign debt markets financed with ECB money? Strange this situation is not being reported in the mainstream press.

Fitch was in a downgrade mood and they also downgraded BAC, BCS, BNP Paribas, GS, CS, DB and Societe Generale. All finished marginally lower for the day.

On the economic front the Consumer Price Index (CPI) for November showed inflation at the consumer level was zero for the month. This compares to a decline of -0.1% in the prior month and +0.3%, +0.4% and +0.5% in Sep, Aug and July. However, the core CPI rose at a +0.2% pace. On a year over year basis the core rate is up +2.2% but still within the range comfortable with the Fed. Energy prices declined slightly from the prior months but remains up +12.4% over the same period in 2010.

There was nothing notable about the CPI other than suggesting the slump in Europe is migrating to the U.S. and reducing demand and therefore prices. The drop in crude prices last week should help push consumer prices lower over the coming months.

CPI Chart

The economic calendar for next week is also light. The only material report is the Chicago Fed Index and that is still not high on the importance scale. The consumer sentiment surged in the last report and analysts are targeting much lower numbers on thoughts that was a data error. Estimates are a full 10 points below the last reading.

Economic Calendar

In stock news it was all Zynga (ZNGA). Unfortunately the IPO pop was a flop. Shares were priced at $10 and opened over $11 but fell almost immediately to as low as $9 before closing at $9.50 and a loss of -5%. Zynga may have been the victim of IPO overload. Last week was the most active week for IPOs since 2007. Nobody had any specific problems with Zynga but the 100 million share offering put a lot of shares into the market on a week that saw a -3% market decline. Zynga has a valid business model with earnings of $31 million over the last nine months with revenue of $829 million. High marketing costs of $122 million are typical for a rapidly expanding business. Zynga has 54 million users.

Eighteen out of the last 30 Internet stock IPOs are trading below their issue price. I believe this is related to the weak market rather than weak IPO stocks. Granted some of them are dogs but some are not. After a rocky start Groupon (GRPN) is starting to find buyers and the stock has rebounded +$10 from its $15 low.

Research in Motion was the second most discussed (cussed) stock of the day. RIMM shares fell -11% after a disappointing earnings report Thursday night. The blogosphere is alive with calls for the company to be broken up. One investor representing better than 10% of the outstanding shares and hoping to get to 20% believes splitting out the handset business and concentrating on the communications service business and enterprise platform could free RIMM to even bigger things. He suggested RIMM should quit competing with Android and offer the Blackberry software for the Android platform as well. The Blackberry platform is much more focused on businesses and could allow corporations to integrate the multiple devices used by consumers into one secure platform. I am not holding my breath.

RIMM's co-CEOs, Jim Balsille and Mike Lazaridis, announced they are cutting their own annual salaries to $1 each. Many investors probably thought that was still too much with the stock of this former high flyer down -75% this year. According to Yahoo Finance they have recently exercised $3.63 million in stock options. That may be chicken feed in the corporate world but it was still a slap in the face for RIMM investors. There may be a dual lynching in Ontario very soon. The bigger event was the delay of the new Blackberry version from Q1 to Q4. That is a lifetime in the smartphone world. Apple could have two new iPhones out in that same period. Turn out the lights, the party is over unless they find new management soon and make some drastic changes.

RIMM Chart

MagicJack VocalTec Ltd (CALL) said it canceled a planned stock offering because the devices were selling so fast they no longer needed to raise outside money. The company said it sold 365,000 MagicJack Plus devices over the last 30 days. The new device is no longer $14.95 but $69.95 and is expected to raise $50 million in cash over the next month. The old device plugged into a PC. The new device works by plugging it into any Internet outlet like a router or switch. The company said instead of going ahead with its secondary offering it was cancelling the offering and resuming the stock buyback program while the stock was so "attractively" priced.

Does anyone else think this sounds like a cleverly designed advertising campaign? On Dec 1st they announced a 2:1 stock split for Dec-16th. On Dec 9th they announced they would offer 1.5 million ordinary shares, 300,000 of those would be sold by existing shareholders. Seven days later they cancel the offering because of a sudden surge in sales. Now they are buying back shares because the stock crashed from $26 to $20 on the secondary offering announcement. Was this a serious miscalculation by management or a cleverly designed advertising campaign to get the name MagicJack in the news? As ugly as their chart is they needed something to produce a trend.

CALL Chart

Sears Holdings (SHLD) is going to become the world's largest seller of printed books in January. Yes, you read that headline correctly. Sears will begin listing online in January the inventory from all the Alibris sellers. Alibris is a portal through which independent authors, small book sellers and rare book vendors all list their publications. They have portals in countries around the world and a consolidated shipping service. Obviously they are not going to give Amazon or Barnes & Noble a lot of competition but at least it is one more step out of their humdrum routine existence. Unfortunately it did not help their stock price with a -8% decline on Friday.

Sears Chart

Saturday Dec 17th is the second busiest shopping day of the year. Fortunately for terminal procrastinators like myself there is still a week left to mull over my potential purchases. My wife discovered Amazon this year and bought nearly all her gifts without leaving the house. I am in the doghouse because I never told her I had an Amazon Prime account and two day shipping was free. She compensated for that omission by seriously abusing that feature this year.

Unfortunately there are not enough spouses shopping on Amazon this year to rejuvenate the stock price. It remains stuck to support at $180 on multiple worries. Once of those worries comes around every December when those Prime accounts get used to the maximum and Amazon has to eat millions in shipping costs. Amazon charges that off to marketing while other retailers charge it to cost of sales. That helps Amazon's profit margin calculations.

The second problem this year is the explosion of Kindle Fire tablets. Amazon does not release numbers sold but analysts are predicting between 6-7 million in Q4. Amazon claims it is the number one seller on the website. At $199 each and less than the cost of manufacture many analysts are expecting Amazon to take a huge hit on Q4 profits. They will make up for it in the long run because the Kindle is the greatest sales tool Amazon has ever created. Each tablet will be responsible for dozens if not hundreds of downloaded books and purchases from the Amazon site of non-book items. What else could Amazon ask for but a direct website link forever to every Kindle Fire sold? I just wish they could split their stock before the next rally.

Amazon Chart

The broader market managed to make it two days without a major decline but still ended down -3% for the week. The S&P bounced off resistance at 1225 on Thursday and then broke through that level to hit 1231 on Friday but could not hold its gains. The S&P closed at 1219 and a minor four point gain for the day. Support at 1215 has held for two days but there was no serious test.

The nine billion shares of volume on Friday were either expiration activity or index rebalancing. There was minimal activity otherwise. Traders were in the malls not the market. I am afraid that is going to be the pattern for next week as well. Traders have lost the incentive to be in the market. Quite a few hedge funds and professional traders close their books after the December option expiration until after the holidays.

While everyone is hoping for a Santa Claus rally the money flows are suggesting Santa may be AWOL. According to new data from EPFR, global equity funds saw outflows of $9.5 billion in the week ended Dec 14th. That was the fourth consecutive week of redemptions. Bond funds saw inflows of $1.1 billion and money markets $3.2 billion. Money market funds now have 12 consecutive weeks of positive inflows. That is the longest streak since Q4-2008.

EPFR said there was positive inflows of cash to equity funds on the Friday the EU summit plan was announced. However, four days later when everyone began trashing the plan to make a new plan, equity funds saw outflows of nearly $7 billion in one day. That was the biggest one day outflow since August. Emerging market funds have seen outflows of $38.8 billion year to date on worries China is in for a hard landing. This time last year they were sitting on $91 billion in inflows.

I believe the volatility over the last six months has scared investors out of the market. Triple digit ranges on the Dow are an everyday occurrence and quite often it is triple digits in both directions. Most retail investors are probably nursing losing positions and contemplating closing more than usual before year end to capture the tax deductions.

We may not see investors come back to the market until January. Everyone wants to see a Santa Rally but few are willing or convicted enough to make it happen. Opening spikes the last two days were instantly sold. The buyers are notably absent but it was an expiration week. This coming week will be the key.

Resistance on the S&P is still 1225 followed by downtrend resistance at 1250 and the 200-day at 1260. Support is 1215, maybe 1200 as a round number, 1185 and 1160. With a growing number of analysts talking up 1160 it may keep buyers on the sidelines in hopes of getting a bigger dip.

The offset to the bearish sentiment will be the end of year retirement contributions and investment of year-end bonuses. That typically produces an end of December early January bounce. However, I fear for January. Once the year is over and managed funds are able to revert to cash we may see some move to the sidelines until the European crisis cools and China's economic picture becomes clear. The PMI for China was in contraction territory last week for the fifth consecutive month. They are still correcting and were it not for Europe grabbing the headlines every day the market would be a lot more worried about China.

S&P Chart

The Dow was the only major index to close negative thanks to IBM -$3.91 (-32 Dow points) and UTX -$1.55 (-12 Dow points). IBM said it was acquiring software vendor Emptoris for an undisclosed amount.

The Dow is not normally moving average sensitive because of its narrow 30 stock construction but it has come to a dead stop on the support of the 50-day average (11,807) for the last three trading sessions. The 200-day average (11,938) has been the limiting factor on the upside. The reason these averages are asserting themselves now is the thin volume and relative uncertainty about market direction.

The Dow is still mildly bullish until it breaks stronger support at 11,600 and a rebound over 12,200 would be strongly bullish.

Dow Chart

The Nasdaq is in a rut. It has traded in the same basic range for the last three days centered around 2550. The 100-day average (2565) is now solid resistance on the Nasdaq. The Nasdaq was knocked lower on Tue/Wed when Apple declined -$15, Priceline -$40 and Google -$20. Techs were hit hard on those two days and buyers have not returned. However, it was expiration. Monday starts a new week.

Nasdaq Chart

The Russell is holding above critical support and performing slightly better than the large cap indexes. This is probably related to the January effect where fund managers buy small caps for the coming year. Small caps typically rise in late December.

Russell 2000 Chart

The Dow transports have the best chart of all. The falling oil prices are stimulating the airlines and taking the pressures off the trucking sector. The transports have strong resistance at the 200-day at 4975 and a break over that level would be strongly bullish for the market.

Dow Transport Chart

I am neutral for next week. Belgium was downgraded Friday night but it was expected. That could increase the growing expectations for further downgrades of European nations. On the plus side expiration week is over and the institutional traders have left the building. This week is normally bullish as retail traders invest their bonuses and retirement contributions are put to work.

Normally bullish is like saying it normally snows in January. It almost always snows but that does not mean there may be weeks of sunshine. Normally bullish does not mean always bullish. Market sentiment has been damaged by Europe and by numerous earnings warnings. That means the rest of the year is a tossup. Volume should become increasingly light and that favors historical trends.

I would continue to suggest if you must be in the market to limit position size and quantity and exit early.

 

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You cannot bring about prosperity by discouraging thrift.
You cannot strengthen the weak by weakening the strong.
You cannot help little men by tearing down big men.
You cannot lift the wage earner by pulling down the wage payer.
You cannot help the poor by destroying the rich.
You cannot establish sound security on borrowed money.
You cannot further the brotherhood of man by inciting class hatred.
You cannot keep out of trouble by spending more than you earn.
You cannot build character and courage by destroying men's initiative and independence.
You cannot help men permanently by doing for them what they can and should do for themselves.


Commonly attributed to Abraham Lincoln but actually penned by John Henry Boetcker in 1916.