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Daily Newsletter, Thursday, 08/30/2007

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Table of Contents

  1. Market Wrap
  2. New Plays
  3. In Play Updates and Reviews

Market Wrap

A Potential Profit Collapse

Introduction

This morning, Standard & Poor's warned that global banks could experience a profit collapse, employing language that one CNBC commentator termed "apocryphal." S&P warned that pretax profit for those banks could drop 70 percent in the second half of the year.

The potential impact of any such profit collapse on economic growth became readily apparent when the GDP was released later in the morning. Sixty-four percent of the profits in domestic industries were produced by the financial industries. What happens to profits in domestic industries if profit in financials collapses?

Bad news continued. The CEO of H&R Block (HRB) compared the current dislocation in the mortgage lending market to that seen in the 1930s. The company has been trying to divest itself of its Option One unit, but the management says it may be preferable to see that divestiture collapse rather than the company incurring more losses.

The bombardment of negative news continued. In addition to S&P's and HRB's warnings, Lehman Brothers trimmed its price targets and/or earnings-per-share estimates for investment banks MS, MER, GS and BSC. Investment banks have been busy downgrading each other this week, with MER doing the downgrading a couple of days ago.

Credit Suisse cut its price target for Countrywide Financial (CFC) to $28.00, still well above CFC's current price but also well below the firm's previous $40.00 target and CFC's actual prices above $40.00 back in May. KKR wrangled with banks for the $24 billion it needs for its acquisition of First Data (FDC).

In addition, Freddie Mac (FRE) added more worries when it reported a $320 million loss on new mortgages, leading to a 45-percent drop in earnings. The trouble wasn't confined to the financial sectors, however. Merrill Lynch downgraded Wal-Mart (WMT) to a sell rating. Sears Holdings (SHLD) reported a forty percent drop in profit for the second quarter.

After all that terrible news, market breadth as measured by advancers versus decliners was negative much of the day.

So what happened? Why did markets hold up as well as they did? Some posted gains and some tread water, producing relatively small-bodied candles in the top half of yesterday's ranges.

Thornburg Mortgage's (TMA.N) may have helped. The firm asserted that its sale of convertible bonds would allow it to start making new loans. The company also said that it didn't lose as much on the asset sale it was forced to make earlier this month as had been estimated. In addition, the company lost only $863 million rather than the previously estimated $930 million. As you may remember, Thornburg Mortgage is considered a jumbo mortgage specialist with loans that were considered high quality, but the credit crunch forced it to sell assets and delay its scheduled dividend payment. It has rescheduled its dividend payment to September 17.

Techs performed well, too, despite decliners leading advancers on the Nasdaq into the afternoon. Energy-related stocks represented in the XOI and OIX at least held up, if they didn't provide fuel for a push higher. In addition, the Fed issued repos in the amount of $10.00 billion, almost enough to cover the entire $10.25 billion maturing today, so that no liquidity problems arose from that source. Both the euro and the USD rose against the yen since their 6:00 am CST lows, and the maintaining of support for these currency pairs may have proved reassuring, too.

The day's actions may just have been about positioning ahead of our Fed Chairman's Jackson Hole appearance tomorrow, another theory. My theory? The day's actions were part of the pattern we've seen lately. We've seen big up days and big down days punctuated by days that produce small-bodied candles as investors try to recover from their spinning heads and determine what to do next. It was time for uncertainty, and tomorrow's slate of economic events provided plenty of reason for that uncertainty.

Charts

Annotated Daily Chart of the SPX:

If there's a triangle breakout, watch for potentially strong resistance at the 72-ema, of course, and then if 1489-1490 is approached. On a breakdown below the triangle's support, watch for potential support at this week's low and then near 1404-1406.

Annotated Daily Chart of the Dow:

Annotated Daily Chart of the Nasdaq:

Annotated Daily Chart of the SOX:

Annotated Daily Chart of the RUT:

Annotated Daily Chart of the USD/Yen:

I believe, if the calendar I'm studying is correct, that Japan has several reports tonight that could impact the USD/yen and euro/yen action, so what happens on our markets tomorrow might not be and probably won't be predicated entirely on what happens with Fed Chairman Bernanke's address tomorrow. In addition, Germany and the Eurozone also will release important economic reports tomorrow morning that could impact the euro/yen action, at least.

I want to remain aware that intermarket relationships can change. The predictive or corroborative effects of the USD/yen and euro/yen movements on US equity movements might change. I want to move away from total reliance on these movements as indicative of what might happen on equities, but we still can't ignore the impact that's been seen in recent years, on everything from a weekly chart to intraday ones. Watch this as one tool for assessing whether all your ducks are in a row if trading tomorrow.

Today's Developments

The day started off with the typical weekly initial and continuing jobless claims, but that release was overshadowed by the second quarter's GDP report.

Initial jobless claims rose 9,000 to 334,000. The four-week average, considered more accurate, rose 6,250 to 324,500, its highest reading in four months. We walk a narrow road with jobless claims. A few weeks ago, claims were trending down toward 300,000, with numbers below that indicating that the job market is strong enough that wage pressures might be adding to other inflation pressures. If initial claims move consistently above about 350,000, the job market might be getting uncomfortably weak, indicating a downturn in the economy. Right now, claims came in at the midpoint, but they've been trending sharply higher over the last few weeks.

Continuing claims rose 13,000 to 2.6 million. The four-week average rose 11,250 to 2.56 million. The insured unemployment rate rose to 2.0 percent, the first time I remember that moving off 1.9 percent in a while.

The consensus for the GDP was a gain of 4.10-4.40 percent, up from the previous 3.38 percent. Growth in investments in commercial buildings and an improved trade balance boosted the revised GDP up to a 4.00-percent gain. That didn't quite meet expectations but certainly was an improvement, with the improved trade balanced contributing 1.4 percentage points to the GDP growth.

The GDP growth gain was the largest in five quarters, but many economists now expect slower growth for the rest of this year. An AP article pointed out that many economists now expect 2 percent growth for the current quarter, for example. Bullet points from the report include several areas of concern as well as some that assuage concerns.

One of the reasons behind that prediction of slowing growth is the worsening impact of the housing market's decline. While business investments in structures rose 27.7 percent, investments in residences fell 11.6 percent. That drop in residential investments subtracted 0.6 percentage points from the GDP. As we all know by now, the damage due to the declining housing market can no longer be considered contained. Financial institutions across the globe are being forced to fess up to exposure to the subprime difficulties in the U.S. When corporate profits are discussed later in this coverage of the GDP, the possible impact will be revealed.

First, let's talk about the good news. The GDP report also provided other insights, particularly into price changes. Although headline inflation soared 4.2 percent in the quarter, and you and I know that we're seeing some of the impact of those rising grocery prices, the FOMC reportedly studies core inflation rates more closely. Core consumer prices were revised lower to 1.3 percent on an annualized basis. This is well below what most perceive to be the Fed's comfort zone below 2.0 percent.

The chain deflator, supposedly a favored measure of inflation, remained at 2.7 percent. That was as forecast.

For the year, inflation-adjusted GDP growth was 1.9 percent, rising to $13.77 trillion. Bullet points from that report included before-tax corporate profits that increased 6.4 percent for the quarter, rising now 4.5 percent for the year. Business investments rose 11.1 percent, including that already mentioned 27.7 percent increase in spending on structures. Business investments in equipment and software also rose, by 4.3 percent.

A troublesome question arises from a look at this report and even a glancing knowledge of what's been going on in the financial sector. One has to wonder how much of a hit those corporate profits will take in future reports. In this report, for example, financial industries' profits rose the most in six quarters, making up $57.6 billion of the $89.8 billion in profits in domestic industries. Non-financial domestic industries produced the remaining $32.2 billion of profits in domestic industries. That means that financial industries produced 64 percent of the profit in domestic industries the second quarter. What happens when we start examining the hit they've received?

Consumer spending rose an annualized 1.4 percent, adding 1 percentage point to the GDP. Consumer spending on durable goods rose 1.7 percent and spending on services, 2.3 percent. Spending on nondurable goods fell 0.3 percent, however, the weakest result in more than a decade.

Government spending rose 4.1 percent. Overall growth in federal spending was 5.9 percent, with federal defense spending increasing 8.6 percent but federal non-defense spending rising only 0.5 percent. State and local governments also beefed up their spending.

The weekly report on natural gas inventories was released at 10:30. Inventories rose 43 billion cubic feet, roughly meeting expectations. Natural gas prices have been dropping over the last week, a result likely tied to both expiration-related and weather-related developments. No storms have threatened production. Natural gas ended higher today, at 5.635.

At 11:00, the Kansas Federal District provided its August survey of conditions in the Kansas District. This report isn't as important as the New York and Philadelphia districts' report. I usually have to go directly to the Kansas Fed District's site to find any information on it at all because news sources don't pick it up or offer any reaction to it.

That survey showed a moderate expansion of manufacturing activity in August. The district manufacturers' expectations for future growth declined slightly. Prices indices eased when compared to the previous survey.

The Office of Federal Housing Enterprise Oversight said that U.S. house prices rose 3.2 percent above their year-ago level in the second quarter and 0.1 percent above the first quarter's growth. The organization's director characterized the quarter's growth as flat, while acknowledging that regions that had previously seen the steepest price appreciation or that were currently experiencing slumping economies were now suffering "significant price declines" that he believed were localized.

Sears Holdings (SHLD) was one of the companies reporting earnings early today. SHLD operates both Kmart and Sears stores. SHLD's $1.13 adjusted earnings-per-share met expectations, a Reuters article noted, but both the EPS and revenue fell from year-ago levels. Gross margins also narrowed. SHLD closed lower but off its day's low and with a gain from the open. WMT did the same.

After the close, Dell (DELL) reported, providing a preliminary report for its second quarter. Earnings of $0.32 a share beat expectations of $0.31 a share and were higher than the $0.22 a share seen in the year-ago level. The company noted that demand for their notebook PC's had been better than expected and sales of servers had been strong. As this report is prepared, the results are just being examined. I'm sure industry experts will be making comparisons between Dell's performance and HPQ's. Dell was last at $28.29, down from the $28.46 close.

Tomorrow's Economic and Earnings Releases

The most important or at least most attention-gathering economic event tomorrow will likely be Fed Chairman Ben Bernanke's Jackson Hole address at 10:00. Since the Fed chairman will be speaking about monetary policy and housing, each word will likely be scrutinized. All week, various experts and pundits have debated the wisdom of the Fed making a sentiment-improving rate cut. Experts have argued over whether such a move is within the Fed's scope or would be effective, if made.

However, the Fed chairman's address will not be the only economic event in a day heavy with economic releases. July's Personal Income will be released at 8:30. That will be followed by the August NAPM-NY at 9:00 and the Chicago district's PMI at 9:45, with both reports likely to garner attention.

I've been trying to project whether I think markets will clamp down ahead of Fed Chairman Ben Bernanke's address, not moving on the earlier releases, or will overreact to each jit and jot of the economic outlook the earliest releases, depending on how they are perceived to impact the FOMC's outlook. I just can't decide which is most likely to happen.

Factory Orders for July will be released concurrently with the beginning of the Fed Chairman's address, at 10:00. Later releases, the ECRI Weekly Leading Index at 10:30 and the August Agricultural Prices at 3:00, will not likely have the same impact as earlier ones. Agricultural prices are important, of course, as anyone who has been grocery shopping lately knows, but right now, the focus remains on what the Fed will or won't do.

What about Tomorrow?

What I want to say and have been saying is "Batten down the hatches." Your job as a trader and/or investor right now is to protect your trading or investing capital. Thornburg's action today may have reassured investors that the globe's financial markets weren't collapsing despite Standard & Poor's warning of a profit collapse, but we don't know what news awaits us.

I can't predict what will happen tomorrow. Too many uncertainties present themselves in the forms of overnight economic releases in Japan, Germany and the Eurozone, added to the uncertainties here in the U.S.

I also can't predict what will happen because the charts visually demonstrate the uncertainty that market participants feel right now. Price action chops around within narrowing formations such as triangles, showing that uncertainty in as clear a form as it's possible to show it.

Price action toward the end of the day produced triangles on some intraday charts, too, such as the SPX's, OEX's, and Dow's. Depending on how you squint at the chart, the Nasdaq produced a roughly formed triangle, too, beginning about 2:45.

My opinion is that as long as markets are within the chop zones--triangles, rectangles, whatever it is on that particular index--on their daily charts, we're likely to see chop. Tomorrow may break those formations, but we're just going to have to wait to see. You can, however, watch the movements of the USD/yen for short-term guidance.

Watch the TRAN, too. Something funky was happening on the TRAN in the afternoon. It dove off its middle-of-the-day high, with only a late-day bounce preventing its daily candle from looking worse than it did. The TRAN, sensitive to both energy costs and economic outlook, often leads the SPX, OEX and Dow, and I don't like what I saw happening there this afternoon.
 

New Plays

Most Recent Plays

Click here to email James
New Plays
Long Plays
Short Plays
None None

Play Editor's Note: The markets didn't move much today because everyone is waiting to hear what Fed chairman Bernanke will say tomorrow morning. The challenge for us is that whatever he says will either cause a big rally or a big sell-off. If you are currently in any bullish positions you will want to re-evaluate your risk and consider adjusting your stop loss before he starts speaking around 10:00 a.m. If we had to bet we'd expect him to disappoint the market.


New Long Plays

None today.
 

New Short Plays

None today.
 

Play Updates

Updates On Latest Picks

Click here to email James

Long Play Updates

Cameco Corp. - CCJ - cls: 38.23 chg: -0.79 stop: 37.40

Once again CCJ dipped toward support near $37.50 and once again traders bought the dip. The intraday bounce looks like a new bullish entry point. However, the Fed chairman's speech tomorrow could produce some serious volatility. We would suggest readers wait until after the chairman's speech before considering new bullish positions. More conservative traders may want to wait for a new relative high over $40.50. Our target is the $44.50-45.00 range.

Picked on August 27 at $40.26
Change since picked: - 2.03
Earnings Date 10/30/07 (unconfirmed)
Average Daily Volume: 3.6 million

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EON AG - EON - cls: 54.46 change: -0.18 stop: 52.49 *new*

EON acts like it wants to trade higher but it's struggling to gain any momentum. The stock was positive midday but eventually succumbed to the widespread market malaise this afternoon. Please note that we are raising the stop loss to $52.49. Our target is the $57.40-59.85 range. More conservative traders may want to tighten their stops toward the $53.00 level to reduce their exposure.

Picked on August 26 at $54.55
Change since picked: - 0.09
Earnings Date 08/15/07 (confirmed)
Average Daily Volume: 406 thousand

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Global Ind. - GLBL - cls: 23.53 chg: +0.28 stop: 22.39

There is nothing new to report on for GLBL. Shares were flat with a very minor bullish trend to them on Thursday. We're sticking to our plan, which is to wait for a bullish breakout higher. Our suggested trigger is at $24.65. Our target is the $28.00-29.00 range. FYI: In the news today GLBL announced it was presenting at the Energy conference in New York on September 5th.

Picked on August xx at $xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/30/07 (unconfirmed)
Average Daily Volume: 2.5 million

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Starbucks - SBUX - cls: 27.35 chg: -0.13 stop: 25.95

SBUX drifted aimlessly along with the rest of the market on Thursday. We're not suggesting new positions at this time. Please note we are also adjusting our target due to falling technical resistance at the 100-dma near $28.20. Our new target will be $28.00-28.25.

Picked on August 16 at $26.61
Change since picked: + 0.74
Earnings Date 11/15/07 (unconfirmed)
Average Daily Volume: 17.0 million

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Synalloy - SYNL - cls: 19.66 change: -0.14 stop: 18.95

SYNL displayed some midday strength but gave it all back and more by the closing bell. The market's reaction to the Fed chairman's speech tomorrow will probably decide if SYNL hits our stop or breaks higher. Readers may want to wait for a new rally past $20.75 or $20.85 before considering new positions. Our target is the $24.75-25.00 range.

Picked on August 26 at $20.79
Change since picked: - 1.13
Earnings Date 07/19/07 (confirmed)
Average Daily Volume: 374 thousand

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Vertex Pharma - VRTX - cls: 38.16 change: +0.50 stop: 34.89

VRTX showed some strength with a 1.3% gain and a bullish breakout over resistance at the $38.00 level. More conservative traders may want to consider a tighter stop loss near $36.00 just in case Bernanke disappoints the market tomorrow. Our target is the $39.80-40.00 range. More aggressive traders may want to aim higher. The P&F chart points to a $66 target.

Picked on August 19 at $36.87
Change since picked: + 1.29
Earnings Date 10/25/07 (unconfirmed)
Average Daily Volume: 2.2 million
 

Short Play Updates

Motorola - MOT - cls: 16.75 change: +0.28 stop: 17.05

MOT displayed some strength this morning and probably hit a few stops on the way. Before the opening bell Lehman Brothers (LEH) updated MOT and raised their price target to $20.00. Shares of MOT reacted by gapping higher at $16.73 and rising to $17.03 before stalling out. MOT gave back a lot of its intraday gains so the move almost looks like a failed rally pattern. We're not suggesting new positions at this time and more conservative traders, if you're still short, may want to exit early right here!

Picked on July 29 at $16.95
Change since picked: - 0.20
Earnings Date 10/17/07 (unconfirmed)
Average Daily Volume: 25.7 million
 

Closed Long Plays

XenoPort - XNPT - cls: 40.77 change: +0.68 stop: 39.75

This might be a new short-term bullish reversal in XNPT. The stock produced what looks like a bullish engulfing candlestick pattern. Unfortunately, the early morning dip to $39.53 would have hit our stop loss at $39.75. More nimble traders may want to reconsider bullish positions on a move over $41.00 or a move over $42.50 or the 50-dma. For us the play has been closed.

Picked on August 26 at $42.29
Change since picked: - 1.52
Earnings Date 08/08/07 (confirmed)
Average Daily Volume: 198 thousand
 

Closed Short Plays

None
 

Today's Newsletter Notes: Market Wrap by Linda Piazza and all other plays and content by the Option Investor staff.

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