The summer doldrums are in full swing and Friday was a quadruple witching. Need I say more? That alone is a recipe for a decline but there were plenty of other negatives adding to the momentum. The Dow fell to within 80 points of the March lows as the selling in the banking sector intensifies. Add in ratings downgrades by S&P and Moody's and it was not a fun day for the bulls.
Wilshire 5000 Broad Market Index Chart - Weekly
There were no material economic reports on Friday. The only one of note was the Mass Layoffs for May, which rose to 1,626 events involving 50 workers or more. The May layoffs hit 171,387 compared to 133,914 workers in April. This suggests the labor picture is declining but you need to realize this is a lagging report for May and the announced layoffs will take place over several months, not all in May. The announcements are usually forward looking like "we are cutting 1100 employees by year-end." Construction and manufacturing have fallen the most with a sharp deterioration over the last two months. Manufacturing is being hurt by the sharp drop in automobile sales with production falling to 1998 levels.
Next week the calendar is busy but with few material reports. The Richmond Fed Survey on Tuesday and Kansas Fed Survey on Thursday along with the GDP will be the only items of real interest. The big event on the calendar is the Fed meeting on Tue/Wed. The rate announcement will be 2:15 on Wednesday and that is going to heavily influence the markets.
The Fed is caught between a rock and a hard place or in this case recession and inflation. The ammunition to fight either feeds the other. Cutting rates feeds inflation and raising rates feeds the recession. Their best alternative is to do nothing and that is what the market is expecting as of Friday. Chances of a rate hike have decreased sharply this week. However, the "whip inflation now" or WIN crowd is lobbying for a rate hike regardless of the impact on the recession. Richmond Fed President Jeffrey Lacker is adamant that "reversing rate cuts now makes eminent sense." And, "Just as easing policy aggressively in response to emerging downside risks makes sense, withdrawing some of that stimulus as those risks diminish makes eminent sense as well." Lacker is no stranger to the markets because he is a constant inflation hawk. He voted against several of the rate cuts saying inflation risks were already too high. Other Fed officials have also been making comments on inflation that were seen as hawkish and that pushed the chances of a rate hike higher.
The various news items on Friday diminished the chances of a hike significantly. S&P warned that it was putting GM, Ford and Chrysler on negative credit watch because of the falling auto sales. Moody's also lowered its ratings on Ford and Chrysler. Both said the sudden and significant drop in auto sales, specifically trucks and SUVs, was a bad omen for the automakers. Sales have fallen to 1998 levels. Liquidity for the big three for the rest of 2008 does not appear to be a problem. However, S&P said if sales don't pickup sharply in the first half of 2009 their liquidity levels could reach "undesirable levels." Not only have sales dropped off a cliff but it is especially painful that their highest profit lines of trucks and SUVs have been the hardest hit. I seriously doubt this is going to change soon. Ford said it was putting off the release of the redesigned F-150 pickup, the largest selling vehicle in the world, until they clean out the inventory of the older models. The downgrade on the automakers and the negative comments about sales would definitely weigh on any rate hike chances next week.
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Another factor weighing on the Fed is the bearish comments out of the banking sector this week. Citigroup fell under $20 on comments that loan losses could produce significant additional write-downs. Goldman Sachs said on Friday that the credit crunch was ongoing and would not peak until 2009. Credit losses would increase, loan loss reserves would need to be increased and capital raises would become much harder. Every capital deal done over the last three months is now underwater. Merrill said on Friday that loan losses in the banking sector would materially weaken earnings and they saw no improvement until 2010. All the major banks have said the consumer is under serious pressure and future defaults, foreclosures and bankruptcies were expected to increase. The Fed will find it very tough to justify raising rates under these conditions.
Lastly the bond insurers are in trouble again. Moody's downgraded bond insurer MBIA (MBI) by two notches to A2 from Aaa. This was much harsher than expected and literally shuts the door on new business for MBIA. The stock dropped 13% from $6.45 to $5.60 but that is not the problem. This puts MBIA $2.6 billion short of the capital needed to regain an investment grade rating. MBIA said it only has $1.1 billion in capital and would probably have to post an additional $4.5 billion in eligible collateral to satisfy potential collateral posting requirements under existing contracts. Moody's said their exposure to mortgage backed securities had risen to $5.9 billion as of last week. The ratings cut on MBIA will cause the ratings to be cut on hundreds of billions of bonds MBIA insured. This means holders of those securities will in some cases be forced to sell them because of rules regulating the quality of investments they are allowed to hold. For instance money market funds cannot hold securities that are not in the top two categories. This would knock those securities out of that range and force their sale. Moody's also cut the rating on the other major insurer, Ambac, to Aa3 from Aaa. Just when the Fed thought the worst was over these ratings cuts are putting about $1 trillion in bonds in jeopardy. Can the Fed afford to raise rates in this environment?
MBIA Chart - Weekly
I am betting against the Fed changing rates. That does not make the 2-day meeting any less of a market event. Traders are likely to remain on the sidelines until the smoke clears on Wednesday. The Fed will likely claim inflation is now more of a threat than recession and talk tough about mounting an aggressive fight but in the end do nothing. I am not sure it will help the market or not because those same points I made above are still negative for stocks.
August Crude Oil Chart - 120 Min
Crude prices firmed to gain +2.69 at $135 ahead of this weekend's meeting in Saudi Arabia. Friday was also the last day of trading for the July contract. Oil was expected to be weak ahead of the weekend meeting but news from around the world erased those expectations. It was reported in the New York Times on Friday that Israel had staged a maneuver over the Mediterranean and Greece that had all the appearances of preparations for an attack on Iran's nuclear facilities. The mock raid involved more than 100 Israeli F-15 and F-16 warplanes along with aerial refueling tankers, helicopters for pilot rescue, radar planes, etc. The warplanes flew more than 1400 kilometers, about the distance from Israel to Iran's nuclear enrichment facility in Natanz. This major exercise was obviously designed to demonstrate their capability of striking Iran as they have promised if Iran continues uranium enrichment. The U.S. confirmed the maneuvers and the potential of an attack on Iran. This was clearly designed to send a message to Iran and to the world that Israel was not making idle threats to end Iran's nuclear project. Israel destroyed Iraq's reactor facility in 1981 and a nuclear site in Syria several months ago.
The potential for an attack on Iran sent oil prices spiking early Friday to $136.80 but the Israel/Iran scenario was not the only market-moving event. Shell declared force majeure on 225,000 bpd of June and July production from Nigeria after the rebel attack on Thursday. That is a huge amount of light crude off the market for the next six weeks. A Chevron pumping station in Nigeria was attacked on Thursday night but there was no word on production declines. Chevron was also in the news as talks with workers in Nigeria fell apart and a strike is expected. A strike would impact Chevron's daily output of 350,000 bpd in Nigeria.
Those news events offset the negative price impact of the impending meeting in Saudi Arabia. The rumors are flying and I don't have the space to get into all of them here. Saudi already leaked that they will announce a production increase of 200,000 bpd at the conference. That leak has been making the rounds for a week. The newest rumor is that the announcement will actually be an increase of 500,000 bpd. That would take Saudi output to an even 10 million barrels per day and a level that many analysts doubt they can achieve. "IF" they actually bumped the announcement to 500,000 bpd "AND" actually managed to pull it off then it would be very bearish for oil prices. Saudi appears dead set on lowering prices and to emphasize their commitment they announced on Friday they were spending $90 billion to increase production to 12.5 mbpd by the end of 2009. This is not new news but their reiteration only days before the meeting suggests they are serious about talking down prices. That has been an impossible task recently. For the last two weeks oil prices have stabilized just under $137 and that suggests the oil bulls are running scared that the Saudi meeting could pressure prices next week.
In stock news Yahoo announced the departure of several executives. The brain drain included senior executives focused on search, email and services such as photo sharing, are departing. Current president Sue Decker is reportedly considering a reorganization that would centralize Yahoo mail, search and home page divisions into a global product organization. The brain drain and the rumors of a major reorganization knocked YHOO back to $21.99 on Friday.
In a major last minute market shocker SunTrust Banks (STI) said late Friday that it did not see any need for a dividend cut or to issue new stock or raise capital. They reaffirmed their charge-off and capital ratio guidance for Q2. They took this unusual step of announcing this late Friday to counter the sell off in the financial sector and in their stock price. Merrill Lynch comments earlier in the day suggested STI would be forced to cut their dividends. The move worked and the announcement lifted them +$3.50 off their lows. Huntington Bancshares (HBAN) had already shocked investors when they affirmed their prior guidance earlier in the morning and said charge-offs would not exceed prior estimates. HBAN spiked +30% on the news.
SanDisk (SNDK) was hammered after Citi downgraded them to hold from buy citing slowing demand in Asia and slowing handset orders from European companies. "Contract pricing weakness ahead of a seasonably strong build period along with demand erosion point to a loosening of fundamentals for NAND-based flash memory cards in the second half of the year" according to the Citi analyst. SNDK fell -10% on the downgrade.
Determining market direction for next week is no easy task. There are many conflicting factors which taken together could cancel each other out. The bear market in financials is becoming worse. The PHLX Banking Index (BKX) closed at 62.72 and a new 10-year low on a weekly basis. The Merrill, Goldman and Citigroup comments over the past week suggest there is more pain to come and in Merrill's view we may not see a rebound until 2010. If that is true there is almost no way for the broader markets to rise. The financials are the biggest component of the S&P. No financial rally, no market rally, period. The downgrades on the bond insurers will cause an entirely new ripple down effect for that trillion dollars of bonds insured by Ambac and MBIA. This will cause more write-downs and capital raises all down the food chain. This suggests there really is more pain ahead. The earnings warning cycle will be in full bloom next week.
The consumer is struggling as we saw with the bankruptcy and foreclosure numbers. The rise in the mass layoff numbers indicates the weak job market should continue. The Saudi oil meeting could send oil prices lower and oil stocks would follow. At 18% of the S&P that, along with the banks, would be a win for the market bears.
On the flipside no move by the Fed is already priced into the market. A positive statement of some kind could actually give the market a lift. There are six trading days left in the quarter. With a large amount of cash on the sidelines and NYSE short interest at a record high as of last week at 4.6% of all outstanding shares there is plenty of kindling for a bear-b-que. That is 17.65 billion shares short compared to the previous record of 16.43 billion on May 30th. The last three days of a quarter and first four days are generally bullish as retirement funds are deposited and put to work. Lastly the Dow is only 102 points away from the March closing low. This would be an excellent place for the bulls to produce a rebound. At one point on Friday decliners on the NYSE were outpacing advancers by 10:1. By the close that had improved to only 5:1. Still bad but indicated buyers had stepped in. It was probably just short covering ahead of the weekend but you can never tell.
The markets on Friday were heavily influenced by the downgrades on the automakers, financials, bond insurers, chip stocks and by the quadruple witching option expiration. If that was not a quintuplet of shocks to the market's foundation I don't know what is. Volume was very high at more than 9 billion shares. Was it a short-term capitulation? Who knows for sure but the market and especially the Dow is very oversold. Even the oil stocks have been losing ground despite rising oil prices. Granted it is summer and there is no compelling reason to own stocks right now but there is always a reason to own the right stocks as one reader pointed out as a rebuttal to that statement I made last Tuesday. Unfortunately even the right stocks go down in a bear market but that becomes a buying opportunity for those with risk tolerance.
That brings me to my final point. Funds have been sitting on a pile of cash while waiting for the market to pick a direction. Three weeks ago the Russell 2000 was breaking out as eager fund managers were starting to nibble on the "worst is over comments" coming out of the Fed. That idea cratered with the current round of problems and everybody is back in cash. Extremely oversold, a 10:1 A/D line, end of quarter window dressing, new retirement money, record short interest and the Dow within 102 points of its March closing low. That all adds up to a potential bear-b-que and we could see it next week. The SunTrust (STI) and Huntington Bank (HBAN) positive guidance could have been the leading edge of some good banking news for next week. There is absolutely no way to predict which of these scenarios will play out next week but I believe the fuse has been lit for a sharp rebound even if it is only a couple days in length.
The Dow closed at 11842 and gave up -220 points for the day and -464 points for the week. FYI the markets have been negative for 7 of the last 11 Fridays. The March closing low was 11740 and that is the level to watch. The Dow dropped below that level twice in January but rebounded to close higher both times. If the Dow closes below 11740 then all bets are off and we start looking for the next support level, which could be well below at 10700. That would be another thousand-point drop but there is nothing of any significance in terms of support between those ranges. Under 11740 is where the bears put everything in cruise control and take a thousand point nap.
Dow Chart - Weekly
Nasdaq Chart - Weekly
The Nasdaq continues to be far less bearish with a stop on Friday at support at 2400. Granted it was a -56 point loss for the day but the loss for the week was only 48 points. For the Nasdaq the 2400 level is the line in the sand that must be defended. Once that level breaks we could see a cascade lower to 2275. If the Dow and the financials continue to be weak the Nasdaq probably will not be able to hold that 2400 level. We have a clear double top at 2550 and this is the second test in the last two weeks of support at 2400. This is a critical test!
The S&P-500 has split the charts between the very bearish Dow and slightly bullish Nasdaq. The index stopped its descent on Friday at 1315 and although under the 1320-1327 some analysts were watching it is still over weak support at 1310 and much stronger support at 1275. The S&P is being pushed lower by the financials with 73 of its 500 components being financial in nature. There is little hope for the S&P as long as the financials continue to weaken. The odds are very good that we will eventually test that 1275 level even if it is not next week.
S&P-500 Chart - Weekly
Like the Nasdaq the Russell continues to find support at higher levels and is struggling to hold on to its gains. 720 is current support and it closed at 725 on Friday.
The Dow Transports were the most bullish index for the week and despite a -98 point loss on Friday the transports actually ended the week higher by +45 points. This is astounding with oil at $135 and is most likely helped by the positive earnings guidance from YRWC earlier in the month. It was definitely not due to the FedEx disaster on Wednesday where they dropped -$5 on earnings news. It had to be the rebound in the airlines pushing it higher. You may recall that the airlines closed at their multi-week lows last Friday and then rebounded on announcements about cuts in capacity, fare increases and a couple dollar drop in oil prices. This is a false rebound and any day the market is open is a good day to sell airline stocks. Earnings estimates for the top 10 U.S. airlines for 2008 are for a loss of $10 billion and growing.
Dow Transports Chart - Weekly
Airline Index - XAL - Chart - Weekly
For next week look for an oversold bounce and undue consternation around the Fed announcement. Volume is going to continue to slow as we approach July 4th and after Wednesday's Fed announcement the volatility should shrink dramatically. Plan your trades carefully and trade your plan. Emotional trading is an expensive hobby.
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Play Editor's Note: It is really looking ugly out there. Fortunately, we know that stocks don't normally move in a straight line for very long so we should see an oversold bounce soon. Even bear markets have their rallies. The idea here is to try and buy the dip on any follow though from Friday's sell-off. Friday's session was ugly and as the mom-and-pop investor crowd read their newspapers this weekend there could be another spike lower on Monday morning as they hit the "sell" button. We're expecting the Dow Jones Industrials to bounce from the March lows and that could carry the rest of the market higher even if it's temporary. The really sad news this evening is that we didn't find many candidates that looked good enough that we wanted to buy the dip.
New Long Plays
Citigroup - C - close: 19.30 change: -0.87 stop: 17.74
Why We Like It:
Picked on June xx at $xx.xx <-- see TRIGGER
DIAMONDS - DIA - close: 118.24 chg: -2.12 stop: 116.99
Why We Like It:
Picked on June xx at $xx.xx <-- see TRIGGER
SPDRs - SPY - close: 131.58 chg: -2.17 stop: 129.19
Why We Like It:
Picked on June xx at $xx.xx <-- see TRIGGER
New Short Plays
Long Play Updates
Adaptec - ADPT - close: 3.29 change: -0.01 stop: 3.19
ADPT continues to hold its ground with traders buying dips at the $3.20 level all week long. Volume surged on Friday as the stock rebounded from the $3.20 level, which is bullish. While the trend remains bullish there is no denying that momentum has stalled. We would hesitate to open new positions until we see the market really bounce. Our first target is $3.50. Our secondary, more aggressive target is $3.70. The stock can be somewhat volatile so we do consider this a higher-risk play. Our time frame is several weeks. FYI: The most recent data listed short interest at more than 7% of the 118 million-share float. Based on ADPT's average daily volume that is a lot of short interest and the stock could see a short squeeze.
Picked on May 28 at $ 3.25
BPZ Resources - BZP - close: 25.53 change: -0.89 stop: 24.45
As the market extended its losses on Friday BZP crept closer and closer to broken resistance and what should be support near $25.00. The intraday low was $25.15. This pull back can be used as a new bullish entry point but more conservative traders may want to wait for signs of a bounce in the broader market first. BZP has already exceeded our first target at $27.50. Our secondary target is the $29.90 mark. The Point & Figure chart is bullish with a $40 target.
Picked on June 12 at $25.53 / 1st target hit $27.50
Crown Castle Intl. - CCI - close: 41.40 chg: -1.07 stop: 39.95
The widespread market sell-off was too much for CCI to withstand and the stock lost more than 2% on Friday. The general trend is still bullish and we would use the pull back as a new entry point. However, if you're patient, we will probably get a better entry point on a dip into the $41.00-40.50 region if the markets slip again on Monday. The rising 50-dma near $40.40 should be technical support. The bull flag pattern is forecasting a $50 target. Coincidentally the Point & Figure chart is forecasting a $49 target. Our first target is $44.95, since the $45.00 level might be round-number resistance. Our second target is $47.25. We're putting our first stop at $39.95 but more conservative traders may want to consider a tighter stop loss.
Picked on June 18 at $42.02
Cognizant Tech. - CTSH - close: 34.97 change: -1.74 stop 33.90
Ouch! CTSH just lost 4.7% thanks to a downgrade by Goldman Sachs from "buy" to "neutral". The stock gapped open lower at $35.31 on the news. This move also looks like a bearish reversal from potential resistance near $37.00. We are not suggesting new positions at this time. If you look at the weekly chart and see how CTSH has now produced a failed rally under the trendline of resistance we would seriously consider an early exit right here! If we don't see a bounce soon we're going to be looking for an early exit. Our target is the $38.00 mark. The P&F chart is much more bullish with a $49 target. We do not want to hold over the late July earnings report.
Picked on June 12 at $34.57
SLM Corp. - SLM - close: 22.84 change: -0.79 stop: 21.75
The rally in SLM has struggled all week after breaking out over resistance at $24.00. The move higher now looks like a possible bull trap pattern. We are expecting an oversold bounce in the market this week so watch for a rebound in SLM as a new entry point. More specifically we would watch for a dip near $22.00 as a possible entry point to buy the stock. Our target is the $28.00-29.00 range or the 200-dma, whichever one SLM hits first. We are adjusting the stop loss to $21.75.
Picked on June 16 at $24.25 *triggered
Steel Dynamics - STLD - close: 38.90 change: -1.77 stop: 36.49
Last week was a bumpy ride for STLD. The stock was up 3.7% on Thursday and down 4.3% on Friday. The breakout over resistance near $40.00 has failed twice now. The general trend is still up but the bears are putting up a fight. Or more realistically we have some wary buyers who are quick to jump out in spite of STLD's relative strength. At this time we would look for a pull back into the $38.50-37.50 zone. Use the dip as a new entry point to buy the stock. If you're not comfortable buying the dip then consider waiting for a new relative high. Our target is the $44.00-45.00 range. We do not want to hold over the July earnings report. The P&F chart is bullish with a $50 target.
Picked on June 17 at $40.17 *triggered/gap open entry
Short Play Updates
Allstate - ALL - close: 47.89 change: -0.76 stop: 50.51 *new*
Thus far shares of ALL are cooperating. The stock sank to new relative lows on Friday. It's probably time to start looking for an oversold bounce soon. Look for resistance in the $49.50-50.00 zone. We're adjusting our stop loss to $50.51. Wait for a new failed rally before considering shorts again. Our target is the $45.25-45.00 zone.
Picked on June 11 at $49.31
Darden Rest. - DRI - close: 31.64 change: -0.50 stop: 33.65 *new*
We are almost out of time with this bearish play for DRI. The company is due to report earnings on June 24th after the closing bell. If DRI does not hit our target at $30.10 before Tuesday afternoon we will end this play at the closing bell so we won't hold over the announcement. Don't be surprised if DRI just trades sideways the next two sessions as investors wait to hear the earnings report. We're not suggesting new positions and adjusting our stop loss to $33.65, just over last week's high.
Picked on June 13 at $32.50 *triggered
Paychex Inc. - PAYX - close: 32.39 change: -0.87 stop: 33.91 *new*
We're running low on time for this bearish PAYX play. The company is due to report earnings on June 26th. That is this Thursday. With only four days left we're not suggesting new positions. Please note the new stop loss at $33.91. Our target is the $31.00-30.00 zone. FYI: The most recent data listed short interest at 5% of the 320 million-share float. That's several days worth of short interest.
Picked on May 22 at $34.87
PowerShares QQQ - QQQQ - close: 47.42 change: -1.32 stop: 49.26
Thursday's rally was quickly forgotten on Friday as the Qs plunged to a 2.7% decline. Shares fell back under the 50-dma and 200-dma to finally settle near its exponential 200-dma. The Qs mimic the NDX 100 index, which is suggesting more weakness ahead for the NASDAQ. Yet if the DJIA can bounce from its March lows the Qs may bounce as well. We're not suggesting new positions at this time. Our target is $46.10. The $46.00 level and its 100-dma might be support.
Picked on June 17 at $48.54
Closed Long Plays
Closed Short Plays
Amer.Capital Strat. - ACAS - cls: 27.15 chg: -0.80 stop: 31.05
ACAS continued to sink on Friday and gave up another 2.8%. The stock closed near its lows for the session, which is normally bearish for the following session. We've been suggesting that readers take some money off the table and we've decided to follow through on that idea with an early exit. Lock in a gain now with ACAS down more than 12% from our picked price. More aggressive traders may want to just tighten their stops and let ACAS run. Our original target was the $26.50-26.00 region.
Picked on June 08 at $30.95 /early exit 27.15
Kraft Inc. - KFT - close: 29.21 change: -0.43 stop: 31.25
Close enough for us! We can't claim KFT hit our target but it came awfully close. Shares dipped to $29.01 on Friday. Our target was $29.00. The stock is down several days in a row and looks very oversold and due for a rebound. We are suggesting that readers lock in a gain right here. Jump out now and we can always follow KFT for another entry point down the road.
Picked on June 11 at $30.78 *exiting early ***
Patterson Cos. - PDCO - close: 30.80 change: -0.77 stop: 33.25
PDCO is another play that was close enough. We can't score another win in the target-achieved column but Friday's intraday low of $30.58 was close enough for us. Our target has been the $30.50-30.00 zone. Shares of PDCO now look very oversold and due for a bounce. It's entirely possible that PDCO will sink to the $30.00 level on Monday but we're suggesting readers exit now for a gain.
Picked on June 03 at $33.42 *early exit ***
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