Option Investor
Newsletter

Daily Newsletter, Saturday, 1/30/2010

Table of Contents

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

Market Wrap

No Surprise Here

by Jim Brown

Click here to email Jim Brown

The market's continued decline after the Microsoft earnings, Bernanke confirmation and SOTU speech was no surprise to anyone reading these pages. I have been warning for several weeks that there would be nothing to hold up the market once these news events passed.

Market Statistics

The only real surprise for me was that the decline was not worse than the -53 point loss on the Dow. We have entered the "why buy" period and by all indications the indexes should have declined even further. Of course the -662 point plunge by the Dow since the high close at 10,723 on January 19th has already removed a lot of the expectations that were powering the rally in early January.

The Nasdaq was down because the big caps have already reported and some of the earnings guidance was lackluster at best. Microsoft's beat by a penny was the final straw. Apple's iPad announcement had been anticipated for months and the actual features left a lot to be desired. Friday was a classic sell the news event now that the majors have reported. Declines in MSFT, AAPL, INTC, QCOM and AMZN were responsible for subtracting -25 of the -31 points from the Nasdaq index on Friday.

The markets started off with a bang after the Q4 GDP was released Friday morning. The Q4-GDP came in with a gain of +5.73% on an annualized rate. This was the strongest quarter in more than six years. This was the largest headline gain since 2003-Q3 and much stronger than the expectations for a +4.5% increase. However, and I warned you about this back in late December, the adjustment to inventories accounted for 3.4 points of the 5.73 reading.

Real final sales of domestic product, which is the real GDP minus the change in inventories and a true measure of demand for U.S. goods and services, grew +2.9% in Q4 compared to +2.0% in Q3.

The +3.4% GDP gain from the increase in inventories was the largest contribution to growth in over 25 years. Inventories had been allowed to dwindle to very low levels due to the credit crisis and the inability by many companies to finance new inventory. When business conditions began to improve the additions to inventories were large on a percentage basis because the starting levels were very low. What counts for the GDP is the percentage change in the inventory levels.

There were some negatives in the report. Personal consumption expenditures, how much consumers actually spent, rose +2% but that was down from the +2.8% increase in Q3. Spending in the holiday quarter was actually lower than Q3. Auto and auto parts sales subtracted -0.6% from GDP because of the hangover from the end of cash for clunkers. Stronger exports added +1.9% to GDP but stronger imports subtracted -1.4% points.

This will be the largest GDP reading for a long time. Overall GDP is expected to be positive but significantly weaker for the next year. The following comments from Moody's is inline with what most analysts and the Fed believe.

Near-term growth will weaken from the very strong pace of the fourth quarter. In fact, growth in the first half of 2010 will be below that needed to keep pace with an expanding labor force, and the unemployment rate will move higher, peaking at close to 11% in the fall. Growth will then pick up at the end of the year because of a stabilizing labor market, an expanding global economy, additional federal stimulus, improved credit flows, and stronger homebuilding. Growth will be very strong in 2011 and 2012 as pent-up consumer demand kicks in, finally bringing down the unemployment rate.

The inflation component in the GDP report, the core PCE deflator, was up by 1.4% compared to the +1.2% inflation in the Q3 report. The Fed has no worries for inflation and there is no reason for them to raise rates with unemployment moving higher. They never raise rates out of a recession until unemployment improves significantly. Most analysts now expect no changes in rates until late 2010 or even early 2011.

U.S. GDP Chart

There were two other indicators of economic activity out on Friday in the ISM - NY and ISM - Chicago. The ISM - NY index rose to 403.9 from 392.6 for January. The current conditions component rose to 72.6 and the highest reading since November 2006. The six-month outlook rose to 97 (out of 100) and no survey respondents gave a negative outlook for the next six months. That is the highest reading in the history of the report dating back to 1993.

The problem in the New York area is the proposed banking regulations and the proposed TARP tax. If by chance these proposals become law it will cost tens of thousands of jobs in the New York area. New York is heavily dependent on the financial sector and with banks under attack they are not going to be hiring until the proposals die and they are going to be trimming the staff and operations as any of these proposals begin to gain traction.

ISM-NY Chart

The ISM-Chicago was much stronger than expected with a gain of +2.8 points to 61.5 on the headline number. This was the fourth consecutive monthly gain. The biggest news was a +12.2 point jump in the employment component to 59.8. That is a +17.4 point gain in just the last two months. The new orders, back orders and production components all gained slightly. The Chicago area is benefiting from an improving auto sector. GM said on Friday that sales were very good in SUVs and full sized vehicles and they were increasing production in those products and cutting production in the smaller economy cars. Last week carmakers said they were adding workers to increase production. This is all positive for the Chicago ISM.

Chicago ISM Chart

Lastly the final reading on Consumer Sentiment for January rose to 74.4 and broke out to a new 23-month high. The present conditions component rose +3.1 to 81.1 and was responsible for pushing the headline number higher. Long-term expectations remain subdued with a +1 point gain to 70.1.

Investors should realize that these gains came from the market hitting new highs in the first two weeks of January as well as the Scott Brown election. Consumers were feeling good about the market and their year-end retirement contributions were already in positive territory. That is a powerful stimulant to sentiment. Secondly the Scott Brown win encouraged consumers that maybe the health plan would be killed and they would not be forced to change health care plans for less coverage and more money. The chances for higher taxes also declined. You could interpret this jump in sentiment as a collective sigh of relief from concerned consumers.

However, I believe the future reports will decline now that the banks are under attack and there is talk of new taxes to lower the deficit. I believe the same political negativity that is pushing the market lower will impact sentiment as well.

Consumer Sentiment Chart

Another problem that is going to push sentiment lower is the flood of foreclosures expected in 2010. Some analysts believe there are as many as 4.5 million homes facing foreclosure in 2010 and believe that while many will escape through a sale or modification there will still be more than three million that actually get foreclosed. This compares to the 2.8 million foreclosed in 2009.

The National Association of Realtors and the Mortgage Bankers Association believe home sales will rise by 448,000 in 2010 from the 5.45 million pace in 2009. An additional three million foreclosures will continue to push home prices down because most potential buyers have already taken advantage of the low prices, decades low interest rates and homebuyer tax credits in 2009. Existing home sales dropped -17% in December and the largest drop on record. There will be another wave of byuing in March-June but after that the expectations are for much slower sales.

According to the average estimates of fifty-nine economists surveyed by Bloomberg, unemployment will average 10% or higher for all of 2010. That is the highest rate since 1948. The average for 2009 was 9.3%, the most in 26 years.

The governments HAMP loan modification program has a goal of modifying four million mortgages by 2012 to allow homeowners to keep their homes. Unfortunately it is not working with only 66,645 permanent modifications to date. The program reduces interest, extends payment terms and defers principal payments. It is not working because a $200,000 loan on a house that is now worth $150,000 does not give the homeowner an incentive to tough it out. With unpaid interest accruing they will never get out from under the loan during the average holding period of seven years. If they take the modification it becomes a ball and chain to keep them locked into the home for a decade or more just to break even.

According to Deutsche Bank for the program to be successful it needs to reduce the principal to a level where the homeowner can expect to have positive equity in 3-5 years. Try that with four million home loans and you have another $250 billion bailout to the mortgage industry in addition to the $230 billion already spent by HAMP. Banks are already under attack for making too much money and another bailout would not be politically popular. That also brings up the problem of fairness.

If I own a $200,000 home worth $150,000 next to a guy getting the modification but I am current on my mortgage then I am getting screwed when the other guy gets a $50K principal reduction simply because he can't make the payment. There is always the argument that keeping his home out of foreclosure keeps property values from falling further. Of course the basis for the principal reduction in the first place is that values have already fallen so that argument does not cut it.

25% of American homeowners are underwater with their home loans. That equates to 10.7 million homeowners with negative equity. Currently 6.5 million households are behind on their payments by at least one month. If lenders begin to seize these homes in volume or the Fed begins to withdraw stimulus too quickly it could drive the economy back down into a double dip recession.

Economic Calendar

Next week we will get the national ISM Manufacturing Index and the ISM non-Manufacturing or services index. Both are expected to post gains. The Factory Orders report on Thursday is a lagging indicator for December but some analysts do follow it.

The big report is of course the Non-Farm Payrolls for January. The estimates for job losses are all over the place with nobody sure how the termination of seasonal holiday workers will impact the numbers. The official consensus number is for a loss of 5,000 jobs compared to a loss of 85,000 in December.

The problem is the 250,000 seasonal workers who took jobs for the holidays so they could pay bills. When UPS, FedEx, Macy's, Target, etc, let them go I am sure they did not simply walk right into another job. The consensus estimate could be off by 100,000 or more depending on how strong the job market was in January.

The consensus whisper number today is for a loss of 65,000 jobs but I have heard numbers as high as 150,000. There are also some analysts that believe we created jobs in January with estimates as high as 25,000 new jobs. This is the most indecision I have seen over an estimate in a long time.

Bloomberg surveyed 24 analysts and two-thirds expected an increase of jobs with the average at +20,000 jobs. Analyst Thomas Lee at JP Morgan cited a component of the Consumer Confidence surveys as an indicator suggesting there was job growth. The component tracks the number of survey respondents that feel jobs are plentiful. Since 1967 there were six times that they rebounded from a significant low and in each case payrolls started to grow within two months of the rebound. That component rose to 4.3% in January after two months at 3.1% and the lowest reading since 1983. According to Lee we should see jobs growth in February.

Helping the jobs numbers will be the 1.15 million temporary workers the Census Bureau will hire over the next couple months to conduct the census. That hiring will peak at about 700,000 in additional monthly jobs in May and then begin to decline in June as the task wraps up. They are already running ads and interviewing applicants for the $18 per hour jobs. Before you rush out to apply check the Census Bureau website for the rate in your area. It may be more or less than $18. This is a stimulus program in its own right and will put quite a few people to work. This is a gift for the administration since it will create positive jobs numbers for the next several months. Prepare to hear how the stimulus program is working and has created or saved large numbers of new jobs. Obviously the census hiring every ten years and the stimulus are unrelated.

Regardless of what number appears this Friday there will be considerable fear and trepidation ahead of the report. If by chance it is positive we can bet that the next four months will be positive because of the census so the market should like the headlines.

Economic Calendar

I guess you probably heard that Microsoft blew out earnings on the strength of Windows 7 sales to consumers. Headline, "Microsoft posts larger than expected 60% jump in quarterly profit from strong sales of Windows 7." Wow, 60% jump in profit in this economy? Reading further you see that they posted 74 cents per share compared to 47 cents a year ago. Sounds good. Oops, Microsoft included deferred revenue from pre-sales of Windows 7 to PC makers and its free upgrade program. Excluding that to get the regular operating income number and it drops to 60-cents and analysts were expecting 59-cents. They beat by a penny!

I know I was being overly dramatic there but I think you get the idea. Microsoft is seeing higher revenues because of Windows 7 but it really has not translated into operating income, yet. It will over the coming year but investors were expecting a much higher operating number from Microsoft.

The second blow to expectations came with their guidance. Microsoft said they "did not see any enterprise spending growth in the quarter just ended." Since businesses are the biggest buyers of software and hardware and there was no increase in purchasing then the economic recovery may be a figment of our imagination or recovering so slowly that we will still be waiting in 2015.

All the Microsoft revenue increase came from consumer sales and sales to PC makers. Those PC makers may or may not have sold those PCs. However, Microsoft said PC sales grew by 15.2% in Q4 and that is good news. If the consumer is stepping up to the counter to buy PCs then businesses should not be far behind. Microsoft implied this by saying, "our general view is a recovery will occur starting this calendar year and gradually build over the next several years." I would have to say that was far from bullish guidance. Investors want to know about the next couple quarters not the next half decade. Microsoft lost -4% on the less than exciting news. I believe Microsoft is a strong company and once the recovery does find some traction they will blow out earnings and break that $31 barrier.

Microsoft Chart

Steve Jobs took to the stage to announce the rumored and much anticipated tablet PC and the audience cheered for every point. That was until he told them it ran on the AT&T network. AT&T has some serious problems and just getting a voice call through their network in Denver is challenging at best and in some areas of the country nearly impossible. They claim it is the massive bandwidth consumption by iPhone users that has clogged the system but regardless of the reason it is horrible. I have AT&T and I have gotten a service credit every month for the last six months for blocked and unintelligible calls.

Adding what is expected to be an even bigger bandwidth hog in the iPad was a crushing blow to the announcement. Most Apple watchers expected them to announce a Verizon option but it didn't happen.

Secondly the iPad today is really just an iPhone on steroids. I think it is a nice gadget but what is the practical purpose. It is too big to put in a purse and carry around for watching video over lunch. Now that all the hype and speculation is over the Apple community is left with one question. What is it for, or better yet, how can I use it that makes me want to spend an average of $700 for an electronic toy?

I am sure Apple will sell a million of them eventually but today the bloom is off the rose and Apple stock has collapsed back to $190 after trading at $215 last week. It was a classic sell the news event and the next discussion will be where do I get back in?

I am sure it will pause at $190 but if the market decides to really dump here we could see $160. I would be a buyer at whatever level it decides to end the drop because the next product due out in June is rumored to be a 4G iPhone. Since they are not going to get any kind of true 4G from AT&T in 2010 the odds are good it will be on a different network and I guarantee you Apple addicts will be flooding Ebay with used iPhones and plunking down $300 for a new 4G iPhone by the millions.

I have two kids (32 & 37) who are ready to chuck their iPhones now and go to the Verizon Droid because of dropped calls on AT&T. If they had the opportunity to have an iPhone on another network they would jump at the chance. There are millions of others out there and I am sure Apple has heard their pleas. Buy the dip when it stops dropping.

Interesting link: 5 Reasons to Wait for iPad 2.0

Apple Chart

Big oil got a little smaller last week as companies suffered from the drop in oil prices and the drop in demand. Chevron posted a -37% decline in profits on Friday after suffering huge losses in its refining business. Oil prices doubled from February to December but gasoline and diesel prices did not keep pace due to lack of demand. This caused refinery crack spreads to shrink and in some cases go negative.

Chevron said earlier in the month they were going to cut spending on their downstream businesses, which includes refining and marketing and cut employees. It is planning on removing its name from 1,100 service stations in the eastern half of the U.S. where it has the most competition. That suggests they are going to sell them to someone else and reduce their retail sales in those areas. Chevron lost $613 million in Q4 in its refinery business compared to profits of $2.1 billion in the comparison quarter. That has got to hurt.

Oil prices rebounded with the market in 2009 as traders anticipated an economic recovery and a recovery in demand. Demand has not come back. Gasoline demand last week was 2% below the same week in 2009 and distillate demand, which includes diesel, jet fuel and heating oil, was down -8% from the prior year. Demand will come back but not until the roughly 15 million people currently out of work can find a job and that will probably be 2011.

Chevron lost a buck on Friday but it was just one more buck on top of the $9 it has lost since mid January on declining oil prices.

Chevron Chart

Oil prices rallied since Christmas week on record inflows of year-end cash into commodity funds. For the week of Jan-12th there was a record number of net-long contract held for speculation in crude futures. Crude traded over $84 on January 11th but then the year-end cash flows ended.

Crude futures declined for three weeks to close on Friday at $72.89 and a -14% decline from the highs. For the calendar month crude fell 8% and that was the biggest monthly drop since December 2008. Technically Friday was a bad day for oil prices. After flirting with support at the 200-day average for a week that support finally broke and it appears crude will test $70. We have been planning on this drop for two weeks in the OilSlick.com newsletter and it appears it will happen right on schedule. You may remember my prediction when oil was trading around $82 back in Oct/Nov that we would see $70 before we saw $85.

Crude Oil Chart

Amazon declined slightly after posting a +71% increase in profits on strong holiday sales and strong sales of the Kindle. Amazon earned 85-cents per share compared to analyst estimates of 72-cents. Revenue of $9.52 billion exceeded estimates by half a billion dollars. Not a bad quarter.

CEO Jeff Bezos was pressured for the number of Kindles sold but as always he would not say specifically only that "millions of customers have one." According to several analysts quoting an unnamed inside source Amazon has sold over three million Kindles. Amazon did say it was now selling six Kindle e-books for every 10 hardcopy books of the same title.

Amazon reached a milestone on Christmas Day where it sold more copies of e-books than physical books as recipients of Kindles as gifts loaded up with new book purchases. Kindles can be purchased in 100 countries and the Kindle book library is now over 400,000 titles. They are by far the leader in the e-book race. Bezos said he was not worried about the iPad because customers prefer a dedicated device. Forrester research expects more than 10 million e-readers to be in consumer hands by the end of 2010.

I found this link comparing the leading e-readers to each other and the iPad. One category that really stood out for me was the battery life. Comparing E-Readers

I have been an Amazon agnostic for years because they work on such a low margin and their current PE of 73 reminds me of the Internet bubble market. However, with every earnings report they continue to expand their revenue and earnings per share and hardly a week goes by that I don't buy something online from their website. I believe that is the business model that works. Sell cheap and promote repeat business. I think between Amazon.com, NewEgg.com and Ebay.com a true couch potato would never have to leave his house.

I am still not a buyer of Amazon stock but I like the company. Note in the chart that Q3 earnings produced a major spike but even tough Q4 earnings were just as good traders were not impressed. How fickle we can be when we become used to outstanding performance.

Amazon Chart

Fortune Brands (FO) reported earnings on Friday along with a strong dose of caution. Fortune said full year earnings would be between $2.30-$2.80 compared to estimates of $2.88. They blamed skittish consumers and lingering woes in the housing market. They make everything from golf balls to bathroom faucets to Jim Beam and Makers Mark bourbon. The stock was crushed on the news.

I bring this up because we are seeing a lot of "cautious" guidance from nearly every sector. Actual earnings have been good with 220 S&P companies reported and 78% beating estimates. It is the 50% percent that are providing cautious guidance that is killing the market.

SanDisk (SNDK) was knocked for a 12% loss on Friday after reporting better than expected earnings of $1.18 compared to analyst estimates of 69-cents. Expectations were exceptionally high and guidance was less than the street expected and the stock paid the price.

SanDisk Chart

Qualcomm (QCOM) implied everything was great at the January CES expo in Vegas. The stock rallied and everybody could not say enough good things about their future. That all changed when they reported earnings and cautious guidance this week. QCOM beat the street estimates of 56-cents with earnings of 62-cents but nobody was listening. Once they lowered guidance it was all over but the selling. The Qualcomm spokesman said they were seeing only a "subdued economic recovery" and that is not what investors wanted to hear. QCOM lost -$8 since their report on Wednesday night.

Qualcomm Chart

Given the lowered guidance from multiple chip companies it is not surprising to note that the Semiconductor Index is down 13% for the month of January. Compared to the other major indexes with losses in the -4% range it was positively beaten and left for dead by frustrated investors. The chip sector is supposed to lead tech stocks higher whenever the economy is recovering from a recession. So much for historical trends.

What chip stocks and tech stocks seem to be telling us is that the recovery is limping along like a drunken sailor with no specific direction. That is not the guidance investors want to hear after an 80% rally off the lows in 2009. Suddenly investors understand the markets really did run ahead of reality and that reality has finally caught up and bitten us in the butt.

Semiconductor Chart

The other sector that normally leads out of a crash is the financials and after five months of flat trading they are also leaning heavily to the downside. Credit problems are growing again and although the banks are fully capitalized thanks to endless debt and stock offerings the guidance from them is also questionable. The commercial real estate loan problem continues to get pushed under the rug as banks extend and ignore those problem loans in hopes they will go away when the recovery kicks into high gear. As long as they keep extending them they don't have to recognize them as in default.

The credit card problems are easing according to the recent earnings reports but other loan defaults are growing. Jamie Dimon from JP Morgan said he did not know if the worst was behind us. That is a sobering thought if the CEO of the a top five bank does not know if Oct/Nov 2008 was worse than what may be ahead. That comment along with several other not quite so scary comments from fellow bankers along with the political attack on the sector has pushed some charts over the cliff. The XLF is holding right on support but stocks like Goldman and JP Morgan are in full decline below recent support.

There are already rumors Goldman will dump its newly acquired bank charter to escape the new rules proposed by the administration restricting trading by banks that accept deposits. Some analysts say no because it would look bad to run for cover now when the regulations may not pass. It would be a wasted effort on Goldman's part. They will wait until the regulations pass and then dump the bank charter. Somebody made a big bet on Goldman on Friday. With Goldman at $148 they bought $1.6 million of the July $200 calls. That is a gutsy play unless you have inside knowledge. Goldman has broken though support and appears headed for $140. I would be a buyer at that level.

Goldman Sachs Chart

You have probably heard over the last couple weeks about a potential debt default by Greece. If you are like most people you probably attached about as much significance to that as hearing a weather report for Chicago say it is going to snow and you are living in Miami. It has no impact on you and it does not even register on your conscious thought.

Unfortunately Greece is a different event. Actually there are problems in Greece, Italy, Spain, Portugal and Ireland but to start with I will deal with Greece. You may remember when Russia defaulted on its debt in 1998 and created a world crisis. Russia's debt at the time was the equivalent of 51 billion Euros. Russia had huge natural resources and assets with which to deal with the problem. They are the largest oil producer and have massive natural gas fields plus minerals and ores and things that they could use for collateral. Still the default caused global stock markets to crash.

To put this into perspective Greece has a debt of 254 billion Euros and no resources to pay it back. They are running a 12.5% annual deficit and need to borrow about 25 billion Euros (€) a year to keep things running. Eurozone rules require a 3% deficit limit so they are 300% over the limit. Their GDP was €240 billion in 2008. That is a debt to GDP of more than 100% and Eurozone limits are 60%.

The only way Greece has to get within the Eurozone limits is to slash spending to literally nothing and pay back debt. To return to Eurozone limits over the next five years would require Greece to slash spending to the equivalent of the U.S. running on a $500 billion a year budget. It would be impossible without mass riots, civil unrest and almost a complete lack of government services, military, etc. To put it bluntly there is no way for Greece to come back from the brink.

Greece is living on borrowed time and money. They sold $8 billion in debt last week at 6.25%. It is already up to 6.5% and before they can sell any more it may be 8-9%. Like the U.S. they have to sell debt to make the payments on the prior debt of €254 billion. Eventually they will not be able to sell more debt because everyone realizes they can't make the payments and the entire house of cards collapses.

OK, so Greece collapses, why is that important to me. Greece is part of the Eurozone. This is a union of 16 countries with a single currency that are supposed to be stable, financially sound and compliant with a strict set of economic rules. That is what gave the Euro its strength over the last ten years. In theory the European Central Bank (ECB) manages the monetary policy of Eurozone countries. As one analyst put it, "Greece won't default because there is no default in the Eurozone. We are one unit." Don't look now bucko but your bus has a flat tire that is about to come off the rim.

If Greece defaults, which is inevitable and the Eurozone governments and ECB don't come together to bail them out then the Euro is a sham currency. It was sold on the basis of strong and united economics that conformed to a strong set of economic rules. Unfortunately Eurozone officials have already said there will be no bailout of Greece. They are not even enforcing the legal limits of debt on Greece so the illusion of Euro strength is rapidly evaporating.

If they are not going to enforce the rules on Greece or bail them out then what about Italy, Ireland, Spain and Portugal? Why should they suffer under the limits and obviously they are not going to be bailed out either. If/when Greece defaults the entire Eurozone theory collapses. The Euro is already collapsing and broke under 1.38 to the dollar on Friday. When Greece defaults the Euro could collapse under 1.25 or even lower in a matter of days.

Euro Chart

Debt Chart from John Mauldin

If you have assets denominated in Euros then this collapse will be catastrophic and could eventually be worse than the subprime crisis. Loaning money to Eurozone countries was seen as a top credit because each country had the implicit backing of the Eurozone union or at least that is what lenders believed. That is like saying "Your one of Bill Gates kids? No problem, how much money do you need?" It was unthinkable that the Euro would collapse because of the stringent economic rules for entry and continued membership. Now a default by Greece calls into question the entire Eurozone premise.

Banks and lenders with loans to Eurozone countries will see the value of those loans plummet overnight. It will be ugly. If by chance the Eurozone leaders do decide to bail out Greece are they going to bail out Ireland, Italy, Portugal and Spain as well? It is one thing to bail out your own financial system but forcing your citizens to bail out other countries with their taxes is not going to be popular.

Right now there is no settlement on the horizon. If they kick Greece out of the Eurozone they might salvage some of the Euro value but what does that say about the other weak countries. If they fall behind on payments do they get ejected as well? Lenders would immediately quit lending to those other countries and the Eurozone illusion continues to collapse anyway.

I am sure that is more of an explanation about Greece than you wanted but now you know what will happen when Greece defaults. The markets will crash and the dollar will rocket higher. That is amazing in itself since we are running our own $1.4 trillion a year deficit and we are rapidly approaching the same position as Greece. We sell $80+ billion in new debt every two weeks to make the payments on the old debt. It is going to be an interesting year.

The charts below were sent to me by a reader. Does this chart look familiar?


That is the chart of the Dow in 1929-30. There was a monster crash to the lows in November 1929 that took only 72 days from peak to trough. The corresponding chart below is the current Dow with the lows in March 2009. This time around we took a little longer to fall but the resemblance of the two charts is amazing.


What the writer was trying to do was compare those two charts above and then draw a comparison to what might happen in 2010. You see the 1929 chart above is only a piece of whole picture. The 1929 chart above only represents the area in blue in the chart below. There was a 50% rebound from the initial dip but the markets continued to fall for two more years. PE ratios had reached an extravagant level of 26.3 on the S&P and a level unheard of before the crash.

Personally I do not subscribe to the great crash of 2010 theory but Robert Prechter was on CNBC last week warning everyone to run to cash because the second dip was coming. Watch Video Interview I have to admit the charts above are very similar but there is no way in heck we are looking at a repeat of that continued crash. Just consider this a short history lesson and nothing more.

Full chart of 1929-1932 crash

As January goes, so goes the year or so the adage goes. Unfortunately it is not true. Since 1950 there have been an almost equal number of years that followed the pattern as those that didn't. In the last 113 years the ratio increased to about 65% that followed the pattern. In short, the saying is about as accurate as a coin toss. I have enough trouble just getting through each week without worrying about an entire year.

For next week I don't hold out a lot of hope for a rebound. There are still a lot of earnings but the only one that really matters now is the Cisco earnings on Wednesday. I listened to John Chambers in a Davos interview last week and even though he is in the quiet period before earnings it sounded like he was trying to say that IT spending was picking up. He is in a position to give us a heads up when that IT spending starts since his gear is the leading edge equipment going into new datacenters, expanded infrastructure, etc. They have to install the routers and switches before anything else will work. You build the networks out first then add the computers.

I don't think it will help the markets. All the indexes have broken support and appear headed for a full correction. At this point we need to be worrying about whether it is a full 10% correction or worse. With this much cautious guidance you have to believe that institutional investors are worried that there may be a double dip ahead and moving to cash so they can position themselves to profit from a debt default in Greece. That would mean moving to dollars instead of equities or commodities. We have already seen a commodity crash since early January as the dollar moved to new six month highs last week. The transfer of positions is underway and I don't think it is done.

Dollar Index

I warned for the last several weeks that we were facing a potential decline once we entered the "why buy" period where there were no events left to give the market a positive bias. The beginning of the decline started a few days earlier than I expected due to political news but close enough for government work.

The Dow's high close was 10,723 and a -10% correction would take it to 9650. I believe we could get some overshoot and see 9500 once again. The 200-day average is 9450 so that is my worst-case scenario. I think there is enough of a recovery underway to prevent a double dip recession so bulls will buy the dip. The wild card is the pending Greek default. This could keep institutional investors on the fence or in alternate investments for months unless the Eurozone steps up to the plate and handles the problem. If they default and start a domino scenario with the other Eurozone weaklings then there is no bottom in sight.

I am planning on continuing to short any bounce until proven wrong. Markets rarely go down all at once so expect a short squeeze or two before we get to 9650.

Dow Chart

The high close on the S&P was 1150 and a 10% correction takes us to 1035. That seems almost a given after the break of strong support at 1085 and the 100-day average at 1089 on Thr/Fri. Four levels of converging support have all collapsed. Financials, techs, chips, materials and energy have all led to the downside. It is not one sector imploding but a broad market decline. There is no support of any significance until the 1035 correction level.

S&P-500 Chart

The Nasdaq is only 59 points away from a 10% correction to 2088. At the speed the big cap techs are dropping I would be surprised if we did not continue lower to support at 2040. The 2040-2088 range brackets the 50% retracement from the March lows at 2063. All three of these levels should act together to slow the Nasdaq's decline.

All the big cap Nasdaq techs that matter with the exception of Cisco have already reported and Cisco reports on Wednesday. There is nothing to provide a story for traders to buy. The warnings in the chip sector have knocked the legs from under the techs and nothing falls faster than a tech stock after a warning.

Nasdaq Chart

Nasdaq 100 Chart

The Russell came to a dead stop on prior resistance at 600 but this is only a resting place and not a bottom. Russell 584 would be -10% and it is very close already thanks to a couple big drops the prior week. Small caps are actually behaving rather well and big caps are getting hammered.

Russell 2000 Chart

The Wilshire 5000 Index is so much cleaner than the other charts because the large caps are a much smaller weighting and the broader diversity smoothes out the volatility. The Wilshire is threatening to break support at 11100 and the 10% level is 10678 with nothing in between.

Wilshire 5000 Index

Dow Transports Chart

When the markets are declining I like to be able to look at the internals and point out we are dropping on lower volume. That was not the case last week. Monday was the lowest volume day for the week at 8.2 billion shares and each day thereafter rose steadily to 11 billion on Friday. The selling pressure was escalating day by day and four of the top six volume days of the year have been Thr/Fri of the last two weeks.

In summary the path of least resistance is still down. The highlights for the week are the Cisco earnings on Wednesday and the non-farm payrolls on Friday.

To further complicate your life most of the charting/quoting services are switching over to some form of the new option symbols this weekend. The rules don't call for a forced switch until the first batch converts on March 12th but several of my quote services issued notices that they were switching this weekend.

To complicate the switch almost every broker and quote service is using some subset of the new option symbols rather than go with the full symbol format. The new industry format is what you see in this image.

New Symbol Format

Some quote services are moving to a hybrid system to make it easier for customers. For instance DTN is changing symbols to this format:

Old = FDX-SX (August 22.50 Put expiring 7/18/10)
New = FDX1018S22.5 (1018 is the year/day and S remains the put/month)

Why they want to keep the put month code of "S" and breakup the date is a mystery. Personally I think the new industry standard format in the image above is easier but it is longer.

The mandatory dates for conversion of all symbols are:

March 12th - First test group (unknown)
April 9th - Stock symbols beginning with A
April 23rd - Stocks beginning with B thru G
May 7th - Stocks beginning with H thru O
May 14th - Stocks beginning with P thru Z

This should be a really interesting week!

Jim Brown


New Plays

Biotech, Consumer Goods, and Drugs

by James Brown

Click here to email James Brown
Editor's Note:

Bearish candidates were a dime a dozen on Friday. The challenge is finding a stock that did not look too oversold and still offered a decent risk-reward. The market is definitely short-term oversold. I think the best play right now is to wait for a bounce this week, possibly on Friday's jobs numbers but hopefully sooner and then open new put positions as the bounce starts to roll over.


NEW BEARISH Plays

Life Technologies - LIFE - close: 49.71 change: +0.33 stop: 52.01

Why We Like It:
Investors don't seem to care how good earnings were last quarter. They're using every rally as an opportunity to sell into strength. LIFE spiked higher on its earnings report after beating estimates by eight cents and guiding higher. Yet shares reversed. Now after breaking down earlier in the month this failed rally looks like a very clear bearish reversal signal and a chance for us to launch bearish positions.

Shares of LIFE are very overbought on a longer-term trend and way overdue for a correction. I'm suggesting bearish positions now with a stop loss above last week's high. Our first target is $45.25, just above possible support at the 200-dma. We will cautiously set a second target at $41.00 but I suggest exit the majority of the position at $45.25.

Annotated chart:

Entry on   January 30 at $47.91 
Change since picked:     + 0.00   			
Earnings Date          01/28/10 (confirmed)    
Average Daily Volume:       2.6 million 
Listed on   January 30, 2009    


J.M.Smucker CO - SJM - close: 60.07 change: -0.92 stop: 61.51

Why We Like It:
SJM actually has one of the stronger looking charts but on a short-term basis the stock is reversing. There has been a breakdown from the January trading range and support near $60 and the 50-dma looks like it's going to break. If that happens it could be a quick decline toward stronger support near $55.00.

I am suggesting a trigger to open bearish positions at $59.49. Our target is $55.15. More nimble traders could try and open positions in the $61.50-52.00 zone.

Annotated chart:

Entry on   January xx at $xx.xx <-- TRIGGER @ 59.49
Change since picked:     + 0.00   			
Earnings Date          02/24/10 (unconfirmed)    
Average Daily Volume:       698 thousand
Listed on   January 30, 2009    


Warner Chilcott - WCRX - close: 27.33 change: +0.75 stop: 29.31

Why We Like It:
WCRX doesn't report earnings until late February but the company issued positive earnings guidance on Friday. Shares spiked toward short-term resistance near $28.00 and its 30-dma and reversed. This failure at resistance looks like a new bearish entry point. Now that the company has already pre-announced better earnings there is no reason to hold the stock into the announcement. I am expecting a correction and if you look at a weekly chart you can see shares are very overbought.

I am suggesting bearish positions now. The stock can be a little volatile so let's keep positions smaller. We're listing the stock with a stop loss at $29.31 but more conservative traders may want to consider a tighter stop in the $28.20-28.30 zone. Our first target is $25.00. Our second target is $22.25.

Annotated chart:

Entry on   January 30 at $27.33 
Change since picked:     + 0.00   			
Earnings Date          02/26/10 (unconfirmed)    
Average Daily Volume:       1.3 million 
Listed on   January 30, 2009    



In Play Updates and Reviews

Tech Stocks Underperform

by James Brown

Click here to email James Brown


BULLISH Play Updates

CVR Energy - CVI - close: 8.02 change: -0.10 stop: 7.48

Once again I am suggesting that more conservative traders consider an early exit or raising their stop loss. CVI is holding support near $8.00. Yet now that the S&P 500 has broken significant support I am expecting more market weakness and CVI could trade down toward $7.50 and its 50-dma. I am not suggesting new bullish positions at this time and we're going to adjust the stop loss to $7.48 just in case CVI does dip to $7.50.

Annotated chart:

Entry on   January 19 at $ 8.20 
Change since picked:     - 0.18 
Earnings Date          03/10/10 (confirmed)         
Average Daily Volume:       411 thousand     
Listed on   January 17, 2009    


BEARISH Play Updates

Atlas Air Worldwide - AAWW - close: 36.67 change: +0.19 stop: 40.05

I suspect that the airlines are holding up due to the weakness in crude oil. That could continue as long as the dollar keeps inching higher. Short-term it looks like AAWW could still bounce from its rising 50-dma. Readers may want to wait for a more clearly defined failed rally under its 10-dma or the $38.00 level before initiating new positions. Our first target is $32.60.

Annotated chart:

Entry on   January 23 at $37.66 /gap open entry
Change since picked:     - 0.99   			
Earnings Date          02/24/10 (unconfirmed)    
Average Daily Volume:       291 thousand
Listed on   January 23, 2009    


American Tower Corp. - AMT - close: 42.45 change: +0.13 stop: 43.75

AMT is still consolidating sideways. The recent relative strength has me turning more cautious. Wait for a new relative low (under $41.80) before launching new bearish positions. Our first target is $40.10. Our second target is $37.75. We do not want to hold over the late February earnings report.

Annotated chart:

Entry on   January 27 at $41.90
Change since picked:     + 0.55   			
Earnings Date          02/24/10 (unconfirmed)    
Average Daily Volume:       2.8 million 
Listed on   January 26, 2009    


Ameritrade - AMTD - close: 17.76 change: -0.12 stop: 20.05

Friday turned out to be relatively quiet for AMTD. Overall I don't see any changes from our Thursday night comments. The trend is down and AMTD has broken several layers of support. I'm suggesting bearish positions now. Our first target is $16.10. Our second target is $15.05. We'll start with a stop loss at $20.05. More conservative traders may want to use a stop closer to $19.00. Our time frame is about six weeks.

Annotated chart:

Entry on   January 28 at $17.88 
Change since picked:     - 0.12   			
Earnings Date          04/21/10 (unconfirmed)    
Average Daily Volume:       6.1 million 
Listed on   January 28, 2009    


Best Buy - BBY - close: 36.65 change: +0.30 stop: 40.26

Yet again BBY tried to bounce but reversed midday. Shares did end up closing Friday with a gain. The stock remains very short-term oversold and probably due for a larger rebound. Look for resistance near $38.00 and its 200-dma. I am not suggesting new positions at this time. Our first target to exit is $35.25. Our second and final target is $32.25.

Annotated chart:

Entry on   January 12 at $38.95 (small positions)
Change since picked:     - 2.30   			
Earnings Date          03/25/10 (unconfirmed)    
Average Daily Volume:       8.0 million      
Listed on   January 02, 2009    


Companhia Brasileira de Distribuicao - CBD - cls: 66.72 chg: -0.97 stop: 74.05

CBD is still sinking and getting closer to potential support at its rising 100-dma. Shares are short-term oversold so we should expect a bounce soon. Broken support near $70 and its 50-dma should act as overhead resistance. Remember this is a volatile stock and I'm expecting a bumpy ride lower. We want to use small positions to limit our risk. Our first target is $61.00. Our second target is $56.00. Time frame is several weeks.

Annotated chart:

Entry on   January 26 at $69.40 (very small positions)
Change since picked:     - 2.68 
Earnings Date          03/03/10 (unconfirmed)    
Average Daily Volume:       261 thousand
Listed on   January 23, 2009    


DSW Inc. - DSW - close: 24.10 change: -0.45 stop: 25.55

Shares of DSW have faded back to the bottom of their recent trading range. I am very tempted to open positions now but we will stick to the plan, which is using a trigger to open bearish positions at $23.75.

If triggered at $23.75 our first target is $21.50 (essentially we're aiming for the 100-dma). Our second target is $20.05.

Annotated chart:

Entry on   January xx at $xx.xx <-- TRIGGER @ 23.75
Change since picked:     + 0.00   			
Earnings Date          03/24/10 (unconfirmed)    
Average Daily Volume:       387 thousand
Listed on   January 26, 2009    


F5 Networks - FFIV - close: 49.43 change: -1.29 stop: 52.55

We did not have to wait long for FFIV to hit our trigger at $49.45. The stock quickly reversed on Friday morning and sank to new relative lows. Now that the play is open our first target is $46.10. Our second target is $44.00. Don't be surprised to see an oversold bounce at its rising 100-dma.

Annotated chart:

Entry on   January 29 at $49.45 
Change since picked:     - 0.02   			
Earnings Date          04/22/10 (unconfirmed)    
Average Daily Volume:       1.2 million 
Listed on   January 28, 2009    


Children's Place - PLCE - close: 31.80 change: -0.76 stop: 35.05

It looks like we're starting to make some progress on PLCE. Shares accelerated lower on Friday and finally broke through the bottom of its recent trading range (and its 40 and 30-dma). This looks like a new bearish entry point. Our target is $28.05. My time frame is about three weeks.

Annotated chart:

Entry on   January 23 at $32.41 
Change since picked:     - 0.61   			
Earnings Date          03/18/10 (unconfirmed)    
Average Daily Volume:       598 thousand
Listed on   January 23, 2009    


RTI Intl. - RTI - close: 24.75 change: +0.16 stop: 27.01 *new*

We don't have much time left. RTI is due to report earnings on Feb. 4th and we do not want to hold over the announcement. That only gives us a few days. I am lowering our stop loss to $27.01. You might want to tighten your stop loss even more. I'm consolidating our exit target to $23.00. No new positions at this time.

Annotated chart:

Entry on   January 25 at $25.83 (small positions)
Change since picked:     - 1.08   			
Earnings Date          02/04/10 (confirmed)    
Average Daily Volume:       720 thousand
Listed on   January 25, 2009    


SBA Communications - SBAC - close: 33.09 change: -0.60 stop: 35.55

SBAC sank to new relative lows with a 1.7% decline o Friday. I don't see any changes from our prior comments. Shares are breaking support as short-term momentum turns bearish. Our target is $30.15. More aggressive traders could aim for the 200-dma.

Annotated chart:

Entry on   January 28 at $33.45
Change since picked:     - 0.36   			
Earnings Date          02/25/10 (unconfirmed)    
Average Daily Volume:       1.5 million 
Listed on   January 26, 2009