The Dow was knocked for a -298 point loss at the open by the continued bad news from the damaged nuclear plant in Japan.
The continuing flow of negative news from Japan and their leaking nuclear plants created an unreasonable drop in our markets at the open. The uncertainty of what is actually happening in Japan somehow translated into a monster futures drop overnight and a huge opening decline. This decline triggered sell stops and forced margin selling as all the weak holders were flushed out of the market.
The fear over the potential meltdown is vastly over done. These are not the same kind of reactors that exploded in Chernobyl. The potential for a major disaster is significantly less. The kind of radiation they are releasing in the form of steam has a very short half-life from several seconds to several days. The amounts being released are miniscule and are not specifically harmful unless you were right at the plant when it was released. Read this detailed description for the real story: Meltdown Link
Here is the key point for tonight. There are four reactors at the Fukushima Daiini plant. The first one was installed in 1981, 30 years ago! All four have had the cooling systems repaired and three have already been shutdown and are no longer a problem. The fourth one is in cool down mode and it expected to be successfully shutdown within the next several hours. Three are now "cold" and the fourth is going through the shutdown mode as I type this. The nuclear problem is over and there was NO catastrophic meltdown.
The market crash today was simply a prime example of heard mentality. The lead cows panicked and the rest of the herd followed them off the cliff. Unfortunately once you run over the cliff it is very difficult to reverse your direction until you hit bottom. Where that bottom might be is the $64 question.
The Fed did its best to reassure the markets today when they improved their statement language and reaffirmed they will complete the entire $600 billion QE2 program along with leaving the "extended period" phrase in the statement. There was no mention of extending QE2 or a possible QE3 but that should not have mattered. What they said was perfectly scripted and it was unanimous. There were no dissenting votes as many had expected.
The Fed did acknowledge higher commodity prices such as oil but said they believe the prices are only temporary. Despite the higher commodity prices the Fed said inflation was still low and was expected to remain low for the foreseeable future.
They said specifically they would complete the $600 billion in treasury purchases by the end of June. Since the next meeting is April 27th this means they would gain nothing by announcing at the end of April they were ending the program early in May. It would cause more harm in the market to have a sudden change in direction. We can glean from today's announcement the program will end on schedule and that means there should be no further worries by fund of an early termination.
The Fed said the economic recovery was "on firmer footing and overall conditions in the labor market appear to be improving gradually." This was a change from the prior statement where they said the recovery was progressing "at a rate that has been insufficient to bring about a significant improvement in labor market conditions."
The new language inserted into the statement had this phrase. The FOMC will "pay close attention to the evolution of inflation and inflation expectations." This could mean the recent uptick in commodity prices has started to concern some Fed members. This is a way to ever so slightly lean towards a future bias change. It might have also been a phrase the hawks wanted to add in order to get their vote on the statement with no dissent. It is seen as a veiled warning for the future. Up until now the Fed has always claimed that inflation was nonexistent and bordering on disinflation. Could the stance be changing ever so slightly?
The Fed left rates at 0.125% and kept the extended period statement. In reality the Fed cannon raise rates until it reduces its balance sheet. It would be financial suicide even for the Fed to start hiking rates with more than $2 trillion in treasuries on its books. When we see the Fed beginning to sell treasuries rather than buy them we will know the end is in sight but it could still take many months before they can raise rates.
The unanimous vote was a key point. This will stifle many of the analysts and commentators who have been expecting an early end to QE2. Without any dissenters the analysts have run out of bricks to build the foundation of their arguments. QE2 will complete on time and for the full $600 billion.
There were some analysts who expected the possible mention of extending QE2 because of the Japan quake and Middle East crisis. There was no mention today and they can still extend it in the future if they so desired. I am sure there was no rush to make an extension decision with three months left on the program. They can monitor the impact of Japan and the Middle East and extend the program later if needed.
The statement had something for everybody and tied up a couple loose ends. It was credited with the afternoon rebound in the markets but the damage was already done. The margin selling at the close prevented a continued rebound.
Other economic reports included the NAHB Housing Market Index, which rose to 17.0 for March and a ten-month high. The expectations component rose from 25 to 27 and +3 points over March 2010. Buyer traffic remained at 12 but is still +2 points higher than March 2010. Analysts believe the slightly better report ahead of the spring selling season is bullish. The Housing Index dropped significantly at the open but quickly recovered and closed with a +0.6% gain.
The NY Empire Manufacturing Survey rose more than +2 points to 17.5 from 15.4 and backorders finally turned positive. The +2.6 print on backorders was the first positive number in more than a year. However, new orders declined -6 points to 5.8. The employment component soared to 9.1 from 3.6 but it has been very volatile in recent months. Prices paid and prices received both rose and indicate sales are strong enough to allow manufacturers to pass on costs to their customers.
Empire Manufacturing Chart
The remaining reports for the week include the PPI, CPI and the Philly Fed Survey. The Philly Fed is a proxy for the national ISM so it is the most critical of the three.
Dow component GE was knocked for a -6% decline at the open but recovered to close down by -1.5%. The GE problem was the Japanese nuclear leak. GE designed the four reactors in question about 40 years ago plus 29 of the same design in the U.S. and elsewhere. Late in the day Barclay's said GE had ZERO liability from the failures under Japanese law.
This was not a failure in the reactor. This entire scenario was due to plant operators placing their backup diesel generators next to the ocean where the tsunami could wipe them out. It was a bad decision by plant operator decades ago that resulted in the problem. The reactors did exactly what they were supposed to do when the quake hit by shutting down automatically. Once they shutdown and electricity production stopped it was up to the backup generators to keep the cooling flowing. When the generators were wiped out by the tsunami 26 minutes later they had to switch to their secondary backup of batteries to power the cooling pumps. Without electrical power the batteries could only last so long and once the batteries were exhausted the cooling failed. This was not a liability issue for GE. Shares are grossly oversold on this news.
Companies that do have liability to Japan are Aflac (AFL) and Hartford Group (HIG). Both have substantial insurance risk to the quake and tsunami damage. Aflac is the number one insurer in Japan in terms of individual policies in force. They derive 75% of their profits from Japan. Japan estimated the quake and tsunami damages could be 15 trillion yen or about 3% of the country's GDP. Insurance modeler AIR Worldwide estimated insured losses could be as high as $35 billion but that did not include tsunami losses. However, as the largest insurer in Japan that also means they have policies in force on the 99% of the population that was not impacted by the quake and those will remain profitable. Once the impact to their financials is known they will raise rates on everyone else to recover the losses in the years ahead. Aflac shares are down hard since last week but I would not be bottom fishing here. It is way too early.
There are some concerns that our treasury market could be disrupted by Japan. The country is the third largest holder of U.S. treasuries and they may be forced to sell quite a few to pay for the recovery. It could be a while before this impact appears if in fact that is the way they decide to raise money.
There were some stock winners today. The NPD Group released a report saying 61% of digital movies delivered by download in January and February came from NetFlix. The number two provider was Comcast at 8% with Time Warner Cable, DirecTV and Apple in a three-way tie for third. NPD said digital movie downloads now make up 25% of al home video volume. The news powered NetFlix shares to a $16 gain.
Freeport McMoran (FCX) rebounded strongly after the miners said there would be no material impact from the Japanese quake. In January Japan imported nearly one third of copper supplies from Chile with the worlds biggest copper mines. The quake shutdown several copper smelters but as of Tuesday they had not claimed force majeure to prevent deliveries. BHP Billiton (BHP) and Freeport said the world market for copper is so tight there would be no impact. Other countries and primarily China can easily absorb any additional ore according to BHP. Companies were touching base with buyers to see if they needed to divert any shipments on a temporary basis.
Freeport McMoran Chart
Our markets plunged at the open but the damage was much worse on Japan's Nikkei. At the morning lows the index has fallen -15% since the quake. However, now that the reactors have been shutdown and the crisis is over the Nikkei has rallied +531 points in early trading on Wednesday.
The S&P plummeted to 1261 at the open and within two points of the 100-day average. This should be strong support but the markets are always prone to over reaction on world events. This selling was grossly overdone and even though the indexes did not make it back to positive territory I believe the worst was over. As I said earlier the weak holders have been flushed out of the market and those wanting new long positions have been given an excellent buying opportunity. The Fed has confirmed QE2 will complete on schedule and the recovery is improving. The Japanese reactors have been shutdown and the nuclear crisis is over. There is nothing on the horizon to prevent our markets from rebounding from here. I view this as a buying opportunity. The two-day drop was a knee jerk event on the nuclear news. It is over.
The Nasdaq fell farther on a percentage basis because of fears over the Japanese chip industry. More than 20% of chips used in the U.S. come from Japan. Even if the tsunami did not reach the chip factories the quake caused damage. There have been more than 1,000 aftershocks, some as large as 6.9. When these quakes shake the chip plants they shake the delicate production equipment out of alignment. When you are dealing with microscopic tolerances the shaking forces a realignment of all processes that could take days or weeks if the aftershocks don't subside. How that delay in production will impact U.S. tech companies is unknown.
The Nasdaq rebounded +50 points off its low at 2619 but still gave back -33 points for the day. The key level to watch now is 2,675 and current overhead resistance. Support from this level is 2615 and almost exactly where it stopped on the morning drop.
I am looking for a rebound on Wednesday. With the nuclear problem resolved the quake becomes just another unfortunate circumstance and historically the market allows about a 72-hour period of mourning and reaction before closing that chapter in the book and moving to the next story. The reaction was overdone and could just as easily see an overdone rebound. I am not betting on that because we did break some key technical levels today. The market may need a day or two to acclimatize to these levels before moving higher. With the FOMC behind us the focus should start to move to Q1 earnings, which starts in three weeks. There will be a flurry of mid-quarter guidance over the next week or so and hopefully it will take investor's minds off Japan. Did you notice how Libya dropped out of the headlines? Did you know that Saudi Arabia sent troops into Bahrain? Those were big headlines the prior week and the market has forgotten about them while the Japan news was hot. Something will return to hog the headlines later this week and I hope it is a market rebound. Time will tell.
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