Bad news out of Greece hit markets already stalled at resistance and the result was a failure and a drop back into negative territory.

Market Statistics

After two days of conference calls between Greece and the troika (EU, ECB, IMF) over satisfying the requirements for the next payment in the bailout process, the receiver was slammed shut on Greece late today. The troika is not satisfied with the progress Greece is making in the austerity program. They claim the country has missed nearly all the austerity targets and continues to delay implementation of many cuts. The troika told Greece late today they were delaying any further visits to check on the progress until October. Basically, they said "after you comply with our prior agreements we might give you another chance."

Greece said it may have to start issuing IOUs instead of checks for payment of some government expenses and some employees. Greece will run out of money in October if it does not receive the 8 billion euros in the next tranche of the bailout.

The troika is demanding that Greece privatize large sections of the government and fire up to 100,000 government workers. Greece has already laid off 20,000 but hired 7,000 back, which is also in violation of the agreements not to hire more than one person for every ten fired. Another problem is the termination rules. Greece may be laying off workers but thanks to the Greek civil service plan they continue to pay them at 60% of the salary even though they are not working.

We have been talking about the EU ripping off the band-aid and suffering some short term pain to put this Greek problem behind them. It is starting to look more like an amputation is needed rather than a band-aid event.

The rumors of a pending resolution pushed the markets higher at the open but the news of the failed conference calls erased all the gains and knocked them back into negative territory.

The IMF also helped to pressure the markets with a warning the global economy was entering a danger zone. The IMF slashed economic expectations on worries the EU would not be able to resolve its credit problems in time to avert a serious downturn. They cut the expected GDP growth for the 17 EU countries that use the euro to 1.6% growth in 2011 and only 1.1% growth in 2012. They cut estimates for the U.S. GDP to 1.5% for 2011 and 1.8% in 2012. Their prior estimates were 2.5% and 2.7% respectively. They said there was increasing worry that Greece would default on its debt. They should know since they are one-third of the troika.

The IMF chief economist, Oliver Blanchard, said "There is a wide perception that EU policy makers are one step behind the markets" and Europe and the U.S. could slip back into recession if the situation was not corrected soon. "Europe must get its act together."

Reuters reported the Bank of China, a big market maker in foreign exchange, had halted trading and swaps with several European banks due to the unfolding debt crisis in Europe. The banks cut off from trading with China were Societe Generale, Credit Agricole and BNP Paribas. They also halted trading with UBS after news of the $2.3 billion loss from unauthorized trading.

S&P lowered its credit rating for Italy overnight and that caused additional European stress. The one notch downgrade to A-1 was due to poor growth prospects and political instability. The kept their outlook negative suggesting there was a possibility of further downgrades. The S&P rating is now three notches below Moody's and puts Italy below Slovakia and equal to Malta.

The German side of this equation is getting worse. Germany is responsible for 27% of any funds paid out on behalf of the EU. The election losses for Merkel's party over the weekend make it less likely the vote on the EFSF fund will fail. That vote has been postponed until the 29th because of a visit by the Pope.

This week will see meetings by the G20, World Bank and the IMF. The G20 is likely to put some extreme pressure on the EU to make something happen soon.

In the U.S. the weekly Chain Store Sales declined -1.2% after rising +1.3% in the prior week. This report carries little market weight.

The Housing Starts for August were ugly with a -5% decline from July. Starts fell to 571,000 (annualized) from 601,000 in July. Estimates were for a gain to 610,000. July starts were revised lower from 604,000. Single family starts declined -1.4%. Completions declined -2.7%. The only positive news was a rise in new permits of +3.2% to a pace of 620,000. That is +7.8% higher than August 2010. New apartment construction is leading the sector thanks to declining vacancy rates and rising rents. Very few people can qualify for the home loan today.

The event calendar for Wednesday is headlined by the Fed statement at 2:15.

Economic Calendar

The FOMC is under a lot of pressure to do something that will sharply stimulate the lackluster economy but they have run out of policy bullets that could do the trick. Most believe the Fed will institute Operation Twist where they buy treasuries farther out in duration in order to push interest rates even lower. Most analysts feel this is only a symbolic move only since rates are already at historic lows.

The Fed can't produce growth. All they can do is fertilize the economy with obscenely low rates and hope private enterprise will flourish. Another step they could take would be to eliminate the .25% interest they pay on money banks have on deposit with the Fed. This would force banks to try and find somewhere to lend or invest that money to produce a yield. The availability of credit no longer seems to be a problem. The availability of credit worthy borrowers is the challenge.

With three dissenters on the FOMC Bernanke will be hard pressed to make any policy announcement with a chance of having a big impact. This could be a strong sell the news event if traders are disappointed with his choice of new policy.

I believe regardless of the Fed decision it will be hard for the market to rally until the Greek problem is solved. About the only thing I have not heard suggested would be for the Fed to buy the outstanding debt from Greece. They owe about 370 billion euros. How much would he Fed have to buy and cancel before the problem became manageable? €200 billion?

Obviously I am joking here just to put the problem in perspective that is about two weeks of Treasury borrowing for the USA. By comparison Argentina had $82 billion in debt when it defaulted in 2001. Russia had $79 billion when it defaulted in 1998. Today Russia has an annual GDP of about $1.3 trillion compared to Greece at $329 billion. Argentina has $307 billion in GDP. This is why Greece is in so much trouble. Their debt is more than their GDP and there is no way they can ever repay it. The debt service at 5% is €18.5 billion and more than the revenue they receive from taxes at €15.5 billion. How long can that continue?

More than 250,000 private jobs have disappeared in Greece over the last year out of a population of 11.2 million and labor force of 4.9 million. If the government cuts another 100,000 as the troika wants and halts payments to terminated workers the unemployment rate will rise to nearly 20% on an official basis and even higher unofficially. Currently 42% of those under 24 are unemployed and 22.6% of those from 24-35 are out of work. Now you know where all the protestors come from when they televise the riots.

The Greek problem is not going away until they default. The Fed can't announce anything on Wednesday that will affect Greece. The EU can't fix it without letting Greece default and restructure their debt to something they can pay. Some analysts believe that is something in the €125 billion range. That means roughly a $250 billion haircut for holders of Greek debt. It is not going to be pretty but there is no other way out. This will keep our markets under pressure until after the default occurs.

In stock news NetFlix was crushed again after they announced they were splitting the company into two divisions. The company seems to be doing everything wrong. The stock has declined from $238 to $130 over the last three weeks and there is no slowing in the decline. The latest disappointment came when they announced they were splitting the company into a DVD division and a streaming division. The DVD division will be renamed to Qwikster with its own website. The streaming division will remain NetFlix. The reason for the split is obvious. They made such a mess in the original price change process where they announced they were going to charge for both services that they had to back up and do it again. This time by splitting the name they reduce the confusion for subscribers. Too many people were still bewildered by the change in structure they were getting cancellations in frustration and plenty of hate mail for the extra billing.

Now existing subscribers for the DVD rentals will log into Qwikster and the two sites will not cross pollinate. Each one will stand alone. New subscribers will not be confused by the dual subscription products under the same name. NetFlix management admitted in a letter to subscribers that they totally messed up the original price change. Their hurdle now will be to advertise and generate subscriber loyalty to two brands instead of one. Netflix had tremendous subscriber loyalty and was generating significant increases in new subscribers before the change. Everything was going right for them and the stock was priced for that continued growth. Now that stock is being priced to account for horrible management, major mistakes and hostile subscribers. Brokers are slashing price targets and there are real worries that subscriber flight may cause NetFlix to lose some of its content deals over fears of nonpayment. Content providers don't want to structure multiyear billion dollar content deals if the company has lost its momentum and may not be able to pay. NFLX shares lost another $14 today and $100 looks like a valid target.

NetFLix Chart

Carnival Corp (CCL) rallied sharply after the company posted earnings of $1.69 that beat estimates of $1.64. They lowered guidance slightly but remained in the prior range. Bookings were flat for Q2 and they did lose business because of the weakness in Europe but they said the ticket price rose and costs for other than fuel declined. North American ticket prices rose +6% while European and Asia/Middle East revenues declined -2% on political events and economic weakness. Fuel rose from $473 per ton to $686 per ton. Carnival has 191 ships with 10 new ships coming online from 2012-2016. Shares rose +5% on the news.

Carnival Chart

After the bell Adobe posted earnings of 55-cents that beat analyst estimates by a penny and sales that rose +2.3%. That did not produce much excitement but they also predicted current quarter earnings of 57-64 cents and that beat analyst expectations of 58-cents. Revenue is expected to be in the $1.08 to $1.13 billion range and analysts were looking for $1.07 billion.

Adobe Chart

Oracle also posted earnings after the close of 48-cents and beat estimates of 46-cents. The said new software sales rose 17% in the quarter and much better than the estimates of flat to +10% by a variety of analysts. Oracle said they expected revenue to rise 4-8% in the current quarter with earnings slightly over analyst estimates. Margins rose to 54% from 48%. They also announced a 6-cent cash dividend to be paid on November 2nd. Oracle shares rose about a dollar after the news.

Oracle Chart

The S&P rallied to resistance at 1220 early in the day and then traded sideways until the news broke around 2:PM on the failure of Greece to win approval for the next payment. On Monday the S&P declined from Friday's touch of 1220 to secondary support at 1190. The dip was bought, twice, and the markets recovered at the end of the day. Tuesday's opening rally returned to that 1220 resistance level and it was a dead stop. The afternoon sell off took the S&P back to the morning's lows at 1202.

The lack of progress on Greece was a disappointment. However, I believe it had as much to do with fear of the Fed as it did with Greece. Too many traders are expecting a big announcement on Wednesday but the reality is sinking in that there may not be much Bernanke can do.

Initial support for Wednesday is probably about where we closed at 1202. The positive results from Adobe and Oracle have turned the futures positive. How much of that will carry over into tomorrow's market is unknown. If we break that initial support I would expect to see 1190 again with 1140 as the bottom of the channel if things turn really bad.

S&P Chart

The Dow gave back about 140 points of its intraday gains but still managed to close positive. I view that as a plus given the event risk for Wednesday. Initial support on a deeper decline on Wednesday would be 11,275.

Dow Chart

The Nasdaq posted a new six week high intraday but declined to close more than 50 points off its highs. Amazon was a big factor in the decline with a loss of -8.50 on no specific news. Amazon was the only big cap with major losses over than NetFlix. SINA was also down hard with a loss of -16 but they are not a big cap weighting in the Nasdaq.

Techs have been winners over the last two weeks and I believe this was profit taking ahead of a material event. It was not a change in sentiment but simply profit taking. Initial support should be 2570 followed by 2450.

Nasdaq Chart

I would be cautious ahead of the FOMC announcement. There are still major challenges in Europe and Bernanke can't do anything to change that. Without a major new program announcement we are likely to see a sell the news event. There is no need to trade the announcement. Smart money will wait for the smoke to clear before putting that money at risk.

Please excuse the brevity and lateness tonight. I have been fighting a migraine all day.

Jim Brown

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