Thursday Morning

Yesterday went as well as could be expected.

In the morning post I said: "We’ll be looking to hold test levels today that were breakout levels yesterday: 10,650 on the Dow, 7,400 on the NYSE and 1,135 on the S&P" and, right at 10:03, my comment to members was: "Construction spending unchanged but ISM down to 43.5, that is terrible!!!  TERRIBLE!!!  50 is the contraction line and last month was 49.9.    Now we’re going to test those levels so be careful…."  The Dow hit 10,650 on the nose at 11:10 and the NYSE went as low as 7,372 around the same time but the S&P never went below 1,144 and that kept us bullish, along with our observation that the big banks were keeping the faith, despite the downturn.

As quickly as 10:19 the drop looked questionable and I noted: "Nice hard level test there and we actually may be holding it, don’t get too attached to your puts if this is all the down they can muster…" and soon after that we heard from GE's Immelt that their capital position was strong etc. as rumors on GE were a big part of the market's weakness.  By 11:24 we were back to bottom fishing, using the same bullish plays that worked Tuesday and, true to form, they worked again as the market rallied back into the afternoon.  It's still very much a day-trading environment and we just barely closed at the target levels I set at 1:24, which were: 10,850 on the Dow, 1,160 on the S&P, 7,500 on the NYSE, 300 on the SOX and the Nasdaq finished 6 points below my 2,075 mark, which made us nervous and I also raised my S&P target to 1,165 at 2:41 after looking at where we needed it to be priced in Euros.

My complaint about the "rally" yesterday afternoon was: "Advance/Decline is still nasty today.  Most of the greens are Banks and consumer goods.  Tech is a sea of red, Materials including oil is wreck, all the Conglomerates are red.  Consumer Goods are mixed but Services look awful.  Utilities are mixed, kind of flat overall.  Healthcare is also mixed.  On the whole, it sure does not look like a sustainable rally but we’re all waiting for the government to drop money on us and that’s what it’s all about."  We had lots of bad signals heading into the close including IBM, SLM and RYAAY falling hard.

As expected, the Senate passed the ammended bailout (they still can't get people to say "rescue") package 74 to 25 and that cheered up the foreign markets somewhat but the Senate vote was never in question.  Tomorrow at noon the House should be voting and everything will be very much up in the air until that moment.  Additions to the original bill include an increase in bank deposit insurance limits, a suggested change to accounting rules, and a $150.5 billion package of unrelated personal and corporate tax cuts.  The 10-year, $150.5 billion package of tax proposals includes a measure to ease the bite of the alternative minimum tax, as well as research-and-development tax credits coveted by high-tech companies and drug makers. Its addition is designed to secure the support of Republicans, who were overwhelmingly opposed in the House. But it could irk conservative House Democrats because the measure will add to the deficit.  The bill, which started out less than three pages long, now comprises more than 400 pages.

Asian markets had a mixed response to the Senate vote with the Hang Seng gaining 194 points (1%), mainly on rumors that the government would be subsidizing home buyers, while the Nikkei gave up 213 points (-2%) and Shanghai and Bombay are closed for holidays so all trading was fairly thin.   Japan suffered from carnage in the auto sector as TM reported a 32% drop in US sales for September as the company's failure to provide sales or credit incentives to struggling US consumers.  Overalll US auto sales were off 27% and GM was the winner, losing "just" 16% of last year's sales.  "The slowdown in global demand is worse than expected," said Yoji Takeda, head of Asian equity management at RBC Investment Management (Asia). "It means that automakers which have been expanding their capacity to meet ever-growing demand are now facing excess capacity."

Another interesting trend was noted in India where Honda's local car unit posted a 45.3% decline in sales, though its motorcycle and scooter sales climbed 17%, indicating continuing demand destruction for fuel as people around the world rapidly change their driving habits.  One problem the US has is a lack of small car options as there are still waiting lists for hybrids but US consumers are not as likely to switch to motorcycles and scooters for transportation.  China is, as always, the demand wild card but gas prices in China have doubled this year as subsidies have been lifted so it will be interesting to see if their consumption growth will continue now that they are paying US prices for gas (still cheap compared to most of the world).

We had a nice 4.3Mb build in US crude inventory and a 900Kb build in gasoline while distillates were drawn down 2.4Mb as refineries stayed at just 72.3% capacity.  Overall consumption in the US was down 7.1%, roughly 1.4Mbd less than last year (which is 18% of China's ENTIRE 7.9Mbd consumption) and yesterday's consumption report marked 22 consecutive weeks of declining US demand, uninterrupted by holidays over the summer.  Oil bulls are using China demand to offset the obvious drop in global consumption but many of the figures they are citing are boosted by the run-up to the Olympics and it remains to be seen what the real consumption numbers are going to look like in Q4. 

Over in Europe, the ECB disappointed investors by holding rates steady.  UBS had good news, saying they expect a profit in Q3 but UK banks are suddenly having trouble as investors rush to switch money to the now-guaranteed Irish banks and banks that have already been taken over (and backed) by the British government.  This sent the Euro below $1.40 to the dollar in a huge 2.5% drop yesterday.  I'm not sure that this trend will continue as the WSJ notes that a lot of the demand for the dollar is being caused by overseas lenders who are demanding dollars in order to reduce their exposure to dollar-funded borrowing.

To interpret the latest swings in the euro-dollar exchange rate as reflecting economic fundamentals "would be to misread what's going on," says Alan Ruskin, chief international strategist at RBS Greenwich Capital. There are a "lot of must-do-type trades that are dominant." One such trade involves an appetite for dollars among banks in Europe and elsewhere, especially as the third quarter drew to a close this week.  One way to play a Euro bounce is the FXE, which tracks roughly the Dollar to Euro exchange and the very thinly traded Jan $140s were last sold at $2.33 (ask is $2.55) and could quickly double on a Fed cut or even simply the passage of the now $1Tn bailout bill.  Trichet has just made doveish comments to take the Euro lower this morning so picking up the Jan $138s for about the same price ($2.50) would be a great way to enter as front-month contracts can be sold for good premiums like the $141s, which have a bid of $1.90 (but should open lower as well). 

Of course the US is not cornering the market on bailouts.  As I said to members at 3:13 yesterday, when we were discussing the need to cover into the rally: "Be real guys, we got that little rally after they said they are bringing back the uptick rule and that didn’t last.  Two weeks ago that news would have been good for 300 points.  This is not a strong market and it’s costing global banks about $200Bn a day to support it for the past week."  France had, in fact, called for an EU-wide response to the banking crisis but Germany has already strongly objected (and they've got all the money in that group) ahead of the summit meeting to be held in France on Saturday.

"Germany supports efforts to beef up regulation," Finance Minister Steinbrück said. "We need more cooperation and convergence of oversight in Europe — that's the right way forward," he said. "But this grand design with a pan-European umbrella, I don't know what that is meant to look like. Unless it means the Germans should pay.  The origin and center of gravity of the problem is clearly in the U.S.A.," he said.

Speaking of the problem being clearly in the USA – 497,000 jobless claims were filed last week, a shocking number but, supposedly, adjusted for seasonality and  hurricane related claims the number is about 440,000, well below the 4-week average of 474,000.  Economists had expected 19,000 fewer claims overall and 3.59M continuing claims is the worst level since September 2003.  The pre-market is reacting to the headline at 8:30 and selling off hard so it's going to be another difficult morning where we'll be watching our two sets of levels for breakouts in either direction. 

At 10 am we get our Factory Orders report, which are expected to be flat at 33.7, which would be a relief after yesterday's terrible data.  Tomorrow we get Nonfarm Payrolls and Unemployment data (both of which will also be shocking if they match up with these claims) ahead of the bell and ISM Services at 10 am.  Not much of that matters other than the House vote at noon, which is still sounding like a toss-up.  We also have the Vice-Presidential debate tonight between Joe Biden and Sarah Palin, which should be lots of fun to watch.  Most likely we will reamin range-bound between our levels today and I still like the idea of the same ETF hedges we looked at yesterday coupled with the positive financial plays – just in case this crazy scheme actually works!