Wary Wednesday Morning

"The observer who has thoroughly understood one link in a series of incidents, should be able accurately to state all the other ones, both before and after." – Sherlock Holmes

First of all, as I said in the morning, we were so far above technicals that a 100-point drop, although painful, would not even break our bullish uptrend so let's all keep an open mind this morning and look for market clues without prejudice.

We need to take off our trader hat and put on our detective hat and watch the market's movements very carefully, looking for subtle signals by observing how companies respond to earnings, testing which indices hold up,  listening for changes in sentiment etc.  Of course, on the other hand, when you walk into the room and see a market that's been bludgeoned to death while sub-prime lenders are standing in the corner covered in blood and bad debt – well, it doesn't take the world's greatest detective to make a connection.

But the markets do tend to be more complex than that and it reminds me of what Holmes said about deduction in A Study In Scarlet:  "Like all other arts, the science of deduction and analysis is one which can only be acquired by long and patient study, nor is life long enough to allow any mortal to attain the highest possible perfection in it. Before turning to those moral and mental aspects of the matter which present the greatest difficulties, let the inquirer begin by mastering more elementary problems.  It sharpens the faculties of observation, and teaches one where to look and what to look for."  That's what we try to do here at PSW, we want to teach you what to look for.  No one can have a perfect understanding of the markets but, as a group, we can sure paint a pretty good picture!

The picture in Asia was not so good today with the Nikkei giving up 203 points and the Hang Seng off 278 points.  There is a growing concern that Chinese companies have been playing the markets by plowing their profits back into the stock market (as it makes money faster than most businesses can!) exacerbating the bubble over there.  Many companies are increasingly dependent on investment gains for profits. According to estimates by Goldman Sachs and Wind Information Corp., a Shanghai-based financial-data provider, gains on investments, including stocks, contributed 23% of overall profit at listed, nonfinancial companies in the first quarter of 2007. That was up from 13% in the previous quarter.  With Chinese interest rates low — the standard rate for a one-year loan is 6.57% — some companies are even breaking regulatory rules and using borrowed money to juice their returns.

"It's an unfortunate diversion from their core business," says Michael Kurtz, Asia strategist for Bear Stearns. "What we see is Chinese companies who have some available cash on the balance sheet deciding they can get a better return on that money by investing in the stock market rather than plowing it back into the business or returning it to shareholders."  Wow that sounds crazy right, companies using hard-won profits to buy stock instead of building a business.  Sounds like it could fuel a MASSIVE SPECULATIVE BUBBLE – isn't that right XOM ($28Bn last year), COP ($15Bn just announced), CVX ($4Bn last year), VLO ($2Bn last year), SUN ($1Bn last year), et al???

As I said in comments yesterday, I love the hypocrisy as Dylan Ratigan was on CNBC grilling a guest on what a bad sign it was that HD "has nothing better to do with capital than buy back their own stock" while he goes on fast money later that night and echoes Cramer's BUYBUYBUY on COP for exactly the same behavior.  Speaking of Cramer – he made a $50,000 bet in January with oil pimp extraordinaire, Eric Bolling, as to which sector would be the hottest of 2007.  Jim chose the Financials (XLF) and Eric, no surprise, went with oil.  So far, oil is up 22% and the financials are off .57%.  My pick was tech and I will tell you right now that both of these guys will be negative by December.

China's GDP got an upgrade to 11.1% from 10.7% and Singapore clocked in with Q2 growth of 8.5%, revised up from 7.6% so there is no doubt that Asia is "en fuego" but there's a reason our Fed fights hard to keep our growth under 5% – there a dire consequences when growth like that slows down, even a little.

Europe has been growing at a nice steady pace for so long that the EU passed us this year in GDP and the Euro just posted a new record against the dollar ($1.38) and the German markets don't like that one bit and the DAX is dropping close to 2% (145 points) this morning as export stocks around the world fell as fast as the dollar.  It's time for an intervention by World bankers but I'm wondering if they may be running out of ammunition as they've already traded over 35% of their currency for US dollars.

Our markets have slipped back into our DIScomfort zone but still right at the high end of it so it's not time to panic just yet.  It will be up to US traders to put the brakes on this slip but this week is still light on earnings and economic data that can save us, which will put a lot of emphasis on today's oil inventory.  Nothing looks hopeless yet but we certainly don't want that breakout level to start acting like a top: 

ZMan and I will be reporting live on Market News First at 10:25 where hopefully my short gambles on energy will pay off.  We have put plays on BTU, CVX, DO, PTR, RIG, SLB, SU, TSO, VLO and XOM (spread) but let's not be too greedy and keep tight stops on our profits.

We hit the jackpot on our CHAP play as they announced a $4.2Bn buyout by GGB so we will be in a VERY fine mood this morning!  The timing could not have been better because I had intended to take some profits on this play off the table ahead of tonight's earnings…

Today we will hear from AIR, DNA, RT and YUM, who got a UBS upgrade this morning ahead of earnings.  Tomorrow we get reports of note from MTB, MAR and TXI and on Friday we'll be watching GE, who will dwarf all other news that day.

On the whole, lots of fun and excitement but let's try to stay objective and see which way the wind is blowing.