Monday Market Meltdown – Global Edition!

Total market carnage!

That's what we're waking up to today.  We may be finally getting into oversold territory but the waves of panic are coming from across the globe and it's going to be hard to fight this tide.  On the way down on Friday, at 1:47 we looked at two emergency covers, the FXP $110s at $7.50 and the DXD $63s at $5 to guard against just such an occasion.  Both are ultra-shorts – one on China and one on the Dow.  It's good to have plays like this ready, in cases of emergency as it's faster to cover with one big short position than scrambling to cover a dozen more bullish plays. 

It is also important to remember that a cover like this does not do you any good unless you take the profits.  Taking profits can mean selling all on a good move or selling 1/2 or covering your short plays to raise cash.  If you allocated 30% to the short side and they double, then you have 60% of your virtual portfolio back to cash.  Even if the other 70% dropped in half, you still are coming out pretty well and you can reallocate a new 30% (of the remaining 35%) to cover the remaining longs, which puts you into half cash with a 5% loss.

If you had taken something like the DXD $63s at $7.50 and they open today at $12.  The premiums are likely to be highest on the opening rally (as it's a short) and you need to be realistic as to what you expected out of the position.  Again, if it's a 30% allocation and you gain a quick 60% like that, it means cashing out can put your virtual portfolio in 1/2 cash.  Another tactic could be to sell whatever new call is $7.50, perhaps the $68s, which gives you a free $5 spread but that's only up $1.50 from where you are at $12 and cash is certainly king in this market (just ask Mr. Buffett, who wishes he held onto his this morning!). 

We started picking the ultra-shorts on Wednesday morning, in my "Hedging for Disaster" post.  Tuesday was an up day and we prefer to take those covers when the market is against them but better late than never applies in this situation if the US markets fail the 2.5% rule (Dow 10,050, S&P 1,075, NYSE 6,900, Nadaq 1,900) then additional short positions can be taken, using those levels as stops.  IF those levels hold however, then it will certainly be time to lighten up on the put side as that would be very resiliant considering global markets are down at the 5% rule AND the dollar is up over 2% this morning, making our assets expensive to foreign investors. 

Your stock may be losing 5% but a share of AAPL can be traded for a barrel of oil and you get some change – on that basis, you are only $20 worse off than you were in July.  2 shares of Google bought 1 Oz of gold on August 1st, today they buy .9 oz of gold.  Things are relative.  The best news I see in this sell-off is that the commodity bubble is well and truly popping.  Oil is back under $90 in pre-market trading and looking very weak.  Back in July, as the market melted down that Monday, I fixed the blame for the destruction of consumer spending squarely on oil, which was over $140 at the time.  Now, at "just" $90, US consumers alone are spending $1Bn PER DAY less on fuel than they did at the beginning of Q3.  On a global scale, that's $4Bn per day saved on energy, a $1.5Tn bailout to the global consumer.  Compound that with the drop in other commodities and we can build a pretty good case for cyclical rotation – IF the panic ever subsides…

So commodities are outperforming equities at the moment by about 10%, we should keep an eye on the stocks to oil and gold ratio, perhaps with the S&P and we can see the SIGNIFICANT improvement in the energy buying power of our virtual portfolios.  In fact, the S&P priced in oil is about to possibly break out above the 200 dma indicating either oil will break sharply lower or the S&P will break sharply higher or, perhaps a little of both.  Due to the "flight to safety" issue, we are not looking as good as gold on the chart, still around 15% (combined S&P up/gold down) from looking like stocks are a better investment than gold BUT – don't forget the S&P includes miners and oil companies, so it's a tricky comparison as those same sectors drag down the index. 

In this week's Wrap-Up, we talked about watching the top 10 Dow components and assessing the outlook for each one to get a handle on where the Dow is going next.  Our big worry was, of course, XOM and CVX, both of whom are still miles above the 2005 levels that most of the S&P has sunk to and they are both major weighted components.  IBM also has a long way to fall and all of these make great put plays if the Dow breaks further down as a falling tide lowers all ships and these are still the relative high-flyers of the Dow (outside the staples, which benefit from "flight to quality" plays). 

With the worst-case market melt-down scenario on our minds, IBM Nov $95 puts are surprisingly cheap at $4.25 as IBM was in the mid-$80s in 2005.  XOM is still up 50% from 2005 levels while oil itself is still almost double the $55 average of that year.  If oil comes down fast, so will XOM and Jan $70 puts are only $3.50.  CVX is a very different company than they were in 2005 but they also made big acquisitions and they could fall back to the $60s if oil and natural gas collapse.  That make the March $70s at $4.60 an attractive hedge against the end of the world and the collapse of the Dow but, keep in mind that holding 10,050 is going to be a good thing and the Fed is on the march, throwing everything they can at the markets short of their last few rate cuts (so far) so I'm not saying we should be eager to pick up Dow puts – just ready to do so if things head south from here…

Things are heading very far south in Asia and we'll be drawing up a very scary-looking Big Chart this evening.  The Nikkei closed down 4.3% (-465) and the Hang Seng fell 4.97% (-878) to finish below 17,000, close to 50% off last year's peak at 32,000 and the Shanghai dropped yet another 5.2% to 2,173, over 60% off last year's high.  "There's a growing view that an interest rate cut by the Federal Reserve and other global central banks wouldn't be sufficient, and concerns over a spread of financial woes in Europe still linger despite the approval of the U.S. bailout plan," said Hiroaki Kuramochi, head of the equities department at Tokai Tokyo Securities. 

European markets are faring little better ahead of our open with the FTSE off it's lows but still down 2.5%, the CAC still below 5% and the DAX right at the 5% line.  It should be noted that this is just a retest of last Tuesday's lows for the FTSE and the CAC and won't be so awful if they hold it but the DAX is testing 2006 lows at 5.500 and the prognosis is NOT GOOD if they fail at this level.  As Europe's largest economy, don't expect the rest of the EU to save Germany. "We now believe national recessions in the U.S. and the U.K. will be deeper and longer than previously forecast," said Larry Hatheway, an economist at UBS in London. "For the first time, we also anticipate recession in the euro zone."  "The troubles in the European banking sector are arguably beginning to overtake those of the US," said Philip Shaw, economist at Investec Securities in London.

Russia stopped trading after their markets fell 15% at the open and the RSX is already more than 60% off it's May highs.  As an oil-based economy, Russia is in very serious trouble at the moment as their moves of last year to jack up the price of natural gas come back to haunt them as the world has spun into a cycle of epic demand destruction. 

C is getting no love at $17 as it fights for the WB deal and WFC got slammed too and makes the best looking call play since they never got a big boost from the acquisition but the fact of the deal stamps them as a lasting player.  With the Oct $34 callls sellable at $2.75 the Apr $30 calls are attractive at $8 or lower (about 1/2 premium).  Pending Fed action does make bank plays very dangerous though and full covers are too dangerous so it's more of a long-term bullish, 1/2 cover-type play.  BAC is also getting cheap today as an $8.4Bn settlement with state AGs is in the works.  The value of the modification program is as much as $8.4 billion, according to the Bank of America spokesman. The costs of the program "have already been estimated and accounted for" by Bank of America as part of its acquisition of Countrywide, the spokesman added.

We're hoping for signs of hope but it's the upside plays that remain speculative.  The Fed is pouring money into the markets to no avail and sentiment is very bad.  Needless to say, be careful out there!