Testy Tuesday Morning

Yesterday was not bad!

We were skeptical of the early rally as we expected a minimum of a 2.5% gain from the $1Tn that was dumped into the markets over the weekend but we got nice follow-through that tested or exceeded our more agressive upside targets I set in the morning post that were Dow 9,400 (finished at 9,265), S&P 980 (finished 985), NYSE 6,232 (finished 6,287) and Nasdaq 1,775 (finished 1,770).  Those were pretty good calls but we're still a long way from Dow 10K – so we're not going to get too excited just yet.

The only pick I had in the morning was a re-pick of X from last week and they had a nice, additional 10% move on the day, now up to $46.  We didn't really jump on things as the market drove higher as we've been burned on Tuesday's before and we already had tons of good positions from last week, when things were REALLY cheap.  At 10:06 I revised my targets to look for Fridays highs, saying: "Dow over 9,000, topped out at 9,300 Friday, S&P at 962, was rejected at 985, NYSE we know was 6,232, now 6,121 and Nas was 1,775, now 7,737.    We are right around 2.5% at the current levels so very critical to hold 2% on a pullback.   We are set up nicely for a run up but we need something to hang our hats on…."

We did, in fact, get two somethings.  Bernanke, in his testimony to Congress, endorsed the idea of an additional stimulus package for taxpayers while PIMCO announced they had upped their exposure to mortgage backed securities by 10%, a bottom call if ever there was one!  That was just the fuel we needed to get back to Friday's highs but we do need to break out over those levels in order not to suffer Friday's fate of a rapid pullback that may form a nasty double top near our 40% lines.  So let's not fool ourselves, we had $1Tn before the market opened put into international markets and another $200Bn of promises for the US markets during the day – this does not lead us to getting long-term comfortable with the market direction.

Still we stay technical and let our levels be our guide.  Our intra-day plays had mixed results as we hedged on the way up with BIDU and DXD puts, so of course those didn't work but neither did our FRE and FNM calls but HOV, UYG and SPWRA all did very well.  We're still into balance until we confirm our breakouts but the Big Chart tells us we are getting close: 

The SOX are still pathetic but the Transports are actually closing in on the 40% mark – hopefully oil will calm down and give them a chance to move forward.  All the other US indexes made it back over the line but the S&P, NYSE and Nasdaq are still right there so we do NOT want to see a 2% drop in any of those for the rest of the week if we are going to remain hopeful.   I still like playing the SOX for an up move if we hold the line on the other indexes and SMH 2011 $15s are not a bad entry at $7.50 as you can sell the Dec $20s for $1.75 for a net entry of $5.75 on the $5, 25-month spread.  As this play wipes out most of the $2.30 premium on the first sale, I do like this spread better than owning the ETF with the cover.

Over in Europe, the FTSE made it back over and the DAX is right on the line so we'll be looking for the CAC to confirm an uptrend for the EU markets while we'll have to be happy just to see the Hang Seng get back to 1/2 off it's 2007 highs.   On the left we have the DJ World Index and it simply is not very impressive to see global markets bounce off a 50% drop until that bounce exceeds 20% of the drop.  As we are down 150 peak to trough, we need to see 200 taken back in order to call this anything more than a dead cat bounce on a global scale and the longer it takes to take back 200, the less impressive the move will be.

That's why I was very disappointed to see the Hang Seng and the Shanghai trade off this morning with the Shanghai barely holding their own 200 line on a 1% dip and the Hang Seng just having an awful day, dropping back to the critical 15,000 line (down 2%).  "The stock market is currently in 'intensive-care' mode," said Eiji Kinouchi, chief technical analyst at Daiwa Institute of Research.   Japanese markets led Asia with a 3.3% gain but, like the US yesterday, they were led higher by a bounce in commodities – not our favorite kind of rally…  Another downer for Asia was Citic Pacific, who plunged 55.1% on news of its massive foreign-exchange losses. The company said an executive's soured bets on the direction of the Australian dollar will result in nearly $2 billion of losses.

This morning's rally in Europe only cost France $14Bn as six of that country's largest banks agreed to take the state funding.  That is rallying bank shares across Europe as financial conditions improve on the heels of yesterdays $1Tn injection by Germany and Sweden. "The narrowing in Libor and TED spreads testifies to some easing of fears and may bolster risk appetite for oversold stocks," said Kenneth Broux, an economist at Lloyds TSB in London.  That easing has come at a great cost though, as the UK net borrowings record highs, up 69% from last year. 

Economists said net borrowing could swell to at least £60 billion this year and noted that bringing forward planned public spending could prove difficult in short time spans.  "Further deterioration is likely in 2009-10, with borrowing rising to £92 billion, 6% of [gross domestic product]," said Hetal Mehta, senior economic adviser to the Ernst & Young ITEM Club, a forecasting unit.  "September's U.K. public finances data show that regardless of the cost of recapitalizing the banks and the chancellor's plans to front-load spending, the economic downturn is set to push borrowing to alarmingly high levels," said Paul Dales of Capital Economics Ltd.  Of course, the same could be said for the US – we're just pretending it's not the case…

It's good that we stayed bearish yesterday as earnings were mixed and mixed is not good enough for these markets.  Also this morning we have only FRX guiding up and a lot of negative guidance from:  PKG, TXN, BIIB, CE, DD, ELS, GNTX, IMN, LXK, MAN, MSM, PNR, SWK and TLAB and we're still waiting for 9 reports.  Notable beats came from AXP, HXL, NFLX, MMM, BIIB (which should be good for ELN), PFE, DGX, SGP and WAT.  Of the group, I love PFE, who are effectively paying a 7.6% dividend at $17.34 and you can buy that stock and sell the 2010 $12.50 calls for $5.42.  Of course you will almost certainly get called away at $12.50 but your net basis is $11.92 and you still get the 5 0.32 dividend payments before you get called away for a net gain of $2.18 (18%) on Jan 15th 2010.  This is, of course, assuming they don't cut their dividend but today's earnings report was strong and gave no indication that was in the cards.  Of course, there are more aggressive ways to play, but this one is nice and simple.

The VIX took a 24% tumble, down to 52.97 at the close, really great for last week's VIX puts but really bad for the easy cover plays we've been enjoying the past two weeks as we took advantage of these historic premiums.  We knew it wouldn't last which is why there were over 100 covered call trade ideas posted in member chat in the past two weeks – now we'll have to see how the markets hold up and look at what the best go-forward strategy will be as we head into the close of the year. 

CAT gave weak guidance and that puts global recession/depression fears right back on the table.  The WSJ has a neat list of experts who belive the bailout is working already but it includes Bernanke and Bush – who may be slightly biased.  There's already an issue with the use of bailout funds as some banks have already said they intend to use the $250Bn being given to them under one program to fund acquisitions of other banks.  This is not even close to what the money is supposed to be used for and it's doubtful there will be a net increase in money lent out when one back buys another – just another layer of the Paulson scam coming to light!

I said about yesterday's mad oil rally that it reminded me of all the silly builder rallies as they fell 40%, then 50%, then 60%, then 75% and finally to 90% off their highs.  There were plenty of times when they would suddenly jump up 10% on some bit of news and yesterday it was promises of an OPEC production cut that would boost prices but, of course, this is silly as production is being cut as demand is not there and the entire premise for high oil prices is limited spare production capacity.  It is now estimated that global spare production of crude oil is at the highest level it's been at (5Mbd) since 2002, when oil was trading under $30 per barrel. 

Global demand, which was at 87.5Mbd just a year ago, is down to under 85Mbd.  OPEC just cut the 2009 demand forecast for their crude down to 31.14Mbd, even at these reduced prices.  They are currently producing 32.16Mbd, so that's 1Mbd too many and anything less than that cut at Friday's meeting will be a glut on the market.  OPECs projections are based on a fairly optimistic outlook for global growth at 3.3% in 2009 and makes assumptions that non-OPEC suppliers will also cut production – quite a stretch!  There's a reason OPEC is having an EMERGENCY meeting on Friday so oil bulls beware or you may suffer the fate of the people who repetedly called the bottom on housing.