Testy Tuesday Morning

Wow, what a ride!

Unfortunately, like all good roller coasters, the market has a lot of ups and downs on our crazy trip to nowhere so let's not start betting we're going to jump the tracks we've been on since early October until we have some real evidence.  In a roller coaster there are two forces at work – first there is an artificial stimulus that pushes you up to a higher level and then there is the reality of gravity, which pulls you down at great speed. 

I discussed some of this in Stock Market Physics relating to the orbital model of market movement but that is a model for a calmer market.  Clearly we are on a roller coaster now and different forces are at work.  In an orbital model for the markets, stocks are launched and eventually stabilize at various levels where they happily drift along until some force is exerted on them that takes them higher or lower but, as the world is spinning properly, the tendency is for them to just keep going around. 

In the roller coaster model, gravity has increased and there is a tremendous pull dragging everything down.  Only when force is applied (through government bailouts and stimulus) can we move things back up hill but, as soon as the force is removed, the market quickly goes back to following it's natural path back to the bottom.  For the past 2 months, we've been looking for a floor and we hope that we've found one at 8,000 but let's keep in mind that our "bounce" off 7,500 last week was fueled by, not direct stimulus – but rumor of stimulus as Obama appointed Geithner, who has already been bailing our financials right and left as the head of the NY Fed followed by $326Bn of actual stimulus yesterday in the form of a Citigroup bail-out.

This clear signal was all the push the markets needed to race back up the hill to 8,500, which had been the top of our range since 11/17 and was the bottom of our range during October.  Note at the very end of October, we violated 8,500 to the downside and then had a 900-point rally on 10/28, added 500 more points for a neat 20% run top to bottom and then spent 3 weeks crashing to new lows.  Our fuel for the 10/27 rally was the ANTICIPATION of a Fed rate cut, and I will say the same thing now I said then: "Obviously, nothing fundamentally has changed and I would have been much happier with a slow, steady build back over 9,000 than today’s rocket trip as I’m not sure we have enough fuel left to break orbit."

It took a week but we did not break orbit and that has led me to look at the much more depressing roller coaster model because the market has yet to show us that it's in any way capable of even maintaining a level without money being pumped into it.  I'm not saying pumping money in won't work – that's what physics is all about, you apply a sufficient amount of force for a long enough amount of time and, eventually, you can push something free of the bonds of gravity (D, E and F in the diagram) but the heavier something is, the harder it is to push and we are in a global market collapse.

Back in December of 2006, I predicted the market would break the gravitational pull of 12,000 and take us as high as 15,000 while at the same time warning that our policy of burning dollars to fight gravity would come back to haunt us, pretty much just like it has.  I laid our my case for what was wrong with the US economy and why it was unsustainable saying: "Nothing has been built, no major projects have been undertaken, no one is looking for oil or creating better means of transport or really doing any damn thing to improve the quality of life for the bottom 90%.  And, no, I’m not going all communist on you but the number one investment made by corporations last year was in buying back their own stock!"

Of course it was unsustainable, of course it was all BS – so the question today is:  What is real?  Where should the markets be?  Obama and his team certainly have their work cut out for them and they can change the course this country is gone but to do that means laying some new tracks while this roller coaster is in motion – all it takes is one wrong move and we can derail in a horrible crash.  The current administration knows just one trick and that's to keep pushing us back up hill with money so think of the levels we are testing as the top of the tracks and think of the lack of leadership we now have as a lack of brakes as we run back down.  What we're going to need to get off this ride is yes, money – but also leadership and change – it's what the man promised so lets' hope he can deliver…

Today the Fed delivers an additional $800Bn (that's $1.326Tn so far this week!) in new funding "to unfreeze credit for homebuyers, consumers and small businesses."  There are no details as yet but, who cares?  It's more free money!!!  Once great accomplishment of the Bush administration is they have so dehumanized government that we no longer think of their money as our money – which it is.  When the government gives you $1Tn that they don't actually have, what they are doing is putting your name on a loan (as one of 100M tax-paying families) for $10,000.  The administration has done this about SEVEN times (so far) this year and will likely do so again and there is nothing Obama will be able to do to avoid doing the same in 2009.   Have I mentioned I like gold lately?

That's right, Bloomberg News tabulated data from the Fed, Treasury and Federal Deposit Insurance Corp. and interviewed regulatory officials, economists and academic researchers to gauge the full extent of the government’s rescue effort and came up with $7.76 TRILLION committed to date.  The bailout includes a Fed program to buy as much as $2.4 trillion in short-term notes, called commercial paper, that companies use to pay bills, begun Oct. 27, and $1.4 trillion from the FDIC to guarantee bank-to-bank loans, started Oct. 14.  That, my friends, is a hell of a lot of rocket fuel! 

Meanwhile, we'll see what level today's boost can take us to as we have to fight off a GDP report that shows a 0.5% contraction for Q3 (-0.3% expected), our worst performance since a 1.4% decrease in Q3 2001.  Overall, corporate profits fell 3% and, for the whole year, profits are down 9.9% – not quite catching up to the 45% decline in the stock values of those corporations,  Is the market right, are things going to get much, much worse despite the government infusing 1/2 of our annual GDP into the system? 

Paulson is on TV at 10am and at 1pm we auction off 5-year notes, which should go well, so today would be a good day to get back over 8,500 and hold it but yesterday's rally was on fairly light volume and the markets are closed on Thursday and half of Friday so it's a good week to pump a lot of capital in, while the sellers are on holiday.  I am encouraged by the shift in the advance/decline indicator and it does, in a normal market, indicate a sustainable trend but we need the VIX to come down below 40 in oder to get confident that we won't get whipsawed back down again on a moment's notice. 

On the international scene, Asia was up with the Nikkei at the 5% rule and the Hang Seng adding 3.4% while the Shanghai held flat on the day at 196.  The Nikkei was, of course, catching up from a Monday holiday and the global markets are fighting off all sorts of bad news like the IMF having to bail out Pakistan and the OECD forecasting the worst recession since the early 80s with global GDP now forecast to be -0.4% in 2009. 

Something I had forecast $400 dollars ago – BHP is officially withdrawing their offer to buy RTP, that is sending both stocks 33% in opposite directions.  The company is citing lack of financing as lack of value is not something they want to admit, being in the same business and you would think that would concern the markets but the free money shower is making everyone feel better this morning and Europe is up about 2 points across the board, shaking off a poor open that was led down by the mining sector.  The UK is chipping in by tossing $30Bn onto the pile in the form of tax cuts and spending packages and they also have a $100Bn plan to back up mortgaged-backed securities.  Meanwhile, in a side note, the Ruble continues to collapse…

In member chat yesterday we expected to see a 2.5% follow-through to the upside and we also said that not passing those levels (873 on the S&P, 8,650 on the Dow, 5,450 on the NYSE, 1,500 on the Nasdaq and 450 on the Russell) is a very good reason to cover for the weekend and be done with this crazy rally as we strap in for the next dip.  That includes all of the fabulous calls we made yesterday and today as all those crazy gains should be taken off the table or well protected ahead of the holidays.  I still favor the DIA Jan $85 puts as overall protection to be bought around 8,600 as well as the DXDs again, now that they are back to $75, making the Jan $75s at $12 nice virtual portfolio protection as that ETF was at $100 on Friday but hasn't been lower than $60 since June.

Let's watch our levels and be careful out there!