This was, unfortunately, the data point we feared this week and we have to see how the markets handle it at 2pm this afternoon. The Beige Book is a summary of the economic conditions in each Federal district and is released two weeks prior to the Fed meeting. In October's book the "bright spots" of the report were energy, farming and mining. Since then, the miners and energy companies have fallen off a very steep cliff and the Ags have traded way down and, since the book is compiled from bank and branch directors as well as anecdotal interviews with key businessmen, economists and other "market experts" we can expect this one to be chock full of both doom and gloom at a level that may be shocking.
This is just great! We love the idea of getting another chance to test our levels to see if they are really going to hold. The market was very well behaved yesterday, moving right between the levels I predicted in the morning, giving us two easy shots at picking up our 36 bottom fishing trades from Monday's post. It wasn't quite enough to let us go 60:40 bullish as we barely got past our minimum goals for the close but last Wednesday we had a pre-market sell-off on terrible jobs data, a 1% drop in personal spending and a Chicago PMI that was so low it looked like it was from before the industrial revolution and we bounced back from that, making a huge rally. Today we have to shake off ISM Services, which will suck and we also get Productivity, which should be fine at 1% or so but it's the Beige Book that will give the bears the ammo they need to test the lows – most likely you can pick a quote from any page that would prove we should curl up into a ball and cry.
So today we test Mr. Buffett's mantra: "Be greedy when others are fearful" and we'll see if it's really time to buy the bottom. It's still all about the Nasdaq and we want to see the Qs hold that 27.50 mark (1,425). RIMM was added to our buy list last night as the company cut profit and sales forecasts. We'll see where they shake out this morning but I pointed out to members that dropping their Q3 profit forecast from .91 to .81 is still a 25% increase over last Q3, when the stock was trading over $100 per share and, when they beat Q4s estimated .71 by a penny, the stock flew up to $148. Yes, we were all young and stupid then but, at $36 a share, we can buy the stock and sell the Jan $36.62 puts and calls for a combined $12, which lowers the basis to $24 with a 50% profit if called away and a $30 entry if a second round of stock is put to you below $36. That is textbook being greedy when others are fearful!
If you are following our core strategy of staying well covered with index puts, there is little fear in picking up a stock at a 20% discount because, if the Nas drops another 20% – we will clean up on our puts. Let's say you cover RIMM specifically with QQQQ March $31 puts at $5 and decide you are 65% bullish on that particular position. So you buy $3,000 worth of the RIMM spread at $30 and you spend $1,000 on 2 QQQQ March $31 puts. If the Nasdaq and RIMM drop 20% (and there's no guarantee they fall together) then RIMM will fall to $30, which is your net buy price and the Qs will fall to $22.25, putting your March puts almost $9 in the money. So you would be even on the RIMM side and up $800+ on the put side. From that point lower, you make $200 for every dollar the Qs fall so there would have to be at least a 45% additional drop in RIMM, to $18, before that trade really hurts you to the downside. On the upside, you have a goal of RIMM getting back to $36 and between now and March you need to sell just $1,000 worth of calls and puts to offset 100% of your protection. Of course it's a little more complex than that as we take offsetting puts to the downside of the Qs and we reposition and use market timing to maximize gains but, that's the gist of it, and that's how we are able to pick up bargain-basement stocks with a minimum of fear – we actually do quite well if the market keeps crashing!
The S&P keeps crashing into that nasty 850 line and the trendline from September is still very much down and unviolated at 875 but we did break the 10 dma at 837 and that's what we want to hold this morning. The Nasdaq faces even worse resistance at 1,500 (see Trader Mike's chart) and that is what we're looking to break in order to get our other indexes moving. We took a fresh look at the Dow yesterday during member chat and decided to raise our mid-point to 8,650 from 8,500. That puts the 5% rule to the downside at 8,217 and the 2.5% rule at 8,433 so the close at 8,419 left us just shy of our mark and kept us cautious into the close.
At 2:16, with the Dow testing the 8,200 mark again, I had said to members: "If we hold green, it’s still possible to rally back into the close but now incredibly unlikely that we break over 2.5% levels we tested earlier and certainly not 5% up. On the bright side, the NYSE and the RUT are still up 1.5% and 2.2% respectively and they will help us rally back if they can hold it here. I guess we can blame GMs 41% decline in sales as a trigger here – I don’t see anything better but we just held 8,200 yet again so it’s a great time to flip long in the Dow for a quick 200-points back up!" While it was nice to hit our 200-point goal at 3:35 I had to comment: "Man, this market is like riding mechanical bull – and it feels just as manipulated." We decided that we need to see a 1.25% follow-through in the morning in order to get more bullish and we are getting just the opposite pre-market on a poor ADP Employment Report that shows another 250,000 jobs lost in November. Productivity was up 1.3% as we expected but 30% more than "economists" expected and I think that is a very nice number.
So we should hold our floors (same as yesterday's post) into the reading of the Beige Book but where we go from there is anyone's guess. David Fry points out that RSI levels have not been below 30 on the monthly charts since 1974 and, before that, only during the great depression. I pointed out to members the other day that 40% of New Yorkers believe they may lose their jobs and 80% have cut back on spending on fear of loss of income yet, even in the Great Depression, "only" 25% of the people were out of work so the fear and reactions of 80% of the people are probably 80% wrong as it's very unlikely more that 20% of them would lose their jobs – even in a severe economic catastrophe.
Far be it for us to stand in the way of the stampeding mobs, we are keeping an eye on our levels and will move 60/40 bearish if we break them but I am hopeful that, at some point, common sense will come back into play and we will start seeing individual stocks and, eventually, individual sectors start to assert themselves and begin to buck the downtrend. Clearly we need the energy play to die. It keeps sucking up money on the upturns and that's a bad thing. We need the SOX to show signs of strength as they are killing the Nasdaq and we need the Russell to lead us higher, although it's already 15% off the bottom vs 13% on the Dow and 14% on the S&P. Longer-term, the Russell has been killed the past 3 months and is significantly lagging the other indexes so we still like the UWMs (ultra long RUT) down around $15 as they were $60 last year and can only go as low as zero so not a bad risk/reward for an index tracker. As I said Monday night, if things are really going to be so bad that we think the Russell will drop another 50%, what's the point of trading anything to the upside? You can enter UWM at $15 and sell the Jan $14 puts and calls for $5.70 which is a net $9.30/11.65 entry, covering a 22% drop in the ETF or an 11% drop in the RUT from here (since it's a 2x ETF) to 400, which it managed to hold in mid-November.
The Shanghai had a good day, jumping up 4.4% to 209 and the Hang Seng and the Nikkei managed to tack on about 1.5% on more talk of China bailout money and a decent start to the retail shopping season. Still, this is just roller coaster action with an arificial push as news that Central Huijin Investment, a unit of China's sovereign wealth fund, increased its Class A-share holding in China Construction Bank as part of the government's efforts to shore up the sagging domestic stock market raised hopes for similar moves. "It's possible that other big institutional investors, such as the national pension fund and insurance companies, will follow Huijin's footsteps in the near term," said Wang Junqing, an analyst at Guosen Securities. China Construction Bank rose 5.2% and Industrial & Commercial Bank of China was up 2.9%. Gravity will take it's toll and we will buy some FXPs if the US doesn't rally today.
Europe is trading down 1-2% ahead of tomorrow's Central Bank rate meetings as reports of UK consumer defaults mounting against the now government-backed banking system there. Things are looking grim in Europe and anything but sharp rate cuts will be taken badly by the markets over there. "The PMI data shows serious weakening in activity as prices fell and businesses turned gloomier. It gives the European Central Bank plenty of cover to cut interest rates aggressively, Thursday," said economist Kenneth Broux at Lloyds TSB Corporate Markets. This will not be good if they end up being disappointed tomorrow morning.
FCX, who I liked yesterday at a $20.91 hedged entry is justifying our bearish stance by dropping near our $17.50 target pre-market as they suspend their dividend and cut output. Our entry basis is $13.21 and our break-even on this position is $15.35 and we'll be happy to get called away at $17.50 as we were mainly in it for the $2 dividend. If you look back at yesterday's entry on this one, it's a great example of how we can ride out a 20% drop in a stock, even a day after we enter the trade. FCX's gloomy announcement is causing a sell-off in the mining sector (star of the last BBook!) and another pullback in commodities. "The suspension of our dividend reflects the sharp and rapid decline in copper and molybdenum prices, the dislocation of capital markets and the uncertain economic outlook," Chief Executive Richard Adkerson said in a statement. Freeport will reduce copper production by about 200 million pounds in 2009 and by about 500 million pounds in 2010 from October estimates. The move to suspend the annual dividend of $2 per share will save the company about $755 million on an annual basis, it said.
So it's going to be one of those days. We have every reason in the world to break down below our levels and, if we don't, we'll have to consider it a positive. Let's see if oil can hold $47 but copper may continue to fall all the way to $100 as they face the same spare production issues that are killing the speculative market for oil. Remember, it's not about the Beige Book per se this afternoon but the market's reaction to it. If we hold our levels and see some buyers, we can get a lot more confident in our bottom call.
