Thursday Morning

We had to flip 60/40 bearish yesterday.

I didn't like the morning rally and, although we still picked up a few calls, we decided the risks of today's jobs number and tomorrow's Retail Sales report outweiged the possible rewards (If we were to manage to break over our trading range), so we added DIA puts along with the usual covers and rolls.  We felt great about our decision as the Dow fell from 8,850 to 8,650 but we had the usual nonsense into the close that took that index up 100 points to finish the day up 70 at 8,761, missing my 3:23 closing prediction by 3 points. 

The S&P was just under our 900 goal after briefly touching our 950 upside targe (David Fry's chart left) and the Nasdaq beat our 1,550 minimum by 15 points but failed by 10 to make 1,575, which is what we really wanted to see.  My whole comment at 3:23 was: "That was a perfect test at 8,650, almost to the penny and then manic buying to get us back to 8,758 (1.25% up) but I doubt we make 8,866, which is 2.5% and would require the S&P to break 900 and, with Unemployment possibly a new record tomorrow (let GW end the year with a bang!) I would think people will be selling into a strong close."  Today is likely to give us the same trouble – if we go up at all but, on the whole, we are expecting more likely a sell-off as the economic news is not what one would call "good"

While the House stayed late and passed a $14Bn rescue package for the big 3 (less than 1/2 of what they admit they need), the Senate Republicans are threatening a filibuster to stop the bill dead there and that will give us the same kind of chaos the TARP vote did, which was not at all good for the markets.  Credit card issuers are getting hammered by charge-offs (accounts considered uncollectable), which raises the cost of insuring against losses and collections, ultimately eating into margins.  PG cut sales forecasts, CX is hurting, and LLY forecasts a full-year loss.

Even more bad news: CFO pessimism is hitting record lows.  CFOs "are pretty good at predicting the economy," Duke finance professor John Graham says.  And, "they haven't been saying good things."  One-third of respondents to the survey, by consulting firm Mercer LLC, say they plan "significant workforce reductions" next year; most say they will cut back on bonuses, pay raises and hiring. The CFOs say they expect their companies to cut employment by 5% over the next 12 months, and to reduce spending in 2009 on capital projects, technology, advertising, marketing and outsourcing.  Reality check – 5% is NOT THAT BAD – again, the market is already pricing in far worse.

Our balance of trade was -57.2Bn, actually up a bit from last month but import prices are down 6.7% thanks to cheap oil.  The big number this morning is 573,000 jobs lost last week, up 58,000 from last week's shocking number, which sent the markets down 300 points on Thursday and another 200 Friday morning before we had our turn at 8,200.  We're starting today 300 points higher than last Thursday and NO ONE expected a good number today so we'll see if we can hold 8,433 (97.5% of 8,650) through tomorrow, which would certainly be a sign of improvement. 8,541 is the 1.25% line on the Dow and that would be our goal for today to say we are shaking off this round of bad news. 

Keep in mind that I am not bearish here, just toppish – which does not sound as profound as when I say I'm not bullish but bottomish at 8,200 but what can you do…   Anyway, we are playing Dow 8,650 as a mid-point to our trading range and using our rules to guide us while factoring in the changing fundamentals we obseve and yesterday, in the morning post, I noted that we had powerful resistance on the S&P, both on the standard charts as well as our Euro-converted chart.  That gave us an early warning that 900 would be tough to hold and this weigting of news along with oil jumping back over $45 and the fact that the "rally" was led by the energy sector, who must die for the markets to live, led us to shift to a more bearish stance into yesterday's moring rally.  It was very hard sticking to my guns yesterday and at 12:20, with the Dow at the high of the day, I was starting to feel like a party pooper as I kept putting a lid on the enthusiasm, saying to members: "3-month TBill at 0.005%, 10-year still at 2.7%. XLF getting redder, C heading to $8, BIDU negative, AXP hit very hard, GS down — I know it seems silly but I do not like this rally…"

We were discussing the wrongness of oil at the time and I mentioned that a rise back to $3 per gallon would whip $165Bn a year out of the pockets of US consumers and four times that on a global scale and that is certainly another 2/3 $Trillion that we cannot afford.  JD had a great article in Phil's Favorites about the growing oil glut and, until investors accept the fact that this sector is dead, we are still having too much money diverted to the energy stocks in the rallies.  Without proper rotation AWAY from the energy sector, this market is very unlikley to put in a sustainable rally. 

While the IEA is lowering their official demand outlook for crude to show the first contraction in 25 years, it's worth noting that these guys were off on their demand outlook by over 10% for 2008 and are equally as clueless about 2009. "The consumption numbers have just been coming in dramatically weaker, particularly in the U.S. It's very clear the weakness we are seeing," said David Fyfe, editor of the monthly report, adding that crude-oil demand forecasts may continue to be cut.  As JD mentions, Oil analyst Philip Verleger claims that OPEC needs to reduce output by at least 7 million barrels a day to balance supply and demand.  Mr. Verleger, a former Carter administration official, academic, and energy-industry consultant, says OPEC can forget about tiny production cuts of 1 or 2 million barrels when it meets later this month in Algeria. The cartel needs to wipe out at least 7 million barrels per day of oil production to bring oil markets close to balance, he says, according to Platt’s The Barrel.

Because of tepid demand, oil inventories are well above their five-year average in OECD nations, at 56.8 days of forward demand cover at the end of October, up from 55 days in September. Stocks are set to rise further, the IEA said.  OPEC nations, which produce about four out of 10 barrels consumed globally every day, would like to see forward demand cover — a measure of back-up oil supply — at 52 days. OPEC is widely expected to cut production by at least one million barrels a day at its final meeting of the year on Dec. 17 in Algeria.  OPEC's effective spare production capacity stands at 3.3 million barrels a day, the highest since 2006, as the group cuts output to halt the fall in oil prices. The group has so far reduced production by just 825,000 barrels a day, or 55%, of the 1.5 million barrels a day members agreed to cut in October.   Note that oil is not bouncing at all, it is an illusion as the US dollar pulls back, oil is flatlining this week 75% off it's high on a dollar adjusted basis and XOM, who we are short on at $80, collects half their revenue in international currency, which is very weak against the dollar right now so it is sheer madness to see money pouring back into the XLE as oil blips from $42 to $46 as if this solves their long-term problems.

Asia was up about half a point today as South Korea cut it's rates a full point to 3%, the fourth cut in 2 months (have I mentioned I like gold lately?).  India said they don't THINK attacking Pakistan is a good solution to terror attacks, but it is being debated.  Europe is down about a point in morning trading ahead of the US open as riots in Greece underly the deteriorating jobs picture over there.  Very unfortunately, in both Asia and Europe, the energy sector is leading the markets – a real fine exampe of fiddling while Rome, as well as Athens, Beijing, Moscow and Tokyo burn…

Speaking of Moscow burning – The Ruble is on the rocks and much closer to collapse than you may think.  If oil does persist below $50, the Russian economy may fall and that will imperil the baltic states as well as the breakaway nations that have joined Europe but are still in Russia's economic sphere of influence.  A breakdown in the 'stans will harm Asia as well and this was one of my "worst case" possiblilities for the market along with GM failing (still on the table) and a major bank failing (not off the table) any one of which can take us to 7,000. 

THAT my friends, is how we ened up back to 60% bearish during yesterday's rally – let's hope I'm wrong and we have a reason to swing back to neutral after we get through tomorrow's Retail Sales report but, with the international news flow such as it is, it's going to be hard not to be a little bearish into the weekend.