Reality time!
Earnings season is here and, as I mentioned in the Weekend Wrap-Up the WSJ is running an article titled: "Time to Brace for Trouble as Profits Debacle Starts" which pretty neatly sums up the market's mood for the week. We went into the weekend 55% bearish and we would have been more so but we expected the strong dollar to boost the Asian exporters and they did as the rally in Japan continued with the the Nikkei testing 9,000 (but pulling back to 8,850) and the Hang Seng finishing up 450 points (3%) at 14,998 but that's almost 100 points below the morning spike high. As usual for the past 4 weeks, the Baltic Dry Shipping Index fell 2.17% for the day – and there is no better leading indicator of reality than the FACT of whether or not goods are actually being shipped somewhere (they're not).
We've been discussing the Baltic Index for weeks now and I know it gets boring, just like it got boring when I would say, week after week, that home foreclosure rates were a real problem. These things always sound like annoying trinkets of data until they get picked up by the MSM and suddenly become the most important things in the world – our goal is to stay SLIGHTLY ahead of the curve because being too far ahead of the curve is really just as bad as missing it – a bitter lesson we learned when we thought oil was at BS levels from $80 to $140…. Sometimes, you just have to go with the flow and just keep your eye on the emergency exits.
That's been our investing strategy during this "rally," we're happy to play along but we're also keeping our tray tables locked and our seats in the upright position and we're wearing our Stock Market Parachutes the whole way up – just in case… Our just in case plays from last week (in addition to our usual hedged DIA puts) were FXP (ultra-short China, good for a roll today), QID (ultra-short Nasdaq) and FAZ (ultra-short financials). We like to make those plays at the top of a good run as you get the best entries there and, as we saw on Friday – you don't get too badly bitten when the market moves against your shorts as long as it stays below overhead resistance, which provides an obvious point to stop out or cover.
Hopefully we hold our levels and have reason to get our of these disaster protection positions, there is nothing better than taking a quick profit on a healthy pullback and flipping the virtual portfolio back to bullish but our concerns run pretty deep and we will continue to apply the gas and brakes model, which has served us well the past two weeks as the market essentially topped out around 7,900 – right at the levels we had predicted back at the beginning of March. We'll still be watching Dow 7,900, S&P 833, Nasdaq 1,580, NYSE 5,225 and Russell 444 and, as I said last week, we're not going to be impressed by an upward move until we break and hold 8,218 on the Dow, about 865 on the S&P…
Below those levels, we have a hell of an air pocket all the way down to our prior support levels of Dow 7,636, S&P 805, Nas 1,525, NYSE 5,075 and Russell 420. Air pocket is the term we use when we have a low-volume run-up. Since there were not a lot of shares purchased to support the inflated prices along the way, you have to take the run with (as I said in Thursday's post) a Lot's wife-sized grain of salt, much the same way as if one idiot pays $1M for a 1BR condo in Miami, it doesn't mean they're all worth $1M does it? The stock market is the ultimate mark-to-market exercise. I can buy 500K shares of GOOG (10% of a day's trading) for $370 near the close and cause the entire 242M share float to be "marked" up to $370 – even though less than one half of one percent of the shares ever found a market at that price.
Sound familiar? It's the same idiocy that led to the housing crisis but we play this game every day and rarely question it. Real estate was supposed to have the same "market efficiency" as the stock market since there were millions of home transactions each year but, as the entire world learned the hard way, it only takes a very small number of idiot speculators overbidding, followed by a lack of real bidders, to quickly turn market efficiency into a liquidity nightmare. That same logic led us to short OIH into Friday's oil pump. As Lincoln famously said: "You can't fool all of the people all of the time" but, sadly, you can fool retail oil speculators most of the time and $53 oil during the largest supply glut ever recorded is simply unsustainable during a recession.
Pullbacks are good and healthy for the market and we'll be looking to see what support level brings in a flood of buyers so we can gain some comfort that there is real interest at those levels. I'm rooting for 800 to hold on the S&P, as long as we don't slip too fast, that should be right around the 50 dma (now 790) by the time we test that level. Just keep in mind that Billions of shares were bought by traders 25% lower than this so we can't begrudge them a bit of profit taking as we run out of gas (figuratively) 10% above the 50 dma, especially as we head into earnings season. The financial sector will probably get slammed this morning as Calyon Securities' Mike Mayo issued a report titled "The 7 Deadly Sins of Banking" where he initiated coverage on 11 traditional banks with a rating of either "Sell" or "Underperform."
Mayo is negative on the sector despite the recent run-up in shares of banking companies such as Citigroup (NYSE:C) and JPMorgan (NYSE:JPM). Mayo states that the recession is likely to persist and further affect commercial real estate loans. Mayo started Citi with a "Sell" rating, target $3; started JP Morgan at "Underperform" and a $24 target; Bank of America (NYSE:BAC) started at "Underperform", target $8; Wells Fargo (NYSE:WFC) started at "Underperform", target $14; Comerica (NYSE:CMA) initiated with an "Underperform", target $16; and PNC Financial (NYSE:PNC) started at "Underperform", target $8.
EU markets all fell hard this morning as European Retail Sales were the worst EVER as Sales volumes in the 16 countries that use the euro fell a larger-than-expected 4.0% from a year earlier versus the 2.6% expected by economists who clearly don't check the Baltic Dry Shipping Index before they make their predictions. Adding injury to insult is a 6.3 earthquake in Italy which, aside from the immediate tragedy, is bound to put serious additional strain on one of the EU's weakest economies.
Markets in Europe have fallen 2% since their open and US futures look to open down about 1.5% (9:10) at the moment but we'd be thrilled to hold this today. Scary earnings are coming up and, amazingly, this seems to come as a surprise to people who were buying with abandon last week. As the WSJ says in the article we discussed earlier "Even though pretty much every investor acknowledges just how ugly things are, they could be setting themselves up to be disappointed. And, if the past eight years are any guide, they probably will be. The last two earnings seasons, which admittedly played out during times of intense market distress, have seen the S&P 500 decline by 8.53% and 9.32% respectively." As the old joke goes: De Nial is no just a river in Egypt….
Analysts are expecting earnings will decline 37% from the year-ago period. All 10 groups in the S&P 500 show a year-over-year profit slide, a uniform decline that hasn't happened in the 10 years Thomson Financial has been tracking such data. The key to keeping the stock rally going won't so much be whether first-quarter earnings meet or beat those expectations. Instead, the gains will be more dependent on what company executives say about the second, third and fourth quarters. "What everybody is hanging their fundamental hopes on at the moment is the compilation of less-worse information," said Linda Duessel, equity-market strategist at Federated Investors. "We want to hear that we fell off a cliff, and we're done falling, maybe."
As usual, we will try to keep our emotions out of this and watch our levels to see what breaks and what holds but, as Ms. Duessel says, attitude is going to be everything this quarter and it remains to be seen what our CEOs have to say in their outlooks. Meanwhile, we will continue to be careful out there – it helps us enjoy days like today…
