Sunday, June 15, 2008

Psychology in the Upcoming Week's Economics & Earnings Data

Good morning and good evening to all. We are happy to have you back. Last week's market activity was negative, yet many are left optimistic after Friday's concussive short covering rally in the financial sector. There are a couple of interesting mechanical facts that must be understood and respected, specifically related to "Profit Taking Friday" with the financials, and "buy the rumor, sell the news" with Apple (AAPL). First though, let's take a quick look back at what transpired with the averages, and while doing so please keep in mind our bearish stance on the NASDAQ last Monday with the article "Apple Optimists Need Not Apply."

The NASDAQ closed down 20 points or 0.8% for the week. From a 6 June close at 2474.56 to a 13 June close at 2454.50.

The S&P 500 Index closed down a whisker for the week, from a 6 June close at 13.60.42 to a 13 June close at 1360.03. Do you appreciate the significance of the flat close in the S&P500 this week, in spite of many financial stocks finishing up 10% plus on Friday? Here's what happened:

The main driver for the week was the financial fallout related to the Brothers Lehman (LEH) and the short covering that occurred all day Friday. LEH closed on at $32.33 on 6 June and rallied from under $21.00 at one point on Thursday to close at $25.81 for the week: that's still a 20% fall. Did anyone find CNBC's Charlie Gasparino's two day old comments from Merrill Lynch (MER) reiterated intraday on cable TV a bit suspect? MER's CEO John Thain did report they may need to raise capital on Wednesday, so Gasparino's commentary was out of bounds: do you agree? Perhaps the market shook down enough in order for his hedge fund buddies to cover at lower prices. Here's a 3 month chart since a 5 day wouldn't show the gap down from its $32.33 close on Friday, 6 June:

Ironically, "Profit Taking Friday" did come true in an up market, as hedge funds decided to cover their short positions in LEH and many other financials. Friday's 20 point explosive S&P rally can be single handedly accounted for in short covering of the beaten down financial sector, but especially Goldman Sachs (GS) and Morgan Stanley (MS), both up 6.9%. The S&P is heavily weighted with financials, so it is a rare day to see the financials rally with the S&P down. Our readers should not be fooled into thinking the financial sector is a buy here after Friday's rally, as earnings from LEH come Monday, GS Tuesday and MS Wednesday. Quick Psychology: If it weren't for short covering in financials and relief rallies caused by MSFT and GOOG, the Consumer Price Index (CPI) coming in at 0.6% was enough to derail the market. The Producer Price Index is slated for Tuesday and hopefully the short covering continues for the bulls’ sake, but we don't think it will.

Please be advised… Wall Street hates uncertainty, and the regulations that lay ahead will not be known for many months. What we do know today is forward earnings will contract due to the dried up real estate/credit/derivative markets as well as lack of global Initial Public Offerings (IPOs) and Merger and Acquisition (M&A) activity of late. The high price of crude and food is affecting many nations and the drumbeats of rate increases from ECB's Trichet and Chairman Bernanke are getting louder. POTC urges readers to be cautious with any long positions, especially ahead of Goldman's report and the PPI on Tuesday before market open.

Another interesting cliché and market mechanic that came true was "Buy the Rumor and Sell the News" with shares of AAPL. POTC was negative on the NASDAQ this past week in our Sunday night Apple piece and we want to congratulate all E-Mini traders who profited, as we did. Also, congratulations to all who voted AAPL would close down for the week in our poll.

POTC strives for all our readers to understand the simple fact that when everyone in the media is on the same side of the trade, as they were with the launch of the AAPL iPhone, the expectations usually back fire. Pete Najarian of Dylan Ratigan's CNBC show "Fast Money" mentioned buying AAPL call options several times preceding the iPhone launch, CNBC had reporters on the scene to cover the event and Steve Jobs. When factors like these converge, you have to realize it's only a matter of time until someone says "fire". Witness that selling stampede with AAPL's price falling over $21 from Tuesday's high to Friday's open. For the week AAPL shares lost.

The last driver that aided the market rally was Microsoft's (MSFT) adamant public statement regarding withdrawing from the Yahoo (YHOO) deal. It was obvious MSFT share holders were fed up with share price under performance and Steve Ballmer was forced to make a final stand: NO DEAL and shares rallied 2.9%. As a result of this news shares of Google (GOOG) rallied over $18.00 or 3% since it is less likely MSFT will be able to effectively compete in search advertising. POTC would buy GOOG on pull backs and does not recommend buying MSFT or YHOO.

Market mechanics were dynamic last week. POTC hopes our readers now better understand what transpired and led to the volatility. Why did the short covering rally ensue you ask? 1) LEH, GS, and MS all report this week. 2) The Fed window is open to cover any and all losses by bad trades and mismanagement, so the chance of another Bear Stearns is nearly zero. 3) The short trade was getting tired and had over 20% profit in one week, even in the face of a 13.7% Friday LEH rally alone! So, "Profit Taking Friday" did in fact occur. We apologize for not bringing you this information earlier, but POTC is very proud to have you aboard and promises to always look back in order to clarify and educate in the dynamics of market mechanics.

Bear in mind that forthcoming week ends with "triple witching" expiration on Friday. This is an event that occurs when the contracts for stock index futures, stock index options and stock options all expire on the same day. Triple witching days happen four times a year on the third Friday of March, June, September and December. This phenomenon is sometimes referred to as "freaky Friday", so be aware that things could be a little strange on Thursday afternoon and all day Friday.

On Monday, June 16th at 8:30 ET, the NY Empire State Index for the month of June is released. It is a regional manufacturing survey that quizzes nearly 200 executives on their current sentiment as well as their six month outlooks. The prior reading came in at -3.2%, now the consensus is from 0 to -2.4%. POTC feels this number will come in strong, as the survey is prepared by the Federal Reserve Bank of New York. Could some politics play into this number as Wall Street is under the knife? Of course. POTC would shrug off the rallies that ensue after this number and pay closer attention to crude oil as a day trade indicator. Also, please pay close attention to the financials, specifically LEH, GS, and MS. Is the short covering rally over? Perhaps, but LEH's Q2 2008 earnings report Monday at 10:00 ET will make headlines and the headlines cannot be good when losses mount and a call for capital is announced. Are Investment Banks not supposed to be experts in hedging strategies? Their mathematical computer models are only as good as their forward-looking projections/estimates/assumptions. The real estate market was thought of as bullet proof, a trade that couldn't lose. (Just ask Bear Stearns.)

Here's the link to the live LEH CC:

Please don't force trades, allow the mechanics of the market and Institutional money (smart money) to give you direction. Our team will be monitoring these three hugely important gauges of short covering, earnings, and oil very closely, but especially the minutes after 10:00 ET, as Institutional money rarely trades early or late. GS reports before market Tuesday, so set your trades up accordingly, as there will be a reaction down before the opening bell. Please understand all these insights are only true with the 10th Commandment in mind.

On Tuesday, June 17th at 8:30 ET, the Producer Price Index (PPI) for the month of May is released.

The prior reading came in at 0.2%, now the consensus is for 1.0%, which is 5X greater. The Core PPI, which strips out food and energy prior reading was 0.4% and the current consensus is 0.2%. Quick Psychology: Food and energy costs have some how not been passed through to other goods. Is it possible this finally shows up in this report? Yes, it is. If it DOESN’T show up, with crude being at roughly $135/barrel isn't the psychology more important than an enigmatic government statistic? We think so. As a consumer, do you see lower gas prices and homes selling at or above asking prices? As a consumer, are you taking more trips and spending the same amount of money as last year on clothes and cars and appliances? POTC is not looking-forward to Tuesday's report with any optimism. If the PPI does finally reflect the average consumer pain, and the short covering rally in financials is over, will the 20 point move up in the S&P on Friday look like a minor hick up to the fall come Tuesday? It's very possible.

Ironically, Housing Starts and Building Permits are released at 8:30 ET for May as well. If you want to see an ugly bear chart, please click this link:

Is it possible the aggressive Fed rate cuts will show an improvement in Housing Starts and Building Permits? POTC wouldn't bet on it with food and energy inflation now becoming a global phenomenon. Mr. Jim Jubak, a financial journalist we praise and hold in high regard wrote this timely piece:
Are you still buying Friday's short covering bear market rally? POTC reiterates there are two sides to the market (long and short), and we hope our readers understand there is a time to be bullish and a time to be bearish. POTC will never pull wool over our faces and try to convince ourselves there "is always a bull market somewhere" (Jim Cramer). There are short covering rallies from time to time and we missed the opportunity to point that out to you before it occurred.

Industrial Production and Capacity Utilization for May are released at 9:15 ET.

POTC will pay closer attention to Industrial Production, as it is slated to improve from a minus 0.7% to a positive 0.1%-0.2%. In past recessions, industrial production dipped well south of zero, which hasn't happened yet. Although it won't happen come Tuesday, the price of oil is taking a toll on both Asian and European economies with every passing day. For every day that crude stays above $130/barrel, negative effects mount squarely on the shoulders of the consumer. Producer and transport costs must eventually be passed on to the individual on the street and with the FOMC hinting at a rate hike, you have to wonder who would want to go long a single share of stock today. GS may in fact report their single worst quarter in over 2 years, so we urge caution. Here's a chart of how well GS did by shorting sub prime. Where will their next spring of wealth come from? Maybe that’s why GS could break down below $160 in the blink of an eye?
Keep in mind the profits from shorting sub prime began being reflected in 2004, now that Collateralized Debt Market (CDO) and Collateralized Mortgage Obligation (CMO) is gone:

GS Q2 2008 earnings report before market open, live CC link:
"Trend Setting Tuesday" will surely live up to its name, and POTC sees no reason to be bullish.

On Wednesday, June 18th at 10:30 ET, Crude Oil Inventories are released for week ending 14 June. This report is coming on the heels of $135/barrel oil, with little relief in sight. The chatter of regulating speculators and exchanges like the Chicago Mercantile Group (CME), and raising margin requirements is not a market friendly development. Markets can be manipulated, and we witnessed that with George Soros in 1992 and the British Pound, but did currency trading become regulated as a result? On the contrary, currency trading at the CME and NY Mercantile Exchange NMX has exploded, and that's a true reflection of well oiled/efficient market forces at work. Two sides to every market, with one winner and one loser. IF the government steps in to regulate the financial sector because of the recent real estate crisis, or the oil speculators, why should we even have a stock market? Perhaps the point is that in a truly free market system, the government does not get involved, except in the case of fraud. If anyone can manipulate a market, that means it still is not completely free, right? As much as we hate to praise George Soros, what he did to the Pound strengthened and exposed currency trading to the world. Nonetheless, until the regulations are understood it is very difficult to put a value on any financial institution like LEH or MS, or any exchange like CME or NMX. POTC will stay away from all financial institutions and exchanges until the dust settles and that won't happen for many months.

Today, shorting the bounces makes more sense than buying. So until crude pulls back under $100/barrel, the alternative energy argument only gets stronger. Have you ever considered First Solar (FSLR) or Energy Conversion Devices (ENER)? Although the irony with the alternative energy trade is if crude climbs and stays above $150/barrel, there is a possibility of a global stock market crash, then these companies get much cheaper.

MS Q2 2008 earnings report before market open. MS will no doubt report the worst quarter in many years. That is expected, and now regulations are on the way.
There are no economic or earnings data coming Friday, so trend setting Tuesday's economic and earnings data along with oil will dictate the tone for the week.

On Thursday, June 19th Initial Claims for Unemployment are released for week ending 6/14 at 8:30 ET.
The employment picture has steadily worsened and this is a greater worry for the FOMC than crude oil. The last weekly unemployment number came in at 384K and that is getting too close to that dangerous 400K recession type alarm. A nation's employment is the most important barometer of future economic health, so traders will not be sleeping in late come Thursday. Since this is only a weekly number, the revision aspect will mute the response, unless it comes in north of 400K. Strangely enough, there are no current consensus estimates, but the last estimate was for 357K and it came in at 384K. Caution is warranted ahead of this release.

The Philadelphia Fed Index is released at 10:00 ET.
The prior reading came in at -15.6 and now the consensus is between -10 and -12. The improvement in most estimates this week is not bullish, as expectations of the stimulus checks seem to be very optimistic. The prices paid component in the Philly Fed Index is what you should be watching more closely than the raw number. The prices paid have blipped above 60 only twice since 1992, so this release could confirm the worst case scenario: rising unemployment and rising prices, a nightmare for the FOMC. No releases are scheduled for Friday, and that usually does not make for a bullish day.

With the FOMC policy meeting scheduled for June 25th, the uncertainties of their actions can only cause panic for traders on Friday and Monday, June 24th. That Monday has Consumer Confidence, Durable Goods Orders, and New Home Sales scheduled for release. Do you feel confident in any of those data points? POTC reiterates there is no reason to be long stocks in the face of a potential interest rate hike: none. Two of the Fed governors have probably made up their minds to hike rates by 25 basis points, or a quarter of one percent come Tuesday June 25th. There were two dissenters to the rate cut last time, so a rate cut at this point is out of the question. With Paulson and the Fed governors addressing a strong dollar all last week, it looks certain a rate hike is ahead. Please remember that Wall Street rarely rallies before the first fed hike, and rarely rallies after it.
Some feel this time is different because of the weak greenback and high crude oil. But what happens if oil fails to pull back after the FOMC raises rates? The anticipation of that psychology still out weighs the bullish argument.
The positives remain:
1) Election year;
2) GDP fails to signal recession;
3) Treasury Market sell off;
4) Extreme pessimism in the Michigan Consumer sentiment (contrarian indicator eventually).

However we feel the positives are outweighed by the negatives:
1) Rising Unemployment;
2) Crude oil fails to break down;
3) Rising food prices; 4) Hurricane season of 2008 5) NASDAQ gap at 2,300
6) Weak greenback;
7) Uncertainty surrounding the June 25th FOMC decision.

The Psychology of the Call team wishes everyone a good week ahead. Thank you for sharing our insights with friends and family by printing, copying, facebooking, and emailing the blog spot as often as possible!


Anonymous said...

Isn't the hurricane season a negative factor?

Anonymous said...

Yes. Thank you for the contribution.

Anonymous said...

Yes. Thank you for the contribution.