Options Trader: Wednesday Outlook

How much of a rate cut do we "need"?

Will half a point be enough for the markets or is .75 to even a full point cut already priced in?  Either way, we are looking at 1% or lower on the Fed Funds rate as we actually cross the line and become Japan.  On a global basis, without cuts also coming from the ECB there will be a lot of disappointment anyway, as free money is now being priced into the markets, which allows us to defy some pretty ugly data this week.

We discussed the TERRIBLE consumer confidence numbers in last night’s post and this morning we get Durable Goods Orders, which are also almost certain to be low (especially ex-Transports) followed by Crude Inventories, which are predicted to rise by 4M barrels as demand destruction is now being baked into the weekly estimates.  Tomorrow is the scariest day of the week as we will get a very big Chain Deflator number due to the difference between the rapidly declining import price of oil and the stubbornly high prices paid at the pump.  This will push consumer prices up over 4% for Q3 and will very likely spook the market tomorrow morning, so we’ll be playing for that and, of course, we also get the Q3 GDP data, which will be dragged down near zero due to a 25% decline in Residential Construction (about 1% loss on GDP) and not helped much by consumer spending.  Still, zero is NOT a recession so that’s the line in the sand for the US, where 0.1% growth in GDP is the entire economy of all but 50 other countries.

Today we expect follow-through as we finished at (and this is amazing) the 10% rule on yesterday’s close, making a move to 12.5% almost a certainty and a 15% total gain a very strong possibility.  12.5% is our 1,000-point goal for the Dow on Fed news and, of course, a bigger than .50 cut should lead to bigger gains.  We have no doubt about the boost from the Fed -- the question is whether or not we hold the levels.  To get a sense of that, we need to keep our eye on other markets and see how they perform at their critical levels.

We have LOST ground in every single index we follow since last week. That’s AFTER yesterday’s huge bounce (does not deserve to be called a rally).  We lost the 40% line on every US index except the Dow, and they SHOULD be doing well with oil at $65 and $3Tn being pumped into the financial sector with American Express (AXP), Bank of America (BAC), Citi (C), GE and JPMorgan Chase (JPM) all benefiting directly and GM getting their own $5Bn bailout this week. 

We need to be realistic in our expectations with all of Asia down over 50% (Shanghai is down 70%, that’s 30% away from ZERO) and Europe in the same awful shape we are in, but the 40% line does seem to be holding in the West. If we can get the SOX (we still like those SMHs, although way up from last week’s pick) back over 40% along with Asia holding 50%, then we may be able to call a real floor to the global markets.  For now, we NEED to take back last Tuesday’s levels as a minimum goal for the day, and we really want to see those 40% lines taken back and held, not just right after the Fed, but through Friday - after the excitement dies down.

The excitement continued in Japan today as the Nikkei gained another 7.7% that swung up and down 500 points 3 times.  Obviously, there was huge resistance at the 8,200 line, the line that held as a floor for most of October and is right at the 55% line off the 2007 highs.  To put things in perspective, getting back to 8,300 would leave the Nikkei down 10,000 points in 12 months!  The Yen pulled back and that was the main booster for Japan, while China cut its rates (to an ominous 6.66%) for the third time in 6 weeks that came after Shanghai closed down 3% on the day, 70% off its highs.  A rate cut is widely expected in Japan as well although where you cut from 0.5% and how much that helps remains to be seen…

Over in Europe, the IMF is bailing out Hungary. Russia is cutting out the middleman and is directly bailing out their billionaires, giving Mikhail Fridman $2Bn to pay back a bank loan.  Russia put aside $50Bn to help companies and banks refinance foreign loans last week and they have already received $100Bn worth of applications for assistance.  The CAC and FTSE are up around 5% (9am) but Germany is slightly in the red as Volkswagen (FRA:VOW) gives up about 25% of the last two days' gains and the DAX is reweighting the index to stop VW from dominating the markets after its 400% gain made it the world’s largest company. 

It’s all about the Fed this afternoon, but we’ll be watching our levels, ready to uncover our short plays at a moment's notice, especially if we fail to make the 40% mark on the NYSE at the famous 6,232 line. We need a big move in the SOX to confirm a bullish stance on our Nasdaq plays (gotta love those QLDs!).  FXI needs to be covered if we go red and FXPs are going to be a fun way to play a downturn in US stocks spilling over to Asia tomorrow, so let’s keep an eye on those after yesterday’s 40% off sale.  I have my eye on the March $100s, now $45.20, that were $75 last week and bottomed out around $35 in October - that can be covered by selling the Nov $190s, currently $10.15 but, ideally, we’d love to get in at $40 or less and just play the disappointment game into the weekend as a nice global downside hedge.

Let’s be careful out there.