Friday Market Preview: Was Dow 8,000 the Bottom?

Includes: DIA, QQQ, SPY
by: The Mole

So the market plays rubber ball rebound with a 900 point intra swing yesterday. The gravitational pull of October lows held sway early as the Dow Jones pushed below 8,000. But while 8,000 was breached, bottom fishing and bargain hunting sparked an impressive technical explosive rebound. Some commentators regarded this as psychologically very important as we have tested this area twice now and bounced strongly.

Today’s Market Moving Stories

  • German press reports that there is about to be a massive shake-up of the Fatherland's banking industry with the myriad of Landesbanks being consolidated into three main banks. This is long overdue and the crisis has merely hastened the demise of a system that was an historical anachronism due to the Federal political set-up.
  • Minneapolis Fed president Stern said that there was “not a lot more room to cut rates”. Talk about stating the obvious.
  • Fed president Plosser from Philadelphia (a noted hawk) said that fourth quarter US growth would show a somewhat sharper decline than Q3. More of the bleeding obvious.
  • US initial jobless claims pushed ahead to 516k last week with continuing jobless claims at 3897k. It’s not a question of will the jobless number be higher than last week, it’s how much more will it be higher.

Why Was Yesterday's Trade Data Important?

The trade balance report confirms that exports, the last bastion of strength for the US economy, has started to rock. The 7.8% drop in real exports was the biggest monthly decline since the inception of the series in 1993.

Keep in mind that the US economy has grown an average of 1.6% between Q2 2007 and Q3 2008. During this time net exports contributed – you guessed it – an average of 1.6% per period to growth. Hence there was no growth outside the export sector. But only last week, the purchasing managers ISM’s new export orders plunged to a new all-time low. There are concerns that US exports might eventually collapse amid the looming global recession and a stronger US dollar.

The outlook: Without the support of the export sector, the US economy will shrink by an annualized 2-2½% this quarter. The bigger picture on a multi quarter, even multi year basis, is that global growth, private consumption , corporate earnings, unemployment, default rates, housing prices, credit spreads and ratings continue to be firmly bearish. In this gloomy environment, I fully expect the Fed to cut rates to near 0% and the government to agree on another big number fiscal stimulus package.

The Next Stages of TARP

While he may be chalking off the days like a prisoner awaiting parole, Hank Paulson stoutly defended his hybrid TARP bailout, with its focus on capital injections. But he’s now saying that the earmarked $700bn won’t be enough to buy the toxic assets! He went on the urge Congress to bailout the auto industry.

Using a poker analogy, under TARP, banks have been able to give back their bad cards to the dealer in exchange for a full house. But now they are again stuck with the original dodgy hand. They are going to have to write this down, which will of course, require more capital injections.

The major issue is that the market price for these assets has now bottomed or stabilized so either banks engage in a fire sale (which further depresses prices) or they engage in the vicious circle of more quarterly write downs requiring more capital injections. In sum the changes look ill timed and poorly thought through and are a serious step backwards.

Data Today

The key number today is US retail sales at 13.30. They are expected to show a sharp drop, about -2.1%, on the back of plunging auto sales and the big drop in oil prices.

The market is also looking ahead to the G20 summit in Washington to see what fresh initiatives world leaders may dream up. There will doubtless be noises about strengthening global banking regulation and some new super duper role for the IMF.

But the two biggest stumbling blocks I foresee are the big question of where the money is going to come from and the conspicuous absence of one Barack Obama from discussions. So I feel that the event can only under whelm.