Options Trader: Wednesday Outlook

Perfect so far.

We went into yesterday’s close a little more bullish than we had intended but, as I said in the morning post: "we really felt 7,750 would hold" and the Dow finished the day at 7,789, so right on target so far. We pretty much filled all our gaps from last Wednesday’s close and today we’ll see if we can avoid testing our lower levels entirely as the earnings reports start to come in. Last night we got a pretty much in-line miss from Alcoa (AA) and the miss we (but not analysts) expected from Mosaic (MOS). Juniper Networks (JNPR) raised guidance to the upper end of expectations, Ruby Tuesday (RT) doubled low expectations and Bed Bath & Beyond (BBBY) beat by 25% as cost cutting trumped flat revenues.

So far so-so, I say! So-so is better than expected in this market and we did all our panicking in early March, so somewhere between 6,600 and 8,600 we will discover the truth of earnings. Today we already have a beat by Joseph A. Banks (JOSB) (expected by us as job seekers buy suits), and Family Dollar Stores (FDO) hit the expected 33% gain in profits over last year. Seagate (STX) is going to have a tough time hitting the .22 target set for them and Shaw Group (SGR) is a wildcard but should do all right and outlook will hopefully be good. After the close today we hear from Pep Boys (PBY) with very low expectations and WD-40 (WDFC), which will be interesting as expectations are dismal for them.

Thursday is a little more interesting with Movado (MOV) and Vimpel (VIP) in the morning and CDC Corp. (CHINA), Excel Maritime (EXM) and Genentech (DNA) at the close but it will be too late by then -- we’re closed on Friday and it’s already Passover so tomorrow is not likely to be very eventful. So today is the day that we will see which way the market goes. The bears were out in force yesterday but they failed to break the will of the bulls and the volume was so low you could really throw out the whole day’s action as meaningless. We’ll be watching our gap fill levels to see if they hold (Dow is 7,750, S&P 812, Nas1,525, NYSE 5,100 and RUT 428) and below that would be our old targets of Dow 7,636, S&P 805, Nas 1,525, NYSE 5,075 and Russell 420. Holding those levels would be very impressive but, if not, we’re sure to at least test the 50 dmas of our indexes, which just happens to be another 2.5% drop away from here for the most part (isn’t it funny how these things seem to work out?).

It did look like we were heading lower in pre-market trading early this morning. As we expected, Asia took our 2.5% drop yesterday very hard and had a 2.5% pullback of their own as Sharp had a profit warning and the World Bank slashed its forecast for Asia’s economic growth and warned of a "painful surge" in unemployment. Excluding China, the East Asian region is expected to grow just 1.2% this year, a "lackluster performance" that places it behind the Middle East and North Africa, South Asia and Sub-Saharan Africa, the bank said.

Europe gapped down at the open but has recovered to flat, as have the US futures despite Daimler saying they expect a "significant" loss for Q1 and despite the Moody’s downgrade of 12 Irish Banks and despite RBS announcing 9,000 job cuts and despite German Exports dropping 23.1%. Miners had led the markets down following AA’s earnings report and energy companies were no help with oil drifting under $48 a barrel. Still the EU markets perked up dramatically along with our futures at about 6am.

What was so exciting? Well, Pulte Homes (PHM) is buying Centex (CTX) for $1.3Bn, a huge 35% premium on yesterday’s closing price. Of course the deal is actually for $1.3Bn of PHM’s stock, which closed yesterday at $10.77 and was as low as $6.47 in January so the question is - Would you take PHM stock in exchange for your home? PHM’s entire market cap yesterday was $2.78Bn so they are diluting their company by 1/3 in order to make a deal that captures a company that was worth $950M before their offer and CTX itself is up 50% from their March lows so PHM may have given up 1/2 of their company for a $600M asset if housing continues to sour. Of course the bull argument is "these guys know what they’re doing so it must be a bottom." Oh yes, because the builders have called things so right before…

When Pfizer (PFE) buys Wyeth (WYE) for cash, then I can believe that the sector is undervalued, but when a builder who lost $338M last quarter acquires a builder who lost $663M last quarter for stock, creating a single builder with $10.5Bn in liabilities in a market where borrowing is very expensive - you’ll have to forgive me if I don’t get up and dance. The other "good" news is more stimulus or, rather, the same stimulus (TARP) that will now be applied to insurance companies and that will strategically give a boost to the Insurance sector which will boost the XLF and IYF and will create the impression that the financials are continuing to recover - even though they are not.

Don’t get me wrong, this is a market booster and an expected one (one of our only stock plays yesterday was buying Hovnanian (HOV) at $1.58, which should net a quick 20% today) but it’s not a reason to go crazy, especially this early in the earnings season. We will do our best to keep our feelings in check though and watch our levels. If we flatline I’ll be very pleased as we can continue to work off our overbought conditions. But another spike up on low volume will put us right back into dangerous territory. So we’re hoping to hold our levels into the weekend and maybe next week we can have a rally we can believe in.