Options Trader: Wednesday Outlook

Just another tricky day in the markets.

We covered up yesterday as the Dow slipped back below 13,000 and my comment to members was: "All you guys with the repositioning need to think ahead to how do you really want to be covered into the weekend with $120 oil, maybe $125 or $130 being the big topic of discussion and NEXT week we have a ton of data including Import/Export pricing for April with dollar at record lows and commodities at record highs, April Retail Sales, the CPI, Cap Utilization and Industrial Production, the ever-depressing Philly Fed, April Housing Starts (if any) and the May Michigan Sentiment numbers, so we’ll see how they like 4 straight months of job declines, $4 gas, rising food prices and record drops in auto sales (truck sales were off 30% - ya think people might be talking about that in Michigan?)…"

Oil is at $122 pre-market; we are looking at over $10 per barrel over last month's highs. For the US, that’s $200M a day being whisked out of consumers' hands and the effect is immediate as we consume this oil daily. Add refining costs and the inflationary effect on food and goods, and we’re looking at about $500M a day per $10 rise in crude. While earnings indicate that US corporations weathered a Q1 average of $98 per barrel fairly well, can we expect the consumers to continue to survive with an additional $1Bn a day going up in smoke in Q2?

You may think to yourself, "Well, we’re a big country, what’s $1Bn a day - we flush $2Bn a day into Iraq and I keep voting Republican so why worry about oil?" The fact is that you are reading this column because you have time and money, something most Americans don’t have. $1Bn a day divided by 300M Americans is $3 per person per day. While that may be just an extra latte for you, for 100M families of 4 with a median income of $900 per week, that’s $84 a week more than they had to spend last quarter. Do you think that might start to add up for people?

Our bullish economy premise is based on the incredible power a DROP in oil would have to unlock consumer spending and relieve the burden that a 100% increase in oil over the past year has placed on the US consumer. While the idiotic "stimulus checks" were bound to be simply flushing more money down an inflationary drain, $120 oil effectively widens the drain substantially. Allegheny Energy (AYE), for example, is asking regulators for permission to raise July electric bills 29%, Portland General Electric is going for 9% (they already got 10% last year), Constellation Energy (CEG) is going for a 7.6% increase in June with commercial customers in Maryland getting hit with 27-41% price hikes.

And those are the regulated utilities! Bush’s unregulated pals at Duke Energy (DUK) are having a whale of a time raising prices and Q1 profits in their commercial power unit was $146M vs. $13M a year ago. That’s right, voters, you may think you are "one of them" but THEY are sticking it to business owners as well! FPL (FPL) (another Friend of the Bushes) reported that their deregulated power plants made almost four times as much profit in Q1 as they did in Q1 ‘07. Isn’t democracy wonderful?

Don’t worry though, Hank Paulson says everything is fine and "the worst is likely to be behind us," by which I’m pretty sure he means Goldman Sachs’ (GS) underperformance as they’ve now bet the farm on oil and made it their business to be absolutely sure that a portion of that $1Bn a day that is being shaken out of our citizens’ pockets finds its way onto their balance sheet as they herd their sheep into $120 oil, betting on $200 - good luck sheep, we’ve got our shears ready! "There’s no doubt that things feel better today, by a lot, than they did in March," Mr. Paulson said.

I could go on all day but it’s funny to hear Paulson praising the bailout of Bear Stearns (BSC) ($30Bn) while Bush threatens to veto Congress’ FHA bill because it would constitute a "bailout" of the consumers. So just to wrap up and summarize - if you are a "consumer" with $100,000 in an IRA, bailing you out is an act of communism, but if you are an investor with $1M invested at Bear Stearns, bailing you out is necessary to preserve the American way of life!

Inflation worries gripped the Asian markets and the Hang Seng fell 651 points, finishing right at the 2.5% rule in a session that did not look pretty at all. The Shanghai Composite fell all the way to the 5% rule (4.69%) in a session that was just as ugly as oil prices and overall inflation concerns sent airlines and manufacturers into a tailspin.

A UN official called Myanmar a "major major disaster" and, as I mentioned in the US example above, it’s not at all good for food prices to rise 25 cents a day when the average Chinese family only makes $5 per day. Myanmar is a major supplier of rice to Bangladesh and Sri Lanka, two places who are barely getting by as it is. 1M people were displaced by the cyclone with 22,000 confirmed dead (41,000 still "missing"). U.N. relief officials say many rice mills have been destroyed. Distribution networks are in tatters, they say, and large tracts of rice-growing land in the muddy Irrawaddy delta are still under water. Rice plants generally die if they remain submerged for about four days, researchers say.

Europe is up about a point as traders there are reacting more to positive earnings news than to inflation worries, but EU retail sales posted a record drop of 1.6% from last year with a very sharp 0.4% drop from last month as they are getting the same fuel shocks as we are (we get our Retail Sales report next Wednesday). This was 100% worse than expected, but February was revised up. Somehow traders are seizing on that little nugget to keep buying as it leaves open the possibility the ECB may not raise rates tomorrow.

Another reason Europe is rallying is because they finally got rid of that pesky IMF Chief Economist, Simon Johnson, who clashed with the ECB and Bush administration who said he was "too pessimistic" in his projections. If you are interested in applying for the position, please line up behind Hank Paulson with your lips puckered up and be prepared to lie a lot! Also of note in Europe, Airbus is informing customers officially that A380s will again be delayed as they HOPE to get production up to 1 per month this year..

We got good productivity numbers and low unit labor costs as the workers that weren’t laid off are doing whatever they can to keep their jobs and this is being spun as a big positive for the markets, but it’s all about the oil inventories today, because if oil holds up over $120 this week, I’m going bearish ahead of next week’s data and, of course, we have the EU tomorrow, where a rate hike can send the dollar lower once again.

Rough sledding ahead, be careful!

Comments

[Coelacanth:]

Good stuff Philip.

I suspect some risk aversion will come creeping back in to the market soon. When I checked the put to call ratio in Barron's over the weekend I was struck by how much skepticism still remains. I don't think bears are wrong.....I just think they're a little early.

I'm blown away by how much bad econmic news investors are currently discounting. Economic fundamentals ultimately matter. If they didn't we wouldn't be paying central bankers to track them.

Domestic retail sales have been, at best, stagnant over the last 2 or 3 months. Anyway upward surprises have been due more to higher food and energy prices than any extra spending. It speaks to a certain disconnect in the market place to hear bulls blithly recite the old refrain that consumer spending makes up roughly 65% of our GDP but then act like it doesn't matter now.

It'll matter to them when it shows up in the form of negative earning surprises 4 months to 2 years down the road.

2008 May 07 02:47 PM

[Bo Peng:]

The sucker's rally over the past few weeks and the drop in VIX have been beyond me. Glad to see some rationality and reality are creeping back.

2008 May 08 12:25 AM

[pondman:]

My compliments! I am glad to see someone who is not kissing the bushes backsides as a measure of business acumen. Keep saying it like it is! RB the pondman

2008 May 08 09:12 AM

[PR Pro:]

Nice anti-Republican screed disguised as business commentary. Since you are all puffed up in your self-righteousness, maybe you could develop some policy ideas to go along with your bitter whine?

Just for today, you are President. We sit admiringly in the White House media room awaiting your wisdom. Give us a full column of specifics (leave the bloviating to O'Reilly, please)

2008 May 08 11:20 AM

[Philip Davis:]

Actually my plan to fix the mortgage crisis that I wrote a column on in January has been adopted by Congress and Bush is currently threatening to veto it...

On our main web site we lay out solutions all time and we have a very active member group that should be put in charge of something if you want to get things fixed.

2008 May 08 09:58 PM