Options Trader: Tuesday Outlook

by: Philip Davis

Taking a deep breath… holding it…. and exhale.

Nope, doesn’t make me feel one bit better.  I’m still pissed off and I haven’t calmed down from yesterday’s rant yet but I’ll try to calm down and just be analytical now….  THIS TOTALLY SUCKS!  What the hell is wrong with this market?  All of a sudden everyone is running screaming for the exits on the exact same issues we’ve been having for several years.  EVERYTHING matters now and the more hysterical the viewpoint, the more media time people seem to get so I guess it’s time to go a little crazy if we want our viewpoint heard.

There is a point at which we cannot fight the tide.  I remember back in January of 2000, when Dow fell from 11,800 to 10,700 in two weeks we said "surely this must be the bottom" and we were so wrong.  It seemed that industrials wouldn’t suffer the same fate as the Nasdaq’s tech stocks but by Feb 14th we had dropped another 500 points.  Sure we recovered and by March 29th (my birthday, so I remember) we were back over 11,000 and business was back to normal but we sure could have done without that extra 500-point drop!

Of course the Bush tax cuts and 9/11 caused a much bigger market disaster when from 2001 to 2003 the market fell from pre-election levels of 11,200 all the way down to 7,500 (33%) as we began Iraq War II in March of 2003.  That turned out to be a "buy on the news" event and the market nearly doubled to 14,200 four years later but now we are being told that over half of that run-up was unfounded.  That US industry has gained no value at all since 1999 and you would think from the way things are going and what you are hearing on TV that we are heading back to pre-Clinton levels of 3,000 or less.

Is it really possible to destroy that much market value that quickly?  I suppose that begs the question of what is the value of a stock.  I’m a really old-fashioned EPS kind of guy.  I look at a stock as an investment that makes money.  Whether I get a dividend or not, I do believe that if I give Google (NASDAQ:GOOG) $521 and they make $20 per share, that I am getting a 4% return on my investment.  Then I have to factor in growth potential (very good) and the risk of owning Google versus owning say, a Treasury note or a CD at 3.5%.   There are, of course, also tax considerations but, overall, money is fairly fluid and will gravitate to where it finds the best returns.

So what is going wrong?  Well, for one thing, the supply of money is getting tight.  While there is plenty of money out there, it is being hoarded by banks, corporations and Sovereign Wealth Funds as well as nations like China, who are sitting on $1.5Tn.  This is money that is NOT being put back to work.  Money is fuel for the economy and what has been going on for the past few years is the Fed is printing record amounts of it and we are sending $375Bn PER MONTH of them (globally) to the oil-producing nations and very few of those dollars are coming back to this country.  So there are lots and lots of dollars in the world - just not in America and certainly not in the hands of the American people, who personally dig in every day to send $1.6Bn out of the country to buy 11.5Mb that we import.

There are "only" 100M housholds in this country, that’s $16 per day per family spent on exports.  Another $16 is paid for the domestic crude and, rather than spend the money we send our local cartel, they use the money to buy back their own stock, bonus executives and maintain outrageous compensation programs.  This too, does nothing for our economy.  So we have the average American taxpayer shelling out $32 a day (without refining markups) for 21Mb of oil that we consume.  That’s $11,680 a year on oil alone. 

Today’s PPI report shows a 1.8% rise in July alone, with the year over year average now up 9.2% as inflation creeps across the nation but don’t worry - the "core" PPI, taking out food and energy, is only up 0.2% for the month and up 2.6% for the year.  This allows the government to avoid giving cost of living adjustments to workers or social security recipients or welfare recipients or unemployment recipients as certainly those people have no need for food or energy.

So, betwen food and energy alone, the average US houshold that earns $48,000 a year is spending $18,000 of it on food and energy.  That’s $12,000 more than they spent when Bush took office in 2001 and, sadly, that median wage has not grown in all that time and has, in fact fallen 7.5% from $51,910 in 2000.  Suffice to say then, that there are very legitimate reasons to believe that US consumers cannot support US corporations to the same extent they could back in 2000.

But corporations are global entities, especially the Dow components and, last we checked, the global economy is much stronger than ours so let’s keep an open mind that the drop in the markets, especially in our industrials, is already overdone.  As I’ve mentioned often enough, despite the assault on the middle class that we’ve endured these past 7 years and despite the millions of people who have been thrown into poverty during that same time and despite the millions of Americans who have lost their jobs under this administration - MOST of the damage that has been done to our economy can be very quickly undone if we can bring oil prices under control.  Obviously, that’s not happening so I wrote a post last night that I hope you can read and hopefully pass on to others as there are very quick and very effective things we can be doing to reverse this crisis, we just need the will to act.

How can we be told that global growth is driving commodity prices while at the same time believing that the global markets should be selling off like mad due to slowing economies.  Something is wrong with this story yet the environment we are currently in is completely divorced from supply and demand fundamentals and amounts to nothing more than an excessive tax on necessities that is siphoning money away from the rest of the economy.  As I predicted when the stimulus was first announced, consumer spending was up 0.8% last month but 0.7% of it was spent on gas.  All the stimulus checks ended up being was a $168Bn check to the oil companies, the Saudis and, oh yes, Iran written by GWB to keep the bubble floating a few more months.

[chart]Asia doesn’t see how they are going to go on without us and the Hang Seng fell 839 points, a real shame for the iShares China (NYSEARCA:FXI) caller we sold to yesterday (despite the Dow failing 11,300, we took a spread).  The Nikkei fell 255 points and that took them below 13,000, all the way to 12,754 and the Hang Seng broke below 22,000 today as well, both key levels we were hoping would be support.  Banks around the world are crashing and the dollar hit new lows against the Euro (they tighten, we don’t) as oil soared to $148 in overnight trading despite the BOJ downgrading their economic outlook as "surging energy and raw material prices take a larger toll on business investment and private spending."

Europe is also looking dreadful this morning, down around the 2.5% rule with Germany’s DAX dangerously close to the 6,000 mark. UK inflation rose to a record high in June, something that should force the BOE to raise rates.   The chart on the right is what our inflation picture would look like if the US government publshed real data - we all buy the same commodities and other goods in a global market, the UK simply reports the straight numbers while the US has dozens of "modifiers" added in to make the administration’s policies look less horrific than they actually are.

BOE Governor King said that to attempt to bring the inflation rate back to the Monetary Policy Committee’s 2% target quickly would require large increases in interest rates that could push the economy into a sharp slowdown and result in an inflation rate below 2% over the medium term.  The Monetary Policy Committee is also worried that a persistently high level of inflation will lead workers to seek pay increases to match, which, if granted by employers, would set off a second round of price rises. So it is unlikely to cut its key interest rate this year, even though Mr. King said there is a "very clear" risk that the U.K. economy will slow sharply.

US Bancorp (NYSE:USB) took a kitchen sink loss (but beat estimates) and gave fuel to the bank bears but we had a beat from Novellus (NASDAQ:NVLS-OLD) last night, Genentech (Private:DNA) missed but raised guidance, Adtran (NASDAQ:ADTN), Eaton (NYSE:ETN), Johnson & Johnson (NYSE:JNJ), Polaris (NYSE:PII), State Street (NYSE:STT) and WW Grainger (NYSE:GWW) ALL beat expectations this morning.  So let’s remember why we buy stocks - we invest in companies that are going to make a good return on our investment.  While there certainly are factors out there that we can legitimately worry about - the fact of the matter is that US equities continue to be the least sucky place to put our money as they have the best chance of giving us a return that beats inflation and I am still buying.