Options Trader Friday Outlook: The Gloom Squad

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Includes: C, DIA, FAS, JPM, MDLZ, MDY, OIH, QID-OLD, QLD, SKF, WFC, XLF, XLU
by: Philip Davis

Happy anniversary awful market!

That’s right, today is day 20 of one of the worst market slides in history. We began Feb 9th at 8,280 and yesterday the Dow closed below 6,600. That’s 1,680 points, almost exactly 20% in 20 days - how neat! It’s not so much the drop that’s killing us as the lack of bounce. The TOTAL lack of positive movement is something Michael Kahn in Barron’s is calling "A Slow-Motion Capitulation." Essentially Kahn is saying that traditional indicators are not working as fed-up investors have stopped buying, but they have also stopped selling as there’s hardly any point. Much to the chagrin of the bears, even Citi (NYSE:C) at $1 is not shaking out the shareholders as volume dropped from 1.8Bn last Friday to 578M yesterday.

Essentially, we have gotten to the point where Elvis has clearly left the building and the 5Bn shares of C that are held at $1.02 are not held by people who are going to panic out at .50. We saw JPM and WFC come under attack yesterday, as we expected after the Moody’s downgrade we discussed in the morning post. Those plays still work and the SKF hit our $250 target and we did, indeed short the hell out of it ,so now let’s see what happens. We are prepared for one last push higher this morning as we are going to get awful jobs numbers, but we don’t think this level of financial panic can be sustained - not just because of technicals or fundamentals but because the government can’t risk this snowballing into an out-of-control crisis.

UNLESS that’s their plan! That’s right, one possible explanation for the inexplicable lack of government action is that the Obama administration looked at the situation, decided it was hopeless and decided it was better to let the big crash happen now than try to prop things up for a year and then having it all collapse anyway. I said to members earlier this morning it’s like when an empty car starts rolling down a hill - If you catch it right away, a single person can stop the momentum but, if it gets rolling, 3 or 4 people would be needed to stop it but, once it gets going, there is nothing to do but let it crash and pick up the pieces after. We are probably right between stage 2 and 3 right now, it’s possible that a globally coordinated effort can halt the economic downturn but, if it turns out we’re too far gone, then countries that try to help will simply get crushed and end up part of the wreckage themselves.

Sadly, we had to finish yesterday net bearish once again as there was nothing encouraging about the close, but we did do some bottom fishing in the afternoon and, obviously, our SKF shorts and FAS longs are pretty aggressive. Fortunately, we took those QID-OLD calls last week (ultra short Nasdaq, see Mike’s chart above) and the XLU and MDY shorts (see last Big Chart Review) are paying off as are, of course our main short plays on the DIA, but our stocks are a horrible, terrible mess and we can barely bring ourselves to buy more, even at these prices. Now I’m hearing that there is something like $11Bn in cash on the sidelines - 50% of the total value of the US markets, investors are just looking for a buy signal, almost any one will do but if this administration is flashing one, it’s more secretive than the most complex of gang signs because we’re all missing it.

The WSJ has a good article today, "Has Fear Blinded Investors to Value," that pretty much touches on the themes we’ve been discussing in member chat recently. Brett Arends points out that there are many great non-financial companies that are "accidentally" paying huge dividends due to their decades-low share prices. "Should Kraft Foods (KFT) really be so low they have a dividend yield of about 5 ½%? What about A T & T (7%)? Or DuPont (9 ½%), Philip Morris (8%), American Electric Power (6%), British Petroleum (9 ½%), drinks giant Diageo (5%) cellular network giant Vodafone (8.5%), Merck (6 ½%) or a host of many others?" he asks. Just as we may have overshot the highs in the commodity bubble, we certainly may have overshot the lows in the bust.

On the right is a fantastic video of the Daily Show (click image to play) recapping the idiocy that was passing as market commentary on CNBC during the market decline. Well, the same idiocy is being practiced now by the same same idiots, who are now cheerleading the bottom as much as they ever cheered for the top. As Jon Stewart says: If only I had followed CNBC’s advice, I’d have a Million dollars today… If only I had started with a hundred Million dollars! Why then now, do we listen to these bozos? It is just as ridiculous to tell us that WFC is going to zero as it was to tell us XOM was going to $100. Goldman Sachs (NYSE:GS) is another group of morons who still manage to move the markets with their prognostications - even though they themselves lost more money than the GDP of 300 nations last year - presumably following their own advice.

So how bad are things today? Let’s take a look at the Big Chart ():

We are down to just the FTSE holding the 50% line - the rest of the global indexes we follow, other than the Dow, are closer to 60% off than 50% off. ALL of Asia crossed the line, with the Shanghai giving up 8% in 10 days of trading despite the efforts of the Chinese government to boost the markets but they did come sharply off the lows this week and we’ll have to wait 2 more weeks to see how things turn out. What we do not want to see is a European index cross that 60% line. It is somewhat encouraging that the SOX are actually UP 2% in two weeks and that helped the Nasdaq have the smallest loss (3%) of all the US indexes.

In fact, the QIDs (ultra-short Nasdaq) have exactly hit our target top at $67 this week and seem content around that line. The QLD (ultra-long Nasdaq) is down to $20.85 and getting tempting but not today, a day we will be happy to just survive. Things are certainly bad but are they 60% off bad? All I can do is repeat what I said on Feb 23rd, in the last Big Chart Review, which was: "I wish I had something optimistic to say here but I don’t." At the time I said we were looking for leadership and so far, we have found none. We are finally getting our long-awaited collapse in the energy sector as XOM et al come crashing down, pulling much-needed cash out of those bloated dinosaurs where, HOPEFULLY, they will eventually be put to work in companies that are good for the economy, as opposed to companies that rake in money when the rest of the economy is being bled dry by high commodity prices (and that includes the fees charged on money and stocks).

Rotation is a very painful thing as money comes out first and THEN is put to work. This chart shows the massive exodus of capital out of the OIH and out of the XLF, which are under-performing the S&P since November by 20% and 30% respectively. Of course this kind of rotation also means jobs rotate out of those industries and the Real Estate / Construction / Mortgage / Banking industry dropped millions of people from the payrolls and Oil Services is in the midst of the largest decline in drilling operations ever, throwing more people out of work. So we are in a trough of money rotating out of the market and people rotating out of jobs - until we see some sector stepping up and carrying the ball, neither the money or the people will have any idea where to go.

We’ve been essentially playing this week looking for fear into the jobs data this morning, but the panic in the financial space was much worse than we anticipated. WFC was just put on ratings watch by Moody’s, who I forgot to include in my list of analysts who are clearly clueless. That bank fell 33% this week, down to $8 from $30 at the beginning of the year. Today WFC cut their dividend to .05 from .34, a move that will save them $5Bn a year and, in the words of CEO Strumpf: "Will help us repay the government’s investment at the earliest practical date." WFC said that its integration of Wachovia Corp is on track to achieve $5 billion in annual merger-related expense savings, and that it expects that total merger integration costs will be lower than originally projected. I mentioned the ridiculous price of GE yesterday and now JPM has joined the gloom squad at $16.80. Even if you don’t want them for that price, you can sell the Apr $12.50 puts for $1.20 for a net entry of $11.30, a 32% discount to today’s price if put to you. If called away, you make $1.20 on $8.15 (assuming 50%) in margin, 15% in 40 days!

8:30 update: Jobs losses were in-line at 650,000 lost for February, but January was revised up from 598,000 lost to 655,000 and December job losses were ratcheted up over 100,000 to 681,000, the most since 1949 when 500,000 losses were the result of a workers' strike (you know, demands for living wages, benefits, security, etc - something we may see here soon). That pushes unemployment up to our expected 8.1%, 0.2% more than was expected by economists, who certainly must read different papers than I do. Close to 2.5M jobs have been lost in 4 months, but, as I mentioned yesterday, the labor and productivity numbers indicate this fad may have run its course, providing things do not deteriorate furthern and companies begin shutting down en masse.

Well congratulations, we made it through our data point - maybe now someone will buy something (please!). Next week we get Wholesale Inventories on Monday, probably still dropping, Retail Sales on Thursday (already BTE based on report we saw yesterday) along with Business Inventories and our Trade numbers on Friday the 13th. Overall, a light data week so the markets are now free to do whatever they are going to do. We do have a Consumer Credit report at 2pm this afternoon.

Obviously we will be happy to cover our long puts and flip bullish, riding our (hopefully) well-timed plays from yesterday but let’s not fall in love with a bounce off a 25% Dow drop since Jan 2nd. We EXPECT a 400-point BOUNCE along this downtrend so we’re not even impressed with anything less than 7,000 next week, which is now a 6% gain off 6,600. Of course we also need to watch our Big Chart levels for signs of further weakness but I’ll be willing to go 60% bullish at the open and stay bullish into the weekend if we hold a 2.5% gain on the day (6,765 Dow, 700 S&P, 1,350 Nasdaq, 4,400 NYSE and 360 on the Russell).

I will be on LiveStock (good name) at 1pm this afternoon and you can watch it live here. Hopefully we’ll find some fun afternoon trades.

Have a good weekend.