Options Trader: Monday Outlook

by: Philip Davis

$70 OilThe dollar is off 2% since Friday.

That is sending oil back over $70 and gold back to $960 and has jacked the futures up 1% as the "value" of stocks tries to keep up with the less valuable dollars that they are exchanged for. People often forget that stocks are a commodity too and are also exchanged for currencies - when the dollar falls, at least initially, stocks tend to rise. Unfortunately so do our commodity costs but, as we saw in last week’s data, wages do not keep up and that, sadly, leads to a deflation of consumer buying power.

Every $10 increase in the price of a barrel of oil rips $25Bn a month out of the hands of global consumers, enough money to employ 6M people a year at $50,000 each. Those jobs are torn away from other sectors as discretionary income goes to commodities and, by the time you add in refining mark-ups and the cascading effects on other raw material cost, the effect of a $10 per barrel rise in oil is doubled to what amounts to about 1M global jobs per dollar.

What we are seeing is the result of the inaction against Goldman (NYSE:GS) and other commodity manipulators as they breezed through Congressional hearings, aided through the process by a massive market rally that kept their nonsense off the front page. Who cares if GS made a few extra bucks if the market is up 10% in a month? We’ll see if the resurging energy and commodities sectors can provide the catalyst to move the S&P up over the 1,000 mark, a level we haven’t seen since the September crash, almost a year ago, but also the last time the dollar index was below 78 so everything is coming full-circle, right back to the conditions that crashed us last time!

This is not to say we are going to fight the tide. In the Summer of 2008 oil was around $120 a barrel and the Dow was around 11,500 from June through September before plunging 35% in the second leg of the crash. If the market is determined to climb back up that cliff and try again, we need to at least head on the fact that they might make it all the way back to the top - especially with help from heavyweights like Alan Greenspan, who knocked the dollar down this weekend, saying there was no need for the US to raise interest rates even though he feels the economy will grow 2.5% in the second half of the year.

This WeekTimmy Geithner also stepped up to the plates (the spinning ones) and hit the talk shows saying: "There are signs the recession is easing… The actions that this administration has taken have been very effective in helping stabilize conditions, help repair the financial system, bring down the costs of credit." It’s an interesting choice of words because certainly the cost of credit is easing but the amount of actual lending is down almost 50% from where it was last year so great for the privileged few that are allowed to borrow money - bad for pretty much everyone else.

While Greenspan did say: “We may very well have 2.5 percent in the current quarter. The reason is there has been such an extraordinarily high rate of inventory liquidations that the production levels are well under consumption.” He also said: "I’m short-term optimistic, but with many caveats. Housing markets have 'stabilized temporarily' though it is 'possible' the economy might relapse if there is a further slide in home prices of more than about 5 percent. If prices dropped by 10 percent or more, that would create a major acceleration in foreclosures." So Greenspan’s premise is entirely based on housing prices NOT dropping 5% more and, if they should drop 10% more - he foresees disaster. I guess we’d better keep a close eye on those housing numbers then!

At the same time as Greenspan was spinning plates on ABC’s "This Week," fellow PIMCO bond pushers Paul McCully and Bill Gross were out on the road saying the Fed "won’t raise borrowing costs before 2011 as the threat of deflation remains for the U.S." Deflation?!? Holy cow, I guess we all better go out and buy bonds, right bond pushers? This is actually a tough call for us as we went into the weekend a little bearish, expecting a pullback and only 1/2 covered on our long DIA puts. We did expect the great success of "Cash for Clunkers" to be considered a market positive but this move in oil from $65 at Friday’s open to $71 as of 8:30 this morning (9.2%) was not expected as it does seem a little surprising that US citizens found an extra $120M a day to pay for oil over the weekend. Without even looking at the refining costs and trading mark-ups, that’s $1 per day from every single American family - $30 a month, $365 a year - a nice tax slapped on all of us over the weekend to support this attempt to boost the S&P back over the 1,000 mark led by commodities.

Over in Asia, commodity stocks led the rally and the Shanghai Composite completed a 3-day, 6% run that completely erased the 5% drop on July 29th. Stocks on the Shanghai exchange are now trading at 37.5 times earnings, double the average measure of other emerging markets and the index is up 90% this year as banks tripled new loans to 7.37 trillion yuan ($1.1 trillion) in the first half from a year earlier to support a 4 trillion-yuan government stimulus package. In action typical of China’s market in July (when the index rose 15%), China Cosco Holdings Co., the world’s largest operator of dry-bulk ships, advanced 8.1 percent to 19.99 yuan. China Shipping Container Lines Co., the country’s second-largest carrier of sea-cargo boxes, jumped the maximum 10 percent to 6.29 yuan even after the company said it expects to post a LOSS for the first half of this year as the global financial crisis undermined demand for container shipping.

China’s policy to boost growth by pumping the economy with money has led to an “unstable” recovery as investments in property and equities surge, paving the way for another slump, said CIMB-GK Securities Pte. The credit boom has led to expansion fueled by “non-productive activities” with limited trickle down to jobs and consumer demand, Song Seng-Wun, regional economist at CIMB-GK Securities in Singapore, said. “If the extra slosh continues to go into property and stocks, obviously the risk of a spectacular collapse is very real because there is no underlying growth of the real economy.” Current bank credit patterns are “not acceptable if the People’s Bank of China is looking for sustainable growth,” Song said.

Over in Europe, bad news from HBC, the world’s largest bank, got the same reaction to their 57% drop in profits as China Shipping did for their poor report as HBC and BCS and other British banks led the FTSE and other EU exchanges higher, up about 1.5% ahead of the US open (9 am). HBC Chairman Stephen Green said that while the economic outlook remains highly uncertain, "it may be that we have passed, or are about to pass, the bottom of the cycle in financial markets." Among the encouraging signs were lower-than-expected impairments at the bank’s U.S. consumer finance business, HSBC Finance Corp., which has dragged on profits since the U.S. housing market started slumping three years ago. In the U.S. consumer finance unit, loan impairments were $7.3 billion, higher than $6.69 billion in the same 2008 period but lower than $8.8 billion in the second half of 2008. One thing that helped turn the numbers around this quarter - HBC stopped lending to consumers in March!

We will be keeping an open mind this week as we expected (following the pattern of June) another week of consolidation at the top before a break one way or the other but S&P 1,000 would have to be considered a major break up, even by the most bearish investor. While it’s a shame to buy more stocks at this level, we have plenty of stocks we bought cheap that we can dollar cost average into on the way up as well. Ideally, we’d like to wait until next week to make our decisions, as options expiration for August is still 3 full weeks away but if the market train is leaving the station, we need to get on and there are still plenty of relative bargains to be had like DBA, which is still 20% below last September’s levels.

XLE is also cheap if you believe oil is heading back over $70 to stay and XLF/UYG have only just begun to fight their way back to last year’s fall levels. We’ll be exploring some ETF trades in chat as well as making some earnings plays now that the insanity of last week’s 1,000 reports is past us. Before we get too excited though, let’s see if all of this weekend’s spinning can accomplish the mission to punch the S&P over 1,000. If we really are going higher, there will be plenty of things to BUY BUY BUY on the way up but, if we are going to fall back off that cliff - we don’t want to be weighed down with too many stocks that are going to act as dead weight in our portfolios.

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