Stop the Week, We Want to Get Off!

As expected in yesterday's morning post, we did not break 9,500 on the morning rally.

It went very quickly downhill from there and thank goodness we had a firm eye on our 40% levels which were; 6.232 on the NYSE (failed at 10:43), 1,717 on the Nasdaq (failed at 2:52) and 946 on the S&P (failed at 3:13) as well as the CAC, who we were watching at 3,701 (never made it up) and the 4,891 line on the DAX (failed dramatically at around 11 am).  That's why it's good to watch the foreign markets – their close gave us a good indication of the trouble ahead in our afternoon session.

I had also said in the morning post: "We have our critical levels for the day:  Dow 9,400, S&P 1,000, NYSE 6,400 – If we can’t hold those, there’s no reason at all to be bullish" and all three of  those levels were lost at exactly 9:56.  It did not take me that long to go negative though as I noted in member chat at 9:38: "This is strange, XLF up 4% and SKF is heading up – that’s not good!  VIX is still nasty at 54.  If you don’t have those downside ultra-shorts, it’s not a bad idea to accumulate them…"  By 10 am things looked much worse and I turned to a bold font to warn members: "The good news is the VIX doesn’t seem happy about the move down but that SKF is freaking me out as it shouldn’t be going up so much with the XLF still green so someone is betting very big on a financial meltdown."

These are the kind of things we have to keep an eye on during the trading day as they are the critical clues that give us a sense of what's going to happen.  That's one of the reasons I like to track the ultra ETFs, they make exaggerated moves that you may pick up ahead of what the broader market does.  The selling was indeed relentless and it wasn't until 10:17 that we got the not very surprising news that Iceland may be going bankrupt, which explained the morning selling frenzy.

At 12:17, someone asked me what a worst-case scenario was for the economy and I said: "All it takes is for GM to go bust.  They directly employ 350,000 people and then there are at least another 1M suppliers and salespeople around the country.  Just the defaults alone will wipe out another 100 banks and businesses and then the unemployment will bankrupt several states.  Then you have another 1M foreclosures which will cascade the bank failures and the destruction of the pension program would put a massive cash drain on the system as a million GM retirees scramble for cash."

In the afternoon there was a series of very negative stories, including a recycled story from May 23rd, when the hyenas first started attacking the financials, that RBC was predicting Hundreds of bank failures between 2008 and 2010, which was treated as a breaking headline on CNBC at 2:45.  CNBC ran another story a little earlier that GM's market cap was as low as it was in the Great Depression and the stock price was back to 1953 levels and, at around 3 pm, the S&P put GM on negative credit watch, sending GM and the rest of the market flying down into the close.  So you can certainly see the short sellers are back in business when you get coordinated attacks on companies like that and rumors were running around the floor that everything from MS to the entire government was about to go bust and, frankly, it was hard to laugh off any of them…

So we ended the day in a terrible state.  The Dow was resting just 166 points over the 40% line at 8,413 and, with the other indexes already below, a test of that level is almost inevitable in the morning.  Also, finishing at the 7.5% rule is another indication of follow-through the next day as was the quickly rejected bounce from 8,600 to 8,800 in the last 10 minutes of trading.  The Transports are right on the 50% line at 1,565, the S&P is down 42% and needs to retake 946 just to be pathetic, the NYSE is down 44% and we may see 5,200 before they turn (the 50% line).   The Nasdaq finished 43% down while the SOX fell to 55% (275 is 50%) and even the Russell is down 42% now, needing to retake 514 to show us some small sign of hope.  More likely than not, we're going to test 50% across the board and, looking at Asian trading this morning – that's nothing! 

The Hang Seng fell 7% for the day and is now 54% off it's highs and the Shanghai lost 5%, making a neat 65% decline (so far).  The Nikkei is down a whopping 9.6%, in the dreaded 10% rule territory, and that too is a 55% drop from the highs as insurance company, Yamato Life, filed for bankruptcy ahead of trading, causing the Osaka Securities Exchange to have to shut down futures trading for 15 minutes.  The Yen is skyrocketing against both the dollar and the Euro and that is sending exporters like TM and banks like MTU into a tailspin. "I haven't seen the market fall this much in a week, it's panic selling," said Hajime Kitano, chief Japanese equity strategist at J.P. Morgan. He said that the G7 meeting may trigger a rebound in the Nikkei if some positive measures are announced to counter the financial turmoil.

Cash-rich Japan has graciously volunteered to help the IMF rescue countries that are facing credit crises:  "If there's something the IMF can do, I want them to do it flexibly. Japan will cooperate with that, including providing funds for it," Finance minister Nakagawa told reporters in Washington for the G7 meeting.  "The impact of the credit crisis is spreading to the world. To minimize the chain-reaction, Japan is ready to take leadership in contributing to support countries by providing funds. And I will call for other countries' cooperation at the G7 meeting tomorrow."  The Nikkei newspaper reported that Japan would propose making trillions of dollars in currency reserves held by Asian and Middle Eastern governments available to support IMF-led bailouts. Japan alone has $995 billion in official foreign currency reserves. China has $2 trillion, the world's largest stockpile.

The DAX is also at the 10% line this morning (7am) and the FTSE and CAC are not far behind, down 7.5% each and all 3 indices are at the 20% mark for the week with the DAX down 40% for the year and 45% off its highs.  Equity trading in Russia, Iceland, Romania, Ukraine, Indonesia and Austria was halted, while nearly half of Milan stocks are suspended for excessive losses.  The Middle East is sharing Europe's pain as investors in the six Gulf states, which include OPEC members Saudi Arabia, the United Arab Emirates, Kuwait and Qatar, have taken a pounding this year, amassing almost $350 billion in stock-market losses since January, according to Zawya Dow Jones estimates.

Oil (Tuesday's short pick) is down to $82 in pre-market trading and, according to the WSJ, while Saudi Arabia may be able to support their economy with oil at $55, Venezuela and Iran need a $95 price tag to avoid destabilizing their economies.  Standard & Poor's said last week that Venezuela's budget balance "could deteriorate quickly" if crude prices fall sharply.  Russia also could face cutbacks, as its budget for 2009 counts on a price of $82 a barrel for Russian Urals crude, which sells at a discount to the U.S. benchmark.  $80 oil brings us back to our breaking point of last November, where oil breaking above $89 was the straw that ultimately broke the back of the US consumer.  In 2008, oil has averaged $110, 52% higher than the $72 paid on average in 2007.  That $38 a barrel has cost global consumers and extra $1.2Tn this year, which pretty much accounts for all those missed mortgage payments.  We still need to focus on getting oil back below $70, a distinct possibility as copper is already below the 2007 lows and platinum has fallen below 2006 levels – both are demand-driven metals.

Back in the USA, GE reported earnings that were in-line with expectations and maintained forward guidance but the headline on the WSJ is "GE's Net Falls 22%," which it did over last year but earnings were $4.5Bn FOR THE QUARTER and revenues were $47.2Bn (up 11%) and the dividend of $1.24 was approved through 2009 which, at yesterday's close of $19, works out to a very nice 6%.  The updated "safe" way to play GE is to buy the stock for $19 (maybe less on a morning sell-off) and sell the 2010 $17.50 calls for $5.90, which lowers your basis to $13.10 and you can buy the 2010 $17.50 puts for $4.88, which raises your basis back to $17.88 BUT you have a right to force someone to buy your stock for $17.50 any time before Jan 15th 2010.  Your maximum loss on the trade is .38 but you will collect $1.64 in dividends (5 periods) against $17.88 so subtract the .38 from the $1.64 and you still get a 7% return in 15 months with no downside – better than most places you will put your money.  Of course there is a bonus as, if GE takes off and you feel safe, you can cash out your puts (or sell against them) and picking up even just an extra $1 on this trade brings you to a better than 10% return. 

We'll be looking at a lot of these kinds of trades this weekend as this is the kind of thing you can do, even in a dreadful market like this one.  Meanwhile, it's too tempting not to bottom fish today as we have been focused on short plays for the past two weeks and there are some amazingly good long stories out there that are worth a stab ahead of what is likely to be massive government action to support the markets both today (Bush at 10:25) and next week after the G7 meeting.  The upside is still speculative but what great speculation there is out there!  As benchmarks, we want to see the QQQQs hold $30 and the Dow hold 8,400 and the S&P hold 900 in order to be brave but fortune may favor the bold on these:

• GE just told us that earnings will be what they said they would be when the stock was trading at $29, no one believes them but the 2010 $25s are just $2.95 and Nov $95s can be sold for .85 (as of last sale yesterday) which is not a bad way to start a spread but, of course, better to give them a chance to head up first.
• AAPL is tempting and GOOG is tempting and RIMM is tempting but why not just play the QQQQs, with September $30s at $5.45.  Nov $35s are $1.27 and selling them reduces the basis to $4.18 and you have a $5 position advantage on the caller. 
• Speaking of AAPL, here's a stupid options trick.  If you think AAPL can go back to $200 but can't stomach the risk, why not spend $164 now?  What you can do is buy the stock for $88 and buy the 2010 $160 puts for $76 for a total of $164.  Like the GE play, you can always get out at $160 but, since you are not selling calls, there is no limit on the upside.  In a quick run-up (before September) your puts should retain some value as well so anything over $160 is likely to be a nice profit.  Of course you can mess around selling puts like the Nov $60 puts for $3.30 but that does give up some protection although 10 sales like that and your basis drops below $130 with a guaranteed sell at $160!
• UYG is probably my favorite leap of the moment.  They are the ultra-long financials and droped 22% yesterday alone so not for the feint of heart but the March $7s are $4.35 and this index was at $24 just 3 weeks ago.  If the government comes up with a financial package that the markets like, this index can take off.  Can the financials go to zero?  I suppose so but, as I said to members yesterday, if that happens, getting wiped out on an options contract will be the least of your worries as you line up at the bank to get whatever percentage of your money is left…

So happy Friday to you!  It's all up to our fearless leaders to turn the markets.  As with yesterday, we expect XOM and CVX to continue to drag on the Dow so we need those financials to lead the way (AXP, BAC, C, GE, JPM) and some action from AA that shows a bottom at $12.50 and signs of life from BA, CAT and UTX.  DIS should respond to GE's good report on NBC that shows there is still money in broadcasting and IBM is insanely low at $87 (2010 $80s are $20) and INTC is being given away at $15.50 and you can sell Nov $15s for $1.80, putting you in for $13.70. 

Have a good weekend.