MP 4/17/08

Traders,

We saw a great rally yesterday up to (and in some cases) through resistance areas. The short-term support had more legs than I expected, but I think a big help was that JPM after the Bear Stearns deal didn’t add any bad news to an already big write down. I think it may take some time before we see the full impact of Bear on JPM’s books. Additionally – several companies are benefiting from the very weak dollar. It’s a very two-sided market and some companies will see huge profits regardless of sales growth, just because of the depreciating dollar.

Companies like Coke, IBM, and others that have huge exposure in the overseas market – love to see a weak dollar – because when they bring back that overseas money and convert it back to the dollar – they have more dollars. However – in the end if the dollar continues to slide – it won’t matter how many dollars they have. At the same time, while it is great for these companies – it is a very hard thing to live with domestically.

The big retailers will all suffer, since they buy overseas to sell locally – additionally the consumer will continue to be impacted by higher inflation in food and energy prices, eventually higher prices will be passed though by the retailers. So the weak dollar is good and bad based on how you view it. Great for investing in companies that sell overseas, Horrible for the local consumer that is affected by inflation (and those companies that buy overseas – like most retailers.) It’s a double edge sword for sure! As consumers – we are on the bad side of a weak dollar. As investors – in the right companies – we could see some gains.

Additionally – while we were all starry-eyed staring as the market rocketed to the resistance levels and hoping that we have finally gotten out of this hole, on the side of my screen going unnoticed (by all) was the massive rally in OIL, EURO, Gold, Swiss Frank, and commodities. Oil hit an all time high above 115 a barrel, while the dollar slid to new lows against the Euro 1.59 – if it breaks the 1.60 barrier – where a hell of a lot of forwards are priced – it could get ugly fast. Of course all this and the inflation news went unnoticed as CNBC was cheerleading to us out of the hole. Maybe we can get a little follow through today?

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Merrill Lynch continues down the bumpy road

Merrill write downs another $6 billion and plans to cut 3,000 jobs. While it seems that the new CEO of the company is trimming the fat, cutting dividends, and reducing over-head there are still some crap positions on the books – which they are writing down. The exposure is still there, since these positions have not been sold – but rather MARKED. So we may see some continued write downs in the 2nd quarter. However, it seems that the CEO is taking this bull by the horns and clearing the decks.

The problem is going forward, while they may be close to the end of the write downs – it a slowdown going forward that is going to see growth curtailed. The cutting in the overhead and dividends will make these firms more lean – to ride out the storm – but I think it will take at the very least another quarter before they get there ships shored up.

Citi on the otherhand, out of all the banks and firms, have the bigger problems because of their vast network and businesses, many of their other units could create new problems – specially the credit card units, which are already seeing a ramp in defaults. Both Capital One and Amex have doubled up reserves as they see the default rate accelerate – Citi is no different.

The good news is that these sovereign investment funds will not let these banks fail – since they already have 10s of billions invested in them. That is not to say these companies will not have bumpy rides and will need MORE injections of capital. But the Middle East have deep pockets – and they WILL through more Good money after Bad - for now. I don’t know what their pain threshold is – but it sure is not $10 billion – which they will probably inject within the next qtr or two.

Expect more volatility in the banking and financial sector – it MAY seem that the worst is over – but we all thought that the last couple of qtrs. Additionally – I think investors have come to accept billions in write downs and it is no longer a shocker as it once was. But if you pause and think about it – just for a second – it IS a shocker to continue to write-down and take Billions of losses over and over. Silly – but investors are typically investing on “Hope” and quickly become numb to bad news.

More bumps a head!
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Pfizer earnings fall – sees competition tighten

Competition is always a great thing – but not necessarily for the world’s biggest drug maker. Profits fell 18% missing analyst’s estimates as competition heats up in the generic sector against their heavy weights Lipitor and Norvasc. The stock is getting hit in the pre-market – as both profits and revenue shortfalls took their toll on the company in the first quarter.

Additionally their pipeline looks fairly lean going into the 2nd and 3rd quarter for new releases - so relying on sales of Lipitor and Norvasc in an already crowded market that is seeing the generics gain ground is going to make for a tough 6-9 months going forward.
Analyst expect, while profitable – growth will not be robust.

Expect the drug sector to see some pressure as the world’s biggest drug maker weights down on the index.

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Futures Pre-market

The futures are getting hit – after making a huge pop in the late trading session from tech stocks carrying some better than expected earnings and some euphoric follow-through from yesterday’s rally. Those gains have been erased and the futures are seeing pressure from Merrill Lynch, Pfizer, and more concerns in the credit market. The futures are front running the cash by a few points – so expect ARB traders to put some pressure on the cash basket at the opening.

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Support / Resistance (SYN. STRADDLE TIME!!!!)

We got a great jolt to the upside to those resistance levels (and in some case through them). We are back up to those testing areas that we had pulled back off from – time and time again. The question is does this market have enough oomph to punch through, will the shorts get squeezed, will sellers step aside? I don’t know – but if that does happen we could see a massive covering rally to the upside again. So while investors should get FLAT and traders Short – make sure to have upside gamma in case of a break out – which would be huge!

INDU 12250 / 12750 (We are back to those 12750 resistance areas that we have been retreating from – over and over again – a good place to flatten and/or get short. But here is the BIG WARNING – any bust out could create a MASSIVE upside rally. So make sure you have your gamma and extra bullets in case we rip. 12750 – a short area with lots of extra bullets to the upside is the play.)

NDX 1800 / 1875 (We bounced off that pivot point pretty solidly – some of the heavy weights really drove this index up hard. This index is more volatile than others and while 1875 – 1900 range is a short area (or flat for investors) – make sure to have gamma to cover yourself in case of a massive rally if we break.)

SPX 1325 / 1375 (Again we are just shy of the short area that we have been retreating from several times since the end of January. It’s the place to get flat or short – but it is also an area which we could see a HUGE rip to the upside – so make sure you over hedge to the upside – you need OTM CALL GAMMA!)

RUT 680 / 720 (We bounced off the 680 range and now heading back to the 720 range which has been hard to get through – just like the above indices. Make sure to over hedge with OTM Call gamma if you get short up at the 720 range.)

We have been bouncing between the ranges for a couple of months – either trying to break through resistances and head higher – only to get smacked back down – then we visit supports and stall not breaking further down. We have NOT revisited the bottoms from earlier this year and have stalled at the short-term supports and it SEEMS that it’s pretty resilient.

Today could be a key day if we DO test those resistance levels – the question is CAN WE BREAK. I would NOT get long HARD DELTAS at the resistance, but rather SHORT. I would however OVERHEDGE myself with extra call bullets to have a butt-ton of gamma in case we do rip. Volatility has come back down and the SKEW is still fairly step – so those OTM Calls are not that expensive to load up on them as you shorten your positions up at the resistance levels. A good hedge will make you money on a big break out or break down. I guess you could say the resistance areas are a straddle area – cause you can make one bet and that is we are NOT going to stay there.

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Conclusion

Write downs, higher oil prices, and weak dollar has been beating on this market so long that we have become numb to it. Investors DO NOT CARE anymore – they just want this market to go up – regardless of how bad the news is. The market has been VERY resilient in the fast of all the bad news and there may not be enough shorts to drive it down any further – I guess the shorts really need the help of the longs to sell their holdings to drive this down further.

So far there is NO blood in the streets – people are NOT scared – I am waiting for Bernanke to give the “Steel Resolve” speech as he rings the bell at the NYSE – leading this nation into devaluation. I am surprise as to the market’s resilience – no doubt – but you can’t fight perception. So if we do breakout – ride the wave – but hedge 100% because any rally is optimistic hopeful perception – and not based on fundamentally sound financials.

Sure there are a couple of sectors that are going to do well – but we must not forget the GDP’s biggest asset is consumer spending. When consumers don’t spend the wheels slow. Additionally – inflation is ramping, dollar dropping, oil going higher, and we have not seen a bottom in the housing market – YET.

So, in my VERY humble opinion, any rally (while a good thing in the short-term) MUST be fully hedged – because we are FAR from seeing any recovery in the economy.

We may be testing the resistance areas today or tomorrow and if we do break through – make sure to have OTM CALL gamma to participate – but these are NOT area’s to get long hard delta. Get ready to play both directions!!! Fundamentally we should probably go down, optimistically we may go up!