Traders,
We pushed up against those resistance levels again yesterday, the NDX actually blew through - with some help from a couple of their overweight’s - toss in a pull back of oil off its highs and we are seeing some confidence return to the market. There was a significant pull back in the futures after the close - led by Microsoft after it's brilliant run - but the futures look to have rebound in the overnight session after that pull back.
This is the day - that we MAY breakout to the upside from being range bond for a couple of months in this negative area being pelted by negative news one-after-another. And even though the U.S. economic picture looks rather negative for the most part (we did get a boost with lower job loss claims yesterday) - the consumer is still under serious pressure - however the investor community seems to have gain in confidence - Hell - this is America the greatest nation in the world - we CAN rally! right?
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Microsoft looking soft after the close
It's High Noon - MSFT set the date for Yahoo to show up! If they don't it could get hostile - the clock is about to strike 12 noon - Steve gave Yahoo till High Noon to agree to the deal or they walk. Yahoo dug their heals in for a $40 dollar price, rather than the $30 price that Steve offer. Does Steve leave town or does this go Hostile? The soap opera continues....
Regardless of all the goofy stories about the Yahoo, Google, AOL, Murdock stock - Microsoft earnings beat estimates, but their profit did drop and forecast is also looking a little leaner - the stock pulled off over $1 in the overnight session. If they go after Yahoo, in a Hostile manner - including large grabs for Yahoo stock - it could also steer focus away from their core business and use up cash reserves. They will probably get what they want in the end. However - it could put pressure on the stock. Traditionally, the takeover candidate usually drops while the target company usually rallies, but MSFT is not a traditional company and has very deep pockets.
The stock HAD made a good rally touching $32 yesterday going into earnings - but in the afterhours the stock has dropped - currently around $30.50. If MSFT stays down here it will put a slight pull on the Dow and NDX - where it is an overweight.
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American Express Beats but what of the future?
American Express - which had announced building up their reserves because of the ramping defaults - beats estimates as overseas utilization (plus again the weak currency) adds to profits. The stock had made a significant drop over the last 9-12 months as unemployment rose and the housing bubble burst. They had increased their reserves as expectations of defaults would start to climb.
However, they have expanded worldwide which offset domestic issues. Overseas utilization rose 14% coupled with a 27% rise in consumer spending (triple that of the US) - help boost profits. Globalization is a clear indication that companies that have pulled up their roots and diversified into both emerging markets and the EU are off-setting the weak U.S. economy.
The US markets didn't fair nearly as well - uncollectible debt in the U.S. credit-card unit rose to 5.5 percent of loans from 4.3 percent in the fourth quarter. Loans late by 30 days or more rose to 4.1 percent from 3.5 percent.
Even though they beat estimates and seeing a rise in stock price in the pre-market, Moody's has a negative outlook on credit card companies - stating defaults will continue to rise. Consumers are taping plastic credit lines as home equity line access declines. Valitne, analyst with Friedman Billings Ramsey & Co, rates American Express to "underperform", states "Consumer spending is slowing, given employment uncertainty, declining home prices and increasing fuel and food costs".
The stock is certainly getting a boost in the pre-market session and overseas growth is expanding - the question is (which I am uncertain) how much can overseas ramping utilization can offset defaults in the US? I don't know - but I think Mr. Valitne and Moody's are correct - take caution - especially as US home foreclosures increase.
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Treasuries tumble
Short-term treasury paper makes the largest two-week decline since 1982 - as traders bet that the Fed has STOPPED cutting rates. The 2 year note rose 72bps in two weeks and actually popped ABOVE the Fed rate for the first time since 2006. This is a clear sign that confidence has returned to the market and that the worst is behind US as traders stop chasing safe money.
The expectation is still for a one and done mentality at the next meeting - a 25 bps cut and some wording indicating the Fed has won, Mission Accomplished! However, many are not too sure about that - as foreclosures continue to ramp and unemployment is still low. Some economist are indicating this is a pause of brief belief in a much negative market - which could push stocks up in the short-term - as money is pulled from bonds and dumped into the market.
The spread between the 3 month T-bills and Libor rate shows credit cost are still rising - which shows that banks are still in need of tons of money - the difference widened to 1.66% from 1.56% a week ago (TED spread). The spread averaged below 50 bps before borrowing costs exploded late last year as the housing bubble burst. Banks are still not willing to lend to each other because the depth of the problems on their books is still uncertain. They are all playing the Write-down game utilizing mark-to-market systems - clearly if this is on 2nd mortgages the mark-to-markets are NOT low enough. No one wants to lend to the next Bear Stearns - if one were to happen. Mr. Lantz, interest-rate strategies for Credit Suisse stated, "The ten-year yields WILL FALL below 3% later in the year." Inflation is a very major concern - while the Fed may have shored-up the banks by cutting rates and making special deals at the Discount Window - has spurred inflation.
Can the Fed raise rates if needed? Probably not without getting back to the money flow issues - which (via the TED spread) show that money lines are still tight. 
Japanese bonds have also dropped fast and hard as concerns about inflations ramp. They actually halted trading for 15 mins as they had dropped fast and hard. That is not necessarily a good sign – inflation could be a Tsunami.
Where we go from here - I am not sure - for now confidence as to the worst in the financials and the Fed is done maybe the story of the day - but the Fed doesn't have much more to cut if they wanted too and 25 bps cut is still in the cards for the next meeting. They are almost out of room and have been offering special deals at the discount window. The LIBOR rates and TED spread clearly indicate that money is still tight and costs of borrowing is ramping NOT declining as the FED and economist would of hoped - thus taking pressure OFF the Discount window. The Discount window is suppose to be a lender of last resort - not the first stop on the lending cycle. Clearly - the banks are still concerned with borrowing from each other. Couple that with AMEX and Capital One increasing their reserve pool as US defaults on plastic increase - well it is not over yet. This may just be a pause in the storm.
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VIX – NO FEAR?
The volatility index (VIX) has a lot of associated myths with it, simply because people don’t know what it is or how it works – other than what they hear on CNBC. A very simple primer. The VIX is simply a measurement of the At-the-money (options) current implied volatility of the S&P 500 index options. So what does that mean? Well – each option has an associated premium (value over intrinsic) – that value is given a number (implied volatility).
Implied volatility is simply the percentage movement over the underlying asset for 1 standard deviation over an annualized basis. Ok – that was a lot of words – so a quick example. If I said stock XYZ trading at 100 per share had a volatility of 20 – that would mean that stock XYZ should be in a range of +/- 20 (between 80-120), 68% of the time (also known as 1 standard deviation) (note: of course there is cost-to-carry and some other items that I excluded for the sake of simplicity – note one of our traders – “brains for math” will read this an roll his eyes – since he works on pricing models – but please “brains” bare with me on this for everyone else – wink wink).
We can surmised what the index S&P volatility is forecasting by looking at the option premiums – in terms of their volatility. When the premiums of options decrease – volatility decreases – and therefore the expectation of movement decreases. Low volatility. Traditionally low volatility equates to a rising market and high volatility equates to a falling market – but in reality volatility does not KNOW direction. If the market pops 100 points or falls 100 points that is still HIGH volatility. It is the psychological affect (there is a math reason – but don’t have the time to go into it) why volatility drops in a rising market – which is investment strategy based – investors STOP buying puts to hedge and start selling calls (covered calls) – which lowers the premium – thus lowers the volatility.
So when you hear that FEAR has left the market because volatility has declined – it is a simple indication that investors have stopped buying puts and started selling covered calls.
However – there are a couple problems with the VIX – first it ONLY measures and weights the near-term at-the-money options – which is fair – but does NOT indicate the SKEW of the options. Meaning when those Out-of-the-money puts increase in value compared to the at-the-money. This is even a better indication when FEAR enters or leaves the market. It is quite possible for the VIX to remain unchanged and the skew to increase or decrease. It is those Out-of-the-money puts that have SO MUCH more value – as those are the options traders REACH fore in the falling market.
Sometimes I refer to HIDDEN VOLATILITY – which is volatility NOT reflected by the VIX – since it only measures current at-the-money premium. Hidden Volatility is the combination of skew combined with a collapsing trading range of a stock or index. There is a hidden ramping or load being injected into volatility that is currently not being measured. When the load is released we see a break out of the index or stock in a violent move up or down.
So let’s review – the VIX is only a measurement of options premium of the ATM in the S&P 500 cash index. It is lease a measurement of actual volatility of the underlying and more of a perceived forecast of what investors are willing to PAY for options based on their belief of movement. Fear and Greed.
The VIX is at 20 – pretty low this year – if it drops below 20 – investors will build confidence that the worse is behind us and the market will rally. However, if you see it hit 10 – then I would say people have forgotten the past and Greed is ruling their investments – time to bet on a BIG pull back in the market.
Watch the VIX +/- 20
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Futures Pre-Market
The futures were down in the after-market session (15 mins after the close) – and have now regained most of those losses. The DOW is above fair-value, but the NQ and ES are right at the number – mainly from the knock down by MSFT and the ramp up by AMEX. Arb traders seem to be sidelined for the moment. Expect a flat to slightly higher opening.
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Support/Resistance
We are up near those resistances and all eyes are on them for a breakout in the S&P and INDU
INDU 12500 / 13000 (1300 is in the cards and we could get above it – will we close above it – that would be a positive sign.)
NDX 1900 (We broke through 1900 which is short-term support a couple of heavy weights pushed it through – but the biggest MSFT is pulling down on it in the pre-market. It is going to be push-pull in this index – expect volatility)
SPX 1350 / 1400 (We keep getting close to 1400 only to pull back off – the confidence is building we could push through- but watch the close.)
RUT 680 / 720 (We might hit the 720 area – but do we close above it)
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Conclusion
We are pushing hard against resistance points and the market really wants to break through – but will it? It could and it may see some follow through – but I think the negative impact of the economy will reel this market back in. So – roll up hedges to lock in gains on big upside moves.
Today IS the test of whether we break through or fall off. If we remain in a close range at the resistance – more hidden volatility will be loaded and we will only get a bigger jolt next week.
I am not sure what the future holds for the market, but the economy remains week. I read a report – I will try to dig it up – by a national agency that mentioned that the NATION may not feel a recession and it could be a state-by-state basis. Interesting – but how many states need to move into a recession for the whole country to be in recession.
My gut keeps telling me to pay attention to inflation and the consumer – which make up the majority of the GDP in this nation. True there are some very good segments in the market that have position themselves in the emerging markets and are benefiting from the dollar – but what does the future hold for them. The dollar DID see some good strength as Gold and Oil pulled back – but is that a short-term reaction to the fall in the bond market and confidence that the Fed has STOPPED cutting rates.
Time will tell – but just as we are uncertain about the Democrat nomination – we are equally unsure as to where this market and economy are heading. Expect MORE volatility not less!
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