MP 5/16/08

Traders,

We got a good solid rally yesterday and broke through some of those resistance, the INDU is still short of the 13000 market – but that is only the narrow based 30 issues. The thing to look at is the RUT which broke 740 and even more so the SPX breaking through 1400 significantly. The strength was lead by INTC (and overweight in the NDX) as the tech sector got positive boosts in some globalization stories about increase demand outside of the US. The oil companies and their huge profits also helped boosted the S&P. JC Penny the 3rd largest department-store chain also posted a first quarter profit, even though the slowdown in the economy is eminent – the discount or lower-end retails are seeing a large bandwidth of clients vs. income – everyone is looking for a discount.

Analyst recommending oil stocks, saying they are undervalued vs. the future oil price forecasts. Buy recommendations seemed to be coming into every sector today – retail, oil companies, tech sector. It was kind of euphoric – it is none-the-less ironic that this massive amount of sector buy recommendations came right at the upper band of the resistance range and in the face of more economic bad news (Job numbers, inflation, weak dollar, and increase in foreclosures). Whatever the case the market bought it and the buy recommendations in the face of economic bad news drove the market higher.

There is no doubt that economic reality vs. the market is facing some serious disparity. My bigger concern is watching the VIX tumble today – the low? Well we KNOW the VIX cannot go to zero (a mathematic impossibility) and 15 is very low – a brief dip in the single digits is never a sign I like to see with a rising market and looming negative economic forecast.

I find it equally perplexing that the billionaires, Ross, Buffet, Rogers, Trump, Pickens, and others have all said we are in a recession and predicted things will get worst before they get better – but then these guys do not measure their investments tick-by-tick in the stock market – most of them probably don’t even watch the monitors and are in it for the longer haul – not a day, week or even a month.

No doubt I still feel there is hidden volatility in this market – we have broken resistance yesterday – today is expiration. While this is a fairly decent confirmation to get long and a dangerous area to be short – the bi-polar economic vs. market situation leads me to take a over-hedged stance on long deltas – or for a long position doing it with soft deltas (rather than hard).

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Oil prices continue to rise

Just when we got a break with the market pushing through some resistance levels – ironically helped by buy recommendations in the oil sector – the oil price goes higher as well. This morning on CNBC they interviewed the CEO of Delta – who clearly indicated that their biggest obstacle is the higher prices in jet fuel. Additionally – CNBC mentioned there was a story that some airlines are not topping their tanks and pilots are voicing their concerns.

While the market gets a solid rally – boost by oil companies as profits rise in tandem with higher oil prices – several other sectors see the squeeze in margins.

The question to ask is how much of the fuel impact costs can a company pass through to the customers to keep margins intact. Remember – it is NOT revenues it is margins that determine profitability. No doubt the high price of oil additionally creates a gulf between companies that can profit on higher oil prices and companies which are financial squeezed with higher oil prices. You can bet that higher prices are not a good thing for the airlines – but what other sectors benefit or suffer. That should be an important factor in discovering good longer-term buys vs. sells.

For now – oil just touched 127 another record.

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Housing Starts CLIMB more than forecast

While the country is seeing the largest ramp in foreclosures (up 66%) – a few days later we see that housing starts jump (based on condos). The first thing that popped into my mind is WTF? I obviously don’t have a clue what is going on. True that single-family houses in April dropped to a the lowest level in 17 years – totally opposite of the condo market. However – I heard a possible answer the condo starts this morning. On CNBC the largest real-estate investor in Atlanta – indicated that in condo development since it is typical vertical construction, even when investors fail the bank continue to complete the project since partial completion on large projects with multiple units make it almost impossible to sell regardless of market conditions. I don’t know how that may affect the condo starts – but I can clearly see the point – a bank repo doesn’t want a partially completed building even in an REO – which regardless of market conditions has to be harder to sell. Any way the investor said that he expects the condo market to continue to go down along with single family dwellings into 2009 – but he is window shopping.

A slowdown was reported in single family homes as builders broke ground on 692,000 single-family homes at an annual rate – the lowest in 17 years - while condos were UP. Total starts surprisingly jumped 8.2% due to the condo building rebound. Hope they presold those condos! Wonder what more condo inventory does to prices?

Builders are continuing to build but at a slower pace and have been offering incentives to get customers to buy. One analyst stated – builders will not stop building if there is funding in the pipeline – builders problems now is trying to sell the inventory – that is what will drive prices down. Economist predicted building permits would fall to a 939,000 annual pace – but last month’s report shows an increase up to 978,000 annual pace (gains in both single family and multi-family dwellings).

The continued concern is the already over burden inventory – that in some states like Florida and California will take 2-5 years to be absorb – adding to an already large inventory base could create more pressure on existing home prices – if new home prices are offered at a discount. The population growth question remains as to how to occupy these homes. While the population in the US is growing through immigration (illegal or otherwise) the US citizen birth rate and baby boomer population is showing a slow down to flat growth. Question – can immigrants – usually low income – afford to take new inventory off the market? Not at these prices.

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ECB focused on inflation

Even though the CPI showed benign inflation and the CORE remain moderate (yeah right) – the ECB has one goal (unlike the US) and that is to strengthen their currency buying power and keep inflation at bay. ECB Governing Council members Mr. Liebscher indicated that they may possibly leave rates unchanged through the rest of the year – regardless of an economic slowdown – IF (this is the big “if”) inflation remains consistent.

``The current monetary policy stance is very suitable to maintain price stability and to avoid inflation expectations building up,'' said Liebscher. When asked if the bank would cut rates in 2008 he stated, “Given the risks for price stability, I think the answer is a clear one. The risks have not diminished. Inflation is much too high -- 3 percent plus is an unacceptable figure. We have a responsibility for price stability. There are no two ways about it.”

Another council member, Mr. Weber, went as far to say that they may still raise rates if inflation measurements continue to rise in order to strengthen the currency and curb inflation by increasing buying power. These comments are not what the U.S. Fed wants to hear – as it is caught between a rock and a hard place. Regardless of what the CPI reported – we ARE feeling inflation in this country and the FED can NOT raise rates while the housing problem and credit problems (while they may seem to have subsided) are still weak. However – any raise by the ECB will push the dollar lower and inflation up in the U.S.

Europe is still seeing increases in inflation and it is important to note the ECB mandate is price stability – the key focus on inflation. They are not there to service bad debt or banking problems – a key difference as to recent U.S. Fed policy.

Only time will tell – but the tailwind of inflation is really starting to take a serious bite out of the U.S. economy.

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Futures Pre-Market

The futures have seen a little volatility in the pre-market, initially up – but then oil rallied above 127 which sent futures back down. Then the housing starts surprisingly increased (the housing boom is back on?) that sent futures back into positive territory again. But then the ECB said they will probably keep rates the same or possible raise them (a cut is probably NOT in the cards) – that sent futures back down. The whip-saw this morning – shows uncertainty in the market. Arb traders will probably sit sideline with the whip-saw. Plus it is expiration and settlement for the indices this morning. Expect a mix opening.

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Support / Resistance

No doubt the bulls kicked the bears butt yesterday and pushed these indices up through the resistance levels yesterday. Some good news in the tech sector helped lead the charge. While we did break up and have started to confirm that resistance has become support – the economic picture has not really changed of yet. Indicating that hedging hard deltas is a must.

INDU 13000 (If we can close above it and strong – expect this to be the new “short-term” support area. The 13000 is a euphoric point that could be what the market needs as an indication that the worst is behind us. The close today will indicate if this most recent rally has succeeded.)

NDX 2000 (Wow – a great break through. 2000 had been a support that was hammered on several times in the 4th qtr of 2007 – which finally broke in Jan and the market continued to slide down. Getting above it yesterday was a long 1st quarter struggle and hope has come back into the tech sector. Of course we are only above it for one day so far – but we broke through it by 30 points. 2000 is a “short-term” support – how far up can we go? Who knows – but if we break back down through 2000 it will not be a pretty picture. Still remain skeptical and make sure to hedge the 2000 line. Investor optimism has trumped consumer confidence.)

SPX 1400 (Another good move by the S&P with a wide sector move higher. 1400 is the new support and we did have (just like the NDX) a good break through. However – remain hedged up here. Take your long deltas and ROLL UP those hedges as we climb higher.)

RUT 740 (This is the confidence factor as long as it can remain ABOVE 740. 750 is in the cards – but make sure to watch the close.)

I heard a lot of “finally” yesterday as we broke through resistance – no doubt a sizeable fight against this bi-polar market. But it has only been a day – so it will be about the CLOSE today. If we can REMAIN above these supports at the close on expiration – then break-out the cigars. However – if we do retest those supports and do NOT hold - you BETTER have your hedge on – because there was no confirmation here. I remain hedged and over skeptical as the bi-polar market conditions remain confusing. Add in a very low VIX and option premium and fear has left the market – which is also sending of an alarm bell in my head. While I maybe long – I would also fully hedge those bets.

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Conclusion

No doubt that investor optimism just gave the smack down to consumer confidence. Several sectors are benefiting from the weak dollar as they are positioning themselves in the global market. However – the U.S. economic landscape looks still very weak. The housing starts on condos has me scratching my head for sure. Why build more when condo prices are getting the smack down – maybe the real-estate investors explanation is the answer – but I don’t know.

At this point the falling VIX combined with higher oil prices still gives me chills. Why am I not as bullish as the TV pundits? Well – I would be if the dollar was stronger, oil was backing off to 80, foreclosures declined instead of hitting an all time high, gold dropped to 600 an oz, and inflation “real” not the CPI was showing that it had subsided, the banks stopped writing down billions, and Bernanke CLOSED the discount window to investment banks. But that story still looms – so what has really changed? So it is very hard to be bullish without some skepticism. Like buying a house in Florida after a big hurricane, or in San Francisco after a big earthquake – you may have just avoided a major disaster – but you want to insure that asset because while it may be improbable it sure IS possible.

The fear leaving the market and the cheerleading on the internet makes me think there is another shoe to drop.

A Seldon Crisis?