7/15/08 (Selling the Faith, GM, JNJ, PPI, Retail Sales)

Traders,

A colleague called me late yesterday and mentioned - why bother with indicating supports, we are beyond technical’s at these levels. He is probably right. The market moves on perception for the most part, but at the end of the day perception falls to the wayside and it becomes strictly about fundamentals. We are seeing that with INDYMAC and Freddie and Fannie. However, while supports have pretty much failed (the RUT the last hope of holding) - it is the faith that has really been extinguished.

Just like with our currency (FIAT) - the market is just an extension of that FAITH. Not only have we (domestically) begun to lose faith (or hope), but more importantly the WORLD has lost faith in the Dollar and the U.S. markets. When faith is lost - technical’s and fundamentals no longer mater. And that is a scary thought. At these times even healthy companies can fall in price and THAT is when real value is found.

It's clear that the TOUGH TALK that we have heard from Bernanke (about inflation and raising rates) was a bluff - he didn't. The TOUGHT TALK that we recently heard from the President ("We are STRONG DOLLAR people!") again was just talk. And recently Bernanke and Paulson didn't SELL the FAITH at the Congressional Hearing last week - specially when Bernanke said "These are LOANS at the Discount Window, we are NOT purchasing these positions. Not ONE loan has failed!" - Of course I paraphrase but that was pretty weak if that was his best job at selling the faith. You KNOW what went through everyone's mind when he said that, one word "YET!"

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Government Inflation Data – Producer Price Index

We get the latest report from the Government about Inflation. As you may know - I am not in favor of their recent (over the last 10-15 years) methodology changes - which LOWERS the reporting substantially. That being said - even their new NEW model can't avoid the fact that inflation is increasing.

The Producer Price Index (a measurement of inflation from the business side) was up 1.8%, exceeding forecasts. I think not one was to surprised, even though it did exceed forecasts. Commodity prices are affecting everyone, not just consumers. Of course – they already started touting the “CORE” – which shows that inflation is rather benign. FINE – and I won’t argue that point – the problem is that the “CORE” excludes energy. The problem we are having is HIGHER energy prices – that is what IS affecting inflation. So as I listen to this analyst on Bloomberg saying the “Core” shows that inflation is not that bad – it is just a bad assumption. EVERY company in the world is affected by Energy Prices – selectively ignoring them to show that inflation is modest doesn’t change the fact that energy prices ARE affecting profits (margins).

Expect the upcoming CPI (Consumer Price Index) to be similar in nature – AND expect some analyst to focus on the “CORE” (excluding food and energy) to show the economy is not that bad (or to argue we are NOT in a recession). Tell that to the man on the street that has to fill up his tank and buy food. We have to eat and pay our energy bills!

The focus on the CORE is something we will continue to hear Bernanke and Paulson refer to – since while they TALK TOUGH as to strong dollar people – they do NOT want to raise rates (to keep the money flowing). The CORE will be used to argue that inflation is NOT that bad. IMHO – as they continue to ignore HEADLINE inflation and focus on the CORE is just one of the reason we are in this weaken dollar economy. It’s just silly!

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Retail Sales – Gas Prices having an affect!

Retail Sales was up very small, up .01%. That is not necessarily good news – since this nation relies on consumer spending (we ARE a consumer nation after all). While the FED continues to quote the “CORE” (inflation of the CPI and PPI – which is obviously lower when you exclude gas, energy, and food) – it IS the “HEADLINE” inflation that affects consumers.

Look – let’s keep this simple – we are a consumer nation, we also ACTUALLY eat food, use heat and A/C, and yes fill up our gas tanks. If Food, Energy, Gas cost MORE money – while it is fairly simple math – consumers will have LESS money to spend at the Retail Stores.

IMHO – the ONLY reason that it is up (even a little) is the remainder of those government stimulus checks still in the system. I think we may see retail sales actually decrease before the end of 2008.

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GM - smells like bacon!

What can GM do anymore. Well - we will hear about it today. Rumors are everything from closing plants, cutting more jobs, and sell-off divisions. They have managed to tread water for almost a decade and now they are finally sinking. There is nothing they can really do at this point - other than reduce liabilities and start selling off divisions. Look - they are the world’s largest manufacturer of TRUCKS (not small little high mpg cars, TRUCKS). Their inventories run deep and NOT moving. Don't expect anything other than just emergency shoring up talk (selling off parts of the company, raising money, closing plants, and cutting jobs - or some combination). You will NOT see any forward guidance.

Yeah the stock LOOKS cheap - but don't get fooled by looks - it's all about value. At this juncture there is NO value (unless you are looking to sell that huge inventory of trucks for scrap metal - something you might think is funny - but there is REAL money in commodities and at the end of the day it might be worth it). The story is being treated like the last supper - and is putting negative pressure on the futures in the morning. Watch this story unfold from the sidelines. Traders come and play, investors stay away!

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J&J the BRIGHT SPOT

One company is shinning in this dark market – it’s J&J the stock is up in the pre-market (close to the 52 wk high) and looks strong on earnings. Even with it up here – there could be selling pressure as those with losing positions elsewhere may have to sell winners to raise money. Also – the news is out. However, we might see people rush to companies like J&J to reduce their market risk. J&J is a low volatile stock – pays a dividend – and pretty much is fairly ranged bound.

So far they are one of the few stocks that has not seen any stress from this market. Additionally – it will help keep the big cap indices from sliding to much (hopefully).

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Futures Pre-Market

The Futures were down with both Asia and Europe also down. While the market initially rallied yesterday on talks of a bailout of Freddie and Fannie – I think for the most part it was just a euphoric knee jerk reaction. When the PPI and Retail numbers came out – we got a pop (I really don’t know why) – but now they are starting to fade again. The spread has about 4-5 points in it so expect ARB traders (if the spread remains) to start buying futures into the opening and short the basket. That will put some negative pressure on the market at the opening.

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Support/Resistance

As I mention I was told that I shouldn’t even both with supports anymore – we are beyond that at this point. To some extent that is true – we are trying to find an area where both price consolidates and volume increases (to build that support). Additionally the broader Russell index has not broken down (like the INDU and SPX) – also the NDX – while very volatile is still above the March lows.

INDU 11,000 (Who knows at this point – GM news is going to be a drag on the market today. GM going from a big cap to small cap? Good news J&J looking good!)

NDX 1800 (We closed just below it and the futures are looking lower – but if we can get above it and start building support – well maybe we can take a breather)

SPX 1225 (That’s a guess – who knows at this point – we broke supports, just like the INDU.)

RUT 650 (This is the key to money flow – we are STILL above the March lows – and while volatile we haven’t broken down. Clearly market panic has NOT set in yet. This needs to hold to see any supports formed in the narrower based indices.)

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Conclusion

I guess we didn't get a follow through yesterday after the opening rally. If you didn't sell that rally at the opening - well - I guess you missed it. There is not really any support except for the RUT. That is what needs to hold 650, but I have little faith that we WILL hold and think that a drop is in the cards – maybe not this week – but I have a feeling it will come before this economic story is played out.

The market is really not down that much – and we have a lot more room to go down. I also have not seen panic enter the market – the VIX is still below 30 and we have not seen any of those days like back in the late 90s (the Asian Flu) when we had intra-day halts in the market because of the huge gap downs. That is what really concerns me – we have NOT had the REAL shake out or PANIC in the market. I think we really need that to find some bottom to this market. The daily slides and the volatility still spells a muddy bottom and we don’t know where that is.

What spells the ROCK BOTTOM? Well it’s a couple of things that NEED to happen (none has happened yet).

1. Dollar needs to see strength (being a FIAT currency we need the leaders to stop TALKING and START acting!). Foreign nations and large investment firms are losing faith in the Dollar (it IS a FIAT currency or faith backed currency). How do we build faith? Well currently if you buy a CD or BOND you are getting about 2% return, but inflation according to the CPI is exceeding 4% - that means you are LOSING money. Additionally the underlying asset (the dollar) is also losing value against the world currencies. The FED needs to RAISE rates – and NOT 25 bps – they need to be aggressive raising rates as they were cutting them. This would bring serious strength to the dollar and a race to treasuries. The strong dollar would also put pressure on oil and gas prices (since they are priced in the dollar). Sure some banks and lenders will complain – but the FED’s job is not to justify failing lending models at banks. Sorry – but they need to take a little accountability and responsibility. The FEDs job is to the economy and the citizens – not be the bailout man!

2. FORECLOSURE SLOW DOWN – when we see the foreclosures decrease that means we are getting close to the end of the housing bottom. There are a finite amount of homes so at some point you will see Foreclosures decrease. I am predicting (not being an expert by any means) that foreclosures will probably slow down late 2008 to early 2009. This will help create a bottom in the housing market.

3. WRITEDOWNS STOP – because banks are writing down illiquid positions to a value they THINK they should be – we will not KNOW a bottom until they just take 100% write-down on those positions. I think the first bank to say “We are taking a 100% write-down on ALL our illiquid positions that have defaulted!” then they can’t write-down any more. At that juncture ANY of that paper that generates a profit is just gravy – since they fully wrote down those losses. We at that point would all KNOW the bank has hit bottom. Of course we will not see that because banks are so over leveraged that they playing a balancing act.

I think those 3 things need to happen at some level before we see a bottom of this market. Oil prices will remain high – so I am not expecting the volatility in oil as a driver or the ability for the market to find a bottom. Companies will and can work through higher prices and so can consumers. What we need is to return VALUE and BUYING power to the dollar to curtail INFLATION. That will also put downward pressures on oil prices. We also need the foreclosures to work through the system – it will take a few more months – but a bottom is coming – the amount of foreclosures is finite not infinite. And eventually banks will write-down those losses to 100% - but the slower they do it the longer it will take.

So – I guess it’s about TIME – we just need these three things to work through the system before we can see a bottom. Any bottom picking at this point is silly. Time now for investors to HEDGE positions and wait out the storm. It will end and we can move on – just like we always do.

Brokers, Investors, Financial Advisors – I would recommend to look for hedging products, ETFs, commodities, etc. for the near-term (6-12 months). I would tell clients – we are in a storm and our job is to PROTECT principal and PROTECT against inflation until the storm passes. When the storm does pass (and it will) we will have a great opportunity to find value in this market when it does bottom (which it will.).