7/23/08 (McD's, Boeing, Oil, Resistance or Support?)

Traders,

An illusion? Yesterday we saw a big break-out through the resistance, especially the RUT – which we have been watching closely. The NDX had lagged – mainly on the AAPL slippage – but even AAPL gained back almost $12 points of its $16 point gap down. The big shocker was the financials – with WHACKovia reporting a massive write-down, AMEX with a profit loss, a few others reporting that the option ARMs will continue to create write-downs, and a trickle-over into an increase in credit card defaults. So why the rally? I spoke to a couple colleagues – all of them were pretty much in the same camp. Follow the money – first we are seeing treasuries come off (Yield going up) – so from the RUT we are seeing an inflow of money, OIL is coming off bringing back some confidence, and the limited ability to short the financials (including some forced buying in) has all but eliminated any downside pressure in that sector. What did have us all concerned? Nothing fundamentally has changed for the better. Banks are for-warning or more write-downs and more resets of mortgages, credit card defaults are on the rise, and credit lines are tightening. So maybe a combination of perception with the oil prices and the limited short ability in the financials has created a line in the sand and brought some bottom pickers into the market.

One of the issues we were talking about is that it has become HARDER to ascertain VALUE. Remember – it is VALUE that we are looking at, not price. We want to KNOW the fundamental stability that the companies can do well. However the increase in the government’s roll from being JUST regulators to market participators has created a FOG and therefore it has become HARDER to ascertain actual value. If Freddie Mac and Fanny Mae were ACTUALLY private – would they have survived? Most certainly they would not be allowed to go 100:1 on leverage. If it were not for the opening of the Discount Window – would Lehman and/or others be the next Bear Stearns. These are NOT to question what the government should or should NOT do (that is a different debate) – these questions are paramount in order to make a decisions whether I should be invested in these companies or short these companies. The deeper the government penetrates the market and creates rules to prop up stocks or companies the harder it becomes to make a valid investment decision. There are two great articles in the Economist this week about Fannie and Freddie – with a small blurb on the SEC Short decision. They can be found in the following links:

Fannie and Freddie http://www.economist.com/finance/displaystory.cfm?story_id=11751139
SEC protection http://www.economist.com/finance/displaystory.cfm?story_id=11751227

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McD’s the place for CHEAP FOOD

As food prices surge, jobless rates increase, and consumers are getting squeezed on money – they STILL need to eat. So where do you go for cheap and fast food? McDonald’s leads that list. I guess you could call McDonald’s an inflation fighting stock – just like we see traditional retail shoppers move down a rung from Macy’s to Target we will see more move down a rung from Red Lobster to McDonald’s. I guess the old argument about Substitution in the CPI is clearly making a case for choice over cost. You remember the argument “People can choose to eat hamburger when steak becomes too expensive!” – an with that we adopted substitution in the CPI. I would argue that statement makes the point that inflation is going up. Thus the CPI is not longer measuring inflation, but rather the choices we make because inflation IS affecting those choice. Maybe that is why the current CPI with those adjustments is running 50% lower than the pre-1990’s model. Hopefully people don’t choose to eat dog food because hamburger gets too expensive. Be that as it may, people are scaling back and moving down a rung because of the 1-2 punch (inflation and less money).

While we might all agree that McDonalds (like other fast food companies) might be a good inflation hedge – they are also getting some good traction overseas. McDonalds had always been a leader penetrating new markets – but with the BRIC (minus INDIA for obvious COW reasons) growing fast – people are moving to a faster life style – that also means faster food. Remember in the 70s when commuting and convince of Fast Food swept this country. It seemed in the 70s like every corner was getting a new Fast Food restaurant – in the 90s it was Starbucks. Well that same thing is starting to happen in these fast paced emerging markets. The population size of these growing cities are increasing fast. People need to eat on the fly and McDonalds is putting themselves in the sweet spot to capture those hungry bellies.

However there are three things dragging on McDonald’s growth that need to be monitored.

1. Gas prices are reducing the driving and less frequent stops at fast food, it also is bleeding into the cost of supplies as McDonald’s is a big shipper.

2. Commodity prices increase – so does their costs – McDonalds has already raised some prices – so far not hurting sales it would seem.

3. Bad Press – Japan already paced a law about waste size and will be fining companies if their employees waste exceed a certain size. Studies in Japan showed that over the last couple of decades the massive increase and introduction of American Fast food is starting to cause obesity in their country and now they are taking action.

See this video: http://www.cnn.com/video/#/video/health/2008/06/23/kyung.fat.busters.cnn

For now McDonald’s is a shining star in the bad economy – it stock is up in the pre-market.

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Boeing – things could get tough


Boeing has a long pipe-line to build – I think it’s 5 years of pre-inventory backlog. However – while some parts of the world are expanding – everyone is feeling the pinch of higher fuel costs. The US market has become a smaller and smaller client as the world market expands. The concern is that if future orders are cancelled – the US while a smaller client of the net – may cancel some contracts and that is a concern.

Boeing is also seeing a shift to the 737s – which are a cheaper and older design then some of their newer designs. I also read an interesting article as to the efficiency of the new airliners vs. ones designed 20 years ago. The surprising and concerning issue (which I know both Airbus and Boeing are paying attention too) is that while the electronic systems and style have increased and become more efficient the utilization of fuel has not increased as much. While cars from the 70s have gone from 10 mpg to 30 mpg on average – we didn’t see that kind of increase in the airline company. I guess no one thought that fuel prices would rocket this fast and that is putting some issues that need to be addressed. New orders are stuck between ordering older vs. new designs – but those newer designs are not showing significantly better fuel consumption that would warrant the cost difference with oil (jet fuel) prices this high. Back to the drawing board?

While their backlog is impressive – the fuel prices could create cancellations and deferred delivery. Which many analyst are indicating that long-term risks (volatility) remain high.

Good news – well the defense contracts have always helped and should continue to help the bottom line. Also the weak dollar (over 20% slump this year) has helped with competition against Airbus (their largest rival).

Right now it is all about the future of fuel prices that will determine if that impressive backlog of orders increases or decreases – long-term risk is high.

Boeing is getting hit in the premarket.

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OIL
We are seeing a good pull back in oil over the last few days down from the $140s to the high $120s. I would think that the 130 range was a good support area, followed by the 120 range. The storm in the gulf had initially looked like it was going to hit Texas and create some refinery issues – but that has sort of steered away – the risk is not over, but for now not eliminated either. The storm is getting stronger – but will it hit Texas? Who knows!

The drop in oil prices has also got the cheerleading if full swing on CNBC – everyone is happy now that it is going down – and that could translate to bullish perception in the equity market. It sure isn’t hurting.

But I think this drop – while necessary – doesn’t mean that we are heading back down into the 50 range any time soon. I also don’t think you CAN see oil crash! Why – because unlike stocks – it is a NEEDED economy. Airlines, Shipping, Cars, Energy Companies, etc – everyone still NEEDS it to function. At what point do one of the big sectors step in and prepurchase a ton of fuel to lock in prices. For now they have stepped aside and are letting if fall. The support will not be determined by investors or speculators – the real support will be when a sector or major company/s step in a say – we are purchasing tons at this level to lock in price as they are concerned about future capacity. What is that price? I don’t know – but I am betting it is above $100 for sure – possibly $120.

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Futures Pre-Market

We are getting some upside movement on the futures from a fall in oil and also seeing McDonald’s showing there is recession stock plays. They are giving up a little going into the opening – but still above fair value. The spreads as of 9am ET are narrowing – but if they remain we could see an upside gap.

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Support / Resistance

It’s not about being right or wrong about direction – it’s about having the Gamma to off-set the deltas when you ARE wrong. I seriously believed those resistances at 11,500 and 700 were going to hold, but as we can see the market is more foggy with the impact of oil prices and government intervention. The RIP in the RUT was surprising – it lead all the indices with almost a 3% run. That clearly shows money flow coming in – probably from commodities and treasuries coming off.

INDU 11500 / 12000 (We broke through that 11500 resistance, which has now become support. We could get a good follow through run up to the 12k area. That would be nice for the long delta holders. Keep an eye on the 11500 area – we could retest it – the question – is IT REAL support? – make sure your gamma is protecting those HARD DELTA positions. Don’t be Long or Short hard deltas in this market without protection. Expect surprises and to be wrong – it is GAMMA that saves your butt!)

NDX 1800 / 1850-1900 (AAPL pulled hard on this index but it got back up to break-even on the close. To give you an example of AAPL’s POWER – when Apple was down $16 points at the opening that was about $21 points in the index. When it rallied back $12 points to close down about $4, that rally was about $16 points of the NDX rally. As you can see one overweight can seriously move these indices. That is why the S&P and RUT are better indicators of the wider market then the INDU or NDX).

SPX 1250 / 1300 (1250 was the pivot point – we got a good rally up and 1300 could be in the cards – a place to unload long deltas and get short – perhaps.)

RUT 700 / 725-750 (WOW – all I can say is WOW. It never got to 650 – March’s lows. Which was a clear indication that the market did NOT panic. We then got a massive rally through that 700 level yesterday turning it into a support. 725 will be the next stalling area. Right now we are in unknown land – a retracement to 700 or a move up to 725 is 50/50.)

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Conclusion

This market has not seen a panic sell off, which is good and bad. The government intervention has kept the stock market from collapsing – the longs would argue that is a good thing – it is from that respect only. However, as I pointed out we can NOT find value when we are unable to know if these companies are solvent or not. The market has not been allowed to work properly and that is not a good thing – regardless of market direction.

The economic landscape has not changed – we have not seen a bottom, we don’t know where the bottom is. Thus this rally is suspect at best. Get long and ride the train – but be damn sure you are hedged – because we have seen what intraday volatility looks like up $300 points can come just as easily as down $300 points. This is a traders market – not an investors market. Be forewarned!