1/7/09 (Buttonwood Rally? Alcoa! GM's Thanks!)

Traders,

Interesting day still flirting around yesterday with the levels in the indices. The action seems to be in a holding pattern – as if to wait for the inauguration (if I had to guess). The volatility is certainly getting squeezed – which leads me back to my assumption that hidden volatility is building – meaning that we should see an expansion in volatility in a very short time (possibly before Obama’s big day).

___________________________________________
Buttonwood – Insight?

If you ever pickup the Economist (magazine) or visit their website (note – one of the few magazines I read regularly) – they have a section in business/finance section called Buttonwood. After reading it last night – I thought it reflected an interesting view – something I am keen to believe. The market moves on perception, rather than fundamentals. Hence the need to measure PE ratio (price to earnings), which helps investors determine if the company is over or under value – or if the growth can catch up with ratio to bring it into the norm. It would stand to reason – that it is simply perception that drives price. That being said the Buttonwood section this week had an interesting observation – which I thought I would share.

Here are a few quotes from the article that I found interesting:

“Markets have a terrible tendency to inflict maximum pain on the maximum number
of investors. For example, if the consensus is bearish on the dollar, investors
will be positioned for a decline in the American currency. If the greenback then
rises, investors are forced to buy the dollar, pushing the currency up even
further.”

“Morgan Stanley, for example, is forecasting a fall of 30% in capital
expenditure between now and mid-2010. If Mr. Bowers is right, low
government-bond yields could lose their appeal and equities could rebound.
Income-seeking investors seem unlikely to get much of a return from cash this
year.”

And this one sums it up:

“An equity rally could occur even if the global economy is in for a prolonged
period of weakness. Two of the best years for Wall Street in the 20th century
were 1933 and 1935, despite the severity of the Depression. The value of the
London stockmarket more than doubled in 1975, in the midst of a stagflationary
crisis and the year before Britain had to ask the IMF for an emergency loan.”

For the full article see: http://www.economist.com/finance/displaystory.cfm?story_id=12856381

__________________________________________________
Commodities – a current slowdown or speed bump?

Alcoa and Rio Tinto – both the big muscle in the commodities (metal) sector are seeing a pinch as demand curtails. Alcoa stock pulled off as another report in production cut (cutting the work force by 13k and production by 135k). According to Bloomberg that total recent output cut is to 750k (or 18% of smelting capacity). It certainly reflects a slowdown in aluminum consumption (in planes, autos, appliances, and other durable goods). Aluminum prices have fallen by 36%.
Rio is also seeing demand drop in from their mining supply, same with Billiton.

However, while supplies increase and demand falters – the consumption remains. The formula that Rio, Alcoa, and others are trying to figure out is three algorithms.

1. The consumption rate of current supply (to dwindle inventories) = fairly simple math
2. The future increase of demand = more complicated forecasting
3. Regardless of supply and demand, the currency (and exchange rate) buying power = more soothsaying

Anyone of these – with any degree of accuracy, will help them weather the slowdown and even being to adjust costs to keep margins in check. The dollar is no doubt going to play an important role in all companies ability to project P&L. Which may have traditionally been overlooked (as volatility on that side of the equation as been fairly low – until now).

______________________________________________________
GM more hot air?

GM reports they don’t need ANY MORE government money (as if the $13 billion is enough). However – those type of statements all depend. Pretty much they don’t have the balls to say thank you to the American people (or government) and thus this is about as close as you are going to see to a “thank you”.

GM stated its worst case scenario (from Bloomberg): GM said Dec. 2 that its worst-case scenario for 2009 U.S. auto sales is 10.5 million vehicles. On Jan. 5, the Detroit- based automaker reiterated that domestic sales will range from 10.5 million to 12 million this year, based on the current economic expectation.

Let me emphasis: “based on the current economic expectation.” – clearly they didn’t expect 2007 or 2008. What makes anyone think that these forecast are going to be any more accurate. They, unlike other auto companies should have had keener insight – via GMAC and the default risk coupled with lending standards – if that wasn’t a warning sign – I don’t know what is.

Additionally – Toyota reported they have seen huge short-falls in demands (as early as last week) – lower than even their worst case scenario.

Certainly, GM nor GMAC has changed their business plan – but rather have their handout and believe that “cuts” are the answer to a failed model. Congress has the rights to recall the loan should GM not show progress in a final report due March 31st. But come one – even if they completely fail do you REALLY think Congress (who is giving them the bailout money – with very weak strings attached) will call in the loan. And even if they did – GM would have already spent the money. There certainly would not be ANY money paid back in that scenario.

Of course GM rallied yesterday and is pushing the $4 price from their recent lows. And thus I will refer to the article from Buttonwood – it’s not necessarily about the health of the business (or economy) but rather perception. If GM is able to state quotes that brings comfort (despite possible failure) – the more the fools will rush in. Hedge your bets – but don’t be surprised to see rallies in spite of fundamental weakness.

______________________________________________________
Futures Pre-market

We are seeing some weakness across the board and the spread is in. Expect ARB traders to buy futures into the opening and short the basket if the spreads remain this wide compared to FV. That means some sell pressure at the opening.

_______________________________________________________
Support / Resistance

We have seen a little movement – but has anything changed?

INDU 8500 / 9000 (Flirting with at this level – is it support or resistance – I am still chalking it up to support, it hasn’t proven to me (anyway) that it is anything more than hope, rather than fundamentals that have pushed us here. Again – it’s perception – so I could always be wrong.)

NDX 1200 (1250) 1300 (We are getting a little push to 1300, could we touch it – sure, futures are looking weak at the opening – but watch the close.)

SPX 900 / 950 (Not there yet.)

RUT 450 / 500 (Yeah – above the 500 line – I still am not buying it on a fundamental basis, but the perception is telling us otherwise.)

_____________________________________________________
Conclusion

There is hidden volatility charging into the market right now – waiting to be woken up. Either a rally on Obama hope or a suck-out as things heat up in Russia or the Middle East. We could also have something out of left field – but I doubt it. It’s really perception vs. fundamentals right now – with perception trying to drive higher and fundamentals bringing us back to reality. Who wins is determined by who has the money – I think the Buttonwood article is very interesting in that respect. Shocking to see that two of the biggest gains were amid the Great Depression – but what do I know. Perception rules, obviously.