Government Plan Spikes Market

SUMMARY:
- Government plan spikes market on short covering at open, hangs on to hold most of the gains on the close.
- Oil quietly surges under cover of the financial meltdown and attempted rescue.
- The plan needs work: ban on short selling distorts option spreads and pricing. Just what else did they not think of?
- World was on the brink of a global financial meltdown and depression. The Treasury plan has bought us some time to resolve our issues.
- What to do now? Market's stagnation after the initial Friday surge shows investors are waiting for the next step.

Treasury fix clears out the shorts, finishes the market flat for the week, but for now that is all.

The ban on shorting 799 financial stocks had its intended effect: it gapped the market back up as shorts cleared out and then left the market unmolested, albeit downright stagnant, for the rest of the session. Oh, it also likely put some hedge funds out of business and it made the options market after the first few minutes of action virtually untradeable for the session. Those were unnecessary and unpleasant side effects of the bigger plan by the Treasury of cutting out the diseased part of the US economy, isolating it, and giving the financial institutions time to recover.

As for the market, it surged financials for the second session (Thursday afternoon rumors of a fix were even more powerful) along with most other stocks. After that initial surge of short covering, however, the market stalled and could go nowhere. There were no shorts to take it down, buyers were uncertain as to what to buy and how much given the details of the plan are still vague. Moreover the options market was a shambles because the ban on short selling failed to exempt market makers and thus spreads that were 30 cents Thursday were now over $3 because the market makers had to hedge themselves some way. For example, typically a market maker will sell a put to a buyer and then short the stock as a hedge; if the stock falls the market maker is covered because of the short. Without this mechanism available the market makers had to widen the spread as the hedge, basically stopping the options market. We were able to sell some financial stock options early on the short covering rally, but once that was over and shorts wanted to buy some puts on some non-annointed stocks, the spreads looked more like the Grand Canyon than a typical bid and ask on a put option.

All of this combined to slow the post-morning short covering spree action to a crawl. The indices traded in a range for the rest of the session, holding nice gains, but off the highs and unable to move significantly.

Everyone was so worried about financials and how the market would react not much attention was paid to oil. It continued its rally over $100, closing at __________ After the dump lower it has found purchase as something of a hedge against wild financial times and it is also benefitting from a weaker dollar that is down in the aftermath of all of the action to shore up the financial markets. One problem gets the attention and starts to come under control, but another one squeezes out elsewhere. This will definitely be something to watch this week as the details of the financial fixes unfold.

TECHNICAL. You can say the intraday action didn't mean much Friday given the short squeeze induced by the 'no shorts' rule and the glee over the proposed Treasury fix, but you would only be part right. It was very telling how the market gapped open and raced higher only to exhaust itself and collapse back down once the short covering binge at the open subsided. It wandered the rest of the session, unable to really challenge the morning highs. Once the shorts were done there was no driver.

INTERNALS. Upside breadth was impressive with a 7:1 showing on NYSE and a solid 3.5:1 on NASDAQ. Volume surged once more, aided by short covering, expiration, and a lot of initial positioning on the announcement of the Treasury plan. New lows dried up to the 100 range. It was a week of massively negative internals that set the stage for a reversal in the market, and indeed one was trying to take shape on Thursday as these internals were joined by a VIX over 40. The Treasury plan, however, jumpstarted the initial bottoming phase that was setting up given the very negative internal readings.

CHARTS. There was a meeting place for all of the large cap indices on Friday. It is as if they huddled before the open: okay boys, we are going to get a big gap higher today. It is going to be crazy and we might get separated. If we do, meet up at the 50 day EMA. Well, they did gap higher and on the session they all made it to the 50 day EMA and pretty much closed right below that level as they culminated a massive 1.5 day rally that left them flat to up after an extraordinary tail kicking basically since Septembers beginning. The gains moved them up to the bottom of the August trading range. At this point, everything is recovery, but there will be a setback or two along the way as the plan is worked out, and if history holds out (though this is not necessarily ordinary history here) there would be another test.

LEADERSHIP. The same old leadership held the line quite well with the early cycle retail and consumer products avoiding a lot of the selling and minding their own business as the market surged higher. They are steady in their work on their bases. Energy is moving and trying to form up decent patterns now that oil is on a new upswing. Some of the agriculture and chemical stocks are trying to set up again after getting pounded lower in the hedge fund de-leveraging. In short, leadership mostly held the line during the selling and improved a bit during the Thursday afternoon and Friday rally, but it was not a sweep higher. In a way that is good as they stepped aside while the shorts covered. How they respond this week, however, will tell a lot more about the market's posture post-Treasury takeover.


THE ECONOMY

Close, too close, to total meltdown. Now we have bought some time and we need to use it.

After reviewing the available data and talking with people who are involved daily with credit default swaps, corporate bonds offerings, and commercial paper, I realize that Thursday the world financial markets were a day or two if not just hours from a total meltdown.

The signs of a complete freeze up were everywhere that day. No one with dollar-based assets could move them or get credit. That is why the Fed's injection of almost $400B in liquidity was snapped up at absurd interest rates (8% in the UK, 10% in Australia) in just seconds from the auction starting. Credit default swaps tying up trillions of dollars in ETF's and other investments saw insurance rates soar outrageously in short order. A policy covering $10M in CDS' went from $14K to $433K as the market realized such insurance was now perilous, threatening to send a cascade of defaults across the globe. Of the $180B the Fed injected into the US Wednesday night, nary a nickel made it to the credit market as all of it went to money market funds to shore them up and prevent runs on them. That last point more than anything is what we are told rattled Treasury and the Fed. I received a voicemail from a banker dealing with the CDS market telling me to go to my banks, withdraw cash, stuff it into a safe deposit box, and hope it would be worth something next week. I am told from a source that within 3 minutes of the meeting with congressional leaders, Paulson and Bernanke turned those leaders white with the picture they painted of the next week in the world finance markets.

All of this adds up to tap dancing on the edge of global financial perdition. The world needed not a lifeline but a destroyer steaming into the fray. I cannot decide if we are fortunate or not having Paulson as the Treasury secretary. Anyone of lesser stature might not have been able to suck it up and do what he did. On the other hand, perhaps we don't need such a massive bailout to solve the problem. In any event, when Paulson, a former Goldman Sachs honcho, saw the financial virus crawling across Wall Street toward his beloved GS, he acted, not with the Bernanke bazooka, but with nuclear weapons. It is a complete and absolute approach to the problem designed to eliminate any doubt that the feds are serious in their gambit to stop the meltdown in its tracks.

The deal is not done and there will be a lot of public posturing over the final format of the fix. One thing I am telling everyone is that you need to call your US senators and House reps and demand that if there is any surplus as there very well may be in a couple of years when this mortgage issue subsides, it needs to be spelled out in the plan that the surplus will be returned to the taxpayers that underwrote this deal. After all, all of us who pay taxes are the ones funding this gambit, and any gains should be paid to those who took the risk, and that is NOT the federal government. It will want all proceeds to spend as it pleases. No. this is our money. Call your senators and reps.

Will it work? It bought us time. It stopped the assault on our financial institutions allowed by lax enforcement of the existing rules. During this timeout there will be ups and downs in the market based on the perceived progress of the negotiations. It will be a bumpy road. If it is implemented, however, there is likely a backstop to the financial markets, giving entities time to clear their balance sheets and make what deals they need to make in order to survive. Basically this is a timeout in which Paulson is telling the financial institutions it is now or never to get things in order. Again, you wonder if Snow or his predecessor could have pulled this off. I doubt it. Now Congress needs to get the deed done so we can try to get onto the healing process.


THE MARKET

MARKET SENTIMENT

The fear manifested itself differently this time around. Yes VIX finally cracked 40, hitting 42.6 on Thursday during the height of the global financial crisis. Yet, it was a crisis that was hard to put a finger on for most basically because of the complex nature of the calamity and the fact that the impact would hit the average Joe late in the process. The fact that runs on money market funds were occurring Thursday, however, shoes that the average Joe was starting to feel the pressure. That is how close we were.

The inability to move dollar-based assets, the lack of credit, the explosion in costs associated with financial transactions, the fear in those close to the action, those telling others to put cash under the mattress it was not an 'its different this time' moment but a 'its all over moment.' But for the Treasury RTC-like plan VIX would have likely hit 60 or higher on Friday as the meltdown progressed and came more into focus in the public arena. That would have been bottom material for sure; or the entryway to hell. As it is, the feds stepped in and tried to put in their own bottom. This likely only moved up the bottom that was in progress given the spike in the VIX. The 'natural' bottom would take a few weeks after this VIX spike to complete. Still probably will; this is the first leg in the process and it likely has to work through a bottom just as most times.

VIX: 32.07; -1.03
VXN: 34.26; +1.44
VXO: 33.55; -2.51

Put/Call Ratio (CBOE): 0.82; -0.36. Below 1.0 on the close for the first time in 9 sessions. Did its job.


Bulls versus Bears:

For the second time this year bears are crossing above bulls, doing so basically where they did in March on their way to much more extreme readings just about the time the market made the March low and started the last rally. Positive for the market and if SP500 is going to hold the long term trendline is the place to do it.

This is a reading of the number of bullish investment advisors versus bearish advisors. The reason you look at this is that it gives you an idea of how bullish investors are. If they are too bullish then everyone is in the market and it is heading for a top: if everyone wants to be in the market then all the money is in and there is no more new cash to drive it higher. On the other side of the spectrum if there are a lot of bears then there is a lot of cash on the sideline, and as the market rallies it drags that cash in as the bears give in. That cash provides the market the fuel to move higher. If bears are low it is the same as a lot of bulls: everyone is in and the market doesn't have the cash to drive it higher.

Bulls: 37.9%. Down from 38.2% though not as much as you would have anticipated givn the volatility. Down from 40.7% on the high during the rally off the July lows. Turned back up before it got down to 35%, below which is considered bullish for the market as the number of upbeat investors is relatively low. A long way up from the 27.8% on the low this round. Hit 31.9% two months back and the 30.9% low hit in March. Steep drop from a rebound high at close to 50% on the run through May. In March the indicator did its job with the dive below 35% and the crossover with the bears. Now it is going above and beyond. Bulls and bears have crossed over again, doing so even before the prior lows are hit. The bulls and bears were eye to eye in mid-February and have crossed. A move into the lower 40's is a decline of significance. A move to 35% is a bullish indicator. This is smashing that. For reference it bottomed in the summer 2006, the last major round of selling ahead of this 2007 top, near 36%, and 35% is considered bullish.

Bears: 43.7%. On the rise as bulls fall, what you want to see for a bottom. Up from 41.6% last week. If the bulls turn over and crap out below 35% again that would be a strong signal. Interestingly they are still 'crossed over,' i.e. more bears than bulls. Moving toward 50.0%, the high on this move, but a long way off. As the NYSE indices test the lows you would want it higher. Still above the 35% threshold so still a bullish indication. A steady rise to 50% on this move: 48.9%, 47.3%, 44.7% and 39.3% before that. Well above the bullish level and the highest since 1995. Again, that is one of the best indications that sentiment is getting extreme on the negative side. It is again past 35%, the level that historically indicates too much pessimism. As with the bulls the jump in bears did its job after hitting 44.7% in the third week of March that was up from an already freakishly strong 43.3% the week before. Up sharply from a low of 19.6% on the last rally. Bearishness peaked at 37.4% in September 2007. It topped the June 2006 peak (36%) on that run. That June peak eclipsed the March 2006 high (33%) and well above the 2005 highs that spawned new rallies (30% in May 2005, 29.2% in October 2005). This is a huge turn, unlike any seen in recent history.


NASDAQ

Stats: +74.8 points (+3.4%) to close at 2273.9
Volume: 3.965B (+1.31%)

Up Volume: 3.133B (-363.491M)
Down Volume: 810.161M (+403.901M)

A/D and Hi/Lo: Advancers led 3.48 to 1
Previous Session: Advancers led 2.82 to 1

New Highs: 231 (+134)
New Lows: 152 (-244)

NASDAQ CHART: http://investmenthouse.com/ihmedia/NASDAQ.jpeg

Finished the week with a gain with two huge upside sessions. Gapped to the 50 day EMA (2312) on the high and then faded. Still a very volatile pattern with a new reaction low for 2008 it now will likely need to test over the next several weeks as the plan is hammered out and implemented.

NASDAQ 100 CHART: http://investmenthouse.com/ihmedia/NASDAQ100.jpeg

SOX CHART: http://investmenthouse.com/ihmedia/SOX.jpeg


SP500/NYSE

Stats: +48.57 points (+4.03%) to close at 1255.08
NYSE Volume: 2.955B (+21.6%). Big volume powered by a lot of covering in the financial sector.

Up Volume: 252.632M (-1.909B)
Down Volume: 418.797M (+157.516M)

A/D and Hi/Lo: Advancers led 7.35 to 1
Previous Session: Advancers led 3.01 to 1

New Highs: 211 (+139)
New Lows: 128 (-913)

SP500 CHART: http://investmenthouse.com/ihmedia/SP500.jpeg

Impressive recovery to the 50 day EMA over Thursday and Friday, but there was that new 2008 low that is way down 1133, and even with the government's attempt at putting in a bottom for the market, it will likely be tested over the course of the next several weeks as concern over the plan and even if it gets passed will swing emotions and thus SP500 all over the place. For now it looks to have made the low for the cycle.

SP600 (+3.39%). Put in a massive reversal and moved up to the June high on the Friday intraday peak (401). Amazing move, but then SP600 is an early economic cycle index that was in the lead before last week's meltdown, holding up very well until that selling. It is now sitting pretty right now even with another test likely to fill that gap as the other indices test their new 2008 lows.

SP600 Chart: http://investmenthouse.com/ihmedia/SP600.jpeg

SP400 CHART: http://investmenthouse.com/ihmedia/SP400.jpeg


DJ30

Finished basically flat on the week thanks to the recovery that took it back up to the 50 day EMA on the Friday high. A new reaction low for the selling cycle, and that will likely need testing before it is ready for a sustained move higher. Nonetheless the pattern has the classic look of a double bottom as it undercut the prior low but reversed it in one day. Thus DJ30 may not need to make that next test.

Stats: +368.75 points (+3.35%) to close at 11388.44
VOLUME: 655M shares Friday versus 488M shares Thursday. Some big short covering volume and expiration as well pumped up the trade.

DJ30 CHART: http://www.investmenthouse.com/ihmedia/DJ30.jpeg


MONDAY

We will have to see what transpires this weekend with respect to the bailout plan. We can expect speech making and posturing despite the call for a nonpartisan approach. It is, after all, an election year. Sooner than later, however, a plan will be adopted because those present Thursday night looked into the pit and blanched.

Even with a plan in place there will still be ups and downs in the market. Just because the Feds step in with the nukes that is not a guarantee and there will be things to iron out as well as doubt creeping in here and there as things progress. Thus we get the up and down action and likely a test on SP500 of those lows before this is over.

What we are going to do is continue looking at strong stocks that held up well during the selling and that remain in solid shape to move higher. We are also looking at solid stocks that sold off ahead of the market dive such as some of the ag and energy stocks. We will watch many and see which show the moves that indicate the big money is moving their way and follow the money. We are not going in 100% on each position, just moving in with partial positions, e.g. a third or half when we get a good entry point; there will likely be plenty of volatility still as the market tries to make the bottom over the Thursday low so we need to move in a bit at a time as we look for a follow through to the Thursday reversal session starting Tuesday. Even if we get it we will still move carefully as there will still likely be that test to set up the market base and more individual stock bases.


Support and Resistance

NASDAQ: Closed at 2273.90
Resistance:
2286 is the first April 2008 gap up point.
2300 is some resistance.
The 50 day EMA at 2312
2340 from the March 2007 low
The 90 day SMA at 2362
2370 is the trendline from the summer 2004/July 2006 lows, Q4 2005 consolidation
2370 from the April 2006 peak
2378 is the mid-February peak; 2379 from the October 2006 peak
2386 is the August 2007 intraday low
The 200 day SMA at 2387
2388 is the June 2008 low
2392 is the April 2008 peak
2419 is the January 2008 peak and the early February peak

Support:
2261 is a March 2008 interim low
The 10 day EMA is 2229
2202 is the January 2008 low
2167 is the July 2008 low
2155 is the March 2008 low
2043-47 from the July 2006 low and October 2005 low
2020 from January and April 2005
1912 from April 2005

S&P 500: Closed at 1255.08
Resistance:
1257 is the March low
The 50 day EMA at 1265
1270 is the January low
1285 is the recent July peak
The 90 day SMA at 1298
1313.15 is the August 2008 peak
1317 from the February low
1324 is the April low
1331 is the June low
The 200 day SMA at 1344
1360 is an ancient trendline

Support:
1244 is an August 2005 peak
1237 is the 2002/2003 up trendline
The 10 day EMA at 1226
1215 is the July 2008 closing low
1200 is the July 2008 intraday low
1176 from the Q4 2005 lows
1167 is the January 2005 low
1154 from the May 2005 lows
1142 is the 2005 closing low
1065 is the Q4 2003 level that SP500 started the run to 2007 after the first run in the recovery.

Dow: Closed at 11,388.44
Resistance:
11,388 is the prior August low
The 50 day EMA at 11,444
11,670 is the May 2006 intraday high; 11,642 closing
11,6700 is the 2004/2005 up trendline
11,700 is the January intraday low
The 90 day SMA at 11,718
11,731 is the March 2008 low
11,867 is the August 2008 peak
12,050 from the March 2007
12,070 from the early February 2008 lows
12,250 from late March 2007 lows
The 200 day SMA at 12,232

Support:
11,317 from March 2006
11,061 from February 2006
10,962 is the July closing low
10,827 is the July 2008 intraday low
10,215 from Q4 2005
10,100 t0 10,000

Economic Calendar

These are consensus expectations. Our expectations will vary and are discussed in the 'Economy' section.

September 24 - Wednesday
Existing home sales, August (10:00): 4.93M expected, 5.00M prior
Crude oil inventories (10:35)

September 25 - Thursday
Durable Goods Orders, August (8:30): -1.3% expected, 1.3% prior
Initial jobless claims (8:30): 455K prior
New Home sales, August (10:00): 518K expected, 515K prior

September 26 - Friday
Q2 GDP final (8:30): 3.4% expected, 3.3% prior
Michigan Sentiment, September revised (10:00): 73.1 prior

By: Jon Johnson, Editor
Copyright 2008 | All Rights Reserved

Jon Johnson is the Editor of The Daily at InvestmentHouse.com

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