Sunday, October 26, 2008

LIBOR Re-Freezes For Second Session

- Global gloom threatens a real selloff, but when the bell rang it was just another down day in the bear market.
- LIBOR re-freezes for second session.
- A watched bottom never forms.
- Sellers appear out of ammo, unable to finish off the prior lows, indicating market is still working on the first bottom, not the second.
- US path set to follow the same policies that led to the prolonged 1970's malaise.
- If market doesn't break the lows Monday, looking for a bounce to precede another bottom finding attempt.

The gloom was there but not the capitulation selloff.

It looked as if salvation was at hand. The world markets were crushed, down 9% and more. US futures were locked limit down from the wee hours of the morning. The bad news abounded. For a second day the credit thaw suffered an unseasonal frost and failed to decline (LIBOR 3 month was 3.52%; 3.53% Thursday). The UK reported its first negative GDP quarter in 16 years. Not quite keeping the British end up. GE was borrowing from the Fed's commercial paper window. AIG was borrowing too much from the Fed's bailout window ($90.3B versus the $85B originally planned). OPEC cut its production by 1.5M bbl/day. Plenty of negatives and an extremely negative air. Many veterans and newcomers alike were certain judgment day had come, i.e. the big blowout to the downside to clean out the pipes.

Then the opening bell rang, and as expected the market opened lower. We were looking at the DIA pre-market given the futures were locked & no one knew where they were trading. DIA indicated an open near 8050, almost 700 points lower but still well over the October intraday low. The open was not that bad. DJ30 hit 8187 in the first few minutes, down around 500 points for an instant.

That was it for the morning. We posited the market may sell after the initial bounce or even in the last part of the afternoon. A look at the early volume showed it was nowhere near the heavy levels that would take the market down and indicate a real burn off to the downside. It looked as if any real selloff would have to come late in the session. We took some of the SPY and DIA downside gain. Stocks continued to the upside, weakened after lunch, but then rebounded toward the bell. The indices closed near session highs, and though still sporting 3% losses, volume was lighter after no real test of the low on DJ30. Friday was not judgment day, just another down day in the bear market.

TECHNICAL. Low to high action on the indices and the in general means more bullish action, but frankly it varies with the wind of the market each session. Some days the bulls are in charge the next the bears. There was a streak there where the bullish action was winning out, i.e. the market was rising even when the market was noncommittal, but that has given up to the return of the back and forth action. The fact that the NYSE large caps have held their prior lows, however, suggests there is a bit of upside overhang still present.

INTERNALS. Once more the internals climbed. You would expect them to with 3% moves on the indices. Breadth was in the -4:1 range. New lows topped 1100 on NYSE, 840 on NASDAQ. Volume was still above average, but it did back down. Thus even if the selling had been deeper the volume was not really there to clean out the plumbing.

CHARTS. No new lows for the year by DJ30 and SP500 but NASDAQ did make its second straight 2008 low and its third straight closing low. While DJ30 and SP500 did not move below the early October intraday lows they did close below the bottom of their two-week range, joining the other indices in that dubious position. They are still holding above the intraday lows so the chance for a bottom of some sort here is still alive, but the solid floor that was forming has cracked. Precarious, but as discussed below there are reasons to believe a bounce is going to emerge from this particular action.

LEADERSHIP. Leadership bases remain a rare commodity. Right now most of what you can find with respect to strength is stocks holding their 2 week lateral consolidations. Steel and energy stocks held tough through the session and through the week. Quality stocks such as AAPL held up just fine as well. Does that mean they are ready to bottom here? As with the indices they could definitely bounce out of these lateral consolidations, but this is not likely their ultimate bottom as discussed below.

Investors outsmart themselves by waiting on the bottom to form.

I said Thursday that the market cannot form a bottom when everyone expects one. Everyone, us included, watches the action each day and sizes up if there is a bottom and what it will take for a bottom to form. After all sentiment indicators are at very extreme levels, internals hit very extreme levels, and the losses are steep enough to conclude a bottom is at hand.

On the other hand, while the losses are definitely deep enough compared to past bear markets, is this selling deep enough to account for the truly historic problems confronting the entire world with respect to the mortgage and subsequent credit collapses? The largest bailout in the history of the world is underway. While the market started selling a year ago, the selling did not really explode until the past two months when the market logged the lion's share of the losses. If the bailouts don't work the losses could be another 2500 points on the Dow. That will also extend the length of the bear market. If the bailouts do work the market bleeding will stop, but that does not mean the recovery will be quicker.

More to the point, as noted above, with everyone looking for a capitulation bottom on a daily basis there is no 'throw in the towel' mentality. They are hanging on, waiting for the bottom, and without the cathartic selloff or slow motion grind out where even the pros say 'forget it,' then the bottom does not come. The market is not to the point yet where the pros and even a lot of retail players are at the 'fer get it' stage (from 'Urban Cowboy'), and thus the pain lingers.

What will it take to get there? Another rise and then another fall.

All of the pieces looked to be in place Friday for a cathartic bottom, but the market could not follow through on the negatives and take out the prior lows. There just were not enough sellers left to drive the knife home. The NYSE large cap indices once again tested lower but easily held and reversed above the 2008 intraday lows. The sellers tried but they simply didn't have the strength.

That action suggests a bottom is indeed here, but it is not THE bottom. If the bailout plans are indeed going to work, this current action is likely the 2008 equivalent of the 'July' leg of the 2002 bottom, i.e., the first bottom in that double bottom process. It takes a bounce and then a second bottom, the equivalent of the 'October' leg of that 2002 double bottom, to complete the process.

Recall that volatility spikes on the first leg of a major bottom. It fades as the market rebounds from that initial pummeling, preferably a bounce that lasts 4 to 6 weeks to the peak before it starts to turn down again. Then the market starts to fall and volatility starts to climb again. It may or may not hit the prior highs; usually doesn't. On that second leg down, however, the fear rises sharply even if VIX doesn't match the prior highs. Veterans start to question if the market can hold this time as that leg is usually pretty ugly and violent to the downside. When they panic and cough up their shares, THAT is the bottom.

That is how it happened in 2002 when we heard that even the pros on the floor of the NYSE were saying that the old tried and true market indicators just were not working anymore. We saw EBAY, TSCO, AMZN and others finishing up good bases that were not ready by any stretch at the July lows, the first leg down. With good stocks in good bases and the pros throwing in the towel we knew the bottom was in.

The failure to capitulate this week and particularly Friday is thus in keeping with historical bottoms. There are hardly any great stocks in good bases ready to move upside just as there were not any in July 2002. There was still work to do with a rebound and them some more selling to get those bases set up. There are still investors that need to get shaken out of the market when they give up on trying to wait out the bottom. October is a month many look for the market to bottom. That is keeping this market from actually making a bottom. They are looking for THE bottom in October, but it is very likely not going to occur in October this year. An interim bottom could very well start to the upside this coming week, but in all likelihood it won't be THE bottom unless there is a big shakeout to the downside Monday or Tuesday in the nature of 1000 points or so on DJ30. That would likely result in a big massive turn, but it would STILL be better to have that blood curdling, screaming, hair on fire drop to come on the second leg lower to really set the true bottom in cement.


Ignoring history and taking the low road to economic mediocrity.

Now all of this talk of the bottom may be moot if the economy heads into a 1970's-like malaise, the worst economic times since the Great Depression. Not necessarily the worst times for the market in terms of absolute losses, but it was a long, 4 year period of nothing after the surge off the bear market low. The economic times were bad, however, and if we follow that path now that means a lot more economic slowing, a longer, drawn out decline, and thus lower earnings and lower stock prices.

Back in the 1970's the US was pretty much a joke for the rest of the world. Our economic malaise left others talking about the 'failed experiment' of a capitalist economy. The irony is, it was not a failure of capitalism but the incessant tinkering with it by injecting big government controls that led to the near demise of our system. Interest rates hit over 20%, inflation ran almost 10%, unemployment topped 11%. New York almost went broke. It was a nation of stagnation.

The parallels of the 1970's problems and those of today and what is planned are frighteningly similar. The 1970's saw oil spike in price with the oil embargos. The Fed flooded the economy with liquidity, fearing a shutdown due to the high prices. The economy shut down anyway due to the high prices and the massive increase in regulation brought about as a result of the social programs of the 1960's and the new initiatives for cleaning up the environment, conserving energy, education, etc. It simply became too costly to do business compared to the rest of the world. That is when the demise of the US auto industry started as they made cheap, throw away cars compared to their foreign competition because the regulatory costs here were so high. Same with the steel industry, electronics, energy (Windfall Profits Tax)- - just about every industry fell behind the world trying to cope with the new regulations and with the cost of new social programs. The cost was not only to industry but for the taxpayer as well as the programs of the 1960's and 1930's were massively expanded as taxes were raised in the hope of capturing more tax revenue.

The Fed didn't flood the economy with liquidity with respect to the oil price surge; it wanted to avoid doing that. Problem is, it has had to flood the economy with liquidity for other reasons, the most recent the mortgage and credit crisis. There is a backlash against deregulation and a push for massive new regulation in housing, banks (the US is actually taking them over) and, business (Rep Frank and Senator Biden are talking of limiting CEO compensation). Increased income taxes, despite the promises of both candidates, are going to happen (Rep Rangel wants a 45% top bracket rate; Frank is talking about taxing 401k's), and increased taxes on capital (capital gains tax is going to increase).

What happens when you employ these changes? If there is a shift to tax the wealthier as well as businesses including the small business category (10 to 500 employees where 100% of the private sector jobs came from in 2004) so that the revenue can be given to or spent on programs benefitting those not paying federal tax initially the tax revenues will rise. The money is distributed and the recipients spend the money and give it back to the companies that were taxed to produce the revenue. What do they do with it? With higher taxes reducing the risk/reward they start looking for ways to shelter the gain. As in the 1970's they look for tax shelters to protect the gains and wait for a better economic environment when the risk/reward ratio is better to expand their business with that money. That takes that capital out of the economy. That further slows the economy and after that initial jump in tax revenues, they fall below the pre-tax increase levels despite the increased rates.

That is what Congress always fails to understand: if you tax more, money will be removed from the areas that result in additional tax assessment and it won't be put into endeavors that generate taxable income or revenue. Thus tax revenues fall even with the higher tax rates and we get the 1970's stagnation: capital is locked away until the day a new direction is taken that rewards risk taking and capital creation once more. The 1970's set up the Reagan tax cuts and economic recovery incentives and the Volcker interest rate hikes (even in a weak economy) that lead to the massive 'invest in America' boom that we rode for 20+ years.

Unfortunately we are not on the cusp of renewing the Reagan/Volcker combination. Instead we are on the cusp of starting the regulation, tax, and inflation cycle of the 1970's and if we go that route many very smart economists and historians fear we are going to have to live through similar times. I was a teenager in the 1970's. It was really a bad time for the US. There was not a lot of hope for the future as we muddled through bad economic and foreign policy decisions. We need to stay on our Congressmen no matter who is elected because either one of these candidates can go that route as both are populists even though the media tries to contrast them.



VIX: 79.13; +11.33. VIX hit a new high on this cycle, spiking to 89.53 right out of the box as the opening bell rang. As noted in the earlier discussion, VIX hits its peak on the first leg. It is still moving higher but this might very well be the peak as the indices held their prior lows as it made this spike and in the midst of the morning gloom.
VXN: 78.82; +8.98
VXO: 79.36; +10.8

Put/Call Ratio (CBOE): 1.24; 0. A week above 1.0 on the close as the downside speculators and protection buying hits highs again.

Bulls versus Bears:

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: 22.2%. Just a modest drop from 22.4%. Down from an already very low 25.3% that was the largest single week drop we have ever seen, down from 33.7% and 37.5% the week before. Well below the 35% threshold considered bullish. Down from 40.7% on the high during the rally off the July 208 lows. Surpassing the 27.8% on the low this round. 30.9% was the March low. In March the indicator did its job with the dive below 35% and the crossover with the bears. 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: 54.4%. Very respectable rise from 52.9% after pausing at that 53%ish level for a couple of weeks. Surging from 47.2% and 40.9% the week before. Surpassing 50.0%, the high on this move. Well above the 35% threshold so still a bullish indication. This move over 50 takes it to the highest since 1995. Extreme negative sentiment. 35% is the level that historically indicates excessive pessimism. As with the bulls the jump in bears did its job after hitting 44.7% in the third week of March. 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.


Stats: -51.88 points (-3.23%) to close at 1552.03
Volume: 2.684B (-15.02%). Lower trade though it was still above average as volume picked up Wednesday to Friday after below average showings to start the week. Some late week distribution in techs.

Up Volume: 478.313M (-352.454M)
Down Volume: 2.191B (-126.71M)

A/D and Hi/Lo: Decliners led 3.84 to 1
Previous Session: Decliners led 2.54 to 1

New Highs: 3 (+3)
New Lows: 842 (+293). Getting up toward those early October levels (1709) but still not there even with the new low on NASDAQ Friday. That is, again, a positive as it shows there are not as many stocks in NASDAQ selling off.


Another new low for 2008 with the gap lower and then another comeback. Not quite as good as Thursday, but the buyers did pick up a few tech stocks. It is still in a downtrend having broken out the bottom of its attempted October lateral consolidation. It is heading toward the 2001 low (1460) and the December 2002 peak after rallying out of the October 2002 bottom (1485). Got close on Friday and then reversed. That should act as some support and if the rest of the market rallies from this level, NASDAQ is ready to do so as well.

Similar to NASDAQ, NASDAQ 100 (-2.98%) gapped lower and out of its lateral consolidation attempt. It recovered to the two earlier intraday lows in October on the close but that still leaves it outside of its closing range as with NASDAQ overall. This is nothing more than a downtrend right now in need of something to pull it back up.




Stats: -31.34 points (-3.45%) to close at 876.77
NYSE Volume: 1.594B (-5.53%). Volume fell back close to average as the NYSE indices sold off, breaking below the lateral consolidation the prior two weeks. Still higher volume overall as the NYSE indices sold lower on the week. There was renewed distribution. Needs something to reverse them off the intraday lows.

Up Volume: 236.995M (-509.902M)
Down Volume: 1.354B (+426.105M)

A/D and Hi/Lo: Decliners led 4.43 to 1
Previous Session: Decliners led 1.67 to 1

New Highs: 17 (+7)
New Lows: 1148 (+322). Up as on NASDAQ but also below the highs hit on that first spike lower in October (2631). Fewer stocks hitting new lows as the old lows were tested. More are holding their ground and that is a silver lining.


Undercut the second and third intraday lows of the month, coming within 14 points of the prior intraday low. Bounced up off that level to recover not quite half of the losses. Yes it broke out of the range of closing lows but it has held the intraday lows and is in a good position to make a rebound. Good position but with the renewed distribution last week it will have to prove it. We kept some of the SPY downside positions alive because while it is laying the groundwork for a rebound it has to find some buyers.

SP600 (-3.81%) is in full-fledged selling with four straight sessions lower after failing at the 10 day EMA Tuesday. No double bottom here, just a continuing downtrend. It is oversold and ready to rebound, but it is just a rebound in a continuing downtrend. That is not good news for the economy as small caps are economically sensitive.

SP600 Chart:



DJ30 again tested lower, and though it undercut the second October intraday low (8199), it has held well above the early October low at 7882, a good 105 points above that level. DJ30 and SP500 are in position to bounce off of this level. The question is whether they do it. The ability to repeatedly hold over those lows and recover indicates the two large cap NYSE indices are sold out on this leg and are going to try and bounce.

Stats: -312.3 points (-3.59%) to close at 8378.95
VOLUME: 335M shares Friday versus 340M shares Thursday. As with the other indices, volume picked up midweek as the selling picked up. Some distribution as it headed lower Wednesday, but it started backing off as the week ended.



Earnings will continue at a torrid pace, LIBOR will be watched for a renewed thaw, and no one admits it, but many will watch oil as well. Sure the decline is a result of a lack of demand, but lower prices aren't going to hurt the world economies. All important, but the market is in technical gear now after a week of shots at the lows on SP500 and DJ30.

While NASDAQ and the small and mid-caps hit new lows on the week, SP500 and DJ30, despite the best attempts of the sellers, held above the prior lows. As noted, there was the perfect storm Friday to send them careening lower but instead it was just another day of 'normal' selling. The sellers appear to have shot up their ammunition for now, and if they cannot push SP500 and DJ30 to new lows to start next week they likely will not do it on this leg.

Thus we see how the first of next week plays out. We could very easily get another test lower Monday or Tuesday that still holds the prior lows and sends the market back up. If we get that push lower we take the rest of the DIA, SPY and NSC positions off the table and then flip to the upside with some more DIA and SPY and even some other indices and stocks that can move for us. As noted, steel and energy held up to end the week; they are in position to rally as well as DIA and SPY bounce back, and as seen, at this price they can peel off large percentage gains as the do.

Friday we opened a couple of upside positions already with AAPL and NUE, both in position to move higher in a market bounce. This is still in our view not the bottom but just a set up to bounce to take SP500 and DJ30 higher so they can test and try to put in the real bottom. Nonetheless, we really like how these two performed on the week. They may come back to test some after a bounce, but this might be as low as they go. We will look for more of these all week ahead.

Support and Resistance

NASDAQ: Closed at 1552.03
1565 is the second low in October 2008
1620 from the early 2001 low
1644 from August 2003
The 10 day EMA is 1679
1752 from 2004
The 18 day EMA at 1764
1782 from August 2004
1882 from October 2003
1900 is the gap down point in October; from August 2004
1912 from April 2005
1947 is the point where the market gapped down from in October 2008
1984 is the lat September low
The 50 day EMA at 1993
2070 from September 2008
2099 is the mid-September closing low
2155 is the March 2008 low
2167 is the July 2008 low

1542 is the early October 2008 low
1521 is the late 2002 peak following the bounce off the bear market low
1387 is the 2001 low
1253 is the March 2003 low on the test of the rally off the 2002 bear market low
1108 is the 2002 low

S&P 500: Closed at 876.77
889 is an interim 2002 peak
The 10 day EMA at 939
965 is the 2003 consolidation low
The 18 day EMA at 983
995 from June 2003 consolidation peak
1065 is the Q4 2003 level that SP500 started the run to 2007 after the first run in the recovery.
1075 from August 2004.
The 50 day EMA at 1102
1106 is the late September low
1133.50 is the mid-September 2008 low
1200 is the July 2008 intraday low
The 90 day SMA at 1203
1244 is an August 2005 peak
1245 is the 2002/2003 up trendline
1257 is the March low
1270 is the January low
1285 is the recent July peak
The 200 day SMA at 1290

866 is the second October 2008 low
853 is the July 2002 low
839 is the early October 2008 low
800 is the March 2003 post bottom low
768 is the 2002 bear market low

Dow: Closed at 8378.95
The 10 day EMA at 8885
8985 is the closing low in the mid-2003 consolidation
9200 is the July peak in the 2003 consolidation
The 18 day EMA at 9247
9323 From June 2003 peak
9575 from September 2003, May 2001
9814 from August 2004
9852 is 25% off of the October 2008 intraday low
9937 from May 2004 low
10,100 to 10,000
10,127 is an April 2005 low
The 50 day EMA at 10,187
10,215 from Q4 2005
10,365 is the new 2008 low
10,459 is a September 2008 low
10,827 is the July 2008 intraday low
The 90 day SMA at 10,939
10,962 is the July closing low
11,061 from February 2006
11,317 from March 2006
11,388 is the prior August low

8626 from December 2002
8521 is an interim high in March 2003 after the March 2003 low
8197 is the second October 2008 low
7882 is the early October 2008 low
7702 is the July 2002 low
7524 is the March 2002 low to test the move off the October 2002 low
7282 is the October 2002 low

Economic Calendar

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

October 27 - Monday
September New Home Sales (10:00): Expected 445K, prior 450K

October 28 - Tuesday
October Consumer Confidence (10:00): Expected 52.0, prior 59.8

October 29 - Wednesday
September Durable Orders (8:30): Expected -1.0%, prior -4.5%
10/25 Crude Inventories (10:35): 3.2M prior
FOMC Policy Statement (2:15): Fed Funds futures indicate a 50BP rate cut to 1.0%

October 30 - Thursday
Q3 Chain Deflator-Adv. (8:30): Expected 4.0%, prior 1.1%
GDP-Adv., Q3 (8:30): Expected -0.5%, prior 2.8%
Initial Jobless Claims, 10/25 (8:30): Expected 473K, prior 478K

October 31 - Friday
Q3 Employment Cost Index (8:30): Expected 0.7%, prior 0.7%
Personal Income, September (8:30): Expected 0.1%, prior 0.5%
Personal Spending, September (8:30): Expected -0.2%, prior 0.0%
Chicago PMI, October (9:45): Expected 48.0, prior 56.7
Michigan Sentiment-Rev., October (10:00): Expected 57.5, prior 57.5

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

Jon Johnson is the Editor of The Daily at

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