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Seeking Alpha

Wednesday, February 06, 2008

Set to Retest Market Lows


For today's market coverage, please visit our home page at Wall Street Greek.

(Stocks in this article: Nasdaq: CSCO, Nasdaq: JNPR, NYSE: TWX, NYSE: ABK, NYSE: MBI, NYSE: DIS, NYSE: BHP, NYSE: RTP, NYSE: TOL, NYSE: CI, NYSE: TWX, Nasdaq: BIIB, Nasdaq: IACI, NYSE: SPY, NYSE: DIA, Nasdaq: QQQQ, AMEX: SDS, AMEX: QLD, AMEX: QID, AMEX: DOG)

Grrrr! The bear is coming back! It appears likely to us that we've set out enroute to retest prior market lows. We will eventually find that true low point for this bear market, and we expect it'll be lower than the previous mark. There are too many factors in play to take us there.


  1. Money Flows - Equity portfolios in pension funds are still emptying as Main Street, and unfortunately many latecomer pundits realize recession is upon us. As an early prognosticator of it, my biggest challenge is in calibrating the impact and timing of the herd finally coming along. Capital invested overseas should eventually contribute to outflow as emerging market investors look to lock up big paper profits before they disappear. Clearly, this was already evident in January, but we expect more to come. As data flow deteriorates, capital flow should intensify. Smart money calls this "opportunity."
  2. Data Flow - Despite enthusing Fed action, the economic data flow should remain horrible for a while. The market should teeter in the near-term, with the flow of data balancing against the anticipated impact of stimulus offered by the government and the Fed. This week, after the ISM Report, we still have Thursday's ECB decision and commentary to contend with, not to mention likely disconcerting retail same-store sales news flow for the month of January. We think the ECB will either keep rates steady or cut by a quarter point, but its commentary and even action will still find much criticism in the U.S. As a result, market low retest seems highly likely.

So, how do we play this...

We're not sure an apology is necessary, but we must bring light to the nimbleness (read short-term nature) of our recent forecasts. In order to capture the short-term movements in this highly volatile period, we've gone to a short-term bias, mostly as a result of evolution from writing daily advice. We think this best suits you if you read on a daily basis. We are careful to outline our timeline, and will do our best to maintain that detail.

We are planning to offer long and short-term outlooks in the near-term for sector weightings. In the short-term, we see the energy sector again turning bearish. This means, as we advised yesterday, our early year views are again upheld. So, we've again (as of yesterday morning) recommended shorting the energy and alternative energy complex, and that includes solar stocks again folks.

In the near-term, we look for the tech sector to weaken, while healthcare and defensive sectors again gain interest. Gold should gain further favor as well, especially since we expect ECB action will be viewed inadequate. As a result, the dollar could weaken further. Also, the energy crisis in South Africa is not properly priced into the price of gold, in our view. Finally, recent suspicious events regarding cables that transmit Internet to parts of the Middle East, Iran and further east hold interest. We continue to expect Israel to force action with Iran, whether George Bush is on board or not. We cannot envision Israel waiting for a Democrat to potentially gain the presidency in the U.S., while Iran continues nuclear development. The sitting Bush in office offers American support post the destruction of nuclear facilities in Iran. History tells us Israel is capable of bold action to defend its future, and the Iranian leadership is clearly a threat to Israel's future.

Super Tuesday Fallout


John McCain surprised The Greek as he pulled out big victories across the country. We expected Romney would do better in California and missed the Huckabee impact. It's clear now that for any serious challenge to be mounted against McCain, it would have to occur through the combination of a Romney Huckabee ticket. Since McCain probably already has his vice president in mind, there seems little risk he could snatch up Huckabee and his ultra-conservative supporters. Romney, on the other hand, is a savvy politician and I mean that in a good strategic sense. His Mormonism has probably hurt him among the religious right of the Republican Party, but by adding Huckabee to his team, that weakness would be resolved.

A serious challenge could then be mounted against the leader. McCain's stubborn nature would lead him to miss the opportunity to solidify his weakness, and before he knew it, he would be in second place. Now, the odds of this playing out seem slim; so let's start really considering the likelihood that a Democrat will win the White House.

McCain's policies would seem on the surface strong enough to pull plenty of cross party votes. However, we suspect his age and his war view will lead him to lose the general election. The country is seriously looking for change, and he would not match that need in most American's view, in my opinion. The way things have played out seem to offer an opening for Michael Bloomberg. Even so, we would be shocked to see an independent win the presidency.

Overseas Woes

Asian markets that were open today mostly fell after Tuesday's hit to U.S. shares. Lunar New Year kept markets in Mainland China, Taiwan, South Korea and Vietnam off the board. It's concerning that the markets that were open traded lower. A replay of last year's Chinese market sell-off could cause deja vu this year. In 2007, Chinese markets fell the week after the holiday, as unsophisticated Mainland Chinese investors returned from their time off to face quite a hangover of compiled negative news. Plenty of it had reached global markets while the Chinese were celebrating.

Today's sell-off should partly reflect that bad memory and concern about this year's return from holiday, considering the state of U.S. trading this week. The Hang Seng was open today and fell 5.4%. Japan's NIKKEI 225 declined 4.7% and the Indian BSE SENSEX 30 eased 2.8%.

In the U.K., the FTSE turned things around because the Bank of England is scheduled to make a policy decision tomorrow. Expectations are the BOE will cut rates a quarter point, but ironically, poor news should inspire hope the bank might act more aggressively to match the movement of the American central bank. U.K. consumer sentiment was measured Wednesday at the lowest since 2004, when the metric was introduced. The consensus economists' view for a quarter point move, and general economist doubt for further cut, is driven by European inflation concern and expectations for the ECB to hold rates steady. We see a 50 point rate cut in the U.K. possible, and view today's trading activity as a sign we are not alone.

The rest of Europe held stronger than the data-impacted U.K. Strength was evident despite recent inflation concerns, with the recent rate measured at 3.2%. Europe also benefited from U.S. futures activity, as they pointed toward a return of stability in U.S. shares.

Economic Data & Analysis

Productivity & Costs Report

This morning's fourth quarter reading of productivity and unit labor costs offered better news than economists expected. Nonfarm business productivity rose 1.8%, compared to expectations for just a 0.5% rise. This great improvement did not occur because of the wonders of technology or because people all of a sudden fell in love with their jobs. Unfortunately, it's a sign that there was some slack in the system, and employers have cut back on workforce and hours (hours worked fell 1.5%), and are asking more from the employees who remain. This is a logical consequence of recession, but can only stretch so far before sales issues at corporations finally impact margins.

Unit labor costs rose less than expected, another logical consequence of hard times. Labor costs rose 2.1% quarter-to-quarter, compared to the consensus view for a 3.0% increase. This may help ease the Fed's concern regarding inflation, and feeds into their own expectations. We view an inter-meeting February rate cut as highly likely.

Mortgage Activity Fierce

Loans for home purchase drove a 3% rise in the Mortgage Bankers Association Mortgage Applications Index. A CNBC article on the subject, linked below, indicates analysts' view that multiple applications are now being filed due to the tighter lending standards that followed the mortgage meltdown. Long-term rates have come down alongside treasury yields, as recession gains acceptance in the marketplace. Despite Fed rate cuts, the shift downward of the yield curve reflects a concerning outlook more than it looks forward to recovery at this point.

Mortgage brokerage survivors are starving and backed by government incentive to move borrowers into more manageable loans, but the refinance index backed up a bit last week as rates inched higher versus the prior week. The refinance problem remains tied to the still declining value of homes and lost equity that must be realized upon refinance. But, it seems possible a few borrowers are getting bigger refis than the value of their homes and refinancing their old mortgages just the same. Also, foreclosures are hitting market and possibly driving some loan demand as well.

Company Specifics

Despite a slew of earnings reports today, the market is highly anticipating Cisco Systems (Nasdaq: CSCO) report at the close. Rival Juniper Networks (Nasdaq: JNPR) reported healthy results recently, but it was CSCO CEO John Chambers' comments last quarter that brought business investment concerns into focus.

While CSCO may report in line - to - better results, we expect Chambers to express caution regarding the forward outlook. Last night, the Fast Money guys pointed out a higher level of interest in calls than puts, with plenty of volatility priced into both sides of the bet. Given CSCO's share decline heading into the news, on anticipation of negative commentary, it seems more likely to us that the shares benefit from a solid earnings report despite Chambers' discussion. However, you had better have a set of steel ones to risk a naked option bet here. You have a high hurdle to overcome in the options price.

Our long-term view for CSCO is likely more value added. We like the shares as the global community expands usage of the Internet thanks to its development and the expansion of video. The shares trade at a P/E-to-growth ratio of less than 1.0 on its fiscal '09 (Jul) EPS estimate. Now, estimates have started on a downtrend in light of global economic woes. Still, the company has surpassed estimates each of the last four quarters. We would own this stock as a long-term position, and buy on any guidance related softness this evening. If you don't own it already, you still might consider taking a small bite ahead of the report. The stock has priced in a lot of the economic scenario, fading well off its November highs. Further downside seems surely possible on tough guidance, but less dramatic than upside potential. Long-term investors can close their eyes and nibble, but short-term players better have courage.

Market-Moving News




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posted by The Greek | 11:11 AM

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