Dec 14, 2008

December 14, 2008

I’m going to be a bit light on the quips this week. I just came home from a funeral for one of my closest friends, and I apologize if tonight’s note is lacking its usual zest.

Weekly percentage performance for the major stock averages

Based on last Friday's official settlement...

INDU: -0.25%
SPX: -0.35%
NDX: +2.4%
COMPQ: +1.9%
RUT: +1.4%

The tech tape was robust this week, with NASDAQ leading the major indices performance, up almost 2.0% for the week. Most of the major indices were flat to slightly down, which is a major improvement over the past few months. December, which last week I cited as historically one of the best months for investing, has started out gangbusters by 2008 standards, with the S&P down 1.8% MTD, but up 7.7% if you exclude December 1st. Additionally, the market has now bounced 17% from its bottom of November 20th. As I have said in the past few weeks, we are certainly due for a bear market rally, which typically runs up from 20-40%. I still believe we are right in the middle of one of these bear market rallies, and you should use this opportunity to reduce your exposure to equities.

Two of the ongoing stories around the street supporting a market rally have been 1) reversion to the mean long term market returns and 2) cheap stocks. Regarding the former, look at the chart below, which suggests that the market has just recently reached its inflation adjusted long term mean. These types of analysis are always interesting, however, in my view they are a bit disingenuous since the beginning (in this case 1871) and end points are very influential in determining what the data ultimately looks like.

Last week the Treasury sold $30 billion in 4-week notes for 0% interest. This could be extremely bad for money market accounts focused on Treasuries. They could lose money if the yields aren’t large enough to cover their expenses-that’s right, losing money on your supposedly safe money market accounts. Many funds have already been waiving fees to keep returns from going negative, and now with no yield they are going to be hard pressed to maintain positive returns. This negative return could happen if the fund adds a monthly account fee that is charged to your account at the end of the month. It seems as though a new bubble has formed in Treasuries, otherwise, how can we explain people giving their money to the government without a return? One theory holds that the Fed is lowering rates to such a point as to encourage risk taking by making the returns on cash unappealing. More risk taking?? Didn’t we just conclude that chapter in our history?

One of our newly anointed kings of the economy, Nouriel Roubini, said earlier this week

“there’s still significant downside risk for the markets”,

“the bear market rally won’t last too long” ,

the idea of a “V-shaped recession is out the window”,

“the probability of something severe like Japan is still low. But this will last until the end of next year, and 2010 is going to feel like a recession even though we’re out.”

The amazing President-elect Obama is being credited with “stepping up his efforts to pull the economy out of a recession”. He accomplished this by “announcing” that he wants to introduce a stimulus plan which is heavy on infrastructure spending. While I want him to succeed, I can’t help but think that he hasn’t done anything but make announcements, which is very much in line with his political career so far. Essentially he has proven to be a great campaigner, yet has spent very little actual time filling his roll as a senator. I don’t think now is the time for someone to pretend to take action, and hope that the new president will be a bit more active governing and a bit less active seeking re-election.

President-elect Barack Obama will propose the largest infrastructure spending plans since the 1950s. The ramp up in spending will not immediately alleviate what will likely be the worst recession in at least 25 years as companies continue to announce cutbacks and reduce guidance. 3M has eliminated positions and reduced guidance, Dow Chemical will close plants and cut jobs, but McDonald’s offered upbeat same-store sales. It seems the consumer still has time for a Happy Meal.

Jobless claims jumped once again, this time to 573K vs. expectations of 525K. Typically we don’t see that kind of jump before the holidays, however, this year the layoffs are coming fast and furious heading into what should prove to be a very weak Christmas.

If You Can’t Beat ‘em, Rob ‘em…

Bernard Madoff, once the Chairman of NASDAQ and the founder/President of Bernard L Madoff Investments, apparently had a side business duping investors. There have been many charges over the years of various ponzi schemes, but this one takes the proverbial cake. Evidently Mr. Madoff found enough time to run an unregistered money-management business alongside his firm’s brokerage business, and somehow managed to siphon $50 billion for himself. In addition to his clients, anyone who did business with the firm is in jeopardy of losing capital.

If You Can’t Beat ‘em, Rob ‘em part 2..

I can’t imagine being in a more amazing place than Illinois last week. First, the Governor, Rod Blagojevich, announced that the state wouldn’t do business with the Bank of America unless they extended a loan to a company that evidently was on its way to bankruptcy. Later in the week this same governor was arrested for trying to sell President-elect Obama’s senate seat to the highest bidder. This might seem unusual for many of us, however in Illinois a corrupt governor is par for the course. Governor Blagojevich is the 4th of the past 7 governors of Illinois to be arrested, three of which have spent time in jail-Otto Kernor, Dan Walker, and George Ryan. Evidently the governor merely wanted an ambassadorship, a cabinet post, or just “a lot of money” in exchange for the open Senate seat. I appreciate his candor, but am wondering what category this was listed under on EBay? In the understatement of the week, a professor at the University of Illinois at Chicago said “We are the capital of corruption in the US.”

Follow Up

Last week, and a couple of times over the past few months, we have discussed the impact of the stock market decline on pension funds. Primarily we have discussed the impact on earnings. Bloomberg reports that pensions funds at “dozens of companies have joined the parade of businesses seeking relief from Congress amid this year's economic meltdown. Instead of money, they want legislation to suspend a federal law that would make them pump billions of dollars into retirement plans to offset stock-market losses as many struggle to find enough cash just to stay in business. They're pressing Congress to consider the issue this week before this year's session adjourns.” Stay tuned-this issue isn’t going away quickly.

Lending Environment
I have discussed the lending environment at length over the past two months. Recently, Steve Alexopoulos at JP Morgan, wrote “Zions indicated that C&I pressures are mounting, and noted some new concern with its Texas portfolio due to the slide in oil prices. Signature indicated that while deterioration is not yet evident, the bank is increasing reserve allocations to C&I loans. With the economy heading into a deeper recession, we believe C&I loans for the industry will see mounting losses over the next several quarters”. C&I loans have been the stalwarts for banks over the past 24 months, however, we have been discussing both the extreme exposure and potential credit problems of many of the small and regional banks to C&I. It appears we may be on the cusp of the second (third?)wave of the banking crisis.

Big 3 Bailout
What is going to happen with the Big 3 bailout? I haven’t the foggiest idea how this will end. My guess is that the government will blink and save the Big 3 by tossing them at least $14 billion. The Republican Senate gave President Bush a nice going away present by calling his bluff on not using TARP money to save the Big 3. The senate blocked the bill, and now the President is blinking by opening up the option of using TARP money, an option he initially deemed to be off the table. GMAC failed to become a bank this week, a move that would have given them FDIC backing and TARP funding. Who derailed this plan? Their debt holders, who wouldn’t swap enough of the outstanding debt to qualify to receive regulatory capital. It’s interesting to note that to purchase CDS on GMAC, you would have to pay $9.5million to protect $10 million in debt. The market is certainly telling us that the plan should be accepted, I wonder what the debt holders have been smoking?

The chart below tracks the sales and market cap of the Big 3 since 1999. Their market cap has closely tracked their sales, and the chart shows that their sales started dropping long before this economy went off a cliff as a result of strong overseas competition.

Bush Era Ending

At the end of every administration there are a slew of requests for amnesty. While this one evidently hasn’t been filed yet, it has been rumored that among those seeking presidential action are former junk-bond salesman Michael Milken. Mr. Milken, for those of you with short memories, was the villain behind the 1980’s M&A and junk bond craze. Among other exploits, he can almost single handedly be credited with turning Las Vegas into a destination resort from it’s humble roots as a small time, corrupt gambling town. He’s no Mark Rich, but who knows, anything can happen in Washington.

I have recently seen estimates suggesting that US wealth dropped $7 trillion in the past year. I’d guess that even with gas down to $1.75 per gallon, it will take a long time for the savings in gasoline to offset the loss of wealth from stocks and bonds.

Ecuador defaulted on their foreign debt for the second time in a decade, and sixth time overall. The President of Ecuador declared that the debt was illegal, and an investigation into its issuance will be launched. While the investigation is occurring, the government will withhold interest payments on the debt. Oil is the number one export for Ecuador, and I’d imagine that at $147 per barrel the government doesn’t mind tossing a few sheckles towards those who funded the government led drilling programs, however, at $41 per barrel all bets are off and its every man for himself. You have to wonder who was dumb enough to lend this country money after five prior defaults?

What did you Say?
In another issue of WDYS, this technical note comes from a friend who is obviously much smarter than your writer. I don’t know what in the world he is talking about, but really enjoy his comments about the Grand Supercycle that started in 1718. As you know, I am a student of history and the market, but this Grand Supercycle predates even my meager studies. Please feel free to skip the next three paragraphs unless you are having issues falling asleep or enjoy getting extremely confused. If you truly understand what he is talking about, take two aspirin and call me tomorrow (and explain it to me).

We continue to get Bullish confirmation from our indicators, as more and more generate buy signals. A pattern of higher highs would complete confirmation that wave (B) up is underway. Friday delivered new buy signals in our Call/Put ratio and in our Plunge Protection Team (PPT) Indicator. These signals join buys in the Monthly and Weekly Full Stochastics for the Industrials and the S&P 500, which have generated from levels where multi-week rallies start. We are in a Grand Supercycle Bear Market decline, wave {IV}, that started in October 2007. This is why we see so many huge 5 percent daily moves up or down, why we see so many 15 percent multi-week moves. It is correcting a Grand Supercycle wave {III} that started in 1718, three centuries ago. We believe the decline from October 2007 to November 20th, 2008, our last phi mate turn date, was wave (A) down, of Supercycle degree. It represents the first of three phases to this Grand Supercycle Bear market.

This Grand Supercycle Bear Market will consist of a wave (A) decline, a wave (B) up pause - either a rally or sideways triangle move, and wave (C ) down, which will be a catastrophic plunge that could change the world as we know it. Grand Supercycle degree waves change governments and nations. This degree of trend is larger than the Great Depression. That is how serious this Bear market is. That is the big picture.

Shorter term, wave (B) up started at our last phi mate turn date, and confirmation continues to roll in. This should take shape as an A-up, B-down, C-up Cycle degree move, a zigzag or flat, or as a five wave triangle that effectively will be a trading range. We believe we are inside the middle of wave A-up. That middle wave is primary degree wave (B) and is taking shape as a triangle sideways pattern in some indices, and as a flat in others. Once complete, wave (C ) up of A up should rally prices through Christmas into our next phi mate turn date, which we cover in detail this weekend. Pictures are easier than narrative when analyzing Elliott waves and patterns, and we show these labelings this weekend in charts on pages 15 and 17 at . If the degree of waves is one less than we show, it means this Bear Market could last into 2012. Our hope is it will end in 2010.

In a move sure to further the ongoing advancement of socialism in our country, Nancy Pelosi is recommending that Paul Volcker become our countries first “Car Czar”. I’ve lost count of all the proposed and existing Czars in our country, but I’m sure we are at least at four (including the Drug Czar).

Oil and such

Gasoline is tracking the near 5 year lows we are seeing in oil, at a 5 year low of $1.75 per gallon nationally. In response to ever declining demand, the Saudi’s announced plans to cut oil production once again. In the chart below, you can see that demand for oil has moderated, while the price (green line) has dropped precipitously after spiking earlier this year. Interestingly, the drop in gasoline prices resulted in an increase in oil purchases last month, up 71 million barrels. Goldman Sachs, which earlier in the year predicted oil to reach $200 per barrel, lowered their target to $45, with a predicted bottoming at $30 in Q1. They feel it will take production cuts of 2 million barrels per day to halt the current slide in price.

China Watch
China reported that exports declined 2.2% in November, the first time that has happened since 2001 and the biggest drop since modern record keeping began in 1995. Imports are also falling as their economy cools. Watch for a government led depreciation of the Yuan in an effort to stimulate their exports. I think it will be futile because it will be almost impossible for any government to debase their currency as much as the US has done with the dollar.

California reports that California's budget crisis is growing worse as its shortfall for its current fiscal year has increased to an estimated $14.8 billion from a previously estimated $11.2 billion. During a press conference broadcast on his office's website, the Republican governor Arnold Schwarzenegger said he would call top lawmakers into a meeting to stress the need for fast action by the Democrat-led legislature on balancing the budget of the government of the most populous U.S. state because it may be out of cash by the end of February. S&P was considering a downgrade of the state’s debt.

Rail Traffic

Total Industry
Major Commodity Groups

Current Week

Vs. 2007

Vs. 2006

4 Week Rolling Avg.

Vs. 2007

Vs. 2006

Quarter to Date

Vs. 2007

Vs. 2006

Year to Date

Vs. 2007

Vs. 2006

There was quite a bit more I wanted to address this week, but will put it off until next week’s note. I hope this finds you and your family enjoying the holidays and maneuvering through these markets successfully.

Thank you again for your support. As always, if you wish to be removed from this list, just let me know.


Ned W. Brines

O (562) 430-3232

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