world stock market, us stock market

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9/15/01 Investment House Daily
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* * THE SUMMARY * * *

Do not ever forget this past week. Do not forget your pain, your sorrow, your sense of loss. Do not forget those who were innocently killed, or those who gave their lives trying to save others in need. Let those memories strengthen us for the times ahead. Let those memories make us better people.

SUMMARY:
- Investors around the world brace for Monday's open.
- Foreign markets fall ahead of Monday as investors head for the sidelines on uncertainty of U.S. open and retaliation threats.
- Economic numbers even before the tragedy come in weak once again.
- Earnings already feeling the effect of the U.S. shutdown.
- Fed pumping tremendous liquidity into the world markets, urges banks to lend.
- Bonds rally again Friday along with oil and gold while the dollar continues to slide.
- What we think: has the picture developing before the attach changed?
- Mind your stop orders and options.

The world awaits the U.S. equity market open.

The open of U.S. equity trading is set for Monday at 9:30 a.m. ET. Tremendous anticipation impacted all markets Friday as traders and investors adjusted positions ahead of that event. Even that open, however, is not certain. There are backup systems that will be meshed with the primary system in order to route around the destruction of many primary systems in New York. Those are going to be tested on Saturday for a full session to make certain that they are working well together. If they are not, the exchanges can still pull the plug on the Monday open. Not likely, but still a possibility.

What are some traders expecting? After Wednesday's and Thursday's overseas trading as well as the trading in the U.S. Treasury markets, hopes have been bolstered that the open will not be a slaughter. Most anticipate some selling at the open by as much as 5% to the downside, followed by buyers coming in. What reasons are given for the rally back? Patriotic buying for one. Another is history where the markets tend to rally after selling off immediately after significant world events.

World markets tank Friday ahead of the U.S. open.

The prospect of patriotic buying or historical market behavior did not provide much solace to foreign traders as European markets reversed and headed sharply lower after two days of modest, low volume gains Wednesday and Thursday. Friday the DAX fell 6.3%, the FTSE 3.8%, and the CAC 40 dropped 5%. Major losses on par with the losses on the day of the attack.

There were two main reasons for the move lower Friday that were not necessarily a simple return to selling based on a loss of confidence. Thus, while the harsh selling was ominous, it may not be indicative of negative things to come. The first reason for the selling was a threat from the Taliban of Afghanistan stating that it would retaliate if the U.S. took any action in Afghanistan. That raised the prospect of a continuing, drawn out war between the U.S. and terrorists. That is one of the scenarios we talked about last week as being a potential drain on consumer and business confidence: if things could last a long time and there could be continued threats of terrorist activity, spending plans may be put off. That is another reason that whatever moves are made, they need to be decisive.

Second, overseas investors were simply getting to the sidelines because despite what pundits have said about a calm and orderly U.S. market, there is understandable uncertainty as to what is really going to happen. Everyone is convinced things will be down at the open; the big question is whether the market will rebound and build from there. As we will discuss below, there are still tremendous internal obstacles that have to be overcome that are no doubt exacerbated by the effective shutdown of the U.S. economy last week and the continued slowdown that will continue over the next few weeks as we adjust to what has happened.

THE ECONOMY

Economic numbers pre-attack are not good.

The economic reports that came out this week were mixed again, but consumer confidence really tanked. While some are saying these numbers mean little as to what the market will do in the aftermath of the attack, their insignificance is only limited to the short term. What they show is an economy that was weakening further even before the Tuesday attack. With the shutdown of the U.S. economy near term, the drag on any recovery attempt is tremendous. Think about it. With all of the cancellations of flights, sporting events, entertainment events, etc., the economy was effectively 50% or more shut down last week. The recovery certainly appears to be put off. What does that mean to stocks? Well, they price in economic improvement or growth. If that improvement or growth is put off, any recovery in stock prices is correspondingly put off.

What were the numbers. Jobless claims spiked to 431,000 last week, up from 410,000 the prior week (revised higher). The 4 week average moved up to 411,000 from 399,500 the prior week. Continued claims jumped to 3.36 million, the highest since August first's 3.45 million. The one silver lining is that jobless claims lag the recovery; they increase even as the economy has turned. Problem is, if the turn was in the making as it appeared to be, the recent acts may set the recovery back.

Industrial production tanks. Production fell 0.8% in August versus a 0.1% decline in July and a 0.2% expected drop. That makes 11 consecutive declines in production, and was a bit of cold water after the NAPM climbed sharply as reported 10 days before. Still, the NAPM still showed a decline overall, and thus we should not have expected a turn yet in production. The leading NAPM indicator of new orders was expanding, and if that holds that is positive. Still, manufacturing is still struggling very, very hard.

Michigan sentiment survey tanks. Sentiment fell to 83.6, the lowest reading for the year, and a staggering drop from August's 91.5 reading. Analysts were expecting 90.8, and the sharp drop was very disconcerting, particularly as it does not reflect the events of last week. In other words, consumers were already pulling back as we feared for the last month. The Fed's reliance on the consumer was over even before the recent events. On the positive side, consumer confidence follows the President's approval rating. President Bush is enjoying almost 90% approval on the handling of this matter.

Earnings already suffering some.

GE announced it will miss its Q3 results by 4 cents. The company said it would have made its number but for the losses incurred by its reinsurance business as a result of last week's events. Ford is cutting its Q3 output by 120,000 vehicles because it has been unable to get parts due to the difficulties in shipping. The impact is already being felt.

On the other hand, PFE announced Friday it will meet its next two quarter numbers. ORCL beat the street by a penny, but it did not issue any statement. The future of course is the key.

Dollar is suffering.

The dollar is suffering, but much as with the short end treasuries, the near term reaction is excessive. One of the indications: there is no reason for the Yen to be rising against the dollar. Even with last week's events, the U.S. economic situation is better than Japan's. It is simply a short term flight out of the dollar to other currencies.

Now this could be more sinister if the uncertainty continues, i.e., further attacks, the threat of further attacks, fear of a seriously weakening U.S. economy. Thousands are working to prevent the former and the Fed, President, and Congress are working to prevent the latter. In the short term it is inevitable that the dollar weakens. The key will be how effective we are in restoring confidence in the U.S.' future.

Some positives.

Retail sales climb 0.3% as expected. This was the strongest gain since the 1.4% gain back in April. Good news, but again, this was the August report, long before the attack. Ex-autos, sales were up 0.5% while July's overall number was revised higher to +0.2%.

Producer prices tame. The PPI came in at +0.4% in August, much higher than the 0.1% gain expected, and well above the -0.9% reading in July. Even with the higher than expected gain, inflation is still nothing to worry about. Prices paid are still very low, and businesses continue to have no pricing power.

Fed continues to pump tremendous amounts of liquidity into world markets.

The Fed is trying to prop things up with massive injections of dollars. In the last three days the Fed pushed $190 billion into the world market. The liquidity was needed even before the attack, and if the Fed maintains liquidity at necessary levels, it will ultimately provide economic growth stimulus down the road.

In addition, the Fed has encouraged banks to loan money, to relax a bit on those impacted by the tragedy (i.e., all of us). This is a continuation of the Fed's admonishment to banks three months ago to lend the money that is available. Banks responded with loan volume up $1.9 billion last week.

Rate cuts?

The Fed has to cut rates. The Fed was behind the curve as the 2 year note yield was about 50 basis points lower than the discount rate. With the rally in the short treasuries last week (the 2 year note closed below 3), the Fed is even further behind. Until the discount rate undercuts the 2 year yield, there is no incentive to invest on the business side. Now the Fed must act for other reasons, and we expect a 50 basis point cut soon. It may happen this week after the markets sell off and then try to recover. The Fed does not want to cut as the markets are tanking unless they just cannot pull out of the dive. We think there will be selling early followed by an attempt to rally thereafter. That will be the Fed's cue.

SEC allowing buybacks.

We reported before, but the SEC is relaxing its corporate buyback rules, allowing companies easier access to buying back shares. This has an important aspect that is closely related to the Fed's actions: it provides liquidity in the market as companies can buy back their shares, in effect making a market for their stocks. That also helps prop up the price of the stock as shares are removed from the market. Cisco has already announced a $3 billion buyback plan, and AIG announced a massive buyback plan late Friday. This will help hold up some pricing near term and possibly longer term.

Bear markets of major proportions end when there is despair and war breaks out.

Looking back at history, significant, longer-term bear markets tend to end when there is despair and no hope, and often when war breaks out. We are not trying to peddle false hope in the shadow of tremendous loss and sadness, but history shows us that out of darkness better times emerge.

THIS WEEK

Has last week changed the overall lay of the land?

The admonitions on the financial stations: keep calm, don't make rash decisions, let cooler heads prevail. Not bad advice. As always, however, we have to have some framework to work off of. We have to analyze what the numbers are showing us after the emotion winds down.

History says there is usually a 5% plus or minus selloff after major shocks to the nation. Those are followed by a recovery that often leads to the market ultimately moving higher. Thus, historically, the majority of the times we have experienced major shocks the markets have risen above where they were at the time of the selling, and it was not years in the making. They were buying opportunities. Still, you have to compare apples to apples. Many of the historical situations cited by analysts occurred when the economy was in good shape or was already making its move higher. Do we fit into the latter scenario? We could; leading indicators are showing improvement even as the laggards continue to tail off. That is the usual pattern. Were we far enough along in recovering such that this shutdown of the economy won't sink the nascent recovery attempt?

Tremendous efforts are being made to prop up the recovery as outlined above. The mass infusion of liquidity in to the world markets as well as into the stock markets will help short term and longer term. Fiscal stimulus by Congress and the President, if it is quick in coming, will add to confidence immediately and if it targets both the individual and the business side with credits, investment incentives, the effect will be even greater. The latter has not occurred yet, however, so we must deal with this week as it stands.

Near Term

We too see the indexes gapping lower on Monday. They may spend the entire session in negative territory. Whether they try to rally or not that day is mere guesswork. A massive selloff (5% or more) will bring buyers into the market. After the selling, the rally attempt will occur. It may start Monday or Tuesday. The big issue is whether that will be the bottom (the final cleansing of the bear market) or just a false hope. Brokerages have noted customers canceling sell orders placed right after the incident. Analysts cite statements about 'patriotic' buying.

This may very well occur. We no doubt will see buyers come in on any heavy selling. Still it may be short term. The economy is still in real trouble. Patriotism may lead some to buy, but after the emotions wane, we have to realize that the markets are about making money and factoring in the future. The economy will no doubt take a hit from this slowdown after the attack. It was weak and is sure to weaken more at least near term. Are investors going to factor in higher earnings if any recovery has been put off further? Those are the hard numbers we have to analyze. What may have been a recovery in the making before the attack is now a big question mark. Thus without some additional stimulus from the government, near term the markets will be waiting for signals as to how much the attack impacted the economy.

Thus we anticipate this scenario until and unless we get news of imminent additional stimulus or some economic numbers (and that will be further off). Selling on the open. Originally we thought that the selling might be muted, but looking at the dollar and the action of foreign markets, we are ready for a full 5% to 6% selloff, maybe more, before the initial rally. A 5% selloff on the Dow is 480 points, dropping it down to just 20 points above its intraday low at 9106. The closing low is 9389.48, just 215 points away.

There will be buyers on such a selloff; the stronger the selling, the more buyers coming in looking for positions. Then we anticipate the upside to last a few days before a re-evaluation of the economic numbers and some more input as to the impact of the attack sends in some sellers again. After the patriotism fades a bit, then the markets have to price in what the future foretells. We then see, without the Fed cutting 50 basis points or more and/or some fast fiscal stimulus, some selling again because the consensus is that the economy is going to suffer from this attack and no one was sure if the economy had really made the turn at the time of the attack. The signs looked promising, but the market was still feeling for the bottom.

After the touchdown to the low and then the recovery, the indexes may find resistance at the former lows. How they handle those levels will be key. Those points could set up downside put plays on the indexes. The lows: Dow (9106 intraday; 9389.48 closing); S&P 500 (1073.15 intraday; 1085.78 closing; March low was 1081.19 intraday and 1103.25 closing); Nasdaq (1619.58 intraday; 1638.80 closing). If we see the indexes rebound to those points and then reverse direction, we will look at downside plays.

The market will of course be in tremendous flux. Uncertainty is the bane of markets, and the uncertainty as to whether the attacks will continue, how long the campaign against terror will last, and how the economy has been impacted will, in our opinion, overcome short term buying unless there is other stimulus, e.g., a. Fed rate cut and fiscal stimulus.

As noted above, several bear markets have ended in the midst of despair and apparent economic weakness (the turn was made but no one was sure it had occurred). After last week's events there is no way to determine where the market or the economy sit right now. That is why we are laying off the downside plays until the market recovers some equilibrium and we can see the direction better after some trading is done. We will let our existing short plays sell down on Monday and then lock in some profits when we see any bounce after a 5% or so selloff. We will wait on further such trades until we get that rally back that fails at a logical point, e.g., the former lows. It is too risky for us to chase downside plays out of the gates; put option prices will be incredibly volatile and thus incredibly pricey. Not the time to be getting in with options.

The upside is all about patterns and strong stocks. Those that survive the selling on Monday while maintaining their patterns are the strong ones, and they will be our upside focus and they are on the reports. If they hold up and breakout sharply on the rally, they could be the next market leaders, the good buys that could lead if the market takes this tragedy and does a historical repeat. We will watch those for the upside moves after the initial selling. Patience and a cool head are indeed necessary at this point.

End Part 1 of 2

world stock market
us stock market