Markets to Open Mixed - Retail Sales Report Dampens the Mood

April 14, 2009 – The futures are indicating mixed openings this morning as the Street reacts to Bernanke comments intimating that the pace of the declines in the economy is slowing down, as well as Goldman Sachs (NYSE:GS) better-than-expected earnings report yesterday after the close.  However, expectations which remain broadly that the labor market will continue to deteriorate well into 2010, as well as increasing uncertainty about other earnings reports on tap, inflation and dollar risk are moderating how the optimism heading into today’s session.

Obama is set to weigh in on the economy today, and the Street will be watching closely looking for a sense of policy dispositions with respect to whether further stimulus is on tap and a sense for whether the administration is leaning towards further involvement in the private sector.

In terms of economic data this morning, advanced retail sales are down by 1.1%. The reading on retail sales came in significantly worse than expected. Ex-autos, it sales were down 0.9%. This bolsters the argument that January’s bounce in retail numbers was anomalous. The PPI is down by 1.2%, while the core PPI was unchanged. The decline in PPI wasn’t a big surprise, but we do fully expect for prices to begin increasing heading out of 2009 and 2010.

The dollar is slightly stronger against the euro this morning, with the euro slipping to $1.3231. Currency traders generally seem to be lacking any strong conviction about  the dollar as well as many of its peers, reacting on a daily basis to economic headwinds. Our mid-to-long-term outlook for the dollar remains bearish, and we fully expect the dollar to resume its slide when traders finally begin to factor in all of the excess money that has been created at the treasury in the administration’s effort to stimulate the economy.

Gold is down $3.90 this morning to $891.90. Gold has been softening since the IMF let it be known that it intends to gold (it is the third largest holder of gold reserves in the world). Traders appear to be concerned about the move creating excess supply on the Street. We think that the pullback represents a buying opportunity, given our outlook on the dollar, and also based on our belief that central banks will be around to soak up the available gold from the IMF.

Oil is up $0.97 this morning, likely due to Bernanke’s comments. This seems to be how traders are recalibrating oil values – on a reactionary daily basis. Yesterday the IEA reduced its forecast for global oil demand and oil fell off. Today, Bernanke says that the pace of economic erosion is slowing down, and oil is being bid higher. We have heard arguments that oil prices could decline all the way back below the $30 level and we just don’t see it.

These arguments totally ignore the fact that China is fast becoming a larger taker of global oil reserves. Historically, China’s drawdown of global oil reserves has been about 7%, while the US has taken about 25%. This dynamic is going to shift – pace the first three months of the year which has seen China surpass the US in auto sales. As further anecdotal evidence, China has been accumulating oil reserves in the $40 range, so obviously it sees the prices as being strategically attractive, and it has also been negotiating long-term supply agreements with Russia, Venezuela and Brazil.  

On the corporate front,

·         Financial Sector – While the Street is breathing a sigh of relief on Goldman’s earnings report (which did have some areas of concern, e.g., its investment banking division), focus is now quickly turning to Citigroup (NYSE:C) and JP Morgan (NYSE:JPM) which are slotted to report later this week.

·         Healthcare Products Sector  – Johnson & Johnson (NYSE:JNJ) reported a 7% Y/Y decline in Q1 revenue to $15 billion and a 2.5% decline in Q1 profit to $3.5 billion, or $1.26 per share. Expectations were for EPS of $1.22 per share on $15.47 billion in revenue.

·         Oil Sector – Royal Dutch Shell PLC (NYSE:RDS-B) is talking with potential Chinese partners to develop oil fields in Iraq.

In international markets, German manufacturing sales fell by more than 23% in February, while domestic sales fell by 19.5%. In the euro-zone, sales fell by 25.9% in February on a Y/Y basis. Singapore’s GDP fell by almost 20% in the Q1 on a Y/Y basis. Expectations are for a 6% to 9% contraction for this year.

In terms of what we expect in today’s session, first, we wholly discount Bernanke’s comments that he is “fundamentally optimistic” about the outlook for the economy. We have documented well how clumsy, if not altogether completely wrong Bernanke has been in past efforts to read the economic tea leaves, and we can’t help but think these comments are based more on hope than clear-headedness. We think that above the 8,000 level, the DJIA is much closer to being overbought (all things being equal) than oversold.

It is interesting to note that the futures are reacting on the Goldman news at current levels anywhere close to how they reacted on the Wells Fargo preannouncement. This is indicative of the fact that traders are probably aware that at current levels there is substantially more risk. There is light support at 7,780 on the DJIA, and then, slightly stronger support at 7,600. We recommend to our readers to look for opportunities at current levels to hedge against downside risk.

We have been advocating a few strategies:

·         Short Dow30 ProShares (NYSE:DOG) – this is effectively a short on the DJIA.

·         Writing out-of the-money covered calls (about 60-90 days out) on profitable positions (or near profitable positions) when the DJIA pushes over the 8,000 level on strength (when premium is likely going to be more attractive). We just don’t see stocks running away to the upside at this level.

·         Locking in profitable positions with married put positions – this limits the downside risk to the premium paid on the put (which is effectively an insurance policy) while still providing unlimited upside.

Consult with your brokers further on these strategies.