We Are Setting Up For A Capitulation Low This Week – Watch For An Intra-day Reversal

There are plenty of reasons to sell this market. Bad news lurks around every corner and reality is finally setting in. We are in deep trouble and this crisis will take years to resolve. Last week the market rested at SPY 75. That was the November low and it was a multi-year support level. A horrible durable goods number, escalating initial jobless claims and a massive downward revision in GDP cracked that support. Yesterday, the selling continued when the government committed another $30 billion to AIG. Last year the insurance giant lost $100 Billion. We now stand at 12-year lows. This is the worst economic cycle we've seen since the Great Depression. Unemployment is sky rocketing and analysts believe that it will jump from 7.6% to 7.9% when the numbers are released Friday. The acceleration tells me that we could see double-digit unemployment this year. As Americans lose their jobs, the crisis spreads. Credit card defaults are up 40% year-over-year and 12% of all homes are behind in their mortgage by a month or more. Municipalities are feeling the pinch as sales tax revenues and property taxes decline. Many states are running huge deficits and Illinois believes it will be $9 billion in the red in 2010. Even Kansas (a state that you would think is "safe") is in trouble and needs to borrow money from the government to make its payroll. State unemployment funds are running out and their hands are already outstretched for government aid. Our national budget deficit will hit $2 trillion this year alone. Income tax revenues will decline dramatically as people lose their jobs. Lower revenue and unprecedented spending translates into the biggest federal budget deficit ever. I would like to have seen last year's $600 billion tax rebate and this year's $800 billion stimulus package be used for the financial bailout. Banks are the fabric of this economy and if the financial system fails an entire collapse will result. If we can stabilize the banks, the rest will eventually fall into place. Regardless, hardship lies ahead and we are complicating the problem by spending money. Unfortunately, the new president can't come out and tell all Americans that they will have miserable conditions for years. He has to try to do everything possible to get through this crisis even if it defies logic. The debt problem cannot be solved with more debt. Europe is in much worse shape than the US and the EU is in serious trouble. Eastern European banks have lent $1.7 trillion and they are on the verge of collapse. They need at least $200 billion in capital to get through this crisis. Yesterday, newcomer Hungary approached the EU for a loan and Germany (the largest member) quickly rejected that request. If every country has to resolve its own issues, the entire EU could break up. If European banks start failing, a global tsunami could result. This is why I feel all of our attention needs to be focused on our banking system. If the United States can shore up bank balance sheets we have a chance for a recovery in the next 5 to 10 years. Without our banking system, a recovery could take decades. By completely focusing on the banking system (not social programs), it would mean that many Americans will have great hardship. This would not be a popular approach. Unfortunately, I believe hardship is still in store for us. If tax increases on the rich were spent to reduce our national debt (as Bill Clinton did) I would be all for it. That is not the plan. We are going to increase social spending in the form of Medicare, unemployment benefits and healthcare. The focus will be on handouts, not jobs. This strategy has very short term benefits. Jobs are the key and corporations need incentives to invest. Business spending was down 25% last quarter. Payroll tax credits and cap ex credits are what is needed. Companies that are on the sidelines waiting for better times need to be encouraged to invest now. Instead, President Obama is going to tax oil companies. Now, other corporations are wondering if they will be slapped with windfall profit taxes. The US has the second highest tax rate in the world, it is highly regulated (OSHA, Sarbanes-Oakley, EPA), it has a highly paid workforce and escalating health care costs. Our high school graduates rank 17th in world in terms of intelligence. I’m trying to figure out why any company would want to invest here. Fortunately, we have the answer. We are going to chastise corporations that send jobs overseas. I predict that in future years you will see companies simply pull up their roots and move their corporate headquarters just as Haliburton did. I didn't intend for today's market commentary to be so political, but I'm concerned with what I see in the future. This week, the market will prepare itself for Friday's Unemployment Report. Tomorrow, we will get our first look at the job situation when the ADP employment index is released. We will also get the ISM services number. In the afternoon the Beige Book will be released and that could weigh on the market. Thursday's initial jobless claims number won't be included in Friday's number, but it will indicate what's to come. All of these releases will simply rub salt into the wound. The market has had a tendency to discount horrible employment news ahead of the number. Once the news is out, the market tends to calm down. We are currently in a deeply oversold condition and I believe that the panic will run its course and end with an intraday reversal this week. Watch for a big down move and a close higher. That will mark a short-term support level and we could see a rally from that low that lasts a week or so. Until we see that capitulation low, you have to keep your powder dry and look for stocks that are already forming support. When the bounce happens you will need to be ready to sell out of the money puts. The premiums are creeping higher and the risk/reward is improving for naked put selling. I currently have 25% of my position on and I am eagerly waiting for signs of support. Today, the market has reversed early gains and it is testing the downside. There's no reason to believe that the decline won't continue. If you are short, take profits during this decline. Keep your bearish trades on a very short leached because the snap back rally will be fast and furious. They tend to happen when all hope is lost and when bears have the highest degree of confidence.

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