Alcoa And Jpm Set The Lows In Q3 Will They Set The Highs In Q4

Thursday, October 08, 2009 Alcoa and JPM Set the Q3 Lows, Are They Going to Set the Highs in Q4? Alcoa beat expectations in Q2 and Q3 now. JPM beat analyst expectations in Q2 by 600%. The June swoon in equities ended on the reporting of AA’s and JPM’s July 8-13 earnings reports for Q2. JPM is a almost a lock to have another decent quarter. Commingled with JPM’s stellar Q2 earnings was banking analyst Whitney’s bullish call on the banking sector. Whitney got that call off “just in time.” On July 13 JPM earned 28 cents for Q2. Analysts have raised the expectations bar for Q3 as a result and expect JPM to report earning 49 cents for Q3 on Wednesday Oct 14. This raised expectation leaves room for JPM to disappoint investors. On Thursday October 15, Citi is expected to report losing -0.21 after earning a whopping 0.49 in Q2. Citi upside surprised analysts sandbagged earnings by 232%. In spite of the Q2 bullish earnings surprise for Citi, analysts have been busily lowering their earnings expectations bar for Citi in Q3. This makes it easy for C to underachieve. If they can’t walk over that lowered bar, god help them. Still, any losses would be bad when measured quarter over quarter or even possibly against the backdrop of the previous day’s positive earnings from JPM. GS is also reporting on Thursday October 15. They had record earnings of 4.93 a share in Q2 beating analysts’ expectations by 39%. Analysts have been raising their earnings estimates for GS over the past 90 days from 2.82 to 4.24, with most of the revisions coming in the last 7 days. You know, sandwiching C’s crappy earnings in between positive earnings from JPM and GS underscores one thing: the winners and losers in the financial system. Citi is a failed entity and only belongs in a socialist financial system, a capitalist system, not so much so. Bank of America will likely add another sour note to the end of next week. They earned 44 cents in March, 33 cents in June, and now are expected to lose -0.6 cents in Q3. If BAC’s earnings are below Q2 earnings, BAC will prove to have entered another earnings contraction/recession since Q1 09. Not so good and a poor way for the stock market to end the first full week of earnings. Like C, BAC only fits in a socialist banking system. As an aside, spearheading the effort to end our socialist banking system is FDIC Chair Sheila Bair, who said last night in NY, bank “resolution authority is clearly at the top of our list. Too big to fail needs to end.” Amen sister! Say a prayer her prayers are answered from above. The Arc of Tension The upcoming earnings season is building an arc of tension which I view as coming on in an anticlimactic sort of way. These are dull and boring. The offsetting Q3 earnings estimates from the Big Five financials indicate anti-climactic outcomes. Digressing again: we roughly know who are going to be the winners and losers in our socialist system. This is wholly unsatisfying. Instead of the financial system firing on all 5 (JPM, GS, C, BAC, and WFC) cylinders, two of them are backfiring. That is a bunch of crap that our policymakers built into the system when they decided to throw a TARP over the mess and pretend that the crap was all gone, that they could make the problems go away by hiding the toxic securities over on the Fed’s balance sheets, and stuffing hundreds of billions of taxpayer dollars into the banksters coffers and then let them borrow money for free at the Fed window so they can make a killing on the yield curve. And that is supposed to be palatable for public consumption. I think not. Back again:so, we are going to have a few winners and a few losers in this earnings season and this will be anti-climactic in a way that is really not very satisfying to either the bulls or the bears. 1

Let me explain. At this point, the stock market is so close to new move highs that we have to concede that new highs on the year are a distinct possibility next week. That means it is possible we will not see a secondary high form this week as I anticipated before the week began, which would result in a rotation lower into the Oct 14 retail sales and Oct 16 IP reports for September. Rather, it is possible that positive expectations from several of the winners are what is keeping the stock market so bid as we enter earnings season and offsetting the upcoming downside risks that we expect to see from the Sept retail sales, PhillyFed and Industrial Production reports.

Keeping and adopting open mind as to the actual outcome: a new move high next week, or a secondary high this week followed by a correction next week, we note that the strength of the rally off the October lows is showing a faster rate of change than the rate of change off the September or the August lows. This is not unusual to see this faster rate of change happening, but it is a bit surprising to see. This rate of change noted off the October lows is one of the reasons that I am amending some of my potential expectations or outcomes for the stock market outcomes next week. The other reason is that the earnings 2

expectations may be offsetting some of the crappy September economic data coming out next week. What I am doing is “reading the tape” and at the same time looking at the upcoming economic data and strategizing different scenarios. The first scenario is a secondary high this week followed by a correction next week. But that may not be plausible if earnings this week and next offset the bearish economic data points we know we will get from September retail sales. Another digression: whether one is a market forecaster, trader, investor, or all three, one must always be flexible with expected outcomes and by extensions one’s risk management strategies. That is why it is so crucial to have a very aggressive and defensive risk management approach. “Play great defense,” is what Paul Tudor Jones coaches. And if he coaches great defense, that is good enough for me. For example, (most investors and money managers do not do what Tudor does at all) short term traders are constantly being chased out of the markets whether on the long side or on the short side and having to adjust their positions until they get it “just right” for their swing or position trades to become decently profitable. If they do their job well, they didn’t lose any money getting positioned just right. Thinking and acting like Paul Jones or a local market maker can be one of the keys to success in both investing and trading. You trade back and forth, in and out, until you get the position on just right for a swing trade, trend trade, or countertrend trade. Back to the matters at hand: Let’s assume this secondary high idea does not work. Not a problem, we are flexible, and we are playing great defense with our risk management, so we don’t get hurt if we are a tad bearish at the moment up here. So, the market marches up to new highs next week. What should be the obvious target? It should be the bearish close gap on the weekly SP500 chart at 1102-1108 (pit session only 1104-1108 on electronic). Incidentally, the 1.41 external retracement is sitting at 1103. That is the SP500’s favorite external ratio this decade. Last decade it was 1.27. Now let is consider what happens once the “rush” to new highs is over. I have had several brief conversations with a SP500 trader in the past few weeks about the remote possibility of an October high. As the possibility becomes less remote, it is now on the front burner. From his point of view, we could set the high of the year in October and then have a serious retrenchment in equity prices going into year-end. This happened on Thursday October 11 2007. We have many other mini-crashes in October as well. The 15% Asian Contagion crash that began on Oct 7 1997 comes readily to mind. We can’t entirely dismiss the potential for a sharp and sudden break in the stock market from an October high, and we might trade for that, but I think that moment has passed with the October 2 NFP low. Nothing But Milk Toast on the Horizon into Year-End Here is why. From what I can see on the horizon into year-end, stock market participants will be getting nothing but milk toast from the economic data. If there were going to be gut-wrenching bullet points that the big boys would have a need to hedge their portfolios against (say for example the monoline insurers they hedged against in Q4 07) between now and year-end, I’d say a sharp and sudden break could be possible. A mix of less bad and less good news, into year end, however are merely offsets that cancel the bearish scenarios out. The see-saw effect of these kind of oscillations points Nor’East on the chart. For this reason, if we set new move highs on the year next week, the market sells off, but roughly no more than 4% to 6%. Then it should just continue its grind higher as everyone settles into the reality that this year the stock market landed on its feet in 2009 and the high frequency trading systems lock up the trade. We have had plenty of low volatility examples of this in recent years. The correction from Wednesday Oct 15 to Friday Oct 24 2003 is a key consideration, because the summer of 2003 was the beginning of the last 3

manufacturing recovery, same as the summer of 2009. If we look in the manufacturing recovery mirror, we should not be surprised to find some similarities in market behavior around this earning season. Oct 6 to Oct 25 2004 was another low volatility pullback. Both pullbacks in Oct 2003 and Oct 2004 ended around the same time, and we should note the potential for a similar pullback to end around Oct 25. A low volatility end to 2009 is cool with me. I can sure stand to see the markets quiet down a bit into year-end. Things will pick right back up in the January anyways at the onset of the Q4 earnings season. Because Q4 08 and Q1 09 were the earnings season troughs, the way I see it from October 2009 as that those two earnings seasons will be friendly to the stock market and will buoy the market in the first half of the year. Beyond that the risks should begin shifting to the downside, so the bulls may not like the second half of 2010 or 2011. October 14 Retail Sales and FOMC Minutes Incidentally, Wednesday Oct 14 is also the Sept retail sales report and it is the release of the Sept 23 FOMC minutes. The high of the year was set on the Sept 23 FOMC meeting when Bernanke announced mission accomplished, the recession was over. We could see an anti-climactic Redux of that. Further, some of our better breaks this year seem have followed retail sales reports, specifically June 11 and August 14.

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