Market looks extended

Charts: The S&P 500 closed at 954, down .05%. XLF (financial index) closed at 12.14, up .08%. The broad index continues to fight with resistance at the top of the 922-955 trading channel. As I’ve been saying, it needs to struggle and consolidate, not blithely blow past resistance. The Nasdaq has had its longest winning streak in a decade. The market is looking extended after the massive recent gains but overall the technical picture is bullish.

Fundamentals: Crude oil inventories in America rose to a 19-year high in the middle of the summer driving season and Apple reported blow-away earnings. These two news items are related; they represent permanent structural changes in America’s economy and consumer behavior. Another example of this seismic shift is the company Polycom (PLCM), the maker of video-conferencing equipment. Don’t drive or fly to a business meeting, instead hook into the web and have a virtual meeting. Polycom is up over 70% year to date.
Structural shifts represent creative destruction. Some companies get hurt with these changes. The weakness in commercial real estate that is weighing on the financial sector may be a long term casualty as online shopping replaces mall crawling. On that note let’s take a look at Goldman Sach’s recent earnings report. It took $1.4 billion worth of markdowns in its commercial property portfolio. Because mark-to-market accounting standards have been relaxed other banks value similar assets at twice the value that Goldman does. So this is a hidden danger that we must be aware of.
CIT Group is not out of the woods. The financing that it is securing for its rescue carries an average interest rate of about 13%. The loans it makes to small businesses pay a much lower rate, so it is digging itself into a hole. Over 1 million small businesses depend on CIT. If it goes bust the ripple effect will be bigger than investors seem to think. And finally, Wells Fargo reported today that non-performing loans rose 45% over the last quarter, completing the picture of genuine weakness in the financial sector.

Geopolitics: The US Marine Corp’s offensive in Afghanistan can be translated as “Thrust of the Sword.” The Taliban tells us that its counter-strategy is called “Iron Net.” The bad guys seek to tangle the sword in a net, avoiding set piece battles with the Marines. Instead they are attacking soft targets throughout the country and using hidden roadside bombs to kill Marines. Unfortunately, it is a smart tactic because America and NATO still don’t have enough boots on the ground to truly occupy the country, allowing the Taliban freedom of movement. But in nearby Pakistan the Paki Army does have the manpower to crush the bad guys and truly occupy conquered territory. This week the Paki Army has killed nearly 100 bad guys. The total bad guy body count in Pakistan will soon reach the low single digit thousands. The number of bad guys surrendering to the Paki Army and being taken prisoner is steadily climbing, reaching over 500 in the Swat Valley alone in the last few weeks. Paki authorities report that 90% of these bad guys are Afghanis. Therefore the Paki Army is obviously taking pressure off NATO in Afghanistan.