Monday, December 17, 2007

Stock Market Update 17 December 2007

It was a very interesting week in the markets last week and where we go from here is somewhat cloudy.

The highlight was the FED meeting on Tuesday where they announced they would cut both the FED Funds rate and the Discount rate (the rate the FED charges the banks if they come looking for a loan, also known as the "discount window") by 25 basis points each (1/4%). The market was expecting a 50 basis point (1/2%) cut on both rates and when it didn't get what it wanted it threw a temper tantrum.......stock prices plunged.

The following day the FED announced it was joining with 4 other Central Banks around the world to offer "liquidity" to banks via a new central bank auction function.

Without all the mumbo-jumbo; here is essentially what is happening:

-banks do not trust each other because of the SIV problem and all the mortgage issues I detailed previous

-because they don't trust each other, they are not willing to lend to each other

-when this happens, the flow of money ceases and a deflation occurs

-banks can still go to the FED as a "lender of last resort", but any loan they get from the FED through the discount window is required to be public knowledge......therefore any bank that goes to the FED for a loan is essentially broadcasting to the world they are in financial difficulty....what bank wants to do this?

Answer.....none........so instead of working to fix the problem the banks are sitting on their hands and hoping for the best (preserving their cash) while looking to the government (FED) to do something to help them out. This the FED did in the announcement of the new forthcoming Central Bank auctions.

The 5 central banks (U.S. Central Bank, U.K. Central Bank, European Central Bank, Bank of Canada, Bank of Switzerland) will be offering $80 billion in 4 auctions ($20 billion per auction; the first of which occurs today) in an attempt to provide liquidity into the system to get the credit processes moving again. They will accept basically anything of "value" (including those mortgage backed securities that have unknown value) in exchange for a loan. In addition, unlike the loans from the discount window, these loans will not be public knowledge so you won't know which banks are in trouble and needing these loans. Neat way to circumnavigate the existing laws that require the credit system to provide full disclosure to the public.

In any case, there is a huge amount of uncertainty in the markets right now. However I am comfortable the charts have kept me in the right place for now.

First chart is the DJW 1 year line chart (click charts to enlarge):




The key thing to note is while the price advanced from the mid-November bottom and broke through the 50 day moving average, it did so without the ADX (14) green line having extended above 60. This indicated to me that while price was rising, the underlying demand structure was not supporting the rise (in other words; the dumb money was buying while the smart institutional money was not). As such, the move was somewhat suspect.


Note the bottom of the mid-November price was 292.17. Any close below this point would be a "lower high, lower low" and would indicate a bearish declining price scenario. More on this next.


Next chart is the PNF 1 box chart:


This chart went "bullish" on the price break above 305. Normally had the line chart previous confirmed the move, I would have moved to a more aggressive equity position but since the line chart did not confirm, this move is somewhat suspect.


The key to note here is the current structure is a series of "O"s...... a continuation and break below 293 (ie. a price print of 292) would change this chart to bearish.


Next chart is the PNF traditional:


Here too the current trend is bullish. However, note this chart has formed a series of "O"s. This unto itself is not a big deal (normal in a rising market) but what is important is this chart would turn bearish on a price close in the next block below that which it currently is at and that is........292.


So we have 3 independent charts that indicate that a price break below 292 would be a very negative indication of a trend breakdown (both short term and medium term).


Final chart is the weekly chart back to the start of the bull market rise:


This chart still looks ok as long as the 13 week ma does not cross the 34 week ma. Should this occur it would be a tremendous indication things are turning for the worst.


Bottom Line:
The markets are at a crossroads:


"Glass half full" view:
In spite of all the banking mess over the past 2 months, the markets have failed to fall. They are still holding their own which is amazing given all that has been thrown at them.


"Glass half empty" view:
The markets have yet to see the real impact of the sub-prime fiasco. The mortgage rate resets next spring/summer will be huge......there is a very real chance at least one major bank will fail and the U.S. will go into recession.


My position remains unchanged:
50% equities
25% Euro
25% USD


Should the DJW close below 292 I will reduce my exposure to 25% equities. Any 13/34 cross on the weekly chart and I will be 100% in cash.


Any closing price above 312 and I'll go to 75% equities as long as the line chart confirms the move. Any closing price above the all time high at 320 and I will move to a 100% long equity position.


Any moves I make will be blogged as soon as I have decided to make them.

Monday, December 03, 2007

Stock Market Update 03 December 2007

As mentioned in my previous posts, I am still long term bullish on today's markets. However, there are unique and dangerous developments within the U.S. banking system that have yet to be sorted out.

As such, I firmly believe that those who are risk averse need to seriously consider whether they want to be invested in equities at such a potentially dangerous turning point in the worlds economy.

Personally, I will continue to follow my charts and invest accordingly. I must stress though that I do this knowing I am doing so in a highly volatile and potentially dangerous market. Enough said I think.

Now on to the charts.

First is the DJW daily chart (click charts to expand):


As can be seen, the chart is still showing a bearish bias at this point. However, there are a number of positives to note on the chart:

-the decline seems to have been stopped at the 61.8% Fibonacci retracement level at 293.66. The 61.8% Fib is usually one of the strongest areas of retracement reversals and if this one holds it could signal the end of the current downtrend,

-the MS World index (shown at the bottom of the chart) appears to have reversed on the 50% Fib,

-the RSI has crossed above 50 and is nicely trending up,

-the ADX lines have crossed, indicating a "neutral" indication,

-the MACD has crossed over, indicating the downward momentum has reversed.

This chart would again become bullish if the price crosses above the 50 day moving average (blue line currently at 308.58) and the green ADX line crossed above 60. Both these occurring would put the index back into a short term bullish bias.

Next chart is the DJW 1 box PNF chart:


Here it can be seen that the chart is still on a sell signal that was generated when price broke below 311. Since then, 2 attempts have been made to break the 305 level but have failed. A closing price above 306 would produce a bullish short term buy signal.

Next chart is the DJW PNF Traditional chart:


Here it can be seen the medium-long term is still bullish. Under the current configuration the price would have to break to the 276 level to signal a sell signal. For now this one is bullish still.


Next chart is the DJW-YEN ratio chart:


As I mentioned previous, this chart has a really good track record of being on the right side of the trade as far as the Yen carry trade is concerned. It currently is bearish but the RSI correcting downwards as it is should eventually allow the ratio to cross the 50 day moving average (blue line). When this occurs it will be a bullish buy signal but for now this chart is still bearish.

Next chart is the longer term view of the DJW in a monthly candlestick format:


Note the market tried once again during the month to challenge the 12 month moving average. It was able to "put a pin" through it (as it has done several times before) but by the close of the month the price was once again above the 12 ma. This is still bullish.


Bottom Line:

My positions are unchanged at 50% equities, 25% Euro cash, 25% USD cash. Should the markets rally this week and we print a closing price in the 306 area (turning the 1 box PNF chart bullish), I will shift into a 75% equities position (most likely selling my Euro holding as it has done well but is severely overbought).

On the downside, should the markets print a low below 292 I would be tempted to move to a 25% equities, 75% cash position. A close near 276 would get me totally out of equities and into cash or bonds.

Interesting Bank developments over the weekend

Looks like a possible bailout of the banks and subprime borrowers may be in the works as of today.

This could be a bullish development for the stock markets and would address some of the concerns in my Risk vs Reward update yesterday.

Charts to come soon; for now still looking neutral to slightly bullish short-medium term.



Paulson Crafts Subprime Deal to Prevent Second Bush Recession
By Kevin Carmichael and Rich Miller

Dec. 3 (Bloomberg) -- U.S. Treasury Secretary Henry Paulson, struggling to prevent a second recession in the presidency of George W. Bush, will today discuss plans to keep troubled subprime borrowers from losing their homes.

The Treasury is negotiating with lenders to fix interest rates on some mortgages to prevent a surge in defaults as borrowing costs on 2006 loans rise from initially low rates. Paulson speaks at a conference in Washington at 10:30 a.m.

Paulson and Federal Reserve Chairman Ben S. Bernanke are concerned that falling home values will throttle consumer spending, which has driven much of the six-year expansion. By heading off further deterioration in the $11.5 trillion mortgage market, officials are also aiming to stem losses on securities backed by subprime loans.

``They were caught behind the ball and now they're trying to catch up,'' said Daniel Clifton, head of research in Washington for Strategas Research Partners LLC, which provides economic and policy research to institutional investors. ``The initial assessment both from Bernanke and Paulson was that this was small and isolated.''

The two spent most of the year playing down the risks that the real-estate downturn posed to growth and financial markets. On June 20, Paulson said ``we are at or near the bottom'' of the housing decline, while the Fed insisted in early August that inflation was the biggest danger. The central bank has since cut rates twice, and may do so again on Dec. 11.

Foreclosures Climb

U.S. home foreclosures almost doubled in October from a year earlier as subprime borrowers failed to make higher payments on adjustable-rate mortgages, Irvine, California-based RealtyTrac Inc. said on Nov. 29.

Subprime loans, given to people with poor or incomplete credit histories, typically offer a low introductory rate for the first two or three years. The rate then resets for the duration of the mortgage, usually 30 years. About 100,000 such loans will reset each month over the next two years, according to research by UBS AG.

``We need to do everything we can to help get the industry ready to meet the growing number of resets that are going to be coming,'' Paulson said in an interview with ABC News on Nov. 30, according to a transcript on the network's Web site.

Sheila Bair, chairman of the Federal Deposit Insurance Corp., has been working with Paulson and favors extending introductory rates for between five and six years. The Office of Thrift Supervision, which hosts today's conference, advocated a three-year freeze.

Kroszner Frustrated

Three months ago, regulators asked lenders to work with borrowers to minimize foreclosures. They have been disappointed by the results. ``It would behoove the industry to go further than it has,'' Fed Governor Randall Kroszner said at a forum in Philadelphia on Nov. 30.

The negotiations have become more urgent as the economy falters after a third-quarter spurt. Growth may cool to an annual rate of less than 1 percent in October to December, economists say, following an expansion of 4.9 percent in the prior three months.

David Rosenberg, North America economist for Merrill Lynch & Co., is among analysts who foresee a recession next year. The last recession was from March to November 2001, according to the National Bureau of Economic Research, the arbiter of U.S. business cycles. The last president to oversee more than one recession was Dwight Eisenhower, who served from 1953 to 1961.

Evolution of Policy

``Early on the administration was seemingly worried about interfering too much and too early, and leaving themselves open to the charges of a bailout,'' said Michael Barr, a professor at the University of Michigan Law School and a former aide to Robert Rubin, who was President Bill Clinton's Treasury secretary from 1995 to 1999. ``I'm glad that Treasury is now at the table and pushing this.''

Paulson, 61, said in the ABC interview that homeowners who can tolerate higher interest rates won't be offered a ``freeze.'' People who are unlikely to be able to keep their houses even if rates are fixed will also miss out.

``We're focused on those in the center -- the middle group -- that are going to have a problem meeting their payment,'' he said.

Political Context

For the Treasury and the White House, failure to broker a voluntary accord would give Democrats in Congress an opening to capitalize on the downturn. It may boost chances that Congress passes a bankruptcy law that bypasses lenders and bondholders and allows judges to change loan terms.

``Voluntary loan modifications under regulatory duress is a softer version of the `cram down' bankruptcy bill being considered in the House,'' said Andy Laperriere, Washington- based managing director at International Strategy & Investment Group.

House Speaker Nancy Pelosi, House Financial Services Committee Chairman Barney Frank and other Democrats plan this week to call for foreclosure prevention, quicker loan modification and increased aid to distressed homeowners.

Democratic presidential candidate Hillary Clinton is expected to call for a 90-day moratorium on foreclosures and a five-year hold on adjustable mortgage rates, the Wall Street Journal reported, citing an interview with the New York Democrat.

To contact the reporters on this story: Rich Miller in Washington at rmiller28@bloomberg.net Last Updated: December 3, 2007 00:09 EST

Sunday, December 02, 2007

Risk vs. Reward

Risk versus Reward

The stock markets have been showing signs of a short term recovery over the past 2-3 days.


As I stated previously on this blog, I expected the markets to fall into a corrective cycle (as they have done) followed by a rally into year end (which is what I think we are setting up for now). HOWEVER, while that is encouraging, I am not confident this is sustainable and the current financial situation worldwide deserves very careful consideration.

I will post the charts soon but for now I want to go beyond the usual technical analysis to give you a bit of a top-down view of what I see happening currently in the worlds financial markets.

Please note I am not calling for the end of the world as we know it………the doom and gloom types have been wrong so many times over the years it is comical. HOWEVER, I have a very bad feeling that this time it could very well be different. As such, I cannot stress how important vigilance is to the current situation and being able to analyze the potential outcomes.

Bottom Line: I truly believe now is not the time to be overly aggressive in equity positions. If I’m right, this could save you a fortune (50% + in your accounts). If I’m wrong (which I truly hope I am), this could cost you next to nothing in terms of lost capital gains if you are in cash. Because we are dealing with pensions here, I feel I would be remiss if I didn’t err on the side of safety when talking about the current market situation and the possible outcomes.

I am not sure how many of you have been following the various gyrations in the banking/financial system over the past month. This is a rather lengthy but simple (I hope) summary to explain what is happening, where we are currently at, and most importantly where we might be going. Hold on tight; this is not for the faint of heart.

As you all know, this mess started years ago (2002) when the Federal Reserve decided to lower their rates to historically low levels. This was done to restore confidence in the American consumer to stave off a recession. As a consequence of their actions, the FED did indeed avoid a recession but in the process produced a much bigger and more dangerous bubble in the form of the housing bubble.

The setting of interest rates well below “neutral” encouraged two types of purchasers. The first is those who didn’t have a home; the traditional low income “renter”. This group should never have been able to purchase a home in the first place but due the very low interest rates combined with “no doc” liar loans (those loans where you signed a piece of paper stating your income but in no way did you have to actually prove what you stated you earned) combined further with “teaser rates” (those where the initial interest rate for the first 2 years is low but then resets to a much higher rate) combined to allow these people to qualify for mortgages they would never have been able to get in the "real" world. Plain and simple; they should never have been able to buy a home but the system allowed them to. They are now defaulting in record numbers.

The second groups are those who were home owners with good credit scores. These were the “flippers” who purchased multiple homes with very little-to-no down payments in the hope of flipping them quickly for a profit and not having to make payments on their purchases. This worked until the music stopped and they were left holding inventory in a declining housing market. They are now dumping those unit’s into a falling housing market.

At some point the process had to reverse. This is now ongoing. Those who never should have owned a home in the first place are now not making payments on their mortgages and are facing foreclosure. Those who have multiple units (the flippers) are now offloading their units at a loss into a continuing falling market. The end is not in sight yet.

On the mortgage side of the question, here is what happened. In an attempt to spread both the risky and sound mortgages amongst a large amount of investors (which, in theory is a good thing), the investment banks took these mortgages and “bundled” them in “tranches”. In other words, they took some very strong mortgages and bundled them with some very weak mortgages. Then they did some financial engineering within these bundled investments (by writing various derivatives upon those loans known as credit default swaps) to “counteract” the effects of any defaults within those bundles. So far, so good.............as long as everyone "sips from the same kool-aid".

At this point they sent them off to the rating agencies to be rated. Due to the “financial engineering” within these tranches, what would normally have been a bundled mortgage tranche classified as a BBB or less (ie, "junk bond grade") instead was turned into an "investment grade" bond product due to the derivative function built into the product. In short, the rating agencies were “encouraged” via the obscure countering nature of the derivative function within the tranche to rate these structures at a much higher rating level (AAA or AA) than these bonds were deserving of. Also another reason I'm sure this was done was because of the substantial fees the rating agencies earned as a result of the shear volume of these “investment grade” products they turned over (as investment grade products, due to the their perceived safety, have a much wider audience to sell to as many conservative investment funds cannot accept bonds below investment grade) .

Once the bundle was rated, it was sold by the investment banks to various conservative investors, pension funds, money market accounts, etc around the world (many of which thought they were buying a AAA rated bond portfolio where in fact they were buy a junk portfolio dressed up as a AAA rated bond portfolio). These are known as known as Mortgage Backed Securities (MBS) and also Structured Investment Vehicles (SIV’s).

Everyone was happy with the deal as long as the housing market continued to expand and everyone was making tons of money. The problem now is the U.S. housing market is in a full blown recession (maybe soon to be depression). Mortgage defaults are skyrocketing and prices are plunging. Many of these “investment grade” bonds are now worth a market value well below face value (in some cases only 25 cents on the dollar) and the banks and brokerage firms who hold them are in big trouble. This is not just a few banks or a few brokerages; it is ALL OF THEM.

The combined write-offs to this point have been in the range of 50 billion dollars. The expected write-offs could top 600 billion dollars. The problem is no one really knows what the real number is for one very good reason; NO ONE REALLY KNOWS WHAT THESE THINGS ARE REALLY WORTH.

Because the market for these products has seized up, the banks who are holding them don’t want to sell them into the market as they know they will only get 25 cents on the dollar for them. No one wants to take the loss on these things. Those banks that can hold on at this point are sitting on them or taking limited write-downs and praying this whole thing blows over (or until the government intervenes to save them). In an effort to do so, they are doing something called “mark to model” which means they are reporting their holdings in these products based upon their theoretical market model value as opposed to a “mark to market” valuation where they would be required to report their price based upon the current market value. In other words, they are lying in an attempt to stave off having to admit the true value of their holdings are well below that which they are currently reporting.

At this point, trust is broken. One bank won’t lend to another bank because he doesn’t know how much the other guy is lying about his holdings in these things. He is wondering if he lends to the other guy whether he will ever see his money again. That in a nutshell is what is happening currently.

No trust = no lending........No lending = no credit...........No credit = no money flow..........No money flow = deflation.

While there have been many write-downs over the past month, here is the latest example this week.

First, Citibank (the largest bank in the U.S.) was given a cash infusion of 7.5 billion dollars by the Abu Dhabi Investment Authority. The stock market went up substantially as it was viewed as “trust” in Citi by the ADIA. What was missing in all this “happy news” is that the interest rate the ADIA insisted upon for their investment was 11%! This is not a normal loan; this is a loan shark loan. This shows you how tough things are right now at the biggest bank in the U.S……..and where does that leave the smaller banks if Citi needs to do this to attract capital?

Second, E-Trade announced it was getting an “investment” from a hedge fund called Citidel. What they did was unload 3 billion in mortgage backed securities (mostly composed of HELOC’s; home equity line of credit loans) to them for 800 million dollars. That is 26 cents on the dollar. The real problem is most of these loans were made to real homeowners with real equity in their homes; not the more toxic loans that were made to those who should never have gotten the loans in the first place. So the question that begs to be answered is……..if these “good” loans are currently marked to market at 26 cents on the dollar, what are the more toxic ones really worth? And what about all those other banks (ALL BANKS) who also hold HELOC’s……….the market is telling us their holdings are now worth 26 cents on the dollar; whether they want to admit it or not.

One example; Washington Mutual is a large U.S. bank heavily involved in the mortgage market. Their current “loans held for investment” (of which some are HELOC’s; how much they are not reporting) are $237 billion dollars mark to model; based upon E-Trade and their latest sale the true mark to market value of those loans is $165 billion less than what they are valuing them at. Problem is…………Washington Mutual’s current net assets (assets minus liabilities) are $24 billion dollars. Even if only a portion of their loans are HELOC and they decided (or were forced) to mark to market, they would be bankrupt.

They are only one example of many and that is why this banking crisis is so important. Where could this all end? Recession/severe recession/1930’s style depression. The degree is unknown; all that is known is this is BIG TROUBLE.

So what needs to happen? Here is a cut and paste from someone who put it in very easy to understand terms:

------------------------------------------------------------------------------------------------------------

They know what is coming! Did you see Kudlow last night? He, and the rest of his crowd, were clamoring not for a rate cut but for 100 to 150 bips of rate cut - right now!
Why?


Because they know what's coming. A massive recession. Bank failures - lots of them. Perhaps even a DEPRESSION.

But, you sputter, can't The Fed fix this? Save the day? Ride to the rescue?
No, it cannot.


What has to happen?

The Fed needs to step in right now and force all of their "bank customers" to take ALL of their off-balance sheet crap back onto their balance sheet and mark it to the market.

Right now.

Period.

If this forces some of them out of business, then so be it. The FDIC will not fail in this situation, contrary to some of the doomsayers. The FDIC's "formula" is to merge the insolvent organizations, using whatever value is left to make those with under $100,000 in deposits whole, while throwing under the bus the common equity holders, any preferred equity holders, and everyone else who happens to have a putative "claim" on the bank.

This is the only way to fix the problem, and whether Bernanke (and Paulson) like it or not, it is what is going to happen.

Lending will not return to normal until confidence returns and confidence requires transparency and truth. So long as market participants continue to lie and obfuscate, lending will remain locked up. PERIOD!

The only choice is to either force transparency now in a manner that is somewhat controlled or we will continue to spiral downward into the dirt, with the disclosure and cleaning out happening through bankruptcy as we reach the depths of a DEPRESSION.

Yes, I used the "D" word.

If The Fed doesn't quit screwing around and act NOW, we're headed for one.
1930s style.


Ben, wake the hell up. The answer isn't playing with system liquidity.

YOU ARE FIDDLING WHILE ROME BURNS.

The problem is that everyone involved in this mess on the banking and "investment" side has been lying through their teeth. E*Trade is just one example - not two weeks ago their CEO said "we could suffer $1 billion in writedowns and remain well-capitalized", strongly implying that the damage was less than that.

Well, guess what - less than two weeks later they sold $3 billion "worth" of loans for $800 million. That is $2.2 billion in direct losses, or more than double what they claimed their maximum exposure was just two weeks before!

IT IS ALL LIES!

Let's count a few of them:

· Treasury (and others) - "Subprime is contained"; "Housing will turn around this year"; "there's no impact on the rest of the economy." All lies.

· Bernanke - How many do I need to count? Testimony in front of Congress that is just flat false. How about a contempt citation guys?

· CEOs up and down the line. Too many bad press releases to count. AHM anyone? CFC? Projected profits for 4Q? All the investment banks taking writedown after writedown, one after another.

· E*Trade, as I noted - "We can absorb more than $1 billion and remain well capitalized", strongly implying that the damage was less than that. Now we find out its $2.2 billion - and we don't know if they're done. I moved my accounts; that proved to be false statement #2; you don't get to bullshit me more than once!

I'm tired of this crap, you should be tired of this crap, and those who are buying this "rally" when every institution that has made claims that they have their exposure under control ends up being shown to be a LIAR as soon as a week or two later, are just plain fooking stupid!
(Oh, and don't look but metals are getting SMASHED today. I told you so.)


Deflation is in our future - the worst-case scenario for anyone in debt. Why?
Because our government is refusing to do its damn job of regulation and has refused to get the handcuffs out and slap 'em on the CEOs and others who have made these insanely-rosy projections and statements, while at the same time encouraging and enabling the hiding of liabilities!


As such confidence has collapsed between parties in the market, and this WILL lead to a collapse in lending and credit - the destruction of money, which is the definition of deflation.
It has already started and is going to get MUCH worse.


If you're in debt and can't get out, you're finished. Sorry; that's how it is.

If you can get out of debt in the next few weeks and months, do so. If you have cash, conserve it. Save. Keep your powder dry. Do not be stupid and listen to people like Cramer who said last night that "cash will be the biggest losing asset class."


Bottom Line:

The markets appear to have entered a corrective bullish uptrend. Under “normal” circumstances, I would be all over this banging the drum to buy equities. However, given the current unique situation I think it is wise to re-assess your current positions.

In my case, I will follow the charts and if they direct me to increase my equity exposure I will do so (and those who are willing to risk their positions; I invite you to join me). However, should this turn for the worst I will be out in a flash.


For those who are risk adverse, I would highly suggest you be very careful with your equity exposure at this point. Should you be in cash and this crisis happens to blow over or be contained……..you will have been in cash and side-stepped a unique financial crisis that was averted. However, if this thing turns nasty…..you’ll be thanking your lucky stars you were in cash when the deflationary collapse occurred.

As always, I am not currently offering financial advice. I think it is up to each of you to assess your own unique position/risk tolerance and decide if you want to be aggressive into a highly explosive financial crisis or safely positioned in cash.

My current position as of tonight remains unchanged at 50% equities/25% USD/25% Euros. As soon as this changes you will know.

Your email address:


Powered by FeedBlitz