Saturday, January 12, 2008

Last Week's Market Action

Although the ride seemed pretty wild last week, pulling back it seems much more logical. Simply put, the markets consolidated.

All three charts show a clear triangle/rectangle consolidation.

However, let's add one complicating factor.

Money is clearly moving into conservative areas of the market. That means traders are getting more and more concerned about the underlying economic fundamentals.

Finally, here is a link to a piece I wrote on Thursday about my theory of the market. Basically, the market is already in a correction and is in the middle of a lower low/lower high move.

Friday, January 11, 2008

Weekend Weimar and Beagle

The markets are almost closed. So -- it's time to stop thinking about them or the economy. Do anything but that.

So, here are some pictures of my and the future Mr$. Bonddad's four legged kids.

This is Kate in a very comfortable position.

This is Scooby playing with one of her favorite toys

And this is Sarge, relaxing

What Inflation?

From CBS:

Gold futures topped $900 an ounce for the first time ever on Friday on speculation that the Federal Reserve will further cut its key interest rates, weakening the value of the dollar and increasing the appeal of gold as an investment haven.

Gold for February delivery gained $6.5 to 900.1 an ounce in mid-morning trading on the New York Mercantile Exchange. It was last up $5.4, or 0.6%, at $899. Gold closed Thursday's trading at a record closing level of $893.6 an ounce.

In a speech to a business group in Washington, Fed Chairman Ben Bernanke said "In light of recent changes in the outlook for and the risks to growth, additional policy easing may be necessary," Read text of Bernanke's remarks.


The dollar index, which tracks the value of the greenback against a basket of other major currencies, earlier dropped to 75.785, the lowest in one week. It was last up slightly at 75.975.

But remember -- there is no concern about inflation, despite Gold's chart.

Note the following:

-- There have been five upward gaps since mid-December

-- Prices are higher than all the simple moving averages (SMAs)

-- The shorter SMAs are higher than the longer SMAs

-- Prices have clearly broken out from their triangle consolidation of November/December

And the dollar is still in a multi-year downtrend.

Note the following:

-- Prices are below all the SMAs

-- The shorter SMAs are lower than the longer SMAs

-- Prices are below the 200 day SMA

-- There is a clear, multi0year pattern of lower lows and lower highs.

Expect both of these trends -- higher gold and a lower dollar -- to continue is the Fed continues cutting interest rates.

Herb Greenberg on the Countrywide Deal or Was/Is Countrywide Bankrupt?

From his market blog

1. The Fed is behind the deal. (Today’s thought: It’s as likely as yesterday.)

2. The Fed is behind the deal because the rumors yesterday of a near bankruptcy were probably true. (Based on the price, it would appear more evident than ever.)

3. As part of the deal, the government likely agrees to guarantee BofA against Countrywide-related losses. (There was nothing in the press release about that, so let’s give them the benefit of the doubt and say BofA is shouldering all of the risk and at this price it believes the risk is worth the reward.)

4. Lost in the in the noise yesterday was that Moody’s downgraded the ratings on 30 (count ‘em — THIRTY!) tranches of Countrywide’s mortgage debt by more than a few notches. They did something similar before American Home Mortgage filed for bankruptcy. (Remains as telling today as it was yesterday.)


8. BofA gets a free bank and a put to the government. (Make that a free thrift on the former; unclear on the latter.)

I have no idea if it is true or not. To back up Mr. Greenberg's thesis here are a few facts.

1.) Hank Paulson was a former Goldman "big guy." In other words, the Treasury Secretary probably knows all of the other financial "big guys" out there, so making a few phone calls on private lines is a definite possibility.

2.) Bank of America is already way down on it's initial investment in Countrywide; they are now doubling up on a big losing bet. Barry over at the Big Picture made this observation:

After that initial disastrous buy in at $18-20, BoA is doubling up -- at $6 . . .

3.) Let's look at a chart of Countrywide:

Notice the massive volume spike a few days ago that bankruptcy rumors caused. Countrywide denied these rumors, but to no avail. Now, were they true? The B of A deal indicates they may well have been. Moody's downgrade bolsters this argument.

Let's go back to the fact that Bank of America's original purchase was three times higher than the price they are currently getting for CFC. That's a huge discount and should raise more than a few eyebrows. Remember one of Bonddad's (and practically every other traders) primary rules of trading -- cut your losses. BAC is adding to their losses right now. That's not exactly the smartest move they could make, unless they are getting something for their investment that is worth the loss

Credit Card Issuers Warn

From IBD:

Heightening fears that credit woes are spreading past mortgages, American Express (AXP) said after the close it's "seeing signs of a weaker U.S. economy." It'll take a $440 mil charge on slower spending and rising delinquencies. Earlier, Capital One (COF) cut targets for the 3rd time in 9 months and set aside $650 mil for unpaid credit card bills. AmEx fell 7% late. MasterCard and Capital One also slid.

I doubt it will be long before we hear more of this type of warning.

The Writedowns Continue

From Bloomberg:

The world's biggest financial institutions have announced about $100 billion in writedowns and loan losses sparked by the U.S. subprime mortgage slump. Zurich-based UBS AG, Europe's biggest bank by assets, said today this will probably be another difficult year for the industry, urging shareholders to back its plan to raise $11.8 billion from Singapore and the Middle East.

It's taken us about 6 months to get $100 billion in writedowns. Total estimates for the writedowns have ranged between $300 - $500 billion. So assuming the same time scale we have about another year of writedown news. Well, let's start the year off right, shall we?

Merrill Lynch & Co., the third- largest U.S. securities firm, may write down $15 billion related to U.S. mortgage losses, almost twice its original forecast, the New York Times reported, citing people briefed on the plan.


Citigroup, the biggest U.S. bank, may post about $14 billion of writedowns when it reports fourth-quarter earnings next week, JPMorgan Chase & Co. analysts estimated today. Bank of America Corp. may announce writedowns linked to collateralized debt obligations of about $5 billion, they said.

Personally, I wish every bank would come out and say, "we're taking a really big hit this quarter of XX%, but that's it." Just get it over with. Instead, we're in a slow bleeding scenario where the markets have no idea when the next writedown will happen or how much it will be.

Thursday, January 10, 2008

My New Market Thesis

So -- where are we with Mr. Market? I have a theory which I will outline. Basically, we are already in the middle of a correction.

First, consider the following:

Merrill, itself one of Wall Street's biggest casualties of the sub-prime crisis, is the first major bank to declare that a recession in the world's biggest economy is now underway.

David Rosenberg, the bank's chief North American economist, argues that a weakening employment picture and declining retail sales signal the economy has tipped into its first month of recession.

Mr Rosenberg, who is well-respected on Wall Street, argues: "According to our analysis, this [recession] isn't even a forecast any more but is a present day reality."

And this

Goldman Sachs yesterday joined a growing chorus of top Wall Street investment banks that are now forecasting the US downturn will turn into a recession.

Morgan Stanley was the first top investment house to forecast a recession,
while long-time bears Merrill Lynch said following the latest jobs report that "recession is no longer a forecast but a present-day reality."

In a note to clients, Goldman said: "We expect economic activity to contract modestly through late 2008, followed by a gradual recovery in the course of 2009."

Bill Poole, president of the St Louis Federal Reserve, acknowledged the risk of recession but said it was still "too early to tell" whether the housing-related problems would push the US into one.

And from today's WSJ:

Economists surveyed by The Wall Street Journal see increasing odds of a recession this year along with mounting inflationary pressures, an uncomfortable mix that could play a role in shaping the 2008 presidential campaign and complicate life for the Federal Reserve.

In the latest monthly survey, economists put the chance of recession at 42%, up from 38% in December and 23% just six months ago. On average, the 54 forecasters who participated see the economy expanding at less than a 2% annual rate in the first and second quarters. Last month's survey estimated 2007 growth at 2.5%.

Short version: There is an awful lot of recession talk in the market.

Now -- let's look at the charts for the SPYs, QQQQs and IWMs (click on an image for a large picture).

Notice we have the same down, up down pattern. Also note the pattern is clearly lower lows and lower highs. In other words, there is a pretty firm trend of a market pullback in play right now.

And this is also true of several important market sectors

The financial sector is in a bear market already.

The consumer discretionary sector is also in a bear market.

The industrial sector is clearly in a lower low, lower high pattern

Technology -- which was going to save us from the housing mess -- as also in a correction.

Bull market news, or News That Will Alter the Market's Downward Trajectory

1.) The clearest and strongest bull market stimulus right now is Fed action or the possibility of Fed action. The markets all jumped yesterday when Bernanke made his comments about aggressive Fed action.

2.) Anything that helps the financial sector. For example, yesterday's news the Bank of America was in negotiations to buy Countrywide was an obvious boost. Any news along those lines will help.

3.) Positive employment news. Last Friday's employment report really knocked the bills down hard because the employment situation was a primary reason the bulls were still in business. So, anything that reignites that thesis will help to move the market higher.

4.) Fourth quarter earnings news. If the fourth quarter turns out to be a good quarter the bears may rethink their analysis.

Today's Markets

From Bloomberg:

Federal Reserve Board Chairman Ben S. Bernanke said more interest-rate cuts ``may well be necessary'' after 1 percentage point of reductions since September to buttress economic growth.

And thus we have an important new dynamic in the market -- that of aggressive rate cuts. In other words, it appears the Bernanke put is alive and well.

The markets first popped on the news from the Fed right after 11 AM. And then we had more speculation/news:

U.S. stocks rose for a second day after Federal Reserve Chairman Ben S. Bernanke signaled he may cut interest rates further and investors speculated Countrywide Financial Corp. will be bought.

The markets were clearly in an uptrend for most of the session. Yesterday I wrote that there wasn't a clear reversal pattern in the market, save for the sharp V bottom. But there was no way to tell if this was in fact a bottom until we had further action. Well, today we had that. When looking at the chart for the entire week, notice the SPYs are pretty much back to Monday's opening level.

The same is true of the QQQQs

And the IWMs

But look what happened in the Treasury Market

Bond traders sold the long end of the curve big time out of inflation concerns.

It sure looks like the markets are changing direction right now. Although I will add this important caveat: The markets will make an ass out of you at any time. And they have a lot more tools at their disposal to do that.

Bernanke's Speech; or Translating Fed Speak

Ben is talking today. Before you read further, please remember this. Before the last Fed meeting there were three very dovish Fed speeches. This led the markets to believe the Fed was going to cut rates by 50 basis points. The Fed wound up cutting 25 basis points which led the market to take a big hit. In other words, I'm not sure how to interpret anything the Fed says right now. However, we still have to know what the Fed is thinking so here are the relevant portions of the speech:

As you will recall, the U.S. economy experienced a mild recession in 2001. During the ensuing recovery, above-trend growth was accompanied by rising rates of resource utilization, particularly after the expansion picked up steam in mid-2003. Notably, the civilian unemployment rate declined from a high of 6.3 percent in June 2003 to 4.4 percent in March 2007. As the economy approached full employment, the Federal Open Market Committee (FOMC), the monetary policymaking arm of the Federal Reserve System, was faced with the classic problem of managing the mid-cycle slowdown--that is, of setting policy to help guide the economy toward sustainable growth without inflation. With that objective, the FOMC implemented a sequence of rate increases, beginning in mid-2004 and ending in June 2006, at which point the target for the federal funds rate was 5.25 percent--a level that, in the judgment of the Committee, would best promote the policy objectives given to us by the Congress. The economy continued to perform well into 2007, with solid growth through the third quarter and unemployment remaining near recent lows. Indicators of the underlying inflation trend, such as core inflation, showed signs of moderating.

Short version: after lowering rates to a level not seen for generations and low rates at which everybody and their brother was borrowing money, we decided to raise rates in an attempt to engineer a "soft landing". Of course, this has never worked before, but we had to look like we were doing something; we are the Fed after all.

However, the situation was complicated by a number of factors. Continued increases in the prices of energy and other commodities, together with high levels of resource utilization, kept the Committee on inflation alert. But perhaps an even greater challenge was posed by a sharp and protracted correction in the U.S. housing market, which followed a multiyear boom in housing construction and house prices. Indicating the depth of the decline in housing, according to the most recent available data, housing starts and new home sales have both fallen by about 50 percent from their respective peaks.

Short version: Record low interest rates led to a huge over-supply of homes -- but we won't admit that lowering rates to 0% after adjusting for inflation had anything to do with the housing bubble. And -- the Fed can't do anything about asset bubbles even though we have an awful lot to do with the creation of said bubbles.

In all likelihood, the housing contraction would have been considerably milder had it not been for adverse developments in the subprime mortgage market. Since early 2007, financial market participants have been focused on the high and rising delinquency rates of subprime mortgages, especially those with adjustable interest rates (subprime ARMs). Currently, about 21 percent of subprime ARMs are ninety days or more delinquent, and foreclosure rates are rising sharply.

Although poor underwriting and, in some cases, fraud and abusive practices contributed to the high rates of delinquency that we are now seeing in the subprime ARM market, the more fundamental reason for the sharp deterioration in credit quality was the flawed premise on which much subprime ARM lending was based: that house prices would continue to rise rapidly. When house prices were increasing at double-digit rates, subprime ARM borrowers were able to build equity in their homes during the period in which they paid a (relatively) low introductory (or “teaser”) rate on their mortgages. Once sufficient equity had been accumulated, borrowers were often able to refinance, avoiding the increased payments associated with the reset in the rate on the original mortgages. However, when declining affordability finally began to take its toll on the demand for homes and thus on house prices, borrowers could no longer rely on home-price appreciation to build equity; they were accordingly unable to refinance and found themselves locked into their subprime ARM contracts. Many of these borrowers found it difficult to make payments at even the introductory rate, much less at the higher post-adjustment rate. The result, as I have already noted, has been rising delinquencies and foreclosures, which will have adverse effects for communities and the broader economy as well as for the borrowers themselves.

Short version: The Federal Reserve and the Treasury department -- which oversea the nation's financial industry -- didn't really do much to prevent the bad practices that led to the poor underwriting standards. Therefore, that can't be the fundamental problem. Instead, the real problem was the pie in the sky fantasies of speculators who thought home prices would go up forever, which the lowest interest rates of a generation helped to create (even though we won't admit to that either).

One of the many unfortunate consequences of these events, which may be with us for some time, is on the availability of credit for nonprime borrowers. Ample evidence suggests that responsible nonprime lending can be beneficial and safe for the borrower as well as profitable for the lender. For example, even as delinquencies on subprime ARMs have soared, loss rates on subprime mortgages with fixed interest rates, though somewhat higher recently, remain in their historical range. Some lenders, including some who have worked closely with nonprofit groups with strong roots in low-to-moderate-income communities, have been able to foster homeownership in those communities while experiencing exceptionally low rates of default. Unfortunately, at this point, the market is not discriminating to any significant degree between good and bad nonprime loans, and few new loans are being made.

Short version: Even though we should have been keeping an eye on the ball about all of those underwriting standards and disclosure requirements, it's still a good idea to extend gobs of credit to everybody and their brother so long as it's done responsibly (and if you actually understand that, I am truly amazed).

Although subprime borrowers and the investors who hold these mortgages are the parties most directly affected by the collapse of this market, the consequences have been felt much more broadly. I have already referred to the role that the subprime crisis has played in the housing correction. On the way up, expansive subprime lending increased the effective demand for housing, pushing up prices and stimulating construction activity. On the way down, the withdrawal of this source of demand for housing has exacerbated the downturn, adding to the sharp decline in new homebuilding and putting downward pressure on house prices. The addition of foreclosed properties to the inventories of unsold homes is further weakening the market.

Short version: because everybody has some exposure to the subprime slime that is literally in every nook and cranny of the economy, everybody is really worried about the long-term effects. Therefore, lending activity has ground to a halt while we try and get a handle on exactly what to do.

OK -- let me vent about this.

1.) I am sick of the Fed not making this basic connection: low interest rates increase the demand for loans which is a fundamental reason why we're in this mess. This is econ 101, and yet no one who is responsible for setting interest rate policy makes this claim in any way, shape or form. It's as though they are operating in a vacuum which considering all of the combined economic degrees in the bunch is absurd (at best).

2.) When asset prices whose value is partially based on interest rates skyrocket there is a problem. While I understand the Fed is basically saying, "we don't want to determine asset prices" the bottom line is their primary responsibility (setting interest rate policies) has by definition an impact on asset prices. In other words, when they rescue the economy from a recession they want all of the credit, but when the economy has a big problem because of Fed policies that by definition created the problem, then it's the market fault.

3.) I think it's time we came to an understanding: not everyone should own a home. Yes, I know that makes me a bastard first class. But the bottom line is pretty clear: it seems that a homeownership rate about 3%-5% below current levels is about the proper level of ownership. There's a reason people have poor credit: they have a demonstrated record of irresponsibility. Do we really want to extend them gobs of credit, or do we instead want to figure out a way to encourage them to become more responsible?

Pakistan Is Safer Than Countrywide?

From the WSJ:

More ominously, investors in the credit-default swap market, where insurance against debt defaults is bought and sold, are signaling rising worries of financial distress for some big banks and insurers. The cost to buy insurance to protect against default on debt issued by Merrill Lynch & Co., Countrywide Financial Corp., Citigroup Inc., MBIA Inc. and others is soaring even as other concerns that nagged at the credit market at the end of the year recede.

Such protection is less expensive for debt issued by the troubled nation of Pakistan than it is for debt issued by MBIA or Countrywide. This, in turn, is raising questions about the health of some of these financial institutions as counterparties in big transactions.

Let's think about that for a minute. Pakistan has recently had a major political figure killed. They have been put under Martial law. Part of their country is having extreme political problems. And yet it's cheaper to buy protection for their debt than it is for a US mortgage issuer.

That's a pretty bad development for a US issuer.

A Closer Look at Retail

Retail sales are announced today so it seems like a good time to look at the various sub-sectors of retail.

Electronic Stores are still benefiting from consumers wanting the "next biggest thing" in electronic land. Best Buy and Gamestop have essentially stopped the bleeding in this sector. However, there are some big losers here like Circuit City and Radio Shack. So there are some problems waiting to happen.

Grocery stores are a pretty defensive play in the market, so it shouldn't surprise anybody that this sector is still moving up. But it is currently trading at it's three year support level, so all is not perfect.

Drug stores have had a nice multi-year run. They consolidate, rally and consolidate in a fairly typical pattern. Because they are also very defensive in nature I wouldn't expect them to fall through the floor anytime soon.

Discount/variety floors are also somewhat defensive in nature. While they do sell impulse items etc.., their low prices make them a bit more immune to economic downturns. However, some stores in this sector have taken some pretty big hits -- take a look at Big Lots, Dollar Tree, and 99 Cent Store. So things could get a bit more dicey here.

Auto parts recently broke a 5 year uptrend. What's interesting here is I would have thought these stores would benefit from an economic slowdown -- as consumers feel more and more constrained they are more likely to repair their cars themselves. However, breaking a 5 year uptrend is not a positive development.

Mail Order stores have been dropping for about 2/3 of a year. They have fallen through some key support levels as well.

Home improvement stores are getting hit in the real estate slowdown. Like the mail order sector, these stores have been falling far about the last 2/3 year and have also moved through key support levels. I wouldn't think this would change anytime soon with the housing mess still far from over.

Home furnishings are also getting hit by the housing mess. This is going to continue as well.

Department stores are taking a big hit right now. The primary reason is an anticipated consumer slowdown. They've fallen through some big support levels and continue to move lower.

Apparel stores are the latest casualty of selling.

Wednesday, January 9, 2008

Today's Markets

Wow -- we finally have a rally that holds in 2008. It was bound to happen sometime, but still it has taken awhile.

All of the chart have the same pattern. In the early afternoon, they broke through resistance on heavy volume and closed at the high point of the day. In addition:

There is not a specific headline that accounts for the spike, but there is strength in some of the bigger financial names, including Merrill Lynch (MER 59.73, +1.56) and Morgan Stanley (MS 47.32, +1.19).

In other words, this looks and feels like a purely technical bounce as opposed to a fundamental news driven event.

However, let's pull the lens back and look at the trading so far this year.

The SPYs are still clearly in a downward moving pattern, although a strong opening tomorrow with follow-through during the trading session would reverse that trend. Also note there really isn't a strong reversal formation on this chart. There is a possible "V" bottom but that could also simply be a lower lower in the pattern of moving lower.

As with the SPYs, the QQQQs are still in a downtrend as well. In addition, aside from a possible "V" bottom, there isn't a clear reversal formation.


It's been a terrible start to the year for the indexes. With more firms making recession predictions and more and more investors expressing concerns about the soundness of the economy I wouldn't expect that trend to stop. But I could be wrong.

I Stand Corrected

From today's Marketbeat Blog:

The first five days of the year, when the S&P 500 lost 5.3%, was the worst since 1930, points out Jeffrey Hirsch of the Stock Trader’s Almanac. However, Mr. Hirsch says the “first five days” indicator, which has proven reasonably accurate in predicting how the rest of the year will unfold, is less accurate when the market falls in that time. Furthermore, the years when the market starts off notably terribly, such as in 1991 and 1978, stocks ended the year higher. As Bill Luby of the Vix and More blog put it, “If there is any message worth remembering from the data above, it is that good starts tend to persist, ugly ones tend to reverse, and slightly down beginnings run the greatest risk of turning into a rout.”

In other words, my post this morning about the First Five Days was incorrect.

My compliments to an Anonymous commenter who pointed that out.

Let me rephrase: This year has started out really badly.

Bonddad's Favorite Investment Books, pt. I

I'm getting into this "list" thing. I don't know why, but it's pretty fun. So here are three investment books that I find 100% necessary. These are three very old authors, but their work is still relevant to the modern market.

Profits in the Stock Market by Gartley. In my opinion, this is one of the best books ever written about the markets. It has formed the basis of how I look at the markets. He hits all the important high points – long-term chart patterns, breadth, reversal formations, high-volume leaders and basically everything else you’ve come to understand about the markets. This is a must read.

No image available. Just imagine a really old hardcover book.

The Truth of the Stock Tape by W.D. Gann. This is a classic. Gann explains how he reads charts and the importance of “float analysis” – an in-depth look at volume. A very readable book and full of incredibly insightful lessons learned from one of the most successful traders ever.

Technical Analysis and Stock Market Profits by Richard Schabacker. This book has lots of nuts and bolts of investing – trend lines, reversal formations, support and resistance levels and some great trading rules. There is a wealth of information in this book.

Why Financials Are So Important

There has been a lot of talk in the financial press -- and on this blog -- about the financial sector. But I haven't explained why the financial sector is so important to the economy. So -- here is why. But first -- you have to promise to to laugh at my rudimentary computer drawing skills.

The above picture is a poorly drawn and simplified diagram of an economy. This is from my old economics textbook written my Paul Samuelson. Basically, business pays wages to consumers who then purchase products from business. That's the outer circle of the system. But financial companies stand in the middle of the economy and act as intermediaries between consumers and business. In the simplified version, consumers either make deposits at financial companies, provide money in the form of investment capital (buying and selling securities) or take out loans that are then repackaged and sold to other financial companies or businesses.

In essence, financial companies are as "intermediaries" between consumers and business. They are a conduit that pools resources from a large number of individuals and then redistributes the money to business in the form of loans or securities.

That is why these companies are so important. When they aren't working properly, the economy either slows or grinds to a halt.

Here are charts from of all the regional and money center banks. Notice that with the exception of NE banks, the entire sector is in a literal freefall right now.

"You Can't Have A Healthy Market Without Healthy Financials"

From the WSJ:

"You can't really have a healthy market without healthy financials," a key bellwether sector that represents more than a quarter of the S&Ps 500's market capitalization, said Anthony Conroy, head trader at BNY ConvergEx Group, a New York brokerage. "People are still waiting for the last shoe to drop."

Financial firms stand at the center of the US economy. They supply credit to the business and consumer sectors in large degrees. If these companies are not functioning well, then the rest of the economy experiences problems.

The financial sector is hurting big time. Notice the following on the chart:

-- Prices are below the 200 day SMA

-- Prices are below all the SMAs

-- The shorter SMAs are below the longer SMAs

-- All the SMAs are headed lower

-- Yesterday be had a big volume sell-off that took us to new lows.

Short version: this sector is far from healthy right now.