Saturday, August 11, 2007

A Look At the Largest S&P Sectors

According to S&P the largest market areas in order are: financials, technology, healthcare, industrials, and energy. These comprise about 65% of the average. Here are the charts in order of size.


This sector is technically in terrible shape. They broke a two and a half year uptrend in late June/early July. They have been droppinig on heavy volume ever since. The average is below the 20 and 50 day Simple Moving Average (SMA). They have another point to go before hitting the 200 day SMA (roughly 3%). In addition to the technical problems, this sector has some serious fundamental problems. In other words, this sector isn't going to recover anytime soon.


This is one of the favorite market areas of the blog Between the Hedges. This market is currently at the trendline of a year long rally. The average is also at the 20 day SMA, adding further support. Despite the volatility in the market, this sector has held up pretty well -- it dropped hard three weeks ago, but the drop has lessened over the last two weeks. All three moving averages are still moving up. Despite the heavy volume, the average is still holding to the trend line. The average has support right around 24.

Health Care

Health care is in a mini-rally that started late last year. The average took a big hit earlier this month but is now hugging the trend line. All three moving averages are still trending up, although the average is below the 20 and 50 SMA which will pull the SMAs down a bit. The sector has support at $33 and a little below.


Industrials are the beneficiaries of global infrastructure investment and a weak US dollar. We have two upward slanting trend lines: one that started in late 2005 and a steeper one that started in mid-2006. All three moving averages are still moving up and prices are trading right at the 20 day SMA. Despite heavy volume on the sell-off of the last three weeks, prices are still at the trend line. The average has support at the 20 day SMA and right around the $37 level.


Energy had a mini-rally that started in March 2007. It has broken the trend but is now at the 20 day SMA. The sell-off over the last three weeks has occurred on heavy volume, but the average is still right at the 20 SMA. While there is about 3%-5% downside, there is a ton of support in the $57 to $62 area.

Why The Fed Won't Lower Rates

The dollar going back to 1990:

The dollar going back three years:

Freddie and Fannie Won't Come To the Mortgage Rescue

From the AP:

Mortgage finance giants Fannie Mae and Freddie Mac will not be allowed to take on more debt, the government said Friday, denying requests to relax the companies' investment caps as a way to pump cash into the struggling mortgage market.

The decision by the Office of Federal Housing Enterprise Oversight capped a week of speculation that buoyed the stock prices of the government-sponsored companies. Investors drove Fannie's share price 17 percent above last Friday's close, and pushed up Freddie's stock by 11 percent.

The markets will not be happy about this.

We're Nowhere Near the End of This

OK -- the week is over and it's time to

1.) Look back on what happened,
2.) Try and figure out what might happen.

What happened

Bottom line: there are a ton of problems in the credit market that aren't going away anytime soon. The main reason for that comment comes from Countrywide Financial's report on Thursday. Countrywide is the largest mortgage lender by volume. That means they have a ton of stature and clout in the market. The problem is simple: they can't find liquidity for their mortgages right now. They had to place $1.8 billion of loans into their investment portfolio and devalue both investments by between 14% and 20% when the transferred those assets. The devaluation tells me that buyers are pretty scared about the whole mortgage mess right now.

Add to this the news that BNP stopped withdrawals from some of its funds a Goldman Sachs fund lost over 20% since the beginning of the year, Washington Mutual agreeing with Countrywide's assessment of the credit markets, and the central banks pumping liquidity into the market, and you have a recipe for increased volatility and concern.

And in case you thought that wasn't enough:

But, he adds, the full weight of resets on adjustable-rate mortgages have yet to been felt. From the beginning of 2007 through the middle of 2008, over $1 trillion ARMs will reset, many from low "teaser" rates. Then the extent of the declines in home prices and the financial fallout will be apparent, Magnus observes.

The news has continued to come out in a very negative vein. And it's the big players who are making the announcements. That is all the more concerning. When the mortgage mess first started in last 2006/early 2007 it was the smaller players making the announcements. While this was disconcerting, it wasn't earth shattering. Now the big boys are saying, "boy is it rough out there". That should concern everybody.

What's going to happen

Expect more of last week for the foreseeable future. Volatility will be around for some time. More funds are going to announce problems, deals will get shuttered, and blow-ups are possible. It's going to get nasty.

Friday, August 10, 2007

Today's Markets

OK -- the week is over. Let's take a quick look at what happened.

Today, the main news was the Fed's announcement that they would add liquidity to the market if needed. This gave the market a floor. We opened lower and rallied twice.

Here's the 5-day chart. Remember that for Monday through Wednesday the subprime problems were behind us. Then came more news of serious issues in the debt/credit markets and the market tanked.

Here's where the rubber meets the road. Once again we're clinging to the 200-day SMA. This is a very important technical indicator. If prices close below the 200 day SMA for an extended period of time, we're looking at a bear market.

From a technical perspective, notice the 20 and 50 day SMAs are moving lower. Because the SPYs are below both of these numbers, these averages will continue to move lower. They will also provide upside resistance in a rally. The only good thing about these SMAs is they are about a point and a half below where they were when the market started first started dropping to the 200 day SMA. That means the market will have to move a smaller amount of points to test upward resistance.

Here are two more charts of the SPYs. These are year-long daily charts that use both Fibonacci fans and retracements. Notice the SPYs are near crucial levels for both the fans and retracements.

The bottom line is the markets are still in bad shape. They are are still clinging to support at areas where the psychology could change from bullish to bearish very quickly. While the Fed's move today will help ease some tension, the market really didn't rally that hard after the announcement and still closed down for the day. That means bulls are still on the sidelines. And the announcements from Countrywide and Washington Mutual and the negative reactions to these announcements indicates there are still a lot of people out there willing to pull the trigger at a moments notice.

Fed Will Provide Liquidity

From Forbes:

The Federal Reserve, trying to calm financial turmoil on Wall Street, announced Friday that it will provide liquidity to help bolster U.S. financial markets.

The Fed, in a short statement, said it will provide "reserves as necessary" to help the markets safely make their way. The central bank did not provide details but said it would do all it can to "facilitate the orderly functioning of financial markets."

This may prevent a big and nasty drop in the markets today. We'll have to wait and see.

Here's the Fed statement:

The Federal Reserve is providing liquidity to facilitate the orderly functioning of financial markets.

The Federal Reserve will provide reserves as necessary through open market operations to promote trading in the federal funds market at rates close to the Federal Open Market Committee's target rate of 5-1/4 percent. In current circumstances, depository institutions may experience unusual funding needs because of dislocations in money and credit markets. As always, the discount window is available as a source of funding.

A Word Of Optimism

Right now the news is not good. There is a credit crunch going on around the globe. Central banks are pumping liquidity into the system in hopes of getting things moving. The financial markets are incredibly volatile.

But, there is room for optimism here. Right now there are a ton of really smart people in offices all over Wall Street who are working 16-hour days 7 days a week, living off of the antacid of your choice and bad Chinese delivery trying to figure out a way through this mess. These people are not water-skiing behind yachts. They are working their asses off trying to figure this thing out.

And the best part about this whole thing is that when things get tight (as they are now) the profit motive will force people to listen to any idea out there. Right now, a mail clerk could walk into a CEO's office and say, "I know how to fix this whole mess. It involves 10,000 Russian soldiers, a witch doctor from Louisiana and a Chinese monk chanting the Arabic alphabet backwards, sung to the tune of Deep Purple's Highway Star", the the CEO will say, "tell me how this works". So long as it might realistically work, they'll try it.

The point is Wall Street and the central bands around the world are on the job. And these are some really smart and capable people who will get the markets through this mess. That does not mean it will be easy. In fact, the news will continue to be bad for awhile. But the markets and the economy will get through this; it will end at some point.

Retail Sales Moderate

From the WSJ:

Collectively, retailers posted a 2.9% increase in July same-store sales, or sales at stores open at least a year, according to an index of 48 major chains compiled by Retail Metrics Inc. More than half missed forecasts, and the result fell well short of the 3.9% increase logged in the year-earlier month, said Ken Perkins, president of the Swampscott, Mass., research firm. Year to date, same-store sales are up 2.8%, a sharp slowdown from the average gain of 3.7% seen in 2006.

OK -- let's not let the prism of a really shaky credit market cloud our vision.

2.9% growth isn't bad. It indicates consumers are still spending. However, the slowdown in same-store sales growth indicates consumers are slowing their purchases. This is consistent with the slowdown we are seeing in personal consumption expenditures in the BEA's personal income reports over the last few months.

The fact that economists missed the slowdown in their projections indicates there is probably still a bullish bias to economic models that needs to be ratcheted down right now.

However, not all the news was bad:

Wal-Mart, Bentonville, Ark., reported a 1.9% gain in same-store sales, at the high end of the 1% to 2% growth forecast it gave last month. But while sales were strong in food and electronics, they were driven by stepped-up promotions, with discounts on more than 16,000 products, said Eduardo Castro-Wright, president and chief executive of the company's U.S. stores.


Costco Wholesale Corp., which tends to attract well-heeled bargain hunters, posted a better-than-expected 7% increase, as shoppers flocked to its warehouse clubs for big-screen TVs, fine wines and stainless-steel appliances. Target Corp., whose shoppers are more affluent than Wal-Mart's, scooped up the "cheap chic" discounter's summer fashions, driving a 6.1% gain in same-store sales.

Here's the chart from the article. It looks like what is happening is consumers are concentrating all of their purchases in a few, bigger discounters rather than spreading out purchases over a variety of stores.

The point here is consumers are still spending; they're just not spending as much and they are becoming more discriminating about what they are going to buy.

PCE's increased 1.5% in the latest GDP report. This isn't great and is certainly a slowdown from the previous pace, but it's not horrible either.

Something to definitely keep your eye on is retail sales over the next 3-5 months. By then, we'll know how the credit market problems are really playing out with consumers.

Deutsche Bank Fund Drops By a Third

From Bloomberg:

The assets of Deutsche Bank AG's DWS ABS Fund fell by a third to 2.1 billion euros ($2.9 billion) from 3 billion euros at the end of July, as the fund's investments lost value and clients withdrew money.

The fund doesn't have any investments in U.S. subprime related debt, spokeswoman Anke Hallmann said today. DWS, based in Frankfurt, currently has no plans to limit redemptions from the fund, though that may change if markets were to ``fall drastically,'' Hallmann said.

WOW -- they had no subprime exposure. None. Zip. Nada. And they still lost 30% in a month as a result of redemptions and the decline in value of assets.

WAMU Reports Credit Problems

From Reuters:

Washington Mutual, the largest U.S. savings and loan, said liquidity in the market for less-than-prime home loans and securities backed by the loans has "diminished significantly." It said that while this persists, its ability to raise liquidity by selling home loans will be "adversely affected."


Seattle-based Washington Mutual said the disruption in the subprime secondary mortgage market in the first half has "spread into markets for all other nonconforming residential mortgages." It said it has been "impacted," but remains "well-capitalized and its capital position is diversified."

Just what we need right now -- another large bank saying liquidity has dried up.

Thursday, August 9, 2007

Countrywide Financial Reports Major Disruptions

UPDATE: I corrected the "14%" mistake. Thanks to everyone who caught that error. When news comes this fast, it's hard to keep everything straight.

From the WSJ:

Countrywide Financial Corp. faces "unprecedented disruptions" in debt and mortgage-finance markets that could hurt earnings and the company's financial condition, the Calabasas, Calif., lender said in a regulatory filing. (Read the SEC filing)


Payments were at least 30 days late on about 20% of "nonprime" mortgages serviced by Countrywide as of June 30, up from 14% a year earlier.


On prime home equity loans, the delinquency rate was 3.7%, up from 1.5% a year before. For all loans, the rate was 5%, up from 3.9%.

In a sign of the growing difficulty in selling loans, Countrywide said that it transferred $1 billion of nonprime mortgages from its "held for sale" category to "held for investment" in the first half. Countrywide marked the value of those loans down to $800 million. It also decided to retain as investments, rather than sell, $700 million of prime home equity loans, marking them down to $600 million. Countrywide has said many of those home equity loans were second-lien mortgages used by people who put little or no money down in buying a house.


Countrywide is the largest home lender in terms of loan volume. If they can't et a deal done -- no one can.

Countrywide couldn't sell $1 billion of loans at a decent price. They cut the value
of these loans by 20% when they transferred those loans to their investment portfolio.

Countrywide couldn't sell $700 billion of prime loans, and devalued those by 14%.

That means the going price on both of these investments is probably lower than the devaluation on the balance sheet. Subprime loans are going for less than 80% of face value and prime loans are going for less than 86% of face value.

Simply put -- liquidity just isn't there in the market right now. And the crunch is getting worse because Countrywide couldn't sell prime loans.

More Signs of a Corporate Credit Crunch

From CBS.Marketwatch:

In the past two weeks, another 13 corporate loan or bond deals have been postponed or reduced, representing slightly less than $43 billion, according to new research released Thursday by Baring Asset Management.

That lifts the total number of deals pulled since June 22nd to 46, analysts at the firm said. They valued those at more than $60 billion. Last year, no pulled deals were counted by the firm's research staff.

The amount of incomplete cash-financed leveraged buyouts and management-led buyouts sitting on bank balance sheets remains substantial, wrote Toby Nangle, a fixed-income manager at Barings, in a note.

He estimated that such debt totaled around $400 billion. "The bond and loan markets know that banks will come knocking sooner or later, asking to refinance loans that they have made to private-equity firms," Nangle added.

Today's Markets

Day's like this are why I am still short-term bearish -- or why I believe the current bounce is purely technical rather than fundamental. In addition, for me to change this outlook we need at least two weeks with no news about hedge fund/investment fund problems. Frankly, I would prefer 3-4 weeks at this point.

As detailed below, there was a ton of bad news in hedge fund land today. As a result, traders realized there were still some major problems in the credit markets. Hence the sell-off.

The markets opened lower, rallied for an hour, and then headed lower for the rest of the day. Also note the markets sold-off at the end on heavy volume. This is never a good sign because it indicates traders don't want to keep positions overnight for fear of what news will come out between the close and open.

Here's the 5-day chart. Note that today's action took us to the 61.8% Fibonacci retracement level from the previous three days rally. In other words, today's action took out a lot of the last three days gains.

On the 3-month daily chart, notice the market sold-off to the 200-day SMA. In other words, we're right back to walking the tightrope between bull and bear market right now.

I wanted to reprint the market breadth charts from yesterday. Here are the NY advance decline line and the NY High/Low line. These are not bullish breadth charts.

The NASDAQ breadth charts (advance/decline and high low respectively) are just as negative.

This market is not in good shape. There is a ton of concern about the subprime market. In addition, this concern is leading to a ton of jitters that lead to quick selling pressure in the markets.

Big Fund Liquidation Occurring

From CBS.Marketwatch:

Black Mesa Capital, a hedge-fund firm that uses computer models to track down investment ideas, has told investors that at least one very large hedge fund or investment bank is liquidating "massive" trading portfolios, according to a letter the Santa Fe, N.M.-based firm sent to investors Wednesday.

That's causing disruptions and triggering big losses among other so-called market-neutral hedge funds, Black Mesa said in its letter, a copy of which was obtained Thursday by MarketWatch.

"Clearly, something is amiss in the markets that few in our strategy, if anyone, have experienced before," Black Mesa's managers, Dave DeMers and Jonathan Spring, wrote. DeMers declined to comment Thursday.


A hedge fund run by Goldman Sachs called the North American Equity Opportunities fund, has sold some of its positions recently, The Wall Street Journal reported Thursday. Goldman's biggest hedge fund, the Global Alpha fund, has suffered losses recently and may also be selling positions, according to other published reports this week. A Goldman spokesman declined to comment Thursday.

Events like this are why I am still bearish. There are obviously some really big problems in the market right now that will probably continue for the foreseeable future.

Read This Now

Chris Perruna makes an excellent point that all should take note of.

Retailers Post Weak July Sales

From the WSJ:

Retailers were projected to post decent sales gains for July, but results came in weaker than expected amid soft sales at apparel shops.

Department stores were slated to report solid growth amid calendar shifts skewing comparisons, but instead posted mixed results. In the discount sector, industry leader Wal-Mart Stores Inc., whose 1.9% same-store-sales increase came in at the high end of expectations.

Seven of the nine chains in Thomson Financial's teen/child category reported weaker-than-expected results.

From CBS.Marketwatch:

With nearly half of the nation's major retailers reporting sales results to Thomson Financial, 75% have missed Wall Street's expectations. Analysts had been expecting that sales at stores open longer than a year, the industry's most important measure, would be weak, particularly among teen and women's-wear retailers.

But the early results suggest that consumers across the board are far more concerned about credit and financing woes sparked by the slowdown in the housing market and the collapse of the subprime mortgage business.

Here's a chart of chained 2000 monthly personal consumption expenditures at seasonally adjusted annual rates. These reports should surprise no one.

The Return of Hedge Fund Problems

There are several article from Bloomberg I'm going to integrate below.

From Bloomberg:

The European Central Bank, in an unprecedented response to a sudden demand for cash from banks roiled by the subprime mortgage collapse in the U.S., loaned 94.8 billion euros ($130.2 billion) to assuage a credit crunch.

The overnight lending rates banks charge each other jumped to the highest in six years. The so-called London interbank offered rate in dollars rose to 5.86 percent today from 5.35 percent and in euros gained to 4.31 percent from 4.11 percent. Three-month dollar Libor rose to 5.5 percent from 5.38 percent.

The fastest increase in the overnight dollar rate since June 2004 signals that banks are reducing the supply of money as losses triggered by the U.S. mortgage slump spread worldwide. BNP Paribas SA halted withdrawals from three investment funds today and Dutch investment bank NIBC Holding NV said it had lost at least 137 million euros on subprime investments, reversing signs yesterday that credit markets were stabilizing.

``Liquidity in the market has completely dried up as investors aren't recycling their money back because of subprime concerns,'' said Saher Bin Jung, a trader on the commercial paper desk at Commerzbank AG. ``Levels have shot up dramatically since yesterday as issuers are trying to entice investors back.''

1.) Part of the reason for the rally over the last three days has been the perception the subprime problem would be contained. The XLF tracking stock increased from $32.20 to $34.75 -- an increase of 7.91%. The news from BNP and NIBC will probably halt this rally or slow it down.

Here's more on the problem:

BNP Paribas SA, France's biggest bank, halted withdrawals from three investment funds because it couldn't ``fairly'' value their holdings after concern over U.S. subprime mortgage losses roiled credit markets.

The funds had about 2 billion euros ($2.76 billion) of assets on July 27, including 700 million euros in subprime loans rated AA or higher. The Paris-based bank said today that it will stop calculating the net asset value for the funds, Parvest Dynamic ABS, BNP Paribas ABS Euribor and BNP Paribas ABS Eonia.


``The complete evaporation of liquidity in certain market segments of the U.S. securitization market has made it impossible to value certain assets fairly regardless of their quality or credit rating,'' BNP Paribas said in the statement.

2.) These are big funds -- 2 billion+ is not chump change. But the manager can't "``fairly'' value their holdings". That means the 2 billion + in total assets may not even be close to accurate. Remember -- Bear Stearns lost 6 billion in 2 funds just a few weeks ago.

3.) The ECB is flooding the market with liquidity. While this is a good thing in the short run because it eases some concerns, it may not be enough. The bottom line is we are seeing announcements of hedge fund/investment losses coming from all over the world. And the pace is snowballing.

4.) "investors aren't recycling their money back because of subprime concerns" Translation: either the ECC can continue to inject liquidity or we're going to have a continued problem in the markets.

5.) In the 1920s, the US banking system collapsed because of runs on the banks. A similar situation is happening with hedge funds right now:

Union Investment, Germany's third-biggest mutual fund manager, stopped withdrawals from one of its funds on Aug. 3 after investors pulled about 10 percent of the assets. Frankfurt Trust, the mutual fund manager of Germany's BHF-Bank, halted redemptions from a fund after clients removed 20 percent of their money since the end of July.

Goldman Hedge Fund Takes A Hit

From the WSJ:

The markets' volatility of the past few weeks has taken a toll on many widely known funds for sophisticated investors, notably a once-highflying hedge fund at Wall Street's Goldman Sachs Group Inc.

Global Alpha, Goldman's widely known internal hedge fund, is now down about 16% for the year after a choppy July, when its performance fell about 8%, according to people briefed on the matter. The fund, based in New York, manages about $9 billion.

The fund's traders in recent days have been selling certain risky positions, according to these people. Early this week, those moves sparked widespread rumors on Wall Street that the entire fund might be shut down. A Goldman spokesman has said the rumors are "categorically untrue."

Campbell & Co., an $11 billion hedge fund that trades in the futures market as well as in stocks and bonds and is completely driven by such computer programs, was down 10% to 12% by the end of July.

Quant funds -- "quant" stands for quantitative -- generally operate by building computer models of market behavior and then allowing the computer programs to dictate trading. A recurring characteristic of the recent trouble in financial markets is that many lenders, funds and brokerages were following statistical models that grossly underestimated how risky the market environment had become.

Program trading has been popular and widely used for the last 20-25 years (and maybe longer). It greatly exaggerated the 1987 drop which led to trading curbs in volatile markets.

But notice what has happened. The programs in this hedge fund did not count on an increase in volatility. There was an underlying assumption of an orderly market. That's a huge assumption. But it also explains part of the overall market psychology. Traders have been lulled into a particular market perspective. That partially explains the increasing volatility over the last month or so. Traders are having an "oh shit" moment, when their overall psychology is completely crushed and they have to come to a new understanding of the market. And that event -- in and of itself -- implies an increase in volatility.

Wednesday, August 8, 2007

Today's Markets

Let's look at what happened in the long term. Remember, right now BD's central thesis is the market is having a bounce and will probably have a bounce for at most another month. This is based on the MACD reading at the daily and weekly level along with the underlying fundamental situation of a tightening credit market.

First, I wanted to include one more long-term chart. This one uses Fibonacci fans. Notice the SPYs bounced near support from these fans.

Let's go to a three-month chart to see the Fibonacci levels from the previous sell-off. Notice the 61.8% line correspond (more or less) to the 20 and 50 day SMA.

Here are two more charts that show why I think this is a bounce rather than a rally. Here is the new high/low chart for the NYSE and NASDAQ respectively. Notice they are still heading south. Granted, these aren't going to be showing good points for a bit because of the recent sell-off, but they're still moving lower.

Also note the advance decline line for the last year for the NYSE and NASDAQ, respectively. These are still in the dumps and will have to show a heck of a lot more upward movement for this to be a rally rather than a bounce.

Now for one more little mini-section. Here's a 2-day, 5 minute chart of the markets. Notice the market once again had a ton of volatility. Late session buying brought the index back up, but the drop starting about 1:30 which completely wiped out the days gains indicates there is still a ton of nervousness in the markets.

Let's Nip This In the Bud

From the Telegraph:

Two officials at leading Communist Party bodies have given interviews in recent days warning - for the first time - that Beijing may use its $1.33 trillion (£658bn) of foreign reserves as a political weapon to counter pressure from the US Congress.

Shifts in Chinese policy are often announced through key think tanks and academies.

Described as China's "nuclear option" in the state media, such action could trigger a dollar crash at a time when the US currency is already breaking down through historic support levels.

Before this comes even close to out of hand... there is no way this is going to happen.

Let's play this out.

China dumps dollars.

Dollar drops hard

US economy enters recession

China's biggest foreign market stops buying Chinese goods.

The US and China have a symbiotic relationship -- we need each other. They supply us with credit, we provide a $9.7 trillion dollar consumer market. While the overall relationship can't last forever, there is no reason to destroy it either.

If our growth rate drops, so does theirs. And the last thing the Chinese government wants is a slowing economy that contains 1 billion people who may start protesting for democratic reforms.

It's important to remember the Chinese play a very complicated foreign policy game. I would suggest reading Henry Kissinger's White House Years to get an idea for the levels of complexity involved. Bobby Fisher's chess strategies are simpler.

Don't Be Surprised By a Bounce

I want to return to the two charts I used yesterday to make a point.

Here's the daily chart with the MACD.

And here's the weekly chart with the MACD:

Both of these charts are giving short term buy signals. The daily MACD is very oversold and the weekly MACD is slightly oversold (although it clearly has a the possibility of downward pressure as well).

Also note the average is moving up from the 200 day SMA consolidation.

But, there are some serious fundamental problems that have finally broken through into public consciousness -- namely, the entire credit mess is now out in the open. More news along those lines and we've got downward pressure on the averages.

So, don't be surprised by an upward move. Just don't expect it to last. I'd be eyeballing the 20 and 50 day SMA as initial resistance. Also note that using the weekly MACD, we have about 3-4 weeks of positive upward moves in the mix (this assumes the the previous MACD high is a peak for the current rally).

Toll Brothers Revenue Declines

From the WSJ:

Luxury-home builder Toll Brothers Inc.'s home-building revenue fell 21% in its fiscal third quarter, as contract signings continue to drop.

For the quarter ended June 30, the Horsham, Pa., firm said home-building revenue decreased to about $1.21 billion from $1.53 billion a year earlier, as net signed contracts declined 31% to $727.1 million from $1.05 billion during the year-earlier quarter.

Toll Brothers said the fiscal third-quarter cancellation rate was 24%, compared with 19% in the fiscal second quarter. Third-quarter cancellations were 347, the lowest in a year. Backlog for the quarter fell to about $3.67 billion, down 34% from $5.59 billion in the year-ago period. And Toll Brothers signed 1,457 gross contracts in the quarter, a 17% decrease from 1,760 gross contracts signed a year ago.

"We believe significant pent-up demand is building, based on solid demographics, a decent economy and still-strong employment," Chairman and Chief Executive Robert I. Toll said in a written statement. "However, we caution that, with the uncertainties roiling the mortgage markets right now, the pace of home sales could slow further until the credit market settles down."

Personally, I think the CEO is throwing shareholders a bone of hope that doesn't exist right now. Overall, inventories of new and existing homes are near all-time highs, mortgage lenders are tightening lending standards and credit to mortgage lenders from investment banks is drying up. These are not the ingredients of a housing rebound.

Tuesday, August 7, 2007

Blatant Self-Promotion

I was a guest on Sam Seder's show at the Yearly Kos convention. I'm the last interview.

Here's the link

FOMC Statement

From the Federal Reserve:

Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.

Although the downside risks to growth have increased somewhat, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected.
Future policy adjustments will depend on the outlook for both inflation and economic growth, as implied by incoming information.

Translation: we're not lowering interest rates.

Or -- this isn't Greenspan's "throw a ton of money at any problem" Fed anymore.

Time To Go Long Again?

OK -- it sounds like a really stupid question right now -- especially with the market in a volatile period. But money gets made by going against the crowd. In addition, simply thinking it doesn't mean we're going to do it; it simply means we're going to look at the markets to see what they are saying.

Here is the chart that led to this question. This is a 5-year daily chart with the MACD indicator. Notice the indicator is showing a big oversold condition.

Let's take a closer look at other periods in the last 5 years when we had a similar situation.

2003: The market had a similar reading once with a gain of about 20 points initially.

2004: There were three similar situations, but the overall trend was sideways. The gais would have been 5-7 points.

2005: There were two times with similar oversold MACD readings and the market gained about 10 points.

2006: There was one time with a similar oversold reading and the overall gain was about 20 points.

2007: There was one time with a similar oversold reading and the overall gain was 10-15 points.

So, we have a ton of winning situations if history repeats itself. Remember, there are always exceptions to every rule. In fact, there are no rules per se, simply observations.

Now let's complicate the picture a bit. Here is a weekly chart of the SPYs going back 5 years, also with an MACD line.

Remember in 2004 we had three daily oversold readings but we also had a downward/sideways trending market? Notice how the weekly MACD in 2004 is in a similar situation as the MACD in 2007? Compare that to the 2003 and 2006 rally when the weekly and the daily MACD were oversold.

In other words, it probably means we'll have a 5% rally followed by another pullback. This seems more likely considering the underlying credit market situation.

Can We Call This a Credit Crunch Yet?

From IBD:

Mortgage lenders are restricting credit to a wide range of borrowers amid rising home loan defaults, analysts say, a move likely to prolong the housing slump and sap economic growth.

The credit squeeze has turned into a credit freeze in recent days, as Wall Street has shunned mortgage-backed securities.

That's accelerated lenders' push to raise rates on some mortgage products, scrap some types of loans altogether and more closely scrutinize borrowers.

"The mortgage spigot is closing. Even prime borrowers are having difficulty now," said Mark Zandi, chief economist at Moody's

IBD is one of the most bullish publications in the financial press. When they start to write about a credit contraction, you know we're go a pretty significant tightening going on.

A Look At Treasury Yields

It's been awhile since we looked at a chart of the 10-year yield. This seems like a good idea, especially considering the volatility in the stock market.

Here's the daily chart. Notice yields have been decreasing since the market started selling off in mid-July. This indicates Treasuries are the clear beneficiary of a "flight to safety" move in the market. Also note the 4.60% - 4.75% area is clear support for the market. Finally, it's important to remember that inflation expectations are not the primary driver of this rally.

Here's the weekly chart, which shows there is a slight upward bias to rates over the last year or so, but that yields are also pretty range bound as well.

Here's the super-long view chart from the St. Louis Federal Reserve. There was a lot of ink spilled over the 10-year yield breaking the long-term trend. Notice that rates have dropped a bit since then.

Finally, here's the 10-year chart of the 10-year. The top line with the arrow is the long-term trend line from the previous chart. Notice yields are back below that line. But because of the underlying reason for this rally -- a flight to quality rather than inter rate concerns -- the break of the trend line isn't as important. Also note the underlying 3-5 year trend in rates is clear up.

Monday, August 6, 2007

Market's Action Today

OK -- the markets rallied today. Here's a two day chart of the SPYs at 5 minute intervals. The market rallied starting about 10 AM and it kept going up from there.

But here's the 6 day chart going back to last Monday. Notice the SPYs are trading in a range with a slightly downward bias.

And here's the big issue -- the 3 month SPY chart. Notice how the average is trending down right now. We're also seeing a pattern of lower lows and lower highs, which is never a good sign.

Short version -- while today's rally was good news, we're not out of the woods by a long shot.

Moody's Says Junk Defaults Will Increase

From CNBC:

Defaults by highly leveraged, illiquid firms will likely rise substantially as credit tightens and less cash is available to keep weak companies afloat, Moody's Investors Service said Monday.

The global junk bond default rate should jump from 1.5 percent currently to about 3.5 percent over the next 12 months and to 4.5 percent by July 2009, Moody's said in a report.

An increase of that magnitude would be the first sustained rise in defaults since 2002, when they peaked at nearly 11 percent.

Rating agencies have been predicting a rise in defaults for years, but buoyant financial markets and investors with healthy risk appetite kept pouring cash into weak companies, helping bankruptcies stay low.

The appetite for risk dried up this summer, however, amid growing losses in the U.S. subprime mortgage sector and a spate of failed financings for leveraged buyouts.

There are a few points that should be made here.

1.) Defaults have been really low for the last few years. So we're starting from a low point. That doesn't mean this won't be painful, but it does mean we have a long way to go before this becomes a credit rout.

2.) That being said, the change in the financial market's risk appetite is quite pronounced and incredibly quick. A mere several months ago it seemed as though no deal would be turned down. Now it seems as though all deals are getting turned down.

3.) This is a prediction, not a fact.

Housing Market In A Panic

From the WSJ:

As regulators and jittery investors force them to adopt more and more conservative lending standards, lenders are cutting more people out of the housing market. In what would strike most people outside the industry as a return to common sense, lenders now are shunning would-be borrowers who can't make a down payment, prove that they have a reliable income and show a record of reasonably regular bill-paying. They also are turning down refinancing requests from many people trapped by adjustable-rate loans that are proving too expensive after the initial feel-good period of low payments.

"This week is going to be a nightmare," says Melissa Cohn, chief executive of Manhattan Mortgage in New York. Lenders are scaling back so fast that it isn't clear which loans are available or on what terms, and rates are jumping even on large loans, known as jumbos, for prime borrowers.

Here's a short course on why this is bad.

Thanks to Calculated Risk we have a graph of new and existing homes available for sale:

New Homes

Existing Homes

Basically we have a glut of homes on the market and have had a glut of homes on the market for some time.

Starting is say mid-2004 lenders started to get really aggressive in lending to people with bad credit. The basic issue here is lenders had pretty much exhausted the pool of solid credit risk, but lenders still wanted to make money. Hence, the easy liquidity.

Now lenders are returning to "prudent lending standards", basically meaning they are returning to the traditional way to doing business. That means concepts like a track record of paying bills is now important again.

So let's add all of these factors together.

-- Inventory of new and existing homes is incredibly high
-- Lenders are tightening Credit standards
-- The pool of good mortgage risk is small

That means the housing market is going to be facing a terrible remainder of the year.

American Home Mortgage Files For Bankruptcy

From the WSJ:

American Home Mortgage Investment Corp. became the latest lender to succumb to the subprime turmoil, filing for bankruptcy days after laying off most of its work force and saying it would no longer take loan applications.

The nation's 10th-largest mortgage lender last year, whose focus was customers who didn't need subprime loans but didn't have top-notch credit, made its Chapter 11 filing in U.S. Bankruptcy Court in Wilmington, Del.

Deutsche Bank AG is listed as American Home's largest creditor, followed by Wilmington Trust Corp., JPMorgan Chase & Co. and Countrywide Financial Corp.

The Melville, N.Y., firm said late Thursday most of its work force would be laid off as the company maintains its thrift and servicing businesses as American Home seeks to preserve the value of its remaining assets. Some 6,500 employees were terminated Friday, said American Home in its filing, leaving about 1,000.

This is not exactly the most surprising development in the markets. But it is a sign (notice how I correctly spelled that?) the mortgage market is under tremendous pressure right now. This is the 10th largest lender going bankrupt, not a small two-person operation.

On a non-related note -- thanks to all who caught my previous title typo. I was in the air coming home from O'hare O-hell airport.

Sunday, August 5, 2007

Four Signs of An Emerging Credit Crunch

From CBS Marketwatch:

Early signs of an impending credit crunch are everywhere:

* Mortgage lenders going out of business, and the lenders left standing are closing their subprime and Alt-A origination channels.
* The spread between corporate debt and riskless Treasurys has widened dramatically. Standard & Poor's has said most corporate debt is now speculative grade.
* Credit for leveraged buyouts has dried up, with dozens of deals canceled, postponed or repriced. The market for complex derivatives such as collateralized debt obligations has shut down like a "constipated owl," according to bond fund manager Bill Gross.
* The price of insuring asset-backed securities against default has soared.