Saturday, September 1, 2007

Last Week's Market Action

This seemed to settle down a bit last week, although there is still a great deal of trepidation out there in market land. Let's see what the charts say.

First -- here's the weekly, 5-minute chart. This is pretty straight-forward. The markets formed a head and shoulders bottom on Tuesday and Wednesday then rallied starting at the low point established on late Tuesday. Notice we have a three day rally going into a holiday shortened week.

Here's the three-month daily chart. Notice that the market is still looking for a trend. Prices are centered around the 200 day SMA. The moving averages are clustered around the 200 day SMA. However, the 10 day SMA is now sloping upward and has moved through the 20 and 200 day SMA. This is a positive technical development. Remember, in a market rally we want the SMAs to be (from highest to lowest on the chart) shorter to longer. Right now the SMAs are slowing moving back into that rally position. However, we still have a long way to go and the jury is definitely out as to what will happen in the coming month.

Despite all of the uncertainty and volatility, the market has not moved below the 200 day SMA. That is also a positive development. While traders are nervous, they have not sent the average into firm bear market territory. There is definitely a wait and see what happens approach to the markets right now.

Here's a really sharp observation that I had missed. It comes courtesy of Alpha Trends. The S&P sure looks like it is forming an inverted had and shoulders pattern right now.

Let's add some fundamental girth to that analysis. Right now we know the market is expecting the Fed to cut rates. However, I think the jury is still out on that possibility. In Friday's speech Bernanake said he would not bail out lenders who made poor loans, but he would lower rates to help the economy if the problems in the credit markets slow economic growth.

It is not the responsibility of the Federal Reserve--nor would it be appropriate--to protect lenders and investors from the consequences of their financial decisions. But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy. In a statement issued simultaneously with the discount window announcement, the FOMC indicated that the deterioration in financial market conditions and the tightening of credit since its August 7 meeting had appreciably increased the downside risks to growth. In particular, the further tightening of credit conditions, if sustained, would increase the risk that the current weakness in housing could be deeper or more prolonged than previously expected, with possible adverse effects on consumer spending and the economy more generally.

Here's the way I read that paragraph.

1.)If the current situation in the credit markets continues the chances of the economy slowing increase. Note the word if at the beginning of that sentence.

2.)However, right now there is insufficient evidence of a broader economic slowdown that is severe enough to warrant Fed action.

Let's tie the the technical and fundamental strands together. From a technical perspective, we have a reverse head and shoulders formation forming. These occur at the end of a trend. So, the market may be forming a short-term bottom here. From the fundamental side, we have the Federal Reserve saying they will lower rates if -- going forward -- they see signs that the credit market problems are infecting the broader economy.

SO -- what are we looking for going forward to convincingly break the reverse head and shoulders formation? Any sign of an economic slowdown. And I think Barron's observation that this week's employment number is a really big key to future Fed actions is a dead-on accurate prediction.

Let me add one final caveat. The market will do everything it can to make an ass out out you. And the market has a vast array of tools at its disposal to make an ass out of you. On other words, the above analysis is nowhere near gospel -- it's just one possible perspective on things.

Friday, August 31, 2007

Weekend Weimar

The markets are closed. Now that things have settled down a bit, we will return to Weekend Weimar.

This means:

-- the markets are closed.

-- stop thinking and reading about economics.

-- Read a book. Go for a walk. Do anything but think about economics.

More tomorrow.

Bernanke Sets The Right Tone

I've been very critical of Bernanke over the last few weeks, largely because I viewed his cut in the discount rate as the first move in a cut in the Fed Funds rate. My concern here was the Fed engaging in a policy which would encourage more reckless lending behavior. This is the exact same policy that got us into the current mess in the first place.

But his speech today set the perfect tone. Here is the money quote:

It is not the responsibility of the Federal Reserve--nor would it be appropriate--to protect lenders and investors from the consequences of their financial decisions. But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy. In a statement issued simultaneously with the discount window announcement, the FOMC indicated that the deterioration in financial market conditions and the tightening of credit since its August 7 meeting had appreciably increased the downside risks to growth. In particular, the further tightening of credit conditions, if sustained, would increase the risk that the current weakness in housing could be deeper or more prolonged than previously expected, with possible adverse effects on consumer spending and the economy more generally.

The incoming data indicate that the economy continued to expand at a moderate pace into the summer, despite the sharp correction in the housing sector. However, in light of recent financial developments, economic data bearing on past months or quarters may be less useful than usual for our forecasts of economic activity and inflation. Consequently, we will pay particularly close attention to the timeliest indicators, as well as information gleaned from our business and banking contacts around the country. Inevitably, the uncertainty surrounding the outlook will be greater than normal, presenting a challenge to policymakers to manage the risks to their growth and price stability objectives. The Committee continues to monitor the situation and will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets.

The emboldened sentences are key. Here's the translation.

1.) If you made a bunch of bad loans it's your fault, not ours. Don't expect a bail-out just because you're stupid.

2.) However, there are broader implications to what is happening in the credit markets. If the economy starts to really slow down because of what is happening, we'll have to do something.

He goes on to make some very important points as well.

3.) Recently released economic numbers should be discounted if their constituent parts occurred before the current mess started.

4.) Going forward, we will be especially sensitive to any sign that overall economic growth is slowing because of the problems in the credit markets.

Let's face facts -- Ben has a really hard job right now. He's caught between his mandate for controlling inflation (which may require an interest rate increase) and full employment (which may require a cut in rates). No matter what he does he'll be relentlessly criticized.

But this statement is the perfect compromise because he's essentially saying the following.

1.) We won't bail-out people who were stupid.

2.) We will act to help alleviate the effect of stupid business decisions if those effects start to really hamper growth, and

3.) The economic numbers over the next few months are very important.

While I am still concerned that lower rates will lead to a de-facto bail-out, the underlying reason for lower rates won't be a bail-out but instead to help the broader economy if needed. I can live with that -- and I bet the markets can, too.

Real PCEs Increase

From the BEA:

Real DPI -- DPI adjusted to remove price changes -- increased 0.5 percent in July, compared with an increase of 0.2 percent in June.

Real PCE -- PCE adjusted to remove price changes -- increased 0.3 percent in July, compared with an increase of less than 0.1 percent in June. Purchases of durable goods increased 0.5 percent, in contrast to a decrease of 1.8 percent. Purchases of nondurable goods increased 0.4 percent, compared with an increase of 0.1 percent. Purchases of services increased 0.2 percent, compared with an increase of 0.3 percent.

PCE price index -- The PCE price index increased 0.1 percent in July, compared with an increase of 0.2 percent in June. The PCE price index, excluding food and energy, increased 0.1 percent, compared with an increase of 0.2 percent.

Here's the chart that really matters -- the inflation-adjusted monthly, seasonally-adjusted annual rate of PCEs. We see an uptick in this months number which is encouraging. The last five months have been a bit stagnant. However, one month does not an increasing trend make. As I said -- this is encouraging but not definitive.

Why A Rate Cut Won't Help

From Reuters:

The credit market is experiencing an unprecedented loss of confidence due to the lack of transparency over where exposures lie rather than underlying credit quality problems, Moody's Investors Service President Brian Clarkson said on Thursday.

I'll be repeating this argument often. The central problem in the credit markets right now is concern over what people are actually buying, not whether or not they have enough money. Lowering the cost of money will not change what people think about the market; it will only force people to dump the new money into T-Bills.

Thanks to Calculated Risk for the link.

Another Hedge Fund Bail-Out

From the WSJ:

Barclays Capital rescued from collapse a structured investment vehicle it helped set up last year, after other so-called "SIV-lites" it arranged were forced to wind down.

Barclays Capital, the investment-banking arm of Barclays PLC, said it will provide $1.6 billion in financing to Cairn High Grade Funding I, a vehicle of Cairn Capital, a London-based structured credit specialist that manages about $9 billion.

The funding will be used to redeem maturing commercial paper, and will stay in place until the underlying securities held by Cairn High Grade Funding mature over the next four years or so. But the bank said it has fully hedged its exposure to the underlying U.S. residential mortgage-backed securities in the Cairn portfolio.

Amid concern about Barclays's exposure to Cairn and similar vehicles, the bank on Thursday acknowledged it had borrowed £1.6 billion Wednesday from the Bank of England standing lending facility, citing a technical breakdown in the U.K. clearing system.

The financing announced Friday came as Cairn High Grade Funding teetered on the brink of collapse, having had to recently draw on $442 million in backup liquidity lines from Barclays PLC and Danske Bank after being unable to roll over maturing commercial paper. Ratings agencies Standard & Poor's Corp. and Moody's Investors Service last week said they were reviewing the vehicle's ratings for possible downgrade.

Is Construction Employment Lower?

From IBD:

"Jobless claims drifting up as they have is consistent with a slowdown" in GDP growth in the second half of the year, said John Silvia, chief economist at Wachovia.

The uptrend comes as mortgage-related firms slash tens of thousands of jobs amid a housing slump and credit crunch.

Housing starts have crashed 40% from their peak. But construction jobs have fallen just 1% from their cyclical high of 7.725 million reached last September.

Economists say the actual employment figure probably is much lower, partly because builders haven't reported layoffs of undocumented workers and other off-the-books personnel.

"There's a fair amount of labor in the construction industry that is not captured in the payroll survey," said Steve Cochrane, an economist at Moody's

Construction employment may be 160,000 below what current government data show, according to a study last month by Macroeconomic Advisers.

"There are less and less jobs every day," said Mario Lopez, lead organizer for the Cypress Park Community Job Center in Los Angeles. "It's a real problem for us."

If job losses are larger than official stats, consumer spending may face more pressure.

Here is a chart from the Bureau of Labor Statistics of construction employment. Economists have advanced several theories as to why this number has not dropped in conjunction with the large drop in housing starts. The most common that I have seen are:

1.) Non-residential construction has absorbed the slack (which I have advanced)
2.) The use of illegal/undocumented labor skews the numbers

In reality, I think we are seeing a combination of these two factors in the construction numbers. Non-residential construction spending has been increasing over the last year. In addition, I would assume that undocumented/illegal labor would be the first to go in a slowdown.

However, the low reported unemployment rate does not jibe with several other economic numbers one of which is consumer spending. Inflation-adjusted consumer spending has been slowing down on a month-to-month basis for the last 5 months. It was revised down to 1.4% growth in the latest GDP report. However, a loss of 160,000 construction jobs is more consistent with a slowdown of that magnitude.

Thursday, August 30, 2007

New High/New Low Index Stil Bearish

Here is the New York new high/new low index and the NASDAQ new high/new low index. Notice these are still trending down. That gives me great pause.

Today's Markets

The markets traded in two different periods today. First they opened lower on the GDP report. Traders are use to the idea of the Fed cutting rates right now. This news makes that less likely. The SPYs consolidated in a triangle pattern until a little after 13:00, then began the second part of their trading, which was a downward slant move. Overall, the SPYs closed lower by .35% which isn't that bad a drop.

The two day chart shows the opening drop more clearly. It also shows that today's action can be seen just as much as a sideways move as a move lower.

On the daily chart, we're still hugging the 200 day SMA. However, the price action over the last few days should give bulls some hope as the index did not follow though on its sell-off from two days ago.

Overall, this is still a market looking for direction. There is an even split between the bulls and the bears right now and it's keeping the market from moving in either direction.

A Look At the QQQQs

While I usually look at the SPYs, there are of course other markets. One of the constant refrains I read in investment letters is large technology companies look interesting largely because they don't buy mortgages. There are some other reasons for liking this sector. So, here are three charts of the QQQQs.

The first is a 4-year weekly chart. Like the SPYs, this index traded in a wide, upward-sloping channel for the last roughly 4 years. However, the market broke out of this channel earlier this year. If spiked above the upper-channel line and has since dropped back to test this support.

Here is a 3-month daily chart. Notice where the arrow is, right after 8/13. These was a lot of volume on this day and a hanging man candle stick. This indicates this day was a short-term selling climax for the QQQQs. The index rose from there, moving back through the upper-trend line referenced in the above analysis. Since then the index has dropped to that level again, retested and moved higher.

Finally, here is the same 3-month chart with moving averages added. Notice the above mentioned hanging man/high volume day also occurred just above the 200-day SMA. In other words the index fell to a standard technical support line, held and moved higher. The 10-day SMA is about to move through the 20-day SMA which is another bullish indicator. Finally, the recent price action may be enough to start moving the 20-day SMA higher.

Short version -- this index is starting to look very interesting.

Commercial Paper Market Still Shrinking

From Bloomberg:

The U.S. commercial paper market shrank for a third week, extending the biggest slump in at least seven years, as investors balked at buying short-term debt backed by mortgage assets.

Asset-backed commercial paper, which accounted for half the market, tumbled $59.4 billion to $998 billion in the week ended yesterday, the lowest since December, according to the Federal Reserve. Total short-term debt maturing in 270 days or less fell $62.8 billion to a seasonally adjusted $1.98 trillion.

Commercial paper outstanding has fallen $244.1 billion, or 11 percent, in the past three weeks, suggesting the Fed's Aug. 17 reduction in the discount rate has yet to entice buyers back into the market. More than 20 companies and funds including Cheyne Finance and Thornburg Mortgage Co. failed to sell new paper as investors fled to safer investments.

``I don't think the Fed understands how critical the situation is,'' said Neal Neilinger, co-founder of NSM Capital Management in Greenwich, Connecticut, in an interview today. ``The market is going to overshoot itself and not lend money to people who deserve it.''


Commercial paper is bought by money market funds and mutual funds that invest in short-term debt securities. In asset-backed commercial paper, the cash is used to buy mortgages, bonds, credit card and trade receivables, as well as car loans. Some of the programs are backed by subprime loans. Subprime loans are issued to borrowers with poor credit or high debt.

About 26 percent of asset-backed commercial paper outstanding as of July was used to fund purchases of mortgage- related securities, according to Standard & Poor's. The yield on the highest rated asset-backed paper due in a month reached a six-year high today of 6.18 percent.

Over the last few weeks PIMCOs Bill Gross wrote an article where he basically argued the central problem faced in the markets right now is no one knows where the next problem will pop-up (I believe he used the "where's Waldo" analogy). That perception is starting to bite the markets because no one wants to buy a land mine. As a result, most people are simply shying away from the market altogether.

However, there is no guarantee a rate cut would change this situation. The problem is not about the cost of money. The problem is what will people do with the money. Just because someone has money to spend, it does not mean they are going to spend it on what the market wants them to spend it on. And as recent experience in the T-Bill market shows, people are looking for safety right now. Lowering the fed funds rate will only make that situation worse.

What we have right now is a problem with asset quality and the perception of asset quality. And that won't go away by making it cheaper to buy assets.

GDP Increased to 4%

Here is a link to the original report from the BEA.

Here is the report from Bloomberg:

Surging exports and business spending propelled U.S. growth to the fastest pace in more than a year before turmoil in the credit markets forced the Federal Reserve to warn of a bleaker outlook.

Gross domestic product rose at a 4 percent annual rate in the second quarter, the Commerce Department said in Washington, up from an initial estimate of 3.4 percent. The median forecast of economists polled by Bloomberg News was 4.1 percent.

The figures may be the peak of the expansion for this year as the cost of borrowing increased in August and the Fed said that risks to growth ``increased appreciably.'' In a sign that the labor market is weakening, separate government numbers today showed claims for jobless benefits climbed to the highest level since April.

``The underlying economy was growing in the first half,'' said Peter Kretzmer, a senior economist at Banc of America Securities LLC in New York. ``We expect it to slow modestly, but not in such a pronounced way. It will slow enough, though, that the Fed will find an excuse'' to reduce interest rates, he said.

Kretzmer accurately predicted the pace of expansion.

The Fed's preferred inflation measure, which is tied to consumer spending and strips out food and energy costs, rose at a 1.3 percent annual rate. The pace of increase was the slowest in four years.

Personal Consumption Expenditures increase 1.4%, whith is .1% less than the previous number.

Non-residential structures investment increased 27.7%. This number was about 22% in the first GDP report. This pace is unsustainable. I have speculated this surge is the last big move in the investment field from the nonresidential sector. The turmoil in the mortgage markets adds to the credibility of that analysis.

Exports increased 7.6%. This plays into the "foreign market demand will help to prevent a recession" argument, which has also led the bulls to again recommend large US industrial and basic materials companies that have strong international exposure.

Federal spending increased 5.9%. This is also unsustainable, and I expect this rate of increase to slow down in the next few quarters.

This report gives the Fed plenty of reason to not lower interest rates at their next meeting.

The Markets Are Working Properly; Let Them Work

From the WSJ:

On the short end of the maturity spectrum, demand remained solid as investors continued to turn away from risk and seek safety. As a result, the bond-equivalent yield on three-month T-bills fell as low as 3.91%, though it ended the session off that low at 3.984%.

Amid the dash for cash, the government's auction of $18 billion in two-year notes was nearly four times subscribed, the best level since 1988, according to Ian Lyngen, interest-rate strategist at RBS Greenwich Capital in Greenwich, Conn. Indirect bidders, domestic and foreign institutions, including foreign central banks, took 32.5% of the new two-year notes.

From IBD:

In fact, money market funds have seen record inflow as investors seek their safety. The Investment Company Institute said $43.67 billion went into money market funds the week ended Aug. 16. The previous week, it was $49.28 billion.

That's more than double the flow — $18.13 billion — for the week ended Aug. 1, before the subprime crisis picked up steam.

Money market funds are moving to shorter duration securities, despite the market's expectation of a decrease in the federal funds rate. Not long ago, the bias was toward a rate increase because of Federal Reserve chief Ben Bernanke's public stance that inflation was a concern.


Jim McDonald, portfolio manager of taxable money market funds at T. Rowe Price, says that's odd. Ordinarily when the Fed plans to lower rates, money market funds move to longer duration securities to lock in higher yields.

But managers are so uncertain about further fallout from the subprime crisis that they are moving a chunk of their money into securities that mature the next day.

Here's a chart of the T-Bill yield.

And here's a graph of the current yield curve.

The flight to quality and the weight it is putting on the short-term part of the government yield curve is a primary reason why some some people are calling for a rate cut from the Fed. But there are some points these people are missing.

First -- this move shouldn't be overly surprising. During times of market turmoil, investors usually put money in safe and liquid short-term government bonds. This is often called a "flight to safety" because of the inherent nearly risk-free profile of government debt. In other words, investors are doing exactly what they should be doing during a period of market turmoil.

Secondly -- this isn't a bad thing. Investors are parking cash on the sidelines waiting for an opportunity. While these investments are safe, they don't yield that much after inflation. That means investors will eventually tire of low yields and look for a better return. There is no actual time line as to when this will happen. But if people continue to flock into the short-end of the curve, yields will continue to decrease, lowering return. And the lower the return goes, the more incentive investors have to look for higher yield somewhere else.

Third -- a steeper yield curve positively effects the Federal Reserve's outlook. A flat or inverted yield curve is usually a sign of an impending recession. A steep or normally inverted yield curve is the way the yield curve is supposed to look, with longer-dated bonds yielding more than shorter bonds. This is a yield curve that does not say recession. Remember that in this analysis, the reason for the yield curve's shape isn't important; all that matters is the actual shape.

In other words, right now investors are acting very rationally. More importantly, the market is acting as it should act.

The people calling for an interest rate cut want immediate gratification; they do not want the markets to work as they should.
Instead, they are use to being bailed out of market turmoil by the Fed. This is to be expected given the Fed's actions in recent market problems. Here is a chart from the above cited WSJ article of the Fed's action to market problems. Note that over the last 15+ years, Greenspan has ridden to the rescue with an interest rate cut in the Fed Funds rate.

Right now the markets are doing exactly what they should be doing. When they unlock and move from government debt to higher yielding assets is unknown. But that will eventually happen. I hope the Fed let's that happen naturally.

Wednesday, August 29, 2007

Today's Markets

What a difference a day -- and more speculation of a rate cut -- makes.

As the Briefing noted:

Onward and upward remains the driving mantra heading into the final hour of trading. With all eyes on Bernanke this week ahead of his opening remarks at a Fed symposium -- a speech we don't believe will offer as clear-cut a signal about the Fed's next move as some on Wall Street are hoping (i.e. there won't be a Q&A session) -- the Fed Chairman reportedly telling Senator Schumer the Fed is ready to "act as needed" has given stocks an added boost.

Even though the letter was dated on Monday, the Fed also reiterating its commitment to ensure financial markets have adequate liquidity serves as a reminder about the surprise cut in the discount rate on August 17 that reduced the probability that the liquidity crunch would result in a recession.

This is nearly the exact same statement the Fed made about a week ago through Chris Dodd. This has reassured the markets that a Fed cut is in the works.

Here's the 2-day, five minute chart of the SPYs. Notice a few things.

1.) Volume picked-up throughout the afternoon. This simply means the buyers were getting more excited both by the actual market action and the possibility of a rate cut.

2.) The market closed over yesterday's open. Technically, this is pretty important.

Here's a three day chart. I put this up because the market formed a head and shoulders pattern (which you can see outlined by the arrows). However, most of the upward play from this pattern is probably already worked into the current closing price.

Here's the 3-month daily chart. Today's volume wasn't that spectacular. That's usually a big warning sign to me. I like seeing buyers in an upward trending market. But the recent volume figures just aren't cutting it for me.

The good news from today's action is buyers seem to be more than willing to come into the market to buy on dips right now. That helps to prevent multi-day slides. But the lack of volume indicates there aren't that many buyers right now. In other words, I'm not seeing an "all clear" sign from the market in any way.

Yesterday I called for a double-bottom. I'm still holding to that call right now. We've only had about a week or so without negative news from the mortgage market. We need at least another week before we can move higher.

A Really Good Explanation Of What Has Happened

From Business Week:

Making sense of this mess is daunting. One good place to start: the ways various financial players indulged in layer upon layer of leverage, much of it far from transparent.

Mortgage lenders threw out common sense underwriting standards.

Wall Street sliced and diced the loans, creating the illusion that risk somehow disappeared in the process.

Hedge funds then multiplied the leverage by borrowing copiously to buy securities based on the rearranged mortgages.

In their version of the game, private equity firms used loads of debt to launch unprecedented buyouts.

Yen and T-Bill

Two keys to the current market situation are the Yen and short-term Treasury bonds. The yen is a proxy for the carry trade (borrowing in another currency and lending/investing in the US), and the T-bill is a proxy for the short-term part of the market. If money is still concerned about volatility, then the T-bill yield will drop. The converse is also true.


Daily Chart

The yen spiked higher then sold-off. The post-spike sell-off is a standard move in the markets.

Here's the weekly chart.

In the circled area note the following.

1.) Prices broke above long-term resistance.

2.) Prices fell back to long-term resistance.

3.) Prices rose from long-term resistance a second time.

Because the carry-trade is so important to finance right now a continued move above the resistance line is very important to watch.


T-Bill yields have retreated from their highs at the start of the credit market problems. While they haven't returned to the previous levels, pressure is easing in this part of the credit market for now.

Tuesday, August 28, 2007

More Charts For the SPYs

Here is a 1-year chart for the SPYs. I added support lines. We have about 1.2% to 1.9% before we hit the lowest support line on the chart.

Here's the 3-year chart. Notice

1.) The index broke out of a channel in late October 2006. Right now the index is bouncing on top of that channel. I you think of the channel as a mean price channel, than recent action is merely a reversion to the mean. Granted -- it could take awhile to return to mean levels.

2.) The 3-year uptrend is still very much intact. The index would have to drop another 7.69% to approach the lower trend line.

Here's a 3-year weekly chart with the MACD. Notice that according to the MACD we could have a bit longer downturn.

Here are two very important breadth charts from The first is the New York new High/Low and the second is the NASDAQ new high/low. I have been harping on these charts for awhile, but the reason is very sound. When a market is really rallying, stocks are moving to new highs. Over the latest post-Fed rally, the number of new lows and new highs has been equal. That is not a rally.

New York New High/Low

NASDAQ New High/Low

Today's Markets

What a difference a Fed statement can make.....

Ever since the Fed cut the discount rate, I have been talking about an upward sloping channel for the SPYs. The index broke that channel today in a big way. Here's the 8-day, 5-minute chart to illustrate.

Here's the chart from today. There was one direction -- down. Notice the big pick-up in volume on the second downward sloping line -- the one that occurred after the release of the Fed minutes.

Here are two 1 month daily charts with two different Fibonacci levels. In the first chart, we're already at the 50% line of support.

In this one we're at the 38.2% line of support

Finally, here is the 3-month daily chart. Notice we are again through the 200 day SMA, which is a bearish sign.

There has been a lot of talk about what the market would do after it's recent post-discount rate cut rally. My guess is we're looking at a double bottom of sorts What is crucial is where the market stops selling and the volume that occurs at that level.

Fed Minutes

The Fed released the minutes of the August 7 meeting. Because the Fed's perception of the economy is so incredibly important right now, let's take a detailed look at what the Fed is seeing.

The information reviewed at the August meeting suggested that economic activity picked up in the second quarter from the slow pace in the first quarter. On average, the economy expanded at a moderate pace during the first half of the year despite the ongoing drag from the housing sector. While the growth of consumer spending slowed in the second quarter from its rapid pace in prior quarters, wages and salaries increased solidly and household sentiment appeared supportive of further gains in spending. Business fixed investment picked up in the second quarter after little net change in the preceding two quarters. Inventories generally appeared to be well aligned with sales at midyear. Overall inflation receded in June because of a decline in energy prices, while the core personal consumption expenditure (PCE) price index rose bit less than its average pace over the past year.

The basic overall picture is OK. Things aren't too hot or cold. Barry Ritholtz over at the Big Picture has called growth "lumpy" which I think is a really good phrase to describe the general trend. Some areas are doing well and others are clearly dragging.

Private nonfarm payroll employment continued to increase at a healthy pace; the rise in July was about equal to the average increase over the first half of the year.

Bulls have argued employment is one of the big areas of strength in the economy, usually citing the 4.6% unemployment rate. The Fed is confirming this view. A serious drop in employment would be a clear signal there was a problem. However, so long as the Fed thinks employment is on solid ground, they will feel far less pressured to lower the Fed funds rate.

Industrial production picked up in the second quarter after little net change over the preceding two quarters.

This observation ties in with this point:

Economic activity in advanced foreign economies expanded somewhat less rapidly in the second quarter than in the prior quarter, but nonetheless appeared to have grown faster than trend, reflecting upbeat business and consumer confidence as well as favorable labor market conditions.

Another general consensus emerging is growth in US trading partners will help to alleviate the housing slowdown in the US. Starting in the first quarter of this year many commentators (including myself) observed that foreign profits were a big reason for the the first quarter profit increases from the big multi-nationals. So long as other countries continue to grow, US exports should as well.

Outlays for nonresidential construction rose rapidly in the second quarter. Business spending on equipment and software, other than transportation equipment, posted a solid increase after being flat, on net, in the preceding two quarter

Non-residential construction increased at a 22% seasonally adjusted annual rate in the second quarter. This pace is not sustainable. My thought is we are seeing the last hurrah (as it were) from the non-residential construction sector.

In addition, we saw some decent increases in business technology investment.

The growth of real consumer spending slowed considerably in the second quarter after substantial increases earlier in the year. The deceleration primarily reflected sharply slower growth in outlays for goods as purchases of motor vehicles decreased noticeably.


Demand for housing in the second quarter was restrained by higher interest rates and by tightening credit conditions in the subprime mortgage market.

Short version: the consumer -- which is responsible for 70% of US economic growth -- is spending less. This is not a good development.

The statement announcing the policy decision noted that economic growth appeared to have been moderate during the first half of the year, despite the ongoing adjustment in the housing sector. The economy seemed likely to continue to expand at a moderate pace over coming quarters. Readings on core inflation had improved modestly in recent months. However, a sustained moderation in inflation pressures had yet to be convincingly demonstrated. Moreover, the high level of resource utilization had the potential to sustain those pressures. The Committee's predominant policy concern remained the risk that inflation would fail to moderate as expected. Future policy adjustments would depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

The bold-faced sentence from above is the real money quote from the meeting. The Fed is still concerned about inflation, and fighting inflation is still their primary policy orientation. This statement is currently sending markets lower.

The bottom line is this isn't a horrible picture. It says what we already know. Housing is in a nosedive. This is probably having a negative impact on consumer spending. However, other areas of the economy are doing OK. Given this outlook, the Fed is completely justified in not lowering interest rates.

And from the Oooops Department....

About a month ago, Google shut my blog down for about a day. They said I had a spam blog. They figured out I didn't have one so I got back up an running.

But to prevent that from happening again I now "moderate" comments. Basically I have to approve all comments. No, I haven't deleted anybody. I'm just making sure no one is doing unwarranted advertising in the comments section.

But, then things like today happen. There were three comments that I wanted to publish but instead clicked reject.

To those of you who commented I am sorry. Sometimes there are just too many buttons to push.

Case Shiller Index Drops 3.2%

From CNBC:

Home prices across the nation declined by 3.2% in the second quarter from a year earlier, suggesting the housing downturn has deepened, according to the S&P/Case-Shiller U.S. National Home Price Index.

The national index, which measures all nine U.S. Census divisions, fell to 183.89 last quarter from 189.93 in the same period in 2006, S&P said in a statement.

"This number may still not be at its lowest," Maureen Maitland of S&P told CNBC. "Many people, including Standard & Poor's economists, expect further declines in home prices throughout the year. They're looking for the bottom to go through the end of the year and turn around in 2008."

Here is the difference between this index and the price data in the post two posts below:

The S&P/Case-Shiller index and another by the Office of Federal Housing Enterprise Oversight track the same home over time and more accurately reflect price trends, economists said.

Gauges from the Commerce Department and the National Association of Realtors can be influenced by changes in the types of homes sold. Higher sales of cheaper homes relative to more-expensive properties will bias the figures down.

This index makes a heck of a lot more sense given the current inventory glut in existing homes.

Credit Card Defaults Increase

From CBS.Marketwatch

U.S. consumers are defaulting on credit-card payments at a significantly higher rate than last year, according to a Financial Times report citing Moody's data. Credit-card companies were forced to write off 4.58% of payments as uncollectable in the first half of 2007, almost 30% higher year-on-year, the report said. But Moody's said the rate of losses remained well below the 6.29% average seen in 2004, a year before the US enacted a new law that made filing for personal bankruptcy more onerous, the report said

Consider that news with the following three graphs from the St. Louis Federal Reserve.

Total household debt outstanding:

Year-over-year percentage change in household debt:

Household's debt service ratio:

What's Wrong With These Pictures?

Here is the total available inventory chart of existing homes from yesterday's report. The WSJ noted:

Inventories of homes for sale jumped 5.1% to 4.59 million, or about 9.6 months of supply at the current sales pace. A supply of about six months generally indicates a balanced market.

And the Blog Interest Rate Roundup noted:

It's also the highest level on record

So -- here's the graph.

From the same report we have the following two graphs.

Median sales price:

Average sales price:

Now -- look at those three graphs and notice the following.

1.) Inventory has increased over the last 6 months and is now at the highest absolute level of record.

2.) Over the same period the average and median price increase as well.

Econ 101: excess supply (which we have in spades) + decreased supply (tightening mortgage standards) = lower prices.

We aren't anywhere near a bottom yet.

Monday, August 27, 2007

T-Bills Easing

From CBS.Marketwatch:

But pressure continued on the shorter end of the curve, where the yield on 3-month T-bills finished at 4.43%, compared to 4.23% late Friday.

The rising yields on short-term notes suggest some of last week's credit woes might be abating, as investors move out of short-term risk-free assets. But the fact that the yield remains below the Federal Reserve's funds target of 5.25% shows that caution remains.

Here's a chart from Stockcharts:

Today's Markets

I'm going to be doing this one a little backwards.

First, the markets have been in an uptrend since the Fed cut the discount rate. Despite today's sell-off, the SPYs are still in an uptrend. Here's the 5-minute daily chart going back to the day of the rate cut. Notice the outer trend lines are still very much intact.

Notice the market has rallied since about noon on Thursday. I added an arrow to this 3-day, 5-minute chart to show where the rally started. Seen through this three-day chart, today's action is a simple sell-off from a day-and-a-half rally.

Finally, here is a 2-day, 5-minute chart. Notice that despite the bearish news from the housing sector, the market found a bottom for most of the day. There was late day, high-volume selling, which should raise some concern. This indicates traders don't want to hold their positions overnight.

Here are a couple points of concern.

First, the Russell 2000 has traded sideways for the market advance. In addition, volume is very low. This indicates traders are shying away from the small caps for now. While this is to be expected because of the market sell-off, don't expect a big rally until investors are willing to move into the higher-risk small cap area of the market.

Here are the new highs/new lows charts for the NYSE and NASDAQ. Note that while the market advanced these indicators didn't. This indicates the number of new lows is at least equaling new highs which is not the sign of a bull run.



Finally, here is a chart of the SPYs with Fibonacci levels for the current advance. Here is what the dk Report said about the current market action.

An important consideration going forward is that V-bottoms are extremely rare. As the story goes, if money managers feel that a bottom is in play, they simply stop buying to get better prices. Without huge money, stock prices eventually slide, weak hands sell and the pros scoop up the slop at prices that interest them. In the world of TA, a double-bottom is born, and they're painful, uncomfortable experiences for the unprepared.

The rub is that the few times that V-bottoms actually work is during market events like this one. Two weeks ago, perfectly good positions were sold -- and perfectly bad ones were covered -- all to raise cash for reasons unrelated to those positions. The market hiccuped on non-fundamental selling, and this raises the odds for a spastic V-bottom to hold.

Read This Now

From the dk Report. It's a great overview of some technical analysis issues and the current market.

Existing Home Sales Drop .2%

From Bloomberg:

Sales of previously owned homes in the U.S. fell in July for a fifth consecutive month, adding to the inventory of unsold properties and showing the housing slump that triggered a collapse in credit markets will drag on.

Purchases declined 0.2 percent, less than forecast, to an annual rate of 5.75 million, from 5.76 million in June, the National Association of Realtors said today in Washington. That was the slowest pace since November 2002. Sales dropped 9 percent compared with a year earlier.

Here's a link to the data.

Here's the only part of the release that matters. It's a chart of the absolute inventory figures.

These figures are 18.9% higher than last year and represent a 9.6 months of supply.

That is called a glut.

Housing's Problems Going Forward

From Bloomberg

The credit crunch is not only making mortgage financing tougher, it will force more homeowners into foreclosure. The surge of more bargain homes on the market will further depress prices. Along with a corresponding pinch on home equity, auto loans and credit cards, this pullback doesn't bode well for the economy.

That paragraph just about sums it up.

Employment Going Forward

Going forward I would expect the bulls to continue arguing that strong employment growth is a sign the economy is doing well. In addition, I would expect the Federal Reserve to keep an eye on employment as they make their interest rate decisions going forward. So let's see what areas of the employment picture we should look at to see possible early signs of weakness.


Over the last year, non-residential construction has risen in prominence in the construction sector, now accounting for more than half of all construction spending. In last month's GDP report we say a big bump in non-residential construction spending. However, that was before the credit crunch. The large bump may have been the last big push in non-residential spending as builders accessed tightening credit lines. So, keep an eye on this number for early signs of weakness in the employment picture. Here's a chart of total construction employment since January 2001. Notice it has leveled off but not declined.

Financial Services

Since the end of last year the financial services industry -- particularly the mortgage sector, has experienced a great deal of turmoil. According to the Implode-o-meter, 136 firms have "imploded" since late 2006. Yet the financial services employment number has continued to increase. Don't expect this trend to continue. Here's a chart of financial services employment since January 2001.


Inflation adjusted personal consumption expenditures have slowed over the last 5 months. Here's a chart of PCE's which are in chained 2000 dollars and adjusted to their seasonally adjusted annual rate.

Here is a chart of retail employment since January 2001. Note it has leveled off as well. Obviously, this number is strongly tied to consumer spending. More weakness in spending and we could see this number drop off.

Temporary Employment

From the WSJ:

Add another item to the economic worry list: Employers are shedding temporary workers.

Temporary employment, long a buffer that gives companies flexibility, has fallen each of the past six months, and in July was down nearly 2% from the start of the year, according to the Bureau of Labor Statistics. U.S. revenue at Manpower Inc., the world's second-largest staffing firm after Adecco Group, dropped almost 9% in the second quarter, as demand fell.


Because the temp and overall job markets haven't tracked closely in recent months, the weakness in temp hiring could be a false indicator. "Nobody has ever seen this type of a pause in temp employment growth," Mr. Camden said. "This is just an unusual array of numbers...In general when you've had a long flat period, it's followed either by a sharp increase or a sharp decrease."

Here is a chart of temporary employment since January 2001.

My biggest concern is that weakness in all of these sectors hits all at once. For example, the mortgage market slowdown continues, hitting the financial services number. This in turn leads to a slowdown in construction spending, lowering construction employment. These two combined events lower consumer sentiment, lowering consumer spending. Given the current environment, the previous scenario isn't that far from possible.