Saturday, February 16, 2008

Last Week's Markets

For the last week I used longer charts to clear out the noise and show the market was consolidating for the week. That's what I'm going to do here. First, here are the line charts of the SPYs, QQQQs, and IWMs to show the consolidation.

We're still firmly in the middle of a consolidation except for the IWMs which broke below support on Friday. However, there has been a great deal of bouncing around on the part of all the averages lately, so I want to see a stronger break before I call a break of the triangle.

Here are all three charts in candle form. I have kept the lines from the previous charts in the same place.

The markets have been extremely hard to read lately -- there is a lot of conflicting sentiment out there. The bulls have the Fed on their side while the bears have literally every other piece of data. Who wins is anybody's guess.

Friday, February 15, 2008

Weekend Weimer and Beagle.

The markets will soon be closed. So that means its time to stop thinking about the economy and the markets for now.

Usually I have pictures of my Weimaraners and the future Mr$. Bonddad's Beagle up right now. But this week a Beagle named Uno won best in show. So here is the You Tube of the moment of victory. Notice how Uno is baying throughout.

And here's a video from the AP with some background.

How Do We Get Out of This Mess?

I've done a great deal of complaining about the overall conditions in the financial markets but I haven't offered any solutions. So, here's my answer.

There isn't much we can do. Any solution would create a moral hazard, meaning the solution would encourage the behavior that got us into this mess in the first place. To illustrate this point, let's take a quick look at what got us into this mess.

This expansion is characterized by a massive expansion of household debt. First, here is a chart of total household debt outstanding going back a few decades.

Here is the same chart for the last 10 years.

To put all of this debt in perspective, here are two graphs.

So, we have almost as much household debt as we do national product, and we have more dent than we have disposable income.

In other words -- we are awash in debt.

All of this debt has to go somewhere. That's where all of the securitizations you've heard about come into play. Here is a definition from Wikipedia:

Securitization is a structured finance process in which assets, receivables or financial instruments are acquired, classified into pools, and offered as collateral for third-party investment.[1] It involves the selling of financial instruments which are backed by the cash flow or value of the underlying assets.[2]

Securitization typically applies to assets that are illiquid (i.e. cannot easily be sold). It is common in the real estate industry, where it is applied to pools of leased property, and in the lending industry, where it is applied to lenders' claims on mortgages, home equity loans, student loans and other debts.

All assets can be securitized so long as they are associated with a steady amount of cash flow. Investors "buy" these assets by making loans which are secured against the underlying pool of assets and its associated income stream. Securitization thus "converts illiquid assets into liquid assets"[3] by pooling, underwriting and selling their ownership in the form of asset-backed securities (ABS).[4]

Securitization utilizes a special purpose vehicle (SPV) (alternatively known as a special purpose entity [SPE] or special purpose company [SPC]) in order to reduce the risk of bankruptcy and thereby obtain lower interest rates from potential lenders. A credit derivative is also generally used to change the credit quality of the underlying portfolio so that it will be acceptable to the final investors.

Securitization has evolved from tentative beginnings in the late 1970s to a vital funding source with an estimated total aggregate outstanding of $8.06 trillion (as of the end of 2005, by the Bond Market Association) and new issuance of $3.07 trillion in 2005 in the U.S. markets alone.[citation needed]

So all of the household debt has been carved and sold to, well, everybody.

As this process accelerated the entire financial system became very lax in literally everything they did. Mortgage brokers stopped performing due diligence -- meaning they stopped making credit checks. Investment banks who bought collateral to securitize stopped performing in-depth analysis of the assets they were purchasing. Ratings agencies totally dropped the ball in their analysis of the collateral, instead giving literally every single piece of paper a AAA rating so anybody could buy it. Investors who bought this paper didn't look under the hood at the collateral either. In short -- everybody dropped the ball.

The problem we're running into now is we're discovering that all of this debt isn't as valuable as we thought it was for a variety of reasons. Either the value of the collateral backing the loans is decreasing in value (declining home values) or people are increasingly not paying their bills (increasing delinquencies). As a result, the entire financial system is experiencing a huge "revaluation of risk" which simply means they are having to writedown the value of all these securitized assets on their books. This is what Bernanake was talking about yesterday.

As the concerns of investors increased, money center banks and other large financial institutions have come under significant pressure to take onto their own balance sheets the assets of some of the off-balance-sheet investment vehicles that they had sponsored. Bank balance sheets have swollen further as a consequence of the sharp reduction in investor willingness to buy securitized credits, which has forced banks to retain a substantially higher share of previously committed and new loans in their own portfolios. Banks have also reported large losses, reflecting marked declines in the market prices of mortgages and other assets that they hold. Recently, deterioration in the financial condition of some bond insurers has led some commercial and investment banks to take further markdowns and has added to strains in the financial markets.

In short, the financial sector is feeling the pain of their complete lack of due diligence for the last 7 years. Now they are going to Congress asking for a bail-out. The problem is this: any bailout will only encourage this kind of behavior all over again. And that is something we have to avoid to prevent this from happening again.

Now -- this policy prescription means the following: the US economy will perform -- at best -- at a sub-par level for a while. It also means we risk the possibility of a recession. There is this fundamental belief -- encouraged by Alan Greenspan's policies -- that an economy does not have to feel pain. Nothing could be further from the truth. The only way to clean out the dead wood is to clear the way for them to report massive losses and possible go bankrupt. That's how you solve the problem.

What the Fed should be doing right now is ensuring that prices don't get out of control so that on the other side of a recovery the economy is not faced with inflationary pressures. That way when we get out of this mess we'll be able to resume a period of solid growth.

What Inflation?

From the BLS:

The U.S. Import Price Index increased 1.7 percent in January, the Bureau of Labor Statistics of the U.S. Department of Labor reported today, led by a 5.5 percent increase in petroleum prices. The overall increase followed a 0.2 percent decline in December. U.S. export prices advanced 1.2 percent in January following a 0.4 percent rise in December.

The January increase in overall imports resumed the upward trend of the past year after a 0.2 percent decrease in December. The index, which had risen 3.1 percent in November and 1.5 percent in October, is up 13.7 percent over the past 12 months, the largest year-over-year increase since the index was first published in September 1982.

The Central Problem We Face

Bernanke spoke to Congress yesterday. Here are some key points from his speech.

As the concerns of investors increased, money center banks and other large financial institutions have come under significant pressure to take onto their own balance sheets the assets of some of the off-balance-sheet investment vehicles that they had sponsored. Bank balance sheets have swollen further as a consequence of the sharp reduction in investor willingness to buy securitized credits, which has forced banks to retain a substantially higher share of previously committed and new loans in their own portfolios. Banks have also reported large losses, reflecting marked declines in the market prices of mortgages and other assets that they hold. Recently, deterioration in the financial condition of some bond insurers has led some commercial and investment banks to take further markdowns and has added to strains in the financial markets.

Let's go back to out basic model of the US economy:

As the chart demonstrates, the US financial system is at the center of the economy. It acts as a financial intermediary between lenders (individuals' assets pooled together) and borrowers. The financial system must be healthy for the economy to prosper.

But it's not. More importantly, Bernanke clearly knows what the the problems are. At a time when lower interest rates should be increasing the total amount and value of loans, financial companies are also reporting increasing losses, a diminishing asset base and the addition of poor performing assets to their respective balance sheets. In other words -- financial companies have a ton of really bad assets on their books which prevents them from making new loans.

BTW: Bernake is a convenient whipping boy for me. I think he is making a boneheaded mistake right now by lowering rates and signaling he will lower further. Inflation is far higher than he thinks and lower interest rates aren't having the effect he wants.

However, despite me vociferous disagreement with Bernanke, he's a bright guy and no one should doubt his ability.

Alan Greenspan Disclaimer

Greenspan is in the news again. Now he thinks the US is almost in a recession.

From now on all news reports that even mention Greenspan's name must have the following opening paragraph.

Alan Greenspan GOT US IN THIS MESS. Greenspan confused asset inflation with economic growth. Greenspan also lowered interest rates to 0% after adjusting for inflation, meaning he encouraged a wave of reckless borrowing the likes of which the world has never seen. As a result, the financial system is currently choking on a ton of bad debt which is slowing the economy. Thanks Alan.

Thursday, February 14, 2008

Today's Markets

The markets resumed their up/down I have no idea where I'm going pattern again today.

The SPYS consolidated a bit at the opening, but then traded down for the rest of the day. The good news is the selling was controlled -- each move down was met with a move up. The bad news is there was considerable selling at the end of the day on high volume spikes, indicating traders were very nervous about holding anything overnight.

Save for the lack of consolidation at the opening of trading, the QQQQs action mirrored the SPYs.

The IWMs had the sharpest selling of the day. But like the SPYs and QQQQs, they traded down for most of the day.

And the consolidation continues for all the averages.

The QQQQs have a downward sloping trend in place, although its also possible to call this a consolidation of sorts.

We're still caught between the bulls and bears. I find it interesting the Bernanke's promise of more rate cuts didn't give the market a bigger lift. That might mean that traders now think the rate cuts aren't working and that further cuts won't either.

Bernanke to Wall Street: "I'm Your Bitch"

From Marketwatch:

Federal Reserve Chairman Ben Bernanke said Thursday the central bank was ready to cut interest rates further if fresh signs of a weaker-than-expected U.S. economy emerge.

The Federal Open Market Committee, which sets Fed monetary policy, "will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks," Bernanke told the Senate Banking Committee in prepared testimony.

The Fed has done a lot to stave off a recession but stands ready to do more if the outlook darkens, he said.

(Sung to the Tune of Ghostbusters) When interest rates are negative after adjusting for inflation, who do you call? Bernanke!

I realize that 1.) Bernanke's in a really bad place, 2.) No one wants to do nothing when the world is falling apart, 3.) Saying "lowering interest rates won't help" isn't an answer anyone wants to hear, and 4.) saying, "The financial intermediary system really screwed up and now they need to pay the price" isn't an answer anybody wants to hear either.

But the signs are very clear that interest rate cuts aren't helping. The credit markets are still frozen. And the problems are spreading. The student loan market is now tightening. Junk Bond Yields are spiking. The CDO market is experiencing more problems. The monoline insurers are a breath away from a credit downgrade. Low interest rates won't help when the issue is counter-party risk and saving your own financial ass.

So maybe the Fed should start thinking about their other mandate -- price stability. If they can keep prices stable through all of this mess we might be better off in the long run.

Clearing Out the Noise

I am not a big fan of line charts. I think candlestick charts give us far more useful information. But sometimes you need to use a different method of looking at the market to clear out the noise and see what is really going on. And line charts show the underlying market trend far better than candlestick charts right now.

On the SPYs, notice we have a clear triangle consolidation pattern.

On the QQQQs we have a downward sloping channel with a trend break. That could a bullish turnaround from a technical perspective.

On the IWMs, notice we have a bear market flag.

Bottom line: I still see a bear market with a temporary rally or consolidation going on.

Of course, it's also important to remember Bonddad's first rule of trading: the markets will make an ass of you whenever possible, and the markets have a ton of tools at their disposal to do that.

Banks Beg For Congress To Establish a Moral Hazard

From the WSJ:

The banking industry, struggling to contain the fallout from the mortgage debacle, is urgently shopping proposals to Congress and the Bush administration that could shift some of the risk for troubled loans to the federal government.

One proposal, advanced by officials at Credit Suisse Group, would expand the scope of loans guaranteed by the Federal Housing Administration. The proposal would let the FHA guarantee mortgage refinancings by some delinquent borrowers.

Credit Suisse officials have met with senior officials from the Department of Housing and Urban Development, which runs the FHA, and other policy makers to discuss the proposal.

The risk: If delinquent borrowers default on their refinanced loans, the federal government would have to absorb the loss.

This news infuriates me to no end. What makes it worse is because this is an election year, the plan might actually gain traction.

Let's review all of the actors that caused this mess.

Mortgage brokers: Because the person brokering the loan knew the loan would be sold to a third party the broker has no obligation to make sure the borrower would actually repay the loan over an extended period of time. In addition, some brokers were given higher commissions for selling riskier loans.

Investment Banks: These organizations were hungry for collateral and pressured brokers and originators for more loans to pool and sell. This is the type of pressure that led the mortgage bankers to stop looking at things like "credit history." In addition, investment banks were lax in their due diligence to deeply inspect collateral.

Ratings agencies: who actually said most of this paper was AAA and therefore could be purchased by practically anybody.

All these people are now suffering. Many businesses have gone out of business or are suffering serious declines in their share price. GOOD. Let me repeat that. Good. Yes, I know that sucks for the rest of the economy. But the only way for these organizations to change their behavior (which was the proximate cause in starting the mess in the first place) is to feel the pain. And publicly traded companies feel pain by reporting losses to their shareholders.

Bernanke has already demonstrated that he is Wall Street's bitch. Let's hope Congress can grow a spine and tell the financial industry to grow up. Of course, this is the same organization that is now investigating steroids at the beginning of a recession, so who am I kidding.

Wednesday, February 13, 2008

What Inflation?

From Marketwatch:

Chocolate makers, already beset by escalating dairy prices, are likely to encounter a bittersweet Valentine's Day. The culprit: a recent surge in the price of cocoa.

Raw cocoa futures for March delivery closed up $33 at $2,454 a metric ton on Wednesday, after reaching as high as $2,471 a ton. The gains on New York's IntercontinentalExchange punctuate a steep run that in the last three weeks has pushed the near-term contract to its highest closing level since April 1985.

Here's a chart of cocoa:

From Marketwatch:

Gold finished slightly lower Wednesday, as platinum soared to a new record high over $2,000 an ounce, fuelled by ongoing worries about declining supply from South Africa, the world's biggest platinum producer.

Platinum for April delivery surged to a new record of $2,001.40 an ounce on the New York Mercantile Exchange. The contract rallied $61.90 to end at $1,983.70 an ounce.

Here's the chart of platinum

From Bloomberg:

Corn fell for the third straight day on speculation that overseas demand for the biggest U.S. crop is slowing after prices climbed to records last week.

Advance sales of corn for delivery before Aug. 31 are up 33 percent in the past five months from a year earlier to a record 47.4 million metric tons, the U.S. said on Feb. 7. Confidence in the global economy fell for a third month in February as the slowdown in the U.S. spread to Europe and Japan, a Bloomberg survey showed.

``End-users are already well covered on their needs for this year and will slow purchases after the run up in prices,'' said Don Roose, president of U.S. Commodities Inc. in West Des Moines, Iowa. ``News of demand slowdowns always follows the market after these kinds of rallies.''

Here's the chart of corn

Note that I've highlighted spiking prices in a variety of commodities -- oil, wheat, soybeans and gold just to name a few. This means we're not looking at a supply disruption in one commodity that is driving prices of that particular commodity higher; instead, we're looking at system wide price spikes.

Today's Markets

As I've done all week, I want to back up use a longer time frame to show the market. The bottom line is I'm just not happy with the way Mr. Market is acting, and the longer version demonstrates why.

On the SPYs we have the following action:

-- A two day rally, followed by a bull market flag.

-- A big 2-day drop, leading into a triangle consolidation that lasted 4 days

-- A three day rally

Notice the pattern -- rally, steep sell-off, rally. And in all the time we've added about 2.68% but have gotten there in an incredibly messy way.

On the QQQQs, notice we have

-- A two day rally and a triangle consolidation.

-- A steep two day sell-off

-- A five day rally that nets us 1 point over 10 days, or a 2.28% gain.

Notice the pattern -- rally, sharp-sell off followed by a rally. This is an awful lot of wasted motion.

On the IWMs, notice:

-- A 2-day rally followed by a one day triangle consolidation.

-- A steep 2 day sell-off followed by a 4 day triangle consolidation pattern

-- A three day rally that nets us almost 4 points or 5.7%.

A case can be made that the IWMs are doing well because of the net gain. But again, loot at the trading.

Traders want to see trends -- and I don't see any at this point. I see a lot of fits and starts and a great deal of tentativeness on the part of everybody in the market.

Retail Sales Up. .3%

From the Census Bureau:

The U.S. Census Bureau announced today that advance estimates of U.S. retail and food services sales for January, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $382.9 billion, an increase of 0.3 percent (±0.5%)* from the previous month and 3.9 percent (±0.7%) above January 2007. Total sales for the November 2007 through January 2008 period were up 4.4 percent (±0.3%) from the same period a year ago. The November to December 2007 percent change was unrevised from -0.4 percent (±0.4%)*.

Retail trade sales were up 0.4 percent (±0.7%)* from December 2007 and were 3.8 percent (±0.8%) above last year. Gasoline station sales were up 23.0 percent (±2.8%) from January 2007 and sales of nonstore retailers were up 10.6 percent (±2.0%) from last year.

The problem occurs in the details.

So what increased?

Food and Beverage Stores: +.6%
Grocery Stores: +.3%
Health and Personal Care Stores, +.8%
Gas Stations: +2%
Clothing: +1.4%
Autos: +.6%

What does this tell us?

1.) Necessities are increasing.
2.) How much of the food and gas station increase is the result on food a gas inflation?
3.) I have no idea why autos increased. It's especially odd considering:

Economists were surprised by the gain. Car companies reported earlier this month that sales fell to just a 15.3-million annual rate.

What decreased?

Furnitures/home furnishings: -.5%
Sporting Good Stores/Hobby: -1.3%
Building Materials/Gardens: -1.7%
Electronics/Appliance: -1%

Housing still stinks. No duh.
Leisure activity and electronic gizmos. Non-necessities (that's a word now).

The point is the food and gas inflation are behind at least some of the increases. Also, consider this:

However, excluding autos and gas, sales were flat in the month. Read government report.

So, two areas are responsible for those increases. But of those two areas --

1.) Auto sales increased despite auto companies reporting falling sales, and

2.) Gas sales -- while are subject to some pretty serious inflationary pressures -- are responsible for a large part of the gains.

Color me unimpressed.

Why A Rate Cut Won't Help

From Bloomberg:

The Federal Reserve's interest-rate cuts last month have failed to lower borrowing costs for many companies and households, increasing the chance of further reductions from the central bank.

Companies are paying more to borrow now than before the Fed reduced its benchmark rate by 1.25 percentage point over nine days in January, based on data compiled by Merrill Lynch & Co. Rates on so-called jumbo mortgages, those above $417,000, have increased in the past month, making it tougher to sell properties and risking further price declines.

``It's the clogging up of the credit markets that worries me most,'' Harvard University economist Martin Feldstein said in an interview in New York. ``The Fed has done a lot of cutting, the question is whether it's going to get the traction that it did in the past.''

Banks and investors are demanding greater compensation for offering credit as losses mount on subprime-mortgage securities and concerns grow that ratings of bond insurers will be cut. Elevated borrowing costs mean Fed Chairman Ben S. Bernanke will have to reduce rates further to revive the economy, Fed watchers said.

``The problem is that every piece of news we're getting continues to be bad,'' said Stephen Cecchetti, a former New York Fed bank research director, and now a professor at Brandeis University in Waltham, Massachusetts. ``They will have to ease more. It's the only thing they can do.''

Let's take this a bit slower to see what is really going on.

The Fed cut rates 1.25% in January. But the interest rate on loans is increasing. That tells us a very important fact. Lenders are scared out of their minds about further losses from new loans. With all of the writedowns we have seen already, lenders are reeling from problems. They are not in a position to make a ton of loans -- it's that simple. As a result, they are demanding higher interest rates. In addition, I'm guessing that some lenders have realized they seriously under-priced risk and are now figuring out that even a good credit risk is more risky than has been priced in the last few years.

I'm also guessing that banks are looking down the road:

And not liking what they are seeing.

What a Real Central Bank Looks Like

From Bloomberg:

The Bank of England raised its inflation forecast and signaled policy makers may need to keep interest rates higher than investors currently predict.

Inflation will overshoot the central bank's 2 percent goal in two years and risks breaching the government's 3 percent limit before then, the bank said in London today. The bank based its forecasts on investors' bets for the benchmark interest rate to fall to 4.5 percent by the end of the year.

The pound rose and rate futures climbed. Bank of England Governor Mervyn King is weighing the need for further rate cuts after the bank reduced borrowing costs last week for the second time in three months to cushion the economy from a slowdown. While the U.S. Federal Reserve lowered its benchmark at the fastest pace since 1990 last month, U.K. policy makers have been more cautious as they seek to control inflation.

``Inflation is, in the medium term, more likely to be above the target than below'' if rates fall as investors forecast, King told reporters in London today. King said it's ``odds on'' inflation will exceed 3 percent and he'll have to write a letter of explanation to Chancellor of the Exchequer Alistair Darling.

According to Bloomberg, the Bank of England rate is 5.25% -- hardly a painful level.

Treasury Market Update

Let's take a look at the Treasury market to see what the charts say.

But first, here are the main events that move the Treasury market:

Inflation expectations: Treasury investors get a fixed rate of return, so anything that lowers that fixed rate of return should cause the market to sell-off.

Flight to safety: The more uncertain the economic times, the more likely investors will buy Treasury bonds.

Interest rate policy: When the Federal Reserve is lowering interest rates, previously issued debt with higher coupons becomes inherently more valuable because it has a higher yield. When the Fed is raising rates, previously issued debt is less valuable because it inherently has a lower yield.

The importance of each of these factors varies depending on more factors than you can count.

The 7-10 year area of the market is still firmly in an uptrend marked by higher highs and higher lows, although it is currently forming a flag consolidation pattern.

Concern about the economy and the credit markets is leading investors to move into Treasuries. The Fed's interest rate policy is also helping. However, consider this information from the BLS:

The Consumer Price Index for All Urban Consumers (CPI-U) decreased 0.1 percent in December before seasonal adjustment, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. The December level of 210.036 (1982-84=100) was 4.1 percent higher than in December 2006.

And now look at this chart from the St. Louis Federal Reserve of the yield of the 10-year CMT (constant maturing treasury):

The real return on the 10-year Treasury is negative after adjusting for inflation. That should tell you how concerned investors are about the markets and the economy.

The 20+ year area of the Treasury market is still rallying as well. It has a clear pattern of higher highs and higher lows. Right now prices are retreating to the trend line, so we'll see if this pattern holds.

However, consider the inflation information from above plus the following chart of the 30-year CMT yield:

According to Bloomberg, the current yield on the 30 year is 4.48%, making it's inflation adjusted interest rates .38.

The Treasury market is not an area where investors play for capital gain. Income is always a consideration. That means safety of capital and return of capital (not return on capital) is driving a lot of traders and investors right now.

How Bad Will Employment Get? pt. II

From the WSJ:

The current weakening of the labor market reflects a slowdown in hiring -- not the mass layoffs that have characterized past economic downturns.

The Labor Department said there were 1.8 million layoffs in December, about the same number as in December 2006 -- despite the mounting turmoil in the meantime in the housing, mortgage and finance markets.

Andrew Tilton, senior economist at Goldman Sachs Group, said the absence of large-scale layoffs partly reflects companies' uncertainty about the economic environment and their determination, at least for now, to hang on to their skilled workers.

"It's really in finance and housing -- and to some extent retail -- where the pain is being felt most clearly," he said. "Many other sectors aren't feeling pressure [yet] to lay off workers [and] are hesitant to let them go if they'll need them back soon," should the economy recover, Mr. Tilton said.

In the first article on this idea I put forward the following thesis.

1.) Overall job growth during this expansion has been incredibly weak.

2.) Yet productivity growth has been incredibly high.

3.) Putting these two facts together, I put forward the following thesis:

Let me throw the following hypothesis out: employers were far more reluctant to hire this expansion. Instead, they hired less but increased their productivity more. As a result, their business models are now wedded to a higher-productivity/lower workers total model. This means businesses can't cut jobs like they would in previous expansions because they would lose valuable employees. In addition, this would negatively impact the increased productivity of their respective businesses, which would have a ripple effect through their respective business

While I am not sold on this idea yet, it does appear that some economists have come to the conclusion that drops in employment won't be as pronounced during this slowdown as in previous slowdowns.

What Inflation? and What Recovery?

The following charts are from This Week in Petroleum.

Gas Prices

Note the price difference between last year's and this year's prices.

Gas: 78.7 cents
Diesel: 84.5 cents
Heating Oil: 89.3 cents
Propane: 55.8 cents.

These aren't small increases. Not only are there strong fundamental reasons for the weak retail sales figures from the holidays there are also strong headwinds against the consumer going forward.

Yesterday, I looked at oil's charts. Right now, it's consolidating between roughly $88 and $100/bbl. While the long term chart shows a possible double top formation, oil hasn't dropped below key support levels despite increasing evidence of a US slowdown. These prices could be key to the speed with which the economy recovers.

Tuesday, February 12, 2008

Housing Is Nowhere Near the Bottom

From CBS Marketwatch:

Lehman Brothers has estimated that about 2.8 million subprime mortgages will reset this year and next at a rate that is 30% higher than the so-called "teaser" rate. The investment bankers also forecast foreclosures to shoot up to about 1 million this year and next, quadruple last year's level.

Today's Markets

I'm going to use a longer view again today to show what the markets did.

Yesterday I commented that the SPYS were forming a triangle consolidation pattern. Today they broke out of that pattern only to form another, 1-day consolidation and then break out lower after the pattern formed.

Notice on this chart the lack of any decent direction. In theory, markets are supposed to rally after a consolidation pattern. But here we have a break out followed by a correction. In short, there isn't a lot of bullish conviction here.

Yesterday I commented that the QQQQs were forming an upward sloping triangle. Today we see that the QQQQs were also in an upward 3 1/2 day trend which they convincingly broke on high volume.

The IWMs broke a 2 day rally on strong volume. Also note this average is whipsawing around with no firm idea where it wants to go.

Here's an exercise for everybody. Pull back and just look at the charts. What do you see? Garbage -- there isn't anything strong in one direction or the other. While you could make an argument for the QQQQs, the really heavy sell-off after the rally makes me question the bull's conviction. That volume sure looks like "let's get the hell out of here .... NOW".

The markets are meandering, moving from one event to the other without any longterm conviction in either direction. The Fed as frozen the bears for now, and the economy as a whole has frozen the bulls. It's an ugly Sargasso Sea in trading land right now.

Hank Paulson -- Comedian

From the AP

Homeowners threatened with foreclosure would in some instances get a 30-day reprieve under a new initiative the Bush administration announced Tuesday.

Dubbed "Project Lifeline," the new program will be available to people who have taken out all types of mortgages, not just the high-cost subprime loans that have been the focus on previous relief efforts.

The program was put together by six of the nation's largest financial institutions, which service almost 50 percent of the nation's mortgages.

These lenders say they will contact homeowners who are 90 or more days overdue on their monthly mortgage payments. They will be given the opportunity to put the foreclosure process on pause for 30 days while the lenders try to work out a way to make the mortgage more affordable to the homeowner.

Folks -- these borrowers are already 90 days behind. What does that tell you? They're poor credit risks. The chances of finding a solution are, well, pretty grim.

Here's what all of these guys should do if they are sincere in their desire to solve this problem. Go back over their records and look for anybody that was given a loan they probably shouldn't have. That's what they need to do to prove they want to make this a smaller problem.

What Inflation?

The Commodity Research Board's index is at an all time high. Notice

-- The index has continually risen since the beginning of 2007

-- In the latter part of 2007 the index made a clearly bullish pattern of higher highs and higher lows

-- The index broke through the previous high

While the index sold-off in mid-2006, that was mostly due to oil's sell-off at the same time which had more to do with Goldman rebalancing its indexes than market fundamentals.

And investors are clearly thinking inflation is going higher

The gold market rose from 2005 to mid 2006. From mid-2006 to mid-2007 the market clearly consolidated. Since then, the gold has rallied. Gold has doubled in price over the last three years.

So -- why do I harp on commodity prices?

1.) If I hear one more person or economist (who should damn well know better) tell me about core inflation I'm going to throw up. If someone can show me a vast majority of the population doesn't consume food or energy, then I'll convert.

2.) Consider this from the last inflation report:

The Consumer Price Index for All Urban Consumers (CPI-U) decreased 0.1 percent in December before seasonal adjustment, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. The December level of 210.036 (1982-84=100) was 4.1 percent higher than in December 2006.

Now, consider this from Bloomberg:

Most interest rates are below 0% after adjusting for inflation. That's what got us into this whole damn mess in the first place. Additionally, with interest rates this low, we stand a chance of letting inflation get out of hand -- as in we'll need another Volcker like interest rate hike to get out of it. I don't want that and I don't think anyone else does either.

Financial Sector Problems Continue -- And Will Continue

Consider the following stories. Those headlines are from today and today alone. And yet we're still going to hear calls for investing in the financial sector because it is cheap, or valuations are low or whatever.

From the WSJ:

Stock markets nudged higher despite a pullback among financial stocks led by bellwether American International Group, which fell sharply after detailing its recent difficulties in valuing complex credit instruments.

The Dow Jones Industrial Average ended up 57.88 points Monday, up 0.5%, at 12240.01, supported by gains in components such as General Motors, which advanced by 5.1%, and Home Depot, which gained 2.6%. On the year, the Dow is off 7.7%.

AIG, also a Dow component, plummeted 11.7% after it acknowledged that its credit-derivatives portfolio lost $4.88 billion in gross market value in October and November, more than four times the $1.15 billion executives had estimated in December. AIG's auditor, Pricewaterhouse Coopers, advised the company that a "material weakness" exists in AIG's internal controls over financial reporting and oversight regarding the credit instruments.

From the WSJ:

Securities tied to student loans, another seemingly safe corner of the credit markets, are succumbing to the credit crunch.

Wall Street's financial-engineering machine bundles together long-term student loans and uses them as collateral for short-term investments owned by money-market investors. Since Thursday, auctions of these securities conducted by Goldman Sachs Group Inc., J.P. Morgan Chase & Co. and Citigroup Inc. have failed to generate investors' interest, leaving roughly $3 billion of such securities in a sort of limbo.

Under normal conditions, the banks would step in when investor demand is weak -- just as a specialist on the New York Stock Exchange intervenes to keep trading liquid in a stock. Because big banks are already bloated with other kinds of loans and bonds they are trying to get rid of, they have been allowing the auctions to fail.

That, in turn, is pushing up interest rates for the securities and leaving them in the hands of investors who might have intended to get rid of them.

From Bloomberg:

Credit Suisse Group, Switzerland's second-biggest bank, said fourth-quarter profit fell 72 percent on lower earnings at the securities unit after writedowns of 1.3 billion Swiss francs ($1.2 billion) on debt and leveraged loans.

Net income dropped to 1.33 billion francs, or 1.21 francs a share, the Zurich-based bank said in a statement today. That missed the 1.43 billion-franc median estimate of 11 analysts surveyed by Bloomberg. Credit Suisse declined as much as 4.9 percent in Swiss trading.

Credit Suisse's markdowns in the quarter compare with $14 billion at UBS AG, the country's biggest bank, and 44 million euros ($64 million) at Frankfurt-based Deutsche Bank AG. Chief Executive Officer Brady Dougan scaled down U.S. subprime- mortgage related holdings before a debt-market slump led to more than $145 billion in writedowns and loan losses at the world's biggest financial institutions.

I am officially going of the record with this statement: the financial sector is pure investment poison right now. Most investors should avoid it like the plague.

Don't believe me? Let's look at the charts.

Above is a weekly chart of the XLF. Notice the following:

-- The index was in a two year uptrend that started in 2Q2005.

-- The index formed a clear double top in 1Q2007 and 2Q2007

-- The index broke that trend in 3Q2007

-- The index has lost 29% (rounded) since its peak in 2007.

And the losses show no signs of abating.

I circled two areas because they are clearly analogues.

In situation 1, prices rose through the 10 and 20 day SMA, bounced off the 50 day SMA and then went lower. This action pulled the 10 day SMA higher through the 20 day SMA. This in turn evened out the 20 day SMA for about a month. Prices resumed their lower move.

In situation 2, prices rose through the 10 and 20 day SMA, moved through the 50 day SMA and then went lower. This action pulled the 10 day SMA higher through the 20 day SMA. This in turn evened out the 20 day SMA for about half a month. Prices continued their lower move.

Ladies and gentlemen, we're nowhere near done with this stuff. Consider the following loss predictions: (ht Calculated Risk)

November 16 2007:

The slump in global credit markets may force banks, brokerages and hedge funds to cut lending by $2 trillion and trigger a ``substantial recession'' in the U.S., according to Goldman Sachs Group Inc.

Losses related to record home foreclosures using a ``back- of-the-envelope'' calculation may be as high as $400 billion for financial companies, Jan Hatzius, chief U.S. economist at Goldman in New York wrote in a report dated yesterday. The effects may be amplified tenfold as companies that borrowed to finance their investments scale back lending, the report said.

``The likely mortgage credit losses pose a significantly bigger macroeconomic risk than generally recognized,'' Hatzius wrote. ``It is easy to see how such a shock could produce a substantial recession'' or ``a long period of very sluggish growth,'' he wrote.

December 18, 2007:

Merrill Lynch may have laid down a new high-water mark for estimated losses on mortgages across all investors and institutions, pegging the ultimate tally at $500 billion.

Feb. 10, 2008:

Senior global policymakers have raised projections for the size of subprime-related credit losses in a move that implies financial institutions will have to increase write-offs.

Speaking after the meeting of Group of Seven finance leaders, Peer Steinbrück, German finance minister, said the G7 now feared that write-offs of losses on securities linked to US subprime mortgages could reach $400bn.

To date, 225 mortgage lenders have imploded.

So far -- we've only seen about $100 - $110 billion in writedowns. Compare this to the lowest estimate of total losses of $400 billion listed above.

This is just getting started.

Monday, February 11, 2008

A Closer Look At the Oil Market

It's been awhile since I've looked at the oil market in detail, so let's see what the charts say.

Since November the market has been trading between roughly between $87 and $100. There is also a consolidation triangle formed from the beginning of 2008 until the indexes' recent upside breakout. The simple moving averages are bunched up indicating the market is looking for direction.

What's interesting with this chart is the lack of serious downside move despite the increased talk of a recession. Theoretically, a recession in the US would lower demand and therefore lower prices. But we haven't had that yet. There is still support in the upper-80s. The recent tone from Chavez in Venezuela doesn't help the sell-off and also indicates the oil market is still vulnerable to geo-political tensions (as it always is).

On the weekly chart, notice two important points.

1.) The market is still in a rally, that started at the beginning of last year.

2.) The market is clearly consolidating. We don't have an strong signs either way which way the market will move. A recession should send prices lower, but more political issues should send the index higher.

I originally thought this might be the formation of a double top, but the market proved me wrong.

Today's Markets

Rather than look at today's action, I'm going to pull have the time frame so we can see what is really going on.

Since last Wednesday, the SPYs and IWMs have been consolidating in a triangle pattern.

Since last Thursday, the QQQQs have been pushing up in a pennant consolidation pattern.

Now, let's pull back a bit farther to the 6 months chart. First, I still think the markets are in a bear market. That means I think we're going lower right now.

On the SPYs, notice there is a clear down up down pattern with the market also setting lower lows and lower highs. But since the beginning of 2008, we've seen the SPYs consolidate. The "technically correct" formation is a triangle consolidation. However, I don't think that's the appropriate call largely because that just looks too wide. I think the appropriate call is triangle with a straight line bottom around 132. This is entirely a judgment call, so I think it's important to keep an eye on both lines.

But, either way remember the SPYs are consolidating.

With the QQQQs we also have a down up down pattern with lower lows and lower highs. Also note we also have a consolidation pattern, this time with a rectangle pattern.

The same analysis of the SPYs applies to the IWMS, with the same caveat regarding the lower trend line.

SO -- why are the market consolidating here? Simple - we have equal competing pressures. The bears have a strong argument regarding problems in the economy. Simply put, the news for the last month or so has been terrible. However, the bulls have the Fed, which slashed rates recently.

So now the question becomes who has more staying power? Let's see what the simple moving averages (SMAs) have to say.

On the SPYs, note:

-- Prices are below the 200 day SMA

-- The shorter SMAs are below the longer SMAs, with the exception being the 10 and 20 area tied.

-- All the SMAs are headed lower

-- Prices are below all the SMAs

This is a bearish chart.

On the QQQQs, notice:

-- Prices are below all the SMAs,

-- The 10, 20 and 50 day SMA are heading lower

-- The shorter SMAs are below the longer SMAs

This is another bearish chart.

This is an interesting chart. Notice

-- The 50 and 200 day SMA are heading lower

-- The 10 day SMA is headed higher and it has crossed the 20 day SMA. This is the possible sign of a turnaround.

-- Prices are right at the 10 and 20 day SMA.

The IWMs could be showing the signs of an early turnaround. However, considering the underlying economic situation (which stinks) I don't think this is possible.

I think the bears will eventually with this, largely because there's no way the economy is gong to turn around anytime soon and we've had some Fed governors issue hawkish statements over the last few days. However -- I take Fed statements with a really large, artery clogging grain of salt.