About an hour into the trading session the Dow was sporting a nice recovery move of about 125 but couldn’t hold it and faded into the close up about 50 on the day. This big rally attempt follows on the heels of Tuesday’s rout in the major indexes. Volume continued to be very strong with over 2 billion shares traded on the NYSE, just shy of Tuesday volume. Tuesday’s volume, you may recall, was cited as the “reason” for the 200 point down draft in those few minutes surrounding 2:00 CST (an hour before the close).
The action on Wednesday was pretty much what everyone expected including us. The big thing to mention about the trading day is the statements made by our esteemed Fed Chairman Bernanke. He tried to soothe the market by agreeing that the GDP should be where Wednesday’s revisions put it, that being 2.2% versus the initial “guess” of 3.5% growth.
Bernanke also tried to assuage those who might think, like we do, that yesterday’s market action signified a turn in the fortunes of the economy, at least we think the market may have Recognized the possibility of a turn in the economy.. He said that sometime during the summer the economy has a “reasonable possibility” of some strengthening sometime during the middle of the year. His comments are translated into our contrarian language. If there is a reasonable possibility of some strengthening, then isn’t there a Good possibility that there will Not be some strengthening???
Turning to some of the big news of the week in the housing market, new home sales were reported to be down 16.6% last month with expectations of only a 3.6% drop. This news follows Tuesday’s report that the January existing home sales were up 3% on expectations for only a 0.5% increase.
But, the more important news this evening is the continuation of the sub-prime mortgage market. Tonight the WSJ is reporting (in an article that should be in Thursday print version, another good read for you) that the “Mortgage Defaults Start to Spread”. The subtitle says “New Data Show That Nontraditional Loans Are Beginning To Haunt Borrowers With Midlevel Credit; Prime Still Fine”.
This article describes the term Alt-A mortgage products and how their default rates have climbed recently: “The credit deterioration has been almost parallel to what’s been happening in the subprime market.” The article says this is in contrast to the report that Bernanke gave to Congress on Wednesday: “Our assessment is that there’s not much indication that subprime issues have spread into the broader mortgage market.” Ok.
One story in the article is about a “retired” couple who “took out an option ARM when they refinanced their $92,700 mortgage in July 2005. The loan carried a 3.5% introductory rate that began moving upward a few months later. The couple, who live on fixed income, are currently making the minimum payments on their loan. But they are afraid they won’t be able to keep up with their loan and other debts once their monthly mortgage payment adjusts upward later this year.” An option ARM allows people to pay basically whatever they want to for the first few years, like interest only, for example.
We have no real opinion on the market this evening except that the direction is down with periods of violent upside. Wednesday’s rally was expected but now what? As we mentioned in our last (long) post was that the analysts will be talking about this being a buying opportunity. The underlying attitude is that of bullishness even for those that say this could result in a 10%, much needed, pullback, resulting in a good buying opportunity. We disagree.
Trading out of the VIX Calls:
Once in a while we make mistakes (haha—leave it alone please) and one of them was our purchase of the VIX calls. With the violent nature of the market in Tuesday’s trading the VIX moved up over 60% and we thought we were in good shape. For some reason the market didn’t give us any results like that however. My reasoning is that these options cannot be exercised before the expiration date (European style) and the value is not derived from the current price of the underlying asset, in this case the VIX. After considering this overnight, we decided to get out of these options and try for something else. We had a nice gain in them but nothing compared to what we thought we should have. It’s a very disappointing way to find out that a good idea didn’t work out even though it did exactly what we thought it would. We were up about 50% but should have been up over 300%. Oh well, now we know. These are new options and obviously trade differently that we are used to.
Dow Industrials: 12,268.63 +52.39