Wednesday, June 27, 2007

Economy Showing Signs of Fatigue

Top Line:
The stock market showed some strength on Wednesday and should now be starting a pretty good up run into the early part of July. After we see some new highs in the Dow, we will be looking for a clear entry for getting short or getting out.

Market Action:
Since Friday morning, coinciding with the Blackstone IPO, the market has shown signs of bearishness. The Dow traded right at 13,550 on Friday morning and Wednesday morning (this morning) it traded down to near 13,250 which would be significant support. Monday and Tuesday had to shake the bulls’ confidence as the market was strong going into the lunch hour but gave way to selling going into the close. Bottom line is that 300 points isn’t really enough to scare any bull.

The economy has shown no signs that the stock market is correct in its quest for higher prices. Wednesday morning, the durable goods orders, down 2.8%, were “surprisingly weak” according to one article we read on the subject. The durable goods orders are a fairly volatile reading but they can go down.

The housing sales were not pretty (our words) this last month either with new home sales down1.6% in May and prices were down some, too. You may recall that the April numbers were up about 12.5%, with April being the lone strength this year. Mortgage rates have risen about a half a point which is hampering sales a bit, too. Existing home sales were down as well with an annual rate of less than 6 million units and prices down year over year.

Consumer confidence, developed to measure the mode of shoppers, took a small dip last month to the lowest level since last August. This number still seems high but we don’t think it will be long before this number moves down strongly.

All in all, the economy is putting in a weak performance, not that you could tell by looking at the stock market.

The Fed:
On Wednesday, the Fed began yet another FOMC meeting to discuss the economy and the future course of interest rates. Do you remember the position of the Update? Well, let us remind you.

We have maintained a stance for some time that the Fed will no longer raise rates and will actually start lowering rates probably later this year. We say this due to the signals given by the economy but more fundamentally from the subprime mortgage situation. We see the Fed saying they are going to be tough on inflation tomorrow (Thursday) but that strong rhetoric will get a drastic change when the consumer decides to pack it in.

We believe that the consumer led recession is just now being felt across the economy. The ATM’s that people live in have gone through a metamorphosis (should we say they have morphed, that would certainly be easier) from the ATM to the debt repayment plan and people are not very happy about it.

Bill Gross published an article that is fully in line with our thinking, that being the subprime situation is still not contained. Mr. Gross presents his points in an entertaining fashion which you should enjoy. Please see Bill Gross’s July Investment Outlook at this site:

As we come to the end of the quarter/month, we should finally be seeing a rally that will extend through the Fourth of July, maybe even a little longer. This move should be the last such move that the market can muster. As this up move matures, we will offer our analysis and if it ever gets to a tipping point we may just have to go back to daily posts.

Sunday, June 24, 2007

A Rare Down Friday

Just a quick post this evening due to the 185 point loss the Dow suffered last Friday. Over the last 13 weeks, Fridays have seen up days so just a down day would have brought some questions with it; but, down 185 starts to give you a sense of unease. The market has enjoyed these up Fridays in the past because Mondays have generally brought some form of buyout news.

With this type of down move, it is the Update’s responsibility to let you know if there is anything more sinister going on. Well, we don’t think so at the present time. As we write this evening, the futures are making a powerful recovery and the Asian markets are not down much.
As we have been saying, we think the Dow will eventually break the June 4th high created right after the May jobs’ report was released. As we said then, there is a slight chance that the June 4th high is the top but we don’t think that is possible given the strength seen in the NASDAQ indexes after that date.

One thing about the stock market, the big Blackstone IPO generated much enthusiasm, at least for that company. We are no less than shocked that this IPO garnered such a huge amount of cash. These are the types of things that cause markets to end their up moves.

Our position continues to be that we are close to a top but not quite there. If we see the Dow make a new high above June 4th we will start to consider the possibility of a top. That event should be related to a weak move in the broader markets but it is not necessarily required. As always, if anything significant happens we will report on it here, otherwise we will be here every Wednesday evening until something the bear really comes back. That means Thursday mornings will bring you something to read other than your emails.

There are some big news events this week, not the least of which is the FOMC meeting taking place on Wednesday and Thursday. We do not expect any interest changes from them this week but we guarantee much hype over the possibilities. Yeah. The real news continues to be the mortgage market with more and more fear about the Bear Stearns funds that are trying to actually sell these illiquid assets.

Meanwhile, this week brings us the monthly home sales, existing home sales on Monday and new home sales on Tuesday. These are the items we will be paying close attention to.

Wednesday, June 20, 2007

Subprime Problems Return

Market Action:
Here we are, with the Dow down almost 150 on Wednesday. This follows a couple of days that could have been substituted by a hibernating bear; sorry for the confusing metaphor but…the market has been very dull until Wednesday’s afternoon trading. After last week Friday’s CPI news, the market did jump out of the blocks and traded a bunch of shares, partly due to options expiration (quad witch again).

Bear Stearns Auction:
Probably the biggest news of the week, in our opinion, is the blow up of two of Bear Stearns’ real estate hedge funds. Not that we are surprised that a real estate fund might be having trouble, it’s just the Way it’s trouble is being handled. We feel the need to spend some time on this topic this evening due to the significance both to the economy and to our position on the subject.

Apparently, Merrill Lynch has seized some of the funds’ assets and is trying to sell them to get themselves off the risk. According to a WSJ article, Merrill Lynch circulated “a list of about $850 million of the mostly highly-rated complex securities used as collateral for the” funds.

In Wednesday’s WSJ, a front page article on the subject (highly recommended reading) noted that the funds had $9 billion in loans which the funds’ managers were trying to get others (Goldman Sachs and Bank of America) to take over those loans. The article says that a few weeks ago, these two funds had assets of $20 billion, “most in complex securities made up of bonds backed by subprime mortgages”.

According to the article, “In recent weeks, however, the firm’s [funds] have been besieged by investors and lenders trying to recover their money as the value of the funds’ underlying bonds fell sharply.” This was after one of the funds “reported that its value fell 6.75% in April after the fund’s bets on the mortgage market went wrong. Two weeks later, it put the loss at 18%, spooking already-nervous investors and creditors and sending many of them running for the exits.”

Now, here is where the story gets interesting, and scary we might add.

The article continues, “Unlike stocks and Treasury bonds, whose prices are continually quoted and easily obtained, many of these derivative instruments trade infrequently and don’t have clear market prices. To come up with market values for these investments—a process known as ‘marking’ to market—investment funds often rely on their own valuation models.”

And, “As of March 31, the Enhanced Leverage fund had $638 million in investor capital and at least $6 billion in borrowings. It used the money to make $11.5 billion in bullish bets and $4.5 billion in bearish bets…Its sister fund had $925 million in investor money, and made $9.7 billion in bullish bets and $4 billion in bearish bets.”

Did you read that right? So, the two funds had roughly $1.5 billion in capital and nearly $30 billion in assets. That’s a 5% capital ratio, borrowing $20 for every $1 it had. These assets are valued based on their own valuation models, not what the market might have considered the value of the assets.

Near the end of the article is a quote from Janet Tavakoli, president of Tavakoli Structured Finance, a consulting firm in Chicago, “No one in the subprime business wants to ask the question of whether they need to re-mark all the assets. That would open the floodgates.”

Enter Merrill Lynch, trying to sell $850 million of their assets. Merrill said that anyone could bid on these assets at an auction that was to take place after the close on Wednesday.

We don’t need to go into the types of assets that were on the block, like CDO’s squareds, but suffice it to say that these securities are fairly complicated. A quote from Mark Adelson, who is a managing director of fixed income research at Nomura Securities, in the online WSJ this evening says that, “ CDO squareds are complicated things, and even the smartest guys can’t figure out what to bid on them in one day.”

These are clear problems in the finance world but the reason for their problems goes back to the original mortgages granted to people who Should Not have been loaned this money. Real people are getting hurt because of these exotic mortgages and underwriting practices.

Wednesday’s decline in the stock market seemed like enough to declare a small victory for the bears but we certainly don’t see it that way. There continues to be the smallest possibility that the June 4th Dow highs can hold but we don’t have much confidence in that at the moment, especially since the NASDAQ indexes have made new highs since then. The several indexes we follow are not tracking with each other at the moment and for the time being we think it would be best to stand aside.

If we notice something that contradicts this position over the coming weeks we will immediately identify it here but, in the mean time, we plan to post only on Wednesday evenings and at other times of interest.

You may want to check out the True Contrarian at the link to the left. He seems to be posting once a week again.

As always, your comments are welcome. We know that the market is close to turning over but until it does, we need to stay to this weekly format.

Wednesday, June 13, 2007

Wave C?

Market Action:
Looking back over the past few weeks of trading, the market has made some effort on the downside. The strong day on Wednesday feels like a culminating countertrend rally. With all of the downside we saw last week, this rally so far has not generated much momentum. The late afternoon move was news based so it doesn’t have as much potential as it would if it had been uninitiated.

The news in the afternoon that put the power thrusters on under stocks was the Fed’s beige book. The beige book indicated that the economy had some moderate growth in the April May period with virtually no upward pressure on inflation. With this news, there was quite a bit of interest in buying stocks. Do the players really think the market is interested in the April May period? We would say, yes, if the year was 2008 but it wasn’t.

The bond market did manage a little bounce on Wednesday but the stock market has forgotten some of the reasons it sold off as close as Tuesday??? The rate on mortgages will push the housing market down even more but the world doesn’t seem to think this matters. The financial sector has not recognized that many mortgage backed securities have not been properly repriced. One article we read today indicated that a group of hedge funds had requested that the SEC not allow price manipulation of bond prices backed by subprime mortgages. (Bloomberg reference)

That article says that “Bondholders stand to lose as much as $75 billion on securities made of mortgages to people with poor or limited credit histories because of a rise in defaults”. And, according to Credit Suisse Group in Zurich, there are ”More than $800 billion of bonds are backed by subprime mortgages”. Does that sound like a lot of money to you? That doesn’t even count the next level up which is also in danger.

Retail Sales:
Announced on Wednesday morning, the retail sales for May were up 1.4%. We are not sure how this number can be correct except that gas prices were a bit higher in May (gas purchases are considered retail sales). Many retailers reported slowing sales after Easter so we’re a little skeptical of this number. The market didn’t really pay much attention to this number.

Upcoming News:
Thursday the PPI will be released and expectations are for an increase of 0.6%, with CPI coming on Friday on expectations for 0.2%. The PPI is a cost item to producers (name is Producer Price Index) so can they pass any increases on or not? Still the Fed doesn’t see any upward pressure on inflation.

As you know, we don’t see any upward pressure on inflation either. In fact, we still think the Fed will lower the Fed funds rate this year (We agree with Bill Gross of Pimco on this.) The inflation pressures are definitely not upward. Take a look at the price of Gold and also the dollar. Gold has dropped while the dollar has rallied. These two items suggest inflation is not much of a problem.

The stock market showed some significant power on Wednesday afternoon but we are not impressed with the volume about the same as Tuesday. The advance/decline numbers were nearly identical in the opposite direction so the two days cancel each other out, mostly.

Normally, we would look at Wednesday’s trading and automatically suggest it is a little c wave which means that it is a culminating move and with power. Many people call this a “fill”. That means that there was a first leg (a wave) and then a deep selloff (b wave) and now we are seeing a completed move or a fill of all of the buy orders.

We are reading others who say that Wednesday was more powerful than just a c wave would indicate. Well, our opinion is that this really felt like a c wave, strong and confident with nowhere else to go. The market will tell us what it thinks in due time. The next move could be stronger than we think but we still have a finishing c wave corrective up move on our minds. This move should be over some time tomorrow with the next leg down starting directly after that.

If our interpretation is correct, we would be looking for a Dow around 13,525 for a top. This would be the 0.618 retracement of the drop from last week’s high to this week’s low. We should see that tomorrow. If the Dow gets much above that, we may have to concede in another answer. (seems to be our destiny)

Tuesday, June 12, 2007

Bonds Rule

Special Edition due to the late day sell off in stocks (and bonds). Tomorrow we will post our full edition.

Market Action:
Tuesday showed some remarkable volatility and, in the end, the market lost some ground, for the Dow that was about 130 points. The market opened down slightly with the Dow losing about 60 points in a few minutes. Those losses widened to about 100 points a couple hours into the session.

From those lows, the Dow rallied back from that down 100 to up about 25 with two hours to go. From there we saw selling into the bell with the market falling on pretty high volume. Overall, the total volume on the day was not spectacular but much better than Monday’s by some 300 million shares on the NYSE.

One news item caught our eye as foreclosures were announced to be up 90% yoy (year over year) from May to May and 19% above April. What do you think, is the housing problem bottoming out? Our opinion remains the same, more trouble in the American Dream for many.

In what is surely to be more bad news for housing, bonds continued their slide with 10 year Treasuries yielding nearly 5.3% (five year highs) after the quarterly refunding on Tuesday. In March this rate was just above 4.4%. The mortgage rates are closely correlated to 10 year Treasuries so you can imagine that mortgage rates are almost a percent higher than in March. This rate increase will put more pressure on an already troubled housing market.

As the title says, we think that this past week, “Bonds Rule”. Higher interest rates seem to be putting the brakes on the stock market rally that we have seen for over four years. Tuesday’s momentum seems to be down with our momentum indicators near oversold levels for the first time since the February stock swoon.

This down day did have some February feel to it as the midday rally lost its footing and sellers came in going into the close. Bonds are forcing leveraged players into some tough corners, selling is the result.

Thursday, June 07, 2007

Dow Breaks Down on Interest Rates

Market Action:
We couldn’t resist writing another post this evening due to the massive sell off in the stock market on Thursday which drove the Dow down nearly 200 points. Some of the action in the stock market was a reflection of the action in the bond market where bonds were punished as the 10 year bond moved above 5% for the first time since last July. Going back to March, the 10 year Treasury yielded 4.5% and after Thursday’s jump now yields 5.13%.

Late in the afternoon, stocks were rallying from the Dow being down 180 points to the Dow being down less than 100 points. Then the bond king, Bill Gross of PIMCO, affirmed his position that the bond market was in a bearish phase and rates may go up to 6.5%. The stock market did not like this news and promptly sold off into the close going out at the lows of the day down nearly 200 points.

Other than that, not much happened on Thursday. The bond market seems to have taken the upper hand here and is now starting to dictate the stock market more. The complacency in the stock market has been aided and abetted by the low interest rates available in the market. All of the LBO’s (leveraged buyouts using borrowed money) have taken place in the idyllic interest rate environment with 10 year Treasuries under 5%, not any more. Now, they will be paying more for those deals.

Alas, higher interest rates will affect the mortgage market and should help to increase mortgage rates by a similar 60 basis points and possibly more if rates continue to move up in a bond sell off. Higher mortgage rates will squeeze even more buyers out of the housing market which will cause some additional headaches for those sellers/flippers out there. With the bond market large and in charge, stocks decided to take the opportunity to sell off.

In yesterday’s post, we mentioned a possible low being formed that might lead to another high before the whole thing fell apart. Today’s sell off confirms (again) that the market wants to go down and this was confirmed by price, breadth and volume. The volume on the NYSE was over 1.9 billion shares with breadth a whopping 280-3081 advances to declines. That’s the largest number of decliners in a day since May, 2004 when the Dow was trading right near 10K. This day was significantly bearish and brings the three day decline to over 400 points in the Dow.

Erick asked us to compare and contrast this market with earlier markets. We will make some comments about that in future posts. Thanks for the suggestion, good idea. Any more out there?

Wednesday, June 06, 2007

Stock Market Shows Some Weakness

Welcome to the weekly post for the Update. We have been going through withdrawal here and do miss the daily version. With the market having difficulty around these prices, daily posts may be back soon. There should be no surprise to those of you who are contrarians, like us, any wavering from that bearish position might result in a pretty solid top—oh, well. But, admit it; you missed the Update, too.

Jobs’ Report:
The May jobs’ report coincided with a new high in the Dow at 13,690.62. On Monday this high was challenged by a high trade of 13,690.21 but failed to improve on the Friday number. From Monday’s high, the Dow fell about 250 points to Wednesday’s low around 13,437.

As you may recall, we think the jobs’ report is the key report for the month for the stock market and maybe the bond market as well. The report came out last Friday after a month long difference of opinion of the bond market and the stock market. The stock market had rallied for most of the month while the bond market fell most of them month.

After the jobs’ report indicated about 157K new jobs, CNN Money proclaimed that “Solid gains in jobs, manufacturing, consumer spending offset weakness in housing; Fed seen on hold” under the title of “Economy hits the sweet spot”. The job gains are “solid” compared with some that have been under 100K but this is not “solid gains in jobs”. But, let’s look at the rest of the headline in light of this week’s news.

Tuesday’s CNN Money late day headline was “Fed rate cuts gone—a hike may be coming”. This headline doesn’t really contradict Friday’s headline but the spin is just a little different. Last Friday the market was doing ok but Tuesday started to leak a little so someone had to come up with a good reason for it.

ECB’s Rate Hike:
On Wednesday morning, in a “widely anticipated” move, the European Central Bank (ECB) raised interest rates a massive quarter point. (Clearly, we still have some sarcasm here at the Update; you missed that, too, didn’t you?) This move was not widely anticipated by market participants as many of the European bourses fell over 1%, some more than 2%. This move prompted players in the US to step back and think (well, ok, maybe they didn’t know what to think about) that maybe the Fed might raise rates, too.

In case you don’t remember, we still stand on the theory that the Fed will Not raise rates anytime soon and will in fact lower them sometime later this year due to the economy being soft ( read that, the stock market is going down to understand the Fed’s motives a little better).

The housing market continues to disappoint those that thought maybe the turn was here already but, not to worry, the new forecast is for housing to pick up next year sometime. We wonder if those that decided to buy two or three houses to flip, can wait around for almost another year to see if that recovery happens. From our view of the housing pond, there are no quick fixes that will bring housing out of its downward spiral.

Today’s report from the National Association of Realtors indicated that the US housing market remains “soft” and they would once again lower their forecast for 2007. Meanwhile, they continued their position that prices for existing homes will fall in 2007 for the first time since they have kept records (in the late 1960’s). This group has a stake in a growing home market and is usually upbeat, as sales people need to be. So, they follow up their decline projection with a rise in 2008. There you go, no worries, mate.

With the stock market having two significantly down days in a row, we thought this would be a good time to reassess the situation. We suggest that there really was no reason for the decline the last two days and offer that these are the worst kind of days for the bulls. Yes, there was sort of a cool breeze blowing over the hot market, the threat of possibly higher interest rates. But, that has been no threat for this over heated Invincible market.

The stock market may want to bounce of these lows so we are not declaring a bear victory just yet but the seeds have been planted (again). Our indicators fell off a cliff the last two days, not that they all went negative but the change was noticeable. What would be ideal would be if the market told us that it was over by rallying a bit and not getting our indicators back to where they were on Monday. Of course, we still believe in Santa Claus, but he’s not going to be here for another six months.

The market could very easily drop right now and no one would really be surprised. In fact most market analysts would announce that the market was due for a correction and it was healthy and now is a buying opportunity. We would say that you should be extremely careful in this dicey situation. In any event, there isn’t much upside left. The global markets are beginning to get some selling pressure, finally, and they could all go down together which would be a very scary event.

We have decided that while we are writing weekly posts, that the numbers are not going to be reported. As we looked back on the posts to contemplate a new format, the items in our list were not very well known and we didn’t mention them much in the text so you could follow along. There are a few that we do really like and one of them is the VIX, which is the volatility index. The VIX jumped a little on Wednesday to a two month high, showing a little fear among the option players.

Your Input:
If you’re so inclined, please post a comment or check out one of the links to the left. We would be happy to give our opinion or discuss topics of interest to you. All you need to do is mention it in the comments and we will make sure we mention it. You don’t even need to sign your name although you certainly can, if you like.

Take care and we will be back at least by next Wednesday, sooner if conditions in the stock market deteriorate much further.