Wednesday, July 18, 2007

Head Fake?

The typical fake out move on news happened once again. Apparently the news isn’t quite bad enough for the real sellers to find their way to their computers. With INTC disappointing its shareholders in Tuesday evening’s session, the stage was set on Wednesday morning to open sharply down. The difference this day was that the relief rally didn’t occur until very late in the day.

The market spent the majority of the day down on what would be considered heavier than normal volume. The move down was holding but not really pushing down like it should have over the course of the day. As we approached the last hour it looked like there might be another selloff but it didn’t materialize so the bulls came back in and bought going into the close. The Dow did manage to recover quite a bit of its earlier losses but still closed down about 50 points when all was said and done.

Since the market needs to play catch up with the late day move, we should see a little more upside going into Thursday but this week is options expiration so there may not be much. Usually the Wednesday of options expiration week gives a reversal from the prior week’s trading and this late day move just confuses the issue. Then, after the close, IBM announced earnings and gave traders an opportunity to bid that stock up so the market has some added incentive to keep the rally alive on Thursday morning.

There has been much news the last couple of days and we can’t begin to present all of it here this evening. We do want to mention that the credit markets are where most of the action seems to be. The stock market needs to pay some attention to what’s going on over in the credit world but for now it seems content to disregard that news. The big item was the announcement by Bear Stearns that it would not provide any more funding for its two subprime mortgage hedge funds we talked about here a few posts back. The announcement included remarks such as there isn’t much value in the fund assets.

The second big item in credit is that Moody’s is said to have started to look at the mortgage category just above subprime called Alt-A. Alt-A has a slightly better risk profile than subprime but worse than prime mortgages. Moody’s must be starting to consider downgrades of these types of assets which starts to get pretty close to the prime market where there really shouldn’t be any problems, right? Well, we aren’t so sure about that. But, still, the stock market disregards the problems in mortgage credit because…

Well, because Bernanke the head of the Federal Reserve says it won’t cause much of a dent in the overall economy. Yes, the market was listening to Bernanke on Wednesday like good followers always do. He was more confident about mild economic growth which would naturally translate to stable interest rates. The Treasury bond market was pretty strong but that may have been due to a flight to “quality” caused by the leakage over in mortgage credit. Or, it could have been due to the housing report that showed building permits “plunged” 7.5%.

The last item we wish to discuss is the CPI number that we saw this morning. We are not so interested in the actual number but with some of the underlying components, like owners’ equivalent rent or OER. In Wednesday’s WSJ on Page A4 there is an article entitled “Is Slip in Homeowner Costs a Trend?” This article discusses OER and how it affects the CPI/PPI numbers. This is something we have mentioned before in the context of the housing slump. If the price of houses falls and rents fall, there is a huge effect on the CPI since the OER makes up about a quarter of the index. This makes sense because housing does represent a large part of most household expenses. The question really is how it should be included in CPI/PPI. Well, we can’t answer that in the time we have tonight but we wanted to point out the article for your review.

Our position tonight is that we think the market is very close to a high but that the players want to actually have a Dow close over 14,000 so they can then rest on their…uh, laurels. The Dow continues to show strength even though the broader market is having a very difficult time. This action leads us to the conclusion that the market is one epiphany away from a strong down move. There are so many choices for the market to notice but so far, it hasn’t. We don’t think there is long to wait.

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