Wednesday, October 31, 2007

GDP and the Fed Follies

Now doesn't that feel much better. The air is better down here, 25 bps lower than yesterday.

The news from the Fed is that housing could put a drag on economic output so they decided to lower rates 25 bps. These are bright people. Well, we knew they would lower by 25 bps but now they have to "justify" their position on the matter. Wednesday's GDP did not really look like a number that would "justify" a rate reduction so the disconnect continues.

Let's start with the GDP. The advance GDP is the first of three "estimates" on the production of the economy for the quarter. The Commerce Department surprised us when they said that GDP had risen a whopping 3.9% but then we looked a little deeper.

As we normally mention on the day the GDP is released, there is a little thing called the GDP price deflator. This is the number used to bring GDP to us without inflation. We try to describe this by saying the economy is made up of one item and it cost $100 last quarter and this quarter it costs $110 which would be 10% (for the quarter and GDP is always reported as an annual rate so this number is only for an example).

In our example, if we said that inflation was 10%, then GDP would be unchanged for the quarter but if we said there was no inflation, then GDP would be up 10% for the quarter. This is how you can report a bigger number, by indicating lower inflation. The price deflator for the first go around on GDP happens to be the lowest number since 1998 at 0.745%. This means that total GDP was about 3.9% plus about 0.8% from the price deflator for a total gross number of 4.7%.

We now go back to the Fed's rate reduction. By looking at their statement which says that they will be vigilant on inflation, we now must look at the price deflator for the past few quarters. This past quarter just reported was 0.745%, the prior quarter was 2.633%, and the quarter before that was 4.228%. That progression looks like a significant falloff.

That brings us to the Fed's fears. The Chairman didn't get his nickname without any reason. He's called Helicopter Ben because he actually said the Fed could drop money from helicopters to prevent deflation from occurring. Well, from the looks of the last few quarters, deflation is just around the corner. We know that the Fed is very keen on deflation and do Not want to deal with the results of it.

That then brings us to the rate cut. We are almost surprised, now that the GDP deflator is out, that the Fed didn't feel like it should lower rates by 50 bps. We have said recently that the market, the T-bill market that is, allows a 75 bps reduction and they only took 25 bps this time. Not only that, they made sure they included a statement about inflation in their release.

More tomorrow...

Tuesday, October 30, 2007

The World Waits With Wonder

Well, we don't wonder. The Fed will lower rates on Wednesday and we think 25 bps is a Goldilocks number. The market would allow 50 bps or more and when we say the market, we mean the Treasury bill market. Since the T-bills are trading just below 4%, the Fed can move down to 4% giving the Fed room to move 75 bps. In fact, even the 30 year Treasury bond is trading below the 4.75% fed funds rate.

What we are saying is that market is allowing the Fed to do whatever they want, short of raising rates. They can justify a little patience in following the market if they want but if they don't lower rates on Wednesday the Stock market will be in revolt. We don't know if that would be the Fed's motivation to lower rates but we're pretty sure they don't really want to test those waters right now.

What we want to try to understand here is the level of the global markets against the backdrop of the Fed now lowering rates. Even some indexes in the US stock markets are at or near highs and still the Fed is lowering rates. We think the stock market has rallied on something that is in contrast to the liquidity problem that the credit markets seems to be in.

Normally the Fed acts in times of financial stress, something the stock market would be warning about by dropping. Currently, the stock markets around the world are too busy going up to worry about the minor liquidity freeze ups occurring in the credit markets. We have a difficult time trying to balance these two facts. Our premise our the housing market bringing down the economy is unfolding before our very eyes but the stock market is Not paying any attention to date.

While the stock market is waiting for their Halloween Interest Rate Treat from the Fed, the economy seems to be slowing. The consumer keeps spending because it has the credit to do so. In a CNN Money article, the joys of consumer credit are discussed. The article talks about the $915 billion of credit card debt that has piled up.

When the housing market was booming and people were using their homes as ATM's, credit cards could be pumped up and then paid off with a visit to the local mortgage outlet. We suspect that the mortgage genie will not be able to help much with the current build in consumer Debt.

We agree that the consumer credit problem is The problem but it includes mortgage debt. Let's also get this straight--the word is Debt, not credit. People will have to pay off their debt at some point. The article points out that in some countries, people are paying their mortgage payments with their credit cards. We wonder if anyone would have enough room on their "credit" card to transact a mortgage payment.

In the news on Tuesday, the consumer confidence number was quite low and, as the WSJ puts it, "stirs worry ahead of holiday season." Yes, combined with the the "credit" (can we even say debt?) problems and the declining home prices, the consumer confidence number should stir worry and we're talking stir with a big spoon.

See you 25 bps points lower, that would be Wednesday evening.

Monday, October 29, 2007

Rate Cut Chatter is Loud

This evening we seem to be waiting, with engines running, for the Fed to lower rates on Wednesday. Even though it many trading hours away, there is a lot of chatter on the subject. We might as well chatter on the subject, too, since this appears to be a Big deal to the market.

As we have mentioned, the Fed is clear for 50 bps and maybe even 75 bps but it would not do that right now. The world, read that the markets, expect a 25 bps drop which would make some sense given how the market has set rates recently.

All the chatter is about how the economic reports are showing a deepening housing crisis causing possible lower consumer spending going into the holidays. There are the comments about those who think the Fed should not lower rates because it will have a detrimental effect on the ever declining dollar. These are things we have included in the Update for the entire year, as well as the Fed rate cuts that would happen in the fall, which is now. But...These are not the real reasons the Fed lowers rates.

The reason the Fed lowers rates is because the market tells it to. No, not in so many words but by pressure on the short term Treasury rates. If there is demand for these securities, the rates on them go down. That would be what is happening now with short Treasuries trading in the 4% range. With the Fed Funds rate up around 4.75%, the Fed has room to move.

While they don't have to move, the Fed would disappoint the markets because they expect a cut of 25 bps. We couldn't agree more with the analysts that are using this line, like PIMCO's Bill Gross in an interview with the WSJ last week. The discussion on the rate cut will continue until we get to that magic decision hour.

Monday's market got pretty excited about the rate cut talk and traded up. Part of this can be attributed to the end of the month strength. Now comes the reality checks from the Fed on Wednesday and the jobs' report on Friday. The market prices are at levels that should now start to see some significant resistance. We remain bearish against the Dow's high near 14,200.

Tuesday morning addition: Banks have been wanting a little help with the mess they got themselves into. Now, some are wondering why there is a double standard. Of course we all know why they are. Thanks for the reminder on this article CM.

Sunday, October 28, 2007

Coutrywide Predicts a Turn Around

The news seems to be more important than the stock market moves these days. We think the stock market's reaction to the latest news from CFC (Countrywide Financial) on Friday is, uh, optimistic. OK, there are stronger words we could use but come on. As the company announces a third quarter loss of $1.2 Billion, the first loss in the company's 25 year history, the CEO, Angelo Mozilo, says that company should return to profitability in the current quarter. There is some questioning of that statement based on the guy selling a bunch of shares recently. With that news the stock made a 30% plus up move to just over 17.

After Merrill Lynch's horrendous earnings' report, the CEO there has decided to negotiate an exit strategy. We're pretty sure the severance package will be more than most of us will make in a lifetime and this is after reporting an $8 billion loss for the company. That's a good reason to get a big severance. Sorry, sarcasm is still alive and well here at the Update. At any rate, the WSJ should have a page 1 article on the subject Monday morning based on what we're seeing online this evening.

Let's take a look at the upcoming week because it looks like a big news week with three big items during the week. The first of course is the the Fed's rate reduction coming up on Wednesday. We think the reduction is almost a lock due to the positioning of the Treasury bills well under the Fed Funds rate, allowing room for the Fed to drop rates. The market has assigned a very high probability for a 25 bps drop this week but we still think there is a possibility for another 50 bps. Tonight we are with the market in assuming a 25 bps drop but we will continue to watch the news over the next few days.

The second big item is Friday's jobs' report. This report indicates the employment situation for the month of October. You remember how the August number was negative when it first came out but then in October there was a dramatic revision in that number as the September number was back into a more normal range. With such unreliability, this number is becoming less important and we think that is by design. We will see how the market reacts to the October number.

The other big number which we think will actually be a little number is the first estimate of the third quarter GDP. We don't know how this number could be good with the huge credit problems that surfaced in the third quarter but the important thing is how the market will react to the number, as always.

This brings us to the analysis of the evening. The stock market thrives on liquidity and we think the liquidity has been challenged even with the Fed trying its best to push money into the system. That money seems to have found a home in the Treasury market more than the stock market or in more productive loan creation. But, we look at the level of the stock market and see how close the Dow is to its all time high and consider that the liquidity must still be there.

Noteworthy is that the Dow is below the those highs for now and we think this week will bring a reaction high, or more commonly called a corrective high here. There will be a point in the week where the market will not be able to go up. That will most likely be right after the rate reduction on Wednesday but we can't know that tonight. We will try to analyze that possibility over the next few days.

This should be an interesting week...

Thursday, October 25, 2007

MSFT Has a Halo

The stock market traded with no real purpose in mind, the whipsaw continues. The news was mostly negative on the day with durable goods down and new home sales coming in below expectations. The September new home sales are a little bit misleading because, while they came in below expectations and expectations were for lower sales, they were above August figures. "How can this be?", you might ask. It's called revisions and in this case a large downward revision in the August number, as well as the July number.

Crude oil had a giant up day with a jump of over $3 to over $90 a barrel. That may sound bearish to some but as we have mentioned here many times, the stock market and the oil market are driven by similar thinking processes in this environment. They went up together and they will probably go down together, too.

During the day there were a couple of strong rumors about the Fed and AIG. First, AIG started to trade down and was down over 5 points at one time on speculation that it too would show some major subprime mortgage losses in its portfolio. This initially dragged the market down but then another rumor surfaced and traveled about as fast as the California wildfires. This rumor was that the Fed was going to do a surprise rate cut today. Please. Don't they know the Fed meeting is just days away?!? Oh well, the market rallied out of its lows on this rumor and AIG managed to close down only 2 bucks.

There was one stunning item that is being mentioned in a few places, Friday's WSJ being one of them. We read that WellCare Health Plans (WCG) halted trading on Wednesday as the company had been raided by the authorities due to alleged Medicaid fraud. So, after halting trading at $115 a share Wednesday, WCG opened Thursday at 64 closing later at 42 down about 65% on the day. We read that there were a few quants in on the company due to the mere fact the stock price was going up. As one analyst put it, computers can only read the trading, fundamentals are sometimes missed.

After the market closed for the day, MSFT announced some stellar earnings and the stock traded up 10%. This news should lead to an up opening but the overnight futures are showing only minor upside. We'll have to wait until morning.

In the broader scene though, the rally we have talked about is nearly over and this should lead to significant selling at least for a while. We'll be back on Sunday evening. Take care.

Wednesday, October 24, 2007

Real Estate Problems Are Not Contained

There were at least two real estate items on Wednesday that deserve mention this evening. The first is the existing home sales which showed an 8% drop from the last month. The stock market fell a little harder just after that news was released. It was almost like the market was going to connect the dots but more about that later.

The other event was Merrill Lynch's earnings announcement...ouch. About a month ago, the company said it would have to write down some of its mortgage debt holdings. In a Fortune article reported on CNN Money, the company had said it would write down about $4.5 billion but when it announced on Wednesday, it actually ended up writing down close to $8 billion.

The WSJ is indicating there will be a front page article on the Merrill earnings situation in Thursday's edition. The article has essentially the same information as the article above.

According to another source, Merrill had to reduce the value of some super-senior subprime assets. According to that source, this debt is normally rated AAA with a plus sign. With this new valuation level, Merrill has sort of "lowered the bar" on the value of these assets which are held by numerous other entities. What this means for them will be determined in the very near future.

Merrill said that it had been conservative in setting the value of these assets but when asked about how many other assets were not marked to a market price, there was not much in the way of an answer. So, it seems that the triple A debt described above was actually never really marked to market but marked to model and now the model is being adjusted to reflect the new subprime reality.

In a related story from Wednesday's WSJ, Countrywide is back in the news once again. Apparently, there is another leak that has sprung on one of its asset categories, that being the option ARM in the prime market place. What was that? Did you say Prime? Why, yes, we did.

You remember the option ARM, the one that allows you to pay less than the full interest payment on the loan. This mortgage is the so called "neg-am" loan, meaning negative amortization loan. What that really means is that the principal is going up on the mortgage. Now, this concept worked pretty well as home prices were rising because home buyers could easily sell or refinance their homes anytime it was necessary. Those days are now over.

Now, credit is more difficult to come by and neg-am is almost a memory but it is still a bad dream for both ends, for people who bought more house than they could afford by getting an option ARM and for investors who now aren't getting principal payments and are having to mark down their assets.

Anyway, CFC has disclosed that there may be a problem with the prime option ARMs as far as the defaults are concerned. This was documented in the aforementioned WSJ article on Wednesday and probably was responsible for the drop in CFC's stock. The stock was down $1.22 to $13.83. We would really enjoy copying the entire article here but the WSJ may frown on that. We highly recommend this article because it has some great facts that you would enjoy.

Some of them include the CEO, Angelo Mozilo, commenting on how he was "shocked" that so many borrowers were making the minimum payment on their loans. The article says he called some borrowers and found out that people said the value of their homes were going up at a faster rate than the neg-am.

The article says that a borrower with a 6.05% $520K fixed rate mortgage would pay $3,134 a month but with an option ARM at 1% the payment drops to $1,673. But, after five years the borrowers need to start repaying principal and meeting full interest payments causing payments to more than double above the fixed rate payment. Another problem is that there is a maximum overage the loan will allow, such as 110% to 125% before principal payments kick in.

We were a little surprised that the market was able to swallow all of this news and then recover from the 200 point loss at midsession. The technical side of this suggests that the late day rally is simple a wave C, which is an ending wave leading to a selloff. The selloff could be fairly large but there is a chance that it will only be a corrective wave...again. We will comment on it as we see how far down this can go. We expect 13K in the Dow before we have to make any real decisions.

Speaking of decisions, the Fed will have to make one by next Wednesday. Yes, we are speaking of the next rate decision due then. As we have said several times before, the Fed doesn't set rates, it follows the market. So, what is the market saying? Well, the 3 month T-bill hasn't traded above 4.25% in October and now sits at 3.85%. This rate would suggest the Fed could actually lower rates at least a half point next week. We don't think they really want to push too hard on that 4.25% October high so we would call for a 25 bps drop tonight. If things get weaker in the T-bill world, we might be pushing on another 50 bps. The market will be interested in the decision but it may not actually like another 50 bps.

Tuesday, October 23, 2007

Whip Saw Rules Stock Trading

This evening as the world got the AMZN news, there was a great expectation for something but AMZN didn't seem to deliver. During the day, the stock rose about 10% in anticipation of the great news and then after the news it fell those same 10%. Such is the life of the great ones, they don't last forever. Even these seemingly never tiring bulls have limits and those limits might have been reached.

Yesterday, when AAPL gave us their news, the world was abuzz with the speculation. Even AAPL didn't fare too well after AMZN's news. Apparently when one Horseman falls, another has to stop to help the other one up.

We have been stuck on this narrow market breadth for a while and now it seems that the real market will overwhelm the brave few leaders which Cramer dubbed the Four Horsemen. There are so many reasons for the market to stop right here. The NASDAQ 100 has benefited from the move in the horsemen but the less fortunate indexes have not. Let's take a look at a couple of them.

Let's start with the RUT (Russell 2000). In July, the RUT set a price level of 856+ and last week it tried mightily to get back there. After the August swoon to 736, the RUT has moved back to just over 850 about ten days ago, failing to get back to that 856 mark from July.

One of our favorite sectors, the semiconductors, has had a horrible run of it over the past couple of months. After a moonshot in July up to 550, the SOX index traded down to 465 in mid-August. After trading in the 480 to 510 range it has recently tried to find that 465 level, trading below 472 today. The SMH index, the American exchange equivalent of the SOX, actually did trade below its August low today.

The small cap stocks have had the most difficulty in this period of time after the Fed's rate cut. The higher cap stocks that seem to be able to withstand a downturn are being sought after. This strategy will ultimately fail.

For other indexes, check out the True Contrarian's new post. Kaplan thinks the global markets will have difficulty in November and December due to tax selling. More importantly, he is calling for a hefty loss in the precious metals stating that the gold mining index has significantly lagged the recent price surge in the metal.

At any rate, the past few days of trading have been wild at a minimum. The trading on Tuesday had the SP500 up 10 points at the opening bell (yes, due to AAPL) but soon it was red but then it rallied the rest of the day (yes, due to AMZN expectations). After the close, when AMZN sort of disappointed, the futures are again down. This is after the important break down from last Friday.

We noted that the NDX has benefited from the horsemen's moves, witness the cruise to a new high for the move today. This move puts the NDX, NASDAQ 100, in a class of its own and has the rest of the world begging to do the same. It's just that the four horsemen can't be in all the indexes around the world. From our way of thinking, that fact will produce outsized losses in the NDX over the next couple of months.

Our position continues bearish especially after last Friday's break. Let's see how we trade post AMZN results and then make an assessment on the Fed's move for next week...when we meet again tomorrow.

Monday, October 22, 2007

One Horseman Gets Push

Monday's market opened down but that was about it. After last Friday's big down move, the bulls felt they could now buy stocks because the selloff is behind us. Well, the proof for that statement can only come when the Dow goes above the last peak it made. Until then, we think the next big move is down.

This, in spite of the news from AAPL after the close that their earnings were huge. So, here we are again with the four horsemen bringing us the big moves. The strength of these four stocks is not being exhibited in the broader market. Yes, there are some days when the weak stocks make moves but it could be that those moves are generated by shorts being covered.

This evening we see a little bounce in progress but the move could be over right after the market opens on Tuesday. We know that the players are extremely bullish which by itself is more than a little bearish for us contrarians. When so many are bullish, there is reason to be nervous but the confidence is thick.

We will be back tomorrow.

Sunday, October 21, 2007

Friday's Break Seems Important

The stock market had a significantly difficult day on Friday. Options expiration probably exacerbated the problem but the damage was done none the less. This break seems important due to the picture it makes with the previous charts.

As you look at the major indexes over the past ten days or so, the theme is not being able to generate much on the upside. The market has stocks down quite a bit over the past week alone. The global markets are all struggling together. As we write this, Asia is down about the same 2.5% that we were down on Friday. Plus, the futures trading over night are down almost a percent and, even though we know that is based on thin trading and Asian markets, Mondays are typically Up days.

We think the market will write its own story but we think that the credit markets are somewhat in control at the moment. Last week's big "bailout" SIV is on death watch and probably will never see the light of day. The comments from Warren Buffet were that the banks can shuffle the paper around all they want to but what is important is that the underlying risk has Not changed. Those comments were probably enough to kill the deal in its tracks.

This evening we see the market being in some trouble. The movement of one day does not dissuade bulls from their particular positions but they will soon change their minds as the prices of stocks start dropping regularly. The bulls are thinking that any dip is only going to be temporary because they have seen it before. The problem is that the stock market has a job to do and that is to confuse the majority of the players.

Bull markets are just grand because they don't force people to think about what to buy. This latest several years has come down to what the world is calling the Four Horsemen, hardly an endorsement for a broad rally. Just the opposite is true.

As we look out over the landscape, there is a Fed meeting next week over Halloween and we think the Fed will almost have to consider another cut. As we have said many times, the Fed Follows the market and right now it is behind and needs to catch up by lowering rates. While most think that lower rates should be bullish, the reason for rates going down is recession on the horizon which is Not bullish for stocks.

Let's see what Monday brings and whether the current futures' weakness holds into the trading day and then whether the bulls can buy that dip. There will be bounces in this decline but we think they will be labored and not lasting. Back here tomorrow.

Thursday, October 18, 2007

Last Rally in the Making?

The credit market has been trying to pull the stock market down over the past year and has failed to do so partly because the Fed has done all it can to prop up the liquidity in the system. Our position continues to be the fundamental weakness in housing will pull the economy and the stock market down. The question is and has been when.

Well, the look of the current market situation seems to be a build for a rally, possibly the Last big move to end the run we've seen for the last year or more. There is a large amount of bullishness in the market place with people believing that a down move is merely a reason to buy. As the credit markets start to pull in the liquidity available to it, the stock market will have trouble finding air.

With the Bank of America earnings out on Thursday morning, there was a negative feel to the trading but the sellers couldn't take the market down. After the close, GOOG announced what looked like positive results and the stock rallied. We seem to think that the likes of GOOG and the other four horsemen are about to find sellers rather than more buyers.

The market could spike to a high any time here and put in the finishing touches on this bull run. When we see this move, we expect it to take place during morning trading. There are some opportunities for up moves over the next few weeks, like the Fed meeting on Halloween and tonight's earnings news from GOOG. At some point we will see exhaustion. When that Finally happens, liquidity will dry up and bulls will turn into bears.

For now we wait...some more. Next week we'll try to analyze the Fed's next move along with any important market action. Erick mentioned the SIVs in his comment and we have tried to mention them here but they are complicated under the covers type of vehicles. Maybe the public will know more about them over the next few months, not that they wanted to.

Citi says they have lined up some short term financing for their SIVs so they are breathing a bit of a sign of relief. They are saying the credit markets are loosening up just a little. You would say that if you could float some commercial paper in this market as Citi did. Some others in the world have not been so lucky.

The WSJ has had a significant, front page article on the mortgage situation every day for about two weeks. We have enjoyed them and hope you have had a chance to read them, too. The Journal has provided us with some very good reading in the subject area. We suggest taking a look at the papers that may be floating by your desk.

Wednesday, October 17, 2007

Fed and Treasury Agree on Housing Mess

Wednesday's market held something for everyone it seemed as there were moves in most of the classes we follow. First, let's look at the stock market. With the three or four "important" earnings released on Tuesday evening, the market was about bursting at the seams before it actually opened. When it did open, there was plenty of enthusiasm for stocks with the NASDAQ up 40 points. Of course, that was the high for the day but there was some incredible action to follow before the end of the day.

For the most part the market tried to hang tough in the first couple of hours but then it just let go and fell for two straight hours. After being up 40 at the opening bell, the NASDAQ Comp traded under water about 10 points at it low. But, after dropping 50 points, it managed to rally nearly back to the opening level up 28 points on the day.

Even oil managed to spike to a high during the day, up to $89 a barrel before closing back in the $87 range. Gold was higher during the morning and then dropped all day. Overnight trading seems to have brought it back to life again. Bonds had a pretty good day with rates dropping slightly.

The Fed's beige book and Treasury Sec'y Paulson both agreed with the September housing starts being 10.2% lower. Actually they said that the housing market has the potential to disrupt the economic expansion. Paulson said, "The ongoing housing correction is not ending as quickly as it might have appeared late last year." Meanwhile the CPI indicated well...we can't really understand how this number manages to be about 0.2% every month so it has become a meaningless number. But, social security payments are based on it and those will increase 2.3% next year. Can't wait until we're on Social Security.

We leave you this evening with a pretty good article from CNN Money Fortune. The article describes 5 things that need to happen before the credit crunch is over. The last one is particularly interesting--"let it actually happen".

Tuesday, October 16, 2007

Can the New MLE SIV Get Launched?

Tuesday's session started out with a bit of a down move. There seemed to be some speculation that the MLE SIV we mentioned in our last post was not going to be able to come to fruition. The banks involved expressed some doubt as to whether enough entities would come together to make it work. The uncertainty led to selling early and the financial sector felt it.

The fact of the matter is that this new entity was not going to be buying distressed debt anyway. Examine the situation as if it was you. You have some cash to invest and what do you want to do? Do you want to buy something that is worth 25 cents and pay a dollar for it? Of course not!!! You want to buy something that is going to make you some money.

But, as the day couldn't be disturbed totally by such negative attitudes in finance, something else had to emerge and that was tech. Several major tech firms are announcing earnings over the next few days, with IBM and INTC right after the close on Tuesday. During the day, several tech names saw some buying.

Then, right after the close most of these firms did show better than expected results and managed to persuade buyers to push up the price of their stocks. The exception is IBM which had a decrease in price. In any event, that pushed up the futures and would seem to indicate an up morning on Wednesday.

That brings us to the technical part of the show. Cue the music... Well, the next move here is significant. Looking back to last Thursday, you can see that the market had a key reversal with the up morning turning down and selling hard into the close. Since then we have had sideways action until this evening.

With the tech earnings news, there seems to be a rally at the start of trading. What we think will be critical is the size of the move. With a move that fails to get back to Thursday's highs, the market should be ready for a sizeable decline. If it does get to Thursday's highs, it could mean essentially the same thing due to the pattern in place right now. One thing we notice is the oil price moving higher and we immediately think the stock market should be doing the same along with it. Is something different?

Wednesday should be important to the near term trading so we will be back tomorrow to discuss it here. For right now, we wanted to provide a link to a great article describing how structured mortgages are set up. It's a little long but it does a pretty good job. The comment section would be a good place to discuss how this works. Make any comments or ask any questions you want there.

The 20th anniversary of the 1987 crash does not mean much so we only mention it as a historical date to remember. It's more important to watch what the market is doing now.

Monday, October 15, 2007

MLE--Mighty Large Enterprise

As the market opened on this Monday, the news from Citigroup that it had a bad quarter brought some modest selling in the early going. For detailed information on the C news, please take a look at the front page of Tuesday's WSJ. This article ties the poor quarter with another story about the new MLE SIV, this one found on page C1 of Tuesday's WSJ.

We urge you to read about the MLE SIV as it's being called. MLE stands for Master Liquidity Enhancement. We have mentioned SIV's (conduits called Structured Investment Vehicles) in prior posts but we think you should take a few minutes to find the WSJ and take a look at this new deal.

We want to spend an extra minute on it and provide you with a little information on this latest development to bail out the investors. As we had mentioned in our last (short) post, Thursday's action was the most important. The reversal seemed to indicate there might be a little selling in the near future. Then Friday, the action was muted at best.

Now we can conclude that the market had an inkling that this new MLE SIV was going to be set up over the weekend. We can't know that for sure but the way the market traded on Thursday should have led to more dramatic selling on Friday but that did not occur. The conclusion is not the only one out there but it did come to mind on Sunday evening as we heard about the news of the new bailout program.

C is the leader of the new deal and it has two big partners, B of A and JPM. These three banks were the center of the plan probably inspired by the Treasury department. The news was that the SIV would have funding of about $100 billion and an implicit government guarantee due to the Treasury's involvment up front.

Before we signoff for the evening, we wanted to mention one other WSJ article from last week. The story is about how some of the assets are priced in the current world (of no transparency). The article is found in last Friday's WSJ and is titled US Investors Face An Age of Murky Pricing. This article is a must read. The article says that there are now more assets that don't trade on exchanges than those that do.

The importance of that statement is the valuation of such securities. How do you value them when you don't have a liquid market in which to trade, a market that can tell you the value. The article says that in some cases, companies would put out an offer price and since there was No bid price, the market could use the offer price for value.

This practice is described by the article like a person would set the value of their house at what they wanted it to be and then say that was its value, even without anyone around who would look at the property let alone consider buying it. Warren Buffet is quoted as saying these securities are not marked to market but marked to myth. He suggests that companies try to sell a portion of their holdings, maybe 5%, in order to find out what the rest is worth.

The article shows three levels of valuation for assets. The first is the normal method which is to look at the price on the exchange, level 1, true mark to market. The second is called marking to matrix by some and is less precise. Values are based on "observable market data" for similar assets, level 2. Then there is level 3, so called marking to model which involves the most guesswork where valuations are based on management's best judgment and its own assumptions about what market participants might use in pricing the asset. Yes, you too can price your own assets. We were always of the opinion that something is only worth what someone else would pay for it, but if we can actually see the assets listed in these three categories we can determine for ourselves how much guesswork was used to value the company assets.

Sunday, October 14, 2007

Turn at Hand?

Just a brief note this evening as we haven't had much time to get back in the saddle after being out of town over the last few days. The most important characteristic of last week's action is the Thursday rally and reversal. The gap up opening and flat trading was followed by a sharp selloff that took various stocks down in a breathtaking drop.

AAPL (Apple) dropped 14 points in a heartbeat or about 1 minute. When stocks drop like that, it just proves the fallability of the bullish argument.

The pattern should be complete to call this rally over with a sharp decline to follow which should be almost immediate. Please come back tomorrow for better coverage.

Wednesday, October 10, 2007

Housing Still a Big Problem

[Editor's note: The Update will most likely not be published on Thursday evening. We will be back again on Sunday evening.]

This evening seems like so many others as we have moved up the mountain on the stock market since the lows back in August. Looking at the Asian markets, they are climbing a sheer cliff with seemingly no difficulty whatsoever.

But, at least here in the US, the stock market is starting to show significant signs of fatigue. There will probably be a little more upside but it is laboring to make those gains. Earnings season is upon us, the time when companies try their best to make everyone think things are going well so owners don't sell their stocks. Alcoa tried its best to do that as the normal first of the Dow stocks to report quarterly earnings.

Tonight, we can only say that things underneath the fluffy bullishness are not so bullish. The bullishness alone, since it is so intense, is bearish by itself. The low volume on the advance is another sign of a weak advance. With narrow leadership the market will have difficulty moving forward. The likes of the four horsemen can't be duplicated even by the four horsemen.

The time has come to set up bearish camp and watch the market fall.

The housing market, along with the mortgage world, is back in the news today with a prediction by the National Association of Realtors predicting a 10% plus drop in existing home sales this year. We are not surprised except by the lateness, it's already October 10th. The other news seems to be the groups that are beating up the mortgage servicers for their lack of speed or performance in adjusting troubled mortgage loans.

As we write this we noticed that the WSJ will be publishing a front page article [that could be] entitled "United States of Subprime" which talks about how pervasive subprime really is. This will be read by many people around the world.

Another issue that is now coming up, which the WSJ is reporting on too, is the evictions of renters due to the landlord being foreclosed for nonpayment. One of the people we know had this happen this past week and she laments the possibility that she will lose her damage deposit. This crisis affects people who didn't have anything to do with it. This is just the beginning.

Tuesday, October 09, 2007

New Record Highs Again

Is the stock market now on borrowed time now? With a vertical rise over the period following the Fed's rate cut, there needs to be a point where the market at least takes a breather. Today's market action looks like that may be a possibility. The Dow and the SP 500 both moved to record highs and the NASDAQ indexes moved to relative highs. The price move in the Dow was a little stronger than the rest and provides some confidence, ok not much, but some confidence of an over extended move right here.

As we look at the trading day especially in the Dow, you can see a feeding frenzy occurring with about 3 hours to go. You could line this up pretty closely with the release of the Fed minutes from their last meeting. We were pretty much shocked by the revelation of these minutes. We have been giving the Fed some credit for maybe seeing the problems in the economy and making some adjustments to policy to ease the credit conditions.

After reading the minutes, we wonder what is going on over there. We jump into the notes (the bold is our emphasis):

" date, initial claims for unemployment insurance did not indicate a substantial and widespread weakening in labor demand, and labor markets across the country generally remained fairly tight, with several participants citing continued reports of shortages of labor from their contacts in some sectors.

Participants thought that the most likely prospect was for consumer expenditures to continue to expand at a moderate pace on average over coming quarters, supported by growth in employment and income. However, some participants saw indications of a possible weakening of consumer spending. Sales of automobiles and building materials had flagged of late, and survey measures suggested that consumer confidence had been adversely affected by the recent financial market developments. Also, a further tightening of terms for home equity lines of credit and second mortgages seemed possible, which could weigh on consumer spending, especially for consumer durables.

Participants reported that recent financial market developments generally appeared to have had limited effects to date on business capital spending plans and expected that business investment was likely to remain healthy in coming quarters. The access of investment-grade corporate borrowers to credit so far remained unimpeded, and rates on investment-grade bonds had declined in recent weeks."

So, the conclusions were reached and the published statement was based on this...

"The Committee agreed that the statement to be released after the meeting should indicate that the outlook for economic growth had shifted appreciably since the Committee's last regular meeting but that the 50 basis point easing in policy should help to promote moderate growth over time. They also agreed that the inflation situation seemed to have improved slightly and judged that it was no longer appropriate to indicate that a sustained moderation in inflation pressures had yet to be shown. Nonetheless, all agreed that some inflation risks remained and that the statement should indicate that the Committee would continue to monitor inflation developments carefully. Given the heightened uncertainty about the economic outlook, the Committee decided to refrain from providing an explicit assessment of the balance of risks, as such a characterization could give the mistaken impression that the Committee was more certain about the economic outlook than was in fact the case. Future actions would depend on how economic prospects were affected by evolving market developments and by other factors."

Now, we apologize for letting the Fed write our blog this evening but please help us understand what they are thinking. The stock market must think they are puppets not central bankers.

We saw an opinion from John Crudele that emphasizes the point.

Our point is and always has been that the residential real estate market is in trouble and will not allow people to continue spending more than they earn. This will put the economy into a recession. For now, the stock market thinks the Fed (see above arguments to the contrary) is smart enough to avert any problems. Oh my.

Monday, October 08, 2007

Quiet Trading on Columbus Day

There are a few items to mention this evening. The big moves were in the "momo" stocks, momentum stocks for those of you new to the game. The advancers were over on the NASDAQ where the four horsemen had big pushes and pretty much everything else was either flat or slightly down. So, if you're in the horsemen, good for you. The four horseflies as Fleck calls them at AAPL, RIMM, GOOG, and AMZN, all had multiple point up days creating an illusion of strength on the NASDAQ.

As for Ryder trucks there was some different news. Ryder warned on earnings and made statements that would make the Update proud. They said that economic weakness is spreading beyond housing and construction. This news drove the Transports down over 1% even as oil dropped $2 a barrel.

Speaking of oil dropping, we note that gold was down also. This happens to be after what looks like a failed attempt to move to a higher price than last week. So, we have oil and gold going down along with the transports. The bond market was closed because of Columbus day but the dollar was up again.

You probably recall that we have said that the oil market has traded up with the stock market which doesn't really make sense generally but in this market is happening. Now that oil seems to have peaked again, the stock market should start its descent as well. We think both are driven by the same fundamentals and in this case, dollars chasing them looking for a home.

Sunday, October 07, 2007

No More Easy Money

We're pretty sure that the market is pretty pleased with itself after Friday's impressive run. With the jobs' report behind it, the market felt ready and able to charge forward and that's exactly what it did.

We have to admit, we're a little confused by the August job number revision from a negative 4K to a positive 89K in a single stroke of the pen. Some said that the number was artificially marked down early in the month in order to provide the Fed with some breathing room to justify a rate cut. While that might be true, we think the Fed rate cut was coming in any event and the jobs' number was not going to change that fact.

In retrospect, though, the stock market did manage to get everything it wanted. It got the rate cut that it didn't need and it got a fairly strong jobs' report in total. We wonder what the Fed is thinking sometimes and over the weekend was one of those times. It does seem as if the world believes the credit issues are behind us, meaning the money is free flowing to anyone who wants or needs it. As we said, the stock market is grinning about all of the nice things that it got over the past few weeks.

Skip to the news from the FDIC, where the chief there said that the ARM's should automagically just stay at the rate they are at instead of moving up as they were supposed to. Of course, we're supposed to figure out if the loan is for the person actually living in the house. We don't want to provide this benefit to those who are speculating in real estate, that might look bad.

We wonder what the investors in those bonds are thinking. Some of them have lost a lot of money already due to defaults and foreclosures and now this. What's a mortgage investor to do? Well, we submit that they don't want to invest in mortgages, especially ARM's for subprime borrowers.

That's where Fannie Mae and Freddie Mac enter the picture. Rather than trying to summarize the info from Doug Noland at Prudent Bear (check the Credit Bubble Bulletin at the Prudent Bear link to the left), we'll just reprint two of his paragraphs here:

From Doug Noland: The combined growth of Fannie and Freddie’s “Books of Business” will approach $500bn this year (nearing $5.0TN). The (also thinly capitalized) FHLB is on track for unprecedented expansion (assets surpassing $1.2TN). The money fund complex is in the midst of unparalleled growth (approaching $3TN). These key interrelated Financial Structures are at once sustaining marketplace liquidity, while laying the groundwork for a much more perilous financial crisis. They are all ballooning exposures today at double-digit rates specifically because the market risk environment has deteriorated markedly while their liabilities (and GSE guaranteed MBS) retain coveted “moneyness.”

But this does not alter the reality that this is an especially inopportune time to aggressively expand risk intermediation responsibilities. Indeed, the transformation of today’s highly risky Credits into Trillions of perceived safe and liquid debt instruments is but a seductively parlous expedient. I’ll further add that these Financial Structures comprise the greatest distortion of risk in the history of finance. Fannie and Freddie are adding significantly to their already massive exposure just as losses begin to mount – and mount mightily they will. The FHLB is aggressively lending as the risk profile of their borrowers deteriorates rapidly. And the money funds, well, I’ll just posit that the risk of eventually “breaking the buck” is rising right along with their growth in assets. In short, the money funds’ and GSE’s aggressive risk intermediation and market stabilizer roles imperil future “moneyness” – with enormous systemic ramifications.

End of Doug Noland quote.

Our stance on the fragility of the housing situation remains. We believe that the consumer will cave over the holiday shopping season. The reason is simple, there is no more easy money from the ATM, that used to be their house. Now, that will not be an easy way to get money and live well beyond their means. That is both in terms of the money that used to be taken out and the low payments that they have been able to make. Yes, we know the head of the FDIC is pounding her fist on the table to help the poor souls who might lose their homes. The consequences of a move like that are far reaching and will cause disruptions in the availability of credit, except as provided by Fannie and Freddie.

Thursday, October 04, 2007

Jobs' Report Friday on Tap

Friday brings us the jobs' report. The market seems to have been waiting for this event for a few days. The market thinks that the Fed pays a lot of attention to this data point, so they are hoping for a Goldilocks' number. They want a number that is just right, not too big as to delay, we stress "delay", a rate cut to later meeting. They have no reason to believe the Fed is done, far from it.

The market thinks the Fed needs to lower rates and lower rates they will, just for them. The number can't be too small because then the market might have to convince itself that the economy will be ok and they don't want to have to deal with that. Of course there are the revisions that could help the market out, too. If September's number is low but the August number is revised up to compensate, then there could be a Goldilocks' number. All of this with the Dow within an hours' trading to a new all time high. This thinking is so flawed by normal standards but we have seen the Fed act in the past couple of months. We know what they are capable of and so does the market.

Let's get to what we think on this fine Thursday evening in October. First, the market may get what it wants on the jobs' number and the Fed's rate decrease. We don't really argue with the weakness in the economy. We argue that the market is over valued with respect to the state of the economy. Second, we almost expect the number to be a Goldilocks' number giving the market a decent chance to punch up in the early going. This result corresponds to the current pattern in the market, another push up could be a nice bow on the market.

Third, it's a little early to be predicting the Fed's move this month but we do think the market holds a good chance to pop in the morning (regardless of the number) and then a fall off after that. The jobs' report certainly has been the stage for such turn arounds in the past. That is one of the key reasons we pay so much attention to it.

Other observations would be that there has been some interestingly bullish comments on the internet these days. One we noticed indicated that there wouldn't be enough toys available for holiday shopping. Does this make you believe there's a lot of shopping going on with the Wal-Mart price reductions this month? There are comments that Wal-Mart had trouble last December because it had run out of product.

Another thing we noticed was the talk about the apparent loosening going on in the credit markets. The biggest noise on this subject came from former Fed Chairman Greenspan but we have started to hear it from other sources, as well.

These are the type of stories that seem to be designed to calm the public down. There is obviously some plausibility in the stories which gives them credibility.

In closing, we want to say that the job of predicting the number of jobs in tomorrow's report is a tough one. The number is about 100K and the WSJ has 110K. These are big numbers and give the actual a good chance to come in under them giving the market its Goldilocks' number. Since the number comes out an hour before the market opens, there is ample opportunity for the market to pump itself up--or down.

Some of the items we read suggest that the September number is less manipulated than other months due to the lower birth/death additions but August has the history of having the largest adjustments to it. Lots of possibilities on Friday but our guess is Up early and then Down. What else could we say?

Wednesday, October 03, 2007

Waiting for the Jobs' Report

For a Wednesday, there doesn't seem to be much going on. We are patiently waiting for Friday's read on employment which could prove to be an inflection point for the market. As we have mentioned on more than one occasion, the market seems to have no idea that the economy is actually supposed to be the reason it is alive. With the broader economy still struggling for the most part, the stock market seems content to hope for a rate cut from the Fed. We find this concept difficult to understand but somewhat reasonable considering the Fed's actions in the past couple of months.

The news from the tech sector seemed a little odd on Wednesday, not that we disagree with it, it just didn't correspond with normal trading. When Micron brought out some bad news on Tuesday evening, the market was surprised and hit INTC and AMD along with MU. Fleck talks about MU as being the "flying pig" because it seems to always be putting up bad numbers but always says things have "recently" turned around. Fleck says they turned around "in the last five minutes" so there is nothing to worry about.

Well, on Tuesday evening, they didn't say anything about the "last five minutes" and that bit of "truth" was enough to take the market down ever so slightly on Wednesday morning. But, again, not to worry, the market came back after the early drop and was sporting green for a while. Then a strange thing happened, sellers came in and pushed the indexes down below the early morning lows but a late day rally did bring prices off the lows to close near the lows of the morning. All in all, this was pretty much a nothing day as everyone sort of trades a little to get to Friday.

Tuesday, October 02, 2007

No One Can Make Ends Meet

Erick left us a comment to ponder this afternoon so we just have to respond. Erick's quote was: "Is it possible that nobody has enough money to make ends meet these days."

There is so much anecdotal evidence that people are basically struggling financially. We would say they are mostly "house poor" meaning their mortgages are eating up their income. It's true that not everyone is in dire straits as many people actually own their homes outright and, for them at least, this period of time may not be so bad.

The normal troubles of spending more than what you make is something that many people used to do but they would come to a point where there was no more room on their credit cards so they had to cut back, and, dare we say, pay them down. Then, along came the stock market boom in the late 1990's and people were able trade and make money which could then be taken out to pay off their credit cards.

Then came the stock market implosion of 2000 and 2001 which wiped much equity off the books and put people in the credit card spending mode which was ok because they had just paid their balances down. The Fed then had a great idea, lower interest rates to 1% on the short end of the curve and allow people to get ARM's to finance their houses.

What a great idea! Housing prices went up due to the higher demand and people could "refinance" their mortgages and pull cash out to pay off credit cards or take a "much needed" vacation or buy that new SUV they were wanting to buy. Well, you know the rest of the story up until now.

Now, the credit card debt is just part of the overall debt and the mortgage payments are starting to bite down a little more. These are difficult times for many who have already lost their homes and more who are still to lose them.

So, no, we don't think there are very many with the means to get from month to month and they are juggling the mortgage and the other debt they have and possibly the utilities. We see very little relief in store for many as we go into winter across the country. We think Christmas (holiday, for those of you who prefer politically correct) sales will not be very good this year. The first indication was that WalMart is already slashing toy prices to get people to come into the stores.

That should be enough commentary on Erick's comment but please feel free to add your own in the comment section.

Just a few other comments this evening as we continue to wait for something Normal to occur in the stock market. First, there was the, can we say, dismal pending sales report which showed a big drop. The report was that the mortgage meltdown was responsible for lower sales because would be buyers couldn't get mortgages. Right, there were so many buyers out there and they just couldn't get loans. See above.

Second, there was the news that Ford sales dropped 21% and Toyota was also down 4% while GM was up 0.28%. These items were taken as good news by the market, why? Well, of course, you know why. The old argument that the Fed can lower rates on Halloween. But, finally someone decided to say what has been on the minds of all of us ever since the first rate reduction several weeks ago. How can the Fed lower rates when the Dow at Record highs?

Attached to that article is the note from Bill Gross that asks the question "Does the Fed know what it's doing?" By the way, we wonder, too. We have commented on their lack of concern for the global impact of their rate decreases. Their actions are strong verdicts on the financial world as they see it. The stock market doesn't see it because they only worry about the interest rate cuts. But, we are confused by the recent action of the Fed. Yes, the market had dropped a little but there was no panic around the fall even in the face of horrible action in the credit world.

The result of all of this has allowed the Asian stock markets to absolutely go wild. We can not believe the action over there with the Hang Seng up about 40% since the middle of August.

Third, today's action in precious metals is worth a mention. Gold and silver were hit pretty hard as the dollar managed a pretty strong day, and we would say finally. We have been dollar bulls and precious metals bears for a while now even though we haven't acted on those thoughts, thankfully. Today is the first day where that may have made some sense. We'll continue to watch this sector to find a good entry point--we are looking for gold in the $500 range.

Monday, October 01, 2007

New Record High for the Dow

Monday and the start of October as well as a new quarter brought out the buyers. So, let’s see before the market opened, we heard several interesting news items. We brought you the news last night about UBS writing down $3.5 billion in assets. Then Monday morning C (Citigroup) warned on third quarter saying that their net would fall 60% due to credit market problems, yes, subprime is in there.

After the market opened, the ISM manufacturing report came out showing that number stayed above the 50 line but declining from last month. Now, of course, the “bad” news brings out the Fed talk and how the Fed can now lower rates. Yes, that thinking should not be reasonable as the Dow makes a new high but the Fed did lower rates last month even as the market was within a few percent of the top.

As the market moves higher, the bears have vanished except for a few of them. The ones remaining tell us that the market is overbought and that the blue chips are moving up without a lot of participation. Yes, the home builders are being touted as good buys right now and have moved up a little. And, the banks listed above give out bad news and rally on the day making the world think that the worst is over for the subprime problems except that the Fed still needs to come in a lower some more just to make sure. At the very least, the market does not have a lot of leaders that are making new highs along with the Dow.

As we continue to watch this market, this is the first day that the Dow has been able to get much above the highs set the day after the Fed lowered rates. The market has been overbought and Monday’s headline says that the “Dow hits record on Fed cut dreams”. We would emphasize the word Dreams.