Monday, March 17, 2008

Too Big to Fail?

Top Line: From the looks of it, the market avoided a major event on Monday even though many stocks were down on the day, that would be a 5-1 ratio of stocks down to up. The down pattern does not seem to have played out which means we think there should be more to go. The Dow has refused to penetrate the January lows while virtually every other index has. Today's uptick in the index is pretty much all about JP Morgan's 10% rally after bailing out Bear Stearns on Sunday evening. The Dow needs to confirm the down move here very soon.

We find it pretty easy to find articles that are saying things that we have been saying for months now so we start getting a little uncomfortable being the contrarians that we are. At the same time, the market is trying to find a bottom here even though we don't think that one exists at these prices. We think it exists somewhat lower, but maybe not too far away.

Monday was a down day for many stocks with over 700 new 52 week lows which is a dramatic number when compared to the total number of stocks traded. Let's do the real numbers...there were 759 new 52 week lows and 3258 stocks traded. That means that one in five stocks made new lows today. That would suggest that there are a number of stocks trading below their 200 day average which is a potential bullish sign. This is part of our studying to determine a possible interim low that we can trade.

Another indicator we use are the volatility indexes most notably the VIX. This index measures how expensive put options are so as fear grows and people buy puts this index goes up. Back in August this index spiked up to the high 30's and it did the same back at the January lows. This index had been trading below 20, near 10, for several years until we started seeing some volatility this past year. We think this index should spike again before we see a solid low in stock prices. Maybe the high 30's is all it can manage...we are watching it closely now.

Tomorrow brings another Fed day. Doesn't it seem that the Fed is doing something everyday? One article quoted a former Fed Governor saying that it seems the Fed is playing Whac-A-Mole. Whatever financial issue pops up, Bernanke is there with a mallet to Whack it down. Tuesday's rate cut seems too much for this week from the Fed.

But, cut rates they seem ready to do. The 3 month Treasury bill closed Monday at a rate of just over one percent while the fed funds rate is currently at 3% for a wide 2% point difference. The Fed is at liberty to lower rates 2 full points Tuesday even though they won't do that. The market expects a full point reduction based on trading this evening. We won't be surprised at that but we wonder what more the Fed has left. We think the rate cut will be at least 75 bps and no more than 1 full point.

No matter what they do, the market is about tired of the Fed for now. We don't really think the news will do much to trading at all. If they cut more than a point, that may draw some criticism or may spur some additional fear in the market. Liquidity drying up can not be stopped by lowering rates and looking back over the past six months the market has proved that.

Getting back to some analysis by the rest of the world, there were two good articles from two writers we consider to have a good understanding of the world markets. The first is an article by Gretchen Morgenson of the NY Times. Her article, "Rescue Me: A Fed Bailout Crosses a Line", explores the subject of Bear Stearns being "too big to fail". She quotes our favorite bearish hedge fund trader Fleck.

The other article is from James Grant and is in the Washington Post. Mr. Grant's article cuts to the heart of the same issue. Both of these articles are recommended reading.

As we finish this evening, we notice that the Asian markets are mostly red except for Japan with a mild half a percent rise. Looking back to the last 24 hours, we were remembering how far the overseas markets were down and the point of the storm, here in the US, seemed almost calm.

To give you an example of calm, Bear Strearns traded to close near $5. The traders seem to believe that $2 is worth $5. Do they think there may be another rescue partner out there? What could these people possibly think?!?

We think that sentiment is a huge indication of what will happen. Since there seem to be buyers to hold up the market, we think there is more downside. Simple as that. When the buyers go away, there will be a drop and then we can consider getting out of our shorts and possibly into some stocks. We don't think that time is here--although it is probably close by.

FSI: 69.07 (not a bad showing from the speculation team)

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