Coming Down the Mountain (Update): the Wild and Wacky Markets
In case you haven't noticed the markets are giving new meaning to the word volatile - as in wild, wacky and woolly indeed. We haven't posted on the markets though because our analysis in several prior posts has held up reasonably well; and truth be told because we've been too distracted. (Managing the Lizard Brain: Beyond Crisis and Kabukit to Realities,The People's Choices: Rescue vs Revenge)In fact as a not-so-small confession, the last several days down moves compress several months into a few days and were weigh/way beyond our expectations. As a result of which while we were looking for a short-term bounce the markets were in the process of grasping the same economic and fundamental realities and taking them to heart we've been nattering on about for months. The long- and short of it is, literally, we were in cash when we should have been riding the crash down.
After the break you'll find two sets of readings. One on the market per se and the other on the extraordinary measures being taken by the Fed and the world's central banks to re-liquefy the credit markets and get the wheels turning. In the long-run we still stand by our overall analysis. In the short-run, despite the amazing downdrafts of the last three days, we're still looking for a bounce. Which however long it might be we still view as an opportunity to beat on the downside or get out of any positions you've still got. And please note - the important thing here is the credit markets which are still deep in the doodoo indeed. But since everybody looks at and can follow the markets that's where we'll concentrate.
Equity Markets Breakdowns
Let's start with three complementary views of the same stock chart so we can get an idea of just how bad it got and what the implications might be. The first sub-chart shows downtrend lines drawn to filter the excesses of some of the wild swings out. The second shows what happens when they're included. In the latter case the markets were like a high-power engine so over-revved it was shaking itself to pieces. Fortunately various policy actions managed to reduce the fuel flow enough to keep that from happening. Which leads to the third sub-chart with some filtering but showing the bottom resistance still being almost broached last week (these charts are all thru Oct 3rd btw). The question then becomes where do we go from here ? Which dynamic is in control ? That question got answered this week and, unlike all the prior bear rallies we railed against, the economic realities combined with the credit implosion seem to have completely changed market sentiment. Now everybody's running in fear. As they should be - this'll get worse long before it gets better.
Market Outlook
To try and answer those questions we take a look at a 1 year and 10 year chart combination. In the first chart which looks at the SP500 since Oct07 you can see the downtrend metastasizing into a crash. Which if we'd posted this as intended on Sa. would have made us look very prescient on Mo/Tu and today so far. Do good (bad) intentions count ? To some extent perhaps because the long-turn trends downward are more than intact. What we'd hope for is less panic, a more orderly process and not having six months of change compressed into three days. Then on the other hand we've just seen a decade's worth of Financial Industry re-structuring compressed into three weeks so why not ? The bottom 10Yr chart puts this in some perspective. Looking back to 1998 we set up something called Fibonacci lines which show the natural, internal limits that markets tend to follow. The line around 1055 should have been major resistance but was blown right thru. The next stop down would be to give up the last five years and retreat to around 850. But there is an area of resistance in the 950-1000 region. Which in fact seems to be holding, however weakly. If we get a rally off this - yeah, right ! - it'll likely be weak, short and deceptive. It will be however your last clear alternative for cleaning up your investments and re-positioning yourself prior to the return of the Housing and Business Cycle problems. It's also possible that we'll blow on thru it and then we'll be having a different discussion indeed. One where then we'd be back to trimming off the excesses left over from the late '90s. Which, note for the record and from much earlier posts, we never did do. The rally in '03 bottomed before we drained those poisons off; and as we now know there were a lot of poisons indeed that needed draining. Which we're now being forced to deal with willy-nilly, like it or not !
UPDATE: Very interesting BNN interview that's a welcome dosage of reality, calmness and informed assessment vs. the typical CNBC yadda yadda. Recommended - 5 min !
Market Morning : October 8, 2008 : Market Lookahead [10-08-08 9:15 AM] BNN sets you up for your trading day with Chyanne Fickes, VP investments, Stone Funds.
Market Delusions Continued
SP500 Damage Done on Monthly Chart Today’s equity decline undersay has stunning ramifications for the larger time-frame structure of the S&P 500 and other US Equity Indexes - we’re now at levels not seen since 2003. Let’s take a quick look at this structure to see where this takes us. First, let me state that we’ve now officially ‘blown through’ the long-term (large scale) Fibonacci retracements from the 2002 lows to the 2007 highs. The sellers took out the 61.8% Fibonacci retracement at roughly 1,080 this morning. Price is undeniably in a monthly downtrend, though the 20 and 50 month EMAs have yet to cross (the 10 and 30 month EMAs have done so - a popular combination used on longer time frame charts). Where’s the next level of possible support? I suggest it’s potentially the rising 200 month SMA just under 1,000. We may get a bounce off current levels, but should price test the longer SMA, a bounce would be in order. Ultimately, I find it highly conceivable that we retest the 750 - 800 area which marked the early 2000’s bear market low - it looks clearer than ever now that we’re headed there at some point - but not before a few more counter-trend rallies occur. This is not an environment for aggression on either side (long or short). Though it may not seem so, bear markets are much more difficult to trade than bull markets. Case in point, it took only one year to totally destroy the equity gains that were achieved in five years - let that sink in.
Capitulation watch continues in vain It certainly felt like capitulation on Monday, after the Dow Jones Industrial Average plunged more than 800 points intra-day before recovering to end the day down "just" 370 points. But, then again, it has felt like capitulation on a lot of other days in recent weeks too. And yet, as we know all too well now, those earlier days of apparent capitulation turned out to be nothing more than false alarms. So the fact that Monday felt like capitulation tells us little about whether it indeed will mark the final low of the bear market. To determine whether it will, therefore, we have to go beyond our subjective feelings and focus instead on the hard data: Did sentiment really and truly drop far enough on Monday to constitute genuine capitulation? From where I sit as monitor of several hundred newsletters, I'm afraid my answer is "no." Believe it or not, the editor of the average short-term market-timing newsletter actually reduced his bearishness Monday. Consider the Hulbert Stock Newsletter Sentiment Index (HSNSI), which reflects the average recommended stock market exposure among a subset of short-term stock market-timing newsletters tracked by the Hulbert Financial Digest. As of Monday evening, the HSNSI stood at minus 33.5%. As of last Friday's close, in contrast, the HSNSI stood at minus 36.1%. Believe it or not, in other words, the HSNSI actually rose slightly on the day -- by 2.6 percentage points -- despite Monday's market tumult. That's telling enough. But, as I have mentioned on several occasions in recent days, that's not the only source of contrarian concern about the HSNSI. Even at Friday's minus 36.1%, this sentiment index was still markedly higher than where it stood in early July. And though the market wasn't in great shape then, from the perspective of the markets today it looks awfully attractive. Why should there be less fear among the market-timing newsletters today than then? Why should sentiment actually have increased on a day like Monday? In large part, I'm convinced, it's because newsletter editors are so eager to declare that a bottom has been formed. Every time we have a big down day like we had on Monday, some of the short-term market-timing newsletter editors conclude that capitulation has taken place -- and hence decide to become more bullish. This process keeps the HSNSI from dropping as far as it otherwise would, and prevents genuine capitulation from occurring. It's worth remembering a truism about market psychology that has been too often overlooked in recent weeks: When genuine capitulation finally takes place, few will recognize it as such at the time. In contrast, an eagerness to declare that capitulation has occurred probably means that it hasn't.
S&P 500's Drop Points to Potential `Significant Rally': Chart of the Day U.S. stocks may be destined for a rebound because so many shares in the Standard & Poor's 500 Index have fallen to relatively low prices, according to Bespoke Investment Group LLC. ``We believe a significant rally is set to take place,'' Bespoke's analysts wrote in a report today. Only 28 companies in the S&P 500 closed yesterday above their average price in the last 50 trading days, a signal that shares were ``oversold,'' the note said. The CHART OF THE DAY shows the S&P 500 and its 50-day moving average this year. Yesterday's close was 14.7 percent lower than the average, the biggest discount of the year. Four of the index's 10 main industry groups -- energy, industrials, materials and telecommunications -- didn't have a single stock close above its 50-day average yesterday, Bespoke's data show. Chart of the Day
Citigroup's Levkovich Goes From Most Bullish to Most Bearish Stock Analyst Citigroup Inc.'s Tobias Levkovich cut his Standard & Poor's 500 Index forecast by 19 percent to 1,200, turning him from the most bullish U.S. equity strategist tracked by Bloomberg to the most bearish. The new projection represents a 20 percent gain from today's close of 996.23 through the end of the year. Levkovich, 47, said the credit crisis and a slowing global economy made his previous forecast of 1,475 unreachable. The S&P 500 has plunged 36 percent since its October 2007 record under the weight of almost $600 billion in subprime-related losses at banks and an increase in borrowing costs. Levkovich is the third of nine strategists to cut estimates since Lehman Brothers Holdings Inc. filed for bankruptcy on Sept. 15, according to data compiled by Bloomberg. On average, the analysts project the S&P 500 will end the year at 1,344. That would require a fourth-quarter advance of 15 percent, the steepest quarterly gain since the final three months of 1998. ``The anxiety generated by collapsing international stock markets, weaker economies around the world and the failure of a number of leading financial institutions made our previous year- end S&P 500 forecast both stale and improbable,'' New York-based Levkovich wrote today in a note titled ``Eating Humble Pie.'' Levkovich said a month ago that he was sticking with his year-end estimate even though he was getting ``enormous pushback'' from clients. He said he was eating more doughnuts to cope with the pressure.
Coping with the Credit Crisis
Business loan bailout The Federal Reserve announced a new program to help the battered market for short-term business loans - taking its closest step yet to lending directly to businesses. The program addresses commercial paper, a form of short-term funding that is crucial to many businesses operations. In the past month, the amount of money outstanding in commercial paper loans has fallen 11% to $1.6 trillion on Oct. 1 from $1.82 trillion on Sept. 10. Since much of the paper that was outstanding at the start of the credit crisis is now coming up for renewal, there were fears that it could drop even more sharply in the weeks to come without some drastic improvement in the market. Under the program announced Tuesday morning, the Fed will purchase three-month unsecured and asset-backed commercial paper directly from eligible issuers. The program is slated to expire in April 2009 and will have financial support from taxpayers.
Tuesday’s Trading George Says: Has anyone ever had a business and had to meet a payroll? I have. My brother and I ran an electronics business both retail and commercial. We would get loans for big projects to buy equipment and pay employees until such time we got paid for the job from the customer. During seasonal activity, such as Christmas holidays, we would get loans to stock up on those items and in general increase all of the inventory. At the end of the season, if everything went well, we would pay the loans back within weeks or a couple of months. We would have sales to reduce inventory and get prepared for the next season. There were rough economic times when we could not get adequate loans to meet project and seasonal requirements. Then there were times when the loans we got had high interest rates. These were usually short-lived, but these conditions reduced our profits considerably. Imagine not being able to get adequate loans to run a business for years. It doesn’t work. You go out of business. This is similar to not getting a paycheck. And the reason I believe something needs to be done to provide financial institutions capital to keep business running. Each of us is biased about the bail-out due to our environmental conditions, past experience, current financial situation, etc. Sure, some businesses are not run properly. There are greedy cheaters and gouging. Piecemeal, that doesn’t hurt the overall economy. But the bottom line is, if farmers, businesses, cities, states, individuals, and all other sectors of society can’t get the funds needed to survive AT THE SAME TIME, we face a calamity beyond our wildest dreams.
Fed, ECB, BOE Cut Rates in Unprecedented Response to Combat Credit Freeze The Federal Reserve, European Central Bank and four other central banks lowered interest rates in an unprecedented coordinated effort to ease the economic effects of the worst financial crisis since the Great Depression. The Fed, ECB, Bank of England, Bank of Canada and Sweden's Riksbank each cut their benchmark rates by half a percentage point. The Bank of Japan, which didn't participate in the move, said it supported the action. Switzerland also took part. Separately, China's central bank lowered its key one-year lending rate by 0.27 percentage point. Today's decision follows a global meltdown that sent U.S. stock indexes heading for their biggest annual decline since 1937; Japan's benchmark today had the worst drop in two decades. Policy makers are also aiming to unfreeze credit markets after the premium on the three-month London interbank offered rate over the Fed's main rate doubled in two weeks to a record. The Fed reduced its benchmark rate to 1.5 percent. The ECB's main rate is now 3.75 percent; Canada's fell to 2.5 percent; the U.K.'s rate dropped to 4.5 percent; and Sweden's rate declined to 4.25 percent. China cut interest rates for the second time in three weeks, reducing the main rate to 6.93 percent. ``The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability,'' according to a joint statement by the central banks. ``Some easing of global monetary conditions is therefore warranted.''
Understanding the Significance of Mark-to-Market Accounting Recent actions of corporate titans in the financial sector are essentially an admission that their business model was deeply flawed. No one would invest any capital for a ROI of 50 bps per year. They of course knew this -- so they leveraged up that 50 bps 35X or so, creating the false appearance of more attractive returns. This higher risk, potentially higher return paper was part of that misleading process. Suspending FASB 157 amounts to little more than an attempt to hide this broken business model from investors, regulators and the public. Its not just getting through the next few quarters that matters; Rather, its allowing the market place to appropriately reallocate this capital to where it will serve its investors best. If FASB 157 is suspended, I would advise our clients and the investing public that owning any financials that failed to disclose their holdings accurately were no longer investments -- they were pure speculations, with more in common to spinning a roulette wheel than owning Berkshire Hathaway (BRK) or Apple (AAPL) or Google (GOOG). Indeed, I know of no faster way to end up on the DO NOT OWN list than to hide from your shareholders what is on your books. If investors cannot trust the valuations of what is on a firms books, they simply cannot invest in these firms PERIOD. There are other alternatives for the institutions that now must deal with this discounted, thinly traded hard to value junk paper. They can sell it for whatever price a the market will bear, they can spin it off into a separate holding company, they can write it down to zero and reap the rewards of mark ups in future quarters. But suspending the proper accounting of this paper is the refuge of cowards. It reflects a refusal to admit the original error, it hides the mistake, and it misleads shareholders. I find it to be totally unacceptable solution to the current crisis. As Japan learned, not taking the write downs only delays the day of reckoning. They propped up insolvent banks, and suffered a decade long recession for it. That way disaster lay . . .
Quote of the Day: Aggressive lending to 1st-time buyers Its important to understand how this situation occurred in the first place, if we want to be able to fix it. Blaming the CRA and Fannie/Freddie is a total misunderstanding of how the problem occurred, and what we need to do to fix it now, and avoid doing it again in the future. To repeat my prior arguments, the proximate cause of the Housing crisis were 1) Ultra-low rates; and 2) Abdication of traditional lending standards, thanks to 3) originators ability to resell mortgages for securitization purposes, and hence, 4) not have to worry about loan defaults. The credit crisis was caused by 1) the above securitized mortgage paper, that was 2) rated triple AAA by Moody's and Standard & Poors, which then 3) Which was then "insured" by credit default swaps (CDS) -- the unreserved for, shadow insurance products 4) whose exemption was made possible by the Commodities Futures Modernization Act. That legislation exempted these derivatives from any supervision or regulation. The lack of reserve requirements is why there is now $62 trillion in CDS, many of which will never pay their counter parties the promised insurance. If you are going to blame Fannie/Freddie/CRA, or George Bush or Barney Frank, you are missing the big picture.