Stock Market Summary - May 13th 2008

Posted: May 13, 2008 at 9:41 pm by Chuck

bi·zarre

–adjective

markedly unusual in appearance, style, or general character and often involving incongruous or unexpected

elements; outrageously or whimsically strange

Bizarre is about the only word from which I can conjure up to describe the market trading lately. While it is bizarre, it is not surprising. Some of the most unusual moves in the markets take place in bear markets. What we have been witness to over the past few sessions is a liquidation on news. This mornings retail sales data was being painted by the media as "better than expected" which brought a new wave of buyers to the market. And, just like yesterday, the market sold into those new wave of buyers. What is being played out before us in slow motion is the creation of a whole new breed of ‘bag holders’ in my view.

As the markets inch their way up it attracts more and more people into the market. The old "I don’t want to miss out on the market going higher" scenario is created. And it is that exact scenario that those who see the market crashing in the near future use to unload their positions onto. The stock market is a game, a game of keep passing the stock to the next guy until such a point is reached when there is no one left to pass it to. In order for the market to operate there must always be someone willing to pay a progressively higher price, or at least to someone who thinks the price will go higher. The last person holding the stock before the price goes down is the ‘bag holder’.

Look at any chart, find any absolute peak on that chart and know that someone purchased the stock at the highest price on that chart before it rolled over and died. There is always someone left holding the bag. The stock market is in a unique way akin to natures natural selection process, in that the smartest survive, and the dumbest go broke and become extinct. And when the markets advance within a bear market it is usually called a ’suckers rally’ for it attracts the unsuspecting to their doom. And the media loves being the pied piper of sucker rallies.

In 2000, before the dot com bust and before the bear market really got underway the market was getting shaky. There was a period of time when the Dow was making advances and the media was getting all excited that the market was going to go to new highs. This quote from March 22nd, 2000 (before the market crashed)

The explosive rally in the Dow this past week constituted one of those moments when it is best to buy first and ask questions later.

While it is possible this was a sucker rally doomed to reversal, experience indicates a move like that with no apparent trigger signals the start of something big, very big.
—Howard Simons, "This Dow’s for Real," TheStreet.com, March 22, 2000

Mr. Simons of ‘thestreet.com’ said experience indicates the moves in the market was the signal of something very big. He was absolutely right! But the something big was in the wrong direction for in the following months the market plunged. But the point is that even the media can get swept up in the market movements and their enthusiasm leads to new buyers who just keep moving the market further until the moment comes when the drain plug is pulled and everybody is sucked down the hole.

The financial sector took a hit today with banks selling down (Bank Index BKX -2.13%). Confidence in the banking institution continues to be on edge, and rightfully so in my view. In her speech today, Federal Reserve member Janet Yellen showed a PowerPoint presentation addressing the balance sheet of the Federal Reserve. The image below, from her presentation, shows just how much of the Federal Reserve’s budget has been eaten up by having to lend money to banks and financial institutions. What is even more scary then the fact that almost 1/2 of the Fed’s balance sheet has been handed out? It is that in place of that money is collateral that could become worthless at any time as the real estate market continues to falter. That is a big risk the Federal Reserve is taking with our tax money!

(Federal reserve Janet Yellen Presentation May 13th 2008 at Vancouver Conference)

Oh, and while we are talking about real estate and the mortgage backed securities (that the Fed has on hand as collateral), today Moody’s released a memo that addressed growing concern of the bond insurers, yes again. You thought the bond insurer soap opera was over? It may be that a new season of the bond insurer soap opera is starting.

[MBI] MBIA Inc Moody’s: Concerns rising on MBI-ABK capitalization levels

- Moody’s says worsening second lien RMBS could impact financial guarantor ratings

So once again the AAA ratings of the bond insurers are being put under a microscope. Moody’s says that the residential mortgage backed securities (RMBS) is still worsening. And that is going to put added pressure on the bond insurers. The mess just continues on and on. What do you think would happen to Janet Yellens chart if a substantial chunk of that collateral gets downgraded with a removal of the AAA rating of the bond insurers? Well, if the just starting trend of lower sales of treasury notes continues, then the Federal reserve will get into a position of nearing exhaustion of their balance sheet and then you and I will be paying for more of this mess then we already are. A bond market crash would follow if such an event were to play out. Who wants to buy US treasuries if the Federal Reserve ends up being the ‘bag holder’ if the RMBS market is downgraded, and the collateral becomes pennies on the dollar? The Feds need the sale of the treasury notes to keep liquidity moving, without it then we are in for a "lack of confidence" of the entire financial system.

Someone said a few months ago that consumer confidence is directly proportional to the stock market declines or advances. That if the average person sees the market going down everyday, then they automatically equate that to a bad economy and their feelings will be swayed by observations and not personal impact. Well, the market has been creeping back up since the middle of march and today the Washington Post / ABC News consumer confidence poll was released. Guess what? It is still declining even though the market has been rising. So much for that theory from Larry Kudlow (CNBC).

(Data Source: Moody’s Economy.com)

This morning we received the monthly import / export price data. Prices being paid for goods imported is rising rapidly. And it is not just oil, even without oil the prices included, prices are rising quickly. The next two charts are of the import prices and the numbers behind the chart.

(Import Price Index- Data Source: Moody’s Economy.com)

(Import & Export Prices Data - Data Source: Moody’s economy.com)

And the last economic bit of data I want to show tonight is the retail sales data. The next chart tracks the sales of chain store sales. It is released every week and it is very easy to see just how the year over year growth has been deteriorating. And the market got excited this morning over a -0.2 growth rate! Good grief, long term projections of the economy based on many economic trends just scream out deep recession. Well, this is why the market sold off on the media’s hyped ‘good news’ this morning of the retail sales data. The smart money wanted new bag holders to unload their positions onto.

(Chain Store Sales Weekly Data, y/y % - Data Source: Moody’s Economy.com)

One of our members emailed me a chart tonight that he put together showing the S&P 500 vs. the volatility index going back to the last recession and bear market. Some in the media have claimed that fact the volatility index has been declining of late means the market is poised to scream higher. That is just not true, the chart below shows that even a ‘relaxed’ volatility index can scream higher at any moment signaling a return of the panic selling. Good work Steve, and thank you for sending us the chart.

By the way, someone or some large hedge fund has purchased a very large position in VIX calls at 25. Someone is betting, in a large way, that the volatility will rise above 25 by May 21st. A rise back above 25 will be a large sell off in the markets.

(Volatility vs. S&P 500 - Data Source: RebelTraders member ‘Steve’)

Just one more thing to touch on tonight. There is a media report that the United States is sending a large contingent of aircraft carriers to the Persian Gulf. I don’t know if this is true, I don’t know what the US Government has in mind. I’ll just let you watch the news video and you make your own guesses from the news. But, I will say that if these reports are true, and something comes of it, then inflation will take on a whole new meaning.

By the way, Consumer Price Index data comes out tomorrow (Wednesday) morning. Think the Government will still keep saying it "is contained"? I’ll laugh if they do.

Click on this link to see a video from FOX Business Channel (you have to watch a 15 second advertisement first :( )