Special Market Commentary for September 14th 2008 - Credit Crisis Deepens

The events unfolding tonight are indeed unprecedented. If you have not been following the events taking place this weekend I will summarize what we know at this time.

It is important to be mindful that these events are still unfolding. There is likely to be more announcements, speculation, and conjecture about what has happened this weekend, and what will happen going forward.

With that in mind here is what is happening right now:

• Lehman (LEH) was unable to secure a buyer of the company and it is being said that Lehman will be filing bankruptcy papers before midnight tonight.
• Bank of America (BAC) is reportedly buying Merrill Lynch (MER). The share price that has been announced is $29 p/share. There is a swirl of stories circulating this evening as to why this transaction took place and who was pushing for this to be done.
• American International Group (AIG) - news reports coming in regarding AIG are very fluid and still unfolding. What is known so far is that AIG is attempting to stave off a ratings downgrade by the ratings agencies. AIG has been attempting to sell assets or find sources of liquidity this weekend in order to keep their current rating. It is being reported that AIG may have been unsuccessful in finding capital and may be asking the Federal Reserve for bridge financing. It is not known at this time if AIG refused capital from private parties due to unacceptable terms or if private parties backed away from assisting AIG altogether.
• Tonight the Federal Reserve has announced new measures to provide additional support to the financial markets:

Release Date: September 14, 2008

For immediate release

The Federal Reserve Board on Sunday announced several initiatives to provide additional support to financial markets, including enhancements to its existing liquidity facilities.

“In close collaboration with the Treasury and the Securities and Exchange Commission, we have been in ongoing discussions with market participants, including through the weekend, to identify potential market vulnerabilities in the wake of an unwinding of a major financial institution and to consider appropriate official sector and private sector responses,” said Federal Reserve Board Chairman Ben S. Bernanke. “The steps we are announcing today, along with significant commitments from the private sector, are intended to mitigate the potential risks and disruptions to markets.”

“We have been and remain in close contact with other U.S. and international regulators, supervisory authorities, and central banks to monitor and share information on conditions in financial markets and firms around the world,” Chairman Bernanke said.

The collateral eligible to be pledged at the Primary Dealer Credit Facility (PDCF) has been broadened to closely match the types of collateral that can be pledged in the tri-party repo systems of the two major clearing banks. Previously, PDCF collateral had been limited to investment-grade debt securities.

The collateral for the Term Securities Lending Facility (TSLF) also has been expanded; eligible collateral for Schedule 2 auctions will now include all investment-grade debt securities. Previously, only Treasury securities, agency securities, and AAA-rated mortgage-backed and asset-backed securities could be pledged.

These changes represent a significant broadening in the collateral accepted under both programs and should enhance the effectiveness of these facilities in supporting the liquidity of primary dealers and financial markets more generally.

Also, Schedule 2 TSLF auctions will be conducted each week; previously, Schedule 2 auctions had been conducted every two weeks. In addition, the amounts offered under Schedule 2 auctions will be increased to a total of $150 billion, from a total of $125 billion. Amounts offered in Schedule 1 auctions will remain at a total of $50 billion. Thus, the total amount offered in the TSLF program will rise to $200 billion from $175 billion.

The Board also adopted an interim final rule that provides a temporary exception to the limitations in section 23A of the Federal Reserve Act. It allows all insured depository institutions to provide liquidity to their affiliates for assets typically funded in the tri-party repo market. This exception expires on January 30, 2009, unless extended by the Board, and is subject to various conditions to promote safety and soundness.

There are numerous details that are still not clear at the time of this writing. S&P futures trading this evening are down significantly and are still falling. The US Dollar is falling against a wide range of currencies and gold is up to $787 (closed at $768.30 on 9/12).

It should come as no surprise to our long time readers that the credit markets have deteriorated to the point of bringing down another of Wall Streets oldest firms. Lisa and I have worked diligently to keep you apprised of the economy, financial markets, and the big picture for many months.

As traders how do we handle this historic event? First and foremost; if you are new to the stock market  and have been sitting on the sidelines wondering if you should start buying stocks then this is NOT the time to begin your trading/investing endeavors. Patience is paramount at this time.

If you are already invested in the markets you must be mindful of the first rule of trading: ‘Capital preservation is priority one‘. Any long positions in equities must be monitored for stop loss threshold levels being met. We will not be averaging down any long positions. If you are already holding short positions in equities then stay put. If you are holding short positions there is nothing wrong with taking your profits off the table and then wait for the markets next move before taking new positions.

It is important to note that even the most professional traders are tonight scrambling trying to determine how to position themselves and/or how to unwind positions they already have. These are times when swing traders are best to sit on the sidelines. Only experienced day traders should be attempting to play the market tomorrow.

Our long term view of the markets remains as it has since September of 2007, ‘bearish’.

On a personal note mark this day on your calendar. If the events being reported by the press are factual and Lehman does file for bankruptcy, then this will be a historic event in the United States financial markets.

Stocks Close Higher

Yep, it was just a buying frenzy this afternoon.  Or was it?  Bids rose quite fast on low volume, then some volume came in with uncommitted shorts covering.  OK, you don’t have to agree, but that is what I saw on the tape and the charts.  We told you we would test resistance levels and we are.  It is getting a little irksome that we are doing these “tests” in record fashion, but you play what you get!  Plenty of selling into this rally, so be careful.

Earnings reports have left NTGR (Netgear) down after hours, and NTAP (Network Appliance) and VCLK (Valueclick) have guided lower.  Most of the reports are unremarkable or inline with low expectations.  BIDU earnings are out and they are good enough: Q4 $.87 v $.72 expected, revenue $78.3M.  They guided Q1 lower to $73.1M-$75.1M versus the $77.1M expected.  So far after hours trading seems to favor the upside, but it’s touch and go.

Some major shareholders are upset about the Countrywide/Bank of America (CFC/BAC) deal.  They don’t think Bank of America is paying enough for CFC.  I think they’ve already paid too much and the deal isn’t anywhere close to being closed.  But, nobody asked me.

I’m really tired of hearing how the market will climb the “wall of worry”.  I’m sure there was plenty of worry from 1929 to 1932, so check out how well that climb went.  Maybe the market just didn’t have the best belayer!  It remains to be seen if we have one now.

Monsters Under the Bed

If you read last night’s spooky Halloween commentary, you recall I said that the market was worried about monsters hiding under the bed and was afraid of more bad news coming. And today it got more of it, and the monster today was named CitiGroup (C). More bad news coming from the financial sectors is pulling our markets further and further down the rabbit hole. Ever since this credit crisis began we were warning of danger and economic problems were yet to come. I said that we had not heard the end of this, even as the many talking heads on TV said the credit crisis “was well contained and would not spread”. That is why we don’t listen to talking heads, we look at economic data, charts, market sentiment, etc. That is where you can tell if problems are brewing or not. I need to claim a little victory here only because so many have written to me and claimed that we are way too bearish on the markets and we need to ‘lighten up’. That is not our style, we never go with emotions and greed, we go with the logic, hard facts, and charts to tell us where money is going, and not going. The news out of CitiGroup today was a substantial blow to the company and to the entire financial sector as a whole. The reports coming out today with regard to their possible losses are staggering. For some time now Lisa has been talking about the commercial paper liquidity problems and that companies will have a difficult time trying to sell those notes. And that is what has happened, and it has happened in a huge fashion. And it is still not over. This has the potential to keep rippling throughout the financial companies for a very long time because the housing market and the economy are NOT improving.

I was pointing out a month ago that the markets MUST have confirmation from the DOW transportation index, as well as a strong financial sector, in order to be considered healthy and return to a bullish stance. Some even questioned my interpretation of the DOW theory, but I stood my ground and stand by that assessment for it continues to be shown correct. We are not in a bullish market, we are in a market which has moved from bullish to uncertain and scared. These are the kinds of markets which can go on for weeks, months, or even longer. But unless there is something very significant to transition it back to a healthy bull market then this is the middle point before a bear market sets in. As John Murphy, author of Technical Analysis of the Financial Markets, said tonight in his commentary that we are witnessing a market that is preparing itself for a weaker economy. And in a weaker economy you have to be very careful of the momentum stocks and take profits along the way, because just as was witnessed with Crocs (CROX), once a momentum stock has lost its drive, it is over with, and many never recover. They are hot for a while and then they blow up and that is it, they trade sideways for months or years after that. I read tonight that even Jim Cramer (Lisa and I do not listen to him or put any value in his TV show) has told his viewers that Crocs is done and he advised any of his viewers holding it to sell now. Well, if Jim Cramer has given up on a stock then I guess it really is dead now, the fat lady has sung.

Today’s selling hit the financial’s in the worst way. The losses today in the financial sector (XLF) were the worst in 4 years, even worse than the big down days when the credit crisis was unfolding. This needs to be taken notice of, as many financial institutions today have lost key technical support on the charts. Names like JP Morgan, Bank of America, and many regional bank stocks have all dropped below key levels and are extremely bearish. A healthy bull market MUST have supporting financial sector strength, otherwise the walls will collapse.

We have to concentrate on Utility, consumer staples, and metals (both common and precious) stocks, for they may be the only sectors that have any potential as a whole. Sure there will be the few momentum stocks or technology flyers here and there, but they will get softer and and harder to find if this continues. Too much emphasis is being placed on “global growth” as the sure bet. We agree that “global growth” offers companies a better playing field from which to operate a business and to sell products, but where we don’t agree is that global growth will continue if the US economic picture continues to weaken. As it has been said many times, our world is a global economy now, if one of the largest participants in that global economy continues to weaken it will spread. There is no way other countries can isolate themselves from our economic slowdown. So while global growth does give companies a bigger ball park to play in, eventually the weeds on one side of the field will spread and pocket the whole field. Think back to the movie “Caddyshack”, the gopher had a way of finding a way to go anywhere and spread destruction. You get one gopher on your golf course, then you have troubles everywhere.

We need to remain in a capital preservation mode, longer term holdings that you have need to be watched for trend line breaks and sold immediately if they fail. Preserve your money! I don’t know how to say it any stronger. In an uncertain market it is safer to play the charts and when a trend breaks you get out. Better to hold on to your money in cash than to “hope” the stock comes back one day. Why leave money in a stock that become road kill when you could have taken it out and preserved it from any more damage? It makes no sense to stay stuck in a stock once it shows signs of giving up the ghost. That is where the charts offer so much. Always remember that charts are the window for the traders and investors in that stock.  When it shows a significant shift in crowd behavior then you need to act on that. Don’t just wish for it to get better, that does not work and shows you do not have control over your financial situation. Wishing and hoping are for dreams, not stock investing and trading.

Tomorrow we may see a technical bounce, not for any substantial reason, but only as technical traders take advantage of scalp trades. We will get the monthly unemployment data tomorrow and it will be the key to the moves the market makes tomorrow. It is a toss up which way the market will react in the short term, but if the unemployment data plots another dot on the slow down of the economy then we have one more piece of data that is pushing the market toward bear country. If the data is good, then we will have a “relief rally”, but what follows a relief rally is usually high amounts of selling into the strength again by large holders. When the markets were heading down in August, before the extent of the credit crisis was fully acknowledged or understood by many, I saw very large amounts of insider buys taking place as documented on the SEC Form 4 filings. All during the time when stock market talking heads were saying that this was just a simple market correction back in August there were hundreds of SEC 4 filings each day of board members, CEO’s, and other’s making buys on their company stock. Guess what, that has turned, now it is selling that is being seen. And over the last few weeks there have been only a handful of SEC 4 buy filings transacted. Now even they are afraid of what is happening and are no longer bullish and buying on the dips anymore. Now they are sellers.

Below you will find some charts that I chose to show, two are financial companies, and the last one is for Chiquita Brands (the banana grower) (CQB). This company will make its way to our swing trade potential list. It has some good fundamentals along with a chart formation that is setting up nicely. But it needs to break above resistance before we would buy it. It will be included in the next swing trade guide.

We must see what tomorrow brings, but some things are certain, another CEO is now likely to be on the unemployment line (CEO of CitiGroup), new layoffs are coming in the financial companies, more layoffs from the auto makers will come, and there ARE monsters under the bed !