Rebel Traders – Analysis Without The Hype

From MarketWatch.com on March 8th 2008

FBI probes Countrywide for possible fraud: report

Proof of collusion could scuttle Bank of America deal

By Riley McDermid, MarketWatch

Last update: 10:25 a.m. EST March 8, 2008

NEW YORK (MarketWatch) — Besieged subprime lender Countrywide Financial Corp. is being investigated by the Federal Bureau of Investigation for possible securities fraud, according to a news report Saturday.

The Wall Street Journal report said the probe focuses on whether Countrywide’s management misrepresented the quality of its mortgages in routine securities filings, which may have led investors to overvalue the loans it then securitized into more than $100 billion worth investment vehicles between 2004 and 2007.

Banks and lenders lost billions of dollars over bad bets on mortgage-backed securities and analysts estimate they will continue to stanch the bleeding well into 2008.

The FBI inquiry will also take a closer look at how common fraud was in Countrywide’s origination process, the report quoted unnamed sources as saying. The agency is currently investigating more than a dozen subprime lenders about their origination and securitization processes and possible conflicts of interest between the lenders and Wall Street.

CountryWide said it had not been informed of any ongoing inquiry.

"We are not aware of an investigation being conducted by the FBI," Countrywide spokeswoman Jumana Bauwens told the newspaper.

The Calabasas, Calif-based lender is already facing multiple lawsuits in several states regarding its origination and foreclosure policies. A separate class action lawsuit filed by a consortium of government pension funds has accused Countrywide of behavior similar to that reportedly being investigated by the FBI.

A filing in that lawsuit says the lender "misled investors by falsely representing that Countrywide had strict and selective underwriting and loan origination practices, ample liquidity that would not be jeopardized by negative changes in the credit and housing markets, and a conservative approach that set it apart from other mortgage lenders."

Countrywide was also being investigated by the Securities and Exchange Commission for allegedly improper accounting.

Problems would hit merger

If the FBI does find Countrywide misled investors, it could scuttle a planned $4 billion acquisition of the lender by Bank of America, slated to be completed in the third quarter.

Although Bank of America  has repeatedly said it has priced in the lender’s financial woes and potential legal troubles, proof of a management plan to overstate the value of Countrywide could mean all bets are off.

Bank of America reiterated earlier this week that the deal was still on. The bank declined to comment to the Wall Street Journal.

Riley McDermid is a MarketWatch reporter based in New York.

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.

The Dow and S&P closed in positive territory, but the Nasdaq couldn’t hold on to any gains.  In spite of the 133 point gain on the Dow, the market just wasn’t  "strong" today.  There was plenty of selling on the rallies.

Citigroup (C) plans to inject $3.3B in capital to support six of seven SIV’s it took back on it’s balance sheet last year.  They are trying to maintain their credit ratings.  The SIV’s assets total around $49B.

Fitch not only downgraded Ambac (ABK), but now they’ve downgraded 46 classes of RMBS (residential mortgage-backed securities).

A judge has denied Countrywide’s (CFC) appeal of the bankruptcy court’s order allowing an investigation into how the company calculated proof of claims on consumer bankruptcies.  This has been an ongoing affair.  Legg Mason is a major shareholder in CFC and is reportedly unhappy about the Bank of America/Countrywide merger.  It remains to be seen if he will fight this.

This isn’t earth-shattering, market-moving news, but watch for more of this type of action in other companies:  Bryn Mawr Bank (BMTC) announces their plan to freeze their pension plan as of March 31,2008.  They will close the plan to future employees and discontinue future benefit accruals for current employees.  No employee will lose previously earned benefits.  However, the company announced that in addition to the existing dollar for dollar company match on the first 3% of base salary, the Bank will make an additional, fully vested discretionary contribution of 3% of employees’ base salary into their 401(k) accounts without regard to the employee deferral contributions.

The markets closed in the red after a crazy short week.  Next week the big drug makers report earnings and potential market moving economic data will help make next week interesting again.  The XLF (Financial ETF) was unable to break 28.00, closing at 27.20.  Noticed that even Microsoft (MSFT) couldn’t hold that spike up on earnings and closed down 0.93% on the day.

New York City Comptroller is suing 26 financial firms that underwrote Countrywide (CFC) stock and bonds.  Also suing more CFC officers and global accounting firms.  Citigroup (C), JP Morgan (JPM),  Goldman Sachs (GS), KPMG accounting and Grant Thornton are among those named in the class action suit.

Treasury Secretary Paulson says the stimulus package may help create 500,000 jobs this year and that checks may be mailed 2 months after legislation is enacted.  Tax rebate checks are going to help create 500,000 jobs?  Someone want to explain that to me?

Caterpillar’s CEO says he expects to see record results again in 2008 and sees top line sales to be above $50B in 2010.  He expects his company’s softer markets to bottom in 2008 and that any U.S. recession will be short-lived.  Wait a minute!  Isn’t this the same guy that was wailing away last quarter that the U.S. was looking at economic conditions not seen since the Great Depression?  Guess he finally got the memo to knock off all that negative talk.

There will be more commentary and charts later and over the weekend. 

Over the past week we have received requests for some individual stock analysis. In tonight’s post I will address these individual stocks/ETF’ questions.

The first stock is that of Mattel, Inc. (MAT). And this analysis is based on a long term investment. As we all know the toy industry has had a rough patch of time with the Chinese toy recalls over the past year, Mattel has not escaped this problem and it is reflected in their stock price as Mattel has lost approximately 35% of it stock value from the recent high in April 2007. The chart analysis is a very interesting one, there are multiple scenarios at play and I will discuss each one.

• The monthly chart for Mattel shows a nice symmetrical triangle pattern in development since 2000. Symmetrical patterns can resolve to either side over time, it is essentially a 50/50 chance of a failure of the pattern and a drop below, and a roughly equal chance of an upside resolution. Examine the chart shown below, notice the triangle pattern as shown with the black lines drawn below and above price patterns. Also notice the blue box drawn in the center of this triangle, this is a strong support zone. At this time Mattel is trading right at that price support zone. To use this current support as an entry for a long term investment has the risk of failing this support zone and falling to the lower triangle support. So buying at this price is technically a sound idea with the caveat that it could still go lower to the lower support line. And because this is a symmetrical triangle one has to keep in mind that it could fail the lower line, and if that happens then Mattel will be on a new downward path for a long time. Entering at this current price level offers a good price entry with higher risks involved.
• The second investing scenario would be to wait and see if Mattel does pull back further to the lower support line, and then if it consolidates at that price region then that would be a lower risk entry. Why lower risk? Because the lower triangle support line provides an excellent stop loss point to use as exit criteria, for if the price fails the lower line then it will be a significant trend change for the worse and you would want to exit the trade. It also offers the best reward potential as the entry would be on the lower support price level.
• The third and last scenario for considering Mattel as a long term investment would be to wait for an upside resolution to this triangle pattern. If the price breaks above the pattern that has been developing over the past almost 8 years, that would signal a new shift in investor psychology on Mattel and would be the start of a new up side pattern development. The risk of entering this stock on the upside break out of the triangle pattern is lower but the reward is also lowered due to the higher price entry.

Now when you add in the current economic conditions, we would tend to think that there is a higher chance of this stock failing the support price range it is currently trading at. Any more news of toy recalls, decreased sales (especially this Christmas), or more general economic data showing a slowing economy would impact Mattel. So there is the potential for Mattel to fail the current support zone and head down to the lower triangle price support. If it were not for the current economic conditions, I would use this current support pattern to scale into Mattel, but the economy and the declining retail sector concerns me. My risk tolerance would have me wait for a pullback to the lower triangle line or the break above the upper triangle line for a long term investment entry.

The next stock is CountryWide Financial (CFC). Someone asked if this would be an opportunity to get in cheaply. Lisa and I discussed this and we both share the same view, and that is the risk is too high. The sell off in CountryWide stock is not due to normal seasonal conditions, or a slight miss on earnings, or a slightly soft housing market. The sell off has been unprecedented in terms of volume and intensity. We feel Countrywide (CFC) offers day trading opportunities only at this time, over the longer term there is still a high risk of CFC shares going lower still. There is still speculation by well respected analysts that CFC could end up out of business in the future. So with CFC we say "no" to a long term investment, the reward potential is high, but the risk is even higher.

Next question was on ETF’s (IAK) and (PEY). IAK is a fund that seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the Dow Jones U.S. Insurance Index. The Index measures the performance of the insurance sector of the U.S. equity market. This fund became active in early 2003 so there is not much in the way of long term price history to draw any conclusions from. However, based on the insurance sector stocks themselves, there has been a general down trend since the middle of last year. We don’t recommend this ETF for a long term investment.

PEY is a fund that seeks investment results that correspond to the price and yield of a index called the Dividend Achievers(TM) 50 Index. The Fund seeks to achieve this by investing at least 90% of its total assets in stocks selected on the basis of dividend yield and consistent growth in dividends. While we like the investment strategy that the fund manager has chosen, we are again left with little price history from which to work with, this fund became active in late 2004. With the little price history there is, the current pattern looks bad. In general, Lisa and I do not favor ETF’s as long term investments due to the fees involved. We do like them for short term trades to capture some large moves in a relativity short period of time, for example, our play on the GOLD price tracking ETF (GLD). That play yielded us a 20% profit in 3 months.

In summary, we would prefer selecting individual stocks from each of the sectors that the ETF’s track for long term investments, and not an ETF itself. For the insurance industry, we don’t like this sector for the short or long term as this point. As for stocks with consistent growth, many of which reside on the S&P 500, we want to wait until the current economic conditions and credit crisis is behind us before getting to heavily invested in companies for a long term investment. Many prices ‘look’ cheap right now, but they could easily become even cheaper later.

Another question is on Apple (AAPL) and our thoughts on earnings in January 2008. It is our current believe that Apple is over valued and the price momentum has been largely a result of the large popularity of this company. The expectations of the iPhone and their iMac sales are hugely over rated when compared to the PC sales from such names as Dell and HP who have a much higher market share. When a stock becomes a ‘momentum’ stock, it is bid up much higher than reality would normally dictate. Apple has a P/E of 42.25 (at the current price level), where the industry that Apple trades in has a P/E ratio average of 34.94. This would put Apple higher than it’s peers, of course some of the higher price is based on a very well run company, which Apple is. But the price of the stock does not always track the performance of the company financial’s, instead they follow the hype and growth expectations (even if they are over inflated). When the Nasdaq took the hit over the past two weeks Apple has pulled back and so far is hesitant about being bid up anymore. The projections of a subdued retail sales season would have a substantial impact on Apple if their reported sales takes even a minor hit. The expectations of Apple’s performance are being held too high. And if the projections of a bad Christmas shopping season materialize it would be reflected in their next earnings period and the stock would most likely suffer severely. We would be inclined to wait out any retail stock (even though Apple is a technology industry company, their sales are mostly retail dependent) as the economy and falling retail sector stocks are not showing a reversal yet.

The next question is a broader question, it pertains to the price of oil. Some would say that oil has reached a top while others say there is still more room to move up. When gauging commodities prices, some analysts use inflation adjusted data for determining the current value of a commodity. While that analysis methodology is useful from a point of reference (i.e. historical value), it serves no purpose on the actual technical analysis of the charts and the potential of upward or downward potential. We view oil in a healthy up trend that has been in force close to 9 years. The only way we would claim oil was going to be in trouble (speaking of the trend) is if we saw a trend break. Currently, crude oil has a strong support zone in the $75 to $85 range. If oil remains above that price support, then the up trend of oil remains in tact. The fact that we have pulled back slightly from the near $100 price level is of little significance to us. Oil remains on an upward price trend, and only a break below $75 would we see the potential for a shift in that trend.

Another question is concerning buying ‘puts’  (options trading) on some sectors by buying options in ETF’s. First, not all ETF’s are able to be "optioned", and those that are it is our opinion that trying to capitalize on the current volatility in the financial and retail sectors, and their impact on the overall markets is too risky. The chances of gap ups and gap downs within these sectors could be too costly for an options holder. Lisa and I are not day to day options traders, we prefer the stocks over the options, less risk. We will use options in complex trade scenarios where we want to balance our risks on long term investments. But we need to say that absolutely no one should play with options at all unless they have already obtained a steady profit from swing trading over time. If you are struggling with your stock trades, do NOT think that options will be your savior. On the contrary, options more often wipe out the equity of traders who are not already taking profits out of stocks. Stick with the stocks, taste great, less risk. And 4 out of 5 dentists recommend stocks over options.    Ok, a little humor.

Another question is on Garmin (GRMN). The market would not have liked it if Garmin acquired Tel Atlas because the price was too high. The view is the acquisition would have diluted GRMN earnings too much for years to come. The stock price of GRMN gapped up on some upgrades on Friday morning and due to the upgrades the shorts in the stock had to cover. This sent the price up substantially on Friday in pre market, but the upward price gap provided additional opportunities for more people to sell out. In the first 1/2 hour of trading GRMN sold off on high volume. This shows that there were more people wanting to get out then wanting to get in. the chart shown below is an intra day chart of GRMN from Friday (November 16th). Notice the intense selling out in the first 1/2 hour and then throughout the remainder of the day the money flow continued to weaken. This chart patterns reveals the real dynamics of the stock where the gap up was a short covering rally and once the market was open the smart money was cashing out. If there was a genuine belief that GRMN would go higher then we would not have witnessed so much selling immediately after the market opened. Garmin, like many stocks trading on the NasDaq or otherwise considered a "tech" stock are off limits for now. Too much uncertainty surrounding the roll over we saw in many of the momentum stocks. Garmin has been one of those highly speculative momentum stocks. If you are considering Garmin as a long term investment we would prefer waiting for the price to drop to trend support ($70.00). That would provide a lower risk entry for a long term play on Garmin. Grabbing share at this time is too high of a risk to reward ratio.

Another question was on SalesForce (CRM). Last week CRM issued quarterly earnings, they beat the current quarter estimated revenues and issued an "in line" forward guidance for FY2008, for FY2009 they lowered their revenue expectations. Heading into the earnings announcement CRM had a large short interest as the expectations among the street was for a worse than expected quarter. With the beat on current revenues expectations and an "in line" FY ‘08 the shorts had to cover (the majority of shorts on any stock are short term trades) and propelled the share price up almost 13% on Friday. But it stopped right at resistance. We would expect to see CRM trade lower in the coming days, a good entry on CRM would be on the ‘break’ above resistance. CRM is a difficult trade with the lower FY2009 revenue expectations that the company announced. Lowering forward guidance a year or two ahead shows that the company has reached "saturation" within it business space. I would be willing to say that CRM will trade sideways or down over the coming months.

Well, that wraps up the questions we have received over the past few days. We hope we have not missed any. What I decided to do is set up a new email address that both Lisa and I will be able to access. And the email address will be for asking questions on stocks, sectors, etc.. That new email address is: questions@rebeltraders.net

Once the full RebelTraders web site is operational there will be a message forum where anyone will be able to post questions and even discuss among yourselves your trading ideas and get to know the other readers and subscribers of our service!