Rebel Traders – Analysis Without The Hype

A surprise announcement from Microsoft (MSFT) who was originally scheduled to release earnings after the close today.

Microsoft (MSFT):

Commentary & Charts…

Existing home sales data this morning showed an 8.6% drop from the previous month. This was the largest monthly drop yet. And with the issuance of any economic data there is always many different interpretations of the data. Some say that with the recently falling mortgage rates it will quickly turn the housing market around. Some say the ‘bottom is in’, and some say it shows that sales are getting even worse.

The problem I see with the theory of ‘the bottom is in’ is that it needs banks to lend at the pace they were before the housing market collapsed. And banks are not lending like they used to, and are likely not too for a very long time to come (hopefully never, for that is what contributed to this disaster in the first place).

The attempt by the Government to ’stabilize’ housing prices by trying to lower mortgage rates will be a short lived spike in the housing market as I see it. They are simply trying to keep blowing air into the already collapsing housing bubble. The only way the housing market will stabilize is to allow them to decline to their historical averages, without intervention. I have said on numerous occasions, the system needs to flush itself out.

The reason I see any spike in the housing market being short lived is that it requires people to have jobs in order to obtain mortgages. I foresee the unemployment situation worsening at an even faster pace in early 2009. Following the holiday retail shopping season I expect to see a large number of retail sector job losses, and bankruptcy filings among retail companies. And then as the economy continues to worsen it will impact State and Local Governments at an escalating pace which will begin the next wave of job cuts. A vicious cycle it is. Attempts to ‘prop up’ the housing market will fail.

I don’t see any ‘easy’ way out of the housing market collapse except to let natural price discovery processes be allowed to dictate the markets stabilization over time.

Charts…

On the S&P 500 E-Mini futures (hourly chart) we are clearly under the up trend that began with the November lows. But, we are still sandwiched in between a lot of support and resistance levels in the short term. The break of the trend line (beginning point 11/21/08) is giving the bulls some fear that the lows of November may come back again sooner than expected.

(read more…)

Today’s movements in the market was very erratic, confusion in the market was quite evident. Strong selling volume right after the opening bell with a quick short covering rally that only took 10 minutes to get underway. That took the S&P back up to where the market opened by around 11:00am. From there we saw a steady flow of selling which took us down to new intra day lows around 12:30pm. That is where the ‘confusion factor’ really picked up in intensity. The remainder of the day it became a battle of those who are betting that the Federal Reserve will cure all ailments and we have only one direction to go, up. And then there were those who kept selling right alongside those who were trying to rally the market upwards.

Insanity in the market is prevalent everywhere one looks, and I have to say this "thank goodness I have access to the Bloomberg Financial channel", for CNBC has become so lame in their coverage of events that it is sickening. Their floor walkers continue to transverse the aisles of the NYSE talking about how "resilient" the market is, or that "the bottom is in". They are feeding the hunger of those retail traders / investors just waiting for someone to tell them it is time to start buying. I assure you that the smart money managers in the world do NOT listen to what is said on CNBC. CNBC is solely geared to the retail money and it is retail money that has yet to completely acknowledge the gravity of the situation at hand.

I said that people are expecting the Federal Reserve to cure all ailments. The situation with Bear Stearns over the weekend was a surgical removal of a cancerous tumor by Dr. Ben Bernanke and his trusty nurse Hank Paulson Ratchet (for our foreign readers, definition of what nurse ratchet means). Lets make sure we make an important distinction here, when we refer to the ‘financial system’ we are talking about the backbone of our economy which is the exchange of money from one bank to another, the flow of credit, etc. When we refer to ‘the markets’ we are discussing the stock market and the trading of equities. We all know by now that the health of the economy and in turn the financial system has been deteriorating. The US financial system has cancer and it is spreading. Bear Stearns’ implosion represented a large cancerous tumor that was about to explode and spread sepsis throughout the entire financial system unless it was surgically removed right away. Banks and other financial institutions are growing tumors within the entire system, threatening the life of the financial system. The US Government has been trying to cure the cancer by treating the symptoms and not the disease. The constant rate cutting by the Federal Reserve makes the market feel all warm and cozy for a short time before the pain starts up again, and then it wants even more. All the while the cancer that has been working its way through the body of the financial system has been growing.

Bear Stearns was a cancerous tumor that was about to spread a life killing toxin throughout the system and it had to be removed. So with the help of the the JP Morgan surgical center, Dr. Bernanke and his nurse Hank Paulson Ratchet, performed a swift removal of the tumor before it could infect the rest of the body any further. Instead of practicing preventative medicine from the beginning of this crisis the Dr.s have only been doing pain control and the occasional tumor removal in order to sustain life, albeit on life support that it is.

What happened to Bear Stearns should have never had to happen, if only the Government had been responsive to this situation early on instead of constantly saying that everything was fine with the economy it would have never gotten this far and this bad. Eight thousand employees of Bear Stearns are now going to be unemployed because of the inactions by the Government. Don’t get me wrong here, Bear Stearns deserves plenty of credit for their own demise as well as they needed to tell the truth of their condition. They have been hiding behind level 3 assets for so long that when JP Morgan went into Bear Stearns HQ over the weekend to do the due diligence they found the situation so bad that they felt the company was only worth $2.00 per share. Two bucks! Do you see the gravity of this? A company that had been telling the world they had good cash flow, healthy liquidity, and so on was now worth only $240 million dollars when it was discovered just how much toxic paper they were keeping hidden in the closets. If every financial institution (bank, brokerage, investment house, hedge fund, etc) were to bring their level 3 assets out of the basement and put a value on them at current market rates then the earning of the those companies would nose dive instantly. These financial institutions are playing a shell game with what they are leveraged to and to what extent!

The only reason Bear Stearns got in trouble was that they could not contain the losses and they had to call the Doctor. Instead of revealing to the public (and they were a public company) what their problems were, they lied to their shareholders and the general public. And then secretly went to Bernanke for help. All the while screwing the average share holder of the stock.

Now what happens? How many operating room ‘tumor removals’ will Dr. Ben and Nurse Hank Paulson Ratchet be able to keep doing in the name of keeping the financial system on life support? The housing market and home values will not be cured by rate cuts, consumer spending will not be cured by rate cuts, and the $600 check being mailed out to everyone shortly will be used for paying debt and not used to buy the latest iPod. The average American is hurting badly, the cost of living has increased materially over the past 18 months. More rate cuts may ease the pain in the financial system, but it will increase the pain on the average American. No matter what they do at this point it seems as if the Doctors have a terminally ill patient and it is only a ‘pain management’ issue at this point.

Tomorrow the markets will find out how big of a morphine injection the Doctor will be giving. Ahhh, the euphoria of morphine… but when it wears off we are still in a recession and in a bear market.

We remain short the Dow Jones Industrials (our entry was 12750). We are holding this short position unless our stop loss (break even) closes the trade. We are still in a bear market until proven otherwise.

Charts:

(S&P 500 Technical analysis – Daily Chart)

(Nasdaq technical analysis – weekly chart)

(Financial sector ETF technical analysis – daily chart)

Yesterday’s market rally has appeared to quickly run adrift. When the news from the Federal Reserve was issued yesterday the US dollar quickly gained some upside moves. But overnight the dollar headed back down again. If we use the US dollar as a measure of confidence in the US economy then we can safely say this morning that confidence quickly wore out after yesterday’s excitement.

The health care sector is being hit hard today as the rising cost of health costs are actually hurting the earnings of the major health insurance companies. So why the surprise drop in earnings of the health insurance companies? Loss of jobs and the subsequent loss of insurance premiums and what is very concerning is that people are actually putting off some of their health needs in order to pay other bills.

Housing market problems… best to just let the CEO of Freddie Mac speak for us this morning:

Freddie Mac CEO: We are in a 100-year storm in the housing market; "Worst housing market in a century" the CEO said at an analyst meeting.

- Says home price drops are only about one-third over.

The number of mortgage applications have rolled back over and are back on a negative trail.

MBA MORTGAGE APPLICATIONS W/E MAR 7TH: -1.9% V +3.0% PRIOR
- Refinance  -4.7% to 2448.2

Today’s market activity was essentially a "play day" of retail money. What I mean by this is that we did not see much evidence of any significant block trades or other high dollar value trades going through the tape. The commodity stocks brought retail money out of the woodwork as a way to get in on something that is going up. We can’t argue the fact that commodity prices are going up, it is what is partly responsible for our run away inflation now. But even with commodity prices rising there is still caution that is required. For a lot of the commodity stocks we have been watching we are seeing mostly retail money (by analyzing share lot sizes on the tape). Now of course there is some larger money in there as well taking positions but experience has shown us over the years that the larger trades are hedge funds and other large money players who are playing on the exuberance of the sector to only cash out once the ride is over then leaving the retail trader left with the bag.

For the most part those with the big money have already taken their position on the stock market playing field. They are either in cash, short the market, long the market, or (most likely) a combination of all three. Volume has been drying up somewhat lately from our analysis. This tells us that we are in a ‘quiet before the storm’. Time will tell, it all comes down to economic data now, FOMC actions, and major corporate events.

Today we actually did have some ominous events but for the most part the smart money is already expecting these events and are just riding out their positions. It is the surprise bad news that will bring volume levels back up and start the selling in force again. This morning we got the ISM Purchasing Managers Index data for February and it has contracted into the negative growth column. A reading below 50 is considered recessionary. The top line number was 48.3, employment showed a larger decline,  and new orders is also maintaining a down ward path.

The chart below is a 10 year chart of the ISM index. Observe the trend has been declining since 2003.

(ISM | Data Source Moody’s Economy.com)

Also of note today was the construction spending data issued by the U.S. Census Bureau. This is more alarming in that the trend reveals to us a very deep retraction in construction. This will come as no surprise to our long time readers as we have been discussing this index for many months. But with each passing month the trend reveals that conditions are indeed getting worse. The first chart below is construction spending as measured in US Dollars. The 15 year chart shows the recession in 2000 / 2001 with a leveling off of construction spending. And then in 2002 the spending started to increase again. But our current situation reveals an even more alarming pattern in that spending in contracting in a fashion not witnessed before.

(Construction Spending $US | Data source Moody’s Economy.com)

The next chart is also that of the construction spending data but presented in terms of year over year % change. This chart makes it even more clear just how much construction has contracted over the past 2 years.

(Construction Spending Y/Y% delta | Data source Moody’s Economy.com)

In the raw data we are able to see that non residential construction (commercial construction) is starting to show weakness. Commercial real estate and construction will be the next victim of the economy and credit implosion.

Last night I showed you a chart of the S&P 500 with our technical analysis applied. We pointed out the failure of the triangle pattern on the daily chart and some resistance directly below. Today the market traded in a narrow range just at the support line. We don’t see this support level being able to hold once selling volume resumes and is why we are still maintaining our short position on the market. An updated chart is shown below.

(S&P 500 Daily chart)

One the the weakest sectors today was technology. The Nasdaq was the weakest of the three major indices with such names as Apple (AAPL) and Research in Motion (RIMM) adding to the declines in the Nasdaq. Any stock with an elevated P/E ratio is being chopped down to size. Always remember that in a healthy bull market stocks can survive with elevated P/E ratios, but in times of economic trouble high P/E’s are a death sentence for a stock. This is why we were warning last year about our readers taking their profits out of Apple because we saw what was coming. History repeats itself over and over again when it comes to stocks that are bought up on hype, speculation, and hope. Apple (AAPL) was no different, it was a stock that ‘everybody’ had to own as everyone in the media hyped it as the best thing since the invention of bread. Stocks like that are great for a short ride, but not a long term investment. You have to know when to take your profit and move on for once a high P/E stock has been chopped down it usually never obtains those levels again. All one has to do for evidence of this is go back to the tech bubble of 1999 and 2000 to see that. There are still many stocks on the Nasdaq with high multiples and this adds to our concern of the Nasdaq bringing the markets down much further.

The next section of tonight’s commentary deals with one stock. Converted Organics (COIN). One of our readers had asked for a chart analysis of this company and I decided to go a bit further and go into some of the fundamentals of this company as well. Converted Organics is a company that is still in it’s development stage. They have yet to show a profit and they are currently in a negative EPS situation. This company has caught some attention recently as there is some speculation that Dennis Gartman (a highly respected market analyst) has indicated that Converted Organics showed some promise (we have not seen proof of this claim). Aside from the speculation that Dennis Gartman either owns shares in this company, or merely mentioned it as a possible bright spot in the field of agriculture if it is true is not enough to justify the current price. What has driven up the price so much is that this company has been picked up by some stock picking web sites that specialize in ‘pumping’ stocks. There is an enormous amount of stock pumping taken place with this company at this time. And the share structure for COIN is such that it is a stock that can be easily manipulated.

(COIN – Share Structure)

Observe that COIN only has a share float of 4.2 million shares. This is a dangerously small amount, and the short interest is also rising. We can’t speculate on the claims of Dennis Gartman’s involvement (or non involvement) for we can not locate any proof to support either case. But regardless of that, one needs to exercise extreme caution on this stock and should be taking profits to be on the safe side. A stock with this small of a float can quickly lose 50% of its value in one day of trading. Also of note is that Converted Organics is late in filing their current quarter earnings which should have been released a few weeks ago. Not uncommon for small development stage companies to be late with earnings reports but it should always raise an eyebrow when they are not on time. We are not recommending this company for a buy or sell, we are simply pointing out the facts as they stand currently. We have no position in this company, long or short.

The chart below shows Converted Organics’s (COIN) earnings history

(COIN – Earnings history)

Ben Bernanke Speaks…

Some snips of Ben’s testimony today before the US House of Representatives Financial Services Committee. (Bens comments are shown in red text)

The economic situation has become distinctly less favorable since the time of our July report.  Strains in financial markets, which first became evident late last summer, have persisted; and pressures on bank capital and the continued poor functioning of markets for securitized credit have led to tighter credit conditions for many households and businesses.  The growth of real gross domestic product (GDP) held up well through the third quarter despite the financial turmoil, but it has since slowed sharply.  Labor market conditions have similarly softened, as job creation has slowed and the unemployment rate–at 4.9 percent in January–has moved up somewhat

He says that unemployment has ‘moved up somewhat’. This morning we received data on what is called the "mass layoff index". It is an index which is not publicized very often and most people don’t know about it. But it is issued each month by the US Department of Labor and it tracks the number of ‘events’ of any mass lay off. When a company lays off more than 50 of its workers in a single shot it is referred to as an ‘event’, and the number of events is tracked by the Department of Labor. The chart below shows the trend of mass layoffs in the United States. Observe how the trend has been increasing since early 2006. From this we can clearly see the unemployment trend is getting worse. Back in December I projected the US employment rate will reach 5.5% by March or April. This data, which is seldom published in the media, is one indicator I use to predict where unemployment is heading. In January 2008 the hardest hit sector of layoffs was in retail and construction, no surprise there!

(Mass Layoff Events – as of 2/27/2008 | Data Source: Moody’s Economy.com)

Consumer spending continued to increase at a solid pace through much of the second half of 2007, despite the problems in the housing market, but it appears to have slowed significantly toward the end of the year.  The jump in the price of imported energy, which eroded real incomes and wages, likely contributed to the slowdown in spending, as did the declines in household wealth associated with the weakness in house prices and equity prices.  Slowing job creation is yet another potential drag on household spending, as gains in payroll employment averaged little more than 40,000 per month during the three months ending in January, compared with an average increase of almost 100,000 per month over the previous three months.  However, the recently enacted fiscal stimulus package should provide some support for household spending during the second half of this year and into next year.

Ben states that the $160 Billion dollar economic stimulus package will add support for spending in the second half of this year. Got a surprise for you Ben.. Most people will not go out and buy TV’s and iPods. A Bloomberg / LA Times poll released today shows that only 18% of those asked plan to use the money on discretionary purchases, the rest will be saved or otherwise set aside. Only 18%, I don’t think that will do much for the economy Ben. The Bloomberg / LA Times poll is not the only one to come up with figures like these. In another poll taken last month by the Associated Press the data was similar:

An Associated Press-Ipsos poll found that only 19 percent of those surveyed said they planned to spend their rebate checks. Forty-five percent said they would pay bills, while 32 percent said they planned to invest the money

So Ben… don’t go counting on that $160 Billion dollars to save the economy. 

The risks to this outlook remain to the downside.  The risks include the possibilities that the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further

Ben.. you need to read our site from time to time. We will tell you what is happening. The "Hope Now" plan that was put in place back in October 2007 gave a momentary boost to those people looking to refinance their homes, but that has very quickly burned out. And the amount of new mortgages being applied for continues to drop. The chart below shows the refinance applications and the new applications. Both are heading back down. A clear sign that the housing market continues to suffer badly and that "hope now" has failed.

(MBA Mortgage Applications | Data Source Moody’s Economy.com)

The next chart is also with data that was updated today. It is the new home sales data that is provided by the US Census Bureau, and from this chart we can see that the housing market continues to decline sharply with no signs of any improvement yet.

(New Home Sales | Data Source Moody’s Economy.com)

In summary, Ben Bernanke’s testimony today before the House of Representatives told us that the Federal Reserve is ready and willing to keep cutting interest rates, even in the face of rising inflation. Without him saying so it is obvious to us that the Federal Reserve is deeply concerned about a financial system collapse and that trumps anything else at the moment, and it should. But rate cuts are likely not going to save the financial system from a collapse if conditions continue to worsen. It will require something much more, something even greater than ever enacted or put into place. This is a time for some well thought out plans and not just cutting interest rates which run the risk of influencing inflation further and sending the country into an even deeper recession as the cost of living become unmanageable.

The credit crisis continues to deteriorate, it is that simple. So far the rate cuts, the "hope now" alliance, and the new "project Lifeline" have done nothing to solve the problems, they have simply made the average person think that something is being done. The risks to the US economy remain very high for a substantial decline. Yesterday, Nouriel Roubini, Professor of Economics at the New York University who is a very well known and respected economist submitted a written testimony to the House of Representatives. The media failed to cover this or even mention anything about it. But Mr. Roubini laid out before the House of Representatives the real risks to our financial system. His testimony is a must read for everyone. You can read his testimony on the House of Representatives website by clicking HERE. (the file is requires you to have Adobe Acrobat reader installed to read the PDF file). I encourage everyone to read his testimony.

Currency rates in numerous countries continues to rise with respect to our US Dollar. This is great news for foreign tourists that visit our country, but it is bad for those of us that live here. The US Dollar hit another all time low today of 74.09. Oil is remaining at the $100 level and gasoline prices are starting to climb once again. My local gas station (petrol station for our English readers) has increased the price of a gallon of gas by $0.20 in just the past 13 days. Historically the price of gasoline increases with the Spring and Summer seasons as demand increases. I anticipate that $4.00 gasoline will be here sometime in 2008.

Some news items on the wires tonight:

-Japan’s production falls 2% in January, twice the expected amount as shipments to the United States have declined for the 5th month. The weakening economy is impacting foreign markets as the United States is the largest customer of foreign good for many emerging markets.

-In the first 2 months of 2008 $21 Billion Dollars in new IPO’s have been canceled… this is the highest ever on record.

FIXED INCOME: WSJ NOTES THAT NOW VARIABLE-RATE DEMAND NOTES ARE PRESENTING PROBLEMS TO MUNICIPAL BORROWERS
- Variable-rate demand notes let issuers borrow for long periods, but at short-term rates.
- The problem with variable-rate demand notes its that,like auction-rate securities, interest payments adjust on a weekly or daily basis.
- WSJ notes that rates on variable-rate demand notes are rising because dealers are having trouble selling this type of debt.

THE U.S. SUBPRIME CRISIS HAS DONE WHAT OTHER UNSETTLING EVENTS COULD NOT DO – CURB THE APPETITE OF FOREIGN INVESTORS FOR U.S. SECURITIES – JOE QUINLAN AT BANK OF AMERICA
- Capital inflows "basically collapsed over the second half of last year," when subprime problems "bubbled to the surface." He notes foreign purchases of U.S. securities fell more than 48% in 2H07.
- "A crumbling infrastructure, a government deep in debt, a brewing health care crisis" and continuing reliance on foreign oil all point to weaker capital flows ahead. That "could spell more trouble for the world’s largest debtor nation and for U.S. financial markets."

(UK) FINANCIALS: WSJ REPORTS THAT LONDON-BASED HEDGE FUND RICHMOND CAPITAL LOST ABOUT 50% OF ITS FUNDS IN JAN
- As of Dec 2007, the fund had €350M of assets.
- The fund follows a long/short equity strategy.

Sphere: Related Content

The big even in the overnight hours was the continued decline of the US Dollar. At 4:07am (US EST) the US Dollar hit a new low of $74.22. Since that time corporate events have continued to deteriorate the pre market futures. The biggest is the earnings from Fannie Mae (FNM) released a short time ago (see Lisa’s post earlier). Also we have bad news on the biotechnology front with Amgen (AMGN) and Johnson & Johnson (JNJ) having received data that one of their prize drugs used to treat anemia may be increasing the risk of blood clots and even death.

This morning we received the Durable Goods Orders data (Durable goods are industrial products with an expected life of one year or more. They include intermediate goods, such as steel, lumber and electronic components; finished industrial machinery and equipment; and finished consumer durable goods, such as furniture, autos and TVs.). The data this morning showed a decline of 5.3% for January. We have been watching this data over the past year and we identified the down ward trend long ago, this new data adds to the trend down ward (chart will be in tonight’s commentary).

At 10:00am we will also get the Mass Layoffs data, this data, which is usually not talked about much in the media is tracked by us as it provides an early look into the unemployment rate.

And Ben Bernanke will be talking today as well… grab some coffee and a bag of pop corn for the show.

In 1959 a television show began airing in the United States called the Twilight Zone, this very popular and highly acclaimed series was a combination of science fiction, fantasy, and horror all wrapped up in one 30 minute story, which most always concluded with an unexpected twist. Today whenever we think of something very strange we think of the Twilight Zone…

There is a fifth dimension beyond that which is known to man.
It is a dimension as vast as space and timeless as infinity.
It is the middle ground between light and shadow,
between science and superstition,
and it lies between the pit of man’s fears and the summit of his knowledge.
This is the dimension of imagination.
It is an area which we call . . . the Twilight Zone

I brought up the Twilight Zone analogy because with each passing day the markets and the economy just seem to be getting more and more surreal. Economic data received today continues to point to a worsening outlook and today the market took that as a sign that more rate cuts will be coming. The economic conditions are deteriorating so quickly and with inflation rising again the US Dollar today set another new low today. Many Wall Street professionals who were paraded on CNBC a month or two ago stated that they felt the bottom was in on the US Dollar. We never made any claims like that because we don’t call bottoms on speculation or conjecture. We work only with facts and the facts showed us that the dollar could still go lower. And lower it has gone. And with today’s gloomy economic data the markets are now pricing in yet another rate cut. With inflation growing substantially over the past few months, the US Dollar continuing to fall, and commodity prices still rising another rate cut will only exasperate this alreay volatile combination.

But today’s advances in the market stopped right at a significant resistance point. As we said previously, our short position on the Dow Jones Industrials would be covered at break even if the market advanced upwards towards the next resistance level. And that we would short at the next resistance level, and that is what we did. We are maintaining our short position on the market. In technical analysis you have to set emotions aside and use the charts as your guide, never mix emotions and investing/trading together… for that is a bad mix.

The chart below is that of the Dow as of today, observe that we are now at a significant resistance level and from the technical perspective this offers us another opportunity to take an entry on the market in a short position. We are at a point where the markets are likely going to become more volatile very soon, and typically when volatility goes up the markets go down.

(Dow Jones Industrials – Daily chart)

And speaking of volatility, applying technical analysis to the $VIX works just as well as with any stock. In this chart of the volatility (VIX) index I have identified the ascending triangle pattern and superimposed the S&P 500 on top. The volatility index is the blue line (observe the ascending triangle pattern highlighted with the blue trend lines). The S&P 500 is shown as the red line. Each time the volatility rises the markets decline, and currently we are very near a point in the volatility where we can expect to see a rise as it bounces off the trend line. Ascending triangles usually resolve to the upside, so this would tell us that we are likely to see much higher volatility in the future.

(Volatility VIX Index with S&P 500 – Daily chart)

On the economic front we received the Producer Price Index (PPI) data today. This measure of inflation had a top line gain of 1% over last month and a 1% jump is significant. The core PPI rose by 0.4%. Those who say the core is more important than the top line numbers live in an artificial world. Core data is what is left when you strip out food and energy. In the real world people live by food and energy, so those who slam their fist on the table and say "the core is more important" are somewhere in the Twilight Zone.

Inflation is continuing to grow, yet the markets are screaming for more rate cuts. More rate cuts will only add more fertilizer and water to the growing inflation seeds. Cutting the interest rates may help in the short term to un freeze the credit markets, but at what cost to the American people? The old saying is true "They are dammed if they do and dammed if they don’t" (with respect the the Federal Reserve). There is no easy fix to any of these problems, cutting rates only creates an illusion of a functioning market but underneath the fires are being stoked and will result in a pressure cooker explosion.

(PPI data – 10 year chart. Data source: Moody’s Economy.com)

Home prices continued to decline as measured by the very accurate S&P/Case-Shiller Index. We are now at a point where the year over year declines are the largest ever since the index began in 1988. The summary report issued stated that there are no signs of stabilization in the data. The renewed hopes of more rate cuts by the Federal Reserve coupled with the irrational buying on the announcement by IBM that they are going to buy  back $15 Billion dollars of their stock is what is responsible for most of our advance today. Recall that Lisa wrote about the significance of companies buying back shares of their stock. Companies that buy back their shares are essentially "hunkering down". It is used to artificially inflate their EPS by reducing float. The amount of stock buy back announcements has been very high during the past 6 months. And in the course of history we usually see large stock buy backs in times of economic turmoil and bear markets. We will begin our own index of tracking stock buy backs by companies on the S&P 500 and use this index in the future as one more measure of corporate sentiment of the economy.

How about this news item… The Federal Deposit Insurance Corporation (FDIC) is hiring people to get ready for bank failures. As reported by the Wall Street Journal:

(US) WSJ reports that the FDIC may be preparing for a rise in bank failures

- The FDIC is looking to rehire 25 retirees from its division of resolutions and receiverships.
- Many of these agency veterans worked for the FDIC during the late 1980s and early 1990s, when more than 1,000 financial institutions failed due to the savings and loan crisis.

For now, as we wait for the next bit of economic data, or the next announcement of losses by a bank, or as the FDIC is now hiring back employees to get ready for the onslaught of bank failures we can only wait and see, and use the charts for our guide. But one has to admit that the events over the past year could have been something right out of a Twilight Zone episode.

You unlock this door with the key of imagination.
Beyond it is another dimension- a dimension of sound, a dimension of sight, a dimension of mind.
You’re moving into a land of both shadow and substance, of things and ideas.
You’ve just crossed over into . . . the Twilight Zone

Sphere: Related Content

Another piece of economic data received this past week was the latest figures on construction spending. This data goes through some very large spikes, both positive and negative. So the only real way to gauge the trend is to apply a mathematical moving average of the data. The data comes from the Us Government Census Bureau to which I loaded the data into an Excel worksheet and applied a moving average to the data.

Once a moving average is applied the trend stands out very clearly. Just as in the unemployment data in my earlier posting you can easily see that the construction industry is deteriorating and even deteriorating at a rapid pace over the past 2 years.

Over the past 15 years construction spending has never been worse than it is now. Even during the last recession of 2000/2001 the spending was not as low as we are experiencing now. By examining the various pieces of economic data that we track it becomes clear why it is we feel that the United States is in a recession. Additionally, we feel the recession has the potential of being much deeper than previous recessions.

As with all forms of data, trend lines give us a point of reference from which to gauge a turning point. So far we are still heading down and we expect to see further declines. The recent Fed rate cuts may slow the decline somewhat, however it will take a long time before this trend is able to reverse as the glut of homes on the market is extremely high and home values are still deteriorating.

(Data source: US Census Bureau)

Market Analysis,Economy,Housing Crisis,Nikkei

First a reply to a comment from Dave…

The chart of the World Index is meant to show underlying weakness, not as a tool for deciding to buy or sell. You mentioned that the bull market has been strong, on the contrary, all of the technical indicators and market breadth charts have shown that while the markets have advanced the supporting indicators have been softening. This is what is called a divergence and it is important to keep them in mind going forward. The new highs and new lows index chart clearly shows that while the market has been advancing over the past year the new highs has been falling. There is no argument or discussion with regard to what that means. It is a clear indication that the markets have been advancing on fewer and fewer stocks rising. This is visible on the advance / decline charts as well. Just how long do you think the broad markets will keep going on Apple, Google, Solar stocks, and some shippers? Sorry, but a handful of momentum stocks will not support our entire stock market.

We will continue to look for long positions as well as short positions to trade. But we NEVER lose sight of the big picture. For it is the big picture that tells us where we are likely to be headed.

Some news items over the weekend:

• Japanese newspapers are reporting that the Bank of Japan may cut Japan’s GDP yet again, the article reports that Japan may cut the GDP to 1.3%, down from 1.8%. Recall the chart I showed of the Nikkei Average. I am concerned about the Japanese market going into a long down trend.
• The Financial Times reported this weekend that over the last 6 months commercial and investment banks in the United States have had to raise $83 Billion dollars in liquidity. This is an all time record. Now think about this for a minute if you will, never in history until now have banks had to raise so much mi9ney in such a short period of time in order to have enough capital to operate. That does not give me a great deal of confidence in our financial markets health.
• A famous and well respected economist, Robert Shiller from Yale University in an interview with the London Times said yesterday that the losses resulting from the housing crisis will likely triple over the coming years. And goes on to say that the current losses which can be attributed to the housing crisis have already hit $1 Trillion Dollars.

Markets have been down, but range trading.  Most sectors are pretty weak today.  OIH (Oil Service Holders) is getting hit again, too.  At this point it’s hard to tell if we’ll continue this down trend today, or just stay flat.  The NAHB Housing Market Index came in at the expected 19.  Anything under 50 is negative sentiment by builders.  This is the third month at the all-time low number of 19, so expect some to start calling a “bottom” here.  I’m not that optimistic yet, however.

President Bush spoke on the state of the economy this morning, here’s a synopsis: 

He said he will veto any tax increase and is against raising the gasoline tax.  He’s still harping on Congress to fix the alternative minimum tax and reminds them a delay means it’s more likely that $75B in tax refund checks will be late.  He said a budget bill must include funding for troops in Iraq.  He said the Government should never bail out lenders, and says the housing bubble will take a while to work through.  He said that Congress needs to get a bill to his desk to make it easier for FHA to help keep people in their homes (even more legislative interference).  Oddly enough, he said there are too many lawsuits in the health-care industry, causing some doctors to leave the industry, which is helping increase the cost of medical care.  (With all due respect, he is completely wrong about what ails our health-care system!)  He said we need to push nuclear power plants to offset dependency on oil and that it makes ‘no sense’ that we have not been building new refineries. (Most sane thing said regarding “energy problem” yet, and he didn’t even say new-cue-ler).

Before anybody starts yelling at me for being in support of more refineries and nuclear power, governmental interference (oh, I mean support) in the “green energy” field has only contributed to the rise in commodity prices.  Saving our planet is the job of capitalism, not so-called environmentalism and government programs.  The more we stand in the way of true invention and innovation, the more we hurt ourselves in the long run. 

The news on the financial front is bad.  Period.  It doesn’t matter how many times some analyst, CEO, Fed Chairman, or the President says the economy is robust or the “subprime” problem is contained, the news is bad.  From all of the research I’ve been able to do on the financial debacle, I could write a proper horror novel.  For anyone who thinks the financial problems have already been priced in the market, here are a few observations:

Corporate profits are going down.  Prices companies pay for materials are increasing (same for individuals) and their margins are shrinking.  We’ve written before about all of those share buy-backs being an ominous sign.  The reason is this:  A company has 2 million shares and earns .10 per share in year one, then buys back 1 million shares.  In year two the company reports they earned .12 per share.  Did they have a good year?  No.  They actually earned less, but in year two they just don’t have as many shares.  Yes, I made this simplistic, but keep it in mind the next time you simply scan the headlines of an earnings report.  Be sure to dig a little deeper, see if you can find their year-over-year revenues and profit margins.  And right now, expect any company to project a rosy outlook for their sector, unless it is a sector that feels it needs an interest rate cut to survive.  Then you will be hearing wailing and gnashing of teeth.  But, that’s OK, you say, because at least they aren’t involved in this credit crunch thing, right? Do you know how many companies are actually involved in financing activities?  Would you be surprised to learn that Caterpillar (CAT) and Deere (DE) and Pitney Bowes (PBI) derive 12% of their earnings from financing activities? And what about all those store credit cards?  No big deal because people are paying their debt?  Think again.

Loan repayments are defaulting at an increasing rate, and it’s not just subprime, but all loan types.  Construction and industrial (commercial) loans, credit card loans and personal  loans defaults are on the rise.  Why is this happening?  All of this credit was a house of cards.  The following scenario starts with the fact that housing was overbuilt and overpriced. And the more complicated financial schemes and relaxing of financial rules to continue expanding credit are not accounted for, but only makes it worse. 

Bank A loans Fred $1,000, with interest, for a house. The hope of Fred being able to repay, is the risk that Bank A is taking, and if Fred can’t repay it, Bank A will take the house.  Joe finds he needs $2,000 to buy a house.  So, he goes to Bank B and borrows the money, with the same deal as Fred.  Bank A and Bank B sell those mortgages to Bank C, thereby ridding themselves of the risk if Fred or Joe can’t pay the loans.  Bank C doesn’t really want the risk, even though it is making money from the servicing of those loans and collecting the interest.  So, Bank C bundles those loans, calls them an investment vehicle and sells them to Investor A and Bank D.  Why does Investor A and Bank D buy this debt?  Because it’s value should go up as home prices appreciate.  Bank D wants to use it as collateral to borrow money and Investor A expects to make a nice return, since real estate only goes up.  Until it doesn’t.

When the housing prices drop, the collateral supporting the price of those loans drops as well.  Investor A wants to sell these loans now and take his cash out of the market.  But, the problem is that suddenly everyone figures out that housing is in a slump and doesn’t want to pay Investor A’s or Bank D’s asking price.  So they have two choices.  Hang on to the loans (debt) and wait/hope that real estate prices go back up, or sell at a loss. 

Ok, that’s the simple version of what’s going on.  Banks are losing money, broker/banks are losing money, other’s involved in finance are losing money.  And they are all pinning their hopes on real estate values rising.   

Bloomberg article on U.S. Profits  

Forbes Magazine article on corporate financing

Article on mortgage meltdown, not just sub prime