Wednesday, March 4, 2009

Elliott Wave Counts and Fibonacci Levels

A buddy of mine asked me about Elliott Waves and Fibonacci Levels, so I thought I would post about where I think we are in the Wave Count.

If you are into this stuff, then feel free to read it. If you think it is voodoo, then enjoy a good laugh… But keep in mind that the markets have had very thin volume the last few months and these levels have been used by the Hedge Funds and traders to accelerate price moves.

You can read about the Elliott Wave Theory here –

I think we are in Wave 5 of the move off the October 2007 High.
There are clusters of support levels at 664/667, 693/698 and 640/645

Within the larger Wave 5, I believe we have started Wave 4.
The upside resistance levels are clustered at 762/763 and 784/788.
Big chart resistance starts in the 815 range.
Wave 2 of this leg lasted 14 trading days, so we may be in a rally, or a lateral consolidation for a few weeks, before the final leg down for this Bear Market.

Other key levels –
123% retracement of the 2000-2002 Bear Market is at 611
62% retracement of the 1982 – 2007 Bull Market is 663

A rally into the 750-800 range leaves a massive cluster of support at 663,664/667, 661/666 and 654/656
That may be the final support level for the Bear Market of 2007-2009.
Time will tell, but I will be looking to buy reversals off of that level in about 20 trading days.
If 660 fails, then the next support lies in the 611, 611 and 615 cluster.

I'll update these numbers if it is Wave 4 and it does fail.

More on the TALF

I got a reply letting me know that I was overstating the pricing of the debt to be purchased by the TALF.

The way the TALF is written, it will not be able to purchase old debt, only newly created debt. It will protect the Taxpayer by buying ABS at a discount to its maturity price and by charging what amounts to a fee each year for lending the money.

Whether or not the TALF purchases ABS at Par or at a Discount is not the issue. The issue is that the underlying holdings of the ABS will be artificially priced too high and the Interest Rate charged on the loans that find their way into the ABS will be at artificially low, relative to the actual risk of the loans.

If the loans were properly priced for risk, then the interest rates charged on the underlying loans would be so high, that the borrower would refuse the to take the loan. This game of using derivatives or rigged "Credit ratings" to artificially lower interest rates is exactly what got us into this mess.

The fact is that the only entities willing to refinance Mortgage ABS are the US Government or banks who have received money from the US Government. The only way to attract Private Capital would be to price the new ABS with really high interest rates, to reflect their true risk.

But if you refinanced new mortgages at 10%, nobody would be able to afford the loan and they would not buy the house.

So the Fed will overpay to refinance Trillions of Dollars worth of crap off the balance sheet of Banks and move the risk of this filth onto the back of the Taxpayer. I don't think that is an exaggeration.

Feel free to email me and I appreciate you taking the time to reply.

Tuesday, March 3, 2009

The Fed Is Now A Hedge Fund

Actually, thanks to the TALF, it is the Federal Reserve Bank of New York (FRBNY) that is now a Hedge Fund.

You knew this was coming. It was telegraphed last year by Paulson, when he first started to mention “The Super SIV” (think a gigantic Enron). I have been writing about it for months. Geithner’s appointment guaranteed its enactment.

Today the details of The TALF were announced. I want to deconstruct TALF, because it will be the tool used to reflate the Financial System, with the last, epic round of massive leverage.

TALF – Term Asset-Backed Loan Facility
First, an “Asset Backed Security” is created when a bank takes a bunch of loans, pools them together and then turns the pool into a security - splitting it into shares and selling them at a specific price per share. Assets types include mortgages, student loans, auto loans, construction loans, commercial real estate loans, credit card debt, consumer debt …

Asset Backed Securities (ABS) had one glaring flaw – they were priced by the Rating Agencies (S&P, Moody’s) as if the underlying loans were of the highest credit quality, with minimal potential for future defaults. This allowed the banks to issue these loans at artificially low interest rates. It also allowed banks to make loans at artificially low interest rates, relative to the real risk of default by the borrower.

Remember what I told you last week, that banks are pricing this ABS at artificially high prices, so as to make themselves look solvent. But we know that the highest “Rated” stuff is trading at 32 cents on the dollar and the “Junk” stuff is trading at 6 cents.

Bring on the TALF!
The TALF is now under the management of the FRBNY (the bank Geithner used to run). It has been created in the following structure. The Fed will take $20 billion of TARP funds and loan them to the FRBNY. The FRNBY will leverage that money 10 to 1 and buy $200 billion in newly-created loans.

That’s right, the FRBNY is going to invent $180 billion via the Fed (+ $20 billion more via the US Taxpayer) to buy loans that the banks can’t sell, because the yields are too low (prices are too high) to attract any other buyers! We all know that if the banks priced the new ABS to sell at market, then it would be at rates so high, that they could not do any lending.

Remember, the Obama Administration wants to do another round of TARP (TARP II) for $750 billion. That would allow them to buy $7.5 Trillion of loans. They also have at least $200 billion of TARP I funds left. So you would expect to see the FRBNY end up with a pool of about $10 trillion in loans on the books…

The Goal of TALF
TALF is ultimately designed to transfer the junk loans from the balance sheets of banks to the balance sheet of the US Taxpayer.

Remember, TALF is only designed to buy newly issued ABS. So the first wave of purchases will be ABS created by refinanced mortgages.

Here is the game they are trying to play -
Bank A has $100 million in a Mortgage ABS
At origination, the average house value was $500k (2,000 mortgages in the pool)
The mortgage was a Neg Am loan, and is now worth $550k
The borrower financed 100% of the purchase price
The minimum payment was made each month
The house is now worth $300k.

The Fed has continued to allow the bank to price the ABS at $100 million
The ABS still holds a AAA rating
The Market knows that the Bank owns this stuff and is factoring the value of the ABS at $6 million

Under TALF, the homeowner will be allowed to refi their mortgage at 4.5% and stretch the term of the mortgage to 40 years. All appraisal requirements will be waived on these new mortgages. You paid $500k for a house and your mortgage is now $550k, but the house is only worth $300k? “No problemo” says Uncle Sam, we will refi the whole balance! No questions asked. Just sign here!

You now have the bank getting repaid $550k cash, on a loan that is about to recast, and put the homeowner into foreclosure. The bank should have to repo the property and sell it at auction for $250k. But the TALF is stepping in to put the Taxpayer on the hook for $550k.

This is a de facto government subsidy to the bank for $300k per mortgage, or $60 million on this $100 million ABS.

The FRBNY will try and buy all of the crap held by the US Banks, European Banks and Central Banks of places like China and Japan.

Why the Urgency?
The Reason this is going on right now, is because there is an enormous wave of Alt-A mortgages recasting in 2009 and 2010. The size of this mortgage recast dwarfs the size of the Sub-Prime default wave of 2007-2008.

The Fed needs to get this stuff out of the banks, credit unions, pension plans and insurance companies before the coming defaults make all of these institutions insolvent.

So I expect to see the Fed soon use the TALF to buy existing ABS loans off the balance sheets of banks at ridiculously high prices, relative to the real value of the paper held in each ABS (100 but worth 32 or 100 but worth 6).

Either way, the Taxpayer is going to get royally hosed.

What to Do?
If TALF works the way I think it will, then you should see an enormous rally in the stocks of the banks that survive the next few weeks.

This will be the greatest theft of taxpayer money in the history of mankind. But it will put a bottom in on the stock market and lead to a multi-year rally before the US Dollar and US Treasury Bond collapse.

Monday, March 2, 2009

This Chart Says It All

Here is a chart of the rally in the Dow from August 1982 – October 2007
The rally took 25 years. The Dow gave back more than half of those gains in 17 months. 17 MONTHS!!

The Dow has now taken out the key 50% retracement level at 7504. I think the most likely scenario is at least a test of the 62% retracement line, at 5,919. If it occurs, I would expect to see price overshoot 5,900 and test the 5,200 - 5,500 range. But I would then expect to see The Dow close the month above 5,900. We’ll see how it plays itself out.

Bottoms occur in emotional panics. The last few days should be sharp, violent plunges. You do not want to be guessing on the bottom during these days, because you can be a day away from price in time and still be 10-15% away from the bottom in price.

Here is a chart of the Dow from 1996 – Present. You can see how many times the 50% retracement line (Black Solid Line) was tested (Black Arrows).

The last test led to a quick rally (Green Arrow) up into the 38.2% retracement line (Dashed Black Line). This rally failed quickly and the Dow has now taken out the 50% line (Blue Arrow).

Next stop sure looks like the Orange Box.

Weekly Bands
The first big drives down stopped at the -35% Band (Orange Line). That line is currently at 625.7 on the S&P 500. That is a long way below here.

Sunday, March 1, 2009

Obama Nukes Healthcare

On February 18 I wrote the following about Johnson & Johnson (JNJ)

Johnson & Johnson (JNJ) is the single scariest chart in the stock market. If I shorted individual stocks, I would have a BIG short position in JNJ. I would be looking to add on a rally into the $62 range and a retest of the highs near $70. But I don’t short individual companies, so this is an academic exercise.”

I wrote this because I was not only concerned about the company, but I am terrified of the fundamental prospects for the industry. For months, I have been wondering how anybody could invest in Healthcare, when you know that Obama is on the warpath to nationalize it…

JNJ was down -8.4% the last two days.

This week Obama released his Budget proposals and he crashed the Healthcare stocks. Healthcare is the second largest group in the S&P 500 (15.3%), so when it crashed, the market took another leg down too.

Here are a few charts to show you what the Institutions think about holding onto Healthcare stocks –

US Healthcare Index ($DJUSHC)

US Pharmaceuticals & Biotechnology Index ($DJUSPN)

Health Insurance
Humana (HUM)

Review some of these charts if you want to see how bad the damage is to the Healthcare this week –
Amgen (AMGN), Abbott Labs (ABT), Pfizer (PFE), Celgene (CELG), Covidien (COV)…

Continue to focus on Preserving Capital!