Friday, August 13, 2010

Weakness Continues

A plunge like Wednesday should be followed by a better bounce than we have seen. But nobody seems willing to buy, which means that they are probably looking to sell bounces.

The risk indexes were sold pretty hard yet again today – the Russell 2000 -1.21% today and the NASDAQ -0.73% today.

This is the hourly of the S&P 500. The S&P 500 is now below all key moving averages. It has spent the last 2 days in a very narrow range right below the 50-day. This is a really bearish setup and I expect one of two things to occur – a nasty selloff or a nasty short squeeze. The potential is there for both.

Any hard selling early next week will have me looking for a bounce. I will not short a sharp gap down open on Monday. If there is a huge gap up open on Monday, it will be interesting to see if it is immediately sold.

Semiconductors are a critical group and they broke down from a multi-month trading range this week. Disk Drives look horrible and even closed below yesterday’s low today. Yuck. Semis and Disk Drives lead the markets. Financials and Retail are acting poorly as well.

Gold (GLD) has been sitting right above its 50-day (Black Line) for the past two days, in a narrow trading range. Like most everything else, Gold has a critical decision to make in the very near future.

Thursday, August 12, 2010

A Weak Bounce Today

Here is the big picture chart of the Dow Jones. That looks like a top and not like a bottom to me.

On a side note, there is a lot of talk right now about how this high looks very much like the top which preceded the 1987 Crash. There is also some mystical planetary alignment right now that is similar to (worse than) 1987. I don’t follow that stuff, but I’m sure that CNBC will parade some gypsy around the TV studio tomorrow talking about it, because tomorrow is Friday the 13th…

Back to business. One decision at a time…

Here are the updated daily and 120-minute support charts on SPX. If the 1,085 range cannot be broken then I look for a possible bounce in the 1,065 range and then the 1,050 range. The trend is now down, so I am not interested in buying dips for the time being.

The NASDAQ 100 hit a key support level and it has held so far. The same goes for The Euro. Europe is falling apart. The “stress test” was a bunch of bs. Ireland and several parts of Span cannot find buyers for their bonds and the EU is being forced to finance their debt auctions this week. Credit Default Swaps for the PIIGS are going parabolic again.

On the 15-minute chart, you can see that the Euro has a big decision at 1.282. If that level holds, then I would love to see a rally up above 1.293 to set up the reversal pattern. I expect some resolution overnight on this pattern in the Euro and will deal with what exists in the morning.

A Quick Bounce

I put this chart together for the NASDAQ 100 last night. It was setting up with that reversal pattern into the 1,810 range.

Look where the NDX opened today and how it traded in the first 40 minutes today. The low this morning was 1,807! That is nice 27 point rally (1.5%) in 40 minutes…

The Semiconductor Index ($SOX) broke its key support level this morning, but the way the markets have been trading lately, it could recover the 330 level today, causing this morning’s plunge to simply be an exercise in shacking out some stop loss orders.

A weak rally into 330 over the next few days would be very ominous.

Wednesday, August 11, 2010

Fed + 1 Fireworks

First, for anybody who thinks investing right now is easy, they are nuts. The S&P 500 spent 7 days coiling below the 1,130 level and then overnight it imploded – after the Fed started another round of Quantitative Easing no less. Volume is non existent and mysterious ramps in the futures market can drive the Dow up 100+ point in a matter of minutes.

Yesterday, the setup was there to try a short the SPX ETF (SPY) below $113, but the market gapped down about 1% and gave you no reasonable entry point. This morning, SPY gapped down about -1.5%. How many times in the last few weeks has the market opened trading well above or below the close of the previous day, only to reverse sharply and end the day flat?

There was no way to entry shorts today. Very frustrating…

SPX simply blew through support levels and now has turned the trend back down. Here is the hourly chart showing how the gap took price right through the uptrend line and gave you no manageable entry point. I would love to see a rally back into the 15-hour MA (Green Line) that fails.

The next meaningful support is at 1,080 for SPX. That level was hit tonight in the futures market (thanks Cisco) and so far has held. This market has to be taken decision to decision and right now I have to wait for an hourly set up. Remember, these levels get blown through all the time. The idea is to look for reversal patterns are key levels, not take action and hope.

Small Caps, Mid Caps and Equal Weight got absolutely smashed today (-4% was the norm). Here is the chart of the Russell 2000. It is pretty ugly. There isn’t much support below here.

The NASDAQ 100 also had a bad day. Here are the support levels. 1,812 was tested tonight. You can see a little Reverse Triangle pattern set up here with the move below 1,825. I am looking for a reversal from 1,810. I will not buy it, but a weak rally would get me interested.

Semiconductors ($SOX) are on the brink of breaking down. This is the 5th test of the 325 area. The chart has the looks of a 1,2,3 Lower Top. Semiconductors lead the markets. A breakdown here needs to be watched very closely.

Here is the chart of Crude Oil. It did a two-set pattern up into resistance and has failed. The normal move out of that pattern is to see price extend at least -162% in the other direction. I have been saying for some time now that if Crude breaks $70, then we are in a recession. We should find out very soon if the recession talk is for real.

Gold held up well today. The obvious question about gold is whether or not it will be a risk aversion play here or a victim of deflation? I am hopeful but have my stops in place.

The Euro got smoked today. 1.283 was hit tonight and so far has held.

Here is the hourly on the Euro ETF (FXE). It put in the reversal pattern and rallied back into the middle of it, like I would expect it to. But how are you supposed to enter it? The high was hit on Friday. Then on Monday, the uptrend held. You would like to short FXE breaking the uptrend line, but that was unrealistic when FXE gapped down Tuesday morning over 1% below Monday’s close. Today, it gapped down 1.8% below yesterday’s close. A perfect set up if you can trade futures at 2 am…

I want to see bounces. The weaker they are, the more ominous the tone for the markets. I just hope that the bounces haven’t exhausted themselves by the time the markets open tomorrow morning.

Tuesday, August 10, 2010

Structured Products

During the last Bull Market, a lot of money was invested into what were called “Auction Rate Preferred Funds”. These funds offered high Interest Rates and monthly liquidity and were sold as alternatives to Money Market Funds. They worked great until the Financial Crisis hit in 2007 and then their flaws were exposed.

The Financial Crisis revealed that one could only sell these funds each month if there were a buyer on the other side of the trade and that buyer actually turned out to be the brokerage firm that sold the funds. When the banks stopped buying these funds, you could not sell them.

The reason the banks stopped buying these funds back was that a little county in Florida froze its version of an “Auction Rate Fund” that they set up to manage cash holdings for other towns and counties. This Florida fund held a bunch of subprime loans and was pricing them at 100 cents on the dollar. This intentional mispricing made the value of the fund look larger than it actually was and by definition inflated the share price to more than it could be worth. When Lehman blew up, people understood that the fund’s holdings were mispriced too high and there was a run on the fund. The fund realized that it would have a negative net worth if everybody tried to sell, so they froze the fund and would not let anybody else take their money out.

The banks saw this and stopped offering to buy back their Auction Rate funds, because they know the holdings were mispriced and when the pricing became accurate, they did not want to take the losses – better that the client get hit instead…

The holders of these securities were then told that they would get their money back when the securities matured (in 30 years), or they could sell them back to the banks at a discount (say at a 20% loss) and get access to their money immediately.

There were lots of lawsuits and eventually many banks ended up writing some very large checks to their now former clients.

According to Chris Whalen, there is a product class that is being sold to investors, desperate for higher yields, which is the next “Auction Rate Preferred” debacle. That product class goes by the name of “Structured Products” -

“Even as the big banks make a public show for the media of implementing the new Dodd-Frank law with respect to limits on own account trading and spinning off private equity investments, these same firms are busily creating the next investment bubble on Wall Street -- this time focused on structured assets based upon corporate debt, Treasury bonds or nothing at all -- that is, pure derivatives. Like the subprime deals where residential mortgages provided the basis, these transactions are being sold to all manner of investors, both institutional and retail.”

“One risk manager close to the action describes how the securities affiliates of some of the most prominent and well-respected U.S. (Bank Holding Companies) are selling five-year structured transactions to retail investors. These deals promise enhanced yields that go well into double digits, but like the subprime debt and auction rate securities which have already caused hundreds of billions of dollars in losses to bank shareholders, the FDIC and the U.S. taxpayer, these securities are completely illiquid and often come with only minimal disclosure.

The dirty little secret of the Dodd-Frank legislation is that by failing to curtail the worst abuses of the OTC (Over The Counter) market in structured assets and derivatives, a financial ghetto that even today remains virtually unregulated, the Congress and the Fed are effectively even encouraging securities firms to act as de facto exchanges and thereby commit financial fraud. Allowing securities firms to originate complex structured securities without requiring SEC registration, is a vast loophole that Senator Christopher Dodd (D-CT) and Rep. Barney Frank (D-MA) deliberately left open for their campaign contributors on Wall Street.”

“Of course retail investors love the higher yields on complex structured assets. Who can blame them for trying to get a higher yield than available on treasuries, while the Fed keeps rates at historic lows to, among other things, re-capitalize the zombie banks. The only trouble is that the firms originating these securities, as was the case of auction rate municipal securities, have no obligation to make markets in these OTC structured assets or even show clients a low-ball bid. And because of the bilateral nature of the OTC market, only the firm which originates the security will even provide an indicative valuation because the structures and models behind them are entirely opaque.

In fact, we already know of two hedge funds that are being established specifically to buy this crap from distressed retail investors as and when rates start to rise. The sponsors expect to make returns in high double digits by making a market for the clients of large (Bank Holding Companies) who want to get out of these illiquid assets.”

Yet another asset class that cannot be priced and cannot be sold. Fantastic. Structured Product sales to Individual Investors are up 72% versus last year (as of July). Equally fantastic. Know what you own! Structured Products are a combination of derivatives betting on stock prices and Interest Rates. How could that possibly have a bad outcome?

The rules of investing changed when Lehman started to unravel in 2007. I became clear then that you could not own Limited Partnerships, Hedge Funds, Real Estate Partnerships or any other asset class where the fund manager had the discretion to price the holdings in the fund and the ability to deny future redemptions if the fund holdings were not trading at a price the fund manager liked.

After reading what Whalen had to say, it becomes clear that these funds blow up if Interest Rates rise. Interest Rates will finally rise when foreign investors become no longer willing to buy Treasuries at these low yields. That is when the Inflation wave will hit us, because then the Fed will simply be printing money to pay the bills of the US Government.

The other thought I have is that the Mortgage Securitization machine caused massive distortions in the economy, as money chased rising real estate prices that were fueled by the money created as investors chased yield in stuff like Auction Rate Preferred funds. Is the next bubble going to be money chases these “Structured Notes” which then turn around and buy dividend paying stocks and high-yield bonds?

Fed Day Today

It’s Fed Day today and many key markets face critical decisions. The hope being built into the markets is that the Fed will announce that they will start buying at least $250 billion in bonds and will ultimately purchase another $1 trillion to up to $5 trillion of new bonds over the next few years.

I want to start with the Euro (chart below), because so much of the leverage that is driving risky assets up and down is a result of currency Carry Trades. The uptrend in the Euro is now at day 44. Vertical moves like this tend to reverse (or at least pause) in the 45 – 49 day range. I have included resistance levels used by technical traders (and no doubt computer models). The inverse of The Euro is the US Dollar.

Here is the chart of the S&P 500. Key resistance is at 1,140. The setup is there for a reversal and the most bearish scenario would be a break above 1,140 that quickly fails and takes out the 20-day averages at 1,115 and 1,096. If that happens, I will update the chart with support levels.

If key resistance is broken, then the downtrend reverses and technicians start to look at 1,276 and 1,349. We should have a pretty good idea of whether or not 1,140 will hold over the next few days.

US Treasuries have been rallying since the first batch of Quantitative Easing (money printing) ended at the end of March. The 30-year Treasury now faces another set of potential resistance.

Gold has managed to hold support at $1,150 and has now reversed its downtrend from June. Key resistance is the $1,220 – 1,228 range. I will fine tune my support levels later this week.

Conclusion is that the decision of the Fed will impact Stocks, Bonds, Currencies and Commodities. That is the world in which we now live, because there is too much production capacity and vacant real estate, so the only money keeping the economy from contracting is money printed by the government – look at how bad the economic numbers have been since March ended (and Quantitative Easing ended).

Last week, Greenspan said that a rising stock market would do more to improve the economy than any additional stimulus or bond purchases by the Fed. Rising asset prices is a policy tool so expect them to keep spending money they don’t have until the Bond Market revolts and forces them to stop.