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Thursday, January 31, 2008


regional bank concentration in commercial lending

for the surrogate memory...

calculated risk passes on his observations:

As I noted last week, with the failure of Douglass National Bank in Kansas City, the housing bust hasn't hurt most small banks and institutions because the banks didn't hold many of the residential mortgages they originated. Instead the small to mid-sized institutions focused on commercial real estate (CRE) and construction and development (C&D) loans, so rising CRE and C&D defaults will impact community banks much more than rising residential mortgage defaults.

though s&p's forthcoming downgrades will attack regional and local banks who have not marked to market in their residential portfolios, commercial real estate and C&D lending is where a recession and increased corporate defaults could really injure banks like M&I.

Credit ratings agency Moody's Investors Service said Friday it has placed a negative outlook on regional bank holding company Marshall & Ilsley LLC and the lead subsidiary despite affirming some investment-grade ratings.

Moody's said the negative outlook reflects the company's large commercial real estate exposures, which the ratings firm has long cited as a credit weakness. Yet, Marshall & Ilsley has a very strong capital position offsetting that weakness, the firm said.

There's also a potential for increased debt because property markets continue to be volatile, Moody's said. The firm also said if the bank's capital strength falls significantly, "further negative rating pressure could emerge and could result in a downgrade."

However, Moody's said fundamentals for Marshall & Ilsley's parent company are sound.

one can take a look at M&I with the FDIC's reporting interface and note that, while carrying 16.6% of its balance sheet in 1-4 family residential mortgages, the bank is also 12.1% into commercial real estate, 4.0% into multifamily residential, and 18.1% into construction and land development. furthermore, 19.8% of assets are commerical and industrial loans. this totals over two-thirds of the bank's assets.

with a tier 1 capital ratio of 7.08%, it wold not take much in the way of losses to put M&I in some peril -- though that is, by the measure of its competition, a reasonable ratio. (the FDIC's idea of adequately-capitalized is 4%, well-capitalized 6%.)

nonetheless, goldman sachs is calling for 25% price declines in commercial real estate -- and just as home price declines haven't been exclusive to california and florida, CRE disappointments will be felt in the midwest. and the scale of the problem is such that comptroller dugan is giving explicit warnings of bank failures.

“We’re entering a stage of the commercial real-estate credit cycle where problems have started to surface and losses have started to increase,’’ Mr Dugan said in a speech in Florida.

The crisis in the US housing market has had a knock-on effect on commercial property, he said.

Mr Dugan expected a rise in bank failures, since many community institutions had significant exposure to this now-declining market and would face rising delinquencies and loan defaults. “CRE concentrations [have risen] significantly in many banks, even as the quality of risk management practices lagged,” he said.

Mr Dugan said that many banks had failed to adjust their lending practices and risk management procedures, despite previous warnings from regulators.

“Even more significant than this overall industry statistic is the number of individual banks that have especially large concentrations,” Mr. Dugan added. “Over a third of the nation’s community banks have commercial real estate concentrations exceeding 300 percent of their capital, and almost 30 percent have construction and development loans exceeding 100 percent of capital.”

His department would adopt an extremely “pro-active” approach in dealing with deficiencies. “There will be more frequent interaction between supervisors and banks with concentrations in CRE loans that are declining in quality,” he said. “There will be more criticised assets; increases to loan loss reserves; and more problem banks. And yes, there will be an increase in bank failures.”

dugan is referring to CRE concentrations as defined on page 74585 of this document. for the record, as of september 30, 2007, M&I carried $9.5bn in construction and development loans over $4.9bn in equity capital, or 190% of capital -- and a CRE concentration as defined by guidance of $18.1bn, or 370% of capital. perhaps notably, M&I had seen the sum of past due and non-accruing assets in C&D rise from $146mm a year ago to $410mm (180% rise to 8.3% of C&D loans), and in all real estate loans (including C&D) from $371mm to $711mm (92%).

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more on baudrillard's market

kevin depew adds to his brilliant earlier commentary on the gradual degeneracy of the marketplace into hyperreality -- and the advent of what may be the inflection point in a long social and psychological cycle, the beginning of a revolt against unreality.

The bottom line is this is all part of a readjustment that has profound consequences for society. What does a revolt against the displacement of the "real" entail? From a consumption standpoint it suggests a shift in focus, a change in patterns of accumulation and the valuation of material objects.

The proliferation of images, reproductions, the sheer volume and excess of signs, of choices, is itself deflationary, and this secular pattern is evident in everything from clothing and textiles to automobiles, home furnishings, technology and media. This is the structural deflationary paradox where the excess of signs and choices, an inflation of everything, literally, actually creates the conditions for imposing limitations and regulations upon the chaos of apparent freedom.

Deflation is simply the market's attempt to unwind and dismantle the confiscatory dominance of the inflationary regime. Inflation in the purest economic sense confiscates money, purchasing power, control. In the philosophical and social sense, however, inflation confiscates something else that will increasingly be valued above all other concepts or materials: Time.

if we have reached as a society and a marketplace the terminus of baudrillard's progression of the image -- where the image has moved from reflecting reality to disguising reality to masking the lack of a reality to (finally) bearing no relation to any reality, becoming an image without a model -- where the precession of the simulacra has gone through the eras of the original, the counterfeit, the mechanical copy and entered into the third order of simulacra ('hyperreality') where the copy becomes the new original and idealized fantasy is indistinguishable from reality -- what remains?

confusion and apathy -- the hallmarks of postmodernity -- and of course irresponsibility and disintegration. this is what makes the fear of the banking system that "homeowners" (a term of simulation itself steeped in unreality) will simply ignore the contractual obligations which they never truly understood in the first place and do not care enough to try to meet. as depew hints, for these people the concept of "home" is being unmasked as an image without a model, a simulacra signifying neither security nor safety nor sentimentality -- these precepts of the original (now lost in time and space) which reflected a (now vanished) reality are vaporous and illusory -- the referent is dead.

baudrillard posited no action and no remediation from this point. indeed, there may not be any.

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s&p spreads the damage

via bloomberg:

Losses from securities linked to subprime mortgages may exceed $265 billion as regional U.S. banks, credit unions and overseas financial institutions write down the value of their holdings, according to Standard & Poor's.

S&P cut or put on review yesterday the ratings on $534 billion of bonds and collateralized debt obligations tied to home loans made to people with poor credit, the most by the New York- based firm in response to rising mortgage delinquencies. Moody's Investors Service today said losses from mortgages that were packaged into bonds in 2006 could rise to 18 percent.

While banks and securities firms such as Citigroup Inc. and Merrill Lynch & Co. accounted for most of the $90 billion in writedowns to date, S&P said the next wave may descend on regional U.S. banks, Asian banks and some large European banks. The ratings actions may create a ``ripple impact'' that further reduces debt prices, S&P said.

it may be important to note that s&p is not "estimating", at least in the conventional sense, the figure of $265bn. they are calculating how their ratings changes will formulaically affect loss reserves in fiduciary institutions.

Accounting rules have allowed many financial companies to avoid writing down their holdings to market prices until the credit ratings fall if they intended to keep them until maturity or hold them for long periods. S&P said it will review the ratings of smaller banks that are ``thinly capitalized.'' It didn't name any of the institutions.

major banks are largely unaffected by these imminent reratings, but it does highlight the extent to which many smaller banks have not even begun the process of reassessing their balance sheets.

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Wednesday, January 30, 2008


the fed will cut 50bps... right?

i think so, particularly in light of two emergent data points and one parameter:

1) the economy has clearly hit stall speed with the 4q gdp number coming in at 0.6%, a figure that may well be revised down into an actual contraction at a subsequent date. many have commented anecdotally that consumer spending has really deteriorated more recently (ie, december onward) as well. yields across the entire treasury curve have fallen dramatically in recent weeks, and not all of it is just equity money seeking a week of safe harbor. inflation simply isn't going to be a big concern with this as context.

2) the banking situation is taking a turn for the scary. banks -- more clearly now than every -- have to be recapitalized, and one (slow) way to do it is cut their cost of borrowing and thereby raise their margins. even if one argues that the cuts already in the pipeline to the economy are enough to reflate, there's no arguing that bank profitability could be helped immediately.

3) the fed has a lot of market latitude to do so. as noted by traders narrative, fed funds is still 125bps over the 3-month t-bill yield, which it has tracked fairly closely over time. the most recent term auction facility operation was stopped out at 3.123% as well, well under the 3.5% target rate -- meaning the effective borrowing of banks in the TAF is just about already there.

as such, even a 75bps cut wouldn't be out of line with past reflationary practice and current exigency.

UPDATE: right? RIGHT. markets have initially responded positively, with the s&p running straight up to resistance at 1378 -- the 10% line off the recent low.

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Tuesday, January 29, 2008


negative bank reserves

this shocking observation from mish: american banks in aggregate have burned through all their free capital.

Total reserves for two weeks ending January 16 are $39.988 billion. Inquiring minds are no doubt wondering where $40 billion came from. It's a good question. The answer is the Term Auction Facility. You can see that figure in Table 1 of the H3 release, accessible through the link above.

Were it not for the Term Auction Facility, banks would have had to raise $40 billion in capital by selling assets or some other means. We will look at "other means" in just a moment.

For now, the Fed is not disclosing who is borrowing under the Term Auction Facility, probably out of fear that people just might find out what banks are capital-impaired and by how much.

at least as shocking as the net free (borrowed) reserves chart is the straight non-borrowed reserves chart -- the data mish is highlighting in the table indicates that the next datapoint here will be the first negative one in the series.

no wonder then, as mish noted previously, that money center banks have more or less quit lending to anyone, regardless of situation, in an effort to hoard capital. a new example is that countrywide (probably among many others) has begun suspending previously-extended HELOCs. the fed is literally maintaining the static solvency of the system at this moment. if it were to withdraw its anonymous auction facility, it's likely that asset sales and bank failures would begin more or less immediately. it's not that the banks would have no other recourse -- the old discount window is there, after all -- but the lack of anonymity could very well spark bank runs that would destroy the banks that tapped it, as the data here point to conditions well into insolvency for many banks.

that won't happen, of course. but the hard realization is that the solvency situation is not static -- it is dynamic, and the fed may very well end up bumping into the limits of what it can do as debt default becomes so common as to gain social permission.

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what kind of recession? it's up to china

recession -- recently thought all but impossible -- has become the topic du jour in mainstream media. but very little insightful analysis is being done there with regards to what kind of recession we might see, with most outlets passing along very little useful news.

fortunately such analysis is going on elsewhere. james hamilton at econbrowser notes the market response to monetary stimulus has thusfar been positive, though fiscal stimulus is receiving a drubbing in many economic quarters. what is clear is that all the stops are being pulled by the government to support an old (at more than five years) and failing recovery.

i deeply question the intelligence of this. the market -- not just housing, but debt in general -- has been in a mania in some respects induced by the collusion of government (by its refusal to properly regulate and its willingness to allow the inflation of the money/credit supply) and banking (by its adoption of the financial engineering which expanded the money/credit supply), and has obviously been mispriced. this in fact is the essence of the housing bubble: credit was too cheap and too easy. and the essence of the bust is that widespread malinvestment is being made obvious and credit prices marked up where it is being extended at all -- as in every bust.

government stimulation represents an effort to extend that collusion of credit mispricing in an effort to maintain high prices -- an effort to fight the clearing mechanism of the marketplace, which is falling prices.

such efforts are inherently misguided in my view. what is happening in the marketplace is not irrational; it is a return to rationality. it reminds me of murray rothbard's description of the efforts of the government in the 1920s and 1930s.

throughout the early interwar era, the united states countered a global price deflation which began in the depression of 1920-21 with inflationary monetary policies, underwriting an expansion of bank credit that had near its root an effort to restore great britain to the gold standard at its prewar par. in an effort to allow britain to counter the deflationary economic pressure of currency convertability by attempting a policy credit inflation, the united states stemmed the flow of gold from an inflating britain by itself creating an inflation -- effectively subsidizing britain's ill-judged economic policy. as natural deflation of basic commodities were offset by inflation in capital goods, consumer and wholesale price averages gave the illusion of price stability on the whole even as prices by type were bifurcated and the capital system became dangerously overleveraged.

this is similar in some respects to our current situation. china has played the role of the 1920s united states, abetting the inflationary policies of america (playing the role of 1920s britain) even as real american wages erode by joining in with its own inflation, transmitted by its currency peg and huge subsidy of american profligacy by the recycling of its dollar trade surplus into american assets. a strong natural price deflation eminating from china and the rest of east asia as it industrializes has been countered in the united states by the massive expansion of credit, backed by this asian subsidy, which has flowed into finished goods and assets such as stocks, bonds and housing even as consumer prices have seemed to show no inflation at all.

this was a policy direction that in the 1920s thrived until it couldn't. once the asset bubble broke in 1929 and leverage became the enemy, further furious efforts at policy reflation did little that lasted. heavy discount rate cuts, massive open market operations -- with bank reserves in late october 1929 expanding by 10% in just one week thanks to federal reserve operations -- and fiscal stimulus packages stemmed the stock market fall in mid-november after three weeks, the dow industrials having fallen by 50% from its september 3 high. what then followed was a 5-month, 60% rally which recovered just over half the initial decline.

britain, however, had already suffered terribly in the 1920-21 depression and had been in a depressed state throughout the 1920s. policy reflation in the aftermath of the first world war had never really offset postwar credit contraction. returning to the prewar gold exchange rate in 1925 (a political expedient) further crippled british exporting, the core of its economy, by making the pound too expensive relative to other currency-debased european economies. subsequent attempts at policy inflation had been subsidized by america, and when that ended depression struck.

britain's novice labour government too attempted for some time to maintain gold convertibility, wage rates and government spending, but in 1931 finally cut government spending and wages radically to put incomes in line with the reduced cost of living. this gave more efficient lines of business a chance to return to profitability quickly, while the earlier boomtime malinvestments in coalmining, shipbuilding, textiles and steel continued to be liquidated until 1934.

in the united states, however, the government embarked upon the new deal -- first under herbert hoover and then franklin delano roosevelt. the primary object of the program was to support aggregate demand by maintaining high wage rates (through government coercion and then make-work employment) and prices (through price controls), which were wrongly seen as guarantors of consumer demand rather than the outcome of corporate profitability. overpriced labor through 1931 helped lead to mass corporate bankruptcy, accelerating forced asset liquidation and bringing more severe unemployment than was seen in britain. by 1933, this process had forced widespread bank failures and the most thorough systemic deleveraging on record.

there are differences here, but parallels can be drawn from 1920s britain to the need of the 21st c united states to draw on chinese credit throughout the last decade in order to facilitate reflationary efforts of modest effectiveness. modern china has also adopted highly inflationary policies to create a very overextended financial and corporate system, one that would seem to be deeply vulnerable to a potential asset market collapse. should the chinese bubble pop and its offer of credit to the united states be curtailed, the effects in the united states would be incredible -- this would be what the bank credit analyst has called the end of the debt superycle.

at this point, of course, that has not happened. foreign capital inflow has remained strong and continues to be strong. until events in china cut the tether of credit, one should expect the united states to muddle through short of depression no matter how overlevered.

jeff saut of raymond james yesterday called for a strange sort of recession.

By studying the charts, one observes that until recently recessions have been a normal conclusion to the business cycle. As seen, however, recently this has not been the case. In past missives we have railed at the central banks, as well as the politicians, for their continuing efforts to prevent the normal business cycle from playing. They did it again last week when the Federal Reserve panicked and cut interest rates by 75 basis points with a concurrent $150 billion economic stimulus package from the politicos. And if this is a typical recession, such maneuvers will likely ameliorate the downturn. But, what if this isn’t “your father’s typical recession?”

Consider this: typically a recession follows a tightening cycle by the central banks causing the entire interest rate spectrums’ yields to rise sharply. Clearly, this has not been the case. Moreover, recessions tend to occur in a high “real” interest rate environment where interest rates are higher than the inflation rate. Currently, when you compare the nominal, or headline, inflation rate to ANY of the government complex of interest rate yields (Fed Funds, 2-year T’bill, 10-year T’note, etc.), you find “negative” real interest rates. Ladies and gentlemen, negative real rates have always sewn the seeds of economic recoveries. Further, recessions are accompanied by soaring unemployment reports, and hereto this is just not happening. [here i disagree.] The final ingredient of the typical recession is a huge buildup of inventories, but given the current record low inventory-to-sales ratio, this too doesn’t “foot.” Therefore, if we are entering a recession, it is probably a financially-induced recession and not your father’s typical recession, begging the question, “Will the typical remedies work?”

How we got into this mess can be directly traced to the “powers that be” attempting to stave off the normal business cycle via the engineering of a too-low Fed Funds interest rate (1%), too much liquidity (pumping up the money supply), and a financial complex that spun the situation into a spider web of leverage resulting in an enormous abuse of credit. ... The question du jour is, “Will the rate cuts, combined with the economic stimulus package, be enough to prevent the normal ending to the business cycle even if this is not your father’s typical recession?” Evidentially, the D-J Transports think so given their 7% rally last week! Yet even if successful, the nation faces a painful deleveraging process that will take time. As John Stuart Mill wrote in 1867, “Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed into hopelessly unproductive works.”

so perhaps the united states is for now stuck in limbo. with a crippled financial system and heavily indebted consumer sector with a negative savings rate, it would seem the pump is primed for a reduction in both the supply and demand for credit. but with the entire construct still being supported by chinese capital and receiving massive government stimuli in the hopes of sustaining the unsustainable, it seems just possible that the final disaster may yet be deferred even as housing continues to deflate.

at this point, my eyes turn to china. would a stock market collapse end the inflationary mania that has helped to keep the united states afloat? i think quite possibly so. many chinese companies are doing what american companies did in the 1920s to improve profits -- that is, ignoring their lines of production to borrow and speculate in equities. dumb money had of course already been piling in at record rates. a crash and rapid exit of foreign speculative capital could have massive ramifications across corporate and banking sectors, with banking having been acknowledged for some time as a potential weakness. (more on the subject from brad setser.) and the pattern frankly looks very pessimistic, with chinese 'A' shares down 27% from their highs three months ago and still making new lows.

i think rothbard and his acolytes would have to suggest today that the terrific (and global) credit inflation of the last several years has already baked in a terrific (and global) recession. and i think as a group they would oppose the kind of stimulus packages which we are seeing that amount to anti-market measures. but whether or not that recession and liquidation of non-performing loans leads immediately to an american (indeed global) depression is quite possibly going to be decided in china because the american government is going to try to reflate until their source of credit is removed.

UPDATE: some more on china's internal economic condition via russ winter:

There is a chart ... from CLSA Asia-Pacific and shows PMI input and output costs. Both are rising, but input costs are racing far ahead of outputs, indicating unprofitable, money losing make work activities.

- Account receivables are up 20.3% yoy running far ahead of reported GDP growth. This is reminiscent of the tech bubble when companies generated sales via extremely lax credit.

- Inventories are up 18.8% yoy. I think much of this is crack up boom input and commodity hoarding. At any rate it is far ahead of the overreported malinvestment influenced GDP number.

- Fixed capital formation is now 41% of GDP. This makes zero sense now, and is probably 8% too high in normal times. These are not normal times, and I expect that to plunge taking away ALL of China’s GDP growth, perhaps even pushing it negative.

-Real consumer spending growth is 10% adjusted for inflation. It’s been that way for several years. Not really even close to what you would expect for this supposed great “decoupled” economy. Once inventories and labor is liquidated by poor demand and Road Warrior economics, that 10% will too.

indeed, CLSA's january china PMI report said as much:

"Activity indicators ticked up in December after November’s sharp fall. But the key issue revealed by the December PMI was not the pace of growth but inflation and margin pressure. Both the output and the input price indices rose to new highs. But, as in previous months, input price inflation is far above output price inflation squeezing profits. Pressure to control costs is apparent in a wide range of the PMI indicators. Finished goods and raw materials inventories are being reduced and for the first time in more than a year employment is being cut."

in short, commodity inflation -- a byproduct of runaway credit growth -- is killing profits and choking off manufacturing activity. the chinese government is installing price controls to prevent further inflation, and that has had the predictable effect of creating shortages as goods become underpriced. but bank credit is now tightening, as can be attested by house price declines in boom-center southern chinese cities. these are ominous warnings, and will be compounded (as brad setser repeats) by a slowdown in exports to both america and europe as credit tightens in both areas. it seems to me that problems are growing in china now, and the 'A' shares could be indicating that they will be forced to a head sooner than anyone imagines, making sites like china economic review regular reading.

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Monday, January 28, 2008


first mainstream mentions of credit default swaps

i was in naples -- where housing conditions are unbelievably bad, as the folks i talked to were only beginning to understand -- this last weekend and happened to catch over a dinner cocktail a bleak 60 minutes report about the housing bust. i never expect new information from something like television news, but it's often a barometer for how far into the kubler-ross cycle we are as a society. we're past denial now, at least -- but there was still no mention at all of either negatively-amortizing pay-option arms or credit default swaps. this even as bank of america is forecasting "disaster" (their word) if ACA is allowed to go into default and cash settlement becomes the only way out.

but tonight i caught wind of this piece in the washington post.

The astonishingly rapid evolution of swaps took place largely outside the view of regulators. Many Wall Street investors now say that these side bets may have magnified losses in the mortgage industry because they pulled in unrelated investors and financial institutions.

An example of this danger came to light when a little-known firm called ACA Financial Guaranty caused some of Wall Street's biggest banks to write down billions of dollars in holdings, restating their value on corporate balance sheets. ACA revealed last month that it had promised to cover $60 billion worth of mortgage and corporate debt, but had enough cash to cover only a fraction of that. Merrill Lynch, Citigroup and financial institutions in Canada and France, which had all sold swaps to ACA, set aside billions in case the firm collapsed.

ACA isn't the only firm that took on more swaps than it could handle. Two of its larger competitors, MBIA and Ambac Financial Group, had also promised to cover massive losses in subprime mortgages but now say they don't have enough cash to do so.

That shortfall is threatening MBIA and Ambac's $1 trillion business of providing insurance to companies and municipalities that issue bonds. The prospect of losses rippling across the bond markets has pushed banks and regulators in New York and Washington to craft a multibillion-dollar rescue package for the firms. It could involve a cash infusion of up to $15 billion.

With the possibility of a recession and the global financial system unsettled, federal officials say the swaps market has become a primary concern. Since swaps are traded privately, outside any exchange or clearinghouse, it is difficult for regulators to know how losses can spread and who is making the riskiest bets.

"Given the size of the market now and the lack of public information on who holds what . . . this market will be really tested for the first time if we do see a big round of defaults," said David Munves, head of capital markets research group at Moody's. "It's a risk factor no doubt."

so there's some progress. more on the nascent monoline bailout via bloomberg.

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Thursday, January 24, 2008


monoline bailouts?

there are a lot of technical reasons for a bounce here, but one reason to hope that it might be durable emerged (via dash of insight) in the possibility of a bailout for the monolines.

the greatest possible disaster that could emerge from this bear market would be a downward spiral of counterparty defaults in the credit default swap market. this would head off the most imminent threat in that direction.

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Wednesday, January 23, 2008


the chicago housing slump

mish references this crain's article on chicago housing.

Builders sold 2,196 units in the quarter, a 51% decline from the year-earlier period and the biggest quarterly drop since the residential slump began more than two years ago, according to Tracy Cross & Associates Inc., a Schaumburg-based real estate consulting firm. Homes sold in the quarter at the slowest pace in 15 years, the firm says.

The housing downturn, longer and deeper than most people expected, has rippled through the local economy, hitting businesses like Warrenville-based Neumann Homes Inc., which filed for Chapter 11 bankruptcy protection in November, and USG Corp. of Chicago, which saw its third-quarter profit plunge 95% amid weak demand for its wallboard, a key residential construction material. Chicago-based publisher Tribune Co. has seen a steep drop-off in real estate-related advertising. And big-box retailers Target Corp. and Home Depot Inc. are tapping the brakes on plans to expand in the suburbs as residential development slows (Crain's, Dec. 24).

prices need to fall further and faster, as last year's chill has become something much more.

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and now for something completely different

A BOUNCE! call me crazy, but with the banks up 8% there's a ton of short-covering afoot to propel the rocket. and someone is exiting treasuries as well -- the yield up to 3.42% from under 3.30% this morning! this is what every long wants to see off a probe.

what next? i'd still suggest that a 5-15% shot in the s&p off the bottom is probable, if in fact this is the floor, and it might take just a day or two to get there. something like s&p 1378 to 1440 -- and note the moving averages for resistance as well: 21sma @ 1415 and falling (+5.8% from today's close of 1338) and 50sma @ 1440 (+7.6%). in the NDX, 21sma @ 1985 (+11% from 1790) and both the 50sma and 200sma @ 2025 (+13%).

then, at some point after that if all goes according to plan, a revisitation of the lows or worse. there is some possibility of a spike bottom here too -- but, as was seen in 2000 and 2001, not to mention august 2007, those don't generally hold for the long run.

afraid to trade mentions that the sectors one wants to see advance are advancing and today did so in size -- but short-covering is probably the majority of the buying here, as short interest in these sectors is surely massive.



... here's that probe

the s&p opened down again this morning at 1285, accompanied by another huge fall in the treasury yield -- the ten-year yield now under 3.30%! on december 26, the yield was about 4.28%, meaning that over 19 days it has fallen 23%.

i have data for the ten-year back to 1962, and this is the fastest such fall in the data. that is not to say that this is the worst, however -- comparable points include the spectacular 29-day collapse in march and april of 1980, where the yield over 29 days fell 24%. in the aftermath, the s&p rose from around 100 to 142 in november.

the nasdaq 100 opened as low as 1725 on the heels of apple and ebay news, undercutting yesterday's low slightly. 36% of the 100 notched a new yearly low yesterday -- a reading on par with the very worst days of the 2000-2003 collapse, with the 1998 long-term capital crisis, with the 1996 "irrational exuberance" downdraft. there is a pretty important level around 1711, and after that potentially an air pocket to 1485 (gulp).

sentiment measures are getting very bullish now as well, with small traders very bearish. the financials are also seeing some buying -- the banking index is up 5% at 10:45 -- stemming the downside leadership of the sector. indeed, real estate, transports and consumer services have also been improving in terms of relative strength in the aftermath of january 9 -- this was also a notable precursor to the reversal off the august lows.

another observation -- both yesterday and today saw massive drawdowns interday (that is, overnight in the futures market, from the close to the open). yesterday's intraday trade (that is, during regular market hours, from the open to the close) was quite positive. this is something i've studied a bit with respect to the nasdaq 100 -- when interday trade becomes significantly negative over some span of time while intraday is improving, it often spells out at least a local low. the rationale is that the premarket futures can be used to push stocks lower with relatively little money, washing out weaker hands and allowing stronger hands (presumably the same folks selling the premarket down) to accumulate. the timing, however, is imprecise.

studying the 21-day average of both intraday and interday points as a percentage of the 21-day moving average of the NDX itself, we're getting exactly that condition -- index value gained/lost intraday (during trading) has been improving since january 8, while index value gained/lost interday (overnight) is spiking lower.


Tuesday, January 22, 2008


blast, cut, bounce and...

the terrible impending open for the united states was met with the predicted move -- a 75bp cut from the fed. argue moral hazard and i might agree, but this is what the fed has the tool for.

the market response was to pull premarket s&p futures off the 1255 floor to open near 1274 -- and the rally has kept going through this writing, now at 1306. that still down (-1.5%), but a damn sight better than the (-5%) that looked likely. it was still enough to send the VXO to the moon -- at 39, 50% over its 10sma -- and brought in conspicuously strong ISEE readings, which i've anecdotally noticed at the start of recent strong bounces.

will it hold? beats me. but i thought the whole shooting match was putting in good action on friday with excellent risk-reward characteristics, and there's still a plan in place. i have to admit that the shocking intensity of the decline has me inclined to expect a bounce on the larger side of the suspected 5-15% range when it comes. dr. steenbarger notes the precedents and they are opportunities. kevin depew is also noting the extremely low nyse bullish percent index reading, which only rarely gets below 20%. (ditto the nasdaq.) i am not leveraged (unlike this poor soul) and so can wait if i choose, however painful it is. if the low is taken as s&p 1252 (the 38.2% fibonacci retracement level of the entire 2002-2007 bull run), a 5% move up is 1315; 10% is 1378 -- a huge resistance level; 15% is 1440, another tremendous resistance level. but of course watching the 20-day measures will be paramount, not price targets.

UPDATE: end of day, and the markets never could recoup all the losses, with the s&p closing at 1310. there's a pretty high-volume reversal bar now standing atop a low of s&p 1274.

was that "it"? apple's earnings disappointed after the close, so fragile futures broke down yet again with the s&p rolling back to 1300. today there were panic rate cuts, volatility spikes and high volumes. the ten-year treasury has put on its greatest 17-day run in at least the last 50 years, and other nearby timeframes confirm its place among the great flights to quality of the half-century. there is now a truly spectacular fraction of s&p 500 issues hitting new yearly lows -- a shocking 44%, last exceeded in october 1987. but i somehow wouldn't be at all surprised if there was a probe back down to s&p 1252. (nor would others, it appears.)


Monday, January 21, 2008


an absolute crushing

asian and european stocks were hammered monday with the american market on holiday. the economist:

Share prices have now fallen far enough that European indices are in bear market territory having dropped 20% from their peaks. Indices for smaller stocks in Britain have fallen by a similar amount. However, it takes more than just a big percentage fall for a bear market to be officially under way; the decline also needs to be long-lasting (the 2000-02 decline was a classic example).

The markets have had short-term 20% declines in the past (1998, for instance) only to rebound quickly. Indeed, what was remarkable about the long bull run from March 2003 to June 2007 was that it occurred without any such corrections.

Share prices have fallen so far and so fast that an attempt at a rally seems almost inevitable. What may determine if this is a correction or a bear market is whether that rally can be sustained for more than a day or two.

waiting for that inevitable rally has been an expensive proposition. american futures figure to open down about 4.5% tomorrow morning, with the s&p near 1260. this from slope of hope about sums it up for me -- nothing is more frustrating than being a habitual bear who has seen trouble coming for a long time and managing to be long this mess anyway. fine, fine trading there.

the silver lining -- if there is one -- is that something unusual often has to happen. there have been entirely too many folks (myself included) willing to cast about for a bottom. maybe we all need the shit scared out of us to put in a floor, and maybe this is it. (did i just call another bottom? sigh....)

if the fed brains are ever going to offer an emergency intermeeting cut, it's very probably going to come tomorrow before the open. this is exactly the situation such cuts are designed for. their ruminative dithering may be calculated to be so, but it is the worst thing for the markets. to be sure, the psychology has gone so far around the bend now that a 100bp cut may not assuage but inflame.

one has to begin to suspect that, this time, things really are different -- or at least as they've not been in a long time. putting in huge numbers of new 250-day lows has always stopped market declines in the recent past dating back to 1984, but the s&p will (if current levels are held until tuesday morning) open down ~11% from january 9.

the percentage of issues trading below their 150-day moving average is sure to blast lower in tuesday's opening minutes, getting well under any standard level that marks oversold. is that where it stops? i'd have to submit that no one knows now. we might see a big bounce -- but (as mish notes) we could easily see a black tuesday for the history books, one that might very well be prelude to a rapid global levered asset unwind and worldwide depression.

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Saturday, January 19, 2008


reinhart and rogoff

via brad setser and the economist, a paper by economists kenneth rogoff and carmen reinhart contextualizing the american banking crisis.

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countrywide deal not sealed yet

per felix salmon:

The takeover takeunder is valued at $6.47 per share, but Countrywide is trading at only $5.11. How come? Well, have a look at the MAC clause (a/k/a section III 3.8(a) of the merger agreement), detailing the representations and warranties made by Countrywide...

there's skepticism in the market -- salmon himself notes that it's widespread. the $64 question: is it transient selling pressure from delevering arbitrageurs in the midst of a waterfall selloff? or is it an aggregate bet that bank of america won't close a deal that many had to justify by implying government pressure and aid?

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credit default swaps

from msn's jim jubak -- consider the next storm. this is the heart of the bond insurer crisis and counterparty risk.

i've talked about it a little -- corporate defaults are rising, and promiscuous financing has probably created a backlog of weak companies that survived for years on the easiest credit terms ever seen, with only shallow economic washouts since the 1990 recession. with the credit crunch finishing that, it would not be surprising to see corporate defaults "surprise" to the upside. as jubak notes, 12% or even more is not unrealistic; banks are currently forecasting just 5% by the end of 2009; bill gross has noted the scale of the issue.

Bill Gross, chief investment officer at Allianz SE's Pacific Investment Management Co, or Pimco, recently told investors that if defaults in investment-grade and junk corporate bonds this year approach historical norms of 1.25% (versus a mere 0.5% in 2007), sellers of default insurance on such bonds could face losses of $250 billion on the contracts. That, he said, would equal the losses some expect in the subprime-mortgage arena.

With no central trade processing of credit-default swaps, defining trading-partner risks can be a Herculean task. Mr. Buffett learned the difficulty of unraveling such complex instruments in 2002 when he directed General Re Corp., a reinsurer that had been acquired by his Berkshire Hathaway Inc., to pull back from the business of these swaps and other derivatives. It took General Re four years to whittle the business from 23,218 contracts to 197 by the end of 2006.

Doing so involved tracking down hundreds of counterparties to General Re's trades, many of which Mr. Buffett and his colleagues had never heard of, he says, including a bank in Finland and a small loan company in Japan, to name just two. One contract, Mr. Buffett says, was designed to run for 100 years. "We lost over $400 million on contracts that were supposedly" safe and properly priced, "and we did it in a leisurely way in a benign market," Mr. Buffett says. "If we had to unwind it in one month, who knows what would have happened?"

as we saw around the time ACA became incredible, parties are going around trying to find duplicate insurance. the cost, however, has exploded and in the end insurance simply isn't going to be available for most CDS as defaults stack up just as there isn't sufficient fire insurance if 12% of the country burns down -- the sums involved are much too large.

if any event has the potential of turning a recession into a depression, this is it. if several large counterparties start welching en masse, risk aversion will go through the roof.

it's often said -- and rightly -- that derivatives are a zero-sum game, and for every winner there is a loser. but that rather misses the point in my view.

for every loser there is a winner -- until some losers can't pay. most banks hold both winners and losers, as any bank balance sheet's derivative breakdown will show you. most of these massive portfolios are constructed to balance risks on the presumption that contracts will pay out.

but if a bank's winners turn up to be uncollectable and worthless, even a responsible portfolio becomes a net loser -- and the bank then has to move to protect itself in an environment, once sanguine, that will resemble a war zone.

this is not a remote possibility. among large CDS writers are the bond insurers and structured-finance hedge funds -- some of whom have surely made common practice of using leverage to write vast volumes of CDS to collect premium on the presumption that they would never have to pay. the use of leverage ensures that small premiums result in big returns on equity, and the likelihood of bankrupting the fund can be -- through the lens of efficient market theory -- be wrongly seen as a "six-sigma event". in any case, the operators behind the funds can count on the event to be at least a few years off, which is more than enough time to make a ridiculous fortune thanks to the heavily skewed reward system that lies at the heart of american-style irresponsible capitalism. it's a classic example of "picking up nickels in front of steamrollers".

i agree with jubak and gross -- the mortgage bust is a depressing prospect in and of itself, more than capable of leaving banks capital-impaired for many years as was seen in japan from 1992 forward.

but the true barely conceivable disaster in all this is that the housing bust would provoke a consumer-led recession that forces corporate defaults in sufficient number to push several large CDS counterparties -- like ACA, ambac, MBIA but also invisible hedge funds -- to insolvency. that is an process which could trigger the kind of cascading bank failures that haven't been seen in the united states since 1933. money center banks simply don't have anything like the capital to sustain the probable losses that would emerge from an unbalancing of their derivative portfolio.

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Friday, January 18, 2008


the bush stimulus plan

via housing wire.

i won't go into the details, but i really tend to think of economic and monetary outcomes such as deflation as less reliant on policy decisions (or who makes them) than the zeitgeist in which the decisions are made. all policy is reactionary -- we're certainly seeing that now -- and shaped by the context of events.

the reaction now is of course to inflate/reflate as best they can -- but the spirit of events will intervene upon plans and ultimately chart the course. reflation could easily be curbed/halted by an international debt repudiation. or (more likely at this point) the reflationary measures the government undertakes could simply end up insufficient in scope and timing to counter credit contraction from a truly massive high.

i won't pretend to know the outcome, of course. but i do suspect that reflationary measures will be surprisingly ineffective in the united states going forward -- indeed the primary beneficiaries will be overseas, as money supply continues to migrate to asia. i think in some respects that aspects of secular deflation began as early as 1998, and that reflating against the tide using credit expansion is becoming harder and harder almost regardless of the policy measures taken.

for example, to a considerable extent, what bush is proposing could be quite deflationary.

the idea is to give money to downscale consumers and have them spend it. that's great politically, but it's perhaps poor economic intuition.

the united states is experiencing a credit overload and revulsion, particularly among the consumer class. this is still in an early stage, but i would wager that by june recession will have deepened and people will be actively conserving (relatively speaking, of course). if you hand them $800 in that mindset, their use of the money is not going to be to blow it on three ipods.

if they don't need food, many will pay down their credit card or send it to their mortgage servicer. and the effect will be to reduce the velocity of money (or money multiplier), which will serve to slow economic activity yet further. for those who use it to buy food, i'd suggest they're already defaulting on debts -- which is another, more sudden form of slowing money. those who don't have debts to pay or food to buy will likely stuff it in a bank -- where the bank can sit on it for them, raising their reserve and capital ratios.

deflation in the aftermath of a credit revulsion is a very difficult problem for government to solve with stimulus. they will try what they can, but there's no guarantee that it will work. for my money, a better use of $145bn would be to recapitalize weakened american banks -- but that of course has far fewer political fig leaves to hide behind.

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first monoline downgrade

via housing wire, fitch today cut ambac to double-a. the ghoul of counterparty risk has officially visited wall street.

This is going to be felt in the mortgage industry, without question; a number of downgrades on various Ambac-wrapped MBS will be forthcoming. And, of course, the question of whether Ambac goes into run-off has to now be asked.

This story from Dow Jones gives a hint of insight as to what this downgrade might end up meaning for firms like UBS, Merrill Lynch and Citigroup — just looking at already downgraded ACA Capital:

Using Merrill as a rough model, Oppenheimer analyst Meredith Whitney says the top 10 bank underwriters of collateralized debt obligations last year may have to write off $10.1 billion of the $12.7 billion of their bonds insured by ACA. And that estimate is based on her assumption that the insurance is worth 20 cents on the dollar - above the level of Merrill’s reserve.

At the top of the list is UBS AG (UBS), which was the biggest underwriter of asset-backed CDOs in last year’s third quarter when ACA was most active issuing CDO insurance. UBS will have to write down $1.4 billion of its ACA-backed hedges, Whitney estimates. It is followed by Citigroup Inc. (C) - the biggest CDO underwriter in last year’s second quarter - with an estimated $1.398 billion of losses, and Merrill, according to Whitney.

Representatives for Merrill and Citigroup declined to comment, and UBS did not immediately respond to requests for comment.

ACA likely sold protection on about 7% of all asset-backed CDO insurance sold in 2007, Whitney estimated, and on 32% in the third quarter when UBS was most active.

Ambac is much larger than ACA, so this could get ugly. And just for the record, I hate to see this.

i've blogged about the monolines here, here, here and here. MBIA is surely next, now that the period of forbearance has apparently ended.

the question now is, what of it?

it is certainly possible that billions will have to be set aside or written down by major banks holding CDOs and RMBS backed by ambac's insurance. however, the slide of the monolines took enough time that many of the banks may have been able to seek and buy alternative insurance (at a cost) for those securities which they could not tolerate reserving against. while this is difficult long-run news for banks and municipalities, it may not be an immediate disaster.

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volume surge

volume through 1:30 is running wild -- 3.6mm shares on the NYSE, another 16% over the pace of the two previous heavy-volume days.

one point to make about volume: a great deal is made of the balance of volume, whether it comes on the uptick or downtick, and rightfully so. but one thing that often goes unstated in market declines is that someone is buying all this stuff. volume surges indicate huge selling, it's true -- but it also indicates huge buying at discounted prices.

here's a link to a chart of NYSE total volume, with 10ema plotted with the 50sma, and the s&p beneath. note how big spikes in the shorter average coincide with market bottoms -- but note also how large contractions in the 10ema (ignoring the annual holiday drop) tend to precede weakness.

the fact of the moment is that the 10ema of NYSE volume is reaching up to relatively high levels. just another point to consider.


Thursday, January 17, 2008


my belly hurts

as my daughter would say.

dr. steenbarger says what i would say -- improving TICK, divergent new lows against january 9 (20-, 65- and 250-day, nasdaq too, but particularly noticably in the nasdaq 100), very washed out ISEE sentiment, very washed out AAII sentiment, TRIN spike, low participation vs longer term moving averages (he notes the 200-day, also the 50-day) coincident with rising participation against shorter moving averages (i follow the 10-day of the s&p 500 and nasdaq 100), and now even a significant (18.1%) one-day up move in the VXO.

moreover, the ten-year yield has put in one of the greatest 14-day collapses in 50 years -- now down 13.3%, exceeded only at the aforementioned points.

it might go a bit further. i've tracked issues trading over their 150-day, and normally a big bottom coincides with 12% or so -- it's currently 17% in the s&p, 19% in the ndx.

but nothing's as good as old fashioned belly pain for a tell. that kind of capitulative emotion is being felt all around.

i'm stupid (and being unfairly punished! lol) to have ended up trying to catch the falling knife, but i surely would not initiate a short here. for what it's worth, s&p 1320-1325 should provide support.


my daughter would say that too, lol.

Hey, thanks for coming by and contributing to the Live chat. Much much appreciatated, your stuff was great.

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my pleasure, adam -- commiserating in the quality crowd you draw is really time well spent. :)

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philly fed number shocks

here's the january release of the philadelphia fed manufacturing report:

The survey’s broadest measure of manufacturing conditions, the diffusion index of current activity, fell sharply from a revised reading of -1.6 in December to -20.9, its lowest reading since October 2001 (see Chart). [footnote] Forty percent of the firms reported no change in activity from December, but the percentage of firms reporting decreases (41 percent) was substantially greater than the percentage reporting increases (20 percent). Other broad indicators also suggested declines this month. Demand for manufactured goods, as represented by the survey’s new orders index, fell dramatically, from a revised reading of 12.0 in December to -15.2, its first negative reading in 15 months. The current shipments index fell 17 points, from 15.0 to -2.3. Indexes for both unfilled orders and delivery times remained negative.

Weakness was also evident in replies about employment and hours worked. The percentage of firms reporting a decrease in employment (22 percent) was slightly greater than the percentage reporting an increase (21 percent), and the current employment index declined four points, to its first negative reading since September 2003. Weakness was most evident in average hours worked this month: 31 percent reported declines in average hours worked, 15 percent reported increases, and the average workweek index fell from 7.4 in December to -16.1.

hard to have a more convincing recession confirmation than this. (more from calculated risk.) meanwhile, on tops of employment ratio and manufacturing activity falling, the aaii bull ratio four-week average moved to its lowest point since the 1990 recession (31.4%). there's clearly some steep economic consequences emerging from the credit crunch.

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merrill writes off $15bn


The writedown included $11.5 billion to account for the plummeting value of subprime mortgages and related bonds called collateralized debt obligations. Merrill also reduced the value of bond insurance contracts by $3.1 billion, saying provider ACA Capital Holdings Inc.'s credit rating had been slashed below investment grade, making it a less-reliable counterparty. It wrote down leveraged loans by $126 million and commercial real estate by $230 million.

With its capital depleted, Merrill said Jan. 15 that it sold $6.6 billion of preferred stock to a group of investors including the Korean Investment Corp., Kuwait Investment Authority and Mizuho Corporate Bank. The transaction followed the sale in December of as much as $6.2 billion in stock. Thain has freed up at least $2.1 billion in additional capital by selling assets, including Merrill Lynch Life Insurance Co. and Merrill Lynch Capital, a financer of medium-size companies.

Merrill held $8.8 billion of subprime mortgages by June and $32.1 billion of collateralized debt obligations, or CDOs, securities packaged from mortgage bonds, loans and other debt.

Many CDOs were downgraded by Standard & Poor's and Moody's Investors Service as an increasing number of borrowers fell behind on home-loan payments, sending prices on some of the securities plunging to as little as 30 cents on the dollar.

this is MASSIVE -- merril reported holding just $38bn in balance sheet equity on september 30. new CEO john thain is hopefully (like his citi counterpart vikram pandit) finally being aggressive on revaluing those CDOs, but merrill is very likely managing writedowns to correspond to its ability to raise new capital to at least feign solvency. writedowns are very probably not over. (an analyst on bloomberg agrees.)

is it bottom forming? merrill is down a couple bucks at the open but above recent lows -- on the worst quarterly report in 70 years, that has to be construed as a short-term positive -- but s&p 1378, the most important trading number in the market, is overhead now and any rally will have to move past it.

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Wednesday, January 16, 2008


housing rental rates deflating

the incredible evaporation of credit underwriting standards that accompanied the securitization model pushed the prices of houses out of all proportion to rents as it made credit very plentiful and very cheap -- and this is now being corrected. but the attendant speculative mania had another effect, common in such booms, one of massive malinvestment in housing.

simply put, there are now too many houses in the united states. builders capitalized on what seemed to be (and, for a while, was) a money machine by sinking unprecedented amount of capital in comparison to GDP into residential investment and building an incredible number of residences -- significantly more than can be occupied.

and so oversupply in american housing is likely to lead to a general deflation of housing costs. cnn noted exactly that effect took hold in 2007, as rent declined in real terms.

According to data from Investment Instruments Corp. generated by their site and supplied the data exclusively to CNNMoney, the median monthly rental bill for a sampling of 10 metro areas all around the United States rose just 0.5 percent in 2007 from $1,457 to $1,465.

this makes sense, with rental vacanciy rates near all-time highs just as homeowner vacancy rates are. and in comparison to a 2007 CPI of 4.2%, one can see that real housing rents are deflating alongside real (and nominal) house prices.

i've long considered that the housing bust will likely be "over" when prices fall back into line with their approximate historical relationships to equivalent rents and to incomes. that would have been a difficult adjustment if inflation and employment had been maintained. but place a deflationary credit contraction in the context of significant malinvestment/oversupply and declining employment ratio, and the floor seems much further away -- and the return of hardship all the more probable.

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Good one on housing rental rates deflating. If you are looking for corporate housing rentals it doesn't matter if you are a corporate and searching for rental or properties or you own a property and looking to rent out can help. Their service is amazing.


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thomas palley on china

an interesting culturally informed opinion that raises hard questions about the westernization of china, something many americans take as much for granted as the westernization of the mideast -- with a proximate degree of unlikelihood.

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rare scenario

this is really pretty stunning.

the ten-year treasury yield has collapsed 11.68% in the last twelve sessions. that rate of collapse is usually associated with capitulative periods -- i mark only seven in the last 46 years. only one of those -- november 1981 -- was not followed by a large rally.

specifically, the following upswings in the s&p 500 emerged from the week of the signal forward. some occured at market bottoms; others after markets had already jumped off lows.

  • may 2003 -- 25% rally over following nine months
  • october 1998 -- 40% rally over following nine months
  • november 1987 -- 20% rally over following four months
  • october 1982 -- 30% rally over following nine months
  • november 1981 -- 5% rally over two weeks; followed by (-20%) decline into august 1982
  • april 1980 -- 35% rally over following seven months
  • november 1970 -- 25% rally over following five months

i've already marked out the rarity of the s&p new 250-day lows. this is an update. one can see lower levels of new lows made yesterday on the revisitation of these levels -- a sign of improving participation.

two of the three most recent points at which the treasury overbought indication signalled essentially (within a week or two) coincided with a spike in new yearly lows (october 1998 and october 1987); my new low data doesn't reach back before 1984. but eyeballing the index price one might imagine that the 1980 low was just such a point -- while the 1970, 1981 and 1982 signals, like the may 2003 signal, came a few months after the bottom had been put in.

intraday lows in february were 1363 in the s&p and the closing low in the nasdaq 100 in august was 1846. those levels would be down (-1.1%) and (-2.3%) from the intraday lows on august 9. with participation improving since then, this looks like a fine spot for a pretty big rally to take off from.

i made a very basic trading error in not respecting the declining participation signal of december 26, and i've been punished since for disrespecting the power of the market to decline even after the signal has aged. that's one for the books, but i take heart in noting at least that the fault was mine -- the metric i would have watched (rather than vacationing) and should have obeyed (once i got back) was clear enough, as i said january 3:

there had been real improvement in participation building from mid-november, particularly in the nasdaq 100, but that seems to be expiring from late december as seen in new monthly and quarterly hi-lo data. this is troubling. the depth of the plunge in november may not have been enough to bring in sustainable interest.

option market sentiment averages also don't seem to have gone far enough yet to merit a severe pullback. ... but the 5dma has reached up pretty far -- and we don't have data for the 2000 major market top in this indicator, meaning that we're potentially comparing apples to oranges.

on a closing basis to january 15, the s&p is down from december 26 some (-7.8%); from january 3, (-4.6%).

what's important is how to go forward, loss in hand. and so there's a plan to act on:

  1. treat current long holdings as a first-bounce trade with 5-10% upside from s&p 1380 -- a range of 1450 to 1520. watch 20-day highs and lows -- and close the long with extreme prejudice, particularly on any untoward expansion of new lows, even a single suspicious day. accept that each and every 5% move is unobtainable by your methodology.
  2. short any first-bounce reversal anticipated by 20-day new lows with the expectation of a retest.
  3. buy very aggressively on price retests of the intraday lows. often, 20-day hi-lo data will anticipate bounce timing, but downside risk should be quite limited.
  4. be unreasonable about cutting the long trade until either the second test is in, or a very plainly successful first test is in.
  5. be open to the possibility of much higher highs, in spite of whatever you think is happening. trade the charts, not the rationale.

UPDATE: and here it is -- a high-volume hammer up off of s&p 1367 and ndx 1848. volume on the nyse is running 10% hotter than january 10 through 2:30 (market time) and nasdaq volume 34%. looks the real thing to me -- financials leading the way.

UPDATE: a disappointing ending, with the indexes selling off from 2:30 on and ending in the red if well off the lows. still, financials (and housing) rallied strongly and retained their gains.



foreign capital inflow

per bloomberg:

``The report should alleviate concerns over foreign funding,'' said Michael Woolfolk, senior currency strategist at the Bank of New York Mellon Corp. in New York. ``We're seeing the return of investment that had been noticeably absent in the summer.''

or, as the BCA would say, not yet. it won't prevent recession, but continued inflows will probably prevent judgment day.

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Tuesday, January 15, 2008


more damage in citi, merrill, retail

per bloomberg:

Citigroup Inc. posted the biggest loss in the U.S. bank's 196-year history as surging defaults on home loans forced it to write down the value of subprime-mortgage investments by $18 billion.

The fourth-quarter net loss of $9.83 billion, or $1.99 a share, compared with a profit of $5.1 billion, or $1.03, a year earlier, the largest U.S. bank said today in a statement. New York-based Citigroup also reduced its dividend by 41 percent, cut 4,200 jobs and obtained $14.5 billion from outside investors to shore up depleted capital.

massive -- on top of everything that's already come -- an $18bn mortgage-related writedown is the largest so far, the 41% dividend cut that meredith whitney called months ago, another $4.1bn reserved against coming loan losses, and more new capital raised in the amount of $14bn. calculated risk has more, as does minyanville.

the pain isn't limited to citi.

The fourth quarter may be the worst earnings period for the financial industry since the Great Depression. Analysts estimate Merrill Lynch & Co., the biggest U.S. brokerage, will report a record loss of more than $3 billion after writing down the value of mortgage-related securities, and Bank of America, the second- largest U.S. bank by assets after Citigroup, may report its biggest profit decline since its formation in 1998 from the merger of BankAmerica and NationsBank.

Merrill, the biggest U.S. brokerage, said earlier today it raised $6.6 billion by selling preferred shares to a group including the Kuwaiti Investment Authority and Japan's Mizuho Financial Group Inc.

the worst quarter since the depression -- indeed, we are witnessing the return of hardship as the damage widens from a from earlier announcements.

compounded with today's news of an out-and-out decline in retail sales in the christmas season, on top of many other signs of very weak consumer credit, and bank failures look more and more likely as asset deflation takes hold.

Sales at U.S. retailers unexpectedly fell in December, capping the weakest year since 2002.

Sales dropped 0.4 percent, the first decline since June, following a revised 1 percent gain in November, the Commerce Department said today in Washington. Purchases excluding automobiles also decreased 0.4 percent.

Producer prices in the U.S. also dropped in December, against economists' forecasts for an increase. Wholesale prices fell 0.1 percent after a 3.2 percent surge in November that was the biggest in 34 years, a Labor Department report showed.

For all of 2007, retailers posted a 4.2 percent sales increase, the smallest in five years. Purchases rose 5.9 percent in 2006.

``Growth stalled out at the end of the fourth quarter and into the new year,'' Joshua Feinman, chief U.S. economist at Deutsche Asset Management in New York, said before the report.

this shouldn't be a surprise with consumer confidence falling apart for months now. citi's call reinforced the obvious -- consumer credit, especially that considerable portion tied to folks with mortgages, has become a problem.

is this a bottom clearing? possibly, with major banks reporting earnings this week. technically, the broader picture painted is a contrarian's delight -- a multimonth run looks to be possible here. but the formation of the low may take more time.

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Monday, January 14, 2008


the bottom in financials?

it's too early to tell, i think.

several major banks are reporting this week, and whisper numbers on 4q writedowns are astonishing, while sovereign wealth funds -- the hope of hopes -- gave the market a shank over the weekend.

i still maintain that the crisis is one of solvency, not liquidity, and that many smaller banks will be failing. moreover, a severe recession replete with corporate defaults is here and the fed is at an acute loss of truly effectively policy tools for this conundrum. avoiding the end of the debt supercycle will mean continuing flows of foreign capital into the united states in spite of a possible speculative collapse in the BRICs.

and yet, bank stocks have been driven down deeply -- and a plausible case for sufficient discounting can be made, in fact is being made by longtime bank critic doug kass on grounds of valuation and improving conditions. bennett sedacca is seeing isolated instances of risk compensation in the GSEs and MBIA. and the countrywide bailout is the sort of catharsis event that often marks turning points. and LIBOR is returning to something like normality in the aftermath.

i have to say that, on the charts, i don't entirely see it -- and i say that as a market long who thinks a fairly durable bottom could be going in at the recent lows. a bounce, yes. but the IYF financial component list was last week making new lows in cumulative points, cumulative volume, advance-decline -- not the sort of construction one would expect at a durable bottom.

participation -- against 30-day and 150-day moving averages -- is at 11% and 13% respectively. particularly against the 150-day, that represents a deeply oversold extreme -- and it's actually improved from august. i guess that's a positive divergence, but not much to hang the hat on. the washout last week also went to large percentages hitting new quarterly and annual lows -- 62% and 55%, respectively -- exceeding even august, a point from which the financials ran up about 12%, trough to peak, over the following couple of months. that sort of move is quite possible, in my opinion.

the example of the 44 KBW bank ETF components is more optimistic -- net points and on-balance volume have been constructive since the end of october even as the price of the index has slid along with the advance-decline line, both marking new lows last week. this would seem to indicate quiet accumulation in the largest of these banks for some time.

but a final low for the broader sector? color me skeptical. kass might have the price point about right, for all i know, but i would hesitate to be long even for a trade in the financials at this juncture. that will change when some construction in the IYF occurs, be it at this price level or a lower one. just not yet.

in the meantime, act on the plan!

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more on federal reserve limitations -- and the coming BRIC bust

i previously commented on the limits of what the central bank of the united states can really do to help beyond its ability to cut short term interest rates. "money rains" are much more problematic than many equity traders seem to believe, and the fed under ben bernanke has shown so far no proclivity whatsoever to actually print money.

i've also talked at length about the inefficacy of rate cuts -- a liquidity measure -- in a systemic bank solvency crisis, which is what we are apparently faced with. ben bernanke himself will tell you:

Although the TAF [term auction facility] and other liquidity-related actions appear to have had some positive effects, such measures alone cannot fully address fundamental concerns about credit quality and valuation, nor do these actions relax the balance sheet constraints on financial institutions. Hence, they cannot eliminate the financial restraints affecting the broader economy.

the depth of the solvency issue may have been underscored last week in bank of america's move to absorb countrywide, which many have speculated came at the encouragement and with the implicit backstopping of the government as countrywide faced imminent bankruptcy. this amounts to a government-coordinated and quite possibly government-financed bailout, with promises to BoA by the government to make them whole on eventual portfolio losses. more and more obvious bank recapitalizations/bailouts will probably have to be attempted in the coming months.

but what i haven't said, indeed hadn't considered much until now is the possibility that fed rate cuts may have little or no stimulative effect on the economy precisely because of how they work to expand credit and economic activity. paul krugman:

Monetary policy mainly exerts its influence through housing: high interest rates squeeze home construction, low rates encourage it. Interest rates have much less direct effect on business investment. The reason? Housing lasts much longer.

Suppose you take out a loan to buy a machine whose economic life is only 5 years — which is highly likely, given both physical wear and tear and technological obsolescence. How much difference does it make whether the interest rate on the loan is 4 percent or 6 percent? Not much: the monthly payment on a 5-year loan at 4% is less than 5% lower than the monthly payment on a loan at 6%. So interest rates don’t have much effect on business investment.

On the other hand, suppose you buy a house with a 30-year mortgage. The monthly payment on a 4% mortgage is more than 20 percent lower than on a 6% mortgage. So interest rates make a lot of difference to housing.

So here’s what normally happens in a recession: the Fed cuts rates, housing demand picks up, and the economy recovers.

But this time the source of the economy’s problems is a bursting housing bubble.

i think few informed parties question that cuts in the overnight rate are going to nearly nothing to bring back housing. as noted in the orange county register:

“Let’s say that the Federal Reserve lowers the Federal Funds rate to 2%, does this mean that we are going to start buying homes and U.S. automobiles again? The reason why nobody is willing to buy a home today is not that interest rates are too high; the reason is that home prices are too high. Nobody will want to buy a home today when they know that if they wait they could get the home for a large discount.

“This means that it does not matter what the interest rate is on mortgages; nobody is buying. And thus, it does not matter what the Federal Reserve does with the Federal Funds rate. And I actually believe the Federal Reserve knows this. They are well aware of the ineffectiveness of the Federal Funds rate to help bring back the U.S. housing market and/or the U.S. auto sector. Thus, I still believe that many of the Federal Reserve Governors are going to be reluctant to lower the Federal Funds rate even if they ultimately go ahead with a decrease in the rate on January 30th.”

if rate cuts are stimulative primarily through housing, but housing this go-round is unresponsive to rate cuts, it seems there may be relatively little fed policy can do to prevent recession from taking hold and even deepening over the next few years as housing excesses are worked off.

one avenue of positive feedback many economic eyes have been on is exports, which a plunging dollar has aided over the last few years. (of course, rate cuts have helped the dollar down.) krugman believes export growth to have been crucial in avoiding recession earlier in 2007, and so a perceived recent stall in export growth is of some considerable concern. the economist too notes that export growth was responsible for 30% of gdp growth in 2007 through september.

but i for one don't expect much to come of exports as an economic stimulus. first, exports are a relatively minor share of the american economy. second, credit contraction should have a deflationary effect that curtails dollar weakness against export market currencies like the euro -- rate cuts may simply not kick the dollar lower as banks limit the supply of dollars. third, the hypothesis of "decoupling" -- that foreign economies will grow right through an american recession and continue to demand american exports -- seems as specious and wishful a thought as it ever has been in the age of globalization; exported american and japanese bank credit has helped to fuel asset booms in china, india, brazil, russia and elsewhere, and its my opinion that contraction will pull the rug from under these highly-leveraged and (of late) very speculative economies.

satyajit das comments further on this last point:

While emerging market economies are likely to grow at a higher rate than developed countries, equity valuations and earning growth may not be sustainable. Earnings quality is variable and growth has increasingly been driven by investment income – stock market, currency and property speculation. Investment returns in many case are below the cost of capital and projects are predicated on high, continued economic growth well into the future.

Share prices are prone to being influenced by insiders and their associates. In the case of China, most traded shares are in government enterprises that continue to be controlled by the State. Some Chinese shares aren’t even really shares as they don’t convey full ownership rights equally to all shareholders.

The Indian and Chinese markets have been driven by a number of initial public offerings generously priced to provide investors (themselves privileged insiders) with large gains. A few shares contribute disproportionately to market performance. A handful of stocks drove the rise in India’s Sensex Index in late 2007 reflecting the lack of liquidity in many stocks. In China, restrictions on foreign investments by domestic investors and the lack of investment alternatives has contributed to the sharp increase in the price of Chinese stocks. Borrowings by corporations and individual investors have been channeled into the stock market creating dangerous levels of leveraged exposure to share prices.

indeed, it's quite possible that it's already been done. the FXI, an ETF of chinese shares, put in a double-top in october as the credit crisis spread, and has since put in a series of lower highs while holding 165 in a descending wedge. i have little insight on a slowdown in china's economy, but this looks for all the world like the beginning of a collapse in china's speculative mania. kevin depew notes that government efforts to rein in speculative growth may be taking hold, and barry ritholtz highlights the collapsing baltic dry index (a measure of international shipping costs).

does that mean the end of the debt supercycle? perhaps not. but i think it will mean that even very vigorous reflation efforts -- even if ultimately successful in staving off an international credit unwind, capital flight from the united states and deflationary disaster in the end -- will not allay a powerful recession in the nearer term which will not spare the BRIC nations.

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