Barry Rhitholz had this image of the House Price Index on his blog today:

Wouldn’t you think it would be redder?  Why are there green areas?  How can home prices be rising in 14 states - don’t these people know we are in the middle of a melt-down?  Don’t they watch CNBC?  Didn’t Cramer say no one should buy a home this year on every single NBC/GE station he could get his face on?  Doesn’t GE make a fortune bottom fishing the real estate market and taking over failing financial institutions?  Isn’t GE one of the companies angling to take over the GSE’s now that they are "in trouble" due to a housing crisis and isn’t is Jim Cramer telling you that FRE and FNM are "technically insolvent"?  By the way, I love that his video clip is sponsored by Qatar!

In that same clip Cramer says "We don’t want oil to be down huge because there is too much of the S&P that is now oil."  This is like a doctor saying he doesn’t want to remove a 20-pound cyst because it’s too much a part of you now.  Cramer made these comments with oil at $140 on a day it was coming down from $145…  Cramer is also 100% wrong about BAC as his call for their demise was quickly reversed a week later.

It’s a big country out there and we have a very diverse economy.  There are 45 states in this nation where home prices have dropped less than 10%.  The problem is that the states that have dropped the most, Florida, Nevada, Arizona and California - have a LOT more market investors than every state that is positive except for Texas combined.  When you live in a state that has housing problems, your impression is going to be that the whole country has housing problems. 

Another issue with investors is their unbelievably short time horizons.  Investing used to be something you did over the course of years, not minutes but the mash-up of the Web and the Market have caused "crises" to come and go between breakfast and lunch and corporate news both thrives on the turmoil and steers the viewers towards whatever positions benefit their parent company.  When a crisis can be manufactured that benefits the parent company - so much the better!

Look at the chart above - those are pullbacks off RIDICULOUS prices that got so out of control that people finally stopped buying homes.  I bought my home for $400,000 in 1999 and it was "worth" $1M in 2006.  I told my wife we should sell and live in a hotel for a year as it would be cheaper than staying but we didn’t and we "lost" about $200,000.  The funny thing is, like 95% of all Americans in a similar situation, we are not selling.  We are paying the same $400,000 mortgage we had in 1999.  Yes, there are people who refinanced their homes at the top and "used them as a piggy bank" and those people have serious problems but there are also 35M homes in this country with no mortgage at all, so there is some balance to the system.

The comparisons we are being given now by the media, the "shocking" downturn in housing is by comparison what should have been portrayed as the shocking RISE in housing prices between 2003 and 2006 but was, at that time, cheer leaded by the same media as The Great Housing Boom.  The reality is that, so far, only the homes that were actually purchases at the top, since 2004 are "losing" value, the rest (75% of all homes) are still ahead of where they were bought. 

 You can look at this chart and say perhaps, that it looks like home prices may fall back to $175,000 but then, so what?  Even if we assume 10% of all US homes turn over each year, even getting back to $175,000 would only take us back to 2003 levels.  That means that 60% of the homes in the US are still selling for more than the owners paid for them and 40% have lost roughly 20% of their value.  Total damage to US housing value = 8%.  Now that’s 8% of $25Tn and nothing to sneeze at but it’s also not a reason to expect the entire nation to implode either.  8% of $25Tn is $2Tn and those losses sound massive in all the various ways you can assign them.  If 50% of the people who lose 20% of the value of their homes walk away and stick the banks with them and the banks are forced to sell them at a loss AND the banks lent out 100% of the homes’ value then the banks are looking at $1Tn in losses.

$1,000,000,000,000 is a very big number but those same banks hold mortgages on $25Tn worth of other homes and they are collecting 6% interest and that number is $1,500,000,000,000 EVERY SINGLE YEAR!  Obviously, it’s not all profits but, over the course of the entire mortgage, even $1Tn in losses (and currently it’s just $500Bn and most of those losses are paper ones as actual liquidations have been limited) is an absorbable number. 

Another number that "THEY" have had us panicking over is the GDP.  Last month, the preliminary GDP figure for Q2 came in at "just" 1.9% vs. 2.3% that was expected.  That number hit us on July 31st and dropped the market 200 points in 3 days, down to our August 4th test of 11,200.  While it is both fun and easy to panic over a headline miss, the fact is that the entire "miss" in the GDP was caused by an inventory valuation adjustment (housing again!) that knocked 1.92% off the GDP of 3.82%.  The downward adjustment in inventories masked a lot of very good growth that went on under the radar.  We just went through Q2 earnings and there were relatively few misses there and even guidance was mainly in-line with expectations - not very crisis-like behavior..

Even with this "terrible miss" in the GDP, it was still 1% higher than Q1 and that was 1.1% higher than Q4.  So our past 4 quarters had a GDP of 4.8, -0.2, 0.9 and 1.9, that is an average growth rate of 1.69% for the year - not great but not a crisis by any stretch. 

Government spending makes up 20% of the GDP and was up 3.4% last quarter but, as long as Bush is in charge, we can rely on that to continue at this out of control rate.  We know exports have been strong and we can expect an uptick in the PCE as the stimulus checks filter through the system.  Residential investment (mainly home construction) is falling less after bottoming in Q4 and much of the rest of the numbers depend on oil, which peaked out right at the end of June and if we can make it past this hurricane season, we may be getting the opposite effect as it comes down in Q3 and Q4.

While we’re not throwing caution to the wind, we are doing our bottom fishing as there are many great companies out there being sold as if we are entering another Great Depression.  The only thing that is depressing in this country is the quality of the leadership and there is nothing here that can’t be addressed by some good, solid policy making that starts by addressing the problems that those 100M homeowners are facing.   High oil prices can be curtailed and mortgages can be refinanced but we need leadership and action, not just bickering and empty promises.

We get the GDP numbers at 8:30 tomorrow morning and the markets may make a huge move up if things go well.  I reviewed the Long-Term Portfolio last week for members and there were many buying opportunities there if you believe America will survive.  If not - there’s always gold and NEM is looking attractive in the low $40s as is ABX under $35.

Today’s tickers: VIX, XLF, GE, LEH, C, RIMM, AMD, STI, TLAB, ALO

VIX – CBOE Volatility index – It used to simply be the case that when markets plunged, volatility spiked and it was easy to lay the claim that the option market was the heartbeat of the investments world. But with the major indexes in virtual freefall today it’s far from a naïve to wonder why implied volatility is relatively low. Sure, the CBOE VIX index is 11% higher on the session but its reading of 20.88 is still towards the lower end of its two-month range. The reality is that many investors understand the root cause of current market mayhem to be found in the books of financial companies. This explains why investors seem happy to use today’s volatility rally to take in premium of 3.3 points in the November contract on the 22 strike calls. It’s not necessarily the case that they anticipate lesser volatility going forward; it’s simply that they now expect any blow-ups to occur explicitly in the financial sector alone. More than one commentator has predicted further major bank failures before the markets capitulate.

XLF – Financial Select Sector SPDR – Because the VIX reflects option trading and volatility in all 500 S&P index constituents investors seeking shelter from financial fallout have increasingly sought refuge in the XLF SPDR. This is the real eye of the storm and investors have stepped up trading of options here shifting their focus away from the VIX and into the XLF. About 12 months ago on any given day overall XLF options volume would be around 2-3 times that of the VIX. In the last six months volume in financial options has rarely been less than five-times that seen I the VIX. Frequently the volume figure has been in the 10-20 times region sending investors a huge hint as to the continued longevity of the crisis. In Monday’s trading an investor sold premium in the October contract where calls at eth 21 strike were sold at a premium of 1.11 as the underlying moved lower. But today we are seeing some contra plays in the XLF options. One investor is calling a floor under the market by January 2010 where a block of 8,000 puts were sold at the 18 strike for a premium of 2.50. That’s plenty of time to see the wounds heal although it’s entirely possible that the XLF could still be languishing beneath breakeven at $15.50, which would represent a decline from present of some 25%. Elsewhere the March at-the-money straddle at the 20-line was sold 5,000 times at a combined premium of 5.05. Such a play indicates that an investor currently seeks to take advantage of elevated implied volatility (38%) and expects the sector to remain hemmed in between $14.95 and $25.05 over the next seven months.

GE – General Electric - With a little over three weeks to go before September’s options expiration an investor seems to be less pessimistic over the prospects for shares in consumer-giant, General Electric, than today’s 2.7% share price decline otherwise shows. While we can’t tell if this is the action of one trader, but a look at the footprint left by time and sales data indicates to us that a premium seller is content to wear the risk of a further decline in shares at the conglomerate beneath $25.80. An investor appears to have sold almost 20,000 puts at the September 20 strike for 20cents earlier today, which would imply risk piling up in the event of a further 8.8% decline in the share price. There is also significant activity of 16,000 lots at the lower 24 strike where options were sold for just 8 cents premium. If we’re reading the direction properly today this is a fairly brazen risk to take unless the premium seller already has a short position in the stock and doesn’t mind buying at the $26.00 strike.

LEH – Lehman Brothers - Options implied volatility stands at around 156% on Lehman’s to start the week and once again its shares are one of the most actively traded options series at the start of the week. Financial shares are broadly lower and last week’s enthusiasm for Lehman’s has taken an 8% setback today. Early trading in options at the front September contract was perhaps indicative of some strangle selling across three strikes, before a clear trend emerged showing greater appetite for puts at the 10 and 13 strikes. There was again some buying at the 7.5 strike . In the deferred April contract an investor has traded 1250 puts at the 10 strike at a cost of 2.37, which is a little changed on Friday’s closing price. In the January contract the 15 puts have also traded close to 2,000 times at 4.75. Implied volatility there stands at 112%. If this investor is buying puts they clearly feel that the drama has longer to run and shares must move significantly lower to see this trade break even.

C – Citigroup Inc. - bucked the poor Wall Street start as its shares rose for most of the morning. The options data seemed supportive of this rise while a decline in options implied volatility also suggested a loosening of the stranglehold around the neck. Most options volume appeared at the September 20 and 22.5 strikes where almost 10,000 lots traded. Premium at the latter eroded 20% over the weekend and this investor was picking long equity rights here at just 8cents. Nevertheless shares in Citigroup would still need to rebound by 22.6% between now and expiration in three weeks time to break even.

RIMM – Research in Motion - After a positive start, which saw shares buck broad technology market weakness today, RIMM dropped 2.4% to stand at $128.00. It’s difficult to see any stand out trade here – calls outpace puts by 40% at this hour but no broad position sticks out to us just yet. RIMM’s share price is once again pushing up against resistance at $135, which represents a 2-month high. The at-the-money calls seem most active but volume profiles don’t suggest any sizzle above the 52-week high at $148.13.

AMD – Advanced Micro Devices - August has been a good month for AMD whose share price has risen 50% from a 52-week low at $4.00. Today its shares are defying gravity and are 3% higher at $5.95. Its options volume registering a reading of 20,000 by lunchtime is indicative of further bullish positioning in the coming weeks. Call trading is almost five times that of put trading today with September 5 and 6 strikes well sought after. The 7 strike is heavily traded in the October contract. Both options implied and historic volatility remain elevated and close to 70% on this company.

STI – SunTrust Banks Inc - An investor clearly believes that there is the potential for the share price at SunTrust Banks to head lower again. Its shares have rebounded sharply above the 52-week low of just above $25.00 back up to $47.50. However, today’s 5.8% slide to $40.26 was accompanied by what appears to be a fresh put spread at the October 35 and 40 strikes at a net premium of 2.00. Should its shares decline to $35 or below at expiration the investor would reap a maximum of $3.00 per contract on this bear play.

TLAB – Tellabs Inc – With shares neatly off a 52-week low, an investor has traded a tidy 8,000 block of September puts at the 5.0 strike for a dime. Shares are slightly lower today at $5.29, but this could be a closing trade judging by existing open interest numbers. The volume represents 13-times usual activity.

ALO – Alpharma Inc – With shares at $35.77 and standing proud by 3.7% today, options volume – although thin – is above average with a 750-lot trade in the December contract at the 25 line for 10.00. It’s a significantly in-the-money trade and could be a closing position.

Oil is down at $113 pre-market despite a new hurricane (chart thanks to Trader Mike).

That is fabulous news and, if that sticks through the day, it will be our best chance to turn this puppy around again.  Commodities in general are turning down on a rising dollar and declining global demand that is not going to be reversed just because Olympic driving restrictions have been lifted in Beijing.  Commodity investors have been operating in a very special fantasy land based on hope:  They hope for shortages, they hope for war, they hope for terrorism, they hope for natural disasters, they hope for price manipulation by OPEC or the US oil cartel or NYMEX crooks and they hope that people are so dumb that they will continue to buy petroleum products no matter how outrageous the price gets.

While a lot of those things happen some of the time, they don’t happen all of the time and, in the course of this ridiculous run since Jan ‘07 from $50 to $147, they have burned up every one of those excuses at one time or another to add another $5 to the price of oil.  Unfortunately for energy bulls, what they have now done is set a price premium that can be defined.  What happens now when OPEC doesn’t cut production?  Down $10.  When a hurricane doesn’t come?  Down $5.  When Nigerians don’t blow up a pipeline this week?  Down $5.  When they can’t create a draw in the weekly inventories?  Down $5… etc.

Now the oil companies are at odds with the refiners, who are not dropping consumer costs of refined product as fast as the cost of a barrel of crude is falling so demand destruction is proceeding apace despite the 30% pullback in the price of oil since the disastrous July 4th NON-driving weekend.  In fact, had it not been for the stimulus checks, which were effectively Bush’s thank-you gift to the oil thieves as they allowed the record run in crude to happen (oil was $100 before this mad scheme was unveiled), gas purchases would have fallen right off a cliff this summer - the same cliff they are now diving off now that people have to spend their own money on fuel.

I wrote my article entitled "$200 Oil - Who’s Going to Pay For It?" in response to Goldman’s ridiculous call that oil would hit $200 this year.  That was March and, since my former CEO wasn’t running the Treasury, I had no idea at the time that the government would be footing the bill for a massive spike in oil.  At the time, oil was below $100 a barrel and too high at that price and clearly people were running out of money (see article for all the math).  In order to pay $150 a barrel for oil, US consumers need $3Bn a day.  If we assume $70 is the real price of oil then $150 oil needed Americans to fork over an extra $1.6Bn per day.  What a coincidence than, that a stimulus of $160Bn was just enough to cause a 100-day run in the price of crude…

Now we are back to reality and cash-starved consumers must allocate their spending and, as you can see from the above chart - again and again fuel consumption is being sacrificed in favor of fun things like paying off debt.  When gas was $2 a gallon, not going to the shore for the weekend would save you $30 and wouldn’t seem like  a reason to skip the trip but at $60, suddenly it becomes a factor.  The problem for the oil pushers is they lose not just the extra $30 but the original $30 they would have gotten had people taken the trip - that’s demand destruction!

China is skirting the effects of demand destruction because their fuel is subsidized but Sinopec just reported a 77% decline in net profit as the subsidies eat into their margins and PTR also reports this week and is expected to show similar problems.  Now that the Olympics are over, the next shock for oil bulls iis likely to be China’s RAISING of fuel prices and even 10 cents a gallon is a lot when the average person in China makes just $2,400 a year.

Oil is sucking the life out of the entire global economy, the MSCI World Index we discussed in yesterday’s post dropped another 0.8% yesterday, now down 17% for the year yet the EIA continues to project bullish global growth in demand for crude despite evidence of declines in many countries besides the US. “The economic outlook is very negative,” said Gregor Smith, a London-based fund manager at Daiwa Asset Management, who helps oversee $1 billion. “If we continue to see economic weakness, then corporates will continue to cut spending. Uncertainty over global demand and high energy prices continue to make the market nervous.”  The Ifo institutes’ business climate index declined to 94.8 in August from 97.5 the previous month. Economists had predicted a drop to 97.2.

Fortunately, thanks to a boom in shale production, natural gas production is up 8.8% this year, the largest increase in production since the drilling boom of 1959.  Natural gas prices have dropped 42% since early July, outpacing oil on the way down (so far).  “Production is clearly growing, and the growth is sustainable,” said Michael Zenker, a natural gas analyst at Barclays Capital. A Deutsche Bank report, by the analyst Shannon Nome, recently estimated that production from the eight largest shale fields was likely to hit 6.6 billion cubic feet a day this year, or 11.8 percent of national gas production, and then rise to 14.5 billion cubic feet a day by 2011 — almost a quarter of domestic production.

“Shale is the most significant domestic natural gas find in 50 years,” said Chris Ruppel, an analyst at the institutional brokerage firm Execution, “which means the United States will become gas independent, and more industrially competitive versus Europe for gas-intensive industries such as chemicals, fertilizer, smelting iron and aluminum.”  With the growth of power generation from natural gas, the Energy Department estimates that gas consumption will increase 3 percent this year and an additional 1.7 percent in 2009. But that is well below expected supply increases.  So not all is dire in the energy picture, right T Boone?

Asia held up surprisingly well overnight with the Hang Seng dropping just 48 points and holding onto 21,000.  The Nikkei fell below 12,800 with a 100-point decline and Shanghai continued to tumble, dropping another 3.4% on the day.  The good news for the Shanghai is that 3.5% is half the point drop it used to be - see, there’s always a silver lining!  The IMF cut 2009 global growth forecasts to 3.9%, down from 5% last year and 4.1% this year.

Banks led Europe lower this morning as the Euro tumbled to a 6-month low on news that German consumer confidence fell more than forecast, to a 3-year low of 94.8, down from 97.5 in July.  At the same time, German business expectations fell to 87, the worst measure since the 1993 recession.  The German economy contracted in the second quarter and may enter an official recession if there is no growth in the third. “The deterioration of the outlook in Germany is showing no sign of stabilization,” Maxime Alimi, an economist at Lehman Brothers International in London, said in a research note. “The risks of a technical recession are certainly rising.”

Unfortunately, in the time since I began writing this article, oil has ticked back up to $116 on the hurricane news as well as official Russian recognition of the Georgian satellites (9am) and that does not bode well for the US open either.   We still have a very tight inverse correlation between the price of oil and the Dow’s performance and if we are going to get this market off the floor oil MUST go lower.  We have our own consumer confidence at 10am along with New Home Sales (expected 525K) and Fed minutes at 2pm so plenty of fun data to swing the markets back and forth. 

We need to watch our Big Chart levels that we discussed last night as it is critical we hold the line on the S&P at 1,261 as well as 12,350 on the Dow.  Let’s look for ths SOX to retake a still-pathetic 361.  That $115 line in oil is still critical too but if we can’t beat them we can join them by picking up some XOM $80 calls at $1.60 as a momentum play but we need to give up at $1.25 to the downside, looking for $2.20+ so a really quick play.

Other than that, we either hit our lower levels and start to cover up and roll down or we hold the line and sit back for the ride - it’s going to be a bumpy one for sure!