Last weekend I warned my bears: "DO NOT underestimate how irrational the markets can get."
I also closed the wrap-up saying: "Keep in mind I am generally bullish – just not this bullish, this soon!" It was "Just Another Manic Monday" and it was indeed a manic-depressive week with 250 points gained on Monday almost entirely erased on Wednesday afternoon ahead of one of the week's two massive stick saves that, overall, got us even for the week. The markets remain too close to call as we drift into the "Triple Top Testing Zone" I spoke about on Thursday Morning (but these are recovery levels I've been predicting since the March lows). So it was yet another week of watching from the sidelines and making few trades – even in our $106,191 Virtual Portfolio Update on Tuesday, other than buying more FAZ to protect our gains, and setting stops on some winning positions, there was not much to do as even the mix of stops we set on that virtual portfolio left us in a fairly neutral position going into the weekend.
Rather than do a Wrap-Up this week of a directionless week, let's see what we can figure out by reading some bullish and bearish articles, hopefully figure out where we're going in the week(s) ahead. It's very good to be in cash, over the past two weeks we've had both bulls and bears screaming about market manipulation, statistics fraud and both green and brown shoots and having cash lets us laugh at everyone. While our cash out at 8,600 in early May did cause us to miss a 150-point gain in the market over the past month, we also missed a 300-point drop so it's hard to say I regret my call at the time or my continued caution on "Double Top Tuesday," the 19th, where I said: "We continue to remain mainly in cash but playing for a drop unless another index breaks that 40% line at which point we will be forced to add some plays to the bull side despite our concerns."
So, all we have been doing for the past 3 weeks is PATIENTLY (well, some of us have been patient) waiting mostly on the sidelines for our 40% (off the 2007 highs) levels to be broken. Those levels are: Dow 8,413, Nasdaq 1,717, S&P 946, NYSE 6,232, Russell 514, SOX 329 and Transports 1,868. The Dow is 4% over, Nasday is 7.7% over, S&P is half a point below, NYSE is 2.5% below, Russell is 3% over, Transports are 2.2% below and SOX are our worst performer, dragging us down at 16% off the mark, STILL more than 50% off their 549 peak. We DO NOT like to see one of our levels hit resistance at the 50% mark (275), when ALL of the other indexes are well over it. It's kind of like a bunch of kids sneak through a hole in the fence to see a ballgame and one fat kid doesn't fit. There is a point at which they all gather at the hole and, on deciding it's not going to work they have to make a decision to either leave the fat kid (our underperforming index) behind or all go back outside and find another way into the game.
In this particular case, our fat kid is the SOX and we have to factor in that the SOX are the "little brother" of our leader, the Nasdaq. Now the question is going to be, how willing is the Nasdaq to leave the SOX behind? If you look at this long-term chart of the two, the answer is "not very." In fact, the SOX have clearly LED the Nasdaq from 1994 UNTIL Fall of 2008, when the Nasdaq began to assert itself – something we watched with great interest at the time as I used to comment that the Nasdaq "had forgotten their SOX in the winter." If you flip to the 2-year view, you'll see that we are approaching pretty much the maximum divergence of 15% between the two so we'll be watching closely for SOX strength or Nasdaq weakness next week to give us a good directional indicator.
This next chart shows you why I'm liking QID as a speculative bearish play. Notice the massive move they made during the fall sell-off. They are now trading 40% below that starting point at $31.61, yet you can still sell July $33 calls for $2 and a 1/2 sell against the Jan $34s at $5 is a nice way to initiate the trade but it depends on Monday's open so we'll be playing this one by ear in chat on Monday.
So, what am I reading? Well since I don't know if we're heading over or under next week (but my own bets are for under at the moment – those become downside hedges if we go over – as I mentioned, our $100K Virtual Portfolio position is more neutral), I want to try to present both sides but I'm having to dig down deep for those green shoots this weekend as the press seems to have gone bearish all of a sudden.
Graham Summers kicks things off with "The Coming Economic Collapse," Part 1 no less…. Graham is one of those gold bull, hyperinflation types but that doesn't mean he's wrong. He makes many good macro points and this promises to be a good series for those of you considering investing in fallout shelters and are looking for ways to convince your spouse it's a good investment. Now I link it to you at his blog and you say "so what" but go to Seeking Alpha and this is the 4th most popular article at the moment! Whether it's the catch title or we're catching the mood of the investing public – I find this kind of feedback very interesting to follow. What's the most popular article on Seeking Alpha? "Julian Robertson Bets the Farm on Inflation." You can think whatever you like but this is what "the people" are reading – everyone if freaking out about inflation and I pointed out yesterday how they have run for commodity ETFs in record numbers. Whether the crowd is right or mad, it still is a good idea to see which exits they are running for…
Like me, David Fry is confused about the markets and that drives both of us to double up on our research over the weekend. Things are so crazy that David made a post this weekend, something he rarely does, saying: "The victims today were commodity bulls, dollar bears and bond holders. Employment data was superficially “better than expected” despite the headline 9.4% unemployment rate. But inside the numbers things were disappointing with revisions and the ongoing games played with the birth/death model. The latter is an official guess of how many folks have given up looking for work. It’s a crude and easily manipulated number. The bottom line is things still suck as evidenced by the continuing climb in unemployment."
As we had noted in chat both Thursday and Friday, David caught the massive outflow of money from Treasuries which seemed to park itself firmly on the sidelines as we couldn't see it going anywhere else. Perhaps I'm not the only person who spies an inflection point coming up next week and investors seem to think there is going to be a fine opportunity to put some money to work at better than 3.5% Treasury returns. MAYBE it's just short covering into resistance at 87.5… I will point out that the red volume spikes you see into October '07, May '08 and Sept '08 all preceded market sell-offs, not rallies. What about that big stick at the end of March '09? That week was bad but we got a big boost on 4/1, as soon as it stopped. Pull back to the bigger picture and IEF are down right at the 10% off line year-to-date while the S&P is up 5% year-to-date after crossing each other on 4/29 at -5% for each. Dangerous possibilities there!
OK, I promised balance so let's see what we have: WSJ says "Slower Job Losses Lift Hopes." Yes, Rupert hopes his $5Bn purchase of the Journal wasn't the single worst timing ever for the purchase of a newspaper since Gomorrah Holdings bought out the Sodom Times after finally getting rid that Lot family who been pushing for less sex and violence in the media. Like the good Lord himself with Lot, the media keeps lowering their expectations for each jobs report until we finally beat the numbers. At first, Lot needed to find 50 righteous men but, after much haggling, the Lord was willing to settle for just 10 good men, but Lot failed to deliver enough green shoots and the economies of two cities were wiped out in a hail of fire and brimstone. Hopefully we will fare better. Playing the part of Lot's wife is SF Fed President Janet Yellen, who said if the increase in Treasury and mortgage yields is being fueled by rising inflation fears – worries she considers unfounded – it would be "disconcerting."
The Federal Reserve has been buying Treasuries and mortgage debt over the last several months, in a bid to lower borrowing costs both across the broader economy, and in the hard hit housing market. Officials have hoped their purchases would keep yields lower than they would otherwise be, thus adding an additional avenue of support for their extensive campaign to restart both the financial system and the broader economy. But for some time now, yields on longer-term government debt and mortgages have been rising. Investors are reacting to spiking government borrowing levels and an expectation that very stimulative Fed policy, coupled with a recovering economy, will drive inflation levels higher, perhaps dramatically so. The higher yields blunt the effectiveness of Fed policy and suggest the Fed may have to be even more aggressive with its future buying of Treasury and mortgage securities.
Sorry, back to green shoot news, that first item didn't go too well. Ah, here we go! Retail Sales in US PROBABLY climbed 0.5% in May according to 61 economists polled by Bloomberg. As with many polls, the problem is that the economists they poll are, by definition, employed and not representative of 16% of our population. Leading the expected gains in Retail are our friend in the Auto industry, well the two or three that are left anyway, and it kind of makes you wonder how they ever went BK. Had they thought of selling cars below cost to clear lots sooner, we could have had big retail numbers ages ago! “Consumers are out there spending again,” said Ellen Zentner, a senior economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. “They are clearly feeling better about the health of their finances.” Commerce’s report may also show that, excluding automobiles, sales rose 0.2 percent last month, according to the median estimate of economists surveyed. The increase is likely to in part reflect an increase in service-station receipts as gasoline prices climbed. Yipee, I'm feeling better already!
The International Council of Shopping Centers last week said May same-store sales dropped 4.6 percent from the same month last year, more than double its forecast of a 2 percent decline. Macy’s Inc., Dillard’s Inc. and Saks Inc. were among merchants that reported steeper declines than analysts estimated as Americans focused on buying essentials rather than discretionary items. A report from the Labor Department on June 12 may show the cost of imported goods rose 1.4 percent in May, due mainly to higher oil prices, the survey showed. Import prices increased 1.6 percent the prior month. Hey that's 18% annual inflation, no wonder it's 4 of the 5 most popular articles this weekend! “Our expectation is that we’ll begin to see growth in the economy,” Bernanke told Congress last week. “Underlying that prediction is some stabilization in final demand, including consumer spending.”
In related news, Dubai stocks are up for the 9th straight day – it's their best rally since Bush's reelection in 2005, "as oil near $70 a barrel and U.S. economic data boosted investor confidence." Do you think we should explain to them that our Q1 data was when we had $45 oil? “Oil went above 70 dollars, HALLELUJAH, that is about 100 percent above the lows,” said Mohammed Galal, head of institutional sales and trading for Futtaim HC Securities. Dubai’s market has soared 32 percent this quarter, while Qatar’s Doha Securities Market index is up 51 percent. Green shoots are everywhere!
Bank profits are getting fatter according to Bloomberg, as The five largest were profitable in the first quarter, rebounding from record losses for the industry in the fourth quarter. Share prices have jumped, with the KBW Bank Index doubling since March 6. “With our capital and assets, stressed as they have been, we can go back to focusing all our attention on managing our business and restoring value,” Citigroup Inc. Chief Executive Officer Vikram Pandit said after Geithner’s examinations were completed. HOWEVER, this green shoot may have brown roots as Analysts who have examined the quarterly profits and government tests say that accounting rule changes and rosy assumptions are making the institutions look healthier than they are.
Citigroup’s $1.6 billion in first-quarter profit would vanish if accounting were more stringent, says Martin Weiss of Weiss Research Inc. in Jupiter, Florida. “The big banks’ profits were TOTALLY BOGUS,” says Weiss, whose 38-year-old firm rates financial companies. “The new accounting rules, the stress tests: They’re all part of a major effort to put lipstick on a pig.” Further deterioration of loans will eventually force banks to recognize losses that their bookkeeping lets them ignore for now, says David Sherman, an accounting professor at Northeastern University in Boston. Janet Tavakoli, president of Tavakoli Structured Finance Inc. in Chicago, says the government stress scenarios underestimate how bad the economy may get.
I believe "Totally Bogus" is one of the worst ratings a rating agency can give a financial institution – I'll have to check… Without those accounting benefits, Citigroup would probably have posted a net loss of $2.5 billion in the quarter, Weiss estimates. In the five previous quarters, Citigroup lost more than $37 billion. Wells Fargo also took advantage of the change in the mark- to-market rules. The new standards let Wells Fargo boost its capital $2.8 billion by reassessing the value of some $40 billion of bonds, the bank said in May. The higher valuations Wells Fargo put on its securities probably won’t last, as defaults increase on home mortgages, credit cards and other consumer and corporate lending, says Sherman, a former Securities and Exchange Commission researcher: “These changes will help the banks hide their losses or push them off to the future.”
Speaking of bonds, Chuck pointed out this article on how inflation concerns are roiling the bond market already, undermining pretty much everything the Fed is trying to accomplish. "If the meltdown continues in the bond market, then mortgage yields will soon be at levels that choke off refinancing activity," said economist Ed Yardeni, who runs his own investment firm. "Even worse, they could abort any necessary recovery in home sales and prices." Bond investors anticipate a greater supply of government debt being sold to fund federal spending. "The bond market is calling the Federal Reserve out," said Mike Larson, a real estate analyst at Weiss Research Inc. in Jupiter, Fla. "Investors are saying that the Fed can't just print money out of thin air to finance a massive deficit." All this means that even though mortgage rates are still low by historical standards, many of the trends that seem to be pointing to economic recovery in recent months could be undone fast.
Barrons is counting 25M people out of work in America alone – if you include "discouraged" workers, that's an effective unemployment rate (called U6) of 16.4% and it's not likely those people will be running our and buying new homes and Pre's (which, if you don't know what it is, can be put in the same spot in your brain that used to hold the word Zune as the latest Apple-killer). The Barrons' article is very down on the recovery, having discovered the Whitney Tilson research that already kept us bearish as we were discussing his power point in Thursday's member chat but it's nice to see the MSM can still pull it together and catch up within a week! They do get it right when they say:
One of the scarier charts in the report — but which, we think, brings into jarring focus mortgage credit's current perilous condition — lists how much each of the various types of loans is severely underwater. To wit: 73% of option ARMs, 50% of subprime, 45% of Alt-A and 25% of prime mortgages are in that uncomfortable category. Field Check Group's data, cited by the T2 research report shows "that the mid-to-upper-end housing market is on the precipice of the exact cliff that the market fell off of in 2007, led by new loan defaults. What happens to the economy when you hit the mid-to-upper-end earners the same way the low-to-mid end was hit with the subprime implosion? We will find out soon enough." And he concludes on this grim note: "When we look back at the end of 2009, anyone that made positive predictions this year will not believe how far off they were."
OK then, we'll put that one in the negative category…. Also looming as a large negative for tomorrow is the EU Parliament elections, which were held on the weekend because the EU actually wants their citizens to participate in Democracy, unlike our government, who schedules them on a non-holiday Tuesday but sends the kids home from school so you have hire a baby sitter to cast a ballot. A lot of bums were thrown out but Angela Merkel struck the right chord attacking the banker last week and her party did well. Ireland's current government got just 23% of that country's votes and, in more bad news for the Euro – Libertas, who are the "Euro-skeptic" party that organized the Euro's defeat in Ireland last year, is now looking like they will be given a seat in the EU Parliament. That's like electing Ron Paul to be a Governor of the Federal Reserve!
If Ireland doesn't sign up for the Euro in this Novembers elections, the whole currency will come under a lot of strain. The dollar got a huge boost last fall as the vote went down in Ireland and it's something we need to keep our eye on this year as well. I can certainly assure you currency speculators will be watching it very closely! Keep in mind for tomorrow that chaos in Europe can hurt our pre-markets AND boost the dollar which would hurt commodities and hurt our pre-markets so it would be pretty amazing if we don't open lower tomorrow.
Finally, I've made several comments about the fallacy of "Rational Markets" and we've had some good discussion about the failure of the "Efficient Market Hypothesis" in member chat. There's a book Justin Fox will be writing on the subject which is outlined in this weekend's NY Times, and is good enough to justify the 25% bump in subscription rates this week called "Poking Holes in a Theory on Markets." The key point:
Or take the modern emphasis on market capitalization. “At some point in the early 1990s (or maybe it was in the late 1980s), market capitalization became accepted as the best measure of a company’s importance,” Mr. Fox wrote me in an e-mail message. “Before then it was usually profits or revenue. I think that’s a classic example of the way efficient market theory seeped into popular discourse and shaped how we perceived the world. It wasn’t entirely stupid — profits and revenue are flawed, limited measures, and market value does tell you something useful about a company. But it was another one of the ways in which asset prices came to rule the world, which eventually turned out to be a bad thing.”
Also, we're just 5 days away from about 5-10% of the country losing their television signal as the delay from February's transition to digital signals finally expires and stations switch over on Friday. Imagine 10% of the TVs in America not working on Friday night – it's going to be chaos. They can't even switch on the news to figure out why their TV isn't working! If anything, maybe we can go long on RSH and BBY into the weekend as I'll bet people will be lining up at the stores on Saturday to get their TVs working again. If we do have a sell-off early this week, I'll be interested BBY for sure!