WEEKLY TECHNICAL COMMENTARY: WEEKLY TECHNICAL COMMENTARY

Monday, September 22, 2008

WEEKLY TECHNICAL COMMENTARY - Sept 22-26

THIS WEEK’S ISSUE:

In Play: The $700 Billion Bailout? No! It’s the $1.8 Trillion Bailout!
In Play: The Global War Against Short Sellers
In Play: Goldman Sachs (GS) & Morgan Stanley (MS)
Market Commentary: S&P 500, NASDAQ
Sentiment Indicators: HYAD, HYHL, NAAD, NAHL, AMAD, AMHL, CBOE VIX
This Week’s Watch: Economic Reports & Notable Earnings Releases

U.S. FUTURES (as of 5:30AM EST): DJIA -26 (-0.23%), NASDAQ -3.30 (-0.26), S&P 500 -1.50 (-0.09%)

IN PLAY: THE $700 BILLION BAILOUT? NO! IT’S THE $1.8 TRILLION BAILOUT!

In a historic and unprecedented move, the Treasury is trying to push a $700 billion plan to absorb toxic mortgages and other assets (or liabilities if you want to call them) from financial institutions to save the U.S. financial system. This is considered by many to be the “Mother of All Bailouts”. This may help the banks, but the billions in bad mortgage debt simply do not disappear, it is merely transferred from “them” to the taxpayers (you”). It seems unfair, but the alternative in allowing the non-performing assets sit on these banks’ balance sheets seems far worse. Already, we have seen the largest financial institutions fail or get bailed or bought out including Bear Sterns, Lehman Brothers, Fannie Mae (FNM), Freddie Mac (FRE), American International Group (AIG) and Merrill Lynch (MER).

However, if you look at the total amount of taxpayers dollars going into stabilizing the financial crisis this year, we’re talking nearly $2 trillion! Here’s the breakdown:

$700 Billion – Treasury to purchase toxic mortgages and other non-performing assets from financial institutions.
$50 Billion – To guarantee principal in money market mutual funds.
$10 Billion+ – Treasury purchases of mortgage-backed securities (MBS) in September. More to come.
$144 Billion – In additional MBS purchases by FNM and FRE. Limit $850 billion. FNM’s portfolio currently holds $758.1 billion and FRE holds $798.2 billion.
$85 Billion – AIG bridge loan giving the Fed a 79.9% controlling stake in the firm.
$87 Billion – Repayments to JP Morgan (JPM) for providing financing to underpin trades with the now bankrupt Lehman Brothers. In response to the Fed & Treasury’s stand against providing public funds to consummate a deal.
$200 Billion – $100 billion capital infusion for FNM and FRE by the Treasury.
$300 Billion – Provided to the FHA to refinance failing mortgages into new, reduced principal loans with a federal guarantee as part of the housing bill.
$4 Billion – Provided to local communities to purchase and repair abandoned homes due to foreclosure.
$29 Billion – Financing for JPM’s takeover of Bear Sterns. The Fed takes $30 billion in non-performing assets as collateral.
$200 Billion – Currently outstanding loans to banks through the Fed’s Term Auction Facility. Recently updated to allow loans of 84 days in addition to the original 28-days.

Total: At least $1.8 trillion!

From Interfuidity:

The Fed's "balance sheet constraint" is not a hard limit. The Fed can circumvent it. But that doesn't mean that the size of the Fed's balance sheet is not important. Consider this:

“The easiest would be to ask Treasury to issue more debt than it needs to fund government operations. As investors pay for the bonds, their cash moves from bank reserve accounts at the Fed to Treasury accounts at the Fed. The Treasury would allow the money to remain there, rather than disbursing it or shifting it to commercial banks who, unlike the Fed, pay interest. Because the shift of cash out of reserve accounts leads to a shortage of reserves, it puts upward pressure on the federal funds rate. To offset that, the Fed would enter the open market and purchase Treasuries (or some other asset), replenishing banks’ reserve accounts. The net result is that the Fed’s assets and liabilities have both grown but reserves and the federal funds rate are unaffected. This wouldn’t cost Treasury anything so long as it doesn’t bump up against the statutory debt limit. The loss of interest on its cash deposits at the Fed would be roughly offset by the additional income the Fed pays Treasury each year from the interest on its bond holdings.”

It's only true that this operation doesn't cost the Treasury anything if what the Fed buys with the excess cash pays as much as the Treasury's cost of borrowing, and there is no loss of principal. But if the Fed uses the cash (directly or indirectly) to buy or lend against market-shunned securities, then the Treasury is only made whole if those securities perform, or the loans against them are repaid. If the market is irrationally shunning these securities, then the Treasury will eventually break even. But if the securities turn out to be worth less than what the Fed lends or pays, taxpayers might be forced to eat the loss.

For the most recent update on the Fed’s Consolidated Statement of Condition of All Federal Reserve Banks, visit: http://tinyurl.com/fohhe.

IN-PLAY: THE GLOBAL WAR AGAINST SHORT SELLERS

At the time of this writing, there are 10 countries that have either issued additional warnings, restricted short-selling of certain securities, or banned short-selling outright for vary durations.

Most of you already know that the United Kingdom banned short-selling in financial issues. This remains in effect until January 19, 2009. The measure may be extended to ban short-selling in other sectors. You also know that the U.S. banned the shorting of 799 financial stocks, which ends on October 2 unless the ban is extended.

Did you know that some financials were excluded?

For example: CIT and AXP
Conglomerates with large financial divisions were excluded, such as GE.

Did you also know that the list included some “typos”?

Included in the list: 4 delisted stocks, a biotech, and a Nigerian aviation company.

After the U.S. markets closed on September 19, the Ontario Securities Commission (OSC), supported by the Canadian Securities Administrators (CSA), issued a temporary order to ban short-selling effective until October 3. The following financial securities are affected:

Aberdeen Asia-Pacific Income Investment Company Ltd. (FAP)
Bank of Montreal (BMO)
Bank of Nova Scotia (BNS)
Canadian Imperial Bank of Commerce (CM)
Fairfax Financial Holdings Ltd. (FFH)
Kingsway Financial Services Inc. (KFS)
Manulife Financial Corp. (MFC)
Quest Capital Corp. (QC)
Royal Bank of Canada (RY)
Sun Life Financial Inc. (SLF)
Thomas Weisel Partners Group Inc. (TWP)
Toronto-Dominion Bank (TD)
Merrill Lynch & Co, Canada Ltd. (MLC)

Jean St-Gelais, Chair of the CSA and President & Chief Executive Officer of the Autorité des marchés financiers (Québec) stated:

“The CSA is supportive of the action taken by the OSC today, other jurisdictions in the CSA will be taking similar action today, or in the coming days.”

If that’s the case, we’re talking about a possible 12 agencies to follow the OSC (Ontario):

Alberta Securities Commission
British Columbia Securities Commission
Manitoba Securities Commission
New Brunswick Securities Commission
Newfoundland & Labrador Dept. of Gov’t Services – Consumer & Commercial Affairs
Northwest Territories Registrar of Securities – Legal Registries Division
Nova Scotia Securities Commission
Nunavut Registrar of Securities – Legal Registries Division
Prince Edward Islands Securities Office – Consumer, Corporate & Insurance Division
Quebec Autorité des marchés financiers
Saskatchewan Financial Services Commission
Yukon Territory Superintendent of Securities – Community Services

In addition, 5 European countries, Australia and Taiwan also joined in on the fight.

Germany announced that they have halted short-selling in the following financials:

AAreal Bank
Allianz
AMB Generali
Commerzbank
Deutsche Bank
Deutsche Boerse
Deutsche Postbank
Hannover Re
Hypo Real Estate
Munich Re

This ban by the German Federal Financial Supervisory Authority is in effect until the end of the year.

The ban for the US is in effect until October 2, October 3 for Canada, and January 16 for the UK.

Ireland banned the shorting of four of its financials:

Bank of Ireland
Allied Irish Banks
Irish Life and Permanent
Anglo Irish Bank Corp.

The Irish Financial Regulator also requires positions of more than 0.25% of the issued share capital be disclosed every day starting on September 23 at 3:30PM.

In the most dramatic move against short-sellers yet, the Australian Securities and Investments Commission (ASIC) banned short-selling of all listed shares. The ASIC noted: there was a risk that if Australia didn’t follow with its own ban that there would be a risk of “unwarranted activity” in the Australian market.

France

’s AMF stated that they will take similar actions as they increase monitoring of short-selling as well as deliver a warning against naked short-selling.

Switzerland

also issued a warning against naked short-selling on its SWX exchange in Zurich.

Portugal

’s CMVM announced that they will incorporate similar “extraordinary measures” against short-selling. It is possible that most or all European regulators will follow the Committee of European Securities Regulators’ (CESR) extensive efforts to limit or ban short-selling.

Taiwan banned short-selling of 150 stocks for two weeks, effective until October 3. The securities are listed on the Taiwan 50, Taiwan Mid-Cap 100, and Taiwan Technology indices. Short-selling is banned when they trade below the previous session’s close!

If you want my opinions on why this ban is stupid and ridiculous, you can read the previous posts on my blog at: http://www.weeklyta.blogspot.com.

IN-PLAY: GOLDMAN SACHS (GS) & MORGAN STANLEY (MS)

I was getting skeptical this weekend because we haven’t heard any “dramatic” financial news yet. But I spoke too soon when I realized that nearly the entire world has taken steps against short-sellers. But on Sunday, Goldman Sachs (GS) and Morgan Stanley (MS), the two largest (and last) independent investment banks (I-banks) changed their status to becoming a Bank Holding Company.

I did mention in my previous newsletter that without consumer deposits, investment banks face considerable pressure in the condition that they are in. This is the reason why Bank of America (BAC), JP Morgan (JPM), Citigroup (C), Wachovia (WB), and Taunus Corp., collectively the top 5 largest BHC's, have all been able to survive. Now the last members of the I-banking elite have joined their ranks.

A BHC must directly or indirectly own or control 25% or more of a U.S. bank. Under Regulation Y, GS and MS are now under the Federal Reserve's supervision, increasing regulatory oversight as well as reducing the amount of debt these two firms can take on in the future.

From the NYTimes: In its statement, Goldman said that it would become the nation’s fourth-largest bank holding company, with its small existing deposit-taking units to be rolled into GS Bank USA. Morgan Stanley will convert its Utah industrial bank into a deposit-taking national bank, to be called Morgan Stanley Bank.

Typically, new or smaller banks adopt BHC status due to its flexibility, allowing the BHC's to easily raise capital, issue stock, and acquire banks and other entities more so than I-banks. The chance of failure for GS and MS are very slim given the additional backing from the Federal Reserve. Therefore, the WB-MS deal may not even be considered.

Here's the best article (NYTimes) on the details following the announcement so far: http://tinyurl.com/3w55hj.

For more updates regarding Bank Holding Companies, visit: http://www.weeklyta.blogspot.com.

MARKET COMMENTARY -- SPX 1,255.08, COMP 2,273.90

Following the news regarding the ban on short-selling, the S&P 500 rallied almost 100 points to close at 1,255.08. If you look at the charts below, you can see the power spike that occurred on record-level volume. The index is still in a primary downtrend and has met resistance at the 50-day MA and was unable to penetrate above it. Today’s trading action and more importantly, the close, will determine the most likely direction for the market this week, provided that the Fed/Treasury does not disrupt the markets.

The gap up may be characterized as a breakaway gap, but in this case, it looks more like an area gap. Breakaway gaps start new trends in the direction of the gap and area gaps have a greater than 90% chance of filling within one week. Therefore, today’s trading will determine the type of gap.

Notice the divergence between the S&P 500 and the RSI and MACD. This divergence leads me to believe that the market will continue higher for the short-term. There is a high likelihood that the market will act in the direction of the divergence, whether positive or negative. In addition to the 50-day MA acting as present resistance the primary trend and the August short-term highs act as upcoming resistance areas. Thereafter, a failure at the 200-day MA is higher likely.

The NASDAQ has bee doing quite well compared with the other indices as it has attempted to hold its March and July lows. On Friday, the NASDAQ formed a bearish gap up which can be characterized as a breakaway gap on record volume of nearly 4 billion shares traded. A breakaway gap signifies that the index (or security) opened at a certain point but sold off throughout the day to close well below its open. This typically signifies that the selling may continue into the next day. Like the S&P 500, today’s action will determine the market’s likely outcome for this week. The only difference is that the NASDAQ may fill its gap and move higher.

Note that the RSI remains level but a positive divergence exists on the MACD. The NASDAQ could not hold at the 50-day MA and faces additional resistance at around 2350, 2400, and 2460 as well as the 200-day MA, which I expect it to fail.

The market’s previous response to an announcement by the SEC regarding short-selling fueled a short-term rally beginning on July 18. This rally lasted for about 1.5 months. Visit: http://www.weeklyta.blogspot.com for more technical-related analysis.

Sentiment is more important now that ever for the short-term. Some are used to confirm price-volume action, and others are noted for any divergences. Below are the NYSE, NASDAQ, and AMEX Issues New Highs-New Lows (NH-NL) and Advance-Decline (A-D) lines. Typically, the A-D lines follow the market. However, the NH-NL lines (in the right column) are the most important. Notice that after the 700 point Dow and 100 point S&P 500 rally more and more stocks are still hitting new lows! In fact, new-lows on the NYSE and the AMEX have hit parabolic vertical status, comparable to falling off a cliff. I expect this line to rebound gradually. Keep a watch on how these indicators change throughout the week.

How do you use the indicators? HeadlineCharts (http://www.headlinecharts.blog.com), one of my most favorite blogs for sentiment, provides an example for the NYSE/NYHL. Notice how there is always a spike before a short-term bottom is reached?

The VIX indicator is my personal favorite. We recently hit the 40+ level, not seen since mid-2002. Notice the spikes in the VIX:

We recently hit the 40+ level not seen since mid-2002. By this time, the previous bear market was already about 3/4^th’s finished. This is NOT to say that this bear market is over. All bear markets are different and previous readings for the VIX should not be used as a crystal ball but as a measure of how we stand now compared to the past. The VIX is making long-term higher-lows signaling that the VIX is indeed likely to hit at least the 50 level. In my opinion, there is still a bullish group of folks, albeit small, that believe we have finished this bear market. Let me remind you that a bear market cannot end unless there is overwhelming and undeniable widespread pessimism. We have not reached that level yet.

THIS WEEK’S WATCH:

$700 Billion bailout plan approval
Market response to the global short-selling ban
Goldman Sachs (GS) & Morgan Stanley (MS)
Currencies, Treasuries
Economic Reports and Earnings Reports listed below

Economic Reports: Mon. (None), Tues. (Richmond Fed Manufacturing Index, House Price Index, Weekly Retail Sales – 7:45AM), Wed. (Existing Home Sales – 10:00AM, Weekly EIA Energy Inventory – 10:35AM, Weekly MBA Mortgage Applications – 7:00AM), Thurs. (Durable Goods Orders – 8:30AM, Initial Jobless Claims – 8:30AM, New Home Sales – 10:00AM), Fri. (Q2 GDP Final – Personal Consumption, Price Index, Final Core PCE – 8:30AM, Consumer Sentiment – 10:00AM)

Noteworthy Expected Earnings: Mon. (AZO, KMX, COMS), Tues. (LEN, FUL, FDS, CPRT, WOR), Wed. (NKE, PAYX, BBBY, RHT), Thurs. (RAD, CHTT, SCHL, TIBX, ALOG, MKC, TXI, RIMM), Fri. (JBL, AM, KBH)