WEEKLY TECHNICAL COMMENTARY (Oct 13-17)

THIS WEEK’S ISSUE:

• In-Play: The Global bailout – Countries Buying Stakes in Financials
• Market Commentary: S&P 500 ($SPX), NASDAQ ($COMP)
• Identifying Short-term Bottoms & Selling Climaxes
• This Week’s Economic & Earnings Reports

U.S. FUTURES (as of 7:00AM EST): DJIA (+4.56%), SPX (+5.58%), COMP (+4.99%)

HAPPY COLUMBUS DAY! Do people actually do something special today? I’m sure Christopher Columbus celebrated when he set foot on the New World. Likewise, longs will have reason to celebrate this week, but it’ll be a short celebration. Last week’s issue stated that we should see capitulation in the beginning of last week, however capitulation day came on Friday, towards the end of the week. Many times, technical signals are not very clear and may produce mixed results. Therefore, traders utilizing technical analysis must be flexible and adapt to the market situation we’re in. Currently, this is a trader’s market, not an investor’s market. Friday was our “special day” and we will get that bounce everyone was looking for. The technical aspects will be covered in the Market Commentary section.

IN-PLAY: THE GLOBAL BAILOUT – COUNTRIES BUYING STAKES IN FINANCIALS

While we’re in the process of planning our own bailout, Europe became next in line in the credit crisis. The extent of involvement in the CDO/CDS/MBS markets is across borders and without any bounds. I wouldn’t be surprised if Asia also takes a hit. We all know what’s happening in Iceland, and that’s exactly what the rest of Europe wanted to avoid. If you don’t know, Iceland is “seriously considering” going to the IMF now.

Therefore, over the weekend, developed nations all over the world pledged financial support amounting in the hundreds of billions of dollars. But it’s not free. These countries, including the U.S. will be taking massive equity positions in financial firms. The U.K. just became the largest shareholder in RBS and HBOS and will inject $29.2 billion in Lloyds TSB (total cost for all of this will be $63 billion so far). The French government created a 40 billion euro fund as they prepare to take stakes in certain firms. Germany and Italy are also creating their own bailout plans with Germany’s plan alone purported to be worth up to 400 billion euros.

The U.S. will be taking positions, the first ever since the Great Depression, in a coordinated plan of ownership in numerous financial institutions. Effective, the Federal government is the largest hedge fund managers in the world and other countries will receive that title. Should the government own such large stakes in public firms? At least they’re nonvoting shares, so the government can’t run these companies.

Most of the industrialized nations have also guaranteed all bank deposits. Germany, Iceland, and Denmark are guaranteeing all savings and CDs. Ireland is going one step further and guaranteeing banks’ debts. Many other countries have followed suit and the Federal Reserve issued a temporary order guaranteeing all bank deposits.

In addition the Bank of England, European Central Bank, and Swiss National Bank have all announced that they will conduct tenders of U.S. dollar funding at the 7-day, 28-day, and 84-day maturities at fixed rates for full allotment. The Bank of Japan is also considering a similar move. What does this mean? The developed countries are becoming the largest ATM machines in the world.

This massive assault on all fronts in a coordinated attack is the prefect step in the right direction. I don’t think people could really have asked for more given the short amount of time that the world had to make this decision. I will never forget 2008 as “THE” year. I hope we, as the whole world, can learn something from this mistake for the future, but human nature has proved otherwise.

MARKET COMMENTARY – SPX 899.22, COMP 1,649.51

The only real purpose of this week’s commentary is to confirm that we will bounce, starting today. I do not know the duration of the bounce, but it will be sharp, sudden, and in full force. Traders who did not go long on Friday will miss a considerable portion of the initial move.

There are three main items to look at in the above charts (S&P 500, NASDAQ): 1) the candle pattern, 2) volume, and 3) the Bollinger band width. We formed a doji, signaling indecision, or a white real body, forming a bullish piercing pattern. Both patterns are confirmed and back up by the strong volume that’s present in capitulations and selling climaxes. We’ve hit record volume. Notice how we opened and closed outside the lower band on the SPX and we opened lower, gapping down, on the COMP. Typically, a stock or index will return to its mean if it has been extended too far from its standard deviation.

This is a fair warning: This bounce will be short. Very short. It will give longs the opportunity to exit with a smaller loss than they have right now.

IDENTIFYING SHORT-TERM BOTTOMS & SELLING CLIMAXES

Finding a short-term bottom and predicting a bounce is a very skilled art. Below, we can see a 3-day chart of the S&P 500. In the initial stages of a plunge, the market will start to roll over slowly…sometimes way too slow. There will be numerous bull trap rallies that will quickly fade. You might know of recent days where a rally just completely died by the end of the day. This is because there is no serious buying pressure on the stock and there are still too many holders waiting to sell.

Next, we go parabolic or vertical. This is the “falling off a cliff” or “waterfall” stage. It doesn’t really matter what you call it, but if you can take a 6 inch rule out and put it against a chart and if it’s a straight line, there’s a good chance we hit this critical level called the selling climax. The end of the climax is marked by a capitulation spike. Why is it always a spike? Because people don’t calmly sell during a crash. They’re tripping over each others feet trying to be the first ones to sell before other investors drive their stock down. Makes sense, but that’s what happens when irrationality takes over and logic and sound judgment get thrown out the window.

This wave is formed when retail investors, always the last group to act, have completely washed out. They are desperately trying to recover as many pennies on the dollar as they can. What we saw on Friday were millions upon million of Americans dumping everything they own. They are the weak hands, and this phase shakes them out of the market. After all, the stock market isn’t a winning lotto ticket and investors need to be aware that it’s not a free ride. We now hit capitulation.

Capitulation is a psychological pattern. There are feelings of hopelessness, despair, depression (and others) will permeate market sentiment. Go talk to an ordinary person with little market knowledge, and I can guarantee you that they’re going to say something like “why would I want to buy stocks, they stink!” Most retail investors who just got crushed will not have the courage to start buying and this will go on for a long time. Think of this as a kid that burned his hand on the stove. He won’t go near that stove for a while.

At this point, retail investors are shaken out, there’s very little capital in play because more and more investors are ditching the idea of using margin, and most investors have lost real working capital (we lost $2.4 trillion last week alone!). After the decline, there is a lack of money at work in the markets, so it’s only natural to see low volume follow a spike in volume during the climax.

In the S&P 500 on Friday (chart below), you could see buying volume pick up and spike at the end of the day and this volume activity confirmed the price action (rally) that started in the afternoon. This extreme change in sentiment told me that something major will occur. When was the last time you had a 1,000 point range in a single day (on the Dow)? The markets were moving, and the price-volume relationship confirmed it.

The rally we will have will be a short reactionary rally. Why and how do I know this? Because after you lose trillions of dollars, where are you going to find the buyers to propel a rally? Every investor can pick up five jobs and work 24-hours a day and still not be able to come up with the lost capital in the same amount of time they lost it. Bull markets and sustained reactionary rallies are born from excess capital and having the financial ability to speculate in the markets. If you think we’re going to recover soon, stop dreaming.

THIS WEEK’S WATCH

• The tradable bottom in place starting today. Be ready to sell & sell short if an appropriate signal appears. This rally could last from one day to several days.
• Global developments on governments taking large stakes in financial firms and other world news
• Precious metals and their reaction
• A large number of earnings reports this week

Noteworthy Economic Reports: Mon. (none – Columbus Day)Tues. (ICSC-Goldman Store Sales – 7:45AM, Treasury Budget – 2:00PM), Wed. (MBA Mortgage Applications – 7:00AM, Empire State Manufacturing Survey – 8:30AM, PPI – 8:30AM, Retail Sales – 8:30AM, Business Inventories – 10:00AM, EIA Energy Status – 10:35AM), Thurs. (CPI – 8:30AM, Jobless Claims – 8:30AM, Industrial Production – 9:15AM, Philly Fed – 10:00AM), Fri. (Housing Starts – 8:30AM, Consumer Sentiment – 10:00AM)

Noteworthy Earnings Reports (planned): Mon. (STLY), Tues. (ADTN, DPZ, JNJ, PEP, CSX, ENZ, DNA, INTC), Wed. (ABT, KO, JPM, MV, PJC, STJ, WFC, DAL, EBAY, XLNX, LSTR, STLD), Thurs. (BBT, BBW, CIT, C, HOG, HSY, MEG, MER, NOK, NUE, RS, SHW, SON, LUV, UTX, WERN, WGO, CAL, DHR, GOOG, ISRG, PNC, AMD, COF, ESLR, GILD, IBM, LEG, SYK, TPX), Fri. (FHN, HON, SLB, SONC)

BLOG OF THE WEEK: FINANCIAL ARMAGEDDON! (http://www.financialarmageddon.com)

Would you like your blog featured here? E-mail me: JCLee84@hotmail.com

Don't forget to try out the Free Trend Analysis. It's FREE, so give it a shot!

CREDIT CRUNCH FOR SALE

SENATE PASSES BAILOUT BILL

WASHINGTON (AP) -- After one spectacular failure, the $700 billion financial industry bailout found a second life Wednesday, winning lopsided passage in the Senate and gaining ground in the House, where Republicans opposition softened.

Senators loaded the economic rescue bill with tax breaks and other sweeteners before passing it by a wide margin, 74-25, a month before the presidential and congressional elections.

In the House, leaders were working feverishly to convert enough opponents of the bill to push it through by Friday, just days after lawmakers there stunningly rejected an earlier version and sent markets plunging around the globe.

THE REAL REASON FOR THE RUSH?

Financial Armageddon made an excellent post on the Fed's financial situation. This outlines it perfectly:

One of the questions that has come up in connection with this week's scramble to pass a $700 billion bailout package for the beleaguered financial sector is: Why the rush? Why not take some time to fully explore the risks, discuss the financial, economic and political ramifications, and figure out ways to minimize the cost to taxpayers?

Although those in charge have attributed their sense of urgency to fears of an imminent seize-up in financial markets, it is conceivable that policymakers could have applied a few more of the band-aids they have been using prior to now so that the issues and prospective outcomes could be examined more fully in the harsh light of day.

Unless, of course, there is more to it than what our leaders are admitting to. In "Brad Setser: Extraordinary Times," the London Banker blog suggests the pressure for a rapid-fire solution stems from the precarious financial position of the rescuer-in-chief: the Federal Reserve.

Brad Setser has a fascinating insight to offer in his newest post, Extraordinary Times:

In the last two weeks — if I am reading the Federal Reserves’ balance sheet data correctly — the Fed has:

Increased “other loans” to the financial system by around $230 billion (from $23.56b to $262.34b);

Increased its “other assets” by about $80b (from $98.67b to $183.89b);

Increased the securities it lends out to dealers by $60b (from $117.3b to $190.5b);

That works out to the provision of something like $370b of credit to the financial system in a two week period. And that is just what I saw on a cursory glance.

The most that the IMF ever lent out to cash strapped emerging economies in a year?

$30b, in the four quarters through September 1998 (i.e. the peak of the 97-98 crisis).

The most the IMF ever lend out over two years?

$40b, in the eight quarters through June 2003 (this covered crises in Argentina, Brazil, Uruguay and Turkey)

This is a very real crisis. The Fed’s balance tells a story of extraordinary stress. I never would have expected to see the Fed lent out these kinds of sums over such a short-period.

Financial Armageddon's Response:

Excellent and timely, Brad. I’ve been speculating all week that the pressure being used on the Congress to pass the Paulson Plan is the threat of Fed illiquidity. As of two weeks ago, the Fed had lent out more than $600 billion of its $800 billion balance sheet Treasuries against crap MBS collateral.

The Paulson Plan would have allowed the banks to unwind the repos putting the Treasuries back in the Fed, get cash for the crap MBS, and get more Treasuries from the issues financing the $700+ billion funding of the Plan. As a bonus, the Paulson mark-to-maturity price becomes the implicit Level 3 price for capitalisation of all the firms and banks in the system, giving them some breathing room to stay in business. Everyone wins except the poor American taxpayer.

The Fed is very close to being illiquid. That is the fear factor we are seeing at work, and the reason no one will discuss why the bailout is needed - only emphasise the urgency.

THIS IS WHAT THE U.S. IS DOING:

(Courtesy of UpsideTrader)

LOL! Who's that?

You're kidding me, right? This sounds like something I read out of David Einhorn's book:

Yahoo! Finance -- Bernanke suggested buying the assets at a "hold-to-maturity" price, which would be based on an estimate of what the securities would eventually be worth as payments came in over the years. (That's right, it's all assumed)

"If the Treasury bids for and then buys assets at a price close to the hold-to-maturity price, there will be substantial benefits," Bernanke said. "First, banks will have a basis for valuing those assets and will not have to use fire-sale prices. Their capital will not be unreasonably marked down."

In contrast, if banks use existing "mark-to-market" rules that require them to value the holdings at what similar securities have recently sold for — in some cases pennies on the dollar — it could make the whole bailout futile because it would hurt many banks' balance sheets, causing some to fail. "This creates something of a vicious circle," he said.

------

Marked-to-marked = market value of a security. That's the equilibrium between a buyers willingness to pay and the seller's price. So, Bernanke wants to give these securities an "assigned value" and completely disregard market value. To avoid fire-sale prices, we'll just give them a value. Isn't that wrong?

This also means that Bernanke is suggesting that the Federal Government purchase these fake-valued securities at a disproportionately higher price, well above market value (or true value). What does that do to the taxpayer?

But, this doesn't mean I don't support it. It may be highly necessary for this to go through unless we want 1929 again.