CITI BACKS OUT, WELLS FARGO TAKES WB

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WEEKLY TECHNICAL COMMENTARY (Oct 6 - 10)

THIS WEEK’S ISSUE:

• In-Play: The Battle for Wachovia (WB)
• Market Commentary: S&P 500 ($SPX), NASDAQ ($COMP)
• Update: Russell 2000 Small-cap Index ($RUT)
• Update: NYSE/NASDAQ/AMEX New-Highs/New-Lows Index, CBOE Volatility Index (VIX)
• Currencies: U.S. Dollar Index ($USD), Euro Index ($XEU)
• Commodities: Crude Oil ($WTIC), Gold ($GOLD)
• This Week’s Economic & Earnings Reports

U.S. FUTURES (as of 6:00AM EST): DJIA (-2.59), SPX (-2.95%), COMP (-2.94%)

IN-PLAY: THE BATTLE FOR WACHOVIA

Haha…I posted Part 1 of the battle on a previous post on my blog (http://www.weeklyta.blogspot.com) so I’ll get on with the developments, which is part 2 of the comic. If this goes on for a while, I will create an entire comic strip to chronicle the event. It’s an exciting and educational way of breakdown something that’s extremely complicated.

What’s happening now is that on Saturday night, Citigroup (C) asked NY Supreme Court Justice Charles Ramos to issue a order blocking the sale between Wachovia (WB) and Wells Fargo & Co. (WFC). Citigroup’s claim is that WB breached the exclusive agreement (entire agreement found on my blog) between WB and C. C is seeking $60 billion in punitive and compensatory damages against WFC for interfering with the deal.

In response, WB asked U.S. District Judge John Koeltl to declare that the agreement between WB and WFC “is valid, proper, and not prohibited by a letter agreement between WB and C. Koeltl vacated Ramos’ order, however scheduled a hearing tomorrow (Tuesday) for all parties to present their case. This is a complicated matter that can last for a very long time since both WFC and C are large institutions with a lot of money, backing, and attorneys and neither party will back down without putting up a fight. What’s for certain is that both WFC and C has devoted considerable resources in terms of time and money to engage WB, therefore, both institutions have personal interest to get this deal done. The question is: Who will win?

When WB signed the agreement with C to sell their banking operations, it was noted that if WB did not sell part or all of their operations, they risked seizure by the FDIC the very same day. Therefore, the ultimate loser in this battle is WB with possibly only days to survive. In any case of failure, the FDIC would step in as it has done many, many times this year.

The most important section of the letter agreement between WB and C is the following paragraph:

"In consideration of the foregoing and other good and valuable consideration the receipt and adequacy of which are hereby acknowledged. Wachovia hereby agrees that, during the period commencing on the date hereof and ending on Exclusivity Termination Date (Oct 6,2008), Wachovia shall not, and shall not permit any of its subsidiaries or any of its or their respective officers, directors, employees, investment bankers, attorneys, accountants, consultants or other agents or advisors ("representatives") to, directly or indirectly. (i) solicit, initiate or take any action to facilitate or encourage the submission of any Acquisition Proposal, (ii) enter into or participate in any discussions or negotiations with, furnish any information relating to Wachovia or any of its subsidiaries, assets, or businesses or afford access to the business, properties, assets, books or records of Wachovia or any of its subsidiaries to, otherwise cooperate in any way with, or knowingly assist, participate in, facilitate or encourage may effort by, any third party that is seeking to make, or has made, an Acquisition Proposal....."

However, many people argue that the letter agreement is non-binding. I am neither an attorney nor do I have inside information on the matter but it appears that this case is not clear cut. I do agree with the fact that the deal between WFC and WB may be the best for shareholders given that the deal goes not require government assistance, keeps WB intact, and benefits taxpayers. Ultimately, shareholders and regulators will have to approve of any deal and that cannot take place during litigation. What everyone can agree on is that a deal must be consummated quickly. This has once again placed uncertainty in the markets in a time where we don’t need any more uncertainty.

According to the Wall Street Journal, C and WFC may “carve out” WB with C taking WB’s northeast and mid-Atlantic branches and WFC taking southeast and California branches to reach a compromise. No deal has yet been consummated at the time of this writing.

MARKET COMMENTARY – SPX 1,099.23, COMP 1,947.39

The market continues to decline, hitting new lows 2-3 days out of the week. As I mentioned before volume must confirm price action. Once the short ban on financial stocks began, volume on all exchange got cut in half. This past week we are again seeing volume increase on the down days and volume decrease on the up days, which is bearish. This has occurred many times and I have stated this many times in previous commentary. The start of a major rally and the subsequent confirmation days must be confirmed with volume. With the short ban in place, that is extremely difficult to do.

I would like to point out that we may see a short-term low, marked by a capitulation day sometime this week. I am looking for a major gap down at the open today possibly followed by a sharp decline. If a sudden and sustained rally does occur and closes near its highs, then it is time to go long. I am advising all short positions to be covered during the weakest first hour of today’s trading. This is in support of the major oversold levels in several technical indicators, mainly the slow stochastics. This will be corrected soon.

The SEC stated that the short ban will be removed 3 business days after the bailout plan is signed into law. This could be Wednesday or Thursday, depending on the time in which the SEC decides to remove the ban. We should see a marked increase in volume on Thursday and Friday as a result, giving the market the opportunity to act in an undisrupted manner.

As for support levels, the 10,000 level in the DJIA is key support in 2005, the S&P 500 must hold the 1,000 level which is a key level in 2004 and the NASDAQ must hold the 1,900 level which is a key level in 2005.

UPDATE: RUSSELL 2000 SMALL-CAP INDEX ($RUT)

I’m adding the Russell 200 ($RUT) in a separate section to highlight the importance of the index this past week. Below, the chart on the left is a 5-year chart and the one to the right is a 10-year chart:

The significance is that the RUT broke out of its consolidated reactionary rally on Friday and hit a new low. The RUT is the last remaining index to decline to the levels of the DJIA, SPX, and the COMP. Looking at a 10-year chart (to the right), we have a long ways to go for the small caps. The larger capitalized stocks took the first hit in 2008 and it only makes sense for the small-caps to follow suit. Due to their smaller size, small-caps face a greater risk of a sharper decline in the next few months. Also note that the other 3 indices started their 3^rd primary leg down and the RUT only started it’s 2^nd primary leg. This divergence will soon be corrected and I expect the RUT to take the largest hit in the next few months of all indices.

Critical support is at 600 in 2005, which I expect it to break. Afterwards, the 500 level in 2004 is the next target area. At this point, given the sharp decline in the past two days, I expect the RUT to decline in a sudden, volatile and erratic move. Expect considerable selling in the small-caps in the coming weeks.

On the head-and-shoulders pattern, every technician views a pattern slightly different from other technicians. In the 5-year chart (to the left), I view the pattern drawn by the blue lines. Others may consider the purple lines. In either case, there is no disagreement that the pattern has now been reached due to break in the necklines.

UPDATE: NYSE/NASDAQ/AMEX NEW-HIGHS/NEW LOWS INDEX, CBOE VOLATILITY INDEX (VIX)

Below are the New-Highs/New-Lows Indices for the NYSE, NASDAQ, and AMEX. Notice that we are still hitting a lot more new lows than new highs. On Thursday, we hit 5 new highs and 778 new lows and on Friday, we hit 4 new highs and 1076 new lows. This gap is getting wider and wider, killing the chance for a major recover that certain people are still preaching about. Charts do not lie and they paint a very clear picture of what is going on in the markets. This is an undeniable truth in technical analysis. Notice how the AMEX fell the sharpest – most companies on the AMEX are small-to-micro caps. These indices must improve for any confirmation of any type of rally.

I stated in the previous commentary that the VIX will breakout and stay elevated in the 40’s level. This has held true. This is a high-and-tight flag that formed, and these patterns have extremely high reliability and a low-failure rate. These patterns are one of my most favorite patterns to look out for. The VIX is currently consolidating between 40 and 47, however, there is concern as the pattern is overextended. I do expect a bounce in the markets this week and also a slight pullback for the VIX. The fear level remains elevated now that Europe and Asia are the next regions to fall amid the credit crisis.

CURRENCIES: U.S. DOLLAR INDEX ($USD), EURO INDEX ($XEU)

Focus is placed on the U.S. Dollar and the Euro because of the significance of the levels they are at. The USD made a new high and I do expect consolidation, if not a breakout higher. The XEU is testing support. On long-term charts, it appears that the USD will be heading higher after forming a higher low and the XEU will be heading lower. These trends can remain in place for many months unless there is a great and sudden shift in global macro factors affecting both currencies. Both currency indices use the 50-day as support (USD) or resistance (EUR) and make note of their guiding pattern.

COMMODITIES: CRUDE OIL ($WTIC), GOLD ($GOLD)

Just like the XEU (Euro Index), commodities such as oil and gold are testing support levels. Oil follows the 40-day MA and gold follows the 20-day MA as of now. Make note of their respective support levels and react to any clean and full breakdowns. A low-risk trade would involve waiting for a confirmation day of any bounce or a continuation of the decline.

THIS WEEK’S WATCH

• Make note of any intraday reversal and rally into the close on either Monday or Tuesday to make capitulation day. Expect the market to gap down considerably in the morning.
• Pay attention to the VIX
• Note successful or failed tests in support/resistance for the USD, XEU, Oil, and Gold
• Be aware of the notable economic and earnings reports below

Noteworthy Economic Reports: Mon. (ICSC-Goldman Store Sales – 7:45AM, Consumer Credit – 3:00PM), Tues. (MBA Purchase Applications – 7:00AM, Pending Home Sales – 10:00AM, EIA Energy Status – 10:35AM), Wed. (Chain Store Sales, Jobless Claims – 8:30AM, Wholesale Trade – 10:00AM, EIA Gas – 10:35AM), Fri. (Import/Export Prices – 8:30AM, Int’l Trade – 8:30AM, Treasury Budget – 2:00PM)

Noteworthy Earnings Reports (planned): Mon. (AEP, IDT, VOXX), Tues. (PAR, AYI, AA, ZZ, YUM), Wed. (COST, LNN, MON, RT), Thurs. (RBN, SABA), Fri. (GE, HST, SLAB)

BLOG OF THE WEEK: HEADLINECHARTS BLOG! (http://www.headlinecharts.blog.com)

THE BATTLE FOR WACHOVIA

It sounds like a war, doesn't it? It's the corporate type that will most likely end up in court somewhere. Citigroup (C) offered to pay $2.1 billion for Wachovia's (WB) banking operations just 4 days ago. What I don't understand is how Wells Fargo (WFC) could go behind Citigroup's back and do a deal, just like that. A copy of the exclusive agreement between WB and C can be found here.

Remember over the weekend, both WFC and C were involved in a bidding war? If it was a genuine bidding war, how in the world did WFC come up with the $14.8 billion figure in a matter of days but not be able to control WB's banking operations on Monday by bidding a bit higher than $2.1 billion?

WFC has an uphill battle to fight since the FDIC is backing Citigroup. Citigroup also has some legal merit since their agreement with WB states that WB "cannot enter into any transaction with any party other than Citigroup or negotiate with anyone else". Not only that, shareholders and regulators will have to approve of this deal, and with the mess that WB's in, it'll get pretty complicated. This is sort of like having two girls like you, but you have to chose only one (both if you're a freak). The difference is, you can't choose which one you want to be with!

By law, the FDIC is required to find the least-costly resolution for taxpayers and since WFC's deal isn't requiring gov't assistance, that would be the solution. Citigroup's deal relied on gov't assistance, but was the first to consummate a deal with WB. (Citigroup agreed to take on up to $42 billion in losses from WB's portfolio and the FDIC will cover the rest in exchange for $12 billion in C preferreds and warrants). Two large institutions with a lot of lawyers and money -- this could get ugly.

Who will win?

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CITIGROUP TO BUY WACHOVIA BANKING OPERATIONS

UPDATE: WB is down over 90%!!!

NEW YORK (AP) -- The government says Citigroup will acquire the banking operations of Wachovia in a deal facilitated by the Federal Deposit Insurance Corp.

The FDIC says Wachovia didn't fail, and that all depositors are protected and there will be no cost to the Deposit Insurance Fund.

The sale of Wachovia Corp. comes just days after the government's seizure of Seattle-based Washington Mutual Inc. -- the largest bank failure in U.S. history.

Wachovia has been among the banks hardest hit by the ongoing crisis in the mortgage market. Its current problems stem largely from its acquisition of mortgage lender Golden West Financial Corp. in 2006 for roughly $25 billion at the height of the nation's housing boom. With that purchase, Wachovia inherited a deteriorating $122 billion portfolio of Pick-A-Payment loans, Golden West's specialty, which let borrowers skip some payments.

$19 billion in market cap, gone just like that...

I WONDER WHO'S NEXT?

WEEKLY COMMENTARY - Sept 29 - Oct 3

THIS WEEK’S ISSUE:

• In-Play: $700 Billion Bailout – Deal Reached!
• In-Play: Short-Sellers Report Holdings
• In-Play: Citigroup (C) & Wells Fargo (WFC) Bid for Wachovia (WB)
• Market Commentary: DJIA, S&P 500
• Update: CBOE Volatility Index (VIX)
• Update: NYSE & NASDAQ Hew Highs-New Lows Index (NYHL, NAHL)
• This Week’s Economic & Earnings Reports

U.S. FUTURES (as of 6:15AM EST): DJIA (-1.61%), SPX (-1.80%), COMP (-1.99%)

IN-PLAY: $700 BILLION BAILOUT – DEAL REACHED!

It’s about time! On Sunday, Congress and the White House reached a tentative deal (still needing to be voted on) on the $700 billion bailout. To remind you of the times that we are living in, this bailout is the largest financial bailout in U.S. history. You will never forget this time in our financial history. The plan could provide $250 billion immediately, $100 billion if the president saw it necessary, and the last $350 billion subject to Congressional approval. This means that the full $700 billion may not come for a very long time and both the President and Congress may disapprove of the additional funding. In my opinion, Congress fully understands the implications of putting $700 billion in taxpayer’s funds at risk; therefore, the full amount will not be risked.

Still, $700 billion will not stall the inevitable recession we are about to face. Unemployment is projected to hit 7.5% by the end of 2009, housing prices have yet to stop declining (the root of the MBS/CDO problem), and consumer spending is further restricting. I view this as a compromise between furious taxpayers on Main Street who do not wish for a Wall Street bailout and the Federal Reserve and Treasury’s repeated warnings of “total failure” if action did not occur. A recession, or if you don’t believe we are in a recession – the stock market, cannot be “forced” to improve. This is a natural part of the business (market) cycle. The excesses of our incompetence and the last traces of hubris must be eliminated prior to making a full recovery. That is the nature of any market cycle.

Here are the key provisions of the bill:

• The bill would be disbursed in stages. The authority to use the money will expire on December 31, 2009.
• The assets would be bought at “market value”. I have a hard time believing this as market value for the most toxic real estate assets still cannot be determined. Taxpayers may breakeven or make a profit if the assets appreciate (housing prices must improve for that to happen). If the government overpays for the assets, resulting in a net loss, they may be able to recover the majority of the principal on the open market once they sell the securities.
• If a net loss is evident, the bill requires that the financial industry make up the difference. This will be determined in 5-years, after the bill is enacted.
• The Treasury will have the right to take ownership stakes in participating companies. The firms willing to participate are still to be determined. I and a friend on Wall Street (SB) believe that many of the financial firms will not need to want to participate in this program. Well-capitalized firms have little inceptive to participate.
• The government may purchase non-performing assets directly from banks, giving the government more flexibility in modifying the terms of the loans.
• The Financial Stability Oversight Board (FSOB)and a congressional oversight panel will be established to oversee the program. The FSOB will include the Federal Reserve Chairman, SEC Chairman, FHA Agency Director, HUD Secretary, and the Treasury Secretary. The congressional oversight panel will consist of 5 outside experts appointed by the House and Senate.
• The treasury will establish an insurance program to insure against losses. The risk-based premiums will be paid by the financial industry. This includes MBS’s purchased before March 14, 2008.

The House is expected to vote today and the Senate is expected to vote later this week, or as early as Tuesday.

You and I will patiently wait. If you don’t watch CNBC, this week will be a good time to turn on the tube.

IN-PLAY: SHORT-SELLERS REPORT HOLDINGS

Short-sellers, mainly hedge funds, will have to disclose their short positions to the SEC today. The holdings will reveal the number and value of securities sold short for each day of last week. Although the SEC has good intentions to fight naked short-selling, this presents several problems:

• Other short-sellers may follow and add positions that the funds already have in place. Although this does not apply to financial stocks, this will put pressure on stocks in other industry and sector groups. This could result in an artificial short squeeze for buyers who wish to bet against the funds.
• Hedge funds are most likely to shift their strategies. This presents a special problem for short-biased or short-only funds which have to disclose their entire strategy. With hedge funds providing 25% of the markets liquidity, this will cause a major disruption.
• This puts additional pressure on managers and their staff who must fill out a form that includes short positions placed in the beginning of the day, intraday short positions, and the number and value of the shorted securities at the end of the day.

This information will remain private for two weeks, after which it will be revealed to the public.

IN-PLAY: CITIGROUP (C) & WELLS FARGO (WFC) BID FOR WACHOVIA (WB)

Wachovia, the 6^th largest U.S. bank with $40 billion in deposits, is currently locked in a bidding war between Citigroup (C) and Wells Fargo (WF). If WB fails, this would be the 2^nd largest bank failure in U.S history, tied with Continental Illinois National Bank in 1984. This would mean that the top 3 largest bank failures in the U.S. would all have taken place in 2008. But, let’s not speculate.

The Federal Reserve and the Treasury are involved in facilitating the deal and both remain adamant about not providing public capital in guaranteeing WB’s assets or taking over WB, unless the company deteriorates more rapidly.

Shares were down 15% on Friday, after-hours. I don’t expect both Citigroup and Wells Fargo to pay close to WB’s closing price of $10 on Friday.

MARKET COMMENTARY -- INDU 11,143.13, SPX 1,213.01

There are two things that are important for this week: 1) the direction of the triangles that are forming in the market and 2) volume. Notice the symmetrical triangle in the DJIA and the ascending triangle in the S&P 500. Just because we made a higher short-term low does not mean we are out of the woods yet. Any breaks above of below the triangle’s boundaries should be considered.

Observe the volume since the short-selling ban occurred. This is amazing. Hedge funds make up over 25% of the trading volume in the markets and if you get rid of a primary aspect of their trading (in financials), then it is no surprise that the volume has completely dried up. A well-functioning and liquid market should see increasing volume, not volume that is cut more than half! Volume has increased on Thursday and Friday, however, they still remain at ‘average’ levels. This is very discouraging because trading activity has dried up to point where it has discouraged many participants in the market. If there is a rally, it cannot and will not be sustained with volume at these levels. Volume confirms price action – that’s a fact!

UPDATE: VOLATILITY INDEX (VIX)

I want to point out the significance of the VIX at the stage it's in. The VIX is actually consolidating in a high-and-tight flag pattern. If you check the past 3-years, you'll see that the VIX has never done this. This means that the fear is still at elevated levels and probably won't be coming back down anytime soon. This pattern indicates that a breakout higher should occur imminently. But, the bailout could change all of this and the flag pattern could breakdown, sending the VIX into the 20s, but I doubt it. Note any bounce off the 15-day MA.

The VIX is likely to hit the 40s again and stay there.

UPDATE: NYSE & NASDAQ NEW HIGHS-NEW LOWS INDEX (NYHL, NAHL)

What’s important here is that the NYSE and NASDAQ issues are still making new lows! In fact, we’ve continued to make new lows all last week while the short-ban was in effect. We did get a slight rebound as I mentioned in last week’s commentary, but it was only temporary. As the market consolidates in their respective triangle formations, we should see both NH-NL indices remain steady at this level; however, I do not expect many new highs to be hit. On Friday, only 9 new highs were made on the NYSE and NASDDAQ (total) and 263 new lows have been hit. This is a clear indication that the market will most likely make a new low.

Remain vigilant and be aware of any sudden changes in these two indices. The market cannot rally if the ratio between new highs and new lows is only 3%! Be a realist, not an optimist or pessimist, and make note of any increases or decreases in the number of issues making new highs or new lows this week.

THIS WEEK’S WATCH

• House and Senate vote results on the bailout package
• NYHL & NAHL indices
• VIX – possible breakout to the upside
• This week’s economic & earnings reports

Noteworthy Economic Reports: Mon. (Personal Income, Personal Spending, PCE Core – 8:30AM), Tues. (S&P/Case Schiller HPI, Consumer Confidence – 10:00AM, NAPM – 9:45AM, Weekly Retail Sales – 7:45AM), Wed. (Total Vehicle Sales, Weekly EIA Energy Inventory – 10:35AM, Weekly MBA Mortgage Applications – 7:00AM, Challenger Job Cuts – 7:30AM, ADP Employment Change – 8:15AM, ISM Manufacturing – 10:00AM, Construction Spending – 10:00AM), Thurs. (Initial Jobless Claims – 8:30AM, Factory Orders – 10:00AM, Monster Employment Index – 6:00AM), Fri. (Unemployment Rate - 8:30AM, ISM Non-Manufacturing Composite – 10:00AM).

Noteworthy Earnings Reports: Mon. (CC, SCS, WAG), Tues. (PBG), Wed. (BLUD, ATU, MU, ZZ, WWW), Thurs. (STZ, MAR), Fri. (FDO).

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TRADE IDEAS

WB – Wachovia Corp. (Short), $15.06

Why: WB’s rally has faded on weak and weaker volume for the past month. The stock has broken back down below the 50-day MA. Yesterday was a reversal day, and today is a confirmation day.

JPM – J.P. Morgan Chase & Co. (Short), $36.80

Why: After consolidating for a month, a doji appeared yesterday and JPM broke through the 50-day MA again today, confirming an evening star pattern with a high likelihood of a continuation down. Numerous failures at the 200-day is also a bearish signal.

MS – Morgan Stanley (Short), $39.61

Why: MS broke its trend today after failing the 200-day MA. I expect some consolidating at the 50-day MA level, but otherwise, today’s weakness shows a high likelihood of a downtrend.

BAC – Bank of America Corp. (Short), $29.42

Why: BAC traded in a range, but was unable to make a new high. Instead, BAC broke down, rallied for 2-days before dropping again today. I expect support at the 50-day, but it looks like BAC uptrend is over in the short-term.

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