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Tuesday, October 2, 2007

Another One For The Bulls

The DOW closed above 14 000 yesterday. As economic fundamentals continue to deteriorate and the credit markets continue to exhibit serious signs of distress, I simply cannot hold longs overnight. The NASDAQ, DOW and SP500 are fully stretched into overbought territory. I did notice the absence of volume yesterday on such a breakout which leads me to question the conviction and validity of this move.

Fed Fails to Restore Creditor Confidence, Pimco Says (Update1): “As far as the world's biggest bond investors are concerned, the Federal Reserve is failing to restore confidence in the U.S. credit markets.

Pacific Investment Management Co., TIAA-CREF and Insight Investment Management say the central bank's decision to lower the overnight lending rate between banks by half a percentage point last month won't prevent the economy from slowing or corporate defaults from increasing. Lehman Brothers Holdings Inc. strategists say last month's rally in high-yield corporate bonds, the biggest since 2003, may fizzle by year-end.

While indexes of derivatives that measure the risk of default show increasing investor confidence, the difference between the interest that banks and the U.S. government pay for three-month loans is wider now than a month ago. That's a sign the Fed's Sept. 18 rate decision has yet to persuade bondholders that lower borrowing costs will stop “disruptions in financial markets” from hurting the economy.

“The reality is the fundamentals haven't gotten any better, and, if anything, they've gotten worse,” said Mark Kiesel, an executive vice president at Newport Beach, California-based Pimco who oversees $85 billion in corporate bonds.”

So I sit in cash watching and waiting… unable to go long and hold overnight… and unable to go short again… yet.

Greenspan Sees `Rethinking' on CDOs After Losses (Update2): “Former Federal Reserve Chairman Alan Greenspan said there will be ``some rethinking'' of collateralized debt obligations after demand for them helped fuel the collapse of the U.S. subprime mortgage market.

“People always say it's the subprime market that created this crisis,” Greenspan told investors at an event hosted by Bloomberg LP in London. “It's the subprime asset-backed market'' which did, he said. “As a consequence of that there's going to be some rethinking about collateralized debt obligations.”

CDOs provide liquidity. That is their purpose. They free up cash in a company that would otherwise be tied up which is then recycled back into the economy by that company.

“The market for CDOs is already shrinking. Sales fell 54 percent in August to $17 billion from July, the lowest in more than a year, according to Morgan Stanley. CDOs are created by packaging bonds, loans or credit-default swaps and using their income to pay investors interest.”
The market is shrinking. Rapid and significant declines in CDO activity is the equivalent of suddenly employing a tightening monetary policy. Mind you, alone the impact is hardly large enough. But as banks hoard money to keep their conduits and SIVs from busting and raise their loan loss provisions, the cumulative effect IS significant.

Northern Rock Credit Risk Soars on Speculation of Break-Up Bid: “Northern Rock Plc credit-default swaps soared on speculation the U.K. mortgage lender that was bailed out by the Bank of England may be broken up and sold.

Contracts on the Newcastle-based bank increased 60 basis points to 200 basis points, according to Deutsche Bank AG. Credit-default swaps rise as perceptions of creditworthiness deteriorate.”

While this news isn’t unexpected and won’t have an impact, it is relevant. The (failed) business model of Northern Rock will now get picked up by those that gobble up the bank. Since we are still at the peak of this economic cycle, rather than the trough, this does not qualify as bottom fishing for undervalued assets and will almost certainly results in nothing but headaches Northern Rock’s new masters.

In the meantime, another point for the Bulls.