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Saturday, August 25, 2007

The Bernanke Bounce

Lasts friday’s surprise discount rate cut resulted in exactly what Bernanke was hoping for. Those traders that were net short via options were annihilated on the first print where the options instantly expired. The whole process and the consequences are explained very well by Adam Warner from the Daily Options Report in the post The Bernanke Short Options Squeeze. The result was a week long, low volume, unenthusiastic short covering rally.

Bill Luby from VIX and More pointed out the strong mean reversion tendencies of volatility in his posts throughout the week. In the post VIX:VXN Ratio Extremes he demonstrates that the market new something wasn’t quite right with financials as early as February. In yesterday’s post I pointed out the double top and early negative divergence of XLF from broad market indexes as an early warning sign.

Tim Knight has long declared himself a Bear and has been posting fantastic short trades on The Slope of Hope. In the post The Voice of Reason (in a world gone mad) he presents a list of short candidates and argues each and every case for short entry in great detail.

Macro Man continues to present very thorough analysis of economic data. In A few thoughts on economics Macro Man argues that economic conditions and liquidity conditions are both weakening enough that markets will attempt to retest recent market lows established on Thursday. He further argues that this dip should be bought as massive quantities of liquidity held by brick countries and Sovereign Wealth Funds could swoop in and put a floor under prices.

Will Rahal argues for a ‘negative bias’ on Monday based on his proprietary and other indicators in the post Short Term Top for Monday August 27th. I have come to the same conclusion using different measures. This week lacked volume and therefore conviction. Short term oversold indicators have been relieved and prices are coming up on key resistance levels on most equity indexes. Also of significant interest is the fact that while general indices rallied such as the DOW, SP500 and NASDAQ, financial indices across the globe such as XLF and did not. Volatility is actually oversold now as well. Furthermore, I believe weekends over the next little while will bring a lot of headline risk. Its is far more likely that the causalities of the liquidity crunch and forced de-leveraging will be discovered and reported over a weekend rather than on any other day of the trading week.

Friday, August 24, 2007

Now What?

The bounce should be running out of steam right about now. Futures looked strong yesterday pre-market but not could hold the gains even into the open and all US equity indexes ended the day flat or worse. I'm looking for short entries.

U.S. July Durable Goods Orders Rise 5.9%; Ex-Transport Up 3.7%: "Orders for U.S.-made durable goods rose more than forecast in July, suggesting business spending remains a bright spot in an economy hobbled by a housing recession.

Demand for products meant to last several years rose 5.9 percent after a revised 1.9 percent gain the prior month, the Commerce Department said today in Washington. Excluding orders for transportation equipment such as airplanes, durable-goods orders rose 3.7 percent, the most since August 2005."

A little something for the Bulls to rally around.

European Manufacturing, Services Expansion Slows (Update4): "Growth in Europe's manufacturing and service industries slowed in August as the pace of orders cooled, indicating turmoil in world credit markets may be starting to weigh on the economy."

A little something more sobering.

Home Depot May Lower Supply Unit Price by $1 Billion (Update2): "Home Depot Inc., the home- improvement retailer that agreed in June to sell its contractor- supply business, may cut the original $10.3 billion price by about $1 billion to salvage the deal, two people with knowledge of the matter said."

Some of the big deals are starting to get re-priced. None of the major ones have yet been cancelled... Although spreads on deal stocks have started closing again, I think its to early to sound the 'all clear'.

This was yesterday: Coventree Fails to Renew C$5.12 Billion in Notes (Update4). BUT, people have to understand the consequences:

"Russel Metals Inc. (TSX: RUS.TO) says Coventree Inc. (TSX: COF.TO) failed to repay $11 million when asset-backed commercial paper, or short-term loans, held by Russel came due Thursday.

The funds represent five per cent of Russel's $207 million in cash and cash equivalents, the metal distributor said. " (YahooFinance)

Imagine that, you hold a commodity play and suddenly you're exposed to subprime inspired credit woes... What do you REALLY have in your portfolio?

While most of this will resolve itself satisfactorily, its still nerve wracking and messy.

Thursday, August 23, 2007

Risk is Back

The appetite for risk is back.

Bank of America's Countrywide Purchase Boosts Stocks (Update1): "The yen fell the most in three years against the euro as stocks rallied, reviving confidence in trades that depend on borrowing in the Japanese currency to buy riskier assets.

Investors sold yen and bought the higher-yielding Australian and New Zealand dollars, which rose around 3 percent versus Japan's currency. "

Bank of America's Countrywide Purchase Boosts Stocks (Update1): "Bank of America Corp. bought $2 billion of preferred stock from Countrywide Financial Corp., erasing concern the nation's largest mortgage lender will go bankrupt and boosting investor confidence in stocks worldwide."

Countrywide will survive this mess and it may rally as the shorts are squeezed out, but business will still be very weak for a few years.

Bank of China Holds $9.7 Billion of Subprime Assets (Update2): "Bank of China Ltd., the nation's second-largest bank, said it holds almost $9.7 billion of securities backed by U.S. subprime loans, the most of any Asian company."

Globalization spreads risk around, which is good. However, it becomes very difficult to know exactly where it is and how much.

Goldman Global Equity Hedge Fund Rises 12% After Cash Infusion: "Goldman Sachs Group Inc.'s Global Equity Opportunities hedge fund rose 12 percent last week after the securities firm shored up the money-losing pool with $3 billion of cash, investors said.

Assets more than doubled to $7.5 billion as New York-based Goldman put $2 billion into the fund and raised $1 billion from investors including Maurice "Hank'' Greenberg, the former chairman of American International Group Inc., and billionaire Eli Broad. The fund lost about 30 percent in early August as rising mortgage defaults caused stocks to tumble, upending the computer models its managers use to select trades.”

Looks like the models are starting to work better as markets around the world calm down a bit.

Wednesday, August 22, 2007

Cancel That Emergency

I swear traders are schizophrenics with attention deficit disorder. I submit these headlines and the chart for the 3 month T-bill as evidence.

Treasury Bill Yields Fall Most Since 1987 on Money Fund Demand: Yields plummet in a mad dash to safety. The FED will cut. The world is ending.

U.S. Notes Fall; Stocks Gain, Lacker Suggests No Emergency Cut: Yields rise. No rate cut is necessary. Stocks are cheap. Lets party.

Of course out in the real world things don't flip flop quite that quickly. The liquidity bubble caused serious problems that will result in serious consequences.

Home Builder in Spain Crashes as Ex-Chairman Keeps New York Pad: "From the looks of things at the newly built Aparta Hotel Residencia, you'd never know that it's the high summer tourist season in Canet d'En Berenguer, a town of 5,000 just north of Valencia on Spain's Mediterranean coast.

The compound's 308 apartments, completed this spring, are all unoccupied. Grass has started to sprout between the red terra-cotta tiles that lead to the empty, peanut-shaped swimming pool.

The residence is just one of a trail of buildings dotting the sandy coastline constructed by Enrique Banuelos as he amassed a fortune of more than 4 billion euros ($5.4 billion) over the past 15 years. Banuelos lost much of that money -- and shareholders' -- as the stock market punished the firm he founded, Astroc Mediterraneo SA, amid a rapid cooling of Spain's housing market. "

I've mentioned the real estate bubble in Spain a few times now.

The UK is next.

Toll Brothers Profit Drops on Writedowns, Weak Demand (Update2): "Toll Brothers Inc., the largest U.S. luxury homebuilder, said fiscal third-quarter profit fell 85 percent as the deepening housing slump cut sales and forced the company to write down property values."

This is not the bottom yet. Wait for the the big rate reset months of Januaray through June of 2008. (ARM reset schedule in US dollars, billions.)

Solent, Avendis Fund Ratings Slashed to Junk by S&P (Update2): "S&P cut the rankings on $3.2 billion debt issued by funds of London-based Solent Capital Partners LLP and Avendis Group in Geneva by as much as 17 levels to CCC. The credit ratings may be cut further, S&P said today in a statement. "

Expect many many more of these in the coming weeks and months.

Yen Falls on Speculation Bank of Japan Will Keep Rates on Hold: "Japan's yen dropped the most against the Brazilian real and the South African rand as stocks in Europe and Asia rose, reviving appetite for so-called carry trades in higher-yielding currencies. Charts traders use to predict price movements also signaled the yen's advance this month was too fast."

Agreed. The 'too far too fast' rule applies here. The Yen will pull back a bit in coming days. But to slap back on the Carry Trade is little excessive. If one of the big LBO's falls through or another hedgie stumbles that trade could be offside big in an instant.

Tuesday, August 21, 2007

Super China

While we panic over here, the Chinese are calmly stepping on the brakes again.

China Raises Rates for Fourth Time to Cool Inflation (Update1): "China raised interest rates for the fourth time since March to cool the world's fastest-growing major economy after inflation surged to a 10-year high.

The benchmark one-year lending rate will increase 0.18 percentage point to 7.02 percent tomorrow, the People's Bank of China said on its Web site. The one-year deposit rate will rise 0.27 percentage point to 3.6 percent.

China's economy grew at the fastest pace in more than 12 years in the second quarter on investment and exports. Consumer prices climbed 5.6 percent in July as the cost of food soared, while the central bank later cautioned that inflationary pressures were broadening."
The Chinese market remains invincible... for now. That bubble too will burst... Eventually.

Bank of England Loaned Money at Penalty Interest Rate (Update4): "The Bank of England said it loaned money at its penalty interest rate for the first time in more than a month after the U.S. subprime mortgage crisis prompted commercial banks to seek loans from other central banks.
The U.K. central bank loaned 314 million pounds ($628 million) from its standing facility at 6.75 percent yesterday, according to its daily report on money market operations in London today. The facility was last tapped on July 17."

How badly wounded is the bank that required the emergency funding? How many others are out there teetering on the brink? So many questions...

SachsenLB Has EU3 Billion in Subprime, Person Says (Update2): "Landesbank Sachsen Girozentrale, the German state-owned bank getting emergency funding, has about 3 billion euros ($4 billion) in investments linked to U.S. subprime mortgages, according to a person with knowledge of the matter."

Doh. The poor German tax payer gets to eat the loss in classic European socialism style.

German Investor Confidence Falls to Eight-Month Low (Update3): "Investor confidence in Germany, Europe's largest economy, fell more than economists forecast to an eight-month low in August as equity markets tumbled.
The ZEW Center for European Economic Research in Mannheim today said its index of investor and analyst expectations dropped to minus 6.9 from 10.4 in July. That's the lowest since December. Economists expected a decline to minus 1.5, according to the median of 36 forecasts in a Bloomberg News survey."

Capital One Closes GreenPoint Mortgage, Idling 1,900 (Update4): "Capital One Financial Corp. shut its GreenPoint Mortgage unit, eliminating 1,900 jobs, and lowered its earnings forecast as the worst U.S. housing slump in 16 years erodes demand for home loans."

Another victim of subprime slime.

Treasury Bill Yields Fall Most Since 1987 on Money Fund Demand: "Yields on U.S. Treasury bills fell the most in two decades on demand for the safest securities amid concern over a widening credit crunch.

Bill yields have fallen five straight days as money market funds dumped asset-backed commercial paper in favor of the shortest-maturity government debt. Three-month yields dropped the most since the stock market crash of 1987 and more than in the wake of the Sept. 11, 2001, terror attacks in the U.S, as funds shunned assets that may be linked to a weakening mortgage market."

The curve is steepening like there's no tomorrow... not quite unexpected really, seeing as there really is no tomorrow for some of these guys...
U.S. Home Foreclosures Almost Doubled in July, RealtyTrac Says: "U.S. homes in the foreclosure process almost doubled in July from a year earlier as variable-rate mortgages reset higher, leaving more homeowners unable to make their payments, according to RealtyTrac Inc., a seller of foreclosure data.

Lenders sent 179,599 notices of default, scheduled auctions or bank repossessions last month, a 93 percent increase, with the highest rates per household in Nevada, Georgia and Michigan. California, Florida and Michigan had the most homes caught in the foreclosure process, Irvine, California-based RealtyTrac said today in a statement."

Monday, August 20, 2007

The Wheels Are Coming Off...

Just before noon the wheels started coming off. The short end of the curve went into free fall. At noon exactly equity indexes started to slide as well...

A Calm Day?

Things look calmer this morning.

Bernanke's `Rookie Mistake' Forces Fed to Shift Focus to Market : "Federal Reserve policy makers, who declared that inflation was their paramount challenge just two weeks ago, have been forced to make financial-market stability the trigger for changes in interest rates.

By lowering the discount rate and issuing a statement conceding threats to the economy, Federal Open Market Committee members effectively ripped up the economic-outlook statement from their Aug. 7 meeting. Some economists describe the about- face, coming after months of assurances that the subprime- mortgage rout was contained, as Chairman Ben S. Bernanke's first serious error since taking office last year."

We have a new regime at the Fed. Bernanke must establish his 'hawkish' credentials, his inflation fighting credibility to control inflation expectations. This discount rate cut does not signal an imminent rate cut. This discount rate cut was made instead of an imminent future rate cut. When traders realize that Bernanke is willing to let these assets bubbles deflate the selling we recommence...

Campbell, John Henry Get Losses on Carry Trade Exit (Update3): "A doubling in currency volatility since June has knocked the "carry trade'' off its perch as the most profitable strategy in foreign exchange, hurting investors from John W. Henry & Co. to Campbell & Co.

Chalk up another victim to the spreading U.S. subprime mortgage contagion. The fallout from losses on loans made to people with poor credit is spreading so fast that investors are selling any asset smacking of high risk around the globe, causing wide swings in exchange rates that weren't anticipated."
What does that look like? See yesterdays blogpost Global De-leveraging.

London House Prices Fell for the First Time in a Year (Update1): "London house prices fell for the first time in a year this month, a sign higher interest rates are cooling Britain's property boom, a Rightmove Plc report showed."

Just in case you think its over. The subprime situation in the UK is just as bad and by some measures worse. Only their market hasn't rolled over yet. But now that house prices are starting to slip there the reckoning isn't far off.
Subprime Infects $300 Billion of Money Market Funds, Hikes Risk: "Money market funds were invented 37 years ago to offer investors better returns than bank savings accounts while providing a high degree of safety. Most of the $2.5 trillion sitting in these funds is invested in such assets as U.S. Treasury bills, certificates of deposit and short-term commercial debt.
Unlike bank accounts, money market funds aren't insured by the federal government. They almost never fail.

Unbeknownst to most investors, some of the largest money market funds today are putting part of their cash into one of the riskiest debt investments in the world: collateralized debt obligations backed by subprime mortgage loans."

That's how far this toxic sludge has spread.

Stocks May Grow More Volatile After Fed's Rate Cut (Update2): "The Federal Reserve's attempt to calm credit markets may have the opposite effect on equities after the most volatile week for U.S. stocks in four years.

The Chicago Board Options Exchange Volatility Index stayed near the highest since 2003 after the Fed unexpectedly reduced the rate it charges banks for loans on Aug. 17 and sparked the biggest rally in the Standard & Poor's 500 Index in four years. "

Until the VIX drops significantly, it isn't likely that any rally is more than just short covering.