April 19, 2010, 08:00 EST [img]http://www.joe-duarte.com/images/line_main_top_03.gif[/img] Dr. Joe Duarte's Market I.Q. [img]http://www.joe-duarte.com/images/line_main_top_05.gif[/img] [img]http://www.joe-duarte.com/images/line_main_top_07.gif[/img] [img]http://www.joe-duarte.com/images/000.gif[/img]
[img]http://www.joe-duarte.com/images/pic_03.gif[/img] [img]http://www.joe-duarte.com/images/000.gif[/img]
The Internet's Intelligence Digest
Intelligence, Market Timing, And Trading Strategy For Traders and Investors
[img]http://www.joe-duarte.com/images/000.gif[/img] [img]http://www.joe-duarte.com/images/000.gif[/img] [img]http://www.joe-duarte.com/images/000.gif[/img]
Goldman Uncertainty And Earnings Season Combine To Increase Volatility
[img]http://www.joe-duarte.com/images/000.gif[/img] [img]http://www.joe-duarte.com/images/000.gif[/img] [img]http://www.joe-duarte.com/images/line_top_bot_02.gif[/img]
[img]http://www.joe-duarte.com/images/pic_04.gif[/img] What's Hot Today: U.S. stock index futures were pointing to a lower opening on Monday. The uncertainty of what's next for Goldman Sachs, and earnings season is putting together a combination of factors that is likely to lead to more volatility.
- Leading Indicators 10:00 AM ET
- 4-Week Bill Announcement 11:00 AM ET
- 3-Month Bill Auction 11:30 AM ET
- 6-Month Bill Auction 11:30 AM ET
Poll: 80% of Americans don't trust federal government. According to NPR.com: " Americans' trust in government and its institutions has plummeted to a near-historic low, according to a sobering new survey by the Pew Research Center. Only 22 percent of Americans surveyed by Pew say they can trust government in Washington "almost always or most of the time" -- among the lowest measures in the half-century since pollsters have been asking the question. And an increasing number -- almost 1 of every 3 people -- say they believe government is a major threat to their personal freedoms and want federal power reined in. Pew asked people to say whether they were content, frustrated or angry with the federal government -- and 3 of every 4 people said they were either frustrated or angry."
SEC investigating other mortgage related deals. According to The Wall Street Journal: "The Securities and Exchange Commission, after having hit Goldman Sachs Group Inc. with a civil fraud charge, is investigating whether other mortgage deals arranged by some of Wall Street's biggest firms may have crossed the line into misleading investors." The Journal added: "Among the firms that created mortgage deals that soon went sour were Deutsche Bank AG, UBS AG and Merrill Lynch & Co., now owned by Bank of America Corp. It isn't known what deals the SEC is investigating."
Drug war leads to exodus from Mexico. According to The New York Times: "On the other side, a brutal war between drug gangs has forced dozens of fearful families from the Mexican town of El Porvenir to come to the border seeking political asylum, and scores of other Mexicans have used special visas known as border-crossing cards to flee into the United States. They say drug gangs have laid waste to their town, burning down houses and killing people in the street. Americans are taking in their Mexican relatives, and the local schools have swelled with traumatized children, many of whom have witnessed gangland violence, school officials say."
The news is indicative of what may lie ahead, more trouble for fiscally trapped states, municipalities, and the federal government. And it is the latter which remains the most likely source of trouble as the people that pay taxes are increasingly unhappy with what's going on in Washington. It's uncertain as to how this will turn out. But it is clear that what started out in Rasmussen polling, which many consider to be on the fringe, is starting to creep into the mainstream. [img]http://www.joe-duarte.com/images/000.gif[/img]
[img]http://www.joe-duarte.com/images/pic_04.gif[/img] Goldman Uncertainty And Earnings Season Combine To Increase Volatility [img]http://www.joe-duarte.com/images/blok_rub_top.gif[/img] Overbought Momentum Market May Have Found Excuses For Correction [img]http://www.joe-duarte.com/images/blok_rub_bot.gif[/img]
Goldman Sachs (NYSE: GS) is being accused of "fraud" with regard to the way it packaged subprime mortgages, sold them to clients who believed that the packages, also known as collateralized debt obligations (CDOs) would rise in price, and then allowed hedge funds to sell the CDO's short.
At first, that just sounds wrong. The firm, allegedly, sold its clients a product, and then allowed someone else to sell the product short, pocketing fees on both sides of the transaction. But, if you think about it, isn't that what Wall Street does all the time?
Hang in there for a minute and think about it. When Wall Street sells an initial public offering to the public it gets commissions for underwriting the IPO. Then it gets commissions from those who buy the stock. Then, it makes money by lending shares to short sellers. At no point does anyone, except those who don't understand the markets get upset.
So what's the difference here? It's subtle, but it's there, and it revolves around the fact that IPOs, buying shares of any stock, and selling it short, are all fairly transparent. Much of the time, when the shares are transancted, the trade crosses some screen somewhere, and someone sees it. The exception, of course, are so called "over the counter" trades, and other questionable practices such as "dark pools" where big institutions basically trade in secret, or at least way away from the public eye.
That means that Goldman may theoretically have been making a market in CDOs without having the authority, or the transparency required for the transactions to be "fair." In other words, there wasn't a public record of these transactions, which clearly had effects, not just on the public but on the entire global economic system.
So here's where it gets super interesting. On Friday, as the news broke, we listened to the SEC's conference call on CNBC. Reporters kept asking the SEC whether this was an issue that was Goldman specific or whether other banks were involved. The SEC didn't answer the question. But The Wall Street Journal may have.
In fact, the answer to that particular question may have been out there for some time. Journal reporter Gregory Zuckerman wrote "The Greatest Trade Ever" in 2009. In the book he detailed how hedge fund manager John Paulson, who is not being charged by the SEC, made billions by shorting CDOs put together by Goldman Sachs.
According to Mr. Zuckerman, in the Journal, Paulson was a middle of the pack hedge fund manager who became obsessed with the over the top advance and began to work out ways that he could short the market. According to Zuckerman, Paulson and his fund began to short the market but felt as if he couldn't short enough of it by conventional means. That's when he began to approach investment banks with the idea that they should put together CDO's, sell them to investors, and allow his fund to short them.
As Zuckerman put it: "The investment banks would sell the CDOs to clients who believed the value of the mortgages would hold up. Mr. Paulson would buy CDS insurance on the CDO mortgage investments�a bet that they would fall in value. This way, Mr. Paulson could wager against $1 billion or so of mortgage debt in one fell swoop. Paulson & Co. wasn't doing anything new. A few other hedge funds also worked with banks to short CDOs the banks were creating. Hundreds of other CDOs were being created at the time. Other bankers, including those at Deutsche Bank and Goldman Sachs, didn't see anything wrong with Mr. Paulson's request and agreed to work with his team."
Zuckerman clearly reported that Goldman was not the only bank involved in this kind of deal, as Paulson also approached "Bear Stearns - and - Deutsche Bank." Bear Stearns, reportedly, according to Zuckerman, turned Paulson Down. But Deutsche Bank didn't. The irony is in the fact, that as Zuckerman notes: "One of the biggest losers was the bank that worked with Mr. Paulson on many of the deals: Deutsche Bank. The big bank had failed to sell all of the CDO deals it constructed and was stuck with chunks of toxic mortgages, suffering about $500 million of losses from these customized transactions, according to a senior executive of the German bank."
But the story continues to evolve. As The Journal points out: "The SEC's case against Goldman and a vice president at the firm, Fabrice Tourre, hangs on a single critical contention. The SEC says Goldman sold investors a product linked to the performance of certain mortgages without telling them that a hedge fund betting on the mortgages' demise helped design the product."
And as the weekend progressed more information became available. According to CNBC.com, citing information from Mad Money's Jim Cramer, Goldman sunk $90 million of its own money into the CDO in question. Also, Cramer reported that Goldman had the CDO vetted by an independent firm ACA management. According to CNBC.com: "released a report telling potential buyers exactly what was in" the report. Yet, the SEC complaint isn't about the creation of the CDO, called Abacus, it's about whether the clients who were buying into Abacus knew that Paulson's hedge fund had allegedly helped Goldman choose which mortgages to put into the CDO, while at the same time selling it short.
The Wall Street Journal reported along the same lines: "One line of defense, hinted at in Goldman's initial statements, is that the sophisticated investors buying the products should have known these transactions inherently involve investors betting on the success and failure of the underlying mortgages. Lawyers who reviewed the SEC complaint agreed that the products themselves weren't illegal."
Still, The Journal added: "The complaint alleges that Goldman intentionally hid Paulson's role and deceived investors into thinking that an independent mortgage-analysis firm, ACA Management LLC, was responsible for designing the product." But an equally important question is whether the involvement of ACA in the situation qualifies as enough public disclosure of the situation, if the ACA report on the mortgages in the CDO was clear enough to tip investors off about the danger of their involvement in the CDO.
So, the issue seems to be more about whether Paulson talked Goldman into putting bad mortgages into the CDO, and whether Goldman actually followed Paulson's directions. If Goldman put its own money into the CDO, does that mean that even if Paulson directed which mortgages would go into the CDO, Goldman has little to worry about, since they were as foolish as the investors that they sold the CDO to?
According to The Wall Street Journal, the SEC is alleging that Paulson and ACA both chose the bonds that would go into the CDO. The Journal reported: "According to the complaint, Paulson and ACA worked together in selecting bonds to include in the portfolio. Paulson identified 123 bonds. It sent its list to Goldman. ACA came back to Goldman with a list of 86 positions that included 55 of Paulson's initial 123, the complaint says. After some back and forth, including emails between Paulson and ACA, they agreed on 90 securities for the portfolio."
The Journal added: "The SEC alleges that Goldman then marketed the newly created CDO to investors without telling them of Paulson's involvement. Instead, Goldman only represented that ACA selected the assets. The SEC added that "investors were assured that the party selecting the portfolio had an 'alignment of economic interest'" with investors."
Reuters reported the following over the weekend: "An investigation by the online site ProPublica into Chicago-based hedge fund Magnetar's 2007 bets against CDO-related debt also turned up allegations of conflicts of interest against Deutsche Bank, Merrill and JPMorgan Chase. Magnetar has denied any wrongdoing. Deutsche Bank declined to comment. Merrill and JPMorgan had no immediate comment. The Magnetar deals have spawned at least one lawsuit. Dutch bank Cooperatieve Centrale Raiffeisen-Boerenleenbank B.A., or Rabobank for short, filed suit in June against Merrill Lynch over Magnetar's involvement with a CDO called Norma."
According to Reuters: "The SEC's charges Goldman are already stirring up investors who lost big on the CDOs, according to well-known plaintiffs lawyer Jake Zamansky."
What's the take home message? There is a whole lot still to be learned about this case, which means that we have a whole new ball game on our hands, because it's not just Goldman Sachs, it could be many others on both sides of the issue.
Conclusion
Last week, we noted that the momentum run in the stock market could be around for a while, and that there was no apparent reason to run for the hills. That was Thursday. On Friday morning, the world changed as the SEC may have opened a new Pandora's Box for the financial markets.
These are even murkier waters than the original subprime mortgage issues. Those were related, at least initially, to people who bought houses that were beyond their means, and to companies and loan officers who chucked sound lending criteria out the window in order to make a buck. That was also about what the allegations against Goldman and perhaps others are now seeming to bring to the forefront.
So, the original meltdown was the first response to the problem. People couldn't pay their mortgages. Jobs in the financial services industry were lost. And the misery spread accross the economy.
But the government stepped in and eventually things stopped getting worse, at least at the same frantic pace, and some people began to see improvement, as did the overall economy.
This is potentially the second leg, where people figure out that the infection wasn't cured, that the cancer was only in remission. This is where the banking system could be significantly tested. Remember, Goldman Sachs is now a bank. They took TARP money and became a bank, like the banks in your neighborhood. Sure, they paid the TARP money back, and no they don't take deposits from Mom and Pop. But, on the books, they are a bank.
So now we have all kinds of new things in the system that weren't there, at least not at the forefront, just a few days ago. And now the markets have to factor in a whole new set of potential issues.
Frankly, we're not sure about how this will end. But it could end very badly for a lot of people. And even if it doesn't, it will leave a major stigma behind for Wall Street. Worse, it will give the government a chance to regulate the living hell out of the financial services industry, something that in the long haul is almost certain to have unintended consequences.
Prepare for an uncertain future. Get a detailed trading plan in your pocket. Read Dr. Duarte's All NEW Books "Market Timing For Dummies." and "Trading Futures For Dummies." The Trading Manuals for All Seasons. Also Available As Kindle Books.
[img]http://www.joe-duarte.com/images/pic_05.gif[/img] Market Moves S & P 500 SPDR (ETF) Hits Wall Of Uncertainty
The S & P 500 SPDR ETF (NYSE: SPY) looks to have run into a wall of uncertainty.
[img]http://www.joe-duarte.com/images/spy.png[/img]
Chart Courtesy of StockCharts.com
Last Thursday we penned a piece that suggested that the market was in a momentum run and that sentiment was not at a point where things could unravel in a hurry. We did add the following line: " the market is clearly overbought, and some kind of pullback/correction, perhaps even one that could reach that 7-10% area which scares investors, can happen at any time."
And while there was no reason to run to the hills, we did note that "finding a point where a portfolio's risk is balanced is the key to success" and that "There are two ways of doing that. One is to keep enough cash on hand to cushion losses. The other is to buy protection either via options or via ETFs or mutual funds that sell the market short, either via sectors or in a fund that sells the whole market short."
That means that investors who actively manage their portfolio and had been taking a bit of profit here and there, as well as maybe buying ETFs that sell stocks short had some protection on Friday. To be sure, we don't know what lies ahead, and the market could rebound in the next few days and race to new highs. All that means is that the protection strategies also need to be evaluated.
With regard to the S & P 500, the 1200 round number support level got taken out. That leaves the 20 and 50-day moving averages as the next areas of important support. That's a trading range roughly between 1150 and 1180 or so. Below that there is support at 1125 and then not a whole lot before 1000 or so.
At this point, there is no point in speculating whether any of these levels will hold or not. It's not even certain whether any of them will be tested at this point. What's important is that portfolios should be actively managed and reviewed on a regular basis as market conditions are evolving.
Watchful investors who adhere to a well laid out trading plan are likely to survive this period better than those who don't pay attention and fly by the seat of their pants.
Perhaps the most positive indicator at this time is volume. Since March 17, the up days on UUP have mostly come on higher volume, while the down days have been on lower volume. The chart also suggests that dollar buying is occuring when the market dips. That suggests that investors with some savvy are coming into this market. And those tend to be longer term investors.
Finally, the trend in the U.S. is likely to turn toward higher interest rates at some point within the next 12-18 months or sooner. The Fed has already raised the Discount Rate once this year, and is expected to repeat the maneuver at least one more time in the not too distant future. The moderate strength displayed in the March employment data also shows that the U.S. economy is stabilizing, and that some sort of sustainable growth pattern is more likely than it was a few months ago.
The game breaker for the dollar, if any, aside from external events, such as natural disasters or terrorist attacks, is the politics in Washington, and how the mid-term election turns out. But for now, the dollar seems to have bottomed, and the intermediate term trend, barring a reversal, remains to the up side. Dr. Duarte owns shares in UUP.
