Dr. Joe Duarte's Market I.Q.
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The Next Shoe: Unwinding Risk At All Costs. Oil & Commodities: Sell What You Can. Stocks: Sidelines Dancing Advised.
Wall Street awakened to a world of triple digit losses in Asia, Europe, and the Dow Industrials futures as the subprime market's woes multiplied and the selling hit overdrive over the weekend
Today's Economic Calendar: 10:00a.m Feb ISM Non-Manufacturing Business Index . Previous: 59.0. Sources: Wall Street Journal.com, Marketwatch.com.
The Next Shoe: Unwinding Risk At All Costs
Heading For The Exits
The exit doors in the global financial markets are getting crowded, making for yet another tough day.
Friday evening, after the stock market closed, federal regulators, including the Federal Reserve issued a set of warnings and guidelines to subprime mortgage lenders, but the warnings are clearly too late for some in the industry, as well as the individual home owners who are suddenly faced with the prospects of losing their homes if they are unable to meet the new terms of their reset mortgages.
Already, two subprime lenders, New Century Financial, and Fremont General are having problems, with the former possibly having to shut down operations, and the latter looking to sell its subprime business as a response to a cease and desist order from the FDIC.
The big question for regulators, and the mortgage industry is where were these warnings when they would have done a whole lot more good maybe 12-18 months ago when the speculative bubble in real estate was reaching epic proportions?
Stop the presses, as Federal Reserve Chief Ben Bernanke, answering a question from the audience after a Stanford speech, actually said that the subprime lending situation was "concerning. Someone slow the Chief down, as the meltdown continues and is gathering steam.
Bubble bursts will usually have one or two situations that define them. And an early favorite for this particular installment of such an event, might have been the HSBC warning that came just a few weeks ago.
HSBC's actual earnings were a bit better than expected, with the company managing to actually make money, despite an estimated $6 billion in losses in the U.S. subprime market.
According to Bloomberg: "(HSBC) Chairman Stephen Green has fired U.S. managers, tightened loan requirements and made purchases in faster-growing economies in Latin America. U.S. defaults accounted for 64 percent of the company's total of $10.6 billion, HSBC said today. Depending on the housing market and availability of credit, the bank may need two or three years to stem loan losses."
Most interesting is the attitude from HSBC's management, who apparently see no connection between their issues in the U.S. and their growth plans for the rest of the world. According to Bloomberg: "has targeted growth outside the U.S. and the U.K., entering five countries in Latin America with the $1.77 billion purchase of Grupo Banistmo SA, Panama's largest bank, in November." HSBC has also "has spent $5 billion on acquisitions in China since 2002. It has stakes in closely held Bank of Shanghai, Ping An Insurance (Group) Co., China's second- biggest insurer; and Bank of Communications Co., China's fifth- biggest lender. In China, HSBC opened 13 new offices last year, bringing its to al to 45 in the nation. Full year pretax profit more than doubled to $708 million, from 334 million. Profit in India rose 85 percent to $393 million."
The problem with the strategy is that all global markets are starting to melt down simultaneously. And although a good deal of the U.S. economy is still not related to stock market wealth, in other countries, such as India and China, the connection between main street and the financial sector may not be as loose.
Deal Machine Rattled
Not only are the fringes of the U.S. residential real estate market being affected by the sudden reversal of the global financial markets. According to the Wall Street Journal, the big deal makers on Wall Street are starting to look at the current market more closely.
The Journal reported: "Turmoil in the stock and bond markets is causing hiccups in Wall Street's revved-up deal-making machine, which seems likely to worsen in the U.S. and abroad if markets continue to spasm in the weeks ahead."
Specifically, the Journal cites problems in the junk bond market where "nearly $6 billion in corporate junk bonds were sold in the U.S. last week," although "some were on worse terms than planned. "
This is starting to ripple through the leveraged buyout sector (until recently reported as the private equity sector). According to the Journal several instances of rising interest rates and more stringent terms were witnessed last week: "Last week, Univision Communications Inc., the Spanish-language broadcaster, had to pay a higher interest rate on $1.5 billion in junk bonds issued as part of a leveraged buyout, costing it as much as an extra $7.5 million in interest a year. Liberty Mutual Group, an insurer, had to raise the interest rate it offered on part of a $1 billion junk-bond offering. Procter & Gamble Co., the consumer-goods giant, had to pay up for a U.S. offering and delayed a European bond offering."
In fact, a close look at recent deals provides a glimpse into Wall Street's recent disregard for risk. According to the Journal the recent leveraged buyout of Univision will leave a group of private equity firms "saddled with debt that amounts to 12 times cash flow, an extraordinarily high level compared with other deals."
Insiders are also starting to worry. "The sale may have shown the first signs that investor appetite for risk is beginning to wane. Univision first offered to pay an interest rate of 9.25% to 9.5% on its new bonds but had to raise the interest rate it was offering to 9.75% to complete the sale. Even before the transaction, some prominent deal makers were beginning to wonder how stretched the debt markets were becoming. Bill Conway, the co-founder of leveraged-buyout powerhouse Carlyle Group, told his partners in an internal memo recently that the firm's lenders are making "very risky credit decisions" and that Carlyle should start doing fewer risky deals.
More important is the fact that TXU's debt hs bene downgraded to junk after the company agreed to be bought out by KKR and Texas Pacific, two private equity firms, for $45 billion.
That deal is also raising concerns, as the SEC is investigating option trades before its announcement. According to the Journal: "The SEC issued a temporary restraining order on certain unknown accounts Friday, for trading in call options that first began on Feb. 21, two days before word leaked that the utility was to be sold to private-equity firms. These unknown traders -- the SEC plans to identify them in further litigation -- scored $5.4 million in profits, the agency alleges."
Rising Personal Risk
And while the markets continue to unravel, some are saying that this time is different, and that the wealthy are also at significant risk due to their own appetites for higher returns.
According to the Wall Street Journal: "This (past) week's stock-market gyrations highlight an uncomfortable truth about the recent wealth boom, which has created an unprecedented number of millionaires and billionaires and driven up sales of everything from art and wine to yachts and mansions. Behind all that wealth is a rising amount of financial risk and borrowing, which could inflict substantial losses on the wealthy -- and the luxury world -- if markets plummet."
The Journal added: "Today's rich have expanded their fortunes and lifestyles in large part by turning to highly risky investments. In the search for ever-higher returns, they've doubled their holdings in hedge funds and other "alternative investments," and poured their money into stocks while draining down cash. At the same time, they've dramatically increased their debt."
One wealth manager Steve Henningsen, a partner at Wealth Conservancy, a Colorado wealth-management firm, told the Journal: "(the rich are) probably more exposed to more risk than the average investor because they've been the ones buying all these fancy debt products, hedge funds and other investments that their advisers told them to buy."
And aside from risky investments, the risk to the rich is compounded because they "also rely more on borrowed money. The nation's richest 5% held $1.67 trillion in debt, up fourfold from 1989. A large part of that is mortgage debt, but wealth experts say some of the funds have also gone into risky and higher-yielding investments, such as hedge funds. Since hedge-funds themselves are highly leveraged, the double-borrowing could make for a rapid fall should hedge funds start to implode."
More interesting is the fact that "some rich investors have started to pare back their risk, anticipating a downturn. A study by the Chicago-based Spectrem Group found that investors with $25 million or more in investable assets last year started to move their money away from more aggressive investments, like hedge funds and private equity, toward more conservative products."
Conclusion
The financial markets are a very dangerous place to be these days, as the often loose connection between the real world and the trading world has tightened.
The combination of a market meltdown, criminal investigations of deals, and the possibility of a slowing in the global economy, are suddenly painting a dim picture for investors.
Yet, this is not a new set of developments. As we highlight in our recent analysis summary "The Devil's Triangle (http://www.joe-duarte.com/2007_0303_triangle.html), our concerns started back in 2005.
In other words, this bubble, which has three significant and distinct components, has just begun to burst.
First, there is China. That economy and its financial markets, are closely tied to one another, as money from the markets is being used to finance other projects, mostly real estate.
Second, the U.S. housing boom, was a significant contributor to China's economic success, as U.S. homeowner purchases of Chinese products kept the Chinese economy going.
And third, in many cases, profits from Chinese investments were refunneled into private equity deals by the likes of Goldman Sachs, and others involved in the leveraged buyout business.
It doesn't take a genius to figure out what's next. As U.S. housing melts down, along with China, the amount of cash needed to get things done in starting to decrease.
Now, though, the situation is getting personal, as the rich and their risk are becoming a important cog in what may be a significant unwinding of global risk.
Chart Courtesy of StockCharts.com
The Wilderhill Clean Energy Index has been falling for several days.
Chart Courtesy of StockCharts.com
Crude oil prices still have support at $60.
Chart Courtesy of StockCharts.com
The Philadelphia Oil Service Index (OSX) has remained below 200.
Chart Courtesy of StockCharts.com
The Amex Oil Index (XOI) is still trading well below 1200.
Chart Courtesy of StockCharts.com
Sidelines Dancing Advised
It's a good time to be watching from the sidelines, as big money comes pouring out of risky, and not so risky investments.
Big money is running for cover as the emerging markets are starting to melt down, and the established markets are following. Even commodities are getting hit, as investors sell anything that is liquid, in order to cover debt and margin calls.
There is no sign that this could stop any time soon, and that means that anything is possible. The whole spectrum of possibilities is likely as a bottom could theoretically be put in place any time, today, or six months from now.
No one knows, so don't be fooled by pundits and analysts that claim to know.
To be sure, at some point, we'll have a buying opportunity. But that point is not yet visible. First we have to see a good up day, on big volume. Then we need to see a good follow through day within a few days of the first one.
By then, we should have noted a good number of charts starting to perk up, and a whole lot of analysts and economists wringing their hands about the future of the world.
None of that is visible right now, as everyone is calling this a short term "blip" or "correction." And while this may be temporary, only a fool thinks that he can truly know what the market is going to do over the next few days to weeks.
So, we wait, we compile a shopping list, and we wait some more.
For now, we'll stick with our forecast. From a longer term stand point, based on historical trends, this should be a positive year for stocks, given the fact that it's the third year of the Presidential Cycle, which calls for rallies in the third and fourth years of a presidency.
Our long term forecast remains upbeat, unless the major indexes fall convincingly below their 200 day moving averages.
What To Do Now
Disciplined traders who follow our strategies should have been stopped out of most long positions by now and should have large amounts of cash.
Stay patient, keep a good eye on any open sell stops. Aggresive traders should look for short sale opportunities in overextended sectors.
The REIT sector has been weakening and is worth a look if you're an aggressive trader with experience shorting the market.
Visit all our individual sections, both our ETF and individual stock picks daily for new ideas, and changes to open positions.
Now, more than ever, it pays to be careful. So, be very methodical about monitoring portfolios, adhering to trading rules, and ratcheting up sell stops is clearly still here.
Second guessing decisions, and hoping that things will turn out o.k. in the long haul, is the recipe for disaster at a time like this in the market.
Check all our sections daily. See tech, biotech, Fallen Angels, and timing systems for the latest adjustments. Our ETF trading systems for energy, Spyders, Small Caps, and technology have also been updated.
Chart Courtesy of StockCharts.com
Sentiment Summary:
Safety Still At A Premium
Option buyers kept their insurance policies over the weekend, again setting up for more volatility.
Volatility indexes, see below, shot way up on Tuesday, and have mostly stayed up, which may be a bullish sign for the future, although the net effect could take some time to be evident.
Option players hit the panic button before the weekend with put/call ratios rising on both individual stocks and indexes. The action was little changed on Thursday. This may be a short term positive, or a sign that somebody with inside knowledge is putting on a big hedge. We'll have to see what develops.
The index put/call ratio was nearly 4.0, on Friday, 2-23, which is very rare . Frankly, we're still not sure what to make of these readings other than to note them and wonder what somebody with big bucks thought they knew on Friday. We'll be watching the situation carefully.
Still, longer term indicators continue to suggest that market sentiment is nearing levels of significant caution.
The UBS sentiment index, fell for February, although it remained at very high levels. The index rose to the highest number we can recall in January, setting a very cautionary tone in the market.
The CBOE Put/Call ratio checked in at 1.30 on 3-3, falling from 3.87 registered on 2-23. A consistent string of low readings can be a sign of excessive optimism and often signals a top in the markets. Readings below 0.5 are of concern, but not as serious as readings below 0.40. Readings above 1.0 are bullish. The numbers cited here are meant to be evaluated on a closing basis.
The CBOE P/C ratio for indexes checked in at 1.92. Numbers above 2.0 as the market sells off, often lead to rallies. Readings below 0.9 suggest too much bullish sentiment, just as readings above 2 are usually required to mark major bottoms.
The VIX and VXN had readings of 18.61 and 23.66. These are bullish readings. But they are not necessarily a sign of a bottom, yet. A fall near or below 20 on VIX and 30-40 on VXN is considered negative, a fact that is usually confirmed when the volatility indexes begin to rise. Readings above 40 and 50, respectively, are often signs that a bottom may be close to developing.
NYSE specialists were moderate buyers of stock on the week of 2-16, for the second straight week. Specialist short selling remained at very low levels, though. Rising short selling from specialists is usually a very bearish sign.
Market Vane's Bullish Consensus pulled back to neutral at 65% on 3-1. The UBS sentiment index fell to 90 in February after registering a reading of 103, a downright scary number, and the highest one we've seen in January.
Chart Courtesy of StockCharts.com
When Goldman and Merrill are falling, investors should be paying very close attention. Goldman is clearly the deal bellwether, while Merrill is a good gauge of how overall business is doing on Wall Stret.
And the current message is not good for either sector of Wall Street. Both stocks have fallen below their 50-day moving averages and are heading for tests of long term support.
Sure, both companies are making money, and are likely to continue to make money. But, in our opinion, the market's appetite for risk is suddenly down to zero, and these two companies are taking the brunt of a good deal of selling.
At some point, these two stocks will be vastly oversold and will make decent long term plays. Neither of them is going away, or is in danger of going bankrupt. But for now, it's a good time avoid such falling knives.
Chart Courtesy of StockCharts.com
Chart Courtesy of StockCharts.com
Chart Courtesy of StockCharts.com
Chart Courtesy of StockCharts.com
Small stocks made new highs recently, but were not refuge on 2-27.
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