From wndysrf on Clearsttion, also talks of Argentina and credit bubble/
Mark's Market Commentary – October 6, 2001
At every big Hollywood party, when the hour is late, and everyone is coming down from their highs, there is a mad dash of desperation to find more batches of cocaine to keep the buzz going. After all, staying up until dawn until the last important person leaves is critical to the wannabe actress who leaves no stone unturned to become discovered.
As the major stock indexes were nearing exhaustion on Friday, on the brink of closing lower and forming the dreaded “evening star” chart formation, President Bush provided a last minute drug push by releasing some kind of a $70 billion tax cut package on top of his $40 billion stimulus package. That provided a rush powerful enough for us to close at the highs of the day, but just shy of Thursday's high on many individual stocks.
Over the last 3 days, individual Nasdaq stocks staged a huge comeback, and now the big question is whether or not it was short covering or if real, long term investment “sideline cash” also participated.
S & P and Dow continued to advance, but the advance has been gradually losing steam.
By the way, over here on Maui, the job loss and the business interruption as a result of the WTC attacks have been described as “catastrophic” by the locals. So don't buy into Wall Street's predictions of a mid-2002 recovery. The ripple effects will take months to filter through.
So now we sit right on top of the “terrorist gap”, where stocks were melting down prior to the attacks. So are we in a better condition now than before September 11??
Lets count all the lines of cocaine that have already been used up to “save” the market from an imminent meltdown:
- GE's CEO Immelt announces a “double digit growth” projection for 2002
- Bush's announces airline bailout
- Fed rate cuts
- Bush announces stimulus package
- Another “things are not getting worse” announcement from Cisco's CEO
- Bush announces tax cut package
Now lets count all the negative party crashers already “priced in” to the market:
- Earnings deterioration and recession acceleration
- Weak employment
- War risk and terrorist uncertainty
What has been conspicuously absent this week were earnings preannouncements and warnings from the big hitters, with the exception of Sun Microsystems (SUNW) and Alcoa (AA). Now that we are well into October, I suspect that companies are withholding announcements until they finish the damage assessment of WTC related end of the quarter order cancellations, and figure out how many people they need to lay off.
We shall see if the market has already “priced in” unprecedented layoffs and horrible 4th quarter guidance. Can the market rally in the face of all the bad news that will be rolling off the CNBC after hours news ticker? We shall see.
This rally will be the real acid test to determine if sideline cash can replace short covering and continue the high volume buying pressure. And it will also determine if the “buy and hopers” still stuck with losing positions above the April lows can resist selling into this strength. That all depends upon how well the 27-year old mutual fund managers are sleeping at night these days, and whether or they really have any cash left to buy more stocks.
My guess is that the “smart money” holding all that cash on the sidelines will wait for a successful retest of the lows first before committing. And I will also guess that the 24-year old hedge fund managers who had to cover their shorts this week will not have patience to wait for the retest, and they will flip their positions to go for the long bomb.
Now lets examine the negatives and risk factors which are not priced in which could stop this rally cold and start another big leg down:
- Argentina. The Merval got smoked to a new intraday low of 201 on Friday. That's 33% below the “red alert” 300 support level from last month. I am amazed that nobody is talking about this, considering how fragile the financial markets are to such a major event. Until the Argentina index breaks back above 300, retests it and holds it, I will remain on the short side. There is too much downside risk associated with an Argentina debt default, particularly with the global economies weakening at an accelerated pace.
- Liquidity Trap. The Fed has been running the repo operations full speed since May. This is simply a massive money pumping effort into the banking system secured by Treasury notes. The Wall Street Journal reported on Friday that Uncle Al basically ran out of this collateral, and had do some kind of an emergency issue of 10-year Treasuries on Thursday to keep the pump going!!! Just how much more crack can Greenspan dig up to keep this liquidity bubble propped up?? What happens when he exhausts all of his options and the new Treasury calendar runs dry??? I'm not sure, but I know it could get really ugly.
- Telecom Debt. So far, we haven't had any big telecom debt defaults yet. But they are right around the corner. And so much debt defaulting is likely to cause a cascade of other credit problems at the telecom equipment manufacturers which have guaranteed so many of these loans.
- Derivative Breakdown. Nobody is talking about the upcoming default risks looming from AAA rated bonds secured by the large hotel chains, airports, and other municipalities impacted by the decline in tourism. Derivatives are complex mathematical risk prediction products designed to “engineer away” default risks by selling individual pieces of the risk equation to speculators. Since the speculators are absorbing the bulk of the risk, the rating agencies can slap on a AAA credit rating on bonds so investors will think they are buying a low risk product. The problem is that none of the MIT math wizards hired by Wall Street were able to forecast the unthinkable, like the WTC attack and the resultant hairball being coughed up by the insurance and tourism industry. Now all those risks models have grossly underestimated default probabilities, and whoever is holding the bag on the wrong side of the derivative contracts are going to have to eat it.
Just think of making a loan to your uncle who has a gambling addiction. You secure the loan by his house. And you price the loan so that worse case, you foreclose on the house and get your money back. You hire a mathematician to run the probabilities of a default, and you enter into a contract to sell the “default risk portion” of your loan to your timeshare salesman at the country club when and if an event of default occurs. After all, he's a risk taker, and he will buy anything if the “get rich possibilities” are high enough. But all of a sudden, all the houses in your uncle's neighborhood are found to be sitting on a toxic waste dump, and the neighborhood is deemed to be unlivable for the next 100 years. Your uncle goes to Vegas, loses everything, and can't pay you back. Now you need to foreclose on the house, which is worth nothing. Do you think that the timeshare salesman will really pony up on his end of the contract, pay your loan off, and eat such a large loss?? No.
The dramatically higher risk levels now present in the derivative market are likely to put us into uncharted territory once these airport and hotel bonds start defaulting. Remember, most bonds have 2 or 3 month grace periods to allow borrowers to cure a default, so we won't see the brown matter hit the fan until November or December.
We still have many big wildcards out there, any one of which could trigger another wave of anxiety, which could cause a rally failure.
Now lets look at the technical picture. Volume and price action has to be respected, and based on the huge volumes pushing up Cisco (CSCO), Ciena (CIEN), Juniper (JNPR) and Siebel Systems (SEBL), we very well could get a major countertrend rally going in the Nasdaq. Assuming of course, we have no more terrorist attacks and none of the above referenced wildcards suddenly “come out of the closet”.
On Friday, we had another +1,000 TICK reading. This is the fourth day in the last 10 trading days when such a knee jerk panic buying event occurred. After so much frenzied buying, there is always a few days of rest or retracement when the buyers decide to take some profits. After all, anyone who bought at the September lows is up 20% to 40% on some individual stocks. So we need to wait for a retracement on the Nasdaq and see what it does.
Over on the Dow and S & P, I see a very different picture. The technical scene looks very much like August, right before we started the big decline. Here is a summary of what I found by looking at individual stock charts:
Over on the S & P, General Electric (GE) and American Offline (AOL) continue to drift up on lighter and lighter volume. GE in particular is getting very close to that $40 resistance level where it lost that long battle around Labor Day. I expect it to fail within the next 3 trading days. Another major Credit Bubble stock is Freddie Mac (FRE) and Fannie Mae (FNM), which are close to matching the highs made during the summer. FRE has made 9 consecutive days of gains, an exceptional feat in itself considering the breakdown which occurred in this stock in August. These stocks look very toppy, and appear to be ready to roll over. I suspect that later in the year, these two will be taken out to the woodshed and shot, once the mortgage refinance and real estate bubble pops. Its only a matter of time.
The sector to watch which will be of critical importance to sustaining this rally is the drugs. Pfizer (PFE), Merck (MRK), Johnson & Johnson (JNJ) are at “do or die” points on the charts, and must push higher immediately or they will be in for some very ugly chart failures. This is also a sector which has largely escaped the multiple compression which has occurred in the broad market. Pfizer, for example, is a great company. But how much longer can it trade for 40x earnings in a bear market environment??
Most of the Dow cyclicals are tracing out bear flags or retracements on lighter and lighter volume. Examples include DuPont (DD), Caterpillar (CAT), Alcoa (AA), and 3M (MMM).
Another sector approaching a breakdown is the bank and broker/dealer index. If you remember, the first clues of the start of the last market decline in August were provided by watching the banks. Some of the banks experienced sudden chart failures on Friday after the US Bank earnings warning hit the tape. This will be important to watch. Use Wells Fargo (WFB) and Bank of America (BAC) as a proxy.
So to me, it looks like key components of the Dow and S & P are looking very toppy at this point. Only the Nasdaq has come in with real volume during this rally, although each day of volume has been getting lighter and lighter.
Anybody who thinks we have hit a long term market bottom needs to read Alan Newman's latest analysis over at:
www.cross-currents.net/charts.htm updated on September 29.
And anybody who thinks that the mortgage and real estate credit bubble will last forever, or who believes that the WTC disaster will have no long term effect on the financial and credit markets should read Doug Noland's latest piece at:
www.prudentbear.com/credit.htm updated on October 5.
These two pieces are extraordinary in their analysis and explanation of the long term outlook for the stock and credit markets.
And last but not least, the most reliable market timing indicators gave us the sell signal on Friday. Abby “Planet of the Apes” Joseph Cohen and Joe “Squirrel Head” Battaglia were all on CNBC telling people to “buy stocks now”, “nobody can time the market”, and “buy and hold works”. Alan Newman explains that the failure of these Wall Street strategists to maintain any type of sell discipline has caused most buy and hold investors to suffer the dreaded “round trip”. That means anyone who has dollar cost averaged into the S & P 500 the last 5 years, rode the biggest stock market mania to its March 2000 peak, has essentially lost everything they gained and are now at break even. And the reason why the 1050 mark on the S & P index is so important is that if we drop below that line and fail to break back above it, then all the buy and holders for the last 5 years will be in a losing position and will seriously consider selling. I won't be buying for the long term until we get a real market bottom, when the likes of Ape Woman and Squirrel Head actually turn bearish. |
