Friday market update

Yesterday, the charts made a pretty compelling argument that the market was extremely extended and at key resistance at the 50-day moving averages.

This is where you get technical sellers in bear markets and sellers did materialize today. However, selling wasn’t severe so we may yet see another retest of the 50-day moving averages.

With as overbought as we are right now, the probabilities favor a sell off going into the end of March and with corporate earning announcement to come in early April, we are about to find out how brave the bulls really are.

The ugly fact is that corporate earnings dropped 57 percent on average for the 480 companies in the S&P 500 that have reported results since Jan. 12th, according to Bloomberg data. Earnings are nose diving at a speed we have never seen before.

If we have literally no or very little earnings in the P/E ratio for the S&P 500 in the first quarter, rising prices are simply not sustainable. These bear market traps are seductive but deadly.

The Fed’s decision yesterday to buy back some of its debt is something the Fed has not done in 50 years and illustrates that it is operating within a worte case scenario in a desperate attempt to stop the economy from falling into a depression.

What the Fed did yesterday is called deficit monetization and it has resorted to this scenario because we have been moving into a deflationary spiral and a protracted credit tightening (money supply contraction).

If you have been watching the rate of growth of M2 it has been dropping like a rock recently as money flees getting caught in a banking crisis.

Some have interpreted as hyperinflationary with the fallout being a plunge in the dollar the last couple of days and a surge in commodity prices.

However, if you think about what they did yesterday, the Fed is issuing $750 billion in debt to recapitalize Freddie and Fannie, but is buying back $350 billion worth of long-term debt.

Still, the US dollar was slammed by this news and is under heavy selling pressure. Also, pressuring the dollar is talk that a U.N. panel will recommend ditching the dollar as its reserve currency in favor of a shared basket of currencies.

Russia is also planning to propose the creation of a new reserve currency, to be issued by international financial institutions, at the April G20 meeting, according to the text of its proposals published on Monday.

This caused a huge jump in gold which jumped $69.60 an ounce to close at $958.3. Remember, the key number here is $1,017 for gold, which was last year’s high.

The sell off in the dollar over this news sent crude oil prices up $3.47 a barrel to $51.61. It is looking more and more like crude oil prices have put in a long-term bottom but where from here?

Are we looking at $75 a barrel this summer? This is all consumers and corporations need – to see another surge in commodity prices with corporate earnings deteriorating at the fastest pace in history.

All of these issues give me a headache, which is why we need to remain focused on the technical underpinnings of the market.

Despite this rally, market breadth remains subpar. The McClellan Oscillator is at a short-term high and the McClellan Summation Index is well below zero, with NYSE at -611 and the OTC at -782. Any rallies under zero, with numbers this bad should be viewed as an opportunity to sell into rallies.

We have seen some positive changes in the new low/new high indicators. It is constructive to see new lows below 50 in the NYSE and below 75 in the OTC. The 10-day differential is very close to turning positive, but we have gotten very close on every bear market rally only to see it fade at the 50-day moving averages, so the jury is still out here.

Remain defensive.

Thursday Market update

Wednesday market update

The stock market seemed to like the news coming from the housing sector, which showed a huge surge in housing starts today. In fact, housing starts jumped 22.2% in February, which is the largest since the early 1990’s.

What is interesting about this number is almost all of the gain (82.3%) was supported by a surge in multifamily construction. This is construction in apartments, duplexes and condos to meet the growing need for people who need to rent.

Single family homebuilding rose a modest 1.1% nationwide. However, in the West housing starts are still falling sharply. There is still too much supply (10 months) and this has to be narrowed before we can expect existing home prices to recover.

In other news, the Producer Price Index remained barely above zero at 0.1 for the top line number. The stability in the crude oil prices since December and the subsequent advance in oil prices to near $50 are evidence to some that deflation is becoming less of a threat.

I don’t happen to buy that argument, especially with the money supply continuing to fall. M2 dropped again this last week down from 9.7% to 8.1%. Inflation comes about when the money supply is rising rapidly, not falling but there are a lot of issues here that are not transparent and geopolitical trade wars relative to our currencies that make this a challenge.

For now, it appears that seasonality factors and all of the talk of the stimulus package have speculators buying energy again. But the economy is not the same as it was in 2007. There is a lot of technical resistance at the $50 level, so this sector is due for a pullback with intermediate-term cycles at %K 99 and %D at 98.

Let’s talk about the stock market and this six day rally. How many of these spike rallies on low volume have we seen over the last 18 months?

In a healthy market, a rally sees volume increase. In a bear market trap, volume decreases and this is exactly what we have seen over the last few days. This isn’t broad based buying.

Also we are starting to see a wedge formation developing---higher highs but lower lows in the daily ranges, which is typical market behavior as we approach short term resistance in overbought conditions.

Notice, that the daily stochastics are now at %K 97 and %D at 85 for the Russell 2000. We are also approaching the 50-day moving averages.

You can see from this chart the overhanging resistance that stocks face under the 50-day moving averages.

Low volume wedges into resistance/and or moving averages invites another bear attack as long as prices keep taking out critical support levels as happened by breaking the November lows. The bears are still in charge.

I do want to make note that pessimism reached extreme conditions a couple of weeks ago and this is why we have seen such a powerful rebound. The short sellers take profits, but these same short sellers are also looking to retake new positions at key resistance levels.

Technically, the market needs to set up a higher low, so the probabilities favor a need to retest and prove last week’s lows.

In the meantime, the technical underpinnings remain poor.

Tuesday Market update

The stock market ran out of steam today following last weeks impressive short covering rally. This seems par for the course as nervous shorts take profits but with the market lacking real buyers, the rally then fizzles after a few days.

We may see another attempt by the bulls to perhaps test the 50-day moving average, but nothing has changed that signals the birth of a new bull market.

This has been the pattern. Whenever pessimism gets too extreme, the Fed releases something to scare the shorts into covering, as we saw with the “Mark to the Market” talk and with the suggestion of changing the uptick rules to spook the shorts. It worked.

However, for the market to be sustainable on the long side there needs to be a reason to expect economic growth to attract a steady flow of buyers. I sure don’t see it.

The March and April period is a favorable seasonality period that could repeat this year. After last week’s advance the intermediate-term cycle seems poised to climb if one looks at the weekly stochastics and the McClellan Summation Index, which appear to be nesting here.

Yet, after last week’s advance, short-term cycles have moved into overbought territory again. It looks to me like we are setting up for another retest of the lows.

Remember, the primary trend pattern remains the same, lower highs and lower lows. The Nasdaq Composite has retraced in the latest rally about 50% of what has been lot from the peaks in early 2009, so we are running into short term resistance levels.

TRUST BROKEN

I have told you before that I was a stock broker for 12 years with Shearson Lehman Hutton in the 1980’s. I was vested in their retirement program, which Lehman managed.

I got a letter the other day from Lehman Brothers, which said if you have any questions about changes to your retirement plan, contact the new Plan Administrator of Lehman Brothers Holdings Inc. Retirement Plan at 1-800-LEHMAN6

If you call that number it says, “We’re sorry, your call can not be completed as dialed. Please check the number”. I guess I have to say I am not surprised.

The smartest business decision I made was to leave this firm back in 1989. There used to be a saying at Shearson Lehman Hutton: “The brokerage firm makes money, the stock broker makes money and two out of three ain’t bad!”

This is the attitude that led this firm to ruin because they put their interests ahead of their investors. They had little regard about risk their clients faced and it was reason why I left this firm.

Trust is the foundation of our financial system. Two years ago when Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson told us everything is okay, don’t worry, forget housing, forget soaring crude oil prices—look at how strong the economy is--- I knew we were in deep trouble. They knew then we were in deep trouble.

This is the heart of the problem---you can’t trust anything they say.

Today we learn the AIG was set to pay out $165 million in retention bonuses.

“ I was happy to see that AIG finally handed over the counterparty information we’ve been requesting for months,” said Representative Elijah Cummings, a Maryland Democrat on the House Oversight Committee. “However, I am deeply concerned that Goldman Sachs received so much money from AIG considering the relationships between the two companies. We will certainly be investigating this further to ensure that this is merely a coincidence.” Bloomberg

Yeah that is what it is alright, just merely a coincidence. It is merely a coincidence too that Former Treasury Secretary Robert Rubin under the Clinton days was a former arbitrage trader with Goldman Sachs, that Treasury Secretary Henry Paulson was a former head of Goldman Sachs.

I guess it is a mere coincidence that our present Treasury Secretary Timothy Geithner is a former protégé of Robert Rubin and his chief of staff is a former lobbyist for Goldman Sachs.

… just a mere coincidence.

Friday market update

For a third consecutive day, the broader market enjoyed a nice advance. In fact, nearly 50% of the losses seen over 20 plus days of trading prior to Tuesday’s rally were recouped by the end of today.

But it was likely a lot of short covering, when those who have the least confidence in the long term prospects are forced to bank their gains being short and buy some stocks to cover their short positions.

Sure, a retail report came in better than expected and there are a lot of bulls who feel that since Novembers lows have now been tested and since prices of many indexes have moved back above this important low that a spin could be made that the fearful statements of dropping back to 1996 lows is way overplayed and the broader market has actually succeeded in holding the test of support at the November lows.

Technically, this is only true for the Nasdaq indexes. The broad market indexes, such as the Wilshire 5000 and the S&P 500 convincingly broke below the November lows. And while a rebound could recover much of the recent losses, the die seems set.

So what sparked today’s rally on the heels of Tuesday’s oversold short-covering?

It’s the subject of “mark-to-market” for the banks. It is finally getting some real attention. You see, a hearing was convened today in Washington to consider alternative methods of valuation rather than the current mark-to-market rule.

This rule is not very old, only brought into play since November, 2007. Do you see a striking coincidence to when this rule was made and the beginning of trouble in the financial sector?

Here’s why. In a strong economy, when assets are appreciating, i.e., the housing bubble, the investment banks and other financial institutions wanted to be able to state the market value of their collateral, thus giving them higher capital to loan ratios – hence the desire on their part for a mark-to-market rule.

But in a weak economy, when assets are depreciating, i.e., the current bursting of the housing bubble, this new rule bites the financial guys firmly in that large rear muscle.

When assets collapse in value and are then sold at a fire sale, such as what occurs in many foreclosures, the “market” value of comparable collateral is now forced to be valued similarly, forcing banks to write off billions of paper losses, even though the majority of their current loans are being serviced according to the original mortgage terms.

When the government later bails out the banks by purchasing shares and capitalizing the banks the cash inflow does nothing but sit there on paper helping the bank with their capital to loan ratios. All those billions of dollars in essence did nothing by going into the banks as capital even though it did keep them from going under. It really could have been done a different way.

If the toxic assets had been purchased from the banks then the banks would have had cash, remained private, and the asset to loan ratios would have kept them in business and possibly able to re-loan out the new money.

The average person is likely offended at the proposal to suspend or ameliorate the mark-to-market ruling for the banks. They know that if the price of their homes goes down they can’t pretend that it is still worth more and get a loan based on its old 2006 value. Individuals are simply stuck with the losses in home equity.

But stock investors see the picture a little differently. The feeling is that a fire sale of an asset at even lower than market prices forces 90% of their loans that are being serviced just fine to have too low a collateral value. The reasoning being that if these long-term loans instruments are serviced and held to maturity then the real value is at least the face value of the mortgage, not some fire sale price by comparable foreclosures, etc.

And so when a hearing is convened to discuss this subject, shortly after Ben Bernanke even says something different should be done, traders holding short positions became nervous. They bought stock this week to cover their short positions and a spike rally is the result.

This kind of buying is usually over in a few days and the real market bias begins to return, in this case, a decline in prices, coincident with a weak economy.
But this instance may be different.

It is suggested that over the next few weeks a proposal to modify the current mark-to-market rule will be presented. I suspect it could allow banks to state the value of their performing assets much closer to face value rather than the lower fire sale values.

This re-evaluation alone would change the reserve ratios at the banks and in essence free up a lot of capital that is currently locked down. The lending that could result may actually provide more real stimulus than the better known Stimulus Plan just passed by congress.

However, there is motivation to keep the mark-to-market as is. If banks are forced to liquidate these performing assets at fire sale prices and private capital enters the fray to pick them up at these discounts, then who benefits when the loan is serviced to maturity? Right – the private money that came to the rescue of the banks and took the toxic assets off their balance sheet at a bargain price. The banks don’t want to do this.

You will hear strong arguments on both sides of this rule, but my bet is that it will be modified. The market will react positively if this happens. Whether it will be enough to make a difference over the long run is a subject for another day – but I have my doubts.

But for now, the stock market likes the talk that is going on and is hoping for a change in the rule. A change they can have confidence in – for a change.

Thursday Market update

The Dow was up 4 points today but the Russell 2000 was off a point, so I would call that a draw as the major averages approach key resistance levels. We have to keep a close eye on a number of risk factors as this is becoming more and more like a game of dodge ball.

CREDIT MARKETS STRUGGLING

I can’t see how the stock market can get a foothold here if the credit markets continue to deteriorate.

U.S. dollar Libor rates have edged higher. So have the Libor-OIS spread, a proxy for the scarcity of cash, and the TED spread, an indication of preference for interbank lending over safe-haven Treasury purchases. The credit market's recent erosion has not reached the panic associated with last fall's deterioration but it does indicate how precarious our situation is becoming.

This indicates things aren’t getting better, they’re getting worse and that is being reflected in credit spreads as banks continue to distrust each other.

Corporate debt issuance has deteriorated since January and bond prices continue to erode.

UNEMPLOYMENT

I am reading that unemployment is far worse than the government is reporting.

“ The February nonfarm payroll report estimates that the unemployment rate increased to 8.1%, but an alternative measure of labor underutilization suggests a much worse picture. The broad unemployment measure known as U-6 in the Bureau of Labor Statistics' household survey—which includes all marginally attached workers and part-time workers who would accept full-time jobs if offered—indicates that the percentage of those suffering from job loss may be as high as 14.8%.” Dismal Scientist

The scary part is that economists expect the top line unemployment report to climb from 8.1% to over 11% by the end of the year, which means the unreported unemployment report could reach 18%, or nearly one in five people in our country either unemployed or underemployed.

CRUDE OIL PRICES GET WHACKED

Oil price fell more than 7 percent (-$3.36 a barrel) today to close at $42 US per barrel Wednesday on further signs of weak global demand and rising inventories. This is a real tug-a-war between positive seasonality factors (warmer weather coming) but a rapidly deteriorating economy. Keep your eye on this fight because it looks like crude oil prices are now getting ready to test the lows in February again.

The intermediate-term picture for oil looks toppy to me with crude oil failing to trend above its weekly middle Bollinger Band line and weekly stochastics extremely extended (%K 98 and %D 97). It looks questionable whether the oil bulls can hold this but OPEC is likely to cut production again so we’ll see.

OVERHANGING RESISTANCE

From the technical side of things in the stock market, there are a couple points I want to mention today.

The first point is that once an old support level has been violated, the market often back tests the old support level, which in this case is the November low. Old support now becomes new resistance and for the S&P 500 this is at 741.

If the bulls can muster enough strength to break above this resistance, then I look at the Fibonacci retracement levels, which is also illustrated on this chart.

From what I see from the underlying technical picture I am skeptical that stocks can even break above minor resistance but we’ll see how much energy this short covering rally can muster.

MARKET TIMING VERSES PROTECTING CAPITAL

The traditional asset managers have taught us over the years that market timing is a losing proposition. They have drilled into the public’s mind that staying out of the market can be costly. We have heard that patience is more important than market timing.

In my perspective, I am not out to beat the market averages by market timing. Hey, you could be down half of what the market has lost and have easily beaten the market averages but you would have still lost significant money.

Our objective is to protect capital in bear markets. It is not about market timing, it is about protecting principal and profits you have built up over a life time of investing.

Our investment newsletter advice is in the top 5 performers over the last 10 year period according to the Hulbert Digest. We have that ranking largely by protecting capital in bad markets. This is our objective, winning by not losing, especially in bear markets.

The economy expands and it contracts. This just happens to be the worst economic contraction since the Great Depression. In early January the market’s P/E ratio was 11. Historically that would suggest the worst was over as many proclaimed. Then the S&P 500 plunged 23% since that time, only two months ago.

We listen to what the technical underpinnings of the market tell us and frankly, whatever you want to call it, risk management or market timing, as long as the market continues to make lower lows and lower highs---you need to protect capital.

This isn’t market timing, it is common sense! Protect your hindquarters.

Wednesday market update

The short sellers were scrambling to get out of short positions today as the financial sector exploded to the upside.

I mentioned this to you yesterday - we could see a short squeeze this week given the talk about relaxing the “mark to the market” rules.

Ben Bernanke discussed this in his comments today, suggesting that regulators need to examine mark-to-market accounting during financial crises.

In general, it is a good idea for banks to use mark-to-market. However, in periods of crisis, this accounting treatment can be misleading, he said.

I like Karl Denninger’s comments today, which explains in more detail the issues here.

Essentially, if the government relaxes these rules, banks will be able to revalue their balance sheets, just in time before the first quarter ends to save the S&P 500 benchmark from reporting negative earnings two quarters in a row.

Suddenly, Citigroup and Bank of America are now telling the world they are having a pretty good quarter, which sent these companies up dramatically today. Oh really!

It doesn’t matter whether there is a thread of truth in these comments as these banks are insolvent, but if they do relax the “mark to the market” rules, suddenly their balance sheets change. Suddenly, they show profits instead of losses.

The fact that they are talking about doing this just before the first quarter ends is just another example of smoke and mirrors, illusions and misdirection, which translates into mistrust. They can’t con there way through this.

The credit markets are worsening with the spreads widening dramatically again.

The Libor rate, which is what banks charge each other for overnight lending has widened to levels not seen since last December, suggesting banks are afraid of each other and each bank’s ability to hold on in this financial hurricane.

I want to draw your attention to something most people do not track.

This may come as a surprise to you but the money supply is falling! The weekly growth rate for M2 has dropped from +23.2% on 2/6/2009, to +20.1%, +16.6%, +13.2% and this week to +9.7%.

Could this be why the stock market and gold has been under pressure?

Gold fell another $22.1 an ounce today to close at $895.6, off a $110 an ounce in the last few weeks, peaking just when the Fed started cutting the growth rate of the money supply.

This could be the biggest reason why the major indexes couldn’t hold above their November lows.

This is a trend important to watch closely. Why would the Fed not want commodity prices ---gold, crude oil, food etc. climbing this summer? We all need to think about this one and what it implies with the economic wars being waged.

We certainly can’t expect much on the upside if M2 continues to descend!

Technically, we can argue for a short term bounce but nothing more.