Wednesday, February 24, 2010

WLI Data - 2/12/2010 - 4 WEEKS OF DECLINE

I haven't posted the WLI data in a while, but wanted to post it here now and not wait for the March update. The dip in the blue line shows that the Weekly Leading Indicators index published by ECRI . The interesting thing is that the data shows a 4 week consecutive drop and I can only expect when they publish the 2/19/10 data it will show the same.

I also track the 4 week average for this data and while it has not turned negative, almost any reading next week will confirm this drop as well.

I've mentioned this data set often as a good indicator that shows if we are coming in or out of a recession, however I've also discussed that much of the data in the leading indicators index can be pushed around by floods of liquidity (as we've experienced in amounts that blow the mind!).

I can only imagine that the WLI and also the FCI will be hampered and show contractions as the Fed attempts to draw down the juice in the system. I've also commented that this won't be possible in the long run as the markets have only been able to fake a recovery because of the extraordinary measures taken by our central bank, US Treasury, and the Administration.

If this trend continues the notion of higher interest rates could certainly be delayed and the double dip I'm suggested my be coming. I don't want to over-react as I still think we've got a month or two left of momentum higher, but the stage is being set for an April / early May top in the market.

Notice as well that the top of this recent WLI move is still at a similar level as the January 2000 level which ushered in the tech blow up. I personally hope that we don't have similar results in the market, but I wouldn't bet against it.


Saturday, February 20, 2010


I'm planning a trip to Disney World with the family sometime this summer so this story from Mish caught my eye.

Mish highlights the fact that Orlando real estate got creamed in January, prices were down some 15% from December. The blog article goes on to say that the reason for the decline was that 3/4 of the inventory consisted of shorts sales and foreclosures while 1/4 of the homes were your traditional sales of nice houses without credit issues.

As Mish mentions, the article from the Orlando Sentinel suggests that if you could extract out the distressed sales you'd be left with a 3% drop in prices from the previous month on "normal" houses.

GREAT! I thought things were all better? I thought we were coming out of the pit and the economy was surging?

Further in the article they interview a real estate consultant that suggests that pricing in the area will actually remain stable and since homes are more affordable we don't have to worry about the 13 months of foreclosure inventory that is "shadow inventory" meaning that these are homes that the bank owns but hasn't written them down and taken the losses. Hmmmm.

Didn't I just make a post the other day that said the following; WOULD YOU BUY THIS COMPANY?

"These steps may have had some stimulative effects in the very short run with a boost in sales in November, but ultimately we will see that intervention won't help as lenders and the government have realized that they must actually take lending standards to the level where only qualified buyers should be able to obtain financing. As standards are improved, fewer buyers will qualify and excesses in the quantity of homes available will then drive prices lower. In addition, foreclosures WILL be released from the inventory on banks balance sheets and this new supply will only add to this problem."

I love the consultants final conclusion.....

WAYNE - Our main conclusion is that prices are likely to keep steady, despite the massive shadow inventory, because the tremendous affordability we have today will create a floor for pricing. However, if the economic recovery stalls or mortgage rates spike, we’re going to see prices tumble again.

It is almost as if Wayne is trying to hedge his bets and say, "Everything will be perfect, unless the obvious and the inevitable occur, then it will be bad". Yes Wayne, you are correct! The recovery will stall and lending standards are going to be tightened, and we are going to see mortgage rates rise, therefore despite your best efforts to tell the truth, prices are going to tumble further.

Is it any wonder that I am able to rent a 3 story town home that is nicer than my home for $125 a night this summer? Yes, I'll be a few minutes away from the parks, but I am looking forward to Disney at the expense of the continuing housing meltdown.

Short and simple today. Be careful about purchasing real estate in Las Vegas, California, and Florida still. It isn't getting better no matter how many investors attempt to catch the bottom. Remember, real estate often goes down as interest rates go up, especially as financing cost increase for investors and commercial buyers.


Monday, February 15, 2010


There was once a company that needed some money to fund its operations. It had a core business that was plagued by pricing problems and management was simply trying to get financing in place to ensure that they could pay employees and meet obligations while the market sorted its problems out.

As you might guess, the company met resistance among its bankers and lenders as they were hesitant to lend money to a struggling business. As the bankers examined the books of the company they found that the company had some merit - there was tons of potential, great technology, an eager and talented workforce, and lots of capacity to grow. On the other hand, the financial evaluators found that the company had a habit of spending more than it made and over promising some employees benefits and perks.

As the sales of the product declined and prices fell due to poor demand, the company hardly changed any of its spending habits, in fact it actually increased spending to provide extra benefits for its workers.

Because the firm was a very large corporation, they often issued their own debt in the form of bonds. During the financial trouble, the firm's CFO and CEO noticed that the bonds that they sent to the market were often met with lackluster demand and therefore prices were low and (interest rates were high). The greater interest rates meant that the troubled firm needed to pay more every six months in interest costs for borrowing. The growing costs alarmed the CFO and CEO and they hatched a plan. As they sent new bonds to market, they would actually use other accounts and buy their own debt! In this fashion, they would actually bid for their own bonds and bid with lower interest rates to put a cap on the growing interest cost. For a while, the strategy worked great. By artificially buying the debt other buyers felt more confident about them and were willing to participate in the offerings. Soon though, the market participants began to question how wise it was to purchase the debt of a troubled firm at interest rates that were below the true cost of a similar risk. Once these participants realized this, they stopped buying altogether and suddenly the company had to buy almost all of the debt they were issuing. They essentially gained little additional money to fund operations because they were paying themselves. Incoming money was used to pay the old bonds.


If you were a banker, would you lend money to this company? Would you feel comfortable buying the firm's bonds for 30 years at 4.5%? What if you knew that the company was not planning on reducing spending at all, in fact had plans to increase spending? What if the company had financial assumptions that projected that interest rates on their bonds would actually be the same rather than increasing over time?

If you answered no, you wouldn't lend money, I'm in total agreement. While I'm made a very simple example, you might have guessed that the imaginary company is actually our US government.

In my example I mentioned that the firm had one product. If you recall, Ben Bernanke and Hank Paulson told us that housing was so important to our economy that it had to be stabilized and bailed out. We had all sorts of failed efforts to save the housing markets, measures that included mortgage modifications, incentives to purchase houses, and even actions that allowed banks to delay writing off foreclosures without indicating their true value on their financial statements.

These steps may have had some stimulative effects in the very short run with a boost in sales in November, but ultimately we will see that intervention won't help as lenders and the government have realized that they must actually take lending standards to the level where only qualified buyers should be able to obtain financing. As standards are improved, fewer buyers will qualify and excesses in the quantity of homes available will then drive prices lower. In addition, foreclosures WILL be released from the inventory on banks balance sheets and this new supply will only add to this problem.

Remember, housing is the key to the reversal in fortunes for the consumer. Of course I don't believe this is the only product in the US, but our government knows that consumers have used our homes as an atm machine previously and the home truly was the only store of wealth for many. Without a reflation of the housing market, the US consumer has little ability to carry on under the past mega consumption binge that they used to. 70% of the US economy is based on what the consumer spends, not what we manufacture. If in fact there is a material shift downward in the consumer's level of spending, how might it impact growth in the US? Is it any wonder that our government wants the consumer right back where he was spending without regard for saving and assuming that home prices will levitate without end?


Of course it happened and is still happening. The Federal Reserve calls their manipulation "Quantitative Easing", just like the corporate example, the Fed is buying their own debt because they want to control the interest rates and thus are paying more than the market prices to keep interest rates low. Despite their best efforts we will see that interest rates will rise and this will hurt the US in several ways.

First, we will have to pay higher interest costs on all new debt. America is issuing huge amounts of debt because we are spending much more than we are making in the form of tax revenues. The impact of greater rates will be devastating.

Second, because market participants are smart they have stopped buying massive amounts of US debt in long term maturities, in other words they have anticipated that interest rates are going to go up and rising interest rates hurt long term bonds the most. To avoid these losses investors have shortened their purchases and are buying shorter term bonds, leaving the longer term purchases to the US Fed. Summing up, we (the Fed) has been buying all of its own bonds -- the very bonds that will decline in value the most as rates rise.


Like all ponzi schemes and lies, we will see that the Fed's version will be difficult to stop now that it has been set in motion. The Fed has stated that they will attempt to extract themselves from Q.E at the end of March. This approach to removing the drugs from the junkie will come in several phases. First, the Fed states that they are going to stop purchasing treasuries. Second, they are stating that they will stop purchases of MBS or mortgage backed securities. They are the securitized mortgages that are the massive pooled mortgages of agencies like Fannie Mae and Freddie Mac. The Fed has been purchasing these agency pools in an attempt to keep mortgages rates low. The Fed's handiwork here is not small, in fact they now are approximately 80% of the securitized mortgage market. Do you think there might be a reaction in the market when the biggest buyer decides to stop spending? In addition, the Fed says that they are also going to increase the costs of borrowing overnight to banks. So, the $1.5 trillion dollar question is can the addict just quit cold turkey? The answer is no! We have a front row seat to see the impact on interest rates in treasuries and mortgages. I suggest that we all pay very close attention in the first couple of days in April and we'll need to watch interest rates to see how much they go up.

Many of you will say - yes, yes, we know all of this! I know, but frankly this is a summary of a conversation I had with a few friends over coffee. It is stunning to really document how brutal our country's leadership has been and how if it were a business we wouldn't just decline to purchase the stock, we would absolutely be shorting the heck out of it! The scary thing about our story here is that it really is happening! And the message we need to gather from this very simply example is that we need to construct an investment strategy that truly examines how risky US assets are and what the long term implications are for the US dollar.

Given what we know of the situation above and the recent market correction, I believe that this sets us up perfectly for what we've mentioned quite often. We are looking for a move higher here, even to new highs of around 1175 on S&P500 and 11,000 on the Dow. This will extend the range we've discussed for 6 months. I believe this move will occur over the next 6 to 8 weeks, taking us through March and into mid-late April. At that point we will need to have exited trades according to my view that we'll begin to see a significant drop in late April and early May that will be as severe as anything we saw in 2008 and early 2009. Remember, identifying areas in a market range is tough, in fact I have noticed that my experience in trading has gotten better as I sell as we near the upper ranges I've identified - essentially paring my position as it moves up. In the same manner, I buy as I near the target lower range. I almost never reach the bottom range of a target so if I didn't have this discipline I would often never get the chance to enter a position.

One trading update - KSU neared $33.50 earlier yesterday and could have been a good exit at a 10% gain for less than a week. I do believe it will achieve that $33.50 - $34.00 range again and I would use that an an opportunity to sale 100% of the position or at least 75% of it. There is no reason to get greedy when I believe you'll have another chance to play that same range again. I like the company and I like the fundamentals, but you must stick to the levels we identified at entries and exits and be disciplined. You can move your stop up to $31.50 to ensure that you make a solid profit to protect your downside as well.

Continue to watch the fear index. As the market rallies, we will be watching this to come down significantly. If we see it in the 15 or 16 level this will be a signal to start selling long positions and perhaps even pick up VXX again. This would fit well if we get to those highs I talked about earlier.

I will post an update on a few more ideas I've identified, but want to make sure we have confirmation of this move before laying it out.

Beware as well, my friend Guy Lerner has posted an update on that suggests that folks were bearish as the market bottomed and now that the market has reversed, they are suddenly bullish again since the market has recovered a bit. I mention this because we all know that when everyone believes something, it is best to start betting against them. I like to add this piece of information because every trade can and sometimes does go wrong, you need to be prepared if it does.


Tuesday, February 9, 2010

Feb Update - Ok, that was nice - now what??

Ok, we had a nice rebound of a couple of percent today on the back of Friday's pretty strong reversal. I went back tonight and re-read my February update and let me tell you I sound pretty bullish. The funny thing is that I don't actually feel that way at all.

I am writing this evening simply to remind you to be on your guard. The reality is that things are very dicey in the credit markets right now and the sovereign debt of countries like Greece, Italy, Spain, and Portugal are all in question right now.

As I wrote last week, the bailout of Greece could be the catalyst for a move up..... which it was. But I also cautioned that the moral hazard of bailing out Greece would almost obligate the EU to move to assist Spain and Portugal which are much larger and frankly even bigger disasters.

Remember how our Federal government and congress was all too willing to spend your money to help the banks and stimulate to their hearts content? Why would they do this? Well of course it was all in the name of helping ourselves at taxpayer expense. We (they) were going to receive a benefit when we saved the banks, housing, auto manufacturers, and AIG. Remember, we needed to do these things to save us ourselves from the abyss. Self preservation is a strong motivator for going along with things we know are bad, or in this case - outright wrong.

While we often view the EU as something akin to the Federal government, the EU is not the US Federal government, and is only a binding body made up of willing participants. The reality is that the stronger independent countries like Germany will have a strong hesitation about helping the Greeks, Spanish, or Portuguese at their own expense. In other words, helping them hurts Germany. In addition, a prudent person questions spending their own money on a poor cause when they know that they will only need to throw more money in later. In other words, this game is real and Germans may think twice about this bailout when they know that it won't do anything but push the problem out a month or two and not change the final outcome.

Here's the take away about the EU problem. If a bailout is not announced we could see some serious selling as players move to the sidelines. There will be a flight to the dollar. Hedgefunds used today as a way to load up on their shorts of the Euro, so they were not scared off by the drop in the USD today. Their accumulation of dollars vs the Euro has me concerned that this is not over.

We may see continued movement up in the market over the next several weeks or months, but I will stick with my original thoughts about this year in that in April we will start a slide down again. I also believe that we'll see periods of sustained ups and downs within ranges and if you are not prepared to move in and out of the market you may end up absolutely nowhere - but with a few more ulcers than when you started the year.

I will leave you with this picture of the market, but concentrate more on the left side in March, June, and July of 2007. If you recall in credit conditions began deteriorating in February of 2007 when sub-prime mortgages were not being paid back. In April of 2007, UBS' own hedge fund was shut down after suffering big losses, and then in June and July Bear Stearns own funds were in crisis due to margin calls. Through the next several months credit issues increased (not abated). Finally in August, the Federal Reserve stepped in and lowered the Fed Funds rate and also expanded the types of collateral it would accept at the Fed window. This seemed to do the trick as the market thrust higher, more confident that things were better. Note from August to October how the S&P 500 moved up almost 200 points or another 12% or so.

In 2007 we pushed higher despite many warnings.

I've discussed this period previously, stating that I am absolutely on guard for something similar to this event unfolding. The Greece scenario seems familiar to me in that even if everything turns out perfect I believe it would mesh well with my timetable for a push higher for a month or two fueled by the euphoria that the all clear has been sounded. Unfortunately as in 2007, we may simply find that the troubled waters run extremely deep and all government intervention did was to muddy the waters at the top so we couldn't see the sharks below.

As I mentioned the range of this market has now been expanded and I believe that the downside of this move could substantial, with the upside at 1150 (not higher than before). Be watchful. Yes, if the rally looks like it has momentum - play it, but don't load the boat.


Friday, February 5, 2010

February Update

Ok, here's a quick update for February.

RAILS - (from Railfax) -
The next few weeks will reveal how much of the recovery is real. As you can see, rail traffic is now on the verge of a breakout over last year's levels. To this point, all of the talk about recovery has been forward looking and full of "Hope". We will see the truth in the next two to three weeks.

Commercial and residential building is not showing up here in the shipping of lumber and crushed stone. It is very interesting to note though that home builders did not break through their lows in the correction over the last two weeks, and we are seeing lumber prices really catch a bid.

See futures trading - You'll see lumber prices have moved much higher and there is quite a bullish trend underway. They do not give permission to copy their charts so I have included a link here.

The question I am asking here is simply this - Does this move in lumber prices indicate some type of increase in demand that will translate into greater production for homebuilders and commercial development? Someone is buying so we should be looking at these types of investments. It is interesting to note the the XHB (homebuilder's etf - I'll add a chart later)
has not really broken down terribly over the correction of the last couple of weeks. This should be on our radar as a potential bullish breakout if the overall market gains traction.

Once again, KSU is back over last year's trendline in shipping. We might review how the stock is trading and attempt to go back to the well one more time.

Click on the chart for KSU - I see $29.00 as pretty strong support here. I might look to purchase the stock in the low $30.00 level with a target for exit at $33.50. Fundamentals coupled with the channel that remains intact will produce a good opportunity for a 8% to 10% move higher. As I mentioned, set stops at $29.00

The Baltic Dry Goods Index is continuing to make higher highs and higher lows. We'll continue to monitor this trend which indicates that a recovery in commodities and shipment pricing power is underway. It is important to note that a decline here below the $2200 level would indicate that commodity demand is drying up.


The Financial Conditions Index dropped back below zero (0) last week with the market correction. The message here is that we are not out of the woods yet and the recession is not completely over. A strong move over zero would allow us to declare everything is better. As you know, I question the FCI simply because more than 1/2 of its components are Fed liquidity driven, meaning that the slosh of funds provided by our generous Federal Reserve are being captured in many of the inputs here.

The dollar has been the beneficiary of strength due to the concerns with the debt of several European countries - namely Portugal, Greece, & Spain. Recall we had similar issues with the debt of Dubai just a month or so ago. As investors fear uncertainty they flood back to the good old greenback and typically buy US treasuries. They aren't buying treasuries because they yield a bunch or as we've discussed, compensate them for the actual risk they are taking, they are merely buying the dollar because it is the best of the bunch.
What has been the result of this 2 weeks of dollar buying? The obvious answer is just what we noted would happen. When the dollar gets stronger, EVERYTHING else gets beat up. That has included the overall equity market, the corporate bond market, gold, silver, and any other commodity.
Well, what is the strategy for this month? I think the best approach for this month is to recall the ranges we've previously discussed. Remember we've highlighted the upper boundary for the range at 1150, well we punched through the 1110 area on the S&P and now have a lower area of 1060 as a lower boundary.
As traders become more concerned about risks, they put more bearish bets on and that is bullish and portends a rebound in the market.
Greece is the near term catalyst for a bounce. If an announcement is made that protects or guarantees their debt we may see a jump. The EU needs to be concerned though because this will set in motion a precedent for further actions for Spain and Portugal which both are very sick.
If you have dry power left you might consider putting to work some of it here and looking at the same old items we've mentioned before (commodities and emerging markets). Don't forget that KSU trade either because it seems like a good set up. Finally, if you bought the VXX (fear index) I mentioned you made great money, you need to get rid of that because if the market bounces you'll start losing.

View of S&P 500 - look for support at 1018