Diamond Slice

S&P 500 Index Dives Below Resistance Levels

U.S. equities closed substantially lower across the board on Monday as the overbought rally and fear leading into 2009 Q1 earnings data caused selling pressure among stocks.

The Sunday announcement that General Motors CEO Rick Wagoner had submitted his resignation raised eyebrows among analysts and investors as they questioned the reasoning behind his departure. The veil was lifted as President Obama announced the government's plan to support the automaker with 60 days of working capital, after which time the company would be forced to enter into a government backed Chapter 11 bankruptcy filing. The viability of Chrysler was also scrutinized Monday, as the Obama administration set a 30 day window for the automaker to make a deal with Fiat or face bankruptcy.

The ease with which the government flexed its grip on automakers, forcing out GM's CEO, created pessimism among investors fearing that many of the financial institutions with TARP funds could share a similar fate.

Crude oil futures saw a significant pullback to levels under $49/barrel as high inventories, a strong dollar and anticipation of poor corporate earnings made a case for cheaper oil prices.

Despite the bad news stemming from the above related issues, the most crucial aspect of the trading day Monday was the inability of both the S&P 500 and the Dow Jones Industrial average (DJIA) to close above their 50 day SMA's of 791 and 7597 respectively. The two U.S. equity indexes broke through their 50 day resistance levels on March 23, 2009 and have not closed below these important levels of support until today. For the market to decline more than 3% in a single day and simultaneously close below support levels on both the S&P 500 and the DJIA is an extremely bearish signal and warrants increased short positions in traders' portfolios.

Equity markets will look to the Case Schiller HPI (Home Price Index) and the Consumer Confidence data for guidance Tuesday morning. Watch for the market's reaction and expect traders to be more comfortable shorting the overall market if indexes close for a second consecutive day below their 50 day SMA's.

Captain Wagoner Walks the Plank, Obama Defines Last Resort to Automakers

Excluding the bottomless pit of Wall Street executives now tarred and feathered to satisfy the constituents of the "blameless" U.S. congress, the Big Three automaker CEOs rank second as they were publicly chastised for their own inadequacies. While much blame has been rightfully bestowed on Ford, GM and Chrysler for declining from market dominators to market losers, it is necessary to acknowledge that auto manufacturers didn't lead the U.S. Economy into recession.

It seems ironic that while the U.S. Banking sector evolved too quickly and endorsed derivative instruments it didn't fully understand the Big Three U.S. auto manufacturers have lagged in adapting to the demand shift from "gas guzzlers" to economical driving machines over the past 10 years. Both industries have been laden with errors in judgment, yet the banking system is essential to economic growth in all sectors while auto manufacturers reorganizing under chapter 11 bankruptcy will allow only isolated damage as automakers emerge leaner and stronger.

Interestingly the administration with the "right stuff" to endorse such policy decided instead to supersede the refusal by congress and grant GM and Chrysler loans from the TARP fund. The loans designed as bridge financing totaled $17.4 billion and were expected to ensure that the two companies met their debt obligations through March 2009.

The more conservative Bush administration failed to allow the auto makers to reap what they have sown, even as GM's cash burn rate clocked in at $4.7 billion in 2008 Q3. President Obama announced Monday that the government would finance GM working capital for two months ending in June 2009 and will keep Chrysler afloat for thirty days allowing time for the proposed Fiat deal to buy a 35% stake in the company to be reached. If the Fiat deal is successful Obama pledged to offer an additional $6 billion of capital to bring the deal to fruition. The President is taking a hard stance on the issue and suggested that if the companies cannot find a solid footing on their own by the deadlines announced, the companies will be allowed to enter bankruptcy with the “backing” of the United States government.

GM and Chrysler both structured their first loan from Uncle Sam with the premise that demand for automobiles in the U.S. would average 12 million vehicles over the course of 2009, but statements from GM President Fritz Henderson in January 2009 reassessed projected 2009 auto sales closer to 10.5 million units. Earlier this month GM and Chrysler pleaded for an extra $22 billion, citing talks with bond to convert debt into equity shares as evidence of their ability to survive with the government’s help. However, one must wonder whether the holders of relatively secure debt will convert their investment into equity shares given language from Washington on Monday, suggesting stockholders could be wiped out.

Rick Wagoner, CEO of General Motors, announced his resignation Sunday ahead of the U.S. government’s announcement of its stringent requirements for the automakers on Monday. Wagoner had been at GM for a total of 32 years and had served the past nine as the company’s CEO. As captain of the sinking ship he saw GM replaced by Toyota as the U.S. market leader in car sales and is responsible for the lack of forward vision in the new millennium. His removal from the company is not only symbolic of change to come, but a signal to the industry that the Obama administration will not tolerate complacency in the increasingly competitive environment challenging automakers.

Equities Exhausted, State of Banks Less Optimistic

U.S. equities felt strong selling pressure in pre-market trading Friday due to expected yet unfortunate economic data. Markets were unable to build optimism throughout the day Friday as the overbought tech rally ran out of gas and all indexes ended the day down; DJIA -1.87%, S&P 500 -2.03%, NASDAQ -2.63%.

Consumer spending for February came in slightly under consensus estimates and 0.2% higher than January. Personal Income data in February was lower than January as salaries decreased by 0.2% while the Core CPE Price Index actually increased by 0.2% on a month over month basis. Consumer sentiment data was released for February at 9:55 AM, which impressed the slightly improved and above expected level of 57.3 on the index. While the sentiment was slightly better than expected last month, it is crucial to examine the long term trend of the confidence level depicted below.

President Obama had a conference at the White House this afternoon where CEOs from the nations largest banks met face to face with the president and were given a chance to express questions, comments and concerns given the current economic environment. Reporter Erin Burnett of CNBC interviewed many of the CEOs after their meeting with the President and drew several responses which proved important to markets. Jamie Dimon, CEO of JP Morgan Chase (JPM), explained that although his company had been profitable in January and February that JPM incurred trading losses in March. ViKram Pandit, CEO of Citi Group (C), offered several comments as he walked away from the White House and seemed to be "less comfortable" with the summit's outcome. He was undoubtedly unhappy to hear straight from the horse's mouth talk of returning TARP funds by stronger banks.

Equity markets are hovering between 800 and 830 levels of the S&P 500 as traders and investors are at a pivotal point in their strategies. Much is contingent on the performance of the financial stocks, which lead the market higher and could easily send shock waves through all sectors if and when they fall out of favor. Short traders don't feel comfortable committing full force, as they have had to cover some of their bets, while bulls have emerged allocating capital, albeit in meager proportions. 

USO Begs Short Position as Crude Tops $53.50

Crude began to rally early Thursday as U.S. commodity markets opened on positive news that 2008 Q4 GDP numbers were not as terrible as expected. Futures prices are completely ignoring the stockpiles of crude throughout developed countries, in the Arab world, and floating off-shore in tankers. While WTI crude futures were trading below $45/barrel they were argued to be cheap, since which time markets have priced the black gold commodity higher by 20%. The previous levels were optimistic that demand would increase and macro economic data would turn favorable.

To traders who profited from buying DIG or USO while crude was trading near $40/barrel, congratulations, take profits and reverse it. The "re-flation” trade, Chinese stimulus promises, and Thursday's less terrible than expected GDP report have provided enough froth for commodities to float above realistic valuations. Now is the time to take account of the meaningful forward indicators of economic activity and detach the rear view mirror.

 

The supply of crude grew by 3.3 million barrels compared to 2.0 million barrels the week before, according to the EIA Petroleum Status Report on Wednesday. U.S. inventories of crude are at levels above 360 million barrels and are higher than any at any point in the last three years. Refiners are operating at 82% capacity with room to scale up production over time, yet draws in gasoline supply won't have an immediate impact on the prices of crude due to supply gluts. Refiners will moreover be less inclined to scale up production given jobless claims data released Thursday, which suggests it is unlikely that U.S. consumers will increase their consumption of fuel.

The long term trend of crude oil will be to the upside, but the immediate macro and micro economic threats make the case for active traders to short the USO, while a substantial pullback of crude towards $40/barrel will offer an opportunity to get long the USO for "buy and hold" investors.

U.S. Equities Confused at 800 Level of S&P 500

U.S. equities have charged from 666 to 821 in the S&P 500 index, catalyzed by the removal of bankruptcy risk from the financial sector. While prominent fears that the government would nationalize TARP banks pulled the broad market to its bottom, the new found confidence in financials naturally led stocks to surge across the board, settling at their recent levels.

Wednesday the S&P 500 improved on good news that that mortgage applications were up, yet 80% of the new mortgages were refinance mortgages. Durable goods orders improved 3.4% from January to February but on a year over year basis the orders still lower by 23.4%. New home sales saw improvement in February as well but sales are still 41% lower than levels just last year, while new home prices continue hurt home builders at levels 18% lower than February levels in 2008.

The above "rays of hope" helped the S&P 500 and Dow Jones Industrial Average (DJIA) appreciate throughout the day until selling pressure hurt banks and pulled the market below the 800 level of the S&P 500. Although both U.S. equity indexes pulled higher to close above key resistance levels, sellers had no problem exiting positions as the S&P 500 dove under 800. 

Use the hopeful buying seen into Wednesday's market close as an opportunity to get short financials, home builders and the broad U.S. equity market. Commodity futures such as WTI crude oil futures should also pull back from their current levels, but the risk reward of shorting commodities is less appealing.

Market Inevitably Must Confront Housing Woes

The mass of unanswerable questions facing investors navigating this market are nothing less than maddening. Will the economy depreciate back to its lows after such a strong rally? Will the Treasury plan to buy distressed assets help or hurt banks? Yet it is the most pivotal query, concerning when the housing market will recover, that will foretell the “homecoming” of risk to one’s portfolio. As of late the root cause of the economic downturn has been overshadowed, despite the extensive and relentless housing sales decline, by the housing derived chaos within the financial system.

Tim Geithner has finally announced the details of the Treasury’s public/private toxic asset sale proposal. Under the plan the government will buy mortgage backed securities using remaining TARP funds and leverage, while also lending money to a select few institutions to will buy the securities. While the plan provides the option to sell troubled assets, U.S. banks will be selling the assets for considerably less than the projected value over the long term and would be forced to write down more losses.

Able and rational banks will not choose to sell mortgage backed assets at a loss. Simultaneously financial firms are incentivized to return TARP funds as quickly as possible as they avoid losing their “top talent” to firms exempt from the stifling government compensation caps. Assuming that banks act in the best interest of their shareholders it is increasingly likely that these banks will not endorse further lending because such policies would put firms at a competitive disadvantage.

The Mortgage Bankers Association (MBA) has reported increases in mortgage applications in recent weeks due to 30 yr fixed rates hovering around 5% at prime. Some of the refinancing may stifle the rate of foreclosure, yet the national delinquency rate of home loans climbed at an accelerating pace to 7.88% in the fourth quarter of last year. Still more frightening is the level of sub-prime delinquencies, the same mortgages to which the banks’ “toxic assets” are tethered, which reached 21.88% in 2009 Q4.

In a press release on March 5, 2009, the MBA stated, “We will continue to see, however, a shift away from delinquencies tied to the structure and underwriting quality of loans to mortgage delinquencies caused by job and income losses.” The unemployment rate has continued to climb at an increasing rate from 7.6% to 8.1% in February and is expected to rise to over 9% by year end (the worst since early 1980’s), corroborating the projection by the MBA of more delinquencies in months to come.

It is important to consider the “worst case scenario” announced by the President and the Treasury, which will be applied to TARP recipient banks, which allows for 8.9% unemployment and a further 15% drop in home prices. Why would a first time home owner buy a home that may decrease in value by 15% during their first year of ownership?

While U.S. equity markets have made a roaring rally from 666 to 824 on the S&P 500, all evidence suggests that significant headwinds face the U.S. and global economy moving forward. Banks have not substantially increased lending, delinquencies and foreclosures continue to rise, the secondary effects of the jobless rate on the housing sector and broader economy have yet to be seen, and the sentiment of first time home buyers couldn’t be worse. It is delusional to anticipate the recent rally will lead us out of the recession we have endured for the past two years and miraculously change the real economic problems facing consumers and firms alike.

The single most influential forward indicator of a real housing rebound and a derived economic recovery is the level of unemployment, as job security determines the ability and willingness of consumers to buy homes. Until the acceleration of new and continuing jobless claims recedes it is prudent for investors to realize the true and dismal state of the economy.

Chasing Stocks, Lost Cause

Bulls found evidence to further their exposure to U.S. equities on Monday as markets climbed to post the largest daily increase of the new year. The Dow Jones Industrial Average (DJIA) gained nearly 500 points and the S&P 500 soared 7%. The surfacing of a tangible Treasury plan to create the promised "public/private investment program" drove the TARP banks nearly 20% higher. Also notable was the 5.5% surprise to the upside of Existing Home Sales data in February on a month to month basis. 

Troubled banks have lead U.S. equities through the pops and drops of the past year and markets failed to buck that trend today. Monday warmed investors feet as the whopping 500 point gain in the DJIA coaxed money into the market, yet chasing this rally will humble portfolios. 

Stocks may find their way higher to the S&P 500 100 Day SMA (Simple Moving Average) at 845, but this market will not drive straight through this resistance level, after busting up the 50 day SMA, without a significant pullback. It is important to mention that we haven't seen the S&P 500 trade above its 100 day since June of 2008. 

If the S&P 500 nears 845 this week, begin preparing to short U.S. stocks because they will be incredibly overbought.

Take Profits, Keep Powder Dry

After profiting from a trade, humility can be a lucrative virtue...

Regardless of how often one tracks the health of the stock market during these turbulent times, it would be impossible to ignore the fury of the recent rally in U.S. equity markets. Many have called for this rally to be the first leg of the recession's bottom and for investors to get long into U.S. stocks. Browse through my recent posts and you'll find a case being made for the S&P 500 to reach 840 before a significant pullback. Turning to a change in sentiment where the market plowed through economic data at or slightly above consensus estimates it was tempting to trust that the market could break 800 on the S&P. 

As it happens the 800 level, a technical 50 day SMA (Simple Moving Average) and strong psychological level, was too strong for the S&P 500 to close above on Wednesday. Bank stocks have been overbought from their lows but many expected other sectors to take some leadership if the financial sector could simply move "sideways".

Unfortunately, most of these hopes aren't materializing. Financials trading at P/E ratios synonymous with growth have been too rich for most, resulting in a sharp decline for the overall financial sector. Weakness in basic materials, energy and consumer discretionary stocks on Friday is bearish for the market and these sectors will suffer much worse if housing sales data for February comes in much below estimates.

The only trade that I could sleep with is that of shorting financials. Congress seems to be trying to run the very banks THEY OWN out of business by converting them to non-profits. By taxing the talent of these firms at 90%, the goverment is going to chase the talent to the banks who first return the TARP money or worse to countries outside of the United States! If financials drop the market will fall with them and if the market drops the financials will fall harder.

Take profits and enjoy the weekend!

Bernanke vs Banks Matchup Will Determine Friday Close

Growth in U.S. equity markets over the past two weeks has been fueled by new found confidence in the banking sector as XLf, the Financial Select Sector SPDR, as it has driven higher by 52% at the close on Thursday. The decline in bank stocks over the past two days has caused the Dow 30 to decline as AIG, C and BAC have pulled the index lower.

The S&P 500 and the DJIA have been in positive and negative territory throughout the day investors wait for Ben Bernanke to speak to the ability of banks to lend. If Bernanke is able to conjure up confidence, as he has in the past weeks, stocks will show resilience and find strength to close higher.

Drug stocks and Utilities are the sectors keeping the DJIA in neutral territory, but broad market strength will be necessary to end the week on a positive note. 

A positive close today will be a very strong sign that the market can move higher next week into the new and existing home sales data, while a close above 800 would almost certainly secure further gains in the rally.

If the market indexes end up in the red at the end of trading today, markets will lose much of their momentum and create technical headwinds for markets leading into next week. Such a pessimistic close could be a sign to take whatever profits have been made and endorse a "wait and see" approach prior to economic data next week. 

Oil Driving Higher... Play it With DIG

Up until this point the Oil story has been somewhat perplexing. Investors couldn't get a handle on whether the WTI crude futures were trading too expensively in the high 40 dollar range because (1) U.S. dollar strength has been keeping the commodity cheap, (2) demand seems to have bottomed but the fundamentals of the economy are still headwinds and (3) the inventories of refined gasoline and crude oil sitting in tankers hasn't made a convincing swing to negative growth.

As of Wednesday the deflation threat is null and void. Bernanke is dumping cash from helicopters throughout the country's skyline pumping over a trillion more dollars into the money supply. On top of this the current account deficit is shrinking and U.S. government debt is being bought by the Fed, which will cause the dollar to peak and begin to succumb to the inflationary forces from every angle. 

The demand and inventory stories have shown tangible signs of bucking their recent trends that have left WTI crude at such low levels, as compared to their highs above 140. The argument that a bullish Greenback would keep WTI futures cheap has been the major force against the upward momentum of this "lifeblood" natural resource.

Another very important factor lies in the OPEC output cuts. Although the cartel hasn't formally anounced further cuts, they have pressed for all members to cut to the agreed levels while members are averaging only 80% of the agreed cuts. U.S. WTI futures are trading higher on the increases in money supply but the global supply and demand equation remains the same and OPEC is likely to announce futher cuts.

Rather than trying to play the cyclical swings of the USO or trying to pick a winning company, take a position on oil using the DIG ETF. It's an Ultra, so you know you're getting a solid return on your trade, and it is a great inflation hedge to your portfolio as we head forward through this cycle. 

If you aren't convinced, watch the new homes sales data next week and form a more solid thesis as to where the overall industrial sector is going, which will drive DIG higher.