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Friday, May 9, 2008

The Bears Are Back: Consumer Credit, AIG Misses, Oil Moons

AIG rallied off the lows in an Ascending Channel. AIG hit the declining trend around $49.50 and was rejected, turning down. Before earnings, prices broke DOWN and out of the channel... foreshadowing a terrible earnings report.

AIG's Loss, Need for Cash Add to Pressure on Sullivan (Update3) : “American International Group Inc. , the world's biggest insurer by assets, said it needs to raise $12.5 billion after two straight quarterly losses as pressure builds on Chief Executive Officer Martin Sullivan.

AIG fell 8.3 percent to $40.50 in early trading at 7:27 a.m. in New York after the company reported a first-quarter net loss yesterday of $7.81 billion, compared with earnings of $4.13 billion a year earlier. The New York-based insurer disclosed more than $15 billion in pretax writedowns, prompting Standard & Poor's and Fitch Ratings to cut the company's credit grades.”

Not exactly unexpected. Not sure why this is always surprising to the talking heads over at CNBC. There is going to be so much more of this in the quarters to come it won’t even be funny…

AIG earnings could be the catalyst here for the wedge break DOWN and out. Pre-market S&P 500 is trading around 1380. A break below 1370 would seal the deal next week.

Oil hit $125 overnight and is now quietly melting higher. It now basically has to hit $130 as that number acts like a magnet.

Oil Rises to Record Above $125 as Nigeria Cuts Curb U.S. Supply: “Oil rose to a record above $125 and was set for the biggest weekly gain in more than a year on speculation reduced exports from Nigeria will curb U.S. supplies during the peak summer driving season

Nigeria production, which fell to the lowest level in a decade in April, has been cut further this month by rebel assaults on Royal Dutch Shell Plc pipelines. OPEC said yesterday it doesn't need to increase supplies, even as its president warned prices may reach $200 a barrel.”

At some point this should just trigger a rapid implosion somewhere in the economy. Consumers are turning to their credit cards so fast and hard that it can't be good. It must be to pay for necessities like gasoline and food.

The Federal Reserve Statistical Release on Consumer Credit was freakish. The annual rate of increase in revolving (credit card) debt was nearly 8% in March, more than double the annualized rate of increase in wages.

“Look! It's our credit card statement.”
“My eyes! The goggles, they do nothing!”

Those stimulus checks are already spent.

The Bears are back.

Thursday, May 8, 2008

Cracks In The Bear Wedge

Maybe, just maybe we have the first cracks in the rising Bear Wedge...

This formation occurs when the slope of price candle highs and lows join at a point forming an inclining wedge. The slope of both lines is up with the lower line being steeper than the higher one. To trade this formation, place an order on a break up and out of the wedge or a sell order on a break down and out the wedge. Rising wedges, with a prior downtrend are anticipated to break down and out, rather than up and out.

As of right now it looks like the high of 1422 was tested and held. Yesterday the S&P 500 (SPX) broke the rising trend (black trend line) of the last 10 days and accelerated downwards. The SPX also broke the 200 period moving average which has acted as support in the recent past. Volatility (VIX, grey) increased significantly as well, confirming or validating this move down.

The psychologically important 1400 area should also act as resistance now.

This chart perfectly demonstrates the effect of the Japanese Yen (XJY, grey) on S&P 500 (SPX, grey, below). A rise in XJY results in a decline in the SPX. To best demonstrate just how closely this relationship is, I've used the ProShares Ultra Short S&P 500 (SDS, candlestick) instead of the SPX. SDS is inversely related to the SPX and moves 2% for every 1% move in the SPX.

As the Yen moves up, you can clearly see SDS gain in value. Translation: As the Yen rises, risky assets such as equities fall.

On a six month chart the relationship becomes even clearer. Cheap money from Japan fueled an enormous amount of the debt creation in America and Europe directly. It was also the currency of choice for leverage. The Yen Carry Trade was and still is truly massive.

The Yen can be used as a leading indicator and as confirmation. Keep an eye on it.

Related Posts:
Dollar Smile, Global Decoupling, Oil Super Spike and Yields
Bulltrap: ABCP, and Level 3 Bombs
The Yen As A Leading Indicator
Watch The Yen, Carry Trade Unwind

Wednesday, May 7, 2008

All of Inflation's Little Parts

A really cool interactive graphic on inflation: All of Inflation's Little Parts

Dollar Smile, Global Decoupling, Oil Super Spike and Yields

When I first posted about the Dollar Smile Theory in January 2008, there were no obvious signs of economic weakness in Europe. Sure a bank or two had stumbled, but the economic numbers stilled looked robust.

It was only because Europe was lagging, not because Europe had miraculously avoided the credit and real estate bubble that economic numbers held up for a while longer.

The EURO has been SMASHED down from $1.60 since.
Gold has been SMASHED down from $1000+ since.

Related Posts:
The Dollar Smile Theory, Overbought Euro
The Dollar Smile Theory
Commodities Unravel, Confidence Collapses

European Retail Sales Drop by Record on Rising Costs (Update3): “European retail sales declined 1.6 percent in March, the most since at least 1995 and twice as much as economists forecast, as soaring fuel and food costs sapped consumer spending.

The drop in euro-area retail sales from the year-earlier month is the largest since the data series began more than a decade ago, the European Union's statistics office in Luxembourg said today. From the prior month, sales declined 0.4 percent. Economists had forecast a 0.7 percent annual decline and a gain of 0.2 percent from the previous month, according to Bloomberg News surveys.”

The Global Decoupling Theory is garbage. I’ve said that from the beginning and it has now become undeniable. However, the markets haven’t yet fully priced this in. While the Asia indices have corrected significantly, Latin American indices have not.

“Even unemployment at a record low has failed to spur spending. Confidence among households in France dropped to a record low last month, while a European Commission index of sentiment in the euro area also fell in April.

Retail sales in France declined 0.8 percent in March from the year-earlier month, while sales in Germany, Europe's biggest economy, dropped 1.1 percent, today's report showed.”

These economies too shall fall into a recession. They have to.

Related Posts:
Oil and Global Decoupling Theory
Global Decoupling Theory, Correlation Contagion
The Global ‘Decoupling Theory’ is Garbage
Asia Tanks

Of course none of this is immediate. For example, oil looks hell bent on one final speculative blowout. There was talk about an OIL SUPER SPIKE yesterday.

Goldman's Murti Says Oil `Likely' to Reach $150-$200 (Update5): “Crude oil may rise to between $150 and $200 a barrel within two years as growth in supply fails to keep pace with increased demand from developing nations, Goldman Sachs Group Inc. analysts led by Arjun N. Murti said in a report.

New York-based Murti first wrote of a “super spike” in March 2005, when he said oil prices could range between $50 and $105 a barrel through 2009. The price of crude traded in New York averaged $56.71 in 2005, $66.23 in 2006 and $72.36 in 2007. Oil rose to an intraday record of $122.49 today on speculation demand will rise during the peak U.S. summer driving season.”

Increased demand from developing nations won’t drive oil much higher. Developing nations are the new marginal consumers. That is to say they are the most price sensitive elements of oil demand. For first world nations oil demand is very inelastic. For developing countries oil demand is far more elastic. That means for every $1 increase in oil, more demand will be choked off in developing countries than in first world countries.

Translation: Long before high oil prices cripple the SUV driving commuter making $48 201 (2006 US median annual household income) the Chinese factory worker making about $7 700 (2006 Est.) or the Indian worker making $3 800 (2006 Est.) will have given up on certain consumer amenities.

It is a serious mistake to assume that commodity prices at these levels won’t have a serious affect on these developing nations.

Right now it is FINANCIAL demand that is driving the price of oil rather than real economic demand. So a SUPER SPIKE may well be possible but it will be speculative in nature and short lived...

While still range bound, yields along the entire curve have moved up significantly. The further out on the curve, the more significant the move higher. This is most definitely NOT what Bernanke had in mind when he started cutting. The market is not supposed to take away his rate cuts...

The 2 year yield is above the Fed Funds Rate (FFR). Do not expect anymore rate cuts.

Yields at current levels have worked to trigger a switch out of equities and back into fixed income. This has worked since December 2007. With this recent run in equities, I would expect that some profit taking there would be in order and a rotation into fixed income now that yields are more attractive. A stable to rising dollar helps make fixed income more attractive as well. So the stage is set for a rotation out of risky assets… in the US at least.

Tuesday, May 6, 2008

Fannie Mae and UBS Miss, Bankruptcy Filings Up Big Time

The real fun begins now.

Fannie Mae (FNM) reported earnings that obviously sucked badly. I’m still short as I explained in Slowly Building Shorts. (Strangely the market was SURPRISED by this number. Let me get this straight, after the largest speculative real estate and credit bubble in history the market is SURPISED by the magnitude of the losses to the single largest holder of mortgage debt in the U.S.? I'm fairly certain there are NO minimum requirements for becoming an analyst. Can't decide what to do with your life? Become an analyst. It's easy. You don't even have to have to be right. About anything you cover. Ever.)

Fannie Mae Posts $2.19 Billion Loss, Plans to Raise $6 Billion: “Fannie Mae reported a $2.19 billion loss as record home foreclosure rates and falling real estate prices drove the largest U.S. mortgage-finance company into its third straight period of losses. The company plans to raise $6 billion in capital and cut its dividend.

The first-quarter net loss was $2.57 a share, compared with profit of $961 million, or 85 cents, a year earlier, the government-chartered company said in a statement today. Fannie Mae was expected to lose 64 cents a share before some items, the average estimate of 12 analysts surveyed by Bloomberg.

Fannie Mae and smaller rival Freddie Mac may each need as much as $15 billion in capital to cope with the delinquencies and foreclosures that pushed their shares down more than 50 percent in the past year. Fannie Mae was able to narrow its loss from the combined $5 billion recorded for the third and fourth quarters partly by raising fees, and seeking out safer mortgage purchases.”

The $2.57 a share loss was much more than expected. Equity and fixed income futures reacted quickly pre-market. The S&P is now sitting just above the key support level of 1 400. (I'm so excited. In the distance I can already here the first faint sounds of the financial system creaking under the stress... Things could snap anywhere along the chain... anytime. Where is the weakest link?)

FNM cut its dividend in an attempt to save about $390 million a year. They’ve left a 25 cent dividend. Why not just cut it to ZERO? The company IS spiraling out of control with no quick recovery on the horizon. Hilarious.

FNM plans to raise $6 billion in a common and preferred. This is where common shareholders begin to get diluted hard.

“Fannie Mae said last month its holdings of mortgage assets rose at a 2 percent annual rate to $722.7 billion in March and had agreements to add another $8.98 billion in April. Freddie Mac's holdings likely expanded by $34 billion in April after a 5 percent jump to $712.4 billion in March, according to Jim Vogel, a debt analyst at FTN Financial Group in Memphis, Tennessee.”

Even as things deteriorate further and with no end in sight, FNM continues to INCREASE its holdings of mortgage assets. They increased 2% in March alone. Annualize that. Freddie Mac (FRE) is doing the same thing. FNM and FRE are becoming the garbage dumps for toxic waste by intentional design. Concentrating the toxic waste in a handful of key players is just begging for systemic failure.

In the Bloomberg screenshot the line in bright red is most important of all: FANNIE MAE SEES 2009 CREDIT LOSSES WIDER THAN 2008.

Still believe that crap about a second half recovery? Still believe this recession will be shallow?

FNM and FRE make me angry:
Sarcastic Rant on Fannie and Freddie.
Fannie Mae, Freddie Mac: The Dumbest Idea Ever
Fannie Mae: Another Shoe Drops

Also, another bank reports…

UBS Set to Cut 5,500 Jobs After First-Quarter Loss (Update4): “UBS AG, battered by $17.3 billion of first-quarter losses at its investment-banking unit, plans to cut 5,500 jobs and said clients withdrew a net $12.2 billion from its asset- and wealth-management divisions.

The headcount reductions, which amount to about 7 percent of the workforce, will include as many as 2,600 positions at the securities division, the company said in a statement today. The bank also said it plans to exit the municipal bond business and sell $15 billion in distressed assets to a newly created fund managed by BlackRock Inc. UBS had a net loss of 11.5 billion francs ($10.9 billion) in the first quarter.

UBS fell as much as 5.6 percent in Swiss trading, the most in seven weeks, after clients withdrew more assets than they added for the first time in almost eight years.”

UBS has already written off $38 billion. While truly staggering, there is still more to come considering we have yet to dive into the depths of the coming recession...

U.S. April Business Bankruptcy Filings Increase 49% (Update1): “U.S. business bankruptcy filings in April increased 49 percent from a year earlier, the biggest gain so far this year, as the slowing economy prompted more companies to shut down.

Business filings rose to 5,173 during the month, according to statistics compiled from court records by Jupiter eSources LLC in Oklahoma City. Total bankruptcy filings, including those by individuals, were up 31 percent from a year earlier to 93,096, the group said.

Signs of distress, such as bankruptcies and foreclosures, are rising as economic growth has slowed to its weakest pace since the last recession in 2001. The economy lost jobs in April for the fourth month in a row, for a total of 260,000 jobs cuts so far this year.”

Those uber nerds over at the big banks and investment houses are probably furiously calculating exactly how badly they MISCALCULATED when they wrote Credit Default Swaps (CDSs) at ridiculously low prices exactly when business bankruptcies were at RECORD LOWS and set to do a moonshot.

Monday, May 5, 2008

Bulltrap: ABCP, and Level 3 Bombs

Remember all when all those breathless experts on CNBC couldn’t stop talking about SIVs, and ABCP? Remember all that talk about the Super SIV and other ridiculous bailout plans? Need a quick refresher? The posts below chronicle the evolution of the crisis…

Related Posts:
Inflation, SIVs and Balance Sheets
UBS Confesses, More SIVs Go On Balance Sheet, Bond Sales Collapse
The First SIV Goes On Balance Sheet
Banks Agree On Super SIV
Somebody Start A SIV Implode-o-meter
Super SIV? Super Bailout!

To summarize real quick, Structured Investment Vehicle (SIV) “…is a fund which borrows money by issuing short-term securities at low interest and then lends that money by buying long-term securities at higher interest, making a profit for investors from the difference. SIVs are a type of structured credit product; they are usually from $1bn to $30bn in size and invest in a range of asset-backed securities, as well as some financial corporate bonds.”

So, borrow short, and invest long. This is called a ‘duration mismatch’ between assets and liabilities and can go very wrong very quickly. (Which is exactly what happened.)

Imagine buying an asset that has a life of 10 years and thay may not be liquid. Simply assume it is difficult to sell in a timely manner at a fair price. Now imagine buying just such assets on credit. Now imagine having the super brilliant idea of using revolving short term credit of say 30 to 90 days to do this. You can obviously imagine what happens when you can’t roll over that debt and therefore have to ditch those assets.

Why would anybody do this? The answer is a simple one. Normally, do to the shape of the yield curve, short term rates are lower than long term rates. Therefore, you could borrow low and invest higher, capturing the shape of the curve. It’s like printing money…

Of course there is no such thing as a free lunch. Capitalism won’t allow it. There is a very good reason that the normal shape of a yield curve is from the bottom left to the top right. A ‘steep’ curve captures certain important risks, such as the uncertainty that is a function of duration.

As the credit bubble began to pop, these giant SIVs became unable to roll over their maturing short term debt. The whole system having been leveraged up like never before meant that the SIV’s couldn’t turn to anybody else to sell their assets too. Without a bid in the market the SIV’s simply froze. Bailouts were proposed and abandoned. Eventually the sponsors of the SIV started taking them on to their balance sheets.

BUT, the write downs didn’t materialize. How was this managed? Well, without an ‘active market’ it was possible to toss these assets into Level 2 and even Level 3 asset buckets. Translation: Those assets found their way into ‘make them worth whatever you want accounting land.’

Related Posts:
Something To Think About: Goldman Sachs, Level 3
Level 3 Rules

Level 2 and Level 3 asset values have just exploded all over the financial system as the major players are desperately attempting to avoid facing reality. They don’t like market prices and they can’t survive market prices. So they make up their values for these assets and wait, tossing them first into the Leve 2 asset bucket and then over into the Leve 3 asset bucket. If the market doesn’t come back, they will eventually have to eat those losses anyways. In most cases, the market won’t come back. EVER. The losses are real and permanent.

In the meantime, the whole system will sit paralyzed…

Or as Mish would say, the ‘Zombification of Banks’ has begun in Fed’s New Role as Pawnbroker: “Thus with each passing day, the more asset values plunge, the more zombified our banking system becomes. Zombification of banks is exactly what happened in Japan. Bernanke could cut interest rates to zero tomorrow and it would not change matters much if at all. Academia is meeting a real world test, and Bernanke has met his match.”

Outstanding Asset Backed Commercial Paper (ABCP) has continued to drop from a high of $1.2 trillion to a recent low of $762.9 billion. The trend is still down and could be for months and even years. Perversely, this actually has the affect of tightening credit conditions the world over.

Take a look at the top 40 companies with Level 3 assets. Sometime soon, the first few will start to implode, unleashing the next phase of the credit crunch…

S&P 1400 and DOW 13 000 are the perfect Bulltrap. This Bear market will rip your heart out and eat your account. Its going to be that kind of market.