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Bear Stearns & the Subprime Meltdown at Trader’s Narrative





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nelson muntz bear stearns subprime cdo meltdownBy now you’re probably well familiar with the drama playing out over at Bear Stearns (BSC) as they try to come to grips with their exposure to the subprime meltdown. Their massive CDO portfolio is melting faster than a snowman in the Gobi desert. And all the rest of Wall Street wants to do is sit back and watch. And maybe pull a Nelson Muntz.

Bad Karma
Bear Stearns earned some really nasty karma by not helping during the LTCM debacle and now they are reaping what they sowed. Payback’s a bitch.

I’ve been making some bearish noises for a while now. And I think we’re still not in the clear.

Today’s market action was ugly. It gave a slight hint of hope in the morning and then dashed them during the afternoon. Since market lore tells us that the morning belongs to amateurs and the close to the pros, this is a weak market.

The financials, banks and brokers have been a very weak spot in the market and this isn’t going to help at all. If we were already in a protracted decline, and we had a meltdown of a fund or a crisis like Bear Stearns’ then I might have interpreted it as a bullish sign. But right now, this looks pretty ominous. We’re just teetering and it may be an edge.

200 Day Moving Average
I took a look at Bear Stearns’ long term chart and for the duration of this bull market, it has acted very faithfully with respect to its long term moving average. From 2003 till now, it has spent very little time below its moving average. In fact, it has usually just kissed it and zoomed back up.

It did so during:

    July 2003
    November 2003
    May 2004
    May 2005
    August 2005
    October 2005
    June 2006
    September 2006

But the recent price action is uncharacteristic since it doesn’t follow this pattern (see graph below). In late February and early March 2007, Bear Stearns (BSC) fell to its 200 day moving average. This was the time of the market wide correction so no biggie. But then it spent the next months trying to liftoff without success.

Click to Enlarge Graph
bear stearns bsc 200 day MA

And right now it is beneath its 200 day moving average like never before. Well, atleast not in the past 3 years. We may actually get a quick snap back rally but there’s no question that technical damage has been done.

Credit Default Swaps
Now, here’s the really curious part of this whole mess. With BSC trying desperately to offload their ginormous CDO portfolio and save their funds, you’d think that the bond market would be spooked, right?

But according to credit default swap market is taking all of this in stride. CDS’ allow you to offload the risk of high yield bonds by selling the exposure of default to someone else.

By comparing the CDS rates to ‘risk free’ Treasury bonds we can measure how scared the bond market is to default risk. Right now, they simply aren’t. Which, from a contrarian sentiment point of view, paints a negative picture.

Interestingly enough, although this indicator doesn’t have that much history, it has done a good job of also flagging inflection points in equities after a decline. It isn’t finding one here.

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