Trader’s Narrative

Not a moment too soon, the financial markets reacted to leadership from European governments and central banks over the weekend. Sadly, the US team of Bush (excuse me while I roll on the floor convulsing with laughter) Paulson and Bernanke didn’t exhibit one iota of leadership or common sense. Did anyone expect the same team that continuously reassured the world that everything was fine over the past 2 years to be the ones to actually solve this?

The consensus among smart economists (Roubini), investors and traders (Soros) has been the need for “capital injection” - a euphemism for “buy a truckload of financial common stocks”.

The Old World Shows The Way
The US’s muddled TARP proposal instead was aimed at buying into the nebulous and toxic derivatives at the heart of this crisis. Shares are easily priced each second on the open market so it can’t be easier to value a bank’s “worth”. Whereas the derivatives are next to impossible to untangle and value. Also, a share, because of its perpetual existence, has a multiplier effect. So by injecting $100 billion of capital, you in turn leverage the effect by the P/E ratio which even now is around 10 for the average financial institution.

Of course, by now TARP has morphed into the European model. Which can arguably be also called the Swedish model, since this very solution was used by them in the early 1990’s to get a banking crisis under control. And unless I’m mistaken, the Swedish taxpayer actually got significant capital gains out of the whole thing. Seriously, how ridiculous does Paulson sound when he proposes with a straight face to simply use government money to buy assets of dubious quality and worth… without receiving absolutely anything in return?

You don’t need a PhD in finance to know that way lies madness.

Then again, the news of a concerted European effort may simply have coincided with a snap back rally. If you recall, many had high hopes for the TARP announcement to reverse the market’s decline. It did no such thing. So in effect, while the news seems to have caused the market to rally, we can’t truly prove that it was the force behind it. There are strong reasons to believe that the market was simply exhausted from relentless forced liquidation and just hit the wall.

Timing
Last week I facetiously suggested that if this wasn’t the stock market bottom, we should flee to the hills and buy guns. The future was starting to look like some kind of Mad Max distopia, at least if you believed the breathless analysts on TV and the headlines across newspapers. Then just hours later I learned that Tony Oz had taken a large long position, based on similar conclusions.

Of course, no one knows what will happen in the market. The best one can do is to put aside emotion and to look at the facts. Or one better, and use emotion to your advantage by looking at sentiment, rather than having it control you. Last week’s sentiment overview was clearly the most pessimistic in a very very long time.

90-90 Day? - You Betcha! (wink)
As much as last week’s market’s were smashing all records on the way down, Monday’s rally smashed them on the way up. This was as broad based and furious a come back as the bulls could have mounted.

In terms of volume, 95% was accounted by advancing stocks on the NYSE. We went from seeing more than 2,500 stocks on the Big Board hitting new 52 week lows on Friday… to seeing less than 60 today doing the same today. So yes, today definitely met the requirements for a Lowry’s 90-90 up day - and more!. This is something that we had been waiting for because according to the research, a significant floor is created when the market has fallen significantly (90-90 down days) and then reverses with the same ferocity.

Here is a short excerpt from the research done by Paul Desmond of Lowry’s Research:

The historical record shows that 90% Downside Days do not usually occur as a single incident on the bottom day of an important market decline, but typically occur on a number of occasions throughout a major decline, often spread apart by as much as thirty trading days. For example, there were seven such days during the 1962 decline, six during 1970, fourteen during the 1973-74 bear market, two before the bottom in 1987, seven throughout the 1990 decline, and three before the lows of 1998. These 90% Downside Days are a key part of an eventual market bottom, since they show that prices are being deeply discounted, perhaps far beyond rational valuations, and that the desire to sell is being exhausted.

But, there is a second key ingredient to every major market bottom. It is essential to recognize that days of panic selling cannot, by themselves, produce a market reversal, any more than simply lowering the sale price on a house will suddenly produce an enthusiastic buyer. As the Law of Supply and Demand would emphasize, it takes strong Demand, not just a reduction in Supply, to cause prices to rise substantially. It does not matter how much prices are discounted; if investors are not attracted to buy, even at deeply depressed levels, sellers will eventually be forced to discount prices further still, until Demand is eventually rejuvenated. Thus, our 69-year record shows that declines containing two or more 90% Downside Days usually persist, on a trend basis, until investors eventually come rushing back in to snap up what they perceive to be the bargains of the decade and, in the process, produce a 90% Upside Day (in which Points Gained equal 90.0% or more of the sum of Points Gained plus Points Lost, and on which Upside Volume equals 90.0% or more of the sum of Upside plus Downside Volume). These two events – panic selling (one or more 90% Downside Days) and panic buying (a 90% Upside Day, or on rare occasions, two back-to-back 80% Upside Days) – produce very powerful probabilities that a major trend reversal has begun, and that the market’s Sweet Spot is ready to be savored.

Source: Identifying Bear Market Bottoms and New Bull Markets (Dow Awards folder)

Believe it or not, this is the second Lowry’s 90-90 up day we’ve had within 9 trading days. According to Lowry’s 90-90 up days can be spaced out as far as 30 days from each other and still be effective. And although most people keep strictly to the 90-90 definition, Lowry’s actually mentions above that 80-80 up days also qualify. So if you want to be more flexible like them, on September 18th 2008 we had a 89.5% up day which would make it three strong up days.

LIBOR & TED Spread
As I mentioned a few days back, LIBOR and the TED spread stopped going up and today they actually fell hinting that we may have seen the worst of the credit crisis. As banks start to trust one another and lend again, liquidity will flow back into the financial markets and the forced liquidation will cease. It is still too early to be complacent about this but the first signs of a return to normalcy are there.

Unless you’ve been living in a cave, you know that there is total carnage in the stock market, especially within the financial sector. By the way, if you have been living in a cave, congratulations on a very astute real estate investment.

Anyway, bank and investment bank stocks are trading at empty shadows of their glorious past. It almost makes you pine for the dot com bust. Almost. But even amid all this mayhem, are there financial stocks which are left standing, more or less unhurt? or dare I say it, strong?

It turns out, yes, although you have to sift through a lot of muck. And what you do find are small to medium capitalization stocks. The fact that these stocks have held up and are actually going up in some instances while the market as a whole craters is a huge sign.
Continue reading ‘Are There Any Strong Financial Stocks Left Standing?’

Back in May I wrote : Weak Financial Stocks May Not Hold Support Again which turned out to be right on the money.

A bit later in June I wrote that banks where broken:

…I suspect that by the time the Bank Index finds its way down to 65 or thereabouts, the bullish percent index will have commensurately fallen to significant buy areas…

The Philadelphia Banking Index (BKX) did indeed fall to 65 or thereabouts - if you interpret that liberally. In fact, the index broke 50 but when the global financial marketplace is melting before our eyes, why quibble over a few points? And the bullish percent did in fact spike to extreme oversold levels, reaching 5.62% in mid July.

These are the buy points that I’ve repeatedly mentioned and explained in how to use bullish percent to time the market. But to give you an idea of how rare this is, here is a long term chart:

Of course, what happened next is that the US government (along with a few others) decided to poke its finger in the crack of the dam and made it illegal to short sell financial stocks until October 2nd. The result of this blatant government meddling in financial markets was the two day rocket ride higher last week. To see this clearer, here is the same chart as above, zoomed in for the year to date:

Aside from the fact that whenever you get the government involved in the market it throws all technical analysis out of whack, the important thing is that before the financial stocks rallied, they had only fallen to 30% in the bullish percent index. Based on this, I suspect that had the government not banned short selling and placed a temporary, artificial floor below them, the sector would have continued to fall dramatically.

Finally, the consequence is that having meddled, the sector is now at 80% bullish percent! Which makes me queasy to even contemplate taking any new long positions. If anything, this is the sort of thin air levels at which traders start looking around for shorts. But of course, now we can’t. This is a royal mess. We’ve gone from a situation which could be analyzed to one which is totally news driven.

Paulson’s Bailout
Here’s the problem that I and many others have with the proposed bailout plan:

• the firms who are at fault face no consequences and do not give up anything
• in fact, the firms are being rescued by ordinary taxpayers who wouldn’t know a CDO if it hit them in the face
• Paulson has dictatorial power and authority for any decisions he makes
• the management who ran their companies in the ground face no consequences
• alternative plans were not presented nor considered
• there are much much better alternative plans

Raise Your Voice
Democrats have begun to push back against the scheme and I doubt that it will go ahead as presented. You can find a lot more articles about what is going on with the bailout and keep up to date by checking: news.tradersnarrative.com

I’m a Canadian so I can’t call up my representative in congress to give them an earful. But the vast majority of my readers are American so I urge you to educate yourself about what is happening. Once you realize the facts, you will understand why it is imperative that you raise your voice against the proposed bailout plan. This goes beyond partisan politics or the election. This is about the economic health of the US and the world. Do this for yourself and your children.

Today’s market notwithstanding, the financial sector has started to lead the general market once again.

Here is a chart of the Philadelphia Banking Index (BKX) alongside the S&P 500 Index (SPX):

The de-coupling started just recently but it is unmistakeable. Here is another way of looking at the relationship between the indices:

The change has just started and it is far too early to declare a trend change just yet. For that, we need to see the downtrend line broken to the upside by a continued surge in the financial sector.

But the important thing is that counter intuitively, a bull market doesn’t need the financial stocks’ leadership.

Bullish Percent
The spike low corresponds to late June, when the bullish percent for the banking sector dipped below 10% - actually going all the way to 5.62%. The last time we saw the bullish percent this close to zero was back in mid January 2008. And as far as I have data, never before!

Tectonic Shifts
This financial turmoil is unprecedented. For as far as the Philadelphia Banking Index has been trading, it hasn’t broken down this drastically. What we are seeing is tectonic shifts in the banking industry which will not only reverberate for some time to come, but it will produce a horizon drastically different from the one we knew just a month ago.

Two weeks ago I wondered if the financial sector had suffered enough… no, it hadn’t.

But things look quite different now. Today and yesterday we had a remarkable change in tone for this sector. Snap back rallies in a declining trend are characteristically sudden and intense but none of the recent ones in this sector approach what we saw this week:

To add to yesterday’s rebound we had an almost 12% advance. Some of this is due to short covering. ok, a lot of it is due to short covering. But still, this sector was the favorite punching bag of all hedge funds looking for an easy short trade. Not anymore. The shorts are being squeezed like crazy.

Understandably, we snapped back from a tremendously oversold condition. A measly 7% of stocks in the financial sector were above their 200 day moving average. And the bullish percent index didn’t brake until it had broken through 6%. Six percent!

To put that into perspective, here’s the chart I showed last time updated (going back to 1997):

I find it astonishing that this sector could get crushed even more severely than it did than during such periods of financial turmoil as the 1998 LTCM crisis and the popping of the Internet bubble.