Trader’s Narrative

For economic and market news and to see what interesting reading you may have missed last week, check out the list below. To see it all, go to news.tradersnarrative.com:

• Doug Kass: The Hangover (no, not the movieIs This a Real Bull or “Red Bull” Market?)
• Fed telegraphs need to cut US Dollar in half over next 14 years
• Charlie Booker’s take on the cringe inducing Windows 7 ads
• Get a FREE Subscription to Futures Magazine (limited time for US residents only)
• Why Capitalism is Unstable
• 10 Odd Economic Indicators: Hot Waitresses, Men’s Underwear, Blacked-Out Football Games
• Volcker to Banks: Stop Trading with Taxpayer Money
• Is This a Real Bull or “Red Bull” Market?
• Get a FREE 50-page eBook: The Ultimate Technical Analysis Handbook (limited time offer)
• Taibbi on Bear Stearns Naked Short Selling Fiasco
• Jim Chanos for SEC Chairman!

That’s just an ‘amuse-bouche’ - for the main course, follow the graphic link below to news.tradersnarrative.com:

And remember to check back regularly since there are interesting links added throughout the week. If you are a twitter user, add the news.tradersnarrative.com twitter stream to get new stories in real time.

The Week Ahead:

Now that the Bear Stearns (BSC) saga has ended with their absorption into JP Morgan (JPM) for $2, I wanted to go back to the previous time that I looked at the stock, back when it was trading at ~$140 (!).

I sounded a warning note because, in contrast to the previous multiple times until then, BSC had broken down relative to its long term moving average (see graph in link). And even if it was able to claw its way back, the damage had been done. There was a tremendous amount of resistance overhead. Of course, hindsight is 20/20 and we now know it never traded at those levels again - and never will.

I know you want to avert your eye, but can’t. So here’s an analysis of how the whole thing went down (literally):

Not only has Bear Stearns already decoupled from its long term moving average but basic technical analysis is showing that this stock is heading down. The down trend is not only supported by the medium (50 day) moving average in blue and the long term (200 day) moving average in red, but also by the way that both successive tops and bottoms are lower than the previous ones. At each attempt to rally, price is smacked down, unable to mount any real threat to the general down trend.

The most serious attempt to put a floor under BSC was during August 2007 when everything under the sun made an intermediate bottom. But in Bear’s case it quickly melted away. If you were watching BSC in February, you had to wonder if more of the same was in store for this beleaguered financial stock.

In March, prices are once again scraping the $70 level. Will it hold and carve out a triple bottom? or break down? You have to remember the general principle that every time a price level is hit, it becomes just that much more fragile. Think of it using the analogy of a glass floor. It may hold one or two times, but if you keep jumping up and down on it… eventually it will crack and you’ll fall through. Which… is exactly what happened:

At this point, if you were still holding long (in keeping with the triple bottom thesis) you had your chance to get out with a small loss. The market had clearly put in a lower bottom and outside of technical analysis, the news and rumors about Bear Stearns’ health couldn’t have been more negative. That is if you were listening to anyone except Bear Stearns executives (never listen to corporate spin from any company).

And if you didn’t listen and bought or held on to your shares… well, the market tried to talk to you. But you simply weren’t listening.

Come to think of it, the Bear Stearns’ implosion is very similar to the E*Trade (ETFC)example that I went over a few months ago.

The only difference is that rather than languish at low single digits, it will be swapped for 0.05473 shares of JP Morgan common stock.

Tsk, Tsk
Oh and this video is making the rounds on various blogs and forums:

At first glance, it seems Cramer was incredibly wrong. After all, the video shows BSC trading at $62.97 (March 11th, 2008). This was just 2 days before the stock fell to $30… and three trading days before it opened at single digits.

But what people miss is that the question wasn’t about Bear Stearns stock but about its solvency.

So yes, Cramer was correct: the funds and securities deposited with BSC were not in danger.

But if you actually bought the stock, like this poor guy (on margin!!), then that’s a whole different story.

I have a nagging feeling this week will be one to remember. Whether it will be the bulls or the bears that will look on it fondly, only time knows. Here is this week’s unforgettable sentiment recap:

Sentiment Surveys
According to the Investor’s Intelligence survey of newsletter editors, we already had a dearth of bullishness, but now we have historically low numbers: 31.1% to be precise. Since stock newsletter editors are usually an upbeat lot, this is actually the lowest since October 2002 and early 1995.

Not to be outdone, the AAII survey of retail investors is showing that this week, 59% of respondents are bearish. We’ve been here before; at the beginning of the year. Lets see if this time we can light a flame under this rocket.

CBOE Put Call Ratio
Although the VIX rose moderately, thanks to the panic caused by the Bear Stearns (BSC) debacle, the CBOE (equity only) put call ratio zoomed above 1.16 - and I thought last week’s four year high was special!

Hulbert Stock Newsletter Sentiment Index
Mark Hulbert tracks newsletters in general but he also has a sentiment measure based on a sub-set of stock newsletters which time the market. This HSNSI is usually a fantastic contrarian indicator since editors tend to en masse, lose all hope when the market is carving out a bottom. And they tend to be euphoric when the market is about to have the rug pulled from under it.

Although this sentiment measure has been negative for some time, it is now showing real fear. This week it reached -22.5% which means that the average timer is recommending their clients short this market with more than a fifth of their money.

The really bullish significance of this is that in contrast to now, the last time the market was at these levels in mid January, the market timing newsletters were quite nonchalantly looking over the precipice. The fact that they have now soiled their pants (sentiment wise) provides us with a higher probability that the double bottom will hold.

To find a lower sentiment reading from the Hulbert newsletter sentiment index, we’d have to go back all the way to 2005. More specifically, to early May and mid October, 2005 when the market made two important lows:

“Dumb” vs. “Smart” Money
These are two proprietary indicators from Jason Goepfert that amalgamate several sentiment and technical indicators. The “Dumb Money” indicator fell on Friday to 12.5% which means that to find it a friend, we would have to travel all the way back to early 1995 and August 1998. You remember the summer of 1998, right? when we were suffering through the Asian currency and LTCM crisis? …good times, good times.

According to Jason, the gap between the two indicators is also as wide as it has been since 1995 and 1998. Pull up some long term charts and you’ll see the significance of that.

Consumer Sentiment
Although it would usually make big headlines, the results of the Reuters/University of Michigan Surveys of Consumers got buried amid the panic over Bear Stearns today. Consumer sentiment continued to decline to 70.5 - that’s the lowest reading in 16 years!

Like most sentiment measures, this one should also be taken with a spoonful of contrarianism: up is down, down is up. Which means that when consumers are most pessimistic, we have the best opportunity to go long. And when consumers are on average jumping for joy, we have to batten down the hatches.

News Headlines & Covers
Getting your umbrella out will do you no good. We have a torrential downpour of negative news and depressing headlines. To see what I mean, open any news website or newspaper. It is all doom and gloom. This or that hedge fund going belly-up, Bear Stearns pushing up the daisies, the mortgage market collapsing, the credit market in a spasms, consumer sentiment tunneling into the substrata, etc.

Even after the remarkable 90-90 up day we had on Tuesday, the majority are denying that it could potentially have any real bullish portent - although historical precedent says otherwise.

Here are a few recent covers from Business Week:

This week the financial giants Goldman Sachs (GS), Bear Stearns (BSC) and Morgan Stanley (MS) will be releasing their quarterly earnings reports.

I’ve been patient and hopeful with this sector since it has been showing the classic signs of oversold extremes.

But each time it is given a chance to bounce back, it only musters a meager step or two forward… and then falls back.

You can see this in the bullish percent index of the sector:

In July it reached an extreme oversold level of 25% but couldn’t gain any traction. Then again this November the index fell to 20%. But after a feeble “dead-cat” bounce it has rolled over again. This behavior is a marked contrast to the previous years when the bullish percent index remained at very high levels and only sporadically dipped lower.

Looking at the price chart itself (the Philadelphia Banking Index) we see the same thing. A classic downtrend pattern of lower lows (green) and lower highs (red):

No question that things are downright ugly. Within the sector, only 17% of the component stocks are now sitting above their 200 day moving average. This is extreme. But it has been the case for most of the time since the swoon in July. Only 4% closed above their short term, 10 day moving average and a paltry 13% above their 50 day moving average.

But when oversold levels don’t lead to lasting rallies, you know something is wrong. The banks and financial stocks are acting very tired here and I would either wait to see a dramatic washout (the kind that has you gasping) or a miraculous sign of strength before giving them the benefit of the doubt again.

Interesting article on Goldman Sachs’ “luck” in escaping unscathed from the sub-prime mortgage mess:

Goldman’s good fortune cannot be explained by luck alone. Late last year, as the markets roared along, David A. Viniar, Goldman’s chief financial officer, called a “mortgage risk” meeting in his meticulous 30th-floor office in Lower Manhattan.

At that point, the holdings of Goldman’s mortgage desk were down somewhat, but the notoriously nervous Mr. Viniar was worried about bigger problems. After reviewing the full portfolio with other executives, his message was clear: the bank should reduce its stockpile of mortgages and mortgage-related securities and buy expensive insurance as protection against further losses, a person briefed on the meeting said.

The article fails to mention that Goldman Sachs (GS) is Wall Street. They might as well own it outright. And now they’re making inroads into government where policy and oversight reside. They don’t play the game, they are the game.

But in the end, even if you practically own the place, risk and its management is the real game:

At Goldman, the controller’s office — the group responsible for valuing the firm’s huge positions — has 1,100 people, including 20 Ph.D.’s. If there is a dispute, the controller is always deemed right unless the trading desk can make a convincing case for an alternate valuation. The bank says risk managers swap jobs with traders and bankers over a career and can be paid the same multimillion-dollar salaries as investment bankers.

One of my favourite market axioms is “Discipline over conviction.” There is no point in risking ruin when you don’t have to. Coming back to play another day is a prime victory. Had Niederhoffer hired one or two risk controllers, he wouldn’t have blown up (again).

This graph tells the whole story: