Trader’s Narrative

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:

Interactive Brokers Group (IBKR) went public a few months ago with a lot of buzz. Most of the attention was on the Dutch auction process they had chosen to go with, instead of the regular Wall St. investment bank route.

I’m not sure whether it was due to the process they chose, or the fact that the market got lethargic right when they debuted but the IPO sputtered.

A lot of people, had high hopes for IB but it ended up a disappointment. I even put in an offer but it didn’t get accepted because I was too stingy.

I took another look and noticed that it has carved out a fair head and shoulders pattern on the daily chart:

With today’s rumour of Warren Buffet’s involvement in Bear Stearns (BSC) the whole financial sector got a shot in the arm. I’m not sure if the rumour is true or not. There have been quite a few floating about.

In any case, I wouldn’t be surprised. BSC has all the hallmarks of a classic Buffet investment: beaten down sector, temporary dislocation, high barriers to entry, valuable name brand, loads of value, and loads of cash flow.

On Friday’s 1pm conference all, Bear Stearns (BSC) CFO, Sam Molinaro, said:

These times are pretty significant in the fixed income market. It’s as been as bad as I’ve seen it in 22 years. The fixed income market environment we’ve seen in the last eight weeks has been pretty extreme. So, yes, we would make that comparison to market events [late-90s debt crisis].

Although he meant the call to be reassuring to Bear Stearns investors and to the market in general, his comments pulled the plug on an already weak market and we plunged to close below the “line in the sand” 1460 on the S&P 500.

Worst in 22 Years?
While reading the most recent Economist over the weekend, I caught an article about this whole sub-prime mess and Bear Stearn’s involvement. Sure, there are some stresses and quiet a bit of panic, fear and loathing. But worst in 22 years? According to the graph included in the article (from Bear Stearns no less), it is dubious that we are seeing “the worst bond market in 22 years”.

The chart showed the spread between the Bear Stearns high yield bond index and treasuries. I wish I could show it to you but since the scanner is on the fritz, I’ll have to describe it. Keep in mind that the chart is small and the line thick, so all numbers I mention are eye-balled approximations.

According to the chart, there were these significant spikes in the high yield - treasury spread:

1991 -> 900
1998 -> 700
2000-2002 -> 1000-1200
right now -> 450
recent low ->300

The period between 2000 and 2002 showed several spikes within the 1000-1200 range. Since then, the spread narrowed and reached a recent low of 300ish. Now it has increased to 450ish. So, atleast according to this measure, we are just heading back into more reasonable territory, from a long term perspective.

And today, we learn that a scapegoat has been named: Warren J. Spector, co-president of Bear Stearns (BSC) or should I say, ex-co-president.

Now, all eyes are on Tuesday’s Fed meeting and their statement. I don’t think anyone is seriously expecting a rate cut tomorrow but the likelihood of one sometime between now and the new year just got a shot in the arm.

Finally, it looks like the worst may be over in the financial sector as almost all individual securities there are jumping 2-3% or more. We’re still not out of the woods yet but there is no question that this has been one of the deepest oversold conditions in this sector in a long, long time.

The subprime crisis which came to a head when Bear Stearns’ (BSC) funds imploded has now officially spilled over into the rest of the bond market. Take a look at the BBB rated bonds in the mortgage markets:

What looked benign just less than a month ago, has now filtered through the market such that the BBB paper is priced at less than 40 cents on the dollar. As I noted back then the chart for Bear Stearns (BSC) looked ominous but the credit default swaps were showing no real panic in the market.

How much difference a few weeks makes. The credit default swap rate spread has spiked higher than May 2006, when the market last found its most significant bottom.

The poster child for this mess is American Home Mortgage Investment Corp. (AHM) which dropped 90% today to close at penny stock prices.

Here’s another chart (from Jim Stack’s InvesTech) which shows the devastation being wrought in this sector:

Notice how the critical support line (dotted) coincides with the consolidation in the BBB market around 65-70. That is one brutal chart. The only positive thought I can muster is that it looks like most of the damage is over.