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:

• 18 US Banks Miss TARP Payments
• The Missing Paul Tudor Jones Tape (he uses Elliott Wave!)
• Initial Public Optimism - The IPO Market Bounces Back
• Will “Cash-on-the-Sidelines” Really Drive Stocks?
• Get a FREE Subscription to Futures Magazine (limited time for US residents only)
• Taibbi’s Upcoming Article on Naked Short Selling
• Good Trades are not Sexy
• Larry Summers and the White House economic team
• FREE 50-page eBook: The Ultimate Technical Analysis Handbook (lmt time offer)
• Contrarian analysis of current gold market

The above is a tiny sample, for the full list, follow the link 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:

Book Giveaway
If you haven’t already, throw your name into the hat for a giveaway of:
Hedge Fund Operational Due Diligence (follow link and submit comment)

The insistence of AIG to pay $450 million in bonuses dominated the news today. There are a few things that can unite Republicans, Democrats and even libertarians. Well, pretty much every sentient carbon based lifeform in the US is seething.

While the villains of the hour are clear, it is important to remember that at this critical junction in US history, we also have quite a few heroes. Take for example, Beth Israel Deaconess Medical Center. While we want to (rightfully) vilify AIG, we also should to celebrate the heroes.

So how can the Obama administration prevent AIG from awarding taxpayer funded “bonuses” to a handful of AIG executives and traders for nuking the global economy?

Before AIG can be held accountable, the US government needs to grow a pair. Or as the Italians call it coglioni quadrati - literally, square balls. Here are just a few humble suggestions for the Obama administration:

• use the government’s 80% ownership stake to force executives to “voluntarily” give up the bonuses
• introduce a very special tax that would target the bonuses - they get paid but they are then taxed 100% right back to the taxpayer
• buy out remaining 20% - in effect, nationalize it temporarily, then clean house before flipping it
• “leak” the names of all the executives that are clawing for bonuses
• give AIG immunity from any lawsuits that may result by withholding bonuses
• hire some Wall St. type corporate lawyers to find loop-holes
• as a last resort, or just for shits and giggles, send Dick Cheney’s death squad after the lot of them

I’m sure there are other, more creative solutions, so let me know yours.

The world central banks are busy injecting liquidity into the financial markets and the financial markets are busy injecting liquidity into the pants of investors. Today’s market was so bad about the only thing that can redeem it is just how bad it was.

For the third time we are at the precipice - 850 on the S&P 500 Index (SPX). I’m curious how this will influence the retail investors sentiment. If they will continue to be nonchalant or once again turn to historic pessimism.

We had 12 times the number of declining stocks to advancing stocks on the NYSE. For the Nasdaq the ratio was half. Not surprisingly then, well over 90% of the volume flowed from declining stocks.

There divergences popping up all over the place. The CBOE equity only put call ratio, for example, continued to act strangely when it didn’t even rise above 1.0 - in fact, since this waterfall down move began, it has managed to put in lower highs. First in mid September, then in early October and then now. Such a negative divergence would be bad news for the market, except for the fact that the options market has been absolutely crazy lately.

Another divergence that caught my attention was the Bullish Percent Index (of the S&P 500) compared with the S&P 500 Index itself:

Grasping at straws? Maybe. We are sitting at the ledge, peering down to who-knows-where. Paulson has just thrown up his hands, all but admitting that he has no idea what he is doing. Do you really expect the same person who oversaw this crisis in the making and who just a few months ago assured everyone about the soundness of the US financial markets to be the same person that would actually solve the problem?

We may even break down through the 850 “line in the sand” but even if we do, all may not be lost. Looking back through history, it isn’t rare to find lasting bottoms which occurred after a slight penetration of previous support levels. The most recent example would be the 2002-2003 bear market bottom.

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?’