Trader’s Narrative

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.

“Hello, I’d like to order a rally please. Yes, the financials. Good. Can you get that here in less than 45 minutes? ok. And you take plastic right? Ahh, okay. Thanks Bye.”

The financial sector - I use the Financials Select Sector SPDR (XLF) as a proxy - has been a horrible spot in the market lately. Ever since it fell out of bed in late February this year, it has shown one of the weakest relative strengths of any sector. While the market powered ahead in April and May to reach new highs, the best the financials could do was reach their previous highs again and fall down once more.

It has been ugly. But are we anywhere close to putting this sorry mess behind us?

Looking at the bullish percent chart for the sector, I noticed that it has a relatively low 63%. That may not seem low but keep in mind that since the bull market, this sector has tended to bottom around 55%-60%. The market correction in March 2007 only took the BP% down to 65%. Maybe that’s why it didn’t rally as much.

In any case, although the bullish percent is relatively low, it still isn’t low enough to merit a rally here. Take a look at the graph and you’ll see what I mean:

Click to Enlarge Graph

The internals of the sector don’t look that appetizing either. Taking a look at the number of stocks within the sector trading above their moving averages shows: around 50% above their 200 day MA, 20% above their 50 day MA and only 10% above 10 day MA.

When we’ve seen such a short term oversold situation in the sector, it has resulted in atleast a bounce. But not until we see less stocks above their long term MA are we going to set up for a meaningful rally. Today we bounced 1.5% but I don’t think we’re in the clear yet.

The bright spot is that short interest in the S&P Financials Select Sector SPDR (XLF) is at a multi-year high. The last time it was at this level was April 2005. From a sentiment point of view this is positive and it also means that all those short sellers are providing quite a bid under the price.

To conclude, I don’t think we’re seeing any sort of capitulation here. The worst is if we just drip lower. And I’m afraid the technical picture looks like we might just do that some more. If that is the case, it doesn’t bode well for the market in general either.

Here are the top 10 components (by capitalization):

Citigroup Inc. (C)
Bank of America Corp. (BAC)
American International Group Inc. (AIG)
JPMorgan Chase & Co. (JPM)
Wells Fargo & Co. (WFC)
Wachovia Corp. (WB)
MORGAN STANLEY (MS)
Goldman Sachs Group Inc. (GS)
Merrill Lynch & Co. Inc. (MER)
American Express Co. (AXP)