A Near-Term Capitulation Event

by Stephen Tetreault, T-Waves | September 18, 2008

Print

I’m expecting (55-45%) chance for some additional bearish pre-market and into the open (unless the Initial claims report distinctly proves to be a positive) or any disappointment is already baked into the proverbial cake! I am than expecting a huge bullish reversal later in the morning/day as we are close to a near-term capitulation event !    

We will be enlighten tomorrow as to what emotion will win the battle as I believe the bears and bulls will wage a bloody battle again for control, and some early program-trading participants will certainly try to influence the market's direction. I still believe that investors are skittish, and the path of least resistance on any weakness or signs of trouble will be to trigger their sell-buttons. We will soon see which market emotion “Greed” or “Fear” will win out.  Today we saw that deep concerns that the markets may not yet have priced in the continued credit crunch.

We are in my opinion very close to a near-term market capitulation/selling-event, as the new-52-weeks lows are at extreme levels, Short interest is at extreme levels, all the oscillators are extremely oversold and the fear indexes VIX and VXN are approaching extreme readings (36-40) & (38-44) respectively and the market volatility these wild whipsaws is demonstrating pent-up monies are just waiting to get long and be put to work.... if the PPT emerges and creates a massive short squeeze tomorrow would be the best day to do so.  So strap-yourselves in tight as it is sure to be another wild rollercoaster ride!!  As a technician the charts are flashing several positive-divergences and several over-sold and accumulation Buy signals on a near-term basis. We have two opposing forces at work, those who desire to step into the markets and buy the dips and sell the rips and those who are looking to sit out this period of uncertainty, as the market swings pick up in intensity….another group that has grown significantly is those stricken with greed or the fear of missing out on the short-side of this so called bear-market swoon. The excessive positioning and excessive leverage all leaning to the SHORT-side has me very worried…I hate to see so many short all piled in as it get me very worried as such I take the opposite position (bought calls today).  

Yesterday and today was in my opinion a massive unwinding period where we saw a massive amount of volatility and though I believe that we could see more significant declines ahead but looming right ahead is quad options expiration day, and clearly the big-money-option writers/sellers need a significant reversal/rally to protect their uncovered put options and to mitigate their recent losses. Friday is also the start of our turn window wherein my (E-Waves, Gann and Fibonacci timing and propriety-inflection-model starts) so it will no doubt be interesting to see if that turns out to be that we are forming a near-term bottom tomorrow that kicks off the next multiple day-rally that lasts a few days into the end of the quarter or weeks into our my next multiple Fib-Gann and turn-time window 10/06 - 10-09. Monday and Tuesday morning's decline came in a clear five waves, and Tuesday afternoon's rally was a clear three waves, suggesting the rally was corrective and more decline is likely and that is exactly what we saw today…and that wave I believe will be completed by 10:30am if it wasn’t completed this evening.

On the contrarian-front we saw that yesterday and again today that new lows hit an extreme high level which is a level that often marks multi-week bottoms (over 2100 new lows combined between the Nasdog, Amex and NYSE yesterday and we saw almost 1945 today) which compares similarly to what we saw on 7/15 which marked a multi-week bottom back then.  We also saw the (VIX/VXO spike over 36.00/39.00 respectively and any spike on any additional selling tomorrow could trigger a massive reversal and short squeeze). Also tomorrow we could see the shorts on the ropes (that is why I recommended buying CALL on the indexes and holders/ETF’s today) as the Securities and Exchange Commission today outlined restrictions on “naked” short-selling in an effort to prevent overleveraged hedge-funds and pessimistic investors from driving down stock prices too far, too fast. A new “close-out” requirement will force short sellers and their broker-dealers to deliver borrowed securities within three days of the transaction date. In addition, options market makers are no longer immune from the naked short rules. A third rule makes short sellers liable for fraud to lie about their intention or ability to deliver securities in time for settlement. “These several actions today make it crystal clear that the SEC has zero tolerance for abusive naked short selling,” SEC Chairman Christopher Cox said in a statement.

A sharp sell-off, and suspicions of stock manipulation today, led Morgan Stanley CEO John Mack to meet with the head of the Securities and Exchange Commission, the Treasury Secretary and his counterpart at Goldman Sachs….as the meeting was to strategize over how to stop the short-selling carnage. Mack blames a bear raid for the 27% drop in his firm's stock price and told employees today that he was “taking every step possible to stop this irresponsible action in the market.”  Statements of SEC Chairman Christopher Cox and Enforcement Division Director Linda Thomsen Regarding Immediate Commission Actions to Combat Market Manipulation

The indexes were crushed again today as fear about the financial system was extremely high after the government's bailout of American International Group left traders and investors with little confidence in any of the financial stocks. The Dow lost almost 450 points, dropping more than 825 points so far this week and the carnage could get worse, however we are extremely oversold on multiple time frames and a snap-back relief rally is overdue…and when we couple this with options expiration week the moves could be extremely violent.

Traders and investors are scared to death (a buying opportunity for clear heads) as they are very spooked over the AIG debacle as who would have imagined that AIG would have gotten into this position…so quickly and their once darling firm has been decimated. I believe that the anxiety gripping the markets right now was as I stated in the trading room this morning…as I was very concerned that AIG wasn't able to find a lifeline in the private sector and now there is a huge storm cloud looming over the markets as many scramble to ascertain which other institution could falter (MS, GS, and other financials were take out to the wood shed and beaten badly today on this premise as to who will be the next snake to be uncovered, and during times of uncertainty traders and investors trigger the sell buttons, salvage their positions and ask questions later, as they can always reload when the storm cloud passes). Over the past year, firms like FRE, FNM, BSC, MER, LEH, MS, GS, BAC, JPM, “C” and others have repeatedly sought to reassure investors that they weren't in trouble, but they were being deceitful in my opinion (and should be taken on a perk-walk) as market conditions and their contagions were made known their firms were smashed down and many an investor was left holding the proverbial bag-of-crap…and the employees at these firms have seen their retirement and savings smashed to bits….so its no wonder that investors and traders are extremely distrustful of any assurances they make now.

After hours we saw news that Morgan Stanley received interest from Wachovia to merge this would be one of Wall Street's last remaining investment firms and I would be delighted as (we bought MS today outright and bought the calls as well); the New York Times reported, citing people familiar with the discussions. Morgan Stanley, which is also considering other options, has received interest from other banks as well, according to the NY Times.  [Morgan Stanley is weighing a merger with Wachovia Corp. and several other banks as the securities firm seeks to regain investor confidence after its shares sank 42 percent this week, people familiar with the matter said.]

The Dow ended the day at 10,609.66 (down 449.36) in the last 2-hours of trading the bloody index rallied from 10690 to 10,912 (up 220+/-) then in the last 55-minutes of trading the sucker sold off over 300-points…I am now wearing a neck-brace due to the extreme volatility a whopping 520 run in less than 2-hours…we have support at 10,525-10,555 thereafter significant support at the 120Mema at 10,285 (note we are down 3590+/- Dow points in just over a year a staggering development)

The Nasdog ended the day down a whopping 109.05 points to close out the day at 2098.86 and we are only 50+/- points away from very-strong support at 2045, I believe technology will be the first sector to turn as such a LONG position in the QLD or Calls on the QLD would be most advantageous also the SMH is closing in on long term support at 23.75-24.00 and calls in the SMH, KLAC, BRCM, LRCX, INTC could be very lucrative as when these players bounce they bounce extremely hard I recommend the November or December strikes as the best to own!

The SPX ended the day down a whopping 57.21 points to close out the day at 1156.39 and we are only 20+/- points away from very-strong support at 1135-1140, I believe this zone will hold as the charts are extremely oversold and many a sector has been beaten to death as hedge funds rush to liquidate…my favorite sectors are energy, steel and agriculture (stocks that should see significant bounces in my opinion are X, NUE, CLF, MA, V, GS, MS, HES, OXY, DVN, SLB, MON, MOS, AGU, POT) 

Today we saw that investors fled stocks and almost all instruments except gold (thank goodness we have exposure on the LONG side in the(IAU/GLD from $74.00, and NEM), as they sought the safety of hard assets and government debt, sending gold, oil and short-term treasuries soaring.

• Gold futures surged more than $80 an ounce today, the biggest daily gain in dollar terms since in over 25-years as news of the U.S. government's takeover of AIG fueled massive safe-haven buying. Gold for December delivery closed up 9% at $850.50 an ounce; it had jumped as high as $83.80 in electronic trading to $864.30.
• Crude futures closed with a gain of nearly 7%. After several weeks of declines in U.S. supplies of crude and gasoline combined with weakness in the U.S. dollar helped crude (as I had forecasted) oil recover much of its two-session loss of $10 per barrel. October crude closed at $97.16 per barrel, up $6.01, or 6.6%.

Today the AIG bailout appeared to have unnerved the markets more than any-one thought (or was it program-traders unwinding mega option positions) as no one seemed comforted by news that the Fed-heads gave AIG a two-year, $85 billion loan in exchange for a nearly 80% stake in the company, which lost billions in the risky business of insuring against bond defaults.
The selling today could have been much worse had they not acted (even though I believe they should have not) The Federal Reserve's decision to take over AIG put it back into the game of picking winners and losers only two days after it left Lehman Brothers a primary-dealer fall into the abyss of bankruptcy dis nothing to sooth the markets today. This unrelenting credit crisis is forcing the Fed into ad-hoc knee jerk decisions on whom to save setting new precedents for investors as regulators threaten to crowd out the market's own risk and reward incentives to manage exposures too these idiot overleveraged greedy companies. Our lamebrain government-officials drew a proverbial line in the sand with one of their primary dealers “Lehman” and than quickly erased it as they bailed out AIG, and the loan to AIG raises some serious issues for me about what role our Hyper-inflationary-creators at the FED is supposed to be; as despite the contagions I believe they stepped way over the line IMHO.
 
Our Fed-heads with support of the Treasury, invoked emergency powers late yesterday (powers I do not believe that really have or should have) to lend up to $85 billion to AIG after the insurer's losses on mortgage securities threatened to send it into bankruptcy. Lehman filed for bankruptcy after the Fed’s main helicopter easy money infuser Bernanke and Treasury Wolf (I upgraded him from a fox) Secretary Paulson refused to bailout LEH, sending their share-holders into the cesspool.

It was a very strange and an extraordinary turn of events as the Federal Reserve agreed late yesterday to take a nearly 80% stake (this is our money so what they really mean top say is that the taxpayers took a 80% stake) in American International Group, in exchange for an $85 billion loan (they were forced to sell their soul). The Federal Reserve and Goldman Sachs and JP Morgan Chase had been trying to arrange a $75 billion loan for the co to stave off the financial crisis caused by complex debt securities and credit default swaps. The Fed-heads using taxpayer money stepped in after it became clear Tuesday afternoon that the banking consortium would not be able to complete the deal. Without this massive bailout A.I.G. was expected to be forced to file for bankruptcy protection. The need for the loans became necessary after the major credit ratings agencies downgraded A.I.G. late yesterday, a move that likely to have forced the firm to turn over billions of dollars in collateral to its derivatives trading partners worsening its financial health.

Our brilliant bailout specialists (with taxpayer money) agreed to lend as much as $85 billion to American International Group in exchange for an 80% stake to save the country's biggest insurer from total collapse and they did so with out any real authority to do so, without congressional approval….they denied LEH and several days later chose to bailout AIG, does Bernanke have a god-syndrome…they are now choosing which firm dies and which one survives this credit debacle. The Federal Reserve abruptly changed course and determined that, in current circumstances, a disorderly failure of AIG could intensify already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance according to their statement.
 
The agreement, supported by our mage brain-trust cases at the Treasury Department, will keep AIG in business, averting a failure that could have threatened more financial companies and added to chaos in world markets. It is estimated that losses industry wide could have totaled in excess of $180 billion if AIG collapsed, according to RBC Capital Markets. AIG needed the loan after their credit ratings were cut and shares plunged 80% (would it not have been easier to bribe the rating agencies to up-grade their credit ratings as they have certainly been way behind the curve through this massive calamity that they were complicit in and helped to nurture into a festering sore that turned into a cancer. “The two-year loan will assist AIG in meeting its obligations as they come due,” the Fed stated in their release statement. The bailout/lifeline will allow AIG to sell their assets in an orderly fashion rather than at distressed prices, and this will be a good thing so even I must be positive with this development. The loan (hopefully it will be a real loan) is expected to be repaid from the proceeds of the sale of the firm's assets. The catch-22 from what I have read is that the government has the right to veto the payment of dividends to common and preferred shareholders. I like the part that AIG will replace management as part of the deal. Interest will accrue on the outstanding balance at the three-month London interbank offered rate plus 8.5 percentage points; and this could be a good deal if the assets can match the loan which I am skeptical of.

AIG failed to raise private capital (This is a major red flag for me as if the load was such a great deal 8.5 percentage points over LIBOR why did not another group step in?) as its shares slumped, and held talks with bankers as well as Treasury and central bank officials at the New York Fed this week to craft a bail-out solution.

This is very bad news in my opinion and it is a very confusing precedent that this power hungry Federal Reserve is undertaking; as AIG has been bleeding capital and liquidity for months. Anybody in their right mind could have gotten out long before this and we saw a huge swell of apathy and a lackluster attitude…and then an abrupt reversal in tonality as the Fed and Treasury officials made a contrary argument to avoid coming to the aid of Lehman. They spurned help for the primary-dealer/investment bank saying Wall Street knew of its troubles for months, unlike the sudden collapse of Bear Stearns in March. We are in a very bad contagionous environment and the Fed doesn’t really have the authority or any rules and they are now scoffing up more and more power and they are trying to set and make new rules in the middle of the game.
 
Investors bet billions that mortgages, which investment bankers (knowingly and deceitfully) wrapped into complex securities, would continue to pay-off but many writing and selling these packages knew better. Now, nearly one in ten U.S. home loans is in delinquency or default in the wake of the subprime debacle and idiot loans that should never have been written in the first place and now we have a weakening economy that is compounding the negative-situation.
 
Fed officials have attempted to offset the credit debacle that they were instrumental in creating by pumping massive amounts of easy money “liquidity” into markets and setting up new loan programs for commercial and investment banks (it was their easy-cheap-money policies that started this debacle). They also have reduced the benchmark interest rate 325 basis points since September of last year all to no avail to stop the bleeding. They left the benchmark rate at 2.0%, yesterday, rebuffing cries among many so called guru’s and investors for another bailout rate cut.

It could have been a disaster in the financial markets if AIG collapsed, as AIG is so huge, so large, with so much counterparty risks that have yet to be truly known in the market for insurance against credit defaults and as such this unwinding if they went bankrupt could get very nasty.

The next question to be answered very soon is whether lawmakers and economic policy makers will create an agency like Resolution Trust Corp., which took over the assets of failed savings and loan associations over 20-years ago.

At their meeting on Tuesday, the FOMC held their interest-rate target steady at 2% despite a growing cry from Wall Street to cut rates to save their overleveraged and greedy asses (to enhance their carry-trade). Just as they stated this past weekend to Lehman (however they bailed out AIG) the Fed said, "No” to the markets outcries for rate cuts. It's not exactly clear what a rate cut would have done any way, beyond a potential temporary and likely only a psychological lift for traders and investors knowing that the Fed-heads will bail out their sorry asses when every they demand but we already know that the Fed-heads are some what actively engaged in the potential resolution to this financial crisis; that they were instrumental in creating. Typically, lowering overnight interest rates for banks would lead to more credit flowing in to the economy after a normal gestation period of nine months (like a pregnancy) the economy would hopefully give birth to a new-bullish move. But the crisis we're in now a massive debacle that really can't wait nine months. The FOMC has already dropped their  over night target arte by 325 basis points during the past several months but it hasn't stopped the crisis of confidence from ballooning at all so why would another rate cut do it. Cutting the overnight rate can't restore trust that has so badly been bruised and tarnished by the bloodsuckers in the lending, banking and brokerage communities; only targeted direct bail-out aid (most from taxpayers) directly at affected firms, and the healing power of time, can do that…but I believe if taxpayer monies are involved we need drastic reform of these institutions and their management teams (or should I say hired-thief’s) need a huge overhaul as their decisions and cover-ups (non clarity and manipulation of balance sheets) should be severely dealt with.

• Our fed-heads didn't completely ignore the contagions within our economy and in the markets, however. The statement after the meeting made it clear that they were worried more about “strains in financial markets” and weak employment market. They recognized that “economic growth appears to have slowed recently” and they pointed the finger at tight credit conditions, the housing meltdown and added a new worry: slowing exports. (full bias statement)

Yesterday the National Association of Home Builders stated that U.S. home builders grew more positive about their business conditions in early September, with builder sentiment rising for the first time in over 7-months.
The builders' sentiment index rose to 18 in September, from a record low 16 in August. Still, the index shows that barely one in five builders is currently somewhat optimistic; as a reference the index peaked at 72 in June of 2005. Lower mortgage rates according to this administration is a disguised tax break for first-time buyers and the government takeover of mortgage giants Fannie Mae and Freddie Mac have now encouraged builders to think new-home sales may finally be at a turning point, however I believe this is was to early to forecast such an event. All three components of the builders' index improved in September according to the report yesterday.

• The index measuring current single-family sales rose to 17 from 16. The index gauging future sales soared to 30 from 24 while the index of prospective buyers rose to 14 from 13.

All four regions posted better scores in September than in August. Conditions improved the most in the tiny Northeast region, rising to 22 from 16. Sentiment rose by two points in the other regions: to 15 in the Midwest, to 22 in the South and to 12 in the West.

Yesterday Senate Banking Committee Chairman Dodd stated that our country is facing a deepening economic crisis and called for more aid to homeowners and possibly an additional economic stimulus package to help consumers. He spoke shortly after Fed policy-makers decided to leave short-term interest rates unchanged at 2.0%. Dodd also said he is disappointed that the Securities and Exchange Commission hasn't done more about naked short selling and enforcing long-term existing rules (he forgets many at the SEC are beholden toward and bought and paid for by those they regulate) he stated “Where's the chairman of the Securities and Exchange Commission?”

Financial reporters and the horde of talking-butt-heads on the various bubblevision networks are running around in like chickens with their heads cut-off with more news than they can handle and report. Our Hyper inflationary bailout specialist at our Federal Reserve are in the news throughout the day (usually they avoid the spotlight) and we have a several firms in the proverbial calamity/crisis spotlight every morning and often a new one or several crop up in the afternoon. Earnings warnings are beginning filter in with intensity with the technology sector more visible than many.

Normally the Consumer Price Index (CPI) for August would have garnered more attention as it was almost lost amid the high profile news events (AIG the most prolific). We saw that headline inflation actually decreased slightly to 5.4% while core inflation remained level at 2.5%; as we saw a parade of talking-buttheads being pranced about on the various financial networks stating that inflation had peaked I believe this is extremely premature but it clearly has stalled at least temporarily after crude and gasoline prices have significantly retraced these past weeks. We saw that the CPI energy component dropped 3.1% but is still up over 27.2% over the past twelve months. Gasoline prices dropped by 4.2% but are still up over 35.9% for the year. The CPI declined in all regions with the largest decline in the west where the CPI dropped 0.5% from July levels. Food price inflation also appears to have mitigated thanks to lower energy prices.

The big event of the secession yesterday was of course the FOMC as they left their interest rates flat at 2.0% and this was a surprise somewhat for the markets but it was quickly ignored. The statement cited the recent turmoil in financial markets and the ongoing slowing of economic growth. The Fed stunned market participants by stating that inflation was a significant concern and did not change their bias toward lowering rates. However, the vote to hold rates steady was unanimous and the surprise for me was they Richard Fisher changed his well known hawkish stance.

The Fed is professed to be working diligently behind the scenes to lessen the festering contagions that they helped to originate as they injected liquidity in the market twice on Monday totaling $70 billion; that muffle the spike in real rates but it was not enough bring rates down; then again on Tuesday they made two more injections totaling another $70 billion and the total of $140 billion was finally enough to push real rates down to the Fed target of 2% yesterday, and its worth noting that these combined injections totaling $140 billion is a massive amount of easy money hitting the money-flow-stream in a very brief period of time.

By announcing no change in rates the Fed was trying to send a signal that the current financial stress is not an economic problem but a series of individual firm related issues unfortunately many of these firms are the most influential in the financial world.

The latest chapter in the Lehman debacle/catastrophe has Barclay's (BCS) picking up the scraps of the once stellar investment banking and trading operations of LEH for $2 billion; a great discount and buy according to my estimate; on a very positive note this would save 9,000 jobs and give Barclay's a stronger foothold in the U.S. markets I would expect to see several other vultures picking over the Lehman carcass in the days/week ahead.  

The fallout from the Lehman bankruptcy (and a non-bailout from the fed-heads) is starting to appear and the contagions could just beginning as Constellation Energy (CEG) dropped almost 30% on renewed fears that the consortium of banks, which included Lehman, would pull their credit line. This came despite assurances from CEG that the Lehman portion of the line was only a mere $150 million and CEG had over $2 billion in excess liquidity. (I believe the selling was way overdone on this account….the problem came in the rise of its credit default swap premiums to 478 basis points on fears of the lost credit line. That means it would cost $478,000 per year to insure $10 million in debt for five years. Obviously for debt that is yielding 8% that would be an impossible fee. CEG traded as low as $13 before rebounding to close at $31 and "only" a 35% loss.

• There has been a steady stream of comments from other firms throughout the past several days about their liabilities regarding Lehman. MetLife said they had $800 million in exposure to Lehman and another $10 million in common stock. MetLife had also made secured loans to affiliates of Lehman, which Met hopes are still fully collateralized.

I am not going to bother listing the dozens and dozens of firms who have mentioned negative exposure to LEH liabilities this week because it is only going to get larger in the weeks to come. I can tell you this that we should expect quite a few earnings warnings as these liabilities start to be fully reflected in the 3rd quarter as these losses will have to be realized on their balance sheets.

 

Copyright © 2008 Stephen Tetreault
Editorial Archive

contact information

Stephen Tetreault | Southern Maine, USA | Email | Website

The opinions of FSU contributors do not necessarily reflect those of Financial Sense.