Archive for September, 2008

Option Queen Letter for September 28, 2008

Sunday, September 28th, 2008

The modification of the Glass Steagall Act of June 16, 1933 rang the morning bell of the current chaos in the financial system.   The original 1933 act formed the FDIC, and separated banks from investment houses providing a wall between them.    The Gramm-Leach-Bliley Act passed in November of 1999, forever repealed part of the Glass-Steagall act that separated banks, insurance companies and securities firms, thus allowing a mixture of banking, insurance and securities companies.  The walls that once existed no longer can be seen. What did that mean for the little investor?  Your local bank looked more like your brokerage and insurance company.  It now became a place where you could handle all your finances and get mortgages all while depositing your money in a savings account, also, your broker looked more like a bank now could lend you money for a mortgage and do banking type of business.  Oh, and if you felt risky, you could opt for the money market account which, was not insured by the FDIC.  Money market accounts pay higher yields because they lend money to businesses for a very short time, without collateral.  Because these loans have no collateral, they demand a higher cost to the borrower and the money market providing the funds earns a higher rate for the investors.  The problem caused to the money markets or some money market account can be directly linked with failures on Wall Street because in some of these money market funds, were short-term obligations of firms like Lehman Bros etal.  These toxic obligations caused a scare in some money markets and the threat to break the dollar.  What is the dollar value?  That is the value of the money market fund, dollar in dollar out, not a dollar ten or ninety cents.  Money market funds provide short-term loans and were not FDIC insured.  Thus, when the risk to these funds appeared, a risk of a run of these funds was not far behind and that needed to be addressed.   So far so good, we need to also look at the advent of the post dot-nothing era when the Federal Reserve reduced interest rates to a level below inflation. This low borrowing rate was an attempt to avoid a deep and painful recession.  Actually, it did work, however; the result of cheap money became the seeds of excess that would fuel the housing bubble.  By the way, the current rates are below the inflation rate again and this could spur the next bubble.

We have been writing about these excesses in the housing market for at least three years, warning investors not to use their homes at ATM machines.  To make matters worse, or really to bring the problem to a head was the ruling FAS 157.  This rule, which forced institutions to value their assets at the current market value, tipped the balance sheets forever causing irreparable damage.  This rule, which is a dose of reality, forces the banks, brokerages, and insurance companies to carry assets at their current value, not the imagined values of the past.  To be clear, in days prior to FAS 157, it would be possible for a financial institution to carry an asset like a mortgage pool, at its purchase price.  This new rule in essence says, if you had to sell the asset what would you get for that asset, and oh, by the way, that is the value that you can carry that asset on your books.  Say you bought a pool of mortgages for $100,000.  Most of the assets in the pool were fine but say 25% of the assets became impaired.   If you were to sell the asset, you would get $75,000 for that asset today.  That is what the asset is worth today and that is the value you may use on your balance sheet.  So, you are saying what is the difference?  There is a big difference because these financial firms use the value of the assets leverage which allows them to make loans to others.  Should the impaired value sit on the balance sheet, financial institutions can’t make as many loans and will be very careful to make loans to those who can pay them back.  This is a very very basic view.  As you can see, if the loans are curtailed, companies can’t borrow, say to buy goods needed for business or, perhaps to sell financed cars and trucks, or even make a payroll while waiting for receivables, this will slow down the economy, and halt customary business borrowing needs.  This could have caused a liquidity crisis.     

We need to bring our financial house back to reality.  We need to punish the greed seen in packaging these debt obligations.  We need to punish the lenders who knowingly pushed people into buying that which they couldn’t afford.  There needs to be accountability.  Years ago, it would have been unthinkable to buy a home with no money down and without documents that would verify your income.  This was common practice until about a year and a half ago.  Today, we have gone the other way or perhaps back to requiring documentation and a down payment for that house you want to buy.  The bottom line here for investors is that many mortgages will continue to fail, many people will abandon the house that is killing them to keep, and rental properties will again become popular.   

Monday:  August personal income and consumption is released at 8:30.  Tuesday:  Case-Schiller home price index is released for July, September Chicago PMI is released at 9:45, September consumer confidence is released at 10:00 and Atlanta Fed President Lockhart speaks.  Wednesday:   Challenger, Gray & Christmas September job cut report is released, August construction spending is released at 10:00 and September ISM index is released at 10:00.  Thursday:  the European Central Bank releases its interest rate decision and August factory orders are released at 10:00.  Friday:  September nonfarm payrolls and September unemployment are released at 8:30. 

The US Dollar index will be the beneficiary of the initial hooray the deal is done and then the source of funds when the details are unraveled.  The problem with the deal is that we know how much it could cost but we have no other details.  As a lender to the
USA, wouldn’t you want to get some of the details?  The US Dollar index has rallied, or closed higher than the open, for the past four trading days.  Although we failed to push higher in the Friday session, we equally failed to move lower, we had an inside day.  The 5-day moving average is at 76.812.  The top of the Bollinger band is at 80.479 and the lower edge is seen at 76.133.  All the indicators that we follow herein are going sideways none is issuing a clear message.  We had a nine-count on Wednesday.  It really looks as though we are forming a bear flag, however; we are not sure of that at the moment.  Should the US Dollar index close below 76.095, we will have a quick move down to 74.385.  On the other hand, should we trade above 80.655, many shorts will cover and we could see a good rally.  The weekly chart looks as thought the market has topped, for now, and will trade lower.

The Euro chart looks as though the market is forming a bull flag.  The question will be answer if the market removes the 145.52 low of the Friday session.   The 5-day moving average is at 146.51.  The top of the Bollinger band is at 148.36 and the lower edge is seen at 138.45.  The Thomas DeMark Expert indicator is issuing a sell-signal.  The other indicators are neutral.  The stochastic indicator is overbought and not issuing a signal, our own indicator is closer to neutral and not issuing anything and the RSI is on the overbought side of neutral and again is issuing no help.  We are below the Ichimuko clouds on the daily and the weekly chart but above the clouds on the monthly chart.  Our danger level on the downside is at 140.00 which will lead to a downdraft to 137.20 or so.  On the upside, above 147.70 we will see buying which could press the market to trade up to 151.90.    

The S&P 500 just might enjoy a bit of a rally on the passage of the “bail-out” plan.  Will that rally last more than several days?  We seriously doubt that.  We have a doji like candle on the chart as a result of the Friday session.  This candle generally speaks of transition or perhaps a change in direction.  The problem here is that the direction has been very unclear, at the moment we see quick moves up and quick moves down, keeping the daily range of trading wide.  The Thomas DeMark Expert indicator is issuing a sell-signal; the other indicators are somewhat neutral and are not issuing anything of value.  The 5-day moving average is at 1204.35.  The top of the Bollinger band is at 13007 and the lower edge is seen at 1165.20.   We are below the Ichimuko clouds for both the daily and the weekly chart; we are just about above the clouds for the monthly chart.  We remain in a downtrend for all time-frames.  Should we trade below 1159.35 we will go to 1150.50 and the, a lot lower to 1132.80.  On the upside, we need to trade above 1300.95 which would take us back to 1336.35.   We continue to have lots of supply on the upward moves.   

The NASDAQ 100 left a doji-candle on the chart as a result of the Friday session.  We are expanding the lows and contracting the highs, which as you know, is a downtrend.  The Thomas DeMark Expert indicator and the stochastic indicator are both issuing a sell-signal.  Both our own indicator and the RSI are going sideways a little below the neutral level.  The 5-period moving average is at 1669.40.  The top of the Bollinger band is at 1891.88 and the lower edge is seen at 1606.37.  We are below the Ichimuko clouds for both the daily and the weekly time-frame but above the clouds for the monthly time-frame.  So long as we do not remove the recent low of 1612.25, we will either remain in a consolidative pattern or rally.  However; should the 1612.25 level fail to support this market, we could see a rather quick and painful retreat.   

The Russell 2000 index never took out the July low and has continued to trade in a positive manner.  This index has out-performed the other indices, perhaps because it is a small capitalization index and doesn’t have some of the toxic companies in its makeup.  The stochastic indicator, the RSI and our own indicator are all going sideways; the Thomas DeMark Expert indicator is issuing a continued sell-signal, at oversold levels.  We are just below the Ichimuko clouds for the daily time-frame.  The 5-day moving average is at 705.98.  The top of the Bollinger band is at 758.52 and the lower edge is seen at 680.34.  We should see resistance all the way up to 753.75.  Above that area, we could move rapidly higher.  On the other hand, should we trade below 675.00 we could decline quickly.  In-between these numbers there is lots of supply and support.  

Crude oil and the US dollar are linked so, as the US Dollar appreciates, crude will depreciate, given not supply constraints.  There is yet another piece to this puzzle and that is that of a slowing economy.  Many traders believe that less oil will be demanded as the global slow-down sets in.  That would be good for the bears, unless OPEC cuts the supply.  The chart shows that the market is quite jittery, with quick run-ups and equally quick declines.  All and all, the trading has been higher since the low of September 16th.  We continue to trade below the Ichimuko clouds for the daily chart but above the Ichimuko clouds on the weekly and the monthly chart.  The stochastic indicator is not really trending but has a negative bias to it.  The indicators, for the most part, are not helpful.  The 5-day moving average is at 109.63.  The top of the Bollinger band is at 118.27 and the lower edge is seen at 92.08.  These numbers define the range of recent trading although; it has been more to the downside than the upside.  The indicators on the weekly chart are all positive.  We need to close above the 40 week moving average of 113.50 for a more positive feel to this market.   

Gold is in the Ichimuko clouds, on the daily chart!  We find that the indicators are not trending for the daily time-frame.  The 5-period moving average is at 888.10.  The top of the Bollinger band is at 922.10 and the lower edge is seen at 726.63.   We need to see a close above 910.50 and 922.00 to get this market moving towards the highs of 1004.50. We are above the Ichimuko clouds for both the weekly and the monthly time-frame.  The weekly chart clearly shows that the gold market is in a downtrend.   The indicators for the weekly time-frame are issuing a buy-signal.  Should this market retreat, we would expect to see it slide to the 680 area where it will find good support.