Tuesday's have not been kind to the market recently and today was no exception. Five days of gains were wiped out and the indexes returned to their lows set early last week. Volatility returned and the selling was blamed on the continuing subprime meltdown. GM added to the negativity after they released an update on how the subprime implosion was impacting their profits. Brokers, banks and homebuilders led the decline. The result was the second worst day in the markets in 2007.
Dow Chart - Daily
Nasdaq Chart - Daily
There were several economic reports today but none produced any market reaction. Retail Sales rose only +0.1% in February. Business Inventories rose +0.2%. The Job Openings Labor Turnover Survey (JOLTS) headline number was 10.7% and that was only slightly below the 13.4% we saw in the prior month. The job openings rate was unchanged at 3.1% as was the hire rate at 3.6% and separation rate at 3.3%. This indicates the job market is relatively strong and there are no signs of any coming weakness.
The markets ignored all these reports and focused on only one number. That was the spike in the mortgage delinquency rate for all mortgages to 4.95% as reported by the Mortgage Banker Association. This broke down further to a 2.57% default rate among prime borrowers and 13.33% for non-prime borrowers. The default rate for subprime ARMS rose to 14.44%. This was for Q4-2006 and does not represent the serious acceleration in defaults in 2007. We have heard from various sources that as many as 20% of non-prime loans are currently in default. Also concerning analysts is the spike in defaults by prime borrowers. The change was only from 2.4% (Q3) to 2.57% (Q4) but the trend has been rising. If defaults in prime loans accelerate in 2007 as the subprime defaults are doing analysts are worried it could sink the entire mortgage system. Foreclosures are already at a record rate and increasing.
There were multiple news items on the subprime sector today. Trading in New Century Financial (NEW) was halted on Monday and the NYSE suspended NEW on Tuesday while it took steps to delist it from the exchange. Class action suits are springing up everywhere and governmental agencies are filing actions for all kinds of infractions and fraud concerns. New Century said it was being hit by loan charge backs in record amounts. When the loans are packaged and sold to investors the originator (NEW) indemnifies the investors against any defaults. With defaults hitting record highs all the major loan resellers are being flooded with charge backs. NEW said UBS was demanding $1.5 billion in charge backs to be paid immediately. NEW has no cash and nobody is likely to give them any credit until the full extent of the damage is known. NEW said it could be hit with $8 billion in charge backs based on their current delinquencies. NEW insiders are under fire for selling stock in Jan/Feb with full knowledge of the internal problems. NEW is said to be on the verge of bankruptcy and those potential takeouts discussed by analysts late last week have not appeared.
The Massachusetts Attorney General subpoenaed Bear Stearns and UBS over their recent subprime research reports. BSC and UBS, both large buyers of New Century mortgages for resale, upgraded NEW in late Feb and in early March. UBS upgraded NEW on Feb 23rd saying the credit problems were already priced into the stock and gave a price target of $17. On March 1st BSC upgraded the stock saying with the right strategy NEW could return to the high teens. The AG thinks this is too coincidental and could be an effort to prop up NEW while they unwound their loan positions. If new fails then the charge back liability falls on BSC and UBS for those loans they securitized and sold. Looks fishy to me as well.
CreditSight said today that Bear Stearns has the highest risk of impact from defaults because they have the highest percentage of 90-day delinquencies. 4.57% of loans held or sold by BSC are 90 days delinquent or more. Others listed were Washington Mutual at 1.48%, Countrywide Financial 1.42% and GM (ResCap) at 0.92%. Bear Stearns reports earnings on Thursday and Lehman on Wednesday. Lehman is thought to have only slightly less exposure than Bear Stearns. Both should confess some part of their problems but these earnings are for Q4 and before the problem really accelerated.
Master them with Hotstix QQQ Trader. We'll show you exactly when to buy and sell the QQQQ and turn you into a master trader who knows how to cut your losses, nail short term gains and rack up some incredible profits.
30-Day FREE Trial:
The CEO of Countrywide Financial, Angelo Mozilo, was on CNBC today and he said the subprime meltdown was turning into a liquidity crisis that could impact all lenders. He said it was going to impact Countrywide since 7% of their loan portfolio is subprime paper but it only represented 2% of their assets. He believes this will continue to get worse until the Fed steps in with a rate cut to calm the waters. Mozilo said 70% of subprime borrowers refinance their loans before they reset. With the current liquidity crisis that option is no longer available to these borrowers. He felt this would push these homes back on the market and cause builders another prolonged period of weak sales. Mozilo said there would probably be only 2-3 subprime lenders when it was over. He also felt CFC would come out on top because of their 40 years in the business and more than adequate capitalization to withstand any delinquency problem. I believe that CFC will be a strong buy once the problem passes because they are very well positioned and the competition will be significantly reduced.
Accredited Home Lenders (LEND) said today it needed to raise additional capital after paying $190 million in charge backs last month. LEND said it was cutting staff and exploring "strategic options", a term normally reserved for those looking for a take out. LEND started the year with $345 million in cash but today's comments suggest that has been used to fund charge backs. LEND fell -$7.44 or -65% on heavy volume to close just under $4. It was $25 just three weeks ago. Novastar (NFI) fell -19%, IMH -11%, NDE -8% and CFC -4.7%. The major lenders who securitized the loans also fell sharply with BSC falling -$10, or -6.7%, FBR -16%, JPM -4.4%, LEH -5.9% (-$4.55) and WM -5%.
GM released financials today showing it lost $651 million at its mortgage unit ResCap. GM sold a 51% stake in GMAC to Cerberus Capital in November for $14 billion. ResCap is the mortgage arm of GMAC and that division has serious subprime exposure. GM said today they would have to return nearly $1 billion of the purchase money to shore up the portfolio losses in ResCap from subprime defaults. In addition to defaults higher reserves were required to offset potential future defaults.
Take those stories above and repeat them about a dozen times each and you will understand what the various news sources sounded like today. It was ugly and the outlook is for continued ugly with a large serving of ugly for dessert.
There was other news but not much of it. Tech stocks were hit by a disappointing outlook from Texas Instruments in its mid quarter update on Monday evening. TXN tightened its range for Q1 but did not change the midpoint of expectations. Analysts had expected TXN to provide a more optimistic outlook now that the inventory surplus was supposedly over. It appears that assumption was incorrect. There appears to still be a glut of chips in both cell phones and computer components. The chip sector short-circuited and took down the computer stocks and the software stocks. The Vista ramp appears to have stalled and HP and Dell are seeing product begin to pile up.
Google took a -$12 hit after Viacom sued Google for $1 billion for "massive intentional copyright infringement" by allowing users to upload copyrighted material. Analysts claim this will be a milestone event for online content distribution. Viacom demanded last month that YouTube pull more than 160,000 video clips uploaded by users and those clips were viewed royalty free more than 1.5 billion times. Viacom claims YouTube does not police its site for copyrighted material. YouTube claims it always removed clips whenever the copyright owner complained. Viacom wants Google to put a filter in place that prevents them from being uploaded at all. That would be an interesting programming challenge.
Goldman Sachs reported earnings today and blew away estimates of $4.97 with earnings of $6.67. After spiking +$6 at the open the stock collapsed and ended the day down -$3.57. The decline was due to the imploding financial sector on fears the subprime problem was spreading to other than subprime originators. There are fears now that the meltdown is going to strip homeowners of badly needed equity and prevent them from tapping into that equity for consumer needs. 70% of personal wealth creation since 2001 has come from appreciation of home prices. Home Equity Withdrawals (HEW) had risen to an all time high and turned into basically free money. Once prices appreciated enough you flipped your house and the home equity line of credit (HELOC) was erased and the homeowner got to keep all the toys acquired with those equity funds. With equity fading and loans almost impossible to get today those homeowners are not going to be heading down to Best Buy or Circuit City to buy that new 60 inch HD TV. Harley Davison (HOG) is plunging about as fast as the subprime lenders on fears homeowners will not be able to tap home equity to buy a new bike OR will not be able to make payments on the bikes they already own. HOG has a very large financing arm and they carry paper on almost anyone willing to sign on the dotted line. Harley's always held their resale value in the past but a long and serious home equity drought could see a lot of bikes being returned to the dealer in lieu of payments. Subprime credit card companies like Providian, now Washington Mutual, are tanking on fears defaults will rise now that homeowners are being squeezed. Home improvement companies like Home Depot (HD) and Lowe's (LOW) are being hammered since a lack of equity and slumping home sales will prevent homeowners from heading in to pickup supplies for a pre-sale fix-up or remodel. This subprime meltdown is far from over and its impact is going to reach areas few have considered.
Oil prices have fallen sharply since last Thursday's high at $62.30. Prices fell to close at $58 today. Traders are taking profits ahead of the OPEC meeting this week. OPEC is not expected to make any changes but you can never tell when they will say prices are where they should be so they will begin increasing production. $58 is strong support and as I said in the weekend letter this could be the last dip before summer.
Crude Oil Chart - Daily
This is also a quadruple witching options expiration week. I mentioned on Sunday we had not seen the volume you would have expected from an unwinding of all the option groups. Monday's volume for a mixed advance at 4.6 billion was the lowest since February 12th. Tuesday saw volume jump to 6.24 billion but that volume was heavily weighted to the downside. There were 5.7 billion shares of advancing volume compared to only 465 MILLION shares of advancing volume. That is a 12:1 imbalance! Remember, we always need to follow the volume. Large volume on a rebound suggests it has legs while low volume suggests there is no conviction. The same is true to the downside and the outlook here is definitely negative.
The Dow posted its second worst day in 2007 and the second worst day since Bernanke took charge of the Fed. The Dow nearly duplicated its lows from last week at 12050 and this is exactly where we need to be to have a successful double bottom retest. It is a pivot point that really matters. If the markets dip slightly lower tomorrow to complete the retest and then begin to rebound I would be a strong buyer. HOWEVER, based on the deteriorating fundamentals and internals I don't think the retest will hold. I believe we will make the test and maybe see a small bounce but I believe market sentiment has turned sour. We could easily see a further dip to 11950 or even lower. It feels like a real correction has arrived. The Dow found a solid top at 12300 and once that top broke the sellers arrived in volume. Much of this could be simply the flush of the expiring options but that remains to be seen.
The Nasdaq found a similar resistance top at 2400 and the selling was brutal. Since there are very few subprime components in the Nasdaq it is tough to claim the market sell off was just dumping of subprime financials. The various tech stocks giving disappointing guidance and the rising inventory levels have soured tech buyers as well. The Nasdaq closed right on the lows from last week and Nasdaq futures are still slipping lower overnight. Nasdaq 2325 should be the next support point.
The S&P lost -28 points after failing to penetrate resistance at 1410 for three consecutive days. The close at 1378 is only a couple points above last week's lows and a break there sets up the potential for a real washout. 1315-1325 would be the next material support.
DDow Chart - 30 min
S&P-500 Chart - Daily
Russell 2000 Chart - Daily
I said on Sunday the Russell and the NYSE Composite were showing slightly more bullishness than the other indexes. They declined along with the other indexes but neither came close to last week's lows. The Russell closed at 769 with last week's support low at 760. The NYSE Comp closed at 8926 and nearly 100 points above last week's low. While these declines were less than those on the Dow, Nasdaq and S&P, they were not enough to make me retain that slight bullish bias I had on Sunday. I shorted the roll over yesterday and I am still short tonight. These indexes may be lagging the Dow and S&P but I don't have the confidence they will stop the swoon.
This is a key point. Whenever we have a major blow off like we had the prior week there is almost always a failed rebound. The first bottom is then tested and that becomes the pass/fail test to determine the next market direction. A passing grade here means we test those lows tomorrow and a stronger rebound on heavy volume appears. A failure here is a clear signal that there is a real correction in progress and traders will flee to the sidelines to watch the crash. I would buy a bounce and short a failure. It is really that simple for the rest of the week. If we do move lower it could be a very sharp drop as bids are pulled and the ETF junkies start dumping in volume. I would not be eager to buy a rebound from a lower level. Any dip lower could cause problems from margin calls and asset allocation programs from institutions. The next couple days could be highly volatile and probably not for the faint of heart.