Just as storm watchers have monitored Dean's growing strength in the Atlantic, market watchers have attempted to monitor the strength of the financial storm threatening our markets. The storm was contained, investors were assured.
Not when the storm hits the likes of Countrywide Financial (CFC), investors around the globe decided late yesterday. The financial storm strengthened overnight when the Bank of Japan's infusion of 400 billion yen ($3.44 billion) failed to stop the dollar and euro from declining against the yen. The U.S. dollar as measured against the yen dropped to level not seen since July 2006, further damaging the yen carry trade.
What had been a contained, if sometimes scary, drawback into a well-needed retest of former resistance became a rout. Last night, the Nikkei closed almost two percent lower than the previous day. Even scarier were declines on other Asian bourses: the Shanghai Composite, 2.14 percent; the Hong Kong Hang Seng, 3.29 percent; the Straits Times, 3.70 percent; South Korea's Kospi, 6.93 percent and the Taiwan Weighted, 4.56 percent.
Our futures showed the effects of the blowing winds, with the S&P 500 futures down more than twenty points when I woke this morning. Voices cried out for an emergency easing by our Fed, but that hope was squelched early with the Fed's Poole speaking out, saying that there was no need for a rate cut unless there was a "calamity." That sentiment was echoed by others, who wished instead for an infusion of liquidity by our Fed.
The Fed obliged, announcing a $5 billion add by 8:30 this morning, but that add was termed typical for a Thursday according to several news sources, however. The Fed didn't stop with that typical add, injecting another $12 billion a little more than an hour later.
U.S. Treasury Secretary Henry Paulson weighed in, too, in a WALL STREET JOURNAL article, assuring investors that the U.S. economy was strong enough to weather the storm without being thrown into a recession. He did not find the retracement in the markets surprising, given the need to reassess risk. Some investors and traders felt that the term "reassess risk" was a mild description to apply to what was happening in the markets.
Finance ministers in other countries had their say, including Jim Flaherty, Canada's. He affirmed that country's economic strength while acknowledging the pressures that non-bank asset-backed commercial paper was experiencing. Coventree Inc. (COF.T) announced earlier in the week that it couldn't sell debt to investors or repay maturing issues, prompting a decline in Canada's stock market. Flaherty mentioned an adjustment offered today by the major participants in Canada's asset-backed commercial paper market. Those participants said today that outstanding debt would be converted into floating-rate notes with longer terms, a move of which Flaherty approved.
Like moisture adding to the strength of a storm, Countrywide Financial (CFC) made an announcement that added to the financial storm's strength. CFC announced that it had drawn down 100 percent of an $11.5 billion credit facility, using the money to fund its operations since the difficulty in raising money in credit markets has endangered its business. To make matters worse, Moody's Investors Service downgraded the company's senior debt ratings and threatened to drop them below investment grade. As Jim has detailed in many Wraps, that action would mean that pension plans and many institutions must drop CFC's stock from their portfolios. Later, Standard & Poor's cut CFC's counterparty credit rating to A-, four notches above junk status. Standard & Poor's placing of the company on CreditWatch negative status alerted market watchers that the firm could downgrade CFC again.
Worse rumors circulated. I didn't hear all of them, but one was that Moody's thought it possible that a large hedge fund could collapse. This rumor's negative impact was added to the impact of yesterday's deadline for fund redemptions this quarter. If those requests were as large as they were rumored to be, equities would be sold.
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By 9:15 EST, futures had improved enough so that the S&P 500 futures were then less than ten points below fair value, but no one was fooled. It was going to be a rough opening. The USD/yen pair had climbed significantly off the overnight low of 113.59, but at 114.47, was still far below the 117.60-ish level that had been providing support over the last couple of weeks. Those who watch the USD/yen action for guidance, as I do, had little faith in a bounce that hadn't cleared that level.
Meanwhile, Dean strengthened to a hurricane and headed toward the lesser Antilles. Those of us in Texas were already feeling the effects of the tropical storm that preceded Dean, wondering if Dean was going to follow that tropical storm into the Gulf.
We wondered, too, about the strength of the storm headed for our financial markets. We knew when it would make landfall, but we didn't know how little or much damage it would do.
That damage was to knock 343 points off the Dow. It was to bring the Dow and the SPX to a 10 percent correction, and beyond on the SPX, at least.
This storm was to blow through, however, with CNBC commentators crowing and clapping by the end of the day. Unbelievably, some indices ended the day in positive territory; some, barely negative.
Was this the capitulation so many have awaited as a sign that all the weak hands have been flushed out and markets are ready to resume rallies? Has the storm passed or is this the eye of the storm, with the next round still to come?
Last week, I thought that charts showed indices in the process of churning out some sort of eventually recognizable patterns that would then break one direction or another. Although the SPX's pattern had a vague megaphone-type shape, the formation didn't set up well before the markets cratered and the SPX fell out of it.
Annotated Daily Chart of the SPX:
The support on the daily close at the sharply descending red trendline, formerly resistance, does not mean that prices can't slide lower. They can and might, especially as the fit of this red trendline is somewhat awkward. It's confirmed by RSI peaks, however, so I consider it having some possible validity. Short-term bears should have profit-protecting plans in place whenever it's pierced, as it's possible that prices will break above it by the close of the day's trading.
There was a spring after that line was pierced today. In normal circumstances, such a spring could be counted on to produce a bounce tomorrow. It may still do so, as surprised shorts cover their positions and fuel such a bounce, but remembered that markets remain vulnerable and can roll down quickly again, too. These are not normal times. What looks like the return of sunshine might be the eye of the storm.
Those in short-term bullish plays should certainly have profit-protecting plans in place, too, at key levels. Recognize that if three descending trendlines are eventually to be formed, as the corrective fan theory proposes, the markets could still experience marked vulnerability. The second one hasn't even been breached yet and there's potentially a third one to go.
Those key levels to watch for rollover potential include the 1425-1427 former support level. That support might now be converted to resistance. Potential first strong resistance after that extends up to the converging 200-sma and -ema's and then up to the converging 72-ema and descending blue trendline.
Based on the length of time it took the Dow to churn out a left shoulder for a potential head-and-shoulders formation on its daily and weekly chart, I thought it possible that prices could churn around for a while forming a right shoulder. In fact, I warned last weekend that the best possible outcome, in my opinion, was for the indices would spend a prolonged period chopping around, hacking out trustable support levels. If that didn't happen, the most likely alternative appeared to be a quick drop. We got the drop.
Annotated Daily Chart of the Dow:
Keene's suggestion about trading either a decline or a bounce applied to earliest trading, of course, and he was right. He thought such an open could lead to a multi-hundred-point drop in the Dow, and he was right about that, too.
Annotated Daily Chart of the Nasdaq:
Annotated Daily Chart of the SOX:
As with other charts, the SOX's daily candle produced a strong spring from the day's low. Such a spring would normally indicate that we should see some follow-through to the upside tomorrow, but markets remain vulnerable after such a bloodbath as was seen today before the bounce began. The SOX's confirmation of its head-and-shoulders formation visually indicates the damage that was done, although I no longer trust the downside targets that are set by such formations. The SOX, like many other indices the last couple of years, tends to confirm these and then shoot back above the right shoulder, invalidating the formation it's just confirmed. However, the greatest likelihood currently predicted by this chart is that a test of potential resistance will hold back SOX advances, and it will roll down again.
Annotated Daily Chart of the RUT:
As someone on CNBC commented, panicked investors called desks today telling brokers to get them out of everything that didn't have "government" in the name. As a result, bonds climbed and their yields dropped. The yield on the ten-year dropped to a key level.
Annotated Daily Chart of the TNX:
Since bonds stop trading at 3:00 EST, we don't know how they would have reacted to the late-day push higher. We also don't know if the equity bounce was due to the closing of the bonds, when traders had little else on which to spend the money they'd garnered selling everything else they owned.
As markets dove, the VIX, the volatility index, climbed, but it wasn't to hold near its high of the day.
Annotated Daily Chart of the VIX:
Of course, a reversal downward in the VIX would be considered a plus for equities, but the VIX can not always be used as a market timing tool. On the live portion of the site, the Market Monitor, Jane Fox does a great job of predicting whether S&P 500 e-mini futures highs or lows will hold based on what she sees with the VIX, but the VIX on the daily chart doesn't always move in such nicely juxtaposed opposition. Still, be aware of the potential for sharp rallies if the VIX were to drop far from its highs.
I've been advocating that equity traders watch the action of the USD/yen pair for guidelines into equity action. Late yesterday, this pair broke through support that had been holding for more than two weeks, indicating that equity indices would likely do so, too. The break yesterday came in after hours, too late for any but currency or futures traders to react, but it served as a guidepost this morning that the initial declines might be steep.
Annotated Daily Chart of the USD/Yen:
While the bounce from the day's low was impressive, that bounce did not bring this pair back up into the 115-ish support level, much less the higher 118. That former support still must be tested. Some have theorized that the yen carry trade has just about been unwound. When it is, I expect this chart to be less helpful for those wanting to predict or corroborate equity action. The RUT's relatively strong behavior today makes me wonder if those presuming that the unwinding has just about finished might have something, but the currency pair's location below potential support-turned-resistance keeps me wary. For now, I'll keep watching, and I suggest you do, too.
I typically begin this portion of the Wrap with information on economic releases. Those releases, important as some were today, weren't the primary market movers, at least until the Philly Fed number was released at noon. New developments in the Countrywide Financial saga, including Moody's threat of lowering the company's debt below investment grade, rated far more attention during the early morning period.
Moody's may not be out of trouble itself. The European Commission announced today that it will investigate the credit-rating agencies such Moody's and Standard & Poor's, looking into their role in rating securities that utilized assets backed subprime-mortgages. You've read about the concerns over the ratings given these assets on these pages many times, so you understand that writers on these pages such as Jim Brown and Keene Little have been sounding a warning over ratings for many weeks and months.
Moody's may be doing what it can to rectify matters, but some would consider its efforts too late. After hours, another development occurred in the mortgage-backed securities realm. Moody's Investors Service announced that it had downgraded 691 of those securities, all originated in 2006. The assets were closed-end, second-lien home loans, the firm said, what are sometimes known as piggy-back loans. When downgrading these securities, Moody's commented on the higher-than-originally-expected default rate for these loans.
Amid these warnings, meteorological agencies across the world issued their own. Hurricane Dean strengthened. The Japanese Meteorological Agency issued a tsunami alert because of an earthquake off Peru's Pacific Coast. As relatives along the Texas coast began calling in preparation for evacuating, if needed, it seemed that there was no safe haven anywhere. CNBC and print articles noted that metals, typical safe havens, were hurting along with equities, and more segments of the "Is Your Money Market Fund Safe?" variety began to be aired on CNBC.
Curbs finally went in, but at first they scarcely seemed to slow the selling. Nothing was curbing the decline of the dollar against the strengthening yen, with another huge drop as the day proceeded. By early afternoon, the USD/yen had fallen to 112.00, a level not seen since June, 2006, when the currency pair was pulling up off its May 2006 dip into stronger support just below 109.00.
This disaster could still get worse, some of us thought while looking at violated support, contemplating how much lower the dollar could go against the yen. Last week, experts speculated that the yen carry trade had been just about unwound. Almost all the equities that would need to be dumped on the markets as a result of that unwinding had been, some speculated. Today, I heartily hoped that was so, but I continue to advocate that traders should be watching this currency pair as well as the euro/yen pair for short-term guidance in trading. There's been too strong a correlation in the action of these pairs and equities to ignore. Until we have firm evidence that the yen carry trade has been unwound--evidence that will show up when there's a disconnect between what happens with these currency pairs and what happens with equities--we should watch the currency pairs to help us assess risk.
The week's slate of economic releases began winding down today, but it wound down with a number of important releases. The 8:30 time slot was filled by the typical weekly initial and continuing jobless claims, but that release was joined by a couple of others.
Initial claims rose 6,000 to 322,000 with the four-week moving average rising 4,750 to 312,500. Both numbers moved further away from the 300,000 that is the benchmark for a too-tight labor market that might be adding to inflation pressures. Continuing claims rose 17,000 to 2.56 million and the four-week moving average climbed 1,000 to 2.54 million. Continuing claims are higher than they were a year ago, extending a trend that has become noticeable of late. It appears difficult for job seekers to find new jobs once their previous jobs have been lost. The insured unemployment rate has stayed at 1.9 percent.
Keene reported last night on the National Association of Home Builders/Wells Fargo group's assessment of the housing market's weakness, so today's government assessment would normally have received much scrutiny. Perhaps it didn't today, however, at least not when its release was coincident with a Fed statement about its intentions to add liquidity today. July's Housing Starts and Building Permits were released at 8:30, too. Expectations were for housing starts to slip to 1.410 million from the previous 1.467 million and for building permits to edge slightly lower, to 1.400 million from the previous 1.406 million.
The Commerce Department reported that housing starts dropped much more than expected, by 6.1 percent to a seasonally adjusted annual rate of 1.381 million. Building permits fell 2.8 percent to a seasonally adjusted annual rate of 1.373 million, also lower than previous estimates. The Commerce Department noted that this is the lowest number of annualized building permits since October 1996.
The Philadelphia Fed Survey, on of the three district reports on manufacturing that is considered influential when trying to gauge what will happen with the important Institute for Supply Management number, was released at noon. Economists predicted that August's headline number would decline to 8.0 from its previous 9.2, but the number fell to a dumbfounding 0.0 in August. Zero is the benchmark number for this index, indicating that the same numbers of manufacturing firms are experiencing growth as are experiencing declines. If this number had been below zero, the manufacturing sector would be experiencing contraction, a fate that was apparently barely avoided.
Markets already weakened by other worries turned lower again with worries about the economy's strength added to other worries. New orders declined to 7.1, down from July's 11.3.
Although the headline number proved shocking, a few components revealed positive trends. The expectations index rose to 36.2 from 30.4. The prices-received index dropped to 6.8 from 8.8, showing that inflationary pressures still aren't trickling through to consumers. Exports appeared to have increased as a percentage of total sales. Employment also rose sharply, to 21.2 from the previous 4.1. Of course, that last component functions as a double-edged sword. While all profess to want high employment figures, a too-tight labor market adds to inflationary pressures.
Companies reporting earnings today included BEAS, HPQ, KSS and JWN, but few articles even mentioned most companies that reported before or during market hours. JC Penney was an exception. JCP reported earnings that beat forecasts, with the stock making its investors happy and holding up well despite today's fierce market winds. The stock was positive most of the day.
Fannie Mae (FNM) was another exception, reporting 2006 profits that fell to $3.65 a share, down from 2005's $6.01 a share. CEO Daniel Mudd labeled 2006 a year of rebuilding for the company amid dropping home prices that created higher credit losses. Mudd expects the company's credit-loss ratio to increase in 2007, too, but Mudd also reassured investors that the company could weather this difficult period. FNM's CFO believes that 2007's audited financial results will be presented on time after the company's forced restatement of several years of earnings. FNM had a strong day after an initial lower opening.
FNM may also have contributed to the afternoon bounce in another manner. During the afternoon, the company announced that it had been having talks it deemed "constructive" about lifting caps on its mortgage debt holdings. This is an effort from Fannie Mae and Freddie Mac that is ongoing for the company. The Office of Federal Housing Enterprise Oversight had rejected such a request just last week.
Of some importance in sector-related trading was Berkshire Hathaway's disclosure yesterday that it had investments in three financials: Bank of America (BAC), Wells Fargo (WFC) and US Bancorp (USB). Early in the day, it was clear that this group was outperforming many other sectors, if only because its decline wasn't as steep as the decline in other segments of the economy. Some credited the bounce in some financials with prompting the bounces in other groups, too.
In other company-related news, Merrill Lynch lowered its rating of Eaton Vance Corp. (EV), a money-management firm, to a sell rating. We don't have to imagine why. J.P. Morgan, however, upgraded MFA Mortgage Investments to an overweight rating, saying that the liquidity and credit concerns were overdone since this company avoids almost all credit risk. Its portfolio is composed mostly of agency-issued residential mortgage-backed securities, J.P. Morgan said. Presumably J.P. Morgan feels that those agency-issued securities will not suffer from the subprime debacle.
HPQ's earnings report came after the market close. With markets bouncing into the close and the storm stilled for the moment, investors paid attention. HPQ's shares were first reported as surging above $47.00 in after-hours trading, but were at $46.00 when this report was prepared. Per share earnings appeared to meet expectations, but revenue increased to $25.4 billion, above the expected revenue of $24.1 billion.
Dell initially bumped above $26.00 in after-hours trading, too, although it was down to $25.93 as this report was prepared. Dell said that it would restate financial results from 2003 through the first quarter of 2007, but that the restatement would not materially impact the company's current balance sheet.
Tomorrow's Economic and Earnings Releases
Tomorrow the preliminary Michigan Sentiment Index for August will be released. Economists predict an easing to 88.5 from the previous 90.4.
What about Tomorrow?
What about tomorrow? Unfortunately, the day's steep decline and swift bounce scrambled most indicators and technical analysis tools that I use.
The moves are so big that intraday charts have little relevance, and that's what the scrambled intraday charts are showing. So, let's start with a little summary. The VIX punched to a new recent high but then fell sharply, producing a potential reversal signal, with emphasis on potential. The TNX hit potential support. Equities bounced. So did the USD/yen pair.
All that evidence corroborates today's equity bounce and would normally suggest some follow-through tomorrow. That may indeed be what happens tomorrow, but let's look at some more evidence. First, the biggest part of the bounce occurred after bonds closed, when buying "anything that said government on it" ceased and buyers perhaps turned to equities again. That's my first area of suspicion.
Next, the USD/yen and euro/yen pairs suffered a severe blow today and their bounces didn't even bring them up to the bottom of the wide band that begins at about 115, much less the 118 level. The USD/yen pair perhaps remains vulnerable to a retest of the 109-ish level.
So, as this report is prepared in advance of the open of the Asian markets, I'm not certain how the overnight trading will play out, as Asian markets will be trading for the first time with the USD/yen pair at this level in more than a year. Will that matter more than the late-day bounce?
I'm not certain. For now, I'd say that if you're trading long, don't count on a
long-term trade. Be ready to collect profits. Watch for rollover potential at
the levels listed on the charts. It's okay to be skittish. I think we're due for
an astounding short-covering rally one of these days, one that might have begun
at the end of trading today, but I'm certainly not ready to trust it yet. I
suggest that you don't trust it, either.