Responding to a question after his address to the House Budget Committee this morning, Fed Chairman Bernanke referenced "sliced, diced and sold" debt packages. The securitization and wide dispersal of such packages complicated finding a solution to the subprime problem or even quantifying the extent of the problem. A loan servicer who has securitized and widely dispersed loans has more difficulty working out a solution with a mortgagee in danger of defaulting. The servicer likely no longer holds the loan.
Fed Chairman Bernanke did attempt to quantify the problem, saying that currently 5 million subprime loans total $1 trillion in value. Of those, about 20 percent are delinquent, the Fed estimates. If all those foreclose--which they won't, the chairman asserted--and if one wants to be pessimistic and believe that only 50 percent of the value of those properties is recovered, the loss would be $100 billion. If more delinquencies occur, which is expected, the eventual loss could be "several multiples" of that figure.
This week has provided some insight into how those losses will be parceled out. Merrill Lynch (MER) joined this week's list of reporting financial institutions this morning, stunning market watchers with a much larger-than-anticipated loss and a $14.1 billion write down.
Another financial institution estimated that it would be able to earn back mark-to-market losses within four or five years. Phrased less optimistically, that bank will require four or five years to recover those losses. Mark-to-market losses occur when those "sliced, diced and sold" packaged debt instruments turn out to be worth far less on the market than the book values at which they had been held.
More quantification of risk was offered. Moody's signaled that it would be reevaluate ratings on bond insurer Ambac (ABK) and would also study the ratings of other firms that might be impacted by the same pressures hitting Ambac. ABK and peer MBIA Inc. (MBI) both dropped today. A Dow Jones article speculated that any cut in rating could prompt a revaluation of $3 trillion in outstanding debt, such as municipal bonds.
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We wanted to know how bad the damage would be. The widely disseminated view was that once everything was in the open, markets would recover. Today's reaction differed from that bandied-about prediction, however.
Before these earnings announcements, markets had been cheered. Yesterday, Fed Chairman Bernanke had expressed openness to congressional and White House efforts to stimulate the economy, as long as those efforts met certain conditions. Futures rose, with market participants anticipating the chairman's address before the House Budget Committee at 10:00 am ET.
After MER's earnings, the chairman's openness to a stimulus package may have taken on a whiff of desperation, with some market participants worrying that openness was another word for neediness. The Fed needs help, some might have concluded. During Chairman Bernanke's speech and the question-and-answer session, the expressed and often-repeated requirement that such a stimulus package be felt quickly perhaps intensified that impression.
While market participants were reevaluating just how much clarity they wanted after all, more information came their way. "Interbank markets are quite dysfunctional," Chairman Bernanke said at one point this morning, explaining that the rates at which banks lend to one another are too high. Although there's been some recent improvement, it's clear that the so-called credit crunch has not yet been entirely resolved, and that wasn't something that markets wanted to hear.
Then the Philly Fed coupled economic weakness with rising prices, and market participants had had enough. The bottom fell out.
Annotated Daily Chart of the SPX:
The SPX's weekly close beneath the long-term red channel as well as other "not since 2003" weekly closes on other charts suggest to me that the markets have changed their tenor. I would consider any bounces now to be countertrend ones, but that doesn't mean that they can't be sharp and pronounced. That's characteristic of bear-market rallies.
From where would a relief rally begin? A look at the weekly SPX chart shows the May 2006 high near 1327, the weekly 200-ema at 1321, and the weekly 200-sma at 1291.45. Potential daily Keltner support is at 1315.
The SPX, then, moves into a zone rich with potential support. The truth, though, is that markets fall faster than they climb. Those falling knives cut through support like butter. We can see potential support and we can prepare our trading plans for the possibility of bounces from those support levels, but we shouldn't hang onto losing positions that are below our preferred stop levels on the hope that support will hold. That's just not wise account management.
I was watchful for a bounce attempt as that blue trendline was approached. It didn't happen. It's possible that sentiment just pushed prices through support levels today and that there will be quick bounce above it tomorrow. Rumors run wild that the Fed might announce a cut tomorrow morning to blast shorts out of the water again on a settlement-day Friday morning, as they did last summer, but rumors have circulated for a week that the Fed would cut any day now, without that happening.
Annotated Daily Chart of the Dow:
Today, the Dow stopped at the top of a support zone from the weekly chart as the Dow was chopping out its March 2007 lows. Potential Keltner support on the daily chart falls within that zone, too. Vulnerability to the bottom of that zone can't be ruled out, but bears should be watchful for a bounce attempt that could begin at any time.
Most of us, even options traders who can trade both sides of a movement, would like to see our markets steady here. Will they? With markets cutting through all support levels, it's impossible to identify the one that will be "the" one to hold, but I would certainly be watchful for the possibility that a bounce attempt could get started. We'll look later at some short-term signs to watch on intraday charts.
Like the SPX, any bounce should be considered countertrend. Potential resistance must be considered now at the blue trendline, the red trendline and the 10-sma.
Annotated Daily Chart of the Nasdaq:
The Keltner setup shows that target and potential support on daily closes at 2333.54, with strongest resistance currently at 2446.01-2460.17 on daily closes.
Annotated Daily Chart of the SOX:
The SOX behaved much better than many other indices, which is one of the few elements of hope provided to suffering markets today. I don't have room to show all the Keltner charts, too, but the SOX's shows the SOX reaching right up to test the daily 9-ema, getting knocked back from that. The SOX remains in a confirmed downtrend until and unless it begins sustaining daily closes above that 9-ema, at 362.42 at today's close. Stronger resistance exists near 376 on daily closes. Light support on daily closes exists at 342.36, but if that breaks, it looks as if the SOX has just been consolidating prior to a drop toward the 2002 lows.
Annotated Weekly Chart of the RUT:
The RUT's daily chart suggests a potential downside target and potential support on daily closes near 671. On 8/06/07 and 8/16/07, the RUT hit that Keltner channel line exactly and sprang higher both times. That's no guarantee that will happen again, but RUT bears should be alerted to the possibility that support strong enough for a bounce attempt is being approached. If a bounce attempt should begin, either immediately or after a punch down to that channel line, watch for potential resistance at the weekly 200-sma and layered all the way up to 708.
Annotated Weekly Chart of the TRAN:
Several economic releases or developments occurred today, beginning with the Labor Department's regular announcement of weekly initial and continuing jobless claims. With the country perceived to be on recession watch now, these initial claims assume more importance than they did in the past.
The Labor Department reported an unexpected drop of 21,000 in first-time claims. Those claims dropped to 301,000, the lowest level in almost four months. The four-week average, deemed more reliable, dropped 11,750 to 328,500. That's the lowest level in almost three months. Year-over-year, initial claims have risen about 5 percent.
However, continuing claims show a more troubling trend. Those claims rose 66,000. The four-week moving average rose 28,250 to 2.73 million. That's the highest level in more than two years. People who lose jobs apparently have difficulty find new ones. Year over year, continuing claims have risen about 11 percent.
For much of last year, the insured unemployment rate oscillated between 1.9 and 2.0 percent. This latest report pegged it at 2.0 percent.
During the same time slot, December's New Residential Construction figures were released. Industry watchers predicted a slip in housing starts from an annualized 1.187 million to 1.140 million, but the drop was a deeper one. The Commerce Department reported that construction dropped to a seasonally adjusted annual rate of 1.01 million. That's the lowest it's dropped in more than 16 years, one article noted, representing a 14 percent drop in construction. Starts for single-family housing fell 3 percent to 794,000. For all of 2007, housing starts dropped 25 percent to 1.35 million.
Some economists believe that building permits better predict strength or weakness, but that figure offered little comfort, either. Permits fell 8 percent to a seasonally adjusted rate of 1.07 million. Although that wasn't a 16-year low, as was the construction figure, it was a 14-year one. For all of 2007, permits fell 25 percent to 1.38 million, a twelve-year low, and single-family permits fell 29 percent to 1.05 million, the lowest in 15 years.
Housing completions fell, too. The Commerce Department warns that these figures are volatile. For December, the government said that the standard error for housing starts was plus or minus 8 percent.
I want to remind subscribers that while many have called a bottom in the housing market at various times over the last two years, one writer on staff has consistently warned us not to believe the pundits calling for a bottom. Keene Little posted historical figures early last year and warned us not to believe in a bottom until annualized housing starts and/or permits had fallen below 1.0 million. In fact, in an email confirmation of his figures today, Keene stated that a bottom is reached "below 1M, typically closer to 800K." He wonders if the pendulum might swing even lower this time because its arc swung so high toward excesses.
With housing starts and building permits sinking so close to 1 million in today's release and with Keene's previous research in mind, perhaps it's time to begin looking at stocks of homebuilders and studying the DJUSHB, the Dow Jones U.S. Home Construction Index, for signs of a recovery. Don't jump blindly into these stocks or options on these stocks, thinking Keene or I said the bottom is in. That's not what I said. Do consider researching the strongest, comparing relative strengths, thinking about what you'll need to see to be convinced that a tradable bounce might occur. I'm sure Keene will offer more insight when he writes his Wrap next Wednesday.
One of today's biggest developments was Fed Chairman Ben Bernanke's testimony before the House Budget Committee at 10:00. Speaking on the economic outlook for the U.S., Chairman Bernanke reiterated some of the points that he made last week. He walked the committee through the history of the current problems, again talking about how bank balance sheets "were swelled" by various vehicles and the resultant complications for our financial system. He detailed the two-year slump in housing.
More importantly, he repeated last week's conclusion that recent developments have pointed to more pronounced downside risks to growth in 2008. He again mentioned concern about labor market conditions, but noted that weakening conditions in the U.S. were being met by "vigorously" expanding economic activity in our major trading partners that would keep U.S. exports growing. When questioned about the difference in the FOMC's approach to lowering rates and the ECB's determination not to do so, he pointed to differences seen in the U.S. and Europe. Europe and Asia haven't suffered through two years of a housing slump, for example, he said.
Fed Chairman Bernanke also pointed out inflation concerns but said that he believed that core and overall inflation would moderate over the next year. During the question-and-answer session, he responded to a question about the inflation measures that the Fed watches, perhaps because his prepared statement mentioned commodities.
The Fed does watch gold and other commodities, he affirmed, but those aren't pure inflation measures because they're also impacted by geopolitical conditions. The Fed likes to compare the return on TIPS (inflation-protected bonds) with other bonds, and commented that the Fed hadn't seen a ratcheting up of comparative demand for TIPS. That was encouraging, he believed. The Fed also looks at surveys of firms and households. Those indicated some rising concern on the part of households over the short-term, he said, but both firms and households were not showing increased concerns over a 5-10 year period.
Again this week, Fed Chairman Bernanke detailed the efforts that the Fed has made through its monetary policy, including the TAF (term auction facility) and other steps, to improve liquidity. He labeled such actions "proactive" and said some positive results had been achieved. Still, conditions can change quickly, he admitted, and the FOMC must be vigilant.
To verify the "some positive results" part of his talk, the Fed's separately released report on outstanding commercial paper today showed an increase of $33.5 billion in outstanding paper for the week through January 16 when seasonally adjusted. Whether seasonally adjusted or not, outstanding commercial paper rose, with asset-backed paper constituting a large part of the increase. These were the largest increases in the five weeks detailed on the weekly report.
His appearance before the committee gained importance because of recent economic developments as well as from the impression that he might be receptive to a White House and congressional stimulus bill for the economy. Fed Chairman Bernanke had already indicated his interest in a congressional and White House plan January 10.
A relief or stimulus plan was referenced in his prepared remarks, termed "fiscal policy actions." Such a stimulus package must be put into effect quickly enough that its impact is felt in the next 12 months. It should be temporary. It should get the maximum bang (stimulus) per buck ("increased federal expenditure or lost revenue"), he warned.
During the question-and-answer session, Chairman Bernanke resolutely refused to tell policy makers exactly how such a stimulus package should be structured. "The exact mix is up to you," he told one questioner. He did comment that tax rebates had helped moderate the 2001 recession, and that tax rebates received by low- and moderate-income people are more likely to be quickly spent and to stimulate the economy.
He also refused to term the current economic weakness a recession. He reiterated that the FOMC is not forecasting a recession but rather a slowdown. Our economy is resilient and diversified, and "has inherent strengths," he asserted.
Some might not have been sure whether the Fed's new willingness to be aggressive in cutting rates, if necessary, would result in the cuts that market watchers want. The Fed must also maintain credibility on inflation, Chairman Bernanke said, and a later Fed speaker was to harp on that point a bit more than was comfortable for those watching a weak market and hoping for that promised substantive cut.
For those who would like to read Chairman Bernanke's prepared statement, it can be found at this link.
While Chairman Bernanke was speaking, the Fed's Philadelphia district released the important Philly Fed Survey. Officially known as the Business Outlook Survey from the Federal Reserve Bank of Philadelphia, this is one of the district surveys that tend to predict the ISM's direction.
Economists had predicted a decline in this number, and a decline was seen. The diffusion index of current activity dropped "sharply," the Philly Fed said, to -20.9. That's deep into contraction territory. Many releases today were accompanied with a "the lowest since" label, and this one was, too. The Philly Fed said this was the lowest number since October 2001. This index dropped from a revised December reading of -1.6.
The Philly Fed noted that many component indicators also declined. These included the new orders index, current shipments index, unfilled orders index and delivery times index. Perhaps most importantly, employment and hours worked declined. The Philly Fed said that the current employment index fell to its first negative reading in more than four years.
Even worse, the Philly Fed reported that the prices paid index jumped from December's 36.5 to January's 49.8. The prices received index also climbed.
Both sets of figures--those relating to activity and to prices--went the wrong direction in this report. So did the six-month outlook. Those who want a more detailed look at the specifics of each component index can find the Philly Fed report at this link.
December's Risk of Recession also appeared at 10:00. This Moody's Economy.com probability-of-recession number increased to 56 percent. That's the highest number since the last time we were in a recession: 2001.
The Department of Energy released weekly natural gas inventory figures at 10:30. Those inventories dropped 59 billion cubic feet.
Fed Chairman Bernanke wasn't the only FOMC member to speak today. About the time the chairman's question-and-answer session ended, statements from the Fed's Richard Fisher, a voting member, began hitting the wires. Fisher may have knocked the legs out from under recent expectations that rate cuts would be coming at frequent intervals and in big amounts. He also emphasized the Fed's readiness to take "substantive" actions to keep the economy from slipping into recession, but this voting member's qualification that such action would be taken "as long as inflation expectations remain contained" probably wasn't what some market watchers wanted to hear. Fisher wants a tighter monetary policy than that seen in the 90s and says that globalization will complicate the Fed's efforts to control inflation. In fact, he asserted that the Fed would "have to err on the side of running tighter policy . . . to limit upward inflation pressures."
President Bush's administration was also in favor of a fiscal stimulus. Reuters today reported that the administration is close to proposing a package, and CNBC was reporting this afternoon that it would be revealed tomorrow.
As mentioned in the introduction, Merrill Lynch (MER) reported today. MER reported a record loss of $9.83 billion or $12.01 per share. This was a far deeper loss than the $4.93 a share loss on revenue of $399 million anticipated by analysts surveyed by Thomson Financial. A year ago, MER had reported a gain of $2.41 a share on revenue of $2.35 billion. Was this the kitchen-sink quarter for MER, the quarter in which it would throw in everything, including the kitchen sink, the quarter when investors and market participants might finally see how much damage the gutted building had sustained?
The company revealed that it wrote down $14.1 billion for the quarter. CDOs (collateralized debt obligations) and subprime mortgages amounted to $11.5 billion of those write downs, and credit valuation adjustments on hedges on CDOs amounted to another $2.6 billion. One source said that at the end of the fourth quarter, MER had $9.6 billion in exposure to foreign mortgages and $2.7 billion in exposure to subprime mortgages.
If MER might have helped us get a better look at how bad the write downs are going to be, another bank, Bank of New York Mellon, may have given us a glimpse of how long it will take our financial institutions to recover from the damage. The bank took a $118 million charge related to CDOs or collateralized debt obligations. The bank's earnings of $0.45 a share on net income of $520 million were compared to year-ago earnings of $2.27 a share on net income of $1.63 billion. The bank said that earning back its mark-to-market loss would tale four or five years.
Not all reporting companies reported bad news. PPG Industries (PPG) purportedly beat expectations. The company's stock moved higher before market weakness caught up with it and pushed it a few cents below yesterday's close.
Several companies reporting after hours saw late-day bounces. Those included Advanced Micro Devices (AMD), IBM (IBM) and Washington Mutual (WM). Reports were just trickling in as this report was prepared, not allowing time for a close examination of the reports. AMD's report also included a $1.675 billion charge and the company did not report the EPS without the charge, complicating comparisons to estimates from Thomson Financial. Some were characterizing the loss as narrower than expected once the charges were backed out. After hours, it was last trading at $6.56, up from its $6.34 close.
WM reportedly threw in the kitchen sink in its report, too. The company took a $1.6 billion charge that it will use to set aside more provisions for house-market-related losses and to write down the value of its home loan business. The company's net loss was $1.87 billion.
IBM reported earnings of $2.80 a share on revenue of $28.9 billion, matching the preliminary results that it reported Monday. It reportedly raised guidance for 2008. After hours, it was last trading at $106.25, up from its $101.10 close.
Tomorrow's Economic and Earnings Releases
Tomorrow's economic releases begin with January's Consumer Sentiment and the Conference Board December Leading Indicators, both released at 10:00. A big change in Consumer Sentiment away from the 74.7 expectation in either direction might impact trading. I've been saying for a while that consumer spending patterns might assume more importance again, and today's discussion of a stimulus package points out how important it will be for consumers to feel confident enough to spend money and stimulate the economy.
The leading indicators tend to be anything but leading. The numbers tend to be predictable. Expectations are for a 0.1 percent drop.
At 10:30, the ECRI Weekly Leading Index will be released.
Also important on Friday will be GE's earnings announcement. Other reporting companies include ACO, CBU, JCI, WIT and WL.
What about Tomorrow?
Many months ago, I revealed on the pages that I anticipated much more weakness in the stock markets, and I detailed the steps I'd taken on in our personal accounts. Through the intervening months, I've been pinpointing signs that I've been seeing, counseling subscribers not to be panicked but to use these offered opportunities to make some what-if plans of their own.
It now appears to me that the long-term tenor has changed, and I'll need to see some signs that bounces are anything but countertrend or relief bounces before I change that impression.
That doesn't mean that we won't see bounces and perhaps big ones. I don't know about you, but I'm about ready for one. As the day closed, no signs of a imminent bounce had appeared, so let's look at what we'll need to see before we believe one has arrived.
Annotated 30-Minute Chart of the SPX:
Unless the SPX gaps above that 30-minute 9-ema or is being driven higher on strong volume, expect potential resistance there, with stronger resistance at the 1354-1356 zone and then near the descending pink 45-ema. That 45-ema is likely to be closer to 1365-1370 when tested.
Annotated 30-Minute Chart of the Dow:
Annotated 30-Minute Chart of the Nasdaq:
Annotated 30-Minute Chart of the RUT:
I can't tell you what will happen by tomorrow morning. If the last weeks have shown us anything, they've shown us how completely the character of the market can change overnight. Our markets may be being impacted by a further unwinding of the yen carry trade, and that's impacted as much by what's going on in Japan as by what's happening here. Two important numbers will be released tonight in Japan, one at about 6:50 pm ET and one about midnight. If the Fed does lower rates tomorrow morning or GE surprises everyone, although it's not known for surprises, tonight's setup wouldn't mean anything.
What I can tell you is how it works if the tenor is to improve. The 30-minute 9-ema provided resistance today on 30-minute closes, so if you're hoping for a change in tenor, you first want that to change. You want 30-minute closes above that average. Then, you want to see those closes sustained. Those are the first tentative steps.
Then you want gains to be quick enough to roll the 9-ema higher again, dragging that whole blue channel with it. And, on any pullbacks, you then want to see the 9-ema's support sustained on 30-minute closes.
You don't want to see the SPX or other index crisscrossing back and forth across the average--that's choppy consolidation being made evident. If gains begin to be sustained above the 30-minute 9-ema and gains are swift, then you might roll down to a 15-minute chart and watch that same 9-ema. Be aware that during the lunchtime lull period, the 9-ema often flattens and the SPX trades across it at will to the opposite side of the smallest channel, but you don't want it to go further than that on 15-minute closes or something may be changing. Maybe not, but you can't afford to let things go too far the wrong way in this market climate.
If the markets are rallying and you're participating with a bullish play, you want to be aware that no matter now convincing the rally, how long it progresses, markets are susceptible to cratering again at any time, so you absolutely want to maintain good trade management skills. Do set stops and do honor them. Do not take on more risk than you can afford. When I was actively day and swing trading, I tended to avoid trying to catch market turns and particularly avoided countertrend trades, but that's just me.
If you're in a bearish trade and hoping for a continuing decline, then you want continued 30-minute closes beneath the 30-minute 9-ema. It's as simple as that.
So, what do I think is likely tomorrow? I honestly don't know. An experienced
trader and former OIN writer wrote me tonight to point out that the put/call
ratio ended the day today at 1.51, close to its 8/16 value at 1.53. Others have
proposed other reasons to expect a relief rally, something that I've been
watching for all week without it ever appearing. Just pick out a benchmark such
as that 9-ema and watch. It might be a great day for paper trading or
researching. If you jump into
a trade and are proven wrong, then jump right back
out. If you're already in a trade, your task is to protect profits first and
keep losses low second.