I'm substituting for Jim Brown this week. Jim is traveling and researching the crude markets to all our benefit. It's both a privilege and a scary responsibility to write again on this week of weeks.
Mid-week, Dennis Berman, Editor, Money & Investing, of the Wall Street Journal employed the title "The End of Modern Wall Street" for a video piece discussing some of the week's developments. By the week's close, that title was to gain even more relevance.
Some of the changes enacted this week by our government may change the workings of Wall Street as it's been familiar to us in modern times. William Poole, former head of the St. Louis Fed and now Senior Economic Advisor for Merk Investments, called the Paulson/Cox/Bernanke plan eventually concocted to end the credit crisis a "grand idea that perhaps can't be executed." That plan is variously being titled "Paulson's Rescue Plan" and the "Treasury Guaranty Plan." As of this writing, the details were not yet finalized although they may be by the time you read these pages.
That plan appeared when most needed, when markets had reeled from one development after another throughout the week. When markets were piercing long-term support levels Thursday, news of no-short changes made by the U.K.'s equivalent of our SEC and leaks about that Paulson rescue plan were the catalysts that sent indices bouncing from the monthly support levels they were then testing, to be shown in the charts section. No one knows yet how markets will react on the longer term. Democrat Majority Leader Steny Hoyer said today on CNBC that he didn't believe anyone knew the long-term consequences of the plan, but that the "consequences of not acting were too large" to be considered. It will be left to history to determine whether that grand idea played out as hoped by its originators or whether it resulted in unforeseen consequences.
If you've traded through this week, you can now legitimately say you traded through a history-making week. You can swap war stories with those who traded through other history-making periods in the markets. It will be a week that's studied in classrooms for decades if not for centuries. When I say it rates with the 1929 crash and the 1987 debacle, I'm not exaggerating.
What led to the mid-week rout and the resultant actions by central banks across the globe? So many market-landscape-changing events took place this week that this article can do little other than list them without becoming an unreadable tome. To begin, two more of the U.S.'s original five investment banks disappeared, leaving only two of the original five. Insurance giant AIG was rescued by an emergency $85 billion loan by the government. Market pundits questioned the government's involvement in that rescue scheme with others claiming that AIG had met the "too big to fail" criteria. Some applauded the action, with Pimco's Bill Gross noting Friday in an article by Reuters that the "government should get a positive return" on the bailout. Others questioned just exactly how our government ended up in the insurance business.
This week also saw the "breaking of the buck" by Primary Reserve Fund, an unusual occurrence when the NAV or net asset value of a share of a money fund account sank beneath $1.00. When appearing on Kudlow & Company on Wednesday, Andrew Busch argued that it was this event that proved the catalyst for the midweek rout, an opinion that Larry Kudlow also espoused. William Poole, the former St. Louis Fed head, disagreed when speaking on Bloomberg TV Friday morning, saying that only one money market fund had broken the buck and that that event hadn't resulted in market turmoil, although Thursday sure seemed like market turmoil to many. We don't want market turmoil if this week wasn't an example of it. Jeremy Siegel of Wharton Business School at the University of Pennsylvania immediately disagreed with Poole, pointing out several particulars of what he called a "spreading panic," including 90-day T-bills at four basis points. The Bank of New York, another money market fund, was reporting trouble, and Siegel's conclusion matched Kudlow and Busch's, that the panic could have spread "very, very fast."
Central banks around the globe had been infusing the financial system with cash all week. When that wasn't enough to stop the bleeding in equities and the threatened freezing of the credit markets and collapse of the financial system, those global banks coordinated a response to the financial crisis. That involved the U.S. putting up $180 billion in cash that it would supply to the globes' banks that might be short on dollars. Other central banks agreed to contribute, too, with their agreements including the following: $60 billion from the Bank of Japan, $40 billion from the Bank of England, $110 billion from the ECB, $50 billion from the Bank of Canada and $27 billion from the Swiss National Bank.
Amid these developments, our FOMC met and decided to keep rates steady on Tuesday. That development perplexed many, but it was soon far in the rearview mirror as far as traders' attention spans were concerned.
On Wednesday, the SEC announced rules banning naked short-selling. Those rules eliminated the exemption that options market makers had traditionally been accorded on modern Wall Street. In the words of the SEC in its press release, "As a result, options market makers will be treated in the same way as all other market participants." Some worried--and I was among them--about the impact to the options market when market makers, who traditionally short stock to offset the delta risk they take on, no longer can employ that hedge in the same way. Others worries centered more on the fact that such rules will hamper the ability to find true value in stock prices.
Former FOMC Chairman Alan Greenspan ranks among the group that believes that it will be difficult to find true value in stock prices. Speaking on "This Week with George Stephanopoulos" last weekend when such a ban was just an idea and not a reality, he said that it was "a very bad idea to rule out short selling," commenting that short selling "improves liquidity" and provides "price clarity." The U.S. government was not alone in this action, however, and even our government was to take a stronger stance by Friday. On Thursday, the U.K.'s Financial Services Association (FSA), the equivalent of our SEC, revealed new provisions "to prohibit the active creation or increase of net short positions in publicly quoted financial companies." That provision went into effect midnight that night, and was to be in effect until January 16, 2009, although it would be subject to review after 30 days. The FSA made it clear that it stood ready to expand the number of stocks covered if needed. By that evening, some were saying, "this is not a free market but a socialist one," but the reaction on Wall Street had been instantaneous. Stock prices shot up as soon as the news surfaced and then were catapulted higher by rumors of the Paulson plan.
By Friday morning, our SEC had announced that it, too, was banning shorting--not just naked shorting--in a list of 699 financials. By the end of the day, GE had been added to that list.
A Dow Jones report surfaced Friday afternoon, heightening the concerns of some who worried about the impacts to the options markets. The report claimed that "several market makers, and at least one prominent firm in that business" have asserted that they will stop trading options in the 700 or so financials included under the no-short-at-all rule the SEC enacted Friday. These market makers say they will stop trading them Monday.
Some market participants also asked what would happen to the ultra-short ETF's. CNBC's Bob Pisani noted that these funds don't typically short the stock. Instead, they have a swap agreement with a counterparty, with the counterparty assuming the risk. It's the counterparties that are the ones who are shorting, and it may be that fewer counterparties are available.
By late Friday evening, the U.S. Commodity Futures Trading Commission had announced temporary relief to those taking on swap positions, at least those taking on swaps from companies it called "distressed." The CFTC said that, for existing positions only, it would provide temporary hedge exemption relief for 90 days, but it would require weekly reporting by firms that chose that exemption. Other impacts and needed relief on the "commodity futures and options markets" were being studied. While that assuaged some worries, what about the need for hedge relief going into the future?
Others worried, too, about other unforeseen consequences of these actions. Siegel and Poole were among those who questioned the efficacy and wisdom of changing the way the marketplace works. "Why not just reinstitute the up-tick rule?" was a question heard repeated over and over in print and on television. The up-tick rule might not have been perfect, but it had proven workable. Those who claimed in 2007 when the up-tick rule was eliminated that markets would prove more vulnerable to steep declines now looked prescient. Our Keene Little was one.
These and other developments reiterated the concerns about the demise of the Wall Street we have known, but the Fed plan announced Friday morning by Treasury Secretary Henry Paulson built a new landscape for Wall Street and financial centers across the globe. The plan addressed the "breaking of the buck" dangers in mutual funds, the bad debt swamping financials and other companies and other concerns.
Because you'll hear the details of this plan endlessly hashed and rehashed and because some details might change, I'll borrow from CNBC's Steve Liesman's bullet points to describe the plan as it was put forth Friday morning:
The government will insure $2 trillion of money markets. This will include any publicly offered and regulated money fund. The government will charge a fee. The Treasury will set aside up to $50 billion an Exchange Stabilization Fund, a previously established fund formed under the Gold Reserve Act of 1934. The government believes it is paramount that a $1 NAV (net asset value) be maintained in money market funds to keep investors from pulling out their money. Not all money market funds will be covered, so it's important to verify that yours will be.
In addition, the FED will assume a half-trillion dollars of bad debt. The central bank will buy short-term debt obligations that Federal Home Loan Banks, Fannie Mae and Freddie Mac have issued.
In Liesman's words, also announced was the following effective statement: "Government to Shorts, Drop Dead."
Liesman's conclusion echoed that of many, including Paulson, that the cost of a financial bailout was less than that of a financial collapse. Those in the bipartisan group taking part in the overnight talks and decisions agreed. They said Treasury Secretary Henry Paulson and FOMC Chairman Ben Bernanke painted grim pictures of what could occur in such a collapse. Chairman Bernanke is acknowledged as an expert on the 1929 stock market collapse and the subsequent global fallout, and he apparently was painting a picture of something similar occurring if decisive steps weren't taken immediately.
By late Friday, reports surfaced that Pimco's Bill Gross was interested in managing the assets the government acquired in its rescue plans. He thought the government could probably buy mortgage-backed assets for about $0.65 on the dollar.
The week was notable for the quotes already listed and many others pointing to the demise of various companies or of Wall Street itself. Other notable quotes included Andrew Busch's assertion, "It's return OF capital [that drives investors now], not return ON capital." In other words, mom and pop and even big money is not as concerned about how much money they make, but how much of their own money they're able to keep. A commentator on CNBC called this week "a week of atrocities," clearly not agreeing with the government actions. Mid week, Michelle Girard, Senior Market Economist with RBS Greenwich Capital asserted, "I think the financial system will survive," speaking in a confident manner. Still, it was chilling to have her need to respond to such a question.
This summary doesn't even begin to cover all the developments for the week or even for Friday. It doesn't mention the upside surprise in the Philly Fed Index or even the many reasons behind the FOMC's decision to leave rates steady on Tuesday, a topic that Jim Brown discussed in some depth in his Tuesday Wrap. Tuesday's developments seem as far behind us now as if they had happened eons ago.
This Wrap doesn't attempt to discuss the reasons that Russia was forced to shut down its markets for a couple of days, for example, or deeply examine the reason that safe-haven gold fell so steeply while crude rose. It doesnt cover Goldman Sach's (GS) earnings announcement or all the various discussions about what will happen to GS, or Michelle Girard's take on that situation: "I do not expect that there will be stand-alone investment banks once we get through this period of consolidation." Before the rescue packages were announced, she said, "The future . . . is uncertain, not whether or not Goldman will survive but ultimately who they will partner up with."
If I tried to cover any of these developments in depth, you would not have time to read them, and you can find in-depth discussions by experts in each field through other sources, both print and video. What I wanted to give you was some sense of the flow of events, what was at stake and the concerns that some have about the decisions made.
I also wanted to reserve special room for a discussion of what this could mean to options traders. While some think that the government will of course make sure that options and futures markets are not undermined, others look to the government's willingness to throw short sellers under the bus and wonder. Since we don't know the ultimate outcome, the uncertainty requires that we be careful about positions until all the implications are worked through. MM's refusing to make a market in options means fewer buyers and sellers and a less orderly options market. Consider that if the MM's follow through on threats not to make a market in options on those 700 financials, you might not be able to easily sell the options you bought or buy the options you want for those financials and perhaps on indices that hold many financials among their components. Perhaps by the time you read this, changes will be effected or explanations made that make these worries seem outlandish in retrospect, but when you're navigating a new landscape, it pays to trod carefully.
As for the rest of the market, when I want a seasoned opinion, I always listen to Art Cashin, director of floor operations at UBS. What was his opinion? This morning, he said, he could say he "felt a little better." He thought Thursday was "the most credible rally" he had seen. He noted, however, that Friday morning's action was probably exaggerated by 30-50 percent by the inability to sell short. He said this wasn't the vicious kind of short selling he was referencing, but the more regular kind that has also been banned in some cases. Traders should keep in mind when examining charts and thinking about the gains at the end of the week that short-covering accounted for at least a portion of Friday's gains. Perhaps also after reading all the dire news that it was necessary to report, the cautious hope this seasoned man expressed.
We avoided a big catastrophe this week. Did we just postpone it? I don't know yet, but I urge you to page down a bit after you've finished the Wrap and looked at the play list, and read my Trader's Corner article about the TED spread, a measure of default risk. While the TED spread is not something I would use for exact market-timing, it's certainly a tool that helps us gauge when some of this panic and risk are being calmed and when they're still remaining high.
As one article's writer stated, it's going to be left to the history books to sort out whether the measures taken this week were on balance helpful or not. Sorting it out is made even more impossible due to the fact that we don't yet know all the particulars of the Paulson plan, with those still to be sorted out this weekend. Perhaps by the time you read this article, some of those particulars will have changed radically. Whatever else happens, you can congratulate yourself for living through a part of history, and can congratulate yourself that you live in a society in which quick and decisive nonpartisan action can be taken, even in an election year.
Let's look at charts. We'll be looking at monthly charts to get a long-term perspective.
Annotated Monthly Chart of the SPX:
I started this article with more optimism than I felt after looking at this chart. Here are the truths about this chart: the SPX remains in a pronounced descending channel. It's getting the to-be-expected stalling, at least in terms of the candle bodies, at the 38.2 percent retracement of the long rally, but those candle bodies are just moving sideways into resistance instead of rising steeply from that Fib level. There's danger that they can continue to move sideways, maybe rising at the last moment to a dropping lower monthly 10-sma now at 1337.15. It would not be a sign of strength to trade sideways into descending resistance. For now, unless the SPX can maintain upside breakouts--not sideways ones--out of this channel and confirm it by a move above the (black) monthly 30-sma, this chart says it's vulnerable to another downturn through the channel, back toward the 50 percent retracement.
A daily Keltner chart sets up the following parameters for a shorter-term look: until and unless the SPX can maintain daily closes above about 1260.90, it remains vulnerable to a pullback to about 1224, where light support on daily closes might exist. If that support doesn't hold on daily closes, a tst of 1186 is possible. If the SPX does bounce and maintain daily closes above 1260.90, then a test of 1284.60 or maybe even 1304 might be next, but the SPX is likely to encounter potentially strong resistance on daily closes at one of those levels.
Remember that Keltner charts are dynamic and that these levels will change with market movements. If the SPX zooms for three days, the highest level of potential resistance on daily closes that I listed above might have moved upward, too.
We'll look at intraday charts, too, in the last section of this article.
Until we know the exact parameters of the Paulson plan being finalized this weekend and hear some of what Chairman Bernanke has to say in his testimony next week, it's going to be impossible to predict how markets might react. The monthly chart shows us that markets don't know how to react, either.
Annotated Monthly Chart of the Dow:
This chart says that until and unless the Dow can maintain monthly closes above the red channel, confirmed by monthly closes above the black 30-sma, it remains in a downtrend, and we should consider the top of that channel likely strong resistance if tested.
A daily Keltner chart provides benchmarks to watch. It suggests that until and unless the Dow can maintain daily closes above about 11,412, it remains vulnerable to a pullback to about 11,150, where it might find support on daily closes. If that support doesn't hold, next support on daily closes might be found from about 10,500-10,680. If the Dow does break through that resistance and maintain it on daily closes, watch for potentially strong resistance on daily closes at about 11,700 and then just above 11,800.
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We'll look at intraday charts in the last section of the Wrap.
I've focused on the Dow and SPX charts, but if I were to include the OEX's and NYSE's, one narrower than the SPX and one broader, those monthly charts would show many of the same characteristics: prices that remain within sharply descending price channels and, in the OEX's case, at least, prices that ended this week very near June's close, without much to gain from all this thrashing back and forth. The NYSE's candle bodies drift lower, however.
What about the Nasdaq's monthly chart? It turns out that the Nasdaq's closing value of 2273.90 isn't far off the June closing value of 2292.98, either.
Annotated Monthly Chart of the Nasdaq:
The Nasdaq looks better on this chart than do the SPX, OEX and Dow on their charts, but it, too, remains in a descending channel, even if it's been more persistent about challenging that channel's resistance as well as that of the 30-sma. It will retain its bearish tenor until and unless it can maintain monthly closes above that descending channel and confirm by monthly closes above the 30-sma.
Candle bodies form well above the 38.2 percent retracement level, outperforming those other indices on this measure. Some of the same benchmarks can be applied, however. The candles essentially trade sideways. The Nasdaq currently is very near where it ended June, so there hasn't been much movement despite all the thrashing around.
While the Nasdaq's monthly chart looks stronger than the others posted, its daily chart shows relative weakness when compared to behavior near Keltner levels. The Nasdaq popped up Friday morning to potential resistance on daily closes at about 2307, but instead of ending the day rather near that resistance, it fell back away from it, closing well beneath that resistance. This suggests vulnerability to 2225, where the Nasdaq might find support on daily closes. If not, next support appears to be near 2180-2190.
If the Nasdaq does bounce and clear that resistance on daily closes, it bumps up against next potential resistance on daily closes fairly soon, at about 2356.
Annotated Monthly Chart of the SOX:
Despite the different setup on the monthly chart, the X's daily Keltner chart shows many similarities to the others. Until and unless the SOX can maintain daily closes above potential resistance now at 345.30, it remains vulnerable to a pullback to about 325, where it might find support on daily closes. If that support doesn't hold, next potential support on daily closes appears near 315-316 or perhaps 303.
AnAnnotated Monthly Chart of the RUT:
Clearly, those who want markets to recover would like to see the RUT and the Nasdaq lead other indices out of their descending price channels. On a daily Keltner basis, the Nasdaq's ability to do so looks less than convincing, but what about the RUT's?
The RUT gapped up Friday and closed just a little above potential resistance on daily closes at about 750.40. With the upper shadow and the small distance above that potential resistance, the breaking of the resistance wasn't particularly convincing. We must consider the possibility that the RUT could pull back into that gap, perhaps to 744, 733 or perhaps as low as the daily 9-ema, now near 720. If the RUT can, however, maintain daily closes near or above 750, then the charts suggest potential to rise toward 775. For now, be careful of bullish assumptions with resistance being tested, making sure that you examine where you want your stops to be on any open bullish positions, to protect profits.
We'll look at intraday charts to think about nearer benchmarks in the last section of the Wrap.
Annotated Monthly Chart of the TRAN:
What is the TRAN telling us here, clearly outperforming many other indices? Certainly the sharp decline in crude prices has helped this index, both crude- and economy-sensitive as it is. An economy that has seemed to outperform other troubling times has, too. Some market pundits believe, however, that prices have not fully built in the amount of weakness they think will eventually show up the economy, and perhaps the TRAN should be watched for its canary-in-the-mine properties. That goes for bears and as well as bulls because the TRAN could as easily break higher out of this formation as it could drop again to 4130-4150. While it's consolidating in a band like this, try to suspend judgment.
Are there any other clues? If RSI were included on this chart, it would tell a troubling story of descending RSI highs while the TRAN first made a higher high and then an equal one. The MACD histogram is negative and is flattening again after trying to move up through the zero level. These indicators are not sure-fire predictions that the TRAN is ripe for a fall, but they are invitations to prepare what-if plans.
Unfortunately, the daily Keltner chart provides little clarity. The TRAN's daily candle for Friday was a small-bodied one with a long upper shadow. On the TRAN, that's usually indicative of a decline, and usually, lately, one that takes the TRAN down at least a couple of hundred points. That possibility must be considered then without traders counting on anything in this market environment. Unfortunately, a drop of a couple hundred points and a bounce from there would not provide any clarity, either.
Next Week's Developments
Next week's releases and events include the following:
While he's speaking, the OFHEO releases the House Price Index at 10:00 am ET, with that number important but likely to be overshadowed by the chairman's testimony. The Richmond Manufacturing Index will be released at the same time. While this last number doesn't usually prove as important as the Philly Fed, it might be closely watched because of the upside surprise seen in this week's Philly Fed.
At 10:00, the important New Homes Sales will be released, with those expected to total 510,000, down from the prior 515,000. Natural gas inventories follows at 10:35.
Beginning at noon and continuing through 7:45 pm ET, a succession of FOMC members will testify or speak. First up is Fed Chairman Ben Bernanke, scheduled to appear together with Treasury Secretary Henry Paulson before the U.S. House of Representatives Committee on Financial Services, with the top the recent developments.
At 1:00 pm ET, Federal Reserve Governor Kevin Warsh speaks in Chicago, with his address titled "Credit Market Turmoil of 2007-08: Implications for Public Policy." I wish he'd delivered that address before this report was prepared. The conference is co-sponsored by the ECB and the Federal Reserve board of Chicago.
Dallas Fed President Richard Fisher speaks at 6:15 pm in New York, addressing the Money Marketeers of New York University Dinner. At 7:45 pm ET, Federal Reserve of Philadelphia's President Charles Plossner will also be speaking in Chicago, as will Warsh, with the same topic.
What about Next Week?
Obviously with the parameters of the government's plan still being developed, anything shown on short-term charts could prove unreliable. Let's just look at a few, however.
Annotated 15-Minute Chart of the SPX:
Also equally obvious is the potential head-and-shoulder formation at the top of this climb. As the head was produced, price/RSI bearish divergence was, too. Anyone who takes a look at this chart and automatically assumes a confirmation of that formation, however, hasn't been paying attention in recent years. These formations are good ways to watch the underlying psychology but not so reliable as predictors these days. Right now, this formation shows that bears were winning the day as of Friday's close, but all it takes is either a prolonged sideways move or else a breakout that produces sustained 15-minute closes above about 1264.40 to invalidate this formation.
Bulls should exercise caution, however, if the SPX begins producing 15-minute closes beneath the black channel line, spiffing up their profit-protecting plans. Such action would suggest a decline toward 1229-1233.60 and maybe even 1212-1214.
Annotated 15-Minute Chart of the Dow:
Annotated 15-Minute Chart of the Nasdaq:
The Russell 2000 was in complete breakout mode on the 15-minute chart, so the 30-minute was necessary to set some parameters.
Annotated 30-Minute Chart of the Russell 2000:
So, what's the conclusion? Monthly charts show us indices that have not yet verified any change in tenor. Daily charts show us indices that tested potential resistance on daily closes and either ended the week jammed up against that potential resistance or else dropped back to lesser or greater degrees from that resistance. The TRAN's chart suggested the possibility of a several-day pullback through a congestion zone.
While new breakouts are always possible, intraday charts show us the potential for pullbacks from resistance that was being tested near the close or, in some cases, through potentially bearish formations that set up the possibility of to-be-expected pullbacks after a strong bounce. This fits with the often-needed consolidation day produced after a day of either strong gains or strong drops.
What will be important is that any pullbacks, if they occur, remain within normally expected parameters: for example, pullbacks to daily 9-ema's. This would at least help steady markets and convince participants that the government's measures are taking hold and allowing for an orderly market environment. What would not be welcome would be deeper or sharper pullback.
Whether markets will even be allowed to pull back remains questionable. Perhaps by Monday, the government will have announced plans to stop shorting in more stocks, sending more indices higher. Hint to government: how about the TRAN stocks, to break the TRAN up out of its congestion zone instead of down below it? Or how about the SOX stocks because that monthly chart just doesn't look healthy.
All kidding aside, I want to urge subscribers to do what I've been urging them to do for a year. Don't worry all weekend. Spend some time with people and activities that renew you. Schedule some worry time if you must. Definitely spend some time planning how you'll react to certain market actions, how you'll manage your risks, and where you want both stop losses and profit limits. Don't fight the tape if the markets want to rally up to those resistance levels on the monthly charts, but do remain aware that the indices could turn down from that resistance, and that the RUT, at least, is already testing it.
Spend some time gazing at those monthly charts. While I'm encouraged that the world's central governments are acting in concert, I think it's still possible that what they're averting is a chaotic collapse of the financial system, but not necessarily an orderly and continued downturn through those descending price channels. Nothing seen on those monthly charts can yet prove to us that the next time their resistance lines are tested, they'll be convincingly broken. Until that happens, we must be aware of where our risks are and manage them. Hope, but dont hope so much that you forget to manage your risks.
I also wanted to speak to those of you who might have suffered big losses. Shame is almost always attendant on such occasions. It can be a useful emotion when it prompts us to re-examine our actions and change our behaviors, but it's not so helpful if we wallow in it. I urge you, if you suffered losses, to not wallow in shame but to reexamine what happened and what you would do differently. One of my biggest losses led me to a way of managing risk that has served me well, and so I don't regret that loss or feel shamed by it. If I hadn't suffered that loss and spent some time researching ways to manage risk, I might not have the confidence I do to keep trading in this environment, and I most assuredly would not be earning a living by the trading income. The secret is that we're never in control of what happens with the markets, especially in the kind of "once in a century" conditions that we have now, but most times we are in control of how we react and how much risk we accept.
Be in control. Never, ever end the markets with risk that you can't afford to
lose. Unfortunately, the government doesn't have a bailout plan for individual
traders with positions "too big to fail."