Table of Contents
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."
THE BOTTOM LINE:
It's been a peculiar bottom in some other technical respects, since the volatility and whippy nature of this recent period have led to 'oversold' measures like the Relative Strength Index (RSI) showing a less oversold condition then occurred at the July bottom. On a long-term weekly chart basis (not shown) Nasdaq was also less oversold than the July '06 and March '08 bottoms. Only on a daily chart basis did the Nasdaq RSI get equally oversold as occurred in March and July.
These two factors suggests a cautionary stance as to whether its off to the races or a further bottom building process. The question is how much further upside there is before the major indexes start backing and filling and drifting lower from Friday's close. The sharp pick up call volume on Friday suggests too optimistic of an outlook, like the economy is 'saved' all of a sudden. What I understand about this bailout plan is that it's going to be hugely complicated and may only slow the march to a deeper recession. In terms of my sentiment indicator, the shift suggested from an extreme bearish outlook to a highly bullish one doesn't appear realistic and the truth should lie somewhere in between.
There were upside price 'gaps' between the Thursday high and Friday low in both the S&P and Nasdaq charts. Pullbacks ahead that at least 'fill in' those gaps would not be surprising.
Buying index calls on Thursday morning was a good trade for those who took the shot. I didn't find it easy to find potential technical support but could point to potential for upside reversals at the low end of downtrend channels in the S&P 500 (SPX) weekly chart, the S&P 100 (OEX) and Nasdaq 100 (NDX) daily charts. I got some participation based on analysis of these charts but exited on the Friday close. I usually like to stay in an emerging trend or perhaps get out at a preset objective that's shy of major resistance.
However, when I looked at the intraday CBOE volume figures on Friday afternoon and saw that equities call volume was approaching double that of put volume, I felt that the sentiment shift was too quick and too extreme. I prefer being in index calls when there's still a fair amount of bearish sentiment and the reverse when I'm in index puts and there's still significant bullishness.
As to picking a potential bottom, I can't say that I saw such an extreme low coming but when the S&P 500 (SPX) broke down below 1200, a quick review of the longer-term weekly chart suggested a possible bottom at the low end of a broad weekly chart downtrend channel dating from tops seen in July and October last year. The NDX chart will be seen further on in my regular commentaries. Support implied by NDX's lower (daily chart) downtrend channel boundary was even better 'defined' than the SPX weekly lower channel trendline.
I've highlighted a weekly downtrend channel in SPX below. The conventional way of drawing any trendline would be to extend a line from the end point of at least 2 lows or highs. In such a conventional or 'external' trendline (dark magenta line), the lower support trendline of the channel would intersect around 1120. I also allowed for an 'internal' trendline that cuts slightly through a prior low; i.e., blue trend- line and estimated 1150 to 1120 as a zone of support and a corresponding area to buy October 1200 calls.
If I can project potential support at a trendline, I can set a risk point to just under it. If I can't project a relatively close by exit (risk) point that makes sense in terms of the charts, I won't go into a trade. Hey, I learned to be 'scared' from highly successful traders!
On balance, after this rapid first rebound and the 'relief' short-covering rally, I'm taking a wait and see attitude. Although the charts formed significant upside reversal patterns, especially in the Nasdaq Composite (COMP) and all have favorable bull 'flag' type hourly consolidation type patterns suggesting further upside potential in the near-term, although all major indexes are also at overbought short-term extremes. My current preference is to look at calls again after seeing where and how a first correction plays out and get positioned for a second up leg.
MARKET NEWS and INFLUENCES:
** MAJOR STOCK INDEX TECHNICAL COMMENTARIES **
S&P 500 (SPX); DAILY CHART:
Quite a ride to the downside! The S&P 500 (SPX) has seen a major rebound from the 1150 area and in two days rallied over 100 points and managed a strong close above its 21-day average currently at 1250. Further upside potential is to the 1300 area, perhaps to 1340. This may be the continued high end of a range however.
Downside support I've pegged first at 1250, then in the low-1200 area and next around 1180.
Based on a hunch, which is I believe is mostly past experience talking, I think that SPX will get to an oversold RSI extreme again. There may not be a lower low, but a sideways to lower drift once the current excitement quiets down could result in an oversold indicator extreme such as seen at the March and July bottoms. Stay tuned on that! Relief about avoidance of a financial meltdown can boost stocks in a big initial surge, but it won't keep bringing in continued buying necessarily, as investors and traders watch to see how these measures pan out.
S&P 100 (OEX) INDEX; DAILY CHART
The S&P 100 (OEX) chart is bearish in its predominate downtrend as seen in the downtrend channel highlighted on the chart. However, the OEX offered a solid trade in calls if you assumed that OEX could find solid technical support when it reached the low end of its downtrend channel. Who could envision such a major rebound, but even a more modest rally would have offered a good risk to reward, assuming risk was held to a point not far under lower channel line; e.g., an exiting stop at 520.
There's further upside potential to the 600 area, perhaps to 615. Near support is in the 555-550 zone, with major support around 530.
This extreme reversal or flip-flop in my "CPRATIO" suggests to me that this rally will cool down in the coming week. It's too hot not to cool down! Wasn't that a movie line? But also true of this current market craziness.
DOW 30 (INDU) AVERAGE; DAILY CHART
The Dow 30 Average (INDU) remains within an overall downtrend, but bottoming action is again evident, although this recent reversal came from a lower level than seen at the early-July low. It's been a long time since I've seen tops occurring at 3 percent above the centered 21-day moving average and bottoms forming at 6 percent under the average. It's characteristic for more volatility on the downside, but this recent action is unprecedented. Where do we go from here, after Thursday's upside reversal and the strong Friday follow through?
AIG doesn't look like it will help keep the INDU rally going, but as of Monday it gets the gets the hook. We'll see what replacement Kraft can do to help out. Oil stocks Chevron and ExxonMobil should be strong contributors to a further Dow rally as they are rebounding strongly from support. INDU ought to at least make it back to the top end of its recent price range and get back to the 11800 area. A close above 11782 for a couple of days running would be bullish and the first rebound in some months to exceed a prior rally closing high. Given how oversold so many of the 30 stocks are, there's also potential to 12000-12100.
Very near support at the 21-day average is at 11330, with pivotal support in the 11000 area.
NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:
The Nasdaq Composite Index (COMP) saw a bullish turnaround this past week in a convincing fashion technically. A key upside reversal pattern developed with the move to a new low below 2100, followed by a rebound so strong that the Close was above the prior day's HIGH. Friday's close back below its 21-day average wasn't a super strong close, but the big upside price gap of Friday was impressive and continues to show how buyers have come in after successful retests of major technical support in the 2200 to 2150 area or below, even though this recent panic sell off blew through 2150 briefly.
Upside potential is the key unknown as each rally to date after the mid-May/early-July double top has so far led to rally successively lower rally peaks, keeping the overall chart bearish in its pattern. If COMP falls back to the 2200 area and thereby 'fills in' the chart gap, another tradable rally may follow, such as back to the 2350 area.
Near resistance looks like 2290-2300, next at 2350, then at the prior line of resistance at 2410, which also would put COMP at my upper moving average envelope line. The upper moving average envelope line is not an area of resistance in the way that may come in at a prior high, but tends to be a good gauge of where a rally is getting 'extended' and vulnerable to either slowing of upside momentum or a reversal.
NASDAQ 100 (NDX) DAILY CHART:
The Nasdaq 100 chart pattern is that of a bullish rebound from a fully oversold condition (note the 13-day RSI) and support implied by the low end of its downtrend channel. Since NDX remains in a downtrend, the chart remains bearish on an intermediate-term basis. A move to above 1873, resistance implied by the upper channel line, is needed to suggest a bullish breakout. 2-3 or more points will establish a trendline and then a parallel touching just ONE extreme (high or low) will establish the other trend channel boundary.
The lower trendline of the downtrend channel did a superb job of pointing to where this last shot down to the low-1600 area, would find support and establish the potential for an upside reversal. The upside price gap established with the higher Friday opening, didn't see strong follow through as the close was around mid-point in Friday's range, suggesting that prices may drop back to 'fill in' that gap by a pullback to at least 1700 where I've noted support.
Key resistance is at 1800, at the 21-day average. I wouldn't get too bullish without the ability for the index to close above this key moving average and then go on to challenge the upper down trendline, currently intersecting around 1873 as I noted above.
NASDAQ 100 TRACKING STOCK (QQQQ); DAILY CHART:
I've highlighted near support at 42, then at 41. I anticipate that 42 will be tested as an area of support. If QQQQ does not pull back to the 42 area and Q's can climb above 44, this development would show continued upside momentum follow through. If 44 was then established as an area of support on subsequent pullbacks, a move up to next resistance in the 46 area could be next.
The spikes in daily trading volume in QQQQ have continued to come on the declines, suggesting continued liquidation and which keeps the volume pattern concurring with bearish price action. A sizable volume surge on a further big upside move would be encouraging for the bulls and suggest new buyers coming in, not just buying by those short the stock.
RUSSELL 2000 (RUT) DAILY CHART:
The Russell 2000 (RUT) had a key 2-day upside reversal as it made a new low for the move (not by much, but a new low all the same) followed by a close that was above the prior two days' highs. The next important bullish technical test will be on any decisive upside penetration of the prior line or resistance at 763. A close above this level, not reversed (back to the downside) in the following 1-2 days after such a move, would be bullish and set up a possible test of what should be tough resistance around 800.
I've noted near support at the low end of the upside price gap, just over 720. Next lower support is at 714, then back down in the 680 area.
GOOD TRADING SUCCESS!
NOTES ON MY TRADING GUIDELINES AND SUGGESTIONS
Trading suggestions are based on Index levels, not a specific option (month and strike price) and entry price for that option. My outlook often focuses on the intermediate-term trend (next few weeks) rather than the next several days of the short-term trend.
Having at least 3-4 weeks to expiration tends to be my guideline for trade entry choice. I attempt to pick only what I consider to be 'high-potential' trades; e.g., a defined risk point would equal in points only 1/3 or less of the index price target.
I most often favor At (ATM), In (ITM) or only slightly Out of the Money (OTM) strike prices in order not to 'overtrade' my account. Exit or 'stop' points, as well as projected profitable index price targets, are based on my technical analysis of the indexes.
Back in June, we first got acquainted with the TED spread on these pages. It's time to check Ted's pulse again. Unfortunately, it's been racing lately.
A review might be useful for those who either missed the original article or have forgotten its major tenets. To put it simply, the TED spread measures default risk. It is calculated by comparing the difference in interest rates for three-month treasury bills, long considered as close to risk-free as investors could get, and the three-month LIBOR. The difference is expressed in basis points. A 0.2 percent difference in the rates would result in a TED spread of 20 basis points or 20 bps.
The original computation was made comparing the yield on a three-month U.S. treasure bill contract and the yield on a three-month eurodollars contract offered by the London InterBank Offered Rate (LIBOR). The "T" in "TED" came from the word "treasuries" and the "ED," from eurodollars. That eurodollars contract was considered to be impacted by the perceived credit risk of lending to commercial banks, so it was and still is considered the riskier of the two.
As the original article noted, the original computation was changed when the Chicago Mercantile Exchanged stopped offering futures on the T-bills. For more information about the TED spread's background and a discussion of the pros and cons of using the TED spread to measure default risk, you might consult the original article.
Some points from that article must be reiterated, however, before this discussion continues. Because of the way it's calculated, a rising TED spread means that default risk is considered to be rising while a declining one generally means that the risk is perceived to be declining. Equity markets do not like rising default risks, of course.
As that June article noted, a typical historical range for the TED spread is 10-50 basis points, but in August, 2007, it exploded out of that range, eventually ballooning above 200 basis points. How serious was such a rise? In a December 3, 2007 article for Seeking Alpha, Michael Panzer included the following historical chart:
Historical Chart of the TED Spread:
We should have been forewarned of what was coming, and some of us were. Those of you reading these pages certainly were. I've maintained updates on the TED spread ever since that May article on the Market Monitor, the live portion of the Option Investor website.
Panzer's point was that those comparing the situation to that experienced after the failure of the hedge fund Long-Term Capital Management might be underestimating the potential for damage. The TED spread, at least, showed conditions he called "more akin to the chaos that developed around the time of the 1987 stock market crash." That's chaos that we were to see playing out this last week. I began roughing out this article more than a week ago, intending it as a renewed warning, but now it will encapsulate some of what we've seen occur.
It's not enough to know that equity markets are probably acting badly in concert with spiking TED spread values. How high is "high"? We might imagine that any spike out of that typical 0.10-0.50 or 10-50 basis points range is bad for equity markets, but that wouldn't help us out much now even if we verified that were true. Since August, 2007, the TED spread has not returned to that previous historical range.
At the time of that May article, I'd found one article that quantified "bad" or "high" in the new aberrant range for the TED spreads. That was found in an article August 29 article by Bespoke Investment Group, "Understanding the TED Spread," in which they had reported mixed SPX performance after TED Spread spikes above 1.50 or 150 basis points. They had chosen 1.50 or 150 basis points for their benchmark as a high TED spread value.
My June article questioned that thesis. Weren't markets likely to be reacting to bad news already by the time that the TED spread spiked over 1.50 or 150 basis points? Wasn't there a way to pinpoint times when the TED spread was likely to rise again or perhaps, likely to turn down again so that traders could make appropriate what-if profit-protecting plans?
What I found was that since that December, 2007 spike high, the TED spread had been moving inside a wide descending channel. Approaches to support tended to be dangerous for equity bulls, especially those times when the TED spread steadied at that support and then bounced up through 0.90-1.00 again. This was well before the benchmark level studied by Bespoke Investment Group. Like that group, however, I also found mixed performance near my own benchmark high--the resistance level at the top of the descending channel. At times, equity markets had already begun to steady and had even begun bouncing as the TED spread approached the top of that channel; at other times, the declines were far from finished. However, several questions remained. The period was so aberrant that the touches of either trendline were few and the information therefore rendered anecdotal. There just wasn't enough information for any kind of scientific conclusion.
Equity bulls were wise to be alert to the potential for the TED spread to bounce, taking steps to protect their profits, while they could not count on resistance tests as being the time to buy the dips in equities. The possibility of a break through resistance always had to be considered, too. Chaotic conditions in financial markets could eventually result in even more aberrant behavior, as it was to do this week. Like many other observations or measures delving into the underpinnings of the market, the TED spread wasn't always a good market-timing tool, but it certainly served and continues to serve as a good warning tool.
For example, the TED spread stayed stubbornly at higher support as the Fannie/Freddie deals were worked out, all the while that market pundits spoke of the many benefits of this solution and the likely rapid improvement in credit and equity markets. The week of September 8, the TED spread began rising rapidly toward next potential horizontal resistance at 1.50, that same benchmark that Bespoke used to study SPX performance in relationship to the times the TED spread was considered high. As I had already believed, however, the equity markets did not wait for a TED spread move above 1.50 but were already reacting to the TED spread's test of horizontal support and the bounce from that support. They were to react more strongly as the TED spread broke to highs above those seen in the 1987 debacle, showing just how chaotic the markets were.
I apologize in advance for the production quality of the charts I'm including below, but I can find quotes for the TED spread only on Bloomberg, which doesn't allow for annotations or trendlines, so it was necessary to hand-drawn the trendlines and then scan the document in order to provide it.
Annotated Chart of the TED Spread and SPX:
The TED spread's moves after the Fannie/Freddie supposed solution showed us that tremendous risk remained in the market. By early this week, the TED spread had broken through the resistance of its descending channel. It was on its way up to levels that exceeded those seen in the 1987 debacle, pointing to the freezing up of the credit markets as the spread widened on increasing default fears.
Clearly, something had to be done. Something was, in the form of the rescue package announced by Treasury Secretary Paulson Friday morning. The necessity for something to be done was clear but what were the longer-term implications? What would happen as a result?
As of midday on Friday, September 19, the TED spread had pulled back sharply and had dropped to 2.46 as these words were typed. It had however, bounced from a low of 2.20, which just happened to be the December, 2007 high of 2.20. Is it possible that either that December high or else the former resistance line, now at about 1.70, will serve as support?
What can the TED spread tell us going into the future? I would advise watching
it carefully. A failure to break through 2.20 again would suggest that risk
remains inordinately high and that equity bulls might spiff up their
profit-protecting plans. I would again spiff it up if the TED spread should drop
to test the top trendline of that former channel in which it moved. A failure to
break back inside that channel or--worse--a bounce from it could indicate more
problems out there than
we want to see.
Play Editor's Note: I want to remind readers that we remain in a bear market. We just experienced a bear-market rally, which is normally very sharp. Last week's rebound was extraordinarily fast and powerful due to government intervention and some government manipulation of the short-trading rules ahead of an options expiration weekend. It may have very well been a turning point for the market but we won't know that until it's a good distance back in our rear view mirror. I do expect the bounce to continue but after a 1,000 point rebound in the DJIA and a 9.8% bounce in the NASDAQ Composite it's time for a little profit taking. I'm adding some bullish candidates but we are looking for a dip first! FYI: Check out XL. It's on the list of financial stocks that can't be shorted. Shares look like they are bouncing from a bullish double-bottom. It might be a bullish candidate.
Allergan - AGN - close: 58.68 change: +1.67 stop: 54.95
Why We Like It:
BUY CALL OCT 60.00 AGN-JL open interest=8728 current ask $2.25
Picked on September 21 at $ 58.68
Tidewater Inc. - TDW - cls: 62.41 chg: +3.67 stop: 57.90
Why We Like It:
BUY CALL OCT 60.00 TDW-JL open interest=3744 current ask $4.70
Picked on September xx at $ xx.xx <-- see TRIGGER
Toll Brothers - TOL - close: 26.84 change: +1.89 stop: 23.95
Why We Like It:
BUY CALL OCT 25.00 TEP-JE open interest=3532 current ask $3.20
Picked on September xx at $ xx.xx <-- see TRIGGER
Washington Mutual - WM - close: 4.25 change: +1.26 stop: n/a
Why We Like It:
Note: We're not listing a stop loss. This is an aggressive, speculate bet that WM gets bought out at a premium to its current share price. This stock has been too volatile to try and play with a stop. Any stop we did use would be so wide the options would be crushed by the time it was hit.
BUY CALL OCT 6.00 WM-JE open interest=15555 current ask $0.37
BUY CALL JAN 7.50 WM-AQ open interest=113014 current ask $0.45
Picked on September 21 at $ 4.25
Amer. Intl.Group - AIG - cls: 3.85 chg: +1.16 stop: n/a
Friday proved to be another big day for financials stocks. Hope for Paulson's RTC-style of rescue plan for the markets and news that the SEC had temporarily banned short-selling for almost 800 financial stocks set fire to the sector. AIG is on the list of stocks that can't be shorted. I'm not 100% sure of the details but it sounds like if you're already short you don't have to cover but new short positions are not allowed at this time. Shares of AIG reacted with a 43% gain. The stock traded to an intraday high of $4.45. It looks like we could get called out of our play at $5.00 a lot sooner than expected. This is a covered call play and we do expect to be called out when AIG crosses the $5.00 mark at which point we'll close the play on the newsletter. If you're looking for new positions I would be tempted to consider another covered call on a dip (maybe $3.50-3.00 zone) in AIG and maybe this time sell the $7.50 January 2009 call.
FYI: There has been some talk that AIG is already trying to find a way to pay back the U.S. government's $85 billion loan before the government takes an 80% stake in the company.
Picked on September 17 at $ 2.29 *opened at $2.29 on 9/17
SPDR S&P Oil - XOP - cls: 52.02 chg: +4.13 stop: 46.75 *new*
Target achieved. Crude oil soared again posting its second $6.00 gain in the last three days. This time the energy stocks really took off. The XOP soared 8.6% and hit an intraday high near $53.00. The $53.22 high today appears to be a bad tick. Our first target was the $49.95 mark. Our second target is $53.50. We are raising our stop loss to $46.75 but more conservative traders will want to STRONGLY consider a complete exit right here! We are not suggesting new positions at this time but would keep an eye out for a dip back toward the $48.00 region.
Picked on September 16 at $ 46.70 /1st target hit 9/19/08
Volatility Index - VIX - cls: 32.07 chg: -1.03 stop: n/a
Friday marked the close on a historic week on Wall Street. It was a week that may have changed the rules for us on this VIX play. The SEC's new temporary ban on short selling eliminated the exception for market makers. If a market maker can't short stocks to hedge his risk then the spreads and premiums they charge to us on the options will go up. If the premiums on options are now artificially inflated for the next couple of weeks this is going to impact how the Volatility index moves. The ban is set to expire on October 2nd but the SEC could extend it. If you bought the November puts your probably fine. It's the October puts that we're concerned about. There was some talk on Friday about the SEC potentially reinstating the market makers ability to short stocks so they can adequately hedge themselves while creating a market for the rest of the world.
After 1000-point rebound in the DJIA there is a big potential for some "sell the news" type of move next week and if the selling is sharp it could push the VIX higher again. Readers could use another failed rally pattern as another entry point to buy puts on the VIX. We're setting our first target at 25.50. Our second target is 21.00.
Picked on September 16 at = 30.30
Today's Newsletter Notes: Market Wrap and Trader's Corner by Linda Piazza,
Index Trader by Leigh Stevens and all other plays and content by the Option Investor staff.
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