Bear Mountain Bull

Hotel BMB is back in business, this time with the BM In-Laws gracing the halls, so BMB will be offline for the rest of this week and part of next week.

The market feels like it might be getting a little wobbly here, so keep your eyes and ears open. Important levels to watch on the major indices: Dow 12500, S&P 1430, Nasdaq 2450. If those levels are breeched, it will be time to think about getting those shields up.

If you want to keep close tabs on what’s happening in the markets, I have a few recommendations:

1. After the market close each day, listen to Investor’s Edge, Gary Kaltbaum’s radio show. Unfortunately, Business Talk Radio moved their headquarters a few days ago, and they’ve been a little slow at getting their streams/archives back online. If you can’t listen live at BTR, try the live streams at the various radio stations that carry the show, like kbnp.com and whnz.com.
2. Every morning, give a listen to Dave Landry’s Market in a Minute. Ok, so it might take a couple of minutes, but it doesn’t take very long!
3. Enjoy Barry’s market and economic perspectives at The Big Picture.
4. Keep up with the latest ‘dirt’ in the housing and mortgage lending biz at Calculated Risk.

As always, we thank you for your readership, and hope to see you back here when BMB resumes a normal posting schedule, probably around March 7th.

BMB is off to run some errands. I’ll see if I can get a market wrap up later, but I can’t make any promises at this point.

Slight early gains have been wiped out, and that brings the market back to the flat region, with the Transports getting hit and the Nasdaq lagging the big-cap indices. A/D lines are split, as is the action in the groups. The winners are led by the utilities (on the back of the TXU buyout news), oil services, paper stocks and chemicals, while transporation and airlines lead the losers.

Bonds are slightly higher, yields lower. Energy prices are mixed but near flat. The dollar is flat to slightly lower, and gold and silver are slightly higher.

BMB has said before that he doesn’t buy into the idea that the market is an efficient discounting mechanism all of the time, citing the example of the spring of 2000 - there was nothing reasonable in the market’s ‘forecast’ for the Nasdaq at that point in time.

Bill Fleckenstein agrees:

Why does the stock market at large seem not to care about the many problems that exist? My best explanation is this: The stock market, which is normally thought of as a discounting mechanism, doesn’t work that way at the moment.

For the better part of at least six months, and perhaps nine, it has traded more like a price-discovery market (think voting machine). That’s how commodities such as wheat and corn trade — they just get pushed from one price to another. Daily reactions are almost totally to price, although fundamentals are loosely correlated.

Everyone has grown up thinking that the stock market discounts, meaning it anticipates a company’s operational performance and prices a stock accordingly. The market has done so in the past, and it will again.

But for now, it discounts next to nothing. Witness the huge gaps seen recently in the subprime sector, where problems seem to have arisen out of the blue — although they have been easily foreseeable, as I have been chronicling in this column. When the market reverts to discounting and ceases to be the price-discovery animal it is today, there will be a tremendous amount of violence on the downside.

And of course, Fleck gives us the ‘I told you so’ on the subprime lending business:

That game is obviously over. Let me repeat that — over. The real-estate market of the past few years will not be seen again in our lifetimes. The only thing we don’t know is at what rate this unwinding will play out across the economy and, more importantly (to me), in the minds of the Goldilocks-enthralled community on Wall Street…

Meantime, the big question remains: When will folks be forced to connect the dots? Unknowable though the answer may be, my friend in London provided a clue, via a recent e-mail:

“You and I and a select group of others have been all over subprime for months now. But today (last Wednesday) is the first day where equity managers have been in to us, asking questions about subprime. Until today, most of the equity managers knew something bad was happening in subprime, but were prepared to assume it was not going to be a problem for the wider credit market, the economy, and so on. . . .

“Slowly but surely, people are starting to get it, and slowly but surely, I am starting to think that the tipping point in credit — via a subprime-generated shambles in CDO (collateralized debt obligation) land — is closer than anybody imagines.”

Jim Jubak does a lot of good explainin’ about what’s currently going on in the credit markets:

File this under strange but true: Insurance encourages risk-taking behavior, and ultimately, it increases the size of a disaster when it finally strikes.

That is bad news, really bad news, for the debt markets. So bad, in fact, that if you’re worried about a financial-market meltdown, you should be watching the debt markets and not the stock market.

The problem is what I call the insurance effect. Make it possible for homeowners to get flood insurance, and more people will build in flood-prone areas. Sell hurricane insurance, and more people build in areas at risk of getting hit by a hurricane.

The result is logical, if perverse. The insurance policies haven’t reduced the risk of floods or hurricanes, but they have shifted part of the risk from the homeowner to the insurance company. The homeowner with insurance, as a result, has less financial motivation to avoid the risk of floods or hurricanes.

Investors aren’t any different. For example, look at the buyers of mortgages, securities based on pools of mortgages, corporate loans, and corporate and government bonds. If you offer them insurance against the risk that a borrower will default on paying what’s owed, those investors will be more comfortable buying riskier debt from borrowers more likely to default. Why not? Part of the risk has been passed along to those who sell the insurance. In the debt market that insurance goes by names such as “credit default swaps” and “collateralized debt obligation.”

When the inevitable flood or storm or debt-market meltdown does finally take place, of course, since there are more homes in the flood plain, more buildings in the hurricane zone, more shaky credits in portfolios, the size and cost of the disaster is much larger. In fact, if the flood, hurricane or market meltdown is big enough, the costs of the disaster can overwhelm the ability of insurance providers to pay. The availability of insurance has created a feeling of safety that has encouraged so much risk-taking behavior that the insurance safety net itself can fail, leaving homeowners or investors fully exposed to the risks of their behavior.

Read the whole thing if you want a better understanding of how the credit markets have gotten to what could be a breaking point. Then think about what got a lot of the blame for the 1987 stock market crash. You remember. It was called “portfolio insurance”. Once again, everyone felt protected, because they had “insurance”. And we all know how that worked out.

From Jim Wyckoff, via The Big Picture, the Traders’ Top 10 Mistakes:

1. Failure to have a trading plan in place before a trade is executed.
2. Inadequate trading assets or improper money management.
3. Expectations that are too high, too soon.
4. Failure to use protective stops.
5. Lack of “patience” and “discipline.”
6. Trading against the trend — or trying to pick tops and bottoms in markets.
7. Letting losing positions ride too long.
8. “Overtrading.”
9. Failure to accept complete responsibility for your actions.
10. Not getting a bigger-picture perspective on a market.

Wyckoff elaborates a bit on each point - go check out the column for the full scoop.

The latest edition of the ChartWatchers newsletter from StockCharts.com is available. This issue covers commodity prices, semiconductors, the Russell 2000 and a new view of the Rydex funds flow.

Notes on the latest moves in the industry groups:

• The strongest groups: Group 1 - Banks, commodities, defense, REITs, chemicals, paper, steel, HMOs, internets. Group 2: Retail, hospitals, transportation, utilities, gold and silver, metals and mining, telecom.
• The semiconductors came to life this week. It remains to be seen whether they can follow through after some very choppy months.
• While some areas of health care are holding up, like the the HMOs and the hospitals, other areas are starting to look a little shaky, for example, biotech, drugs and health care products.
• Energy stocks have built some nice little bases here, and look like they could be poised for a move.
• For a more detailed breakdown of group movement over various time periods, try Prophet.net’s Industry Rankings page.

Credit default swaps have become very popular investment vehicles over the past few years, being sold as ‘insurance policies’ against bond/debt default. From Bloomberg:

Credit-default swaps on mortgage bonds offer payments to protection buyers if the securities aren’t repaid as expected. Sellers of the contracts are provided monthly payments.

Well, as part of the subprime mortgage debacle, the price of some of that “insurance” has nearly tripled. From the same article at Bloomberg (highlight added):

An index of credit-default swaps linked to 20 securities rated BBB-, the lowest investment grade, and sold in the second half of 2006 today fell 5.6 percent to 74.2, according to Markit Group Ltd. It’s down 24 percent since being introduced Jan. 18, meaning an investor would pay more than $1.12 million a year to protect $10 million of bonds against default, up from $389,000.

Moody’s said late yesterday that it may cut the so-called servicer ratings for affiliates or units of lenders including Irvine, California-based New Century Financial Corp., the second- largest lender to subprime borrowers. Declines in the ABX-HE-BBB- 07-1 and similar indexes accelerated this month as New Century and HSBC Holdings PLC, the biggest lender, said more of their loans were going bad than they expected.

Take a look at the chart of the ABX-HE-BBB- 07-1 bond index:

Yikes. Now tell me there aren’t a few folks somewhere that are having a little trouble sleeping at night. Remember: there is always somebody on each side of every trade…

	The rise in stock prices has not been confined to the US. Markets the world over have been hitting new highs simultaneously, all basking in the glow of abundant liquidity. The BSE 30 in India has been no exception.
	But the Indian market has made several violent lurches downward in the past three months, two of them coming in the last couple of weeks. Could this index be putting in a nasty top here? If so, will we see other indices around the world start to follow suit?

Charts courtesy of StockCharts.com

The Materials and Utilities are easily the strongest sectors at the moment.

Industrials and Discretionaries are holding up, while the Financials and Staples faltered a little this week.

Techs made a bit of a move on the back of the semis, but the XLK is still pretty messy looking. Health care hasn’t gone anywhere in a month-and-a-half, but the Energies look like they’ve built a little base from which they could try to move higher.

The numbers after a rather mixed-up week in the markets:

Charts courtesy of StockCharts.com

More “ultra” ETFs from ProShares, these all tracking double - up and down - various Russell indexes.

Personally, I think some of these people overdo it when it comes to the indexes. I kind of time out on all of the indexes when we’ve got not only the Russell 2000 index, but the Russell 2000 “Value” index and the Russell 2000 “Growth” index. And the Russell 1000 index, along with its “Value” and “Growth” brothers, and on and on.

Gimme a break. Too much, too many.

Update: If you read a little further down on the page linked above, there is an interesting section pertaining to taxes on capital gains with these ultra funds:

The one thorn in the ProShares story is taxes. Last year, holders of the Ultra ETFs got walloped by short-term capital gains.

A five-dollar gain on an $80 fund is quite something, especially in a market like ETFs, where any capital gain raises eyebrows.

“It’s the nature of the beast,” explained Seale. “You get that tax-treatment when you go in to get the leverage.”

Of course, he’s right – to an extent. The ProShares funds achieve their leveraged exposure through a combination of futures and swaps. All futures positions are “marked-to-market” at year end, meaning you can’t defer capital gains, and any profits are taxed as 60 percent long-term gains and 40 percent short-term gains. Swaps, on the other hand, are taxed as 100 percent short-term gains.

Looking at the ratio of short- to long-term gains for 2006, however, it’s clear that ProShares is relying almost entirely on swaps to achieve its exposure.

“People are interested in our funds for the tactical uses and the gains they can receive,” said Seale. “I think they are not as interested in tax efficiency as holders of traditional ETFs like a SPDR.”

Still, the group said it is looking at the problem seriously.

“We are looking for ways to minimize the gains by spreading them out,” said Bob Holderith, vice president and national sales manager at ProShares. “I don’t know if there is a real or easy solution to the problem, but we are on the case, and are looking at alternatives vigorously.”

That could become a more pressing concern later this year if – as expected – Rydex launches a competing slate of leveraged ETFs. While first-mover advantage should lock in the bulk of product flows for ProShares, if Rydex finds a more tax-efficient mousetrap, that could turn the tides a bit.

I hadn’t really considered that the mechanism used to obtain the leverage might incur some cap gains come years-end, but that looks to be the case, at least until they can figure out some way to spread that distribution out.

From Marketwatch:

Private-equity firms Kohlberg Kravis Roberts & Co. and Texas Pacific Group are preparing a bid for TXU Corp. (TXU), the Wall Street Journal reported on its Web site late Friday. The firms are expected to offer around $70 a share for the Dallas-based utility, the Journal reported, citing one person familiar with the matter.

Well, the WSJ may have reported it late Friday, but somebody knew about it early Friday. That would explain the better than 4% jump in TXU stock today.

I wish the SEC did a better job of watching over the leaked rumors on these buyout deals. You just know that there are folks out there with advance information, and they just get to cash in when the news breaks. Sometimes I think the whole Wall Street investment game is run by a bunch of scumbags. And I’m probably right.

	The Dow had a bit of a rough week, and has given back yet another little ‘breakout’. But that hasn’t stopped it from grinding its way higher anyway - it always manages to put together another breakout.
	Reflecting the biggest of the big-caps, the S&P 100 is looking the weakest of the broader indices, as the moving averages have started to converge, and the index is where it was in mid-December, more than two months ago.

As I mentioned in today’s wrap, the action in some of the brokers is looking a bit ominous - take Merrill and Lehman, for instance:

And some of the exchanges aren’t looking real healthy either. A couple of the commodity exchanges - BOT and CME - look like they could be rolling over, and the Nasdaq and NYSE themselves aren’t exactly threatening to set new highs at this point:

Charts courtesy of StockCharts.com

This market just will not go down and stay down for much more than an hour or two. Another poor open, followed by an extremely slow and excruciatingly boring trudge back up as the day wore on, ending with a slight dip into the close. That left most of the major indices with slight losses on the day, with the exception of the strong utilities:

Bonds rallied back, and smacked yields back down:
6-month: 5.15%    2-yr: 4.80%    5-yr: 4.66%    10-yr: 4.67%   30-yr: 4.78%.

Market internals were negative, with volume coming in right around the same levels as the past few days. Advances/declines were just below flat on the NYSE and 4 to 5 on the Nasdaq, with up/down volume 4 to 5 on the NYSE and 3 to 5 on the Nasdaq. New highs/lows were 205/24 on the NYSE and 168/34 on the Nasdaq.

The groups were split, with a lean to the red side. The disk drives (+1.8%) and the utilities (+1.1%) led the winners while the brokers (-1.9%), REITs (-1.6%), airlines (-1.6%) and housing stocks (-1.3%) led the losers.

Energy prices continued to edge higher, with crude finishing the week at $61.14/barrel. Gasoline sits at about two-month highs, at $1.76/gallon, and natural gas also gained a few cents to $7.76/mmBTU. The dollar index slid back to 84.05. Gold gained 5 bucks to $683/ounce and silver had another strong day, rising to $14.49/ounce.

BMB Note: Well, the market hasn’t looked great the last few days, but it hasn’t looked horrible either, despite the 139 point drop in the Dow the past three days. Every time the market looked it had a chance to sell off, it didn’t, and the advance/declines haven’t really started to fall apart yet. That said, the market doesn’t exactly have a ton of upside momentum going for it either.

Strength remains in the metals and precious metals, and the utilities are looking very good as well - of course, we’ll take a closer look at the groups over the weekend. On the downside, the action in the financials could be getting little worrisome - nasty action in some of the brokerages today, the banks weren’t looking so good, and the exchanges themselves are also looking a little shaky. Definitely something to keep an eye on. The semiconductors followed through a bit on yesterday’s big move, and it remains to be seen whether or not they can make a strong bid to hold the Nasdaq together.

A little more economic news coming next week, like durable goods, home sales and GDP, so that might throw some gas on the fire and get something moving, but who knows in which direction, if at all.

Today’s Dilbert cartoon seems rather appropriate, considering the times we’re in.

Here we go again. The market makes its move in the first hour, and then it just gets stuck.

Just an awesome post on gold from Barry at The Big Picture today:

In this corner, weighing 195 pounds, standing 5 foot 10, hailing from Washington D.C. via Harvard, MIT and Princeton, New Jersey, wearing the M1 green trunks, the Charlemagne of Currency, the prince of paper, the bearded bard of the Fed, monarch of monetary policy, Benjamin GOLDILOCKS Bernanke!

And in the opposing corner, weighing 2046 metric tonnes — one ounce at a time — the shiny, precious, storehouse of value, the standard for monetary exchange, the most malleable and ductile of the known metals, that master of disaster, hailing from most of the world, that dense, soft, shiny, yellow metal, GOLD.

The battle between these two titans has become increasingly loud and volatile as of late. Bernanke, a former inflation Hawk, recently went all Lovey Dovey: He now believes there is “growth with ebbing inflationary pressures and a stabilizing housing market.”

When Gold heard this, it laughed out loud, calling the Fed Chair out for such nonsense. Gold dissed Bernanke: “I know what you fear” taunted the metal. “You’re afraid of the drag on growth while inflationary pressures are building and the subprime implosion is threatening the system.”

Gold knows…

***

Want to talk re-acceleration? Gold knows that if the Fed tries to throttle inflation back down, they will launch a cascade of subprime lending implosions far beyond what we have already seen. And, if that were to occur, we might see it metastasize, spreading across the entire lending sector like an invasive economic cancer. So far, the sub prime disasters have been contained, like a large malignant tumor, confined to one small but significant section of the mortgage market. A few hikes and the entire disease could spread much further up the food chain.

And the Fed? They are content to jawbone the markets.

All the while, Gold sits there, smiling.

You must go read the whole thing.

The opening dip hasn’t been bought up yet, and as a matter of fact, it’s gotten a little worse. That has the major indices in the red, and A/D lines solidly in negative territory - for now. Looking at the groups, we see quite a few early losers: airlines, brokers, homebuilders, banks, software, REITs and internets. The few winners are led by the gold stocks and oil stocks.

Bonds are higher, bringing yields back down. Energy prices are mixed, but crude oil has pushed back above 61.50. The dollar is taking a dive, and that has gold and silver moving even higher.

Larry McMillan, in the Option Strategist Weekly Updater this week:

An entire week has passed since $SPX last broke out strongly on the upside to new 6-year highs. Since then, very little movement has taken place. $SPX is up a measly 1.08 points since then, and its closing range has been a minuscule 4 points over the five-day period. Once again, traders are barraged with the “cup half full” (bullish) theories that the market is working off its overbought condition by going sideways, versus the “cup half empty” (bearish) scenario that the market is living on borrowed time because it hasn’t been able to follow through on the upside. We noted similar comments a few weeks ago, and that short- term situation was resolved with a sharp downward move (followed by new highs). We are looking for similar action again…

In summary, we expect the market to have a sharp, but short-lived, correction to actually alleviate the overbought conditions that continue to persist. After that, we expect higher prices. Hence, we are not currently calling for a major top in the market, but we do feel that it certainly needs a minor shakeout before significantly higher prices are possible.

I guess it isn’t bad enough that Vista hasn’t been exactly flying off the shelves. Now Microsoft gets slapped with a $1.5B judgement in an MP3 lawsuit, and Google takes dead aim at Outlook and Office.

It had been looking like some of the health care groups might get going. Right now, it doesn’t look like it’ll be the drugs or the health care products:

These three biggees in the drug business are dragging on the Dow:

And these two tech giants are no longer helping matters much either:

Charts courtesy of StockCharts.com

Another struggle of a day, as the market caught an early bid, but gave that up quickly. Even so, the bears were unable to gain any traction, and the bulls refused to give up hardly any ground at all. The result was an awkward slog to the finish line, leaving a dip in the Dow, the S&P near flat and the Nasdaq clawing its way back above the flat line by the end of the day:

Bonds dipped some more, and yields snuck higher for another day:
6-month: 5.16%    2-yr: 4.86%    5-yr: 4.72%    10-yr: 4.73%   30-yr: 4.83%.

Market internals were mixed - again much better on the Nasdaq than on the NYSE, and probably a little worse on the NYSE than the indices might indicate. Volume edged higher on both exchanges, in some pretty messy trading. Advances/declines were 2 to 3 on the NYSE and just above flat on the Nasdaq, with up/down volume 2 to 3 on the NYSE but 5 to 4 on the Nasdaq. New highs/lows were 286/13 on the NYSE and 198/24 on the Nasdaq.

The groups were pretty evenly split again, and the numbers weren’t real big on either side. For the winners, the semiconductors (+2.5%) awoke from their funk, and oil services (1.8%). On the losing side, homebuilders (-1.5%) and paper stocks (-1.1%) led the way.

Energy prices are starting to get a little concerning once again. Crude oil is still hanging around $60, up to $60.95/barrel today. But gasoline is the real issue, now back up to $1.75/gallon, its highest level in some time. Natural gas worked its way up to $7.73/mmBTU. The dollar index gave up early gains to finish slightly higher at 84.33. The precious metals took the day off, gold holding at $678/ounce and silver at $14.18/ounce.

BMB Note: Kind of an ugly day, not in the price action necessarily, but the trading felt pretty sloppy. Once the early gains were given back, not a lot happened, although the Nasdaq managed to right the ship a bit and work its way higher once again.

In the groups, today the semiconductors were the story, although that group has been such a mess that it’s hard to tell whether things are going well or poorly - the action in the group has been all over the map.

Which leads me to the point that I think is making this market so difficult to trade - there just doesn’t seem to be any underlying major strength, or theme. Sure some groups are outperforming others, but with only a few exceptions it isn’t by a lot, and it isn’t with a great deal of consistency. The news, the upgrades, earnings, etc., keeps jerking groups up and down, but not many of them are able to make a lot of headway for more than maybe a couple of weeks before it ends. Yet the indices continue to grind higher.

Maybe you guys are having an easier time of it than I am. But I generally like to find an area of the market that’s working well and ride it, and right now I’m having a difficult time picking a good seat.

At The Big Picture, Barry ‘celebrates’ the reaching of a new record — margin debt:

Here’s a data point to make you stop and think: As of today, more people have borrowed money from their their brokers to buy stocks than ever before.

That number was reached this past month, with Margin debt hitting an all-time high, passing even the days of the tech/telecom/internet boom.

According to the NYSE, margin totaled $285.61 billion in January, up from $275.38 billion in December and passing the previous peak of $278.53 billion.

Although the previous all time high was set in March 2000 — just as the Nasdaq Comp Index hit its apex — there were prior highs to the penultimate one. This doesn’t mean the top is in or even imminent, but it is a factor well worth watching over the coming weeks.

But as Barry - and the piece at Marketbeat - points out, there are a lot of other “worrying” signs that haven’t meant any trouble - yet:

• The VIX, commonly known as the “fear index,” is hovering around 10, a low point, suggesting a lot of carefree folks out there these days. This level is often a turning point, a calm before the storm, so to speak.
• The Treasury yield curve inverted months ago, suggesting a recession was on the way. It hasn’t happened.
• The Dow industrials, transports and utilities all closed at new highs on the same day last week — something that became a routine occurrence in just two years, 1929 and 1986, both preludes to big market falloffs.
• The current rally is now the third longest since 1900 without a 10% correction.

Fascinating stuff. None of this stuff matters, until it does. Than it matters a whole lot.

The weekly report on crude inventories showed a build in crude oil, but larger-than-expected drops in gasoline and distillates:

U.S. commercial crude oil inventories (excluding those in the Strategic Petroleum Reserve) increased by 3.7 million barrels compared to the previous week. At 327.6 million barrels, U.S. crude oil inventories are above the upper end of the average range for this time of year. Total motor gasoline inventories fell by 3.1 million barrels last week, but remain above the upper end of the average range. Distillate fuel inventories dropped by 5.0 million barrels, and are at the upper end of the average range for this time of year.

Refineries are operating at 85.2 percent of capacity - and demand doesn’t look like it’s backing off any:

Total products supplied over the last four-week period has averaged nearly 21.6 million barrels per day, or 6.8 percent above the same period last year. Over the last four weeks, motor gasoline demand has averaged over 9.1 million barrels per day, or 3.8 percent above the same period last year. Distillate fuel demand has averaged nearly 4.7 million barrels per day over the last four weeks, or 9.8 percent above the same period last year. Jet fuel demand is up 5.7 percent over the last four weeks compared to the same four-week period last year.