Bear Mountain Bull

It’s time again for a little BMB R&R, especially with the market behaving as bizarrely as it’s been. Maybe if we stop watching it start to behave a little better…

Posting will be very light and variable over the course of this week, but we’ll put up an open thread each market day for our readers to comment on the day’s market activity or to post any interesting links they might run across.

Check the space below for whatever the latest might be during this ‘off’ time, and please visit the various sites in the ‘Links’ and ‘Regular Stops’ for up-to-date market news and analysis.

BMB will be back in full swing by next weekend.

Remember a while back when we talked about the possibility of Vallejo, California filing for bankruptcy?

There ya go.

You’ve heard what’s going on in Zimbabwe, right? Land of 160,000% inflation and the $50 million bill that will buy three loaves of bread?

I’m not sure it’s a good thing when their officials are praising our officials:

1.22 Here in Zimbabwe we had our near-bank failures a few years ago and we responded by providing the affected Banks with the Troubled Bank Fund (TBF) for which we were heavily criticized even by some multi-lateral institutions who today are silent when the Central Banks of UK and USA are going the same way and doing the same thing under very similar circumstances thereby continuing the unfortunate hypocrisy that what’s good for goose is not good for the gander.

1.26 As Monetary Authorities, we commend those of our peers, the world over, who have now seen the light on the need for the adoption of flexible and practical interventions and support to key sectors of the economy when faced with unusual circumstances.

From the always practical Mr. Practical:

“It took from 1914 until November 2007 for the Federal Reserve to accumulate $800 billion worth of Treasury debt. It has taken from December 17 to the end of April for the Fed to divest itself of $260 billion of this portfolio, a decrease of one-third. In its place, it has placed AAA-rated mortgages. At the current swap rate, the Federal Reserve System will be out of Treasury debt in December of 2008. But by adding car loans to the list of eligible paper, the Fed will most likely greatly accelerate this.”
- Economist Gary North

To the average person this is gibberish. Perhaps this is why the Fed is able to do what it’s doing: slowly nationalize the banking system. The stabilization that everyone is giddy about has its cost. The private market, with the encouragement of the Federal Reserve, has manufactured vast debt that cannot be repaid. Banks used up their capital long ago, so the Fed has to take those bad loans away from them and give them capital back.

Stabilization is not a working banking system. When you hear all the CEOs of Wall-Street say the crisis is nearing an end, it has no implication for a working banking system that will create more credit.

The Fed adds a new twist everyday. Now it’s going to pay interest on reserves banks must keep at the Fed. This will allow the Fed to expand its balance sheet even more and buy even more bad loans from banks. Again, this isn’t a positive: It illustrates just how bad things are.

By the way, it’s the U.S. taxpayer that will be picking up a good portion of this interest they will now pay to banks. 

Chairman Ben Bernanke has been given high marks for saving the system. But just what are we saving? The average person does not understand that what they are really saving is the bankers and Wall Street at the expense of the middle-class standard of living. A devalued dollar of 50% hurts the middle class much more than a 50% decline in the stock market. Why not let a failed system fail, thus re-distributing savings and income back to the middle class? Of course, everyone will suffer but in the long run that will happen anyway and saving the system will disproportionally hurt the middle class more.

The system is broken. Every action by the Fed says so. Those that anticipate a shallow recession still do not understand this. The credit crunch has barely begun affecting the real economy. We’re in the very early stages of this process and the government wants to boil the proverbial toad (the middle class) as slowly as possible.

Risk is very high.

BMB reader EDN mentioned MER and their “Level 3″ assets in the comments this morning. In this post today, Bennet Sedacca tells us who else has their ass-ets hanging in the wind:

Level Three assets are the least liquid of the firms’ trading assets and therefore are valued using what are called “unobservable inputs.”

Level Three assets include real estate, mortgage-backed securities, private equity investments and possibly even “undertakings of great advantage, but nobody to know what they are” (cf. South Sea Bubble).

The three magic words that make an asset a Level 3 asset are “no observable inputs.” What this means is that not only are they hard to price, but nearly impossible to sell.

Recently there’s been such deterioration in all types of mortgages that more and more assets are finding their way into this category. Also, this is the first time insurance companies have made the list. I think the list will continue to grow.

Ten companies now have more Level 3 assets than capital. In order they are (as a % of total shareholder equity):

1) Bear Stearns (BSC): 313.97%
2) Morgan Stanley (MS):  234.88%
3) Merrill Lynch (MER): 225.4%
4) Goldman Sachs (GS): 191.56%
5) Lehman (LEH): 171.18%
6) Fannie Mae (FNM): 161.48%
7) Northwest Air (NWA): 142.02%
8) Citigroup (C): 125.06%
9) Prudential (PRU): 119.36%
10) Hartford (HIG): 108.52%

So now we have insurance companies joining the party. Yes, the contagion is spreading and no, it’s not over. Not even close. C just had to pay 8.5% for $2 billion in preferreds. One of these days, there will be no takers.

It’s no wonder there are still an awful lot of “level 3″ assets hanging around. Have you seen the ABX indices lately? Most of the BBB and BBB- indices are now below 10. Yes, the values of those mortgage-backed securities started at 100…

While the banks are up off their lows, they’re not exactly making tons of progress, either:

Charts courtesy of StockCharts.com

Well, that was rather interesting. Pretty much a mirror image of yesterday’s action.

Stocks were a bit flat at the open, but sold off pretty steadily throughout the day, and took the indices out near their lows of the day. That gave back all of yesterday’s gains, and sent the indices back below the lows of yesterday morning in a break of very near-term support.

The losses were spread pretty evenly, with the Transports finally showing a little stress from sky-high oil and gas:

Treasuries were mostly higher. Yields moved up in the 3-month, but lower across the rest of the curve:
6-month: 1.74%    2-yr: 2.30%    5-yr: 3.08%    10-yr: 3.85%    30-yr: 4.60%.

Internals were pretty negative, and the highest volume in 3 or 4 days registered a ‘distribution’ day. Advances/declines were about 3 to 7 on both exchanges, with up/down volume about worse than 1 to 4 on each. o 1 on the Nasdaq. The divergence in new highs/lows continues, at 77/33 on the NYSE but 34/98 on the Nasdaq.

Only the HMOs (+1.0%) were able to hold in the green. Leading the decline were the homebuilders (-3.8%), airlines (-3.8%), brokers (-3.6%), banks (-3.5%), transportation (-3.2%), REITs (-2.9%), insurance (-2.4%), internets (-2.0%) and drug stocks (-1.8%).

Energy prices cruised higher again. Crude oil has risen more than 11 bucks in the past four days, hitting new record levels again today, closing the early session at $123.53/barrel. Gasoline rose another couple of cents to $3.12/gallon, and natural gas bounced back up to $11.32/mmBTU. The dollar index rose back up to 73.48, and the precious metals gave back yesterday’s gains, with spot gold slipping to $869/ounce and silver to $16.63/ounce.

BMB Note:   The pundits will be blaming high oil prices, but stock didn’t flinch yesterday when oil prices moved up, so why today?

Whether that’s the reason or not doesn’t really matter. We got another distribution day, but they’ve been somewhat few and far between up to this point. Just as it is on the upside, follow-through will be key on the downside as well. Today’s action certainly wasn’t good news for the bulls, but one day doesn’t a trend make. If we start to see more distribution, and the indices take out more near-term support at say, last week’s lows, then there will probably be cause for some concern.

For now, keep an eye on those financials. They seem to be a key area that has struggled to move higher. The brokers had been doing a bit better than the banks, but both groups took significant hits today. Another area that has stalled on the move up would be the REITs. We’ll have to see if selling in those areas continues.

We talked yesterday about the Transports continuing to move up despite higher energy prices. Well, today the Trannies gave back all of yesterday’s winnings - though the $TRAN is still far from breaking down.

Chinese stocks also took a tumble today, following dips in Shanghai and Hong Kong overnight.

Maybe today was the sound of some sort of warning bell, or maybe it means nothing. It is the week before expiration, and it isn’t unusual to see some gyrations during this time. We’ll see if it’s significant or not - but only time will tell.

I won’t be diving into too many short positions just yet.

From today’s Five Things:

1. Productivity Fine, It’s Just Your Pay That’s Gone Missing

Despite an increase in the supply of chain email letter supply, funny YouTube video links and web sites like this one with humorous cartoon video characters, productivity still managed to increase sharply in the first quarter. 

Productivity, the government’s formal measure of worker efficiency, rose at a 2.2% annual pace, the Labor Department said, more than most economists expected. This information was widely disseminated to the media. Then, hilarity ensued.

On the surface, and only on the surface, the report seemed good. After all, productivity is at a four-year high - a good thing, it means The Man is getting more bang for his buck - and labor costs hit a four-year low - also a good thing, it means The Man is getting more bang for your buck.

The positive spin on this is that the increased productivity and lower-than-expected labor costs suggest inflation remains muted. The reality is that there is little to no inflation in just about anything except food and energy. That doesn’t do you any good with the monthly check book, but know that inflation in a handful of necessary items does not create more inflation.

Meanwhile, the job cuts continue, which will create even more deflationary pressures in the economy in the second half of the year. Employers have cut 260,000 jobs so far this year. If you listen to earnings conference calls, more are on the way. And for those who have a job, real compensation adjusted for inflation decreased 0.7% year-over-year, the weakest performance in 13 years.

Yes, productivity is just fine. It’s just your job and pay that’s gone missing.

Crude oil above $123, gasoline above $3.12.

A mixed start to the day for stocks, as both the indices and A/D lines hover around the flat line. Leading the winners are the HMOs and metals, while banks, homebuilders and drug stocks lead the losers.

Treasuries are lower, yields up, and the 10-year yield is teasing new multi-month highs. Energy prices are fairly flat following the government’s weekly inventory report. The dollar index is higher, gold and silver are lower.

Deron Wagner discusses the 200-day moving average in today’s column:

When analyzing intraday, daily, and weekly charts, the moving averages we most commonly discuss are the 20-day and 50-day MAs. The 20-day MA shows the price trend in the short-term and the 50-day MA shows the overall bias in the intermediate-term. More important than both of these moving averages, but less frequently discussed, is the 200-day MA, which shows the long-term trend of the market.

In technical analysis, the longer the time interval of a chart, the more bearing and weight the pattern will have on the direction of the market than the shorter time frame. The same is true of moving averages. A 50-day MA is more difficult to break through than a 20-day MA, while a 200-day MA holds more weight than a 50-day MA. Many institutions utilize program trading to automatically begin buying when stocks or ETFs retrace to support of their 50-day MAs, or sell positions when they rally into resistance of their 50-day MAs. This is even more the case with the 200-day MA, as it is considered to be a gauge of the overall market’s “big picture” health.

It’s a rather amazing concept, but the 200-day MA simply acts like a brick wall whenever a stock, ETF, or index runs into it. It doesn’t matter whether it’s a test of support from above or rally into resistance from below. Either way, a position will rarely move through the 200-day MA on the initial test. Unless the dominant trend is really strong, it will generally require multiple tests of the 200-day MA before an equity or stock market index eventually busts through. This is not only with the 200-day moving averages on the daily charts, but on the intraday and long-term weekly charts as well.

He then shows an interesting example of an index’s behavior around the 200-day from the summer of last year in the Russell 2000.

The reason for this discussion on the 200-day MA is that both the S&P 500 and Nasdaq Composite will soon test resistance of their 200-day MAs for the first time this year. As history has proven, the 200-day MAs could be the turning point that causes the main stock market indexes to resume their primary downtrends that have been in place since last October. The S&P 500 closed just 1% below its 200-day yesterday, while the Nasdaq Composite is only 1.5% away from its 200-day MA…

Leading the “big three” stock market indexes, the Dow Jones Industrial Average has already run into resistance of its 200-day MA. In each of the past three sessions, the Dow tried and failed to move above its 200-day MA. If the Dow is unable to reclaim its 200-day MA in the near future, the bullish momentum we’ve been seeing could quickly turn into major selling pressure, at least in the short-term.

He also cautions, though, not to get overly anxious:

As for the short side, there’s no reason to consider any entries unless the main stock market indexes fall below yesterday’s intraday lows.

Deron always stresses: “Trade what you see, not what you think.”

I have a feeling this is the way the process works: