Important Juncture

The stock market has rallied nicely off last week’s lows and now it’s “crunch time”. Many events occurred last week to suggest a panic low was made: The Fed came to the market’s rescue and in a 5 day period cut interest rates, guided a bailout of Bear Stearns, bailed out Fannie Mae and Freddie Mac by relaxing capital requirements, allowed member brokerage firms to borrow from its discount window for the first time, set up a variety of other lending facilities for the same institutions, provided a minimum $260 Billion in liquidity (internationally in some cases) and, they cut rates once again. Clearly the US Government is stepping up as lender of last resort to protect our banking system and economy. They did not do this because things were status quo. The Fed did those things because we were on the edge of a market and system meltdown – a true crisis was at hand. They saved the day and since then the stock market has jumped 8%. Perhaps betting against Uncle Sam is a bad idea and the panic is over. And that enormous stimulus to the banking system should spur economic growth producing stock market gains.

At market lows, various indicators should reflect greater anxiety than normal. The anxiety levels in Aug ’07 and late Jan ’08 reached more significant levels than last week. Trading volume, which often surges during sharp sell-offs, was running just above average for most of this recent 3 week decline. The VIX, a fear ratio, got close to but well shy of those other panic levels. Other indicators like new lows, proximity to the 50 day moving average, & other short term ratios did not expand widely either. We sure got the newsworthy anxiety but in many ways the market’s reaction was ho-hum. One could say the government should get their due for that – their actions prevented the crash so the anxiety level was muted. Further, we could deduce that the muted response for whatever reason suggests that sellers were not motivated by the news any more than they had been and that their continued impact on prices would be much less than anticipated. For these and other reasons we could build a convincingly bullish case for that stock market.

One could also ask that if this low wasn’t the major washout then when will that other shoe drop? Shouldn’t a bear market end in a crescendo of technical indicators at extreme anxiety levels? There doesn’t have to be another shoe at this point – there is no rule that the market has to do that. And as it turns out, a quick study of various technical indicators going back to the early 1970’s don’t show consistency with regard to technical indicators and market declines. Sometimes they “do”, sometimes they “don’t”. (The tightest correlation seems to be the rate of inflation, recessions, and bear markets.)

Yet, despite all this evidence, there are concerns about the current environment that could delay all the gratification. The rally from S&P 1256 on Mar 17, 2008 has been impressive but volume has lessened the last two days suggesting demand for stocks at this level is softening. Often stocks will revert to their 50 day moving average. The decline we are in began October 2007 – at first it was simply a reversion to the 50 day line following a strong rally. Since then, every decline bounced back to the 50 day +/- a small % and faded as quickly. We are right at that point now but still in a confirmed downtrend and that pressure has to be respected. There is also the issue of overhead supply. This phenomenon occurs when holders of a security have paid prices higher than the current level. In this environment, most anyone who has bought the “market” in the last 15 months is losing money. The concept is that as prices eventually rise those unhappy holders will unload as they near a breakeven, having held on for so long and finally able to cash out without a loss. This headwind should continue for as long as the “top” took to form. In that regard, even if the low was set last week, the top was 13 months long in forming and we’re only 2 months into the overhead supply phenomenon. As prices rise they become vulnerable within this technical pattern so perhaps this is just a relief rally that’s going to fade and we’re still headed lower.

While the Fed changed some important rules for our financial system, there are other elements of the economy that appear to be suffering. For example, there are 10 major S&P sector indices. None of them show strength, 6 are outright bearish, 4 are questionable at best. This suggests that weakness persists now and will for the foresee­able future. One theory explains this overall malaise. Financial institutions have written off' nearly $200 Billion in assets. Those assets factored into the banks' capital ratios. Without them, the ratios suffer and capital must be increased or the loans written against them must be decreased. If de-leveraging is the answer then $1 – 2 trillion in loans must be eliminated. De-leveraging would affect nearly every sector of the economy. Given the U.S.’s $14 trillion GDP, de-leveraging of this magnitude would be significant, enough to pressure economic growth for some time. It’s no wonder the Fed came to the rescue as the de-leveraging effect became pronounced and dangerous. But much of the Fed’s response can also be viewed as inflationary which would introduce another set of problems, perhaps as bad or worse than our current set of problems.

Of course, the biggest question is how much of the future has been discounted by today’s price structure? The panic lows set last week can initiate a bull market and we have to respect that. But, the de-leveraging of the financial system may continue to put pressure on the economy and profits. And we have to respect that, too. Don’t fight the Fed and don’t fight the tape. Although I date myself that way (alas, there are no more ticker tapes) the best answer is to listen to the market. If it takes out previous highs and then corrects but holds above the recent lows then maybe the tide will have turned. Eventually that will happen and maybe it’s happening now. However, until certain market indicators begin to show strength (or stop showing such weakness) a cautious approach is warranted. Long positions will be built in stocks that have weathered the storm and appear poised for future growth – don’t fight the Fed. But positions in mining companies (gold) and short ETFs will be maintained to offset the risks that still persist – don’t fight the tape. We will hope for the best and prepare for the worst.

Bailout, Goodbye Bear, What's Next?

The Fed came to the rescue and the center held, so far anyway. Previously the S&P was locked into the 1270 - 1400 range that became 1275 - 1325 but has now been broken. After settling at about 1260 prices have rallies towards 1270. This is no surprise as support often becomes resistance and prices often tend to go back to "test" that level. So we can expect some efforts to "regain" 1270. I believe they will fail but we must remain open minded and listen to the market.

Part of me thinks the market should have crashed today to the tune of 10 - 25%. After all, what did the Fed do other than shift the risk to themselves from Wall Street? And, now they have painted an ENORMOUS target on their backs by saying they will treat brokerage firms like banks and backstop them, too. The benefits are obvious in that it buys time and soothes some exposed nerves and one day all this paper should be ok. But the risks are equally obvious, too. Net net, the market is lower but "controlled". Perhaps it shows some strength that we are not crashing but that isn't making me want to reduce shorts and/or add longs.

As long as the market stays below the 1270 - 1275 range we are still very vulnerable to lower prices. Should that change then we must adapt. Until then we move nervously ahead.

For many its been a bad time, fortunately Geller Capital's approach has prevented a disaster for our clients. In some cases we are even positive on the year. Stay tuned, it can and will be both interesting and challenging.

Volatility Anyone?

Since the last post the stock markets have been mostly lower, very volatile and recently strengthening. For all the excitement we are still locked in the S&P range of 1270-1400, oil and gold are setting new highs, and the $US is setting new lows, amongst other action.

The Fed is scrambling to stabilize our financial system through some clever, sophisiticated techniques beyond simple rate cuts and all of those acts will help to turn the tide eventually. However the current evidence says those acts are not yet causing a difference. Today's rally was spurred by the fine people at S&P who claim that subprime related write-offs are past the midway point. They completely missed this debacle - some 85% of all mortgage bonds issued in the last 3 years were rated S&P AAA. Many of them were clearly not up to that standard and at the same time a good number of such AAA bonds have become worthless. Yet investors respect their current analysis. Its clear they didn't understand this before so why should they be trusted to understand it today? One answer is that the market is "oversold" and normal daily buying is enough to push prices towards the top of the range. If such a bounce occurs I would expect it to peter out between here and the 50 day moving average or about 3% higher, give or take. It is noteworthy that the S&P has bounced off of 1270 5 times in the last 6 weeks and this zone was a congestion area from Q4 2005 - Q4 2006. So those points could indicate that the bulls will hold here, for now. If the rally exceeds 1400 then I would be inclined to back off on some of the downside exposure we have but more on that if and when we cross that bridge.

The central point to my thesis is that the confluence of the fallout from the housing bust, the weak consumer, the banking crisis, and the weak dollar (to name a few) will continue to act as a headwind/overhead supply to the economy and the market. Until that changes we will be very careful (perhaps "avoid" is better) in adding more than miminally to long positions. Simply watching the action of the key financial stocks will tell us most of what we need to know. And from that indicator I can say that its not time yet.

Stay tuned.

Checking In

Not much has changed since my post on Feb 19. We are in a bear market although the "experts" will debate that point. They'll also debate the recession point and I for one hope they are correct. However, it acts like a bear market and it acts like a recession so Geller Capital will play it much differently here than during normal periods.

Positions have been pared to only whats working for as long as they keep working. And most of the longs in position look ok. Gold positions have been added and act well. Ultra ETFs have been added to offset downside risk and they are helping. All in all, GCM is outperforming the down market however we know and expect it to be a difficult road. And a full list of attractivew stocks is in hand, ready for action. But not so fast.

The greatest risks today are large and include the unwinding of the credit bubble and that's potentially very bearish. But the risk that the Dollar is losing its pre-eminent status and that the Fed has only inflation to fight the debt burden is much more worrisome. And until that changes those Ultra shares may make all the difference.

Stay tuned...