The stock markets are finally operating in a more logical manner

Finally, the stock markets are operating in a more logical manner. However, volatility levels remain tremendously high and are still a very dangerous element.

It could be difficult to defend the idea that markets are operating in a logical manner with volatility levels at record highs. However, my basis for this statement is that the markets are finally reacting to fundamental economic and policy news. Central banks and governments appear to have finally gotten ahead of the curve. The markets are no longer discounting possible measures for the financial crisis before they happen, they are reacting on analysis of their effectiveness. The governments have finally stopped going after damaged entities in a singular fashion but have started implementing systematic solutions. An additional coordinated rate cut right now could have that “surprise” element that tends to help the markets in the short-term. As I suspected would happen after eight straight losing sessions and a sharp decline to the bottom of 7,800 on the Dow Jones, Monday, Oct. 13 was the first gain in October. It is likely that the bottom has been reached on Friday, Oct. 10, at least for the short-term. The bearish trend could easily resume to form new bottoms but it would be in a more orderly fashion and it would depend on the size of this recession and subsequent corporate earnings. This would be a much healthier way than the 10% daily declines that can cause panic and crashes. To be sure that we do not go back to those days, we first need to see volatility ease down.

Update: Make that 8 straight losses for -23% in October 2008

The DJ and the S&P500 lost more than 1% for an eighth consecutive losing session in October.  So far this month, we have seen a -23% loss for the NY stock markets.  However, this eighth session was tremendously volatile.  The good news is that there were some tremendous rallies before closing very far above the intraday low.  <u>Therefore, I dare say that we could have found the bottom.</u>  Let’s keep our fingers crossed.  If we consider the intraday low, then the Dow Jones has seen a 29% loss so far this month.  That is almost one third loss of value!

Furthermore, that intraday low at the 7,800-8,000 level for the DJ coincides with a long-term bullish trendline.  It appears to have performed as a solid support level on Friday.  We could very possibly see a rebound here and the first winning session of the month on Monday.

Do the guys at the SEC know what they’re doing?

Yesterday, the ban on short-selling was lifted.  Stocks fell another 7%.  Did the ban on short-selling do any good?  It doesn’t look like it, as stocks kept falling anyway. 

Once in place, the SEC should have extended the ban.  The problem was not short-selling but by constantly changing the rules they are making things worse.  This did nothing but add volatility to the stock markets. This action does not cease to amaze me; the market regulator is doing the opposite of what it’s supposed to be doing, which is to provide confidence to the markets.  Changing the rules on traders does not give them confidence.  It makes them constantly reverse long positions and reverse short positions.

Another thing that does not make sense to me is, why did they eliminate the up-tick rule last year? Bring it back!  The up-tick rule makes logical sense to me.  The up-tick rule means that if you want to short a stock you must first wait for an up-tick.  This makes sense and helps to prevent the manipulation that the SEC was so worried about.  With this rule, it means that you could only short if there is still buying pressure left, even if it is small.   In other words, Someone drove the price up before you shorted the stock. (otherwise, shorting has a domino-effect)

The biggest manipulator in the market right now is the SEC!

Read more about the uptick rule on Wikipedia, uptick rule

Update: Make that 7 straight losses for -22% in October 2008

We are 7 for 7, Could we call this a crash yet…  We are most likely avoiding a crash by the skin of our teeth

We are most likely avoiding a crash by the skin of our teeth

We are most likely avoiding a stock market crash by the skin of our teeth.  Instead of what could have been an instant drop in the stock markets, we are seeing a moderately steep decline over several sessions.  Although we are seeing losses of historic dimensions, we must keep in mind that Black Monday of the 1987 stock market crash saw a 22% loss for the Dow Jones in one day and similar losses to other indices worldwide.

The Dow Jones has fallen for six consecutive sessions despite all the announced measures, rescue plans, coordinated rate cuts, liquidity injections, increased deposit insurance, and bank nationalizations.  The market has become more and more demanding as it discounts everything that the monetary authorities could possibly pull out of its sleeve.  Any practical measure that it could be taken quickly becomes expected.  For this reason, when one of these measures is passed the joy in the market is very short-lived because it has already been discounted.  The question that begs to be asked is: If the market had not been given what it wanted, how bad would this be?

As you may know by now, October has been a historically bad month for stocks.  Well, this year stocks have fallen on every single day of the month from a high of 11,022.06 on October 1st to a low of 9,042.97 on October 8th.  That’s an 18% drop over six trading sessions.  The S&P 500 shows a similar story, from a high of 1,167 to a low of 970 over the same period, a -17% decline.  Basically, in my opinion, a crash of 1987’s caliber was extended over a six session period.

An orderly decline is  healthier than a one day crash.  A big one day drop would have a domino-effect as it would be much more difficult to find a buy order that offsets a sell order.  It also leads to volatility.  This year has had its fair share of volatility as well but so far it has been contained, meaning that it has not led to a crash (at least so far).  Although there could continue to be a prolonged decline, this is more due to a lack of investor confidence.  Once confidence returns to the market, this will be over and it will lead to a period of consolidation.  It is likely that the market will continue to search for a bottom this month and the recovery will depend on the ultimate impact this has on the underlying economy.  This quarter and next quarter earnings season will be important.

As I have predicted on earlier posts, and contrary to several analyst predictions, July 15 was not going to be the bottom, there would be a new bottom.  We have pulverized the July 15th low of 1,200 points.

When did the Federal Reserve fail to stay ahead of the curve with its decisions?

The Federal Reserve has failed to stay ahead of the curve with the market now being the one dictating more action.  This turning point most likely occurred on September 16th when the Fed decided to hold the interest rate at 2%, thinking that the credit crisis was contained.  The target rate had been at 2% since the Fed’s latest cut in April.  At the time you couldn’t really be surprised at their reasoning.  The Fed had already made huge and rapid rate cuts with a 50bp cut in January, 75 bp cut in March, and another 25 bp cut in April.  However, the September 16 decision to keep it unchanged with the fallout evolving greatly disappointed the markets.  Lehman had entered into bankruptcy the day before and the focus was solely on rescue plans (works quicker than rate cuts).  Inflation was and continues to be an issue, but the conclusion now becomes that the credit crisis is more imminent and the unavoidable recession will contribute to controlling prices.  (The timing of the ECB was not that great either as the rate was hiked to 4.25% as recently as July)

All the measures that are now being taken are likely preventing a crash but their effectiveness still has not occurred and the impact on the fundamental economy still remains to be seen.

Technorati Tags: crash, rescue, interest rates, Fed, October 1987, stocks

Are we crashing? Dow Jones is below 10,000!

Although it could feel like we are crashing, stocks are likely readjusting to an overwhelming amount of negative data covering the credit market, the financial sector, and the underlying economy. The fact is that we are seeing stock market moves of historic proportions.

Justifiably, we are living in historic times. Some analysts say that this market move is a result of the “buy the rumor, sell the news” phenomenon following the approval of the rescue plan. It is likely that the news of a rescue plan was relatively holding up stocks over the short-term (even with the impressive declines). The market was clearly aware that there was no such thing as a one time miraculous rescue plan. (This just makes me wonder how immediate the stock market decline would have been without the plan and what the consequences would have been.) Now the markets are going back to evaluating the true damage in the credit system and the economic slowdown.

The good thing about these generalized declines is that it is generating some cheap stocks, or buying opportunities. Share prices are falling so much that price to earnings ratios as well as dividend yields are becoming very attractive. During regular market times, these “special offers” would be gobbled up immediately by investors. However, now there is lots of uncertainty. There seems to be many bargains out there, however, the ratios are based on past earnings estimates and we could not be too sure of how accurately these reflect company performances. All this market turmoil will undoubtedly affect the underlying economy, we just need to know how much it will affect the demand for company products and services. If companies do not perform much worse than estimates and if we believe that the economy will start its recovery sooner rather than later, then there could be some really big buy opportunities.

The other threat to the buy opportunities presented by high dividend yielding stocks are that the economic troubles could cause these companies to lower their dividend payments, another uncertainty. In that case, it would be important to limit our focus to companies with large amount of cash. To summarize, the currently attractive p/e ratios and dividend yields could be short-lived because they are lagging indicators since estimates will be based on how the underlying economy holds up (which is very uncertain).

We must keep in mind that there is another reason why this could be a good time to buy “cheap” stocks. The reason for such large drops to the stock market is the major outflux of capital to alternative and safer investments. Big institutions will be unable to incur the same risk levels as before, so capital will flee to low risk assets. This means that there are less funds competing for company stocks and, as individual investors, we could grab some good deals. Those funds will eventually return when the outperforming stocks become more apparent.

Short Eur/Usd at 1.3833

Another opportunity presents itself on the 30min chart. Here we observe a perfect bearish price channel. We could expect this trend to continue with resistance at the upper trendline. The downtrend should continue withoutly completely canceling out the big candle at 2:30pm EST. We will place the stop order at the previous support of 1.3885, which is now resistance. Remember, this breakout took place as soon as the Trichet speech indicated a possible rate cut. This was a significant event and unless there are no surprises we do not expect the move to be given back.

There were some negative U.S. economic indicators but they did not generate much of an immediate impact. So we have two resistance levels, at the upper trendline and at 1.3885.

30min chart

We place the limit order at 1.3770 and if this short-term trend continues we could remain alert to lower both the stop and limit orders.

UPDATE: closed at 1.3885 for a 52 pip loss at 1:27AM EST. Our limit order was barely avoided (1.3772 vs. 1.3770). The bearish price channel remained intact throughout the night as it flirted with the upper limit before breaking out. If our stop order was a tad more conservative we would have closed out at 60 pip gain.

Update: Wow, what a breakout!

As soon as Trichet started speaking, following the ECB decision to keep its rate at 4.25%, the euro/usd immediately broke below 1.3875 and dipped below 1.3800!  He is still speaking and indications of a future rate cut will drive this lower.  It would be a significant change to his policy and he has been very hawkish on inflation.  He also foresees economic recovery next year and this will boost European stocks.

Some significant statements from Trichet: inflation is elevated and a result of energy prices, inflation risks diminish but there are still threats, inflation will moderate in 2009. This is much better news regarding inflation and definitely helps the chance of a rate cut for the euro!

This is the position we discussed earlier:Break out of 1.3875 coming up?

Break out of 1.3875 coming up?

Right now the Euro/Usd is strongly testing the support of 1.3875.  This is the September 11 low and it appears that a breakout could be under way.  This could be an opportunity to short the currency pair in the short-term.  There is a strong short-term bearish price channel on the four-hour chart.  I would short and close the position before the U.S. open.

Remember that the ECB interest rate decision is coming up and although it is expected to be maintained at 4.25%, we could be seeing some traders discount a possible rate cut.  Even without the rate cut, there is a high chance of Trichet softening his stance on inflation.  That would add greater downward pressure.

Update: Position was opened at 1.3858 and closed at 1.3758 for exactly a 100-pip gain. Was pretty lucky in almost catching the very bottom.

Wall Street vs. Main Street

It continues to be all about the rescue plan, U.S. senate votes today

The U.S. stock markets followed the tremendous losses on Monday with big gains on Tuesday.  Volatility continues to dominate with the central focus still being the rescue plan.  The Senate will vote today and if approved it will give the markets a short breather.  The House of Representatives would then follow up with another vote.

Debate: Rescue or bailout?  Wall Street vs. Main Street.

There is a debate going on over whether there should be a rescue plan or not.  Those who are against it argue that taxpayers should not have to pay the bill.  They believe that those who got us into this mess should not be bailed out from their risk mismanagement and that they should learn from their mistakes.  This side of the coin looks down on Wall Street for its evil ways and therefore believes that Main Street should not have to pay for it.

Unfortunately, I must reiterate something that Paulson repeated in his meeting with Congress: “the taxpayer is already on the hook“.  We could not isolate Wall Street from Main Street; sometimes Main Street does not understand its connections with Wall Street (wait until they see their pension plans and 401ks).  Letting financial entities fail would affect taxpayers more than the rescue plan would.  Main Street says, “Sure, let them fail!  They need to punished for their mistakes!”  The bottom line is that a little bit of punishment is ok, but it must be controlled.  (Fallout of Bear Stearns and Lehman not enough for you?).  The consequence of letting more entities fall would be painful for everyone, a hard hit to the economy, a lack of confidence and more unemployment.  The credit markets are suffering, the financial system is in danger.  Corporate investments would dry up; good luck getting a car loan, a mortgage, or even using your credit cards!

So I say to you: Allowing more punishment to Wall Street means more punishment to Main Street.  But I beg your pardon:

Aren’t we all to blame?  Shouldn’t we all bear some responsibility?

Now it’s your turn to answer: “me? what did I do?”

For a long time, average citizens have forgotten what it feels like to have cash in their pockets.  Instead they filled up their wallets with credit cards.  It was a danger to many as swiping their cards was much easier; we became consumer addicts.  We were credit junkies, credit was so easy to come by, rates were low, “bills would be paid off eventually,” we said to ourselves.  I’ll make the minimum payment at the end of the month, easy enough.  Our savings were down, credit was up.. So, where was our risk management?

Let’s speak about mortgages.  Here, there’s plenty of blame to go around.  Speculation was booming all over the housing market.  Many people were buying second homes, but guess what?  We could only live in one place at a time.  That second home is purely an investment.  Banks were handing out mortgages to everyone, even people with poor credit ratings.  Home prices were rising and everyone wanted a piece of the action.  If I were to buy a house I would make sure I could meet those monthly payments.  Some people were honest, hard-working people looking to buy a decent house to live in, and for those who had to go into foreclosure my heart goes out to them.

Now with falling home prices, banks and investment firms are stuck with mortgage-backed assets that continue to lose value.  Cash flooded the housing market from everywhere to rake in some nice returns but that is now gone.  All those loans, bonds, and other assets that were created to fund these investments could not be repaid and risk going into default.  It spiralled out of control.  Result: writedowns, provisions, losses, and more losses.  The credit market is damaged, the financial system could be in danger, and this eventually trickles down into the economy.  Even if you’re a farmer that thinks he has nothing to do with the financial markets.

We’re heading into a recession, but that does not necessarily have to be a bad thing

A recession does not have to be very painful.  The goal here is to avoid panic or a market crash.  We do not want people running to their banks to take their deposits out.  Sometimes recessions are necessary; the key issue is to smooth out the cycle so that the recession is short-lived and does not hit us hard.

Recession could be positive because markets tend to correct themselves during these times.  Prices adjust to reasonable levels.  Prices that were previously driven higher or lower because of excess speculation start reflecting more accurate valuations.  People are driven by emotions and by what other people do; as house prices moved higher and profits were high, everyone jumped in to the point where it stopped being reasonably affordable.  Maybe that house you always wanted will reach a price you could afford but by then everyone will have rushed all their money into something else that generates the best returns.

Recession is ok but let’s limit the damage to the economy and let’s not lose too many jobs.

Then we could all concentrate on what will be the next bubble.