Looking back there has been a year's worth of news in 2008 and it is only the end of the first quarter. The volatility has been greater this year than last, to say the least. The chances of things calming down seem quit slim.
Below is a chart of the S&P 500 Index. This basic chart shows the extension levels based on the opening range. The market rallied into the 1350 area and has since failed to hold those gains and is closer now to the 1290 area.
S&P 500 Index(click to enlarge) One method to measure the strength of any move is to compare the daily pivot,(H+L+C)/3, to the three day rolling pivot, (3day Highest High + 3day Lowest Low + Close)/3. The daily pivot from Friday is 1321.01 and the 3day Pivot is 1326.87. As the daily pivot is below the 3day pivot, the path of least resistance is down. For any rally to change this momentum, prices must cross the 1321.01 and 1326.87. Most years this could take a day or two to set up, but this year it can take 15minutes.
The middle pane in the chart below shows the daily pivot and the 3day pivot.
Usually when one company decides to merge or takeover another company it is because there is some synergies and economic benefit to the two companies combining resources. A few months back Bank Of America decided that Countrywide Financial was a good value at around $17 a share when they did a 2 billion dollar convertible deal. The stock now trades at $5.87. In the spirit of throwing good money after bad, Bank of America decides to take over Countrywide as it traded significantly lower that the convertible deal. The conclusions that can be drawn are either Bank of America didn't do its due diligence in investigating the problems with Countrywide Financial, they underestimated to credit environment in the United States, or there were other considerations in taking over the company.
One thought that comes to mind, is that Bank of America was most likely tied to lending money to Countrywide and was holding a significant amount of paper that it was going to take a long time to recoup its value. So one attempt to help the situation was the convertible deal at $17. When that didn't solve Countrywide's problems, the problems were now Bank of America's problems. So as the price continued to drop, Bank of America finally stepped in and bought the company. This purchase was probably a-have-to type take over.
Countrywide Financial - CFC (click t0 enlarge) Bank of America - BAC Now that JPMorgan has made an offer for Bear Stearns, why should be a question that people are asking. Is it because it was a good deal for JPMorgan or was it because they were financially tied to Bear Stears in all kinds of CDOs and other financial assets that have become totally illiquid? Was this a deal entered willingly or was this done out of necessity? While the Federal Reserve did back all the paper that JPM is taking on from the Bear Stearns deal, the question still exists why did JPM decide on this deal?
Paying $240 million for this company seems like a very low number. The headquarters building of Bear Stearns is estimated to be worth over $1billion. Likely this week there will be talk of JPM increasing the offer for Bear Stearns, this is most likely to quell talk that this deal was not good for shareholders. The $2 offer was a token offer to shareholders. Was the company worth less? If it wasn't for the Fed stepping in it would be trading at zero, and all the paper held buy the company would have traded at ridiculously low values, but it would have helped to cleanse the system. With the JPM deal, the waters are just muddier. There will be more events to come, and this deal will be seen for all it really is.
JPMorgan Chase and Co.- JPM Bear Stearns Companies - BSC Cramer's Take On Bear Stearns
The chart below is the S&P 500 Index. As prices approach the 1350 area, it is a good place to take profits on any long positions and leg into short positions.
Ben Bernanke's deal with the devil might be working for the short term, but two problems still loom on the horizon. The ever present problem of inflation still exists, but it is a secondary concern currently with the problems in the credit and banking markets. The second problem is what ammunition works best to solve the problems in the banking sector. As much as it seems helpful to always being doing something to promote lending and more liquidity, the only cure for what ails the system right now is time. As long as housing prices are going down, it is very hard for prices for stabilize. All of the prices of mortgage backed securities can not be truly valued until housing prices stop their decline. This is not something that is going to happen in a week or two because the Fed has cut rates. All the rate cuts do it hopefully create more room for banks to lend and create liquidity. This can only happen when fear is not the governing emotion in the lending market. It will take time. Time for fear to be replaced by the desire to grow, and time for prices in the housing market to stabilize.
How many more bullets does the Fed have in its gun to fight more potential problems? The Fed has committed as much as 60 percent of the $709 billion in Treasury securities on its balance sheet to providing liquidity and opened the door to more with its recent decision to become a lender of last resort for the biggest Wall Street dealers. This is essentially the same as the idea a few months back when there was talk of some of the largest banks getting together and creating an off balance sheet fund to deal with these mortgage securities. This plan was scrapped, but now the Fed has stepped in to do the same thing. They have time on their side, and many of these securities will perform the way they were intended. It does however make one think to what point does the Fed willingness to take on these debts stop?
Ben's deal with the devil to reduce rates so low to help unfreeze the credit markets can work in the short term, but inflation is still a force to contend with. Calculating inflation figures minus food and energy is like saying a team would be 30-2 if it wasn't for them getting blown out in the fourth quarter of every game. The demographics of our economy that are living on fixed income and interest payments is very large. This group of retired people take a strong hit in income when the Fed decides to reduce rates to effectively zero to compensate for the actions of irresponsible borrowers and aggressive lenders. Finding investments paying 5% six months ago was not a problem, but today that rate is roughly half of that amount. With food and energy rising in price, it would make sense for rates to go higher to compensate savers for the increase in prices, and possibly in return keeping prices, inflation, down.
Below is a chart of the Dow 30. This is a day chart showing a series of standard deviation lines from a long term linear regression line. The yellow circle shows the last attempt to get to the channel and the kiss goodbye. The market is trying to make a short term bottom. We have had a couple very strong up days in the last month, but they have not had much follow through with strong volume. It is going to take time, and an strong rally back to the 12700 area should be sold into.
Dow Jones Industrials (click to enlarge) This is a longer term chart of the Dow 30. It is a 3day bar chart which is used to smooth out daily fluctuations.
Dow Jones Industrial Average(click to enlarge) This is the S&P 500 Index with extensions from the opening range. The 1350.61 area is the next target.
With the Federal Reserve surely cutting rates today by at least 75 basis points, the 68.15 target for the U.S. Dollar Index might be within reach. The price of oil looks to have failed at the $111.25 target level, so the idea of buying oil as a dollar hedge might be over for now.
Below are two U.S. Dollar Index charts, one with the 10 year Treasury Yield.
U.S.Dollar Index (click to enlarge) U.S.Dollar vs. 10 Year Treasury Yield
The Federal Reserve has chosen to attempt to support the weakening economy and to deal with inflation later when the economy improves. One problem is inflation is already here and it doesn't seem to be weakening. Add to the mix that the Fed seems to be set on cutting interest rates again, the weakening dollar, you get a set up that makes it very difficult for commodity prices to retreat.
A look at the chart of Light Sweet Crude tells the story. As the United States' economy has slowed, expectations for global growth have been re-evaluated. Add to this the repricing of risk due to the over leveraging of financial institutions, caution has caused growth expectations to slow around the globe. That being said, looking at the price of Oil at $110, one would think that demand is sky high. It is not. Some commodities are now experiencing a disconnect from the forces of supple and demand. As the U.S. Dollar continues to weaken due to the lowering of rates and the flooding of liquidity by the Federal Reserve, as well as financing our excesses by debt, Oil and some other commodities have become a U.S. Dollar hedge. As oil and gas inventories come out here in the U.S., it is clear to see that the price of oil is not just a function of supply and demand any more. As the economy slows, and inventories build, the price of Oil should come down. This can not happen while the U.S. Dollar continues to fall.
This chart compares the price of Oil to the U.S. Dollar Index. At what point will the momentum of the Dollar's decline slow to the point to allow speculation in Oil as an ill advised hedge to be reduced? My calculations show that $111.25 is a price that could be a short term top, but that could easily be breached and prices running to $114.05 followed by $116.85. As long as the Fed is cutting rates, and becoming ever increasingly creative in bailing out financial institutions that should be left to swing in the wind, confidence in the dollar will continue to weaken.
The same system that the previous posts applied to the S&P 500 Index can be applied to other indexes, equities, or commodities. Below is a chart of Light Sweet Crude. The opening range is marked by the red circle and shows the highest high of the first three days (100.05) and the lowest low of the first three days (97.25). Subtracting this lowest low from the highest high gives us an opening range of 2.80. This value is then added to the top of the range in multiples to give us price extension levels once prices break above the opening range. The same value is subtracted from the low of the range in multiples to give us extensions levels once prices break below the opening range.
S&P 500 Index(click to enlarge) This chart shows that prices are firmly below the last triangle pattern. After the initial break below, there was one attempt back to the lower trend-line which failed. Since then prices went back down the second target price based on the opening range. It will be important to watch if the 400pt positive day for the DOW 30 can hold and act as support. Giving up this gain will be a sign of more weakness. Below is a monthly chart of the S&P 500 to give a longer term picture.
The U.S. Dollar use to be a safe haven when ever economic storms were on the horizon. With the inflating of every possible asset bubble over the past decade, the Federal Reserve has now decided to continue cutting rates when there is in fact little bubbles worth inflating.
It is often said that "this time things are different", but human nature never changes. Cycles happen and while they might be derailed for periods of time by outside influences, they all eventually run their course. As the Federal Reserve continues to cut rates and flood the market with liquidity to keep this economy oiled, the effects of their action counter every stimulus they attempt to create. They can only cut rates to zero and they can only cut down all the trees and print dollars, but when this doesn't work, what will they attempt next. The rates they keep lowering now are not effecting mortgage rates and does not seem to help the people it is intended to help, if you believe Washington. As they cut rates the dollar continues to fall and this causes inflation to become the main culprit. In a few months time inflation will become the headline of the news cycle, and the Fed will make some statement like a light bulb just went on. The chart below shows an example of the increase in the price of oil as the U.S. Dollar declines. Supply and demand aside, the dollar, the Federal Reserve, is responsible for this climb.
U.S. Dollar vs. Light Sweet Crude As this chart shows they are almost a mirror image. The good news is that the Federal Reserve can only cut rates so far, and as they approach this level, expectations will start to look out for them to raise rates because of inflation fears. The chart below shows the S&P 500 Index and where interest rates were back in the booming 1990's.
S&P 500 And Interest Rates The dollar should begin to strengthen when the Fed can not cut rates anymore and decides to focus on inflation. When oil goes from $110 back to $85, it will be seen as a new boom for the economy. Then the focus will be back onto which economy in the global market is growing the quickest, and has the most potential for growth.
