Subprime's New Song: The Worst Is Yet To Come

By Susan C. Walker, Elliott Wave International
August 28, 2007

Remember that catchy love song that Frank Sinatra made popular in the 1960s, "The Best Is Yet To Come"?

"The best is yet to come and, babe, won't that be fine?
You think you've seen the sun, but you ain't seen it shine."

At the risk of mixing musical metaphors and styles, it looks more like the sun has deserted us right now in the financial markets, and we're about to see "The Dark Side of the Moon," the title of Pink Floyd's 1973 smash album. With the subprime mortgage problems reaching farther and farther out to touch hedge funds, U.S. and European banks, mortgage companies and money-market funds, what we're going to experience sounds more like "The Worst is Yet To Come."

That's because the financial markets must contend not only with the credit crunch brought on by rising foreclosures now; they must also deal with the repercussions from more foreclosures over the next 18 months as more adjustable-rate mortgages (whether subprime or not) reset from low teaser rates to higher interest-rate levels.

How bad can it get? Investment adviser John Mauldin recently published a month-by-month account of the dollar amount of mortgages that will be reset through 2008, and the largest reset amounts pop up in the first six months of next year. In fact, as he points out, the $197 billion of mortgage resets so far this year is "less than we will see in two months (February and March) of next year. The first six months of next year will see more than the total for 2007, or $521 billion."

So, we haven't even begun to feel the pain yet. It's bad enough for the folks who will find that they can't keep up with the higher mortgage payments and will have to move out of their homes. But the financial markets won't be catching a break either. The antiseptic phrase used to describe the situation is "repricing risk." That means that investors have woken up to the fact that the AAA-rated mortgage-backed securities and derivatives they invested in look more like junk bonds now. This eye-opener causes them to want higher yields from what they now see as riskier vehicles.

That new investor caution plays out this way: investment banks, hedge funds and any other entity that bought securities backed by subprime loans now find it hard to sell the darn things. It's almost the same as homeowners trying to find buyers for their homes – nearly impossible in a market where home prices are falling. In the financial markets, it's nearly impossible because no one even wants to attach a price to a collateralized debt obligation today for fear that it will be priced much lower tomorrow.

The Fed can try to calm such fears all it wants by lowering the discount rate and giving banks more time to pay back loans (from overnight to 30 days), but the real problem can't be fixed with more access to credit. The fact is nobody wants any more of that. What they really want is cash to pay off their debts, be it a mortgage or an unwinding of a securities bet.

Wall Street's denizens are in the dark about how much their schemes depend on the ocean of liquidity created by the bull market, say Elliott Wave International's analysts, Steve Hochberg and Pete Kendall. They are particularly struck by the image of the Grim Reaper that Business Week magazine put on its cover recently with the headline, "Death Bonds:"

"The grim reaper is the perfect visage to welcome the arriving wave of liquidation; it will wreak havoc with their work. The field's dark fate is clear in one fund manager's description of what caused 'forced sales' at another fund: 'The models work when they look at history, but not when history is all new.' What's 'new' is that for the first time in the experience of many model makers, confidence is on the run. As they rob Peter to pay Paul, all assets will be impacted in negative ways that do not compute in their models." (The Elliott Wave Financial Forecast, August 2007)

And the bad news just keeps accumulating:

* Housing prices dropped 3.2% percent in the second quarter compared with last year, the largest drop since Standard & Poor's started tracking home prices in 1987.
* CIT Group closed its mortgage unit this week, while Lehman Brothers closed its own last week. Mortgage companies that specialize in low-quality mortgages are either going out of business (London-based HSBC) or struggling (California-based Countrywide).
* The Wall Street Journal lists the number of fired employees at seven mortgage companies, including First Magnus (6,000), Capitol One's Greenpoint (1,900), Associated Home Lenders (1,600) and Lehman (1,200), which totals more than 12,000 suddenly unemployed mortgage writers.

To top it off, Bloomberg reports that the subprime mess may lead to lower bonuses for the first time in five years on Wall Street, according to Options Group, a company that's been tracking this kind of information for a decade.
Somewhere, the world's smallest violin is playing a sad song for the fund managers and investment bankers who won't be taking home that million-dollar-plus bonus this year. And Frank Sinatra is singing a sad refrain… "The worst is yet to come."

Susan C. Walker writes for Elliott Wave International, a market forecasting and technical analysis company. She has been an associate editor with Inc. magazine, a newspaper writer and editor, an investor relations executive and a speechwriter for the Federal Reserve Bank of Atlanta. Her columns also appear regularly on FoxNews.com.

For more information on the housing market and the credit crisis, access the free report, “The Real State of Real Estate,” from Elliott Wave International.

Light Volume Week - S&P 500 Overview

The above chart of the S&P 500 (click to enlarge) shows that the market has rallied after testing the opening range of the year. The market is now above the 200 day moving average and right up against the 50 day moving average. This 50 day moving average is a key area to watch and it coincides with the 1476.76 level which was established as a target from the opening range from the beginning of the 2007 calendar year. This should be a light volume week ahead of the Labor Day Holiday weekend.

The two stocks below might be a couple possible winners in the week ahead. With light trading for the pre-holiday week, momentum stocks might have few traders willing to short early in the week.



ASEI - American Science and Engineering, Inc. (AS&E), develops, manufactures, markets and sells X-ray inspection and other inspection solutions, and provides maintenance, warranty, research, engineering, and training services related to these solutions. The Company manufactures a range of X-ray inspection products that can be used to inspect parcels, baggage, vehicles, pallets, cargo containers and people. The Company sells its products in the United States and worldwide to a variety of customers, including authorities responsible for port and border security; aviation security agencies; military organizations, and high threat commercial and government facilities. The Company's products and services is grouped into six different areas, including CargoSearch Inspection Systems, Z Backscatter Systems, ParcelSearch Inspection Systems, Personnel Inspection, Content Research and Development, and Service and Support.



MENT - Mentor Graphics Corporation is engaged in electronic design automation (EDA), and provides software and hardware design solutions. The Company markets its products and services worldwide, primarily to companies in the communications, computer, consumer electronics, semiconductor, networking, multimedia, military/aerospace and transportation industries. Its products are used in the design and development of a set of electronic products. In December 2006, the Company acquired SpiraTech Limited. In October 2006, it acquired Next Device Limited and the technology of Summit Design, Inc. In August 2006, it acquired Router Solutions, Inc. In January 2006, it acquired EverCAD Corporation. In June 2007, the Company acquired Sierra Design Automation (Santa Clara, Calif.), a provider of place and route solutions.

United States Steel Corp And Others

"We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful." -- Warren Buffett


Some of the stocks covered in Monday's post received a lot of attention in today's rally. BHP's earnings report with the guidance that they do not see global demand slowing coupled with a Credit Suisse upgrade of the sector to "overweight" helped the rally that started a couple days ago continue. This group is not always the easiest to trade with a short time-frame. Lately some of the selling in this group has felt like forced selling. Often times when the market is volatile, funds can not always sell what they want to but instead sell what they can, where the liquidity is great. This seems to be the case in some of the steel stocks and was also the case in the energy sector. This selling has less to do with fundamental reasons and more to do with the necessity for some funds to raise cash and reduce exposure.

Below is a spreadsheet with a cross section of some steel companies. In this list it can be seen in the fundamental data that not all of these companies are equal in terms of their internal health. This is important to keep in mind in times of market and credit stress. Companies with lower levels and manageable debt compared to free-cash flow should trade at a premium compared to the sector.



The companies with the highlighted shades of blue seem to have the best ratios when comparing net-income to debt. The companies with the green highlighted free cash-flow areas have the best ratios between free cash-flow and debt. As the price of credit increases, the cost of their debt could increase should it need to be refinanced. Therefore companies with the lower ratios should have an easier time if they do enter tough times. If things improve and this group is the recipient of the strong global economic growth, then the entire group should do well.

On August 1, 2007 Senator Hagel and Senator Dodd introduced a bill,National Infrastructure Bank Act of 2007, that would streamline the process by which national infrastructure projects are targeted. It would create an independent national bank that would identify, evaluate and help finance infrastructure projects of substantial regional and national significance. Infrastructure projects under the Bank’s jurisdiction would include publicly-owned mass transit systems, roads, bridges, drinking water and wastewater systems, and housing properties. Steel companies will directly benefit from a change in focus on the national infrastructure. This will not be a short term change, but should last for decades.

Another area that is worth keeping an eye on is the upgrade and expansion in the energy and refinery sectors. U.S.Steel(X) purchase of Lone Star Technologies should help gain exposure to this vital growth area. Lone Star produces and markets premium casing, tubing, line pipe and couplings for the oil and gas industry; specialty tubing for the industrial, automotive, and power generation industries;and flat rolled steel and other tubular products and services.

Below are some charts(click to enlarge) of various steel companies covered in the spread sheet above. The ones not shown below are covered in a previous article.

AK Steel Holding Corporation - AKS


Cleveland Cliffs Inc. - CLF


Nucor Corp. - NUE


Rio Tinto Plc. - RTP


Steel Dynamics Inc. - STLD


U.S. Steel Corp. - X


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AK Steel Holding Corporation (AK Holding) is a fully integrated producer of flat-rolled carbon, stainless and electrical steels, and tubular products through its wholly owned subsidiary, AK Steel Corporation (AK Steel). The Company’s operations consist of seven steelmaking and finishing plants located in Indiana, Kentucky, Ohio and Pennsylvania that produce flat-rolled carbon steels, including coated, cold-rolled and hot-rolled products, and specialty stainless and electrical steels that are sold in slab, hot band, and sheet and strip form. The Company’s operations also include AK Tube LLC (AK Tube), which further finishes flat-rolled carbon and stainless steel at two tube plants located in Ohio and Indiana into welded steel tubing used in the automotive, truck and construction markets. In addition, its operations include European trading companies that buy and sell steel and steel products.

Cleveland-Cliffs Inc (Cliffs) is a producer of iron ore pellets in North America. The Company manages and operates six North American iron ore mines located in Michigan, Minnesota and Eastern Canada that have a rated capacity of 37 million tons of iron ore pellet production annually. On April 19, 2005, Cliffs Asia Pacific, a wholly owned subsidiary of the Company, completed the acquisition of 80.4 % of Portman, an iron ore mining company in Australia. As a result of the Portman acquisition, the Company operates in two segments: North America and Australia. The North America segment comprises its mining operations in the United States and Canada. The Australia segment comprises its 80.4 % Portman interest in Western Australia. During the year ended December 31, 2006, the Company produced a total of 33.6 million tons of iron ore pellets. In July 2007, Cliffs acquired PinnOak Resources, LLC, a metallurgical coal producer located in the United States.

Nucor Corporation is engaged in the manufacture and sale of steel and steel products. It operates in two segments: steel mills and steel products. Principal products from the steel mills segment include hot-rolled steel and cold-rolled steel. Steel mills segment's hot-rolled steel products include angles, rounds, flats, channels, sheet, wide-flange beams, pilings, billets, blooms, beam blanks and plate. Principal products from the steel products segment include steel joists and joist girders, steel deck, cold finished steel, steel fasteners, metal building systems and light gauge steel framing. In February 2005, it purchased the assets of Fort Howard Steel, Inc.'s operations in Oak Creek, Wisconsin. In June 2005, Nucor Corporation's wholly owned subsidiary, Nucor Steel Marion, Inc., purchased the assets of Marion Steel Company. This facility produces angles, flats, rebar, rounds and signposts. As of March 2, 2007, the Company had acquired over 96% interest in Harris Steel Group Inc.

Rio Tinto plc and Rio Tinto Limited operate as one business organization (Rio Tinto). Rio Tinto is an international mining company. The Company's principal product and global support groups include Iron Ore, Energy, Industrial Material, Aluminium, Copper, Diamonds, Exploration and Technology. Rio Tinto’s Iron Ore group comprises iron ore operations in Australia, Canada and Brazil and development projects in Guinea (West Africa) and India. The Rio Tinto Energy Group comprises uranium, thermal coal and coking coal operations. Rio Tinto's Industrial Minerals group produces borates, talc, industrial salt, and titanium dioxide feedstock. Rio Tinto Aluminium is an integrated product group with operations in Australia, New Zealand and the United Kingdom. Rio Tinto's Copper group comprises Kennecott Utah Copper in the United States and interests in the copper mines of Escondida, Grasberg, Northparkes, Palabora Mining Company (Palabora) and the Resolution Copper project.

Steel Dynamics, Inc. (SDI) is a steel producer in the United States, with an annual steelmaking capability of 5.2 million tons. During the year ended December 31, 2006, consolidated shipments, which excluded shipments between the Company’s operating divisions, totaled 4.7 million tons. The Company has three segments: steel operations, fabrication operations and steel scrap and scrap substitute operations. On April 11, 2006, the Company acquired Roanoke Electric Steel Corporation (Roanoke Electric). In July 2007, SDI completed the acquisition of The Techs, a flat-rolled steel galvanizing company. The Techs’ operations consist of three facilities in the Pittsburgh area: GalvTech, MetalTech and NexTech. Each plant specializes in the galvanizing of specific types of flat-rolled steels.

United States Steel Corporation (U. S. Steel) is an integrated steel producer with production operations in the United States and Central Europe. The Company has an annual raw steel production capability of 19.4 million net tons (tons) in the United States and 7.4 million tons in Central Europe. U. S. Steel is also engaged in several other business activities, most of which are related to steel manufacturing. These include the production of coke in both the United States and Central Europe, and the production of iron ore pellets from taconite, transportation services (railroad and barge operations) and real estate operations in the United States. During the year ended December 31, 2006, the Company had three operating segments: Flat-rolled Products (Flat-rolled), U. S. Steel Europe (USSE) and Tubular Products (Tubular). In June 2007, the Company completed the acquisition of Lone Star Technologies Inc.

% Stocks Above Their 200 Day Moving Average

S&P 500 Index With % Stocks Above Their 200 Day Moving Average(click to enlarge)


This is a monthly chart of the S&P 500 Index going back to 1986. The top section of the chart shows the percentage of stocks trading above their 200 day moving averages. The 25% and 75% levels are marked and shows how a break of these levels coincides with at least a short term extreme in the market. Currently this indicator has fallen from being above the 75% level, but is not near the 25% level that has marked some previous bottoms in the market.

One thing that is certain is that the market isn't very likely to sit still at this level. One way to take advantage of this is to look at buying both calls and puts on the SPY. In looking at this trade today, buying the September 145 calls and puts would cost roughly $8.40. This equates to around 5.8%. To break even with this idea, the market would need to have a move of 5.8% or greater by the third Friday in September. It is important to watch the cost of this type of trade and make sure there is enough energy in the market to accommodate such a move. With the expectations of more Federal Reserve action and more news of the effects of sub-prime credit problems, the market should be able to move 5% from this level. This type of trade is best placed when market volatility is low. This is not the case now, but this trade would have worked best back when the market volatility was low and the percentage of stocks above their 200day moving average was above 75%.

CBOE OEX Volatility Index(click to enlarge)

NYSE Composite With % Stocks Above 40 Moving Average

(click to enlarge)

This chart shows the NYSE Composite Index weekly chart with a 50 week moving average(green line). In the top part of the chart is an indicator that shows the percentage of stocks trading above their respective 40day moving averages. This indicator has proven to be a great signal in the past. In 2003 it showed a great divergence at the low. This is the type of pattern that needs to form for this market to gain any solid footing. Don't look for this to happen in the form of a "V" bottom. It takes time to work of the stress off the last few weeks. If, and it's a big if, the market can hold it's 50week moving average, then in later weeks this pattern will form. There is no reward for being the first one to jump in the pool, especially if there isn't enough water there when you jump. Patience is rewarded!

S&P 500 And Looking South For Winners

Below is a chart of the S&P 500 Index showing the swings and market levels from last week. After a bounce off of 1382.08 the market rallied off the Fed's rate cut to just about reach the 1453.09 level. Any further rally attempt to the 1476.76 level should be a level for short selling to resume.



Below is the corresponding chart of the Nasdaq 100 Index - NDX.



The currency moves last week were just as wild if not more so that the U.S.stock market. Below shows the move of the Australian Dollar.



As the carry trade has unwound many currency charts look like this. All of this volatility has created some opportunities. Below is a chart of BHP Billiton Ltd. This a company which deals with many of Australia's natural resources. According the CIA Factbook, Australia trades with many of the world's fasting growing economies. Export partners include: Japan 19.6%, China 12.3%, South Korea 7.5%, US 6.2%,India 5.5%. These economies are not going to dry up and go away because of the current financial crisis, so BHP's business is not going to go away.

BHP - BHP Billiton Ltd.


Another area that does not have as much exposure to the sub-prime arena is Brazil. One of the larger banks in the Brazil is Unibanco-Uniao de Bancos Brasileiros S.A, UBB. They have exposure to the growing economy in Brazil, with little exposure to the sub prime lending that has plagued our banks. This could be an opportunity to gain some international exposure at these lower levels.

UBB - Unibanco-Uniao de Bancos Brasileiros S.A


Below are some other stocks south of the border which might be worth further investigation.

GGB - Gerdau S.A.


SID - Companhia Siderurgica Nacional


RIO - Companhia Vale do Rio Doce


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BHP - BHP Billiton Limited, together with its subsidiaries, engages in mining, drilling, and processing mineral resources. It operates through seven segments: Petroleum, Aluminium, Base Metals, Carbon Steel Materials, Diamonds and Specialty Products, Energy Coal, and Stainless Steel Materials. The Petroleum segment engages in the exploration for and production, processing, and marketing of hydrocarbons, including oil, gas, and liquefied natural gas. The Aluminium segment explores and mines bauxite, as well as processes and markets aluminium and alumina. The Base Metals segment engages in the exploration for and mining, processing, and marketing of copper, silver, zinc, lead, uranium, and copper by-products, including gold. The Carbon Steel Materials segment engages in the exploration for and mining, processing, and marketing of coking coal, iron ore, and manganese. The Diamonds and Specialty Products segment includes exploration and mining of diamonds and titanium minerals, and fertilizer operations. The Energy Coal segment engages in the exploration for and mining, processing, and marketing of energy coal. The Stainless Steel Materials segment engages in the exploration for and mining, processing, and marketing of nickel. BHP Billiton operates primarily in Australia, South America, Africa, and Canada. The company was founded in 1885 and is headquartered in Melbourne, Australia.

RTP - Rio Tinto plc engages in finding, mining, and processing mineral resources. Its products include aluminum; copper; diamonds; energy products, such as coal and uranium; gold; industrial minerals, including borax, titanium dioxide, salt, and talc; and iron ore. Rio Tinto operates primarily in North America, Europe, Asia, Australia, and New Zealand. The company was founded in 1873. It was formerly known as The RTZ Corporation PLC and changed its name to Rio Tinto plc in 1997. Rio Tinto is headquartered in London, the United Kingdom.


GGB - Gerdau S.A. engages in the production and sale of crude steel and related long rolled products, drawn products, and long specialty products. It offers billets, rebar, merchant bars, wire rod, drawn products, and nails; blooms, slabs, and heavy structural shapes; and structural shapes, medium structural channel, and beams. The company produces steel based on the mini-mill concept from iron ore. It offers its steel products for civil construction, manufacturing, and agribusiness markets in Brazil, the United States, Spain, Canada, Chile, Colombia, Peru, Argentina, and Uruguay. The company, through its interest in Dona Francisca Energetica S.A., operates hydroelectric power plant with a nominal capacity of 125 megawatts located in the state of Rio Grande do Sul, Brazil. The company was founded in 1901 and is based in Porto Alegre, Brazil.

SID - Companhia Siderrgica Nacional (CSN) primarily operates as an integrated steel producer in Brazil. It produces a line of steel products, including slabs, which are semifinished products used for processing hot-rolled, cold-rolled, or coated coils and sheet products; hot-rolled products comprising heavy-gauge hot-rolled coils and sheets, and light-gauge hot-rolled coils and sheets; cold-rolled products, including cold-rolled coils and sheets; and galvanized products consisting of flat-rolled steel coated with zinc or a zinc-based alloy. The company also offers tin mill products, including tin plate, tin free steel, low tin coated steel, and black plate products. Companhia Siderrgica Nacional also mines iron ore, limestone, and dolomite, as well as maintains strategic investments in railroads and power supply companies. The company sells its steel products to customers in Brazil and 71 other countries in North America, Europe, and Asia through its sales force and distributors. CSN was founded in 1941 and is based in Sao Paulo, Brazil.

RIO - Companhia Vale do Rio Doce, together with its subsidiaries, operates as a diversified metals and mining company worldwide. It produces, exports, and supplies iron ores and pellets to the steel making industry, as well as manganese ores and iron alloys, including metallurgical ore used primarily for the production of ferroalloys; natural manganese dioxide used for the manufacture of electrolytic batteries; and chemical ore used in various industries for the production of fertilizer, pesticides, and animal food, as well as used as a pigment in the ceramics industry. The company also produces nickel; copper; platinum-group metals, such as platinum, palladium, rhodium, ruthenium, and iridium; precious metals, including gold and silver; coal; and other non-ferrous minerals, such as kaolin, potash, cobalt, sulphuric acid, liquid sulphur dioxide, selenium, and tellurium, as well as engages in bauxite mining, alumina refining, and aluminum metal smelting operations. In addition, it engages in railroad, coastal shipping, and port handling operations; and provides logistic services, including rail transportation for its mining products, general cargo and passengers, bulk terminal storage, and ship loading services for the company's mining operations and for third parties. Further, the company, through joint venture interests, invests in the aluminum, coal, energy, and steel businesses; and offers hot-rolled steel, cold-rolled steel, galvanized steel, electro galvanized steel, pig iron, steel plates, sheet products, and steel tubes. It also has investments in seven hydroelectric power plants in operation and one under construction in Brazil. Companhia Vale do Rio Doce was founded in 1942 and is headquartered in Rio de Janeiro, Brazil.


UBB - Unibanco-Uniao de Bancos Brasileiros S.A. and its subsidiaries provide financial products and services to individual and corporate customers in Brazil. It operates in four segments: Retail, Wholesale, Insurance and Pension Plans, and Wealth Management. The Retail segment provides various deposits products, including checking accounts, time deposits, and savings account-type products. It also offers secured and unsecured personal loans, short term lines of credit, loans for consumer purchases, auto finance, leasing, and individual lines of credit; and credit lines, account receivable financing, working capital loans, BNDES-funded loans, and leasing for small and medium-sized companies. In addition, this segment offers credit cards, insurance, asset management, payroll, cash management, and Internet and telephone banking services, as well as ATMs and payroll-linked loans. The Wholesale segment provides various products and services, including general and specialized corporate lending, trade finance, derivatives, capital markets, investment banking services, and investment and brokerage services. It also offers project finance, and mergers and acquisitions advisory services to institutional investors and economic groups. The Insurance and Pension Plans segment provides life, auto, health, property and casualty, and extended warranty insurance coverage for individuals and businesses, as well as offers pensions and retirement plans, and certain related products and services. The Wealth Management segment provides fixed income and equity mutual funds to individual customers, as well as manages portfolios on behalf of corporations, pension funds, and private banking clients. As of December 31, 2006, the company operated approximately 7,600 ATMs; and 940 full-service branches. The company was founded in 1924 and is headquartered in Sao Paulo, Brazil. Unibanco-Uniao de Bancos Brasileiros S.A. is a subsidiary of Unibanco Holdings S.A.

HEICO Corporation And Some Other Winners

Heico Corporation was one stock from the last few weeks which has escaped the effects of the sub-prime events. It shows that there are areas that are not exposed to the financing troubles causing fear and effecting so many other areas of the overall stock market. The action taken by the Federal Reserve on Friday morning provided for a great short covering rally. Will this short covering eventually transform into less emotionally based buying? This will be seen over the following weeks. One thing that is certain right now is that the uncertainty is here to stay and that there will be more bad news coming from funds and others who proved to be too addicted to leverage over the last few years. The smart funds were the first to confess their sins. When will the others come clean and have their accounting information in order to report to their investors? This is a story that will continue until the middle of October.

One way to escape the wild swings of the general market is to keep the focus on companies that have a catalyst and/or exposure to an industry that is insulated from the general swings of the market.

On August 1, 2007 Senator Hagel and Senator Dodd introduced a bill,National Infrastructure Bank Act of 2007, that would streamline the process by which national infrastructure projects are targeted. It would create an independent national bank that would identify, evaluate and help finance infrastructure projects of substantial regional and national significance. Infrastructure projects under the Bank’s jurisdiction would include publicly-owned mass transit systems, roads, bridges, drinking water and wastewater systems, and housing properties. One of the many companies that could benefit from the improvement from the national infrastructure is Valmont Industries. This company deals in metal fabrication and engineering support for a vast array of construction projects. Below is a chart of Valmont Industries, VMI.



Another stock that could benefit from this legislation could be Chicago Bridge & Iron . Keep an ear out for news when congress comes back from their month long vacation!



Some other stocks that performed well last week are below.

Radiant Systems - RADS


Natco Group Inc. - NTG


Flir Systems Inc. - FLIR


Tyler Technologies


Chart Industries - GTLS



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HEI - HEICO Corporation, through its subsidiaries, engages in the design, manufacture, and sale of aerospace, defense, and electronics related products and services in the United States and internationally. It operates in two segments, Flight Support Group (FSG) and Electronic Technologies Group (ETG). FSG segment offers jet engine and aircraft component replacement parts, such as combustion chambers, compressor blades, vanes, seals, and various other engine and aircraft parts. It also manufactures specialty aviation and defense components as a subcontractor. In addition, this segment offers hydraulic, pneumatic, mechanical, and electro-mechanical components for the aviation markets. ETG segment provides electronic, microwave, and electro-optical products, including infrared simulation and test equipment, laser rangefinder receivers, electrical power supplies, back-up power supplies, electromagnetic interference and radio frequency interference shielding, high power capacitor charging power supplies, amplifiers, photo detectors, amplifier modules, flash lamp drivers, laser diode drivers, arc lamp power supplies, custom power supply designs, cable assemblies, and high voltage interconnection devices and wire. Its microwave products include isolators, bias tees, circulators, latching ferrite switches, and waveguide adapters that are used in satellites. This segment also offers high-speed interface products, such as telemetry receivers, digital cameras, high resolution scanners, simulation systems, and test systems. The company serves commercial and cargo airlines, repair and overhaul facilities, other aftermarket suppliers of aircraft engine and airframe materials, original equipment manufacturers, military units, and electronic manufacturing services companies, as well as medical, scientific, security, and other companies. HEICO Corporation was founded in 1949 and is headquartered in Hollywood, Florida.

TYL - Tyler Technologies, Inc. provides integrated information management solutions and services for local governments. Its software products are grouped into four areas, including financials, courts and justice, property appraisal and tax, and document management. The company's financial systems include modules for general ledger, budget preparation, fixed assets, requisitions, purchase orders, bid management, accounts payable and receivable, contract management, investment management, inventory control, project and grant accounting, work orders, job costing, payroll, and human resources. Its also offers products that automate various city functions, including municipal courts, parking tickets, equipment and project costing, animal licenses, business licenses, permits and inspections, code enforcement, citizen complaint tracking, ambulance billing, fleet maintenance, and cemetery records management. Tyler Technologies' courts and justice solutions include suite of products to automate, track, and manage the law enforcement and judicial process from the initiation of incidents through the process of arrest, court appearances, and final disposition to probation. The company's property appraisal and tax solutions provide systems and software that automate the appraisal and assessment of real and personal property, including record keeping, mass appraisal, inquiry and protest tracking, appraisal and tax roll generation, tax statement processing, and electronic state-level reporting. Its document management systems record and index information documents maintained at the courthouse, such as deeds; mortgages; liens; UCC financing statements; and vital records, including birth, death, and marriage certificates. The company also offers professional information technology and property appraisal outsourcing services. It operates in the United States, Canada, Puerto Rico, and the United Kingdom. Tyler Technologies was founded in 1966 and is based in Dallas, Texas.

VMI - Valmont Industries, Inc. and its subsidiaries produce fabricated metal products; metal and concrete pole, and tower structures; and mechanized irrigation systems worldwide. The company operates through five segments: Engineered Support Structures, Utility Support Structures, Coatings, Irrigation, and Tubing. The Engineered Support Structures segment manufactures engineered metal structures and components for the lighting and traffic, and wireless communication industries. It offers steel and aluminum poles and structures to which lighting and traffic control fixtures are attached for outdoor lighting applications, such as streets, highways, parking lots, sports stadiums, and commercial and residential developments. This segment also provides solid rod, tubular and guyed towers, poles, and other components for wireless communication and highway sign markets. The Utility Support Structures segment manufactures tapered steel and pre-stressed concrete poles for electrical transmission, substation, and distribution applications. It also produces hybrid structures with a concrete base section and steel upper sections. The Coatings segment provides metal coating services, including hot-dipped galvanizing, anodizing, powder coating, and e-coating. The Irrigation segment manufactures and distributes mechanical irrigation equipment and related service parts, which are used to water crops and deliver chemical fertilizers and pesticides. The Tubing segment produces light-wall welded steel tubing used in various products, including grain handling systems, pneumatic tube delivery systems, fire protection systems, automotive products, and exercise equipment. The company's customers primarily include state and federal governments, contractors, utility and telecommunications companies, manufacturers of commercial lighting fixtures, and farms, as well as companies from general manufacturing sector. Valmont Industries was founded in 1946 and is headquartered in Omaha, Nebraska.

FLIR - FLIR Systems, Inc. designs, manufactures, and markets thermal imaging and infrared camera systems in the United States and internationally. The company operates through three divisions: Thermography, Commercial Vision Systems, and Government Systems. The Thermography division offers products for commercial and industrial applications, where temperature measurement is primary requirement. Its products provide highly sensitive temperature measurement, sophisticated image processing, and extensive analytic capabilities. This division's products are used for predictive and preventative maintenance, research and development, test and measurement, leak detection, scientific analysis, manufacturing process control, building inspection, and thermography applications. The Commercial Vision Systems division offers products for commercial security, automotive, marine, airborne, and first responder markets. This division sells its products through direct, original equipment manufactures (OEMs), and third party distribution. It serves perimeter security, automotive night vision, transportation night vision, marine, electronic news gathering, and law enforcement markets. The Government Systems division provides a range of products, which allow the user to see in total darkness and through various obscurants, such as smoke, haze, and various types of fog. It offers hand-held imaging systems, as well as fixed or vehicle mounted products for land, airborne, and marine applications. This division serves search and rescue, force protection, border and maritime patrol, surveillance and reconnaissance, targeting, federal drug interdiction, military, paramilitary, and police forces markets. FLIR Systems offers its products through direct sales personnel, dealers, distributors, and OEMs. The company was founded in 1978 and is headquartered in Wilsonville, Oregon.

NTG - NATCO Group, Inc., through its subsidiaries, engages in the design, manufacture, and marketing of oil and gas production equipment and systems worldwide. It operates through three segments: Oil and Water Technologies, Gas Technologies, and Automation and Controls. The Oil and Water Technologies segment offers production equipment, including separators, heaters, oil dehydration equipment, water treatment equipment, gas conditioning equipment, and replacement parts. This segment also manufactures built-to-order systems, including integrated oil and gas processing trains, dehydration and desalting systems, offshore production systems, water injection systems, produced water cleanup systems, gas processing equipment, and downstream facilities, as well as wellhead desanders, sand cleaning facilities, sand fluidization, and specialty oil heaters. The Gas Technologies segment manufactures gas-processing facilities for the removal of carbon dioxide from hydrocarbon streams; offers gas processing facilities for the separation, heating, dehydration, and removal of liquids and contaminants to produce pipeline-quality natural gas; and licenses bio-desulfurization technology. The Automation and Controls segment engages in designing, programming, assembling, installing, and commissioning various pneumatic, hydraulic, electrical, and computerized control panels and systems for multiple industries; engineering and instrumentation field services, compliance services, and management services; supervisory control and data acquisition systems that provide remote monitoring and control of equipment, production facilities, pipelines, and compressors via radio, cellular phone, microwave, and satellite communication links. NATCO Group serves independent operators, and international and national oil companies, as well as engineering, procurement, and construction companies acting on behalf of end users. The company was founded in 1988 and is headquartered in Houston, Texas.

GTLS - Chart Industries, Inc. manufactures and supplies engineered equipment used in the production, storage, and end-use of hydrocarbon and industrial gases. It operates in three segments: Energy & Chemicals (E&C), Distribution and Storage (D&S), and BioMedical. The E&C segment offers vacuum-insulated containment vessels, aluminum and air cooled heat exchangers, cold boxes, and other cryogenic components, which are used in the liquid gas supply chain for the purification, liquefaction, distribution, storage, and end-use of hydrocarbon and industrial gases. The D&S segment supplies cryogenic equipment to the bulk and packaged industrial gas markets. This segment's products include cryogenic bulk storage systems; cryogenic packaged gas systems; cryogenic components, including VIP, engineered bulk gas installations, and liquid nitrogen end-use equipment; liquid natural gas and liquid/compressed natural gas refueling systems for fleets operated by metropolitan transportation authorities, refuse haulers, and heavy-duty truck fleets; and beverage liquid carbon dioxide systems that primarily consist of bulk liquid carbon dioxide containers used for beverage carbonation in restaurants, convenience stores, and cinemas, as well as bulk fountain syrup containers. This segment also offers installation, service, and maintenance for cryogenic products comprising storage tanks, liquid cylinders, cryogenic trailers, cryogenic pumps, and VIP. The BioMedical segment manufactures medical respiratory products, including liquid oxygen systems and ambulatory oxygen systems; biological storage systems comprising vacuum-insulated containment vessels for the storage of biological materials; and MRI components that are used to transfer power and/or cryogenic fluids. It has operations in the United States, Australia, the People's Republic of China, the Czech Republic, Germany, and the United Kingdom. The company is headquartered in Garfield Heights, Ohio.

Following The Carry Trade

Below are a couple charts that are worth following to monitor the unwinding of the carry trade. This trade occurs when it is possible to have access to cheap capital from one part of the world and then borrow this capital and invest it in another part of the world at a higher rate-of-return than the borrowing cost. This has been done by borrowing money in Japan with low rates and investing it in places like New Zealand(pays high interest rates) and the United States.



This chart(click to enlarge) shows the Japanese Yen vs the U.S. Dollar. The red shaded areas show other areas where this carry trade was partially effected, but ultimately continued. Is this the ultimate unwind? It could be for a while.



This is a chart of the New Zealand Dollar / Japanese Yen. This shows the velocity of this unwind on a currency that seems to not offer the safety or liquidity of the U.S Dollar. It also helps that New Zealand central bank wants their currency much lower. The chart below shows the U.S.Dollar / New Zealand Dollar.



Watching these charts could give a key to where the selling in our market will slow. It doesn't seem to be today, as the overnight moves in these currencies were huge. When these currencies break, it effects the overnight futures and carries over again to the sentiment at the open. Below is a chart of the S&P 500 showing the levels established from the beginning of the year. Which level will hold? We are now below the opening range, so the next target is 1382.08.

Levels To Watch

(click to enlarge)

The opening range established back in January is 1429.42 - 1405.75. This value is 23.67, and is then added and subtracted to this range to get targets and levels to watch. It is best to watch these levels in conjunction with other indicators and not just use them as a stand alone system. They are more guideposts and act like magnets during market moves.

Below is a second chart of the S&P 500 with an indicator created off the idea of combining pivots with volume. As can be seen when the market reached these higher target levels from the opening range, the indicator showed divergence and how weak the internals really were. This indicator is really similar to an advance/decline indicator combined with volume and closing ranges.



A later post today will deal with scanning baskets of stocks using this indicator to look for stocks that are showing signs of strength. Combining this with scanning for triangle patterns, should create some good trading set ups for when this down move in the market is finished.

The Market Wakes Up New Everyday

The chart above is of the S&P 500(click to enlarge). In the top pane the red dashed lines mark extension levels based on the opening range from the beginning of the calender year. The market came down and tested the top of this opening range and then bounced up 2 levels to the 1500.43 level. The battle of these levels continues as the futures are currently up 12 and it looks like there is going to be a new challenge to get to the 1476.76 level.

The bottom pane of the chart shows a basket of large-cap stocks that have businesses exposed to the global economy. This group outperformed significantly from the lows in March. These large-cap companies still might hold the key to the market's success. While the S&P 500 has be bouncing off of its 200day moving average and trying to regain its 50day moving average, this multinational basket has held above its 50day moving average. Below is a spreadsheet with the components of this custom basket, along with the values of each stocks moving averages.



With the wild market swings lately, it has not been easy to just buy a stock and sit back. The comfort of everything acting tamely and going up in an orderly fashion is over for now. It is pays to be very selective in picking stocks, and it also helps to use options as insurance.

Below is a chart of Altria Group Inc. This chart shows the 200day moving average as a blue dashed line. The channel is based of a linear regression with 2 standard deviations making up the upper and lower channels.(click to enlarge)



A couple months ago buying this stock at this level involved a lot less stress. Today it is another story. There are a few potential ways to limit this stress. If purchasing the stock at this level, we could also purchase a put option at the 65 strike to act as insurance in case of further market weakness.

Another idea that would not tie up as much capital would be to buy just the 65 call option, this would limit our potential loss to just what we paid for the option. If the stock broke down through its 200day, we would just lose what we paid for the call option.

A trickier strategy is to buy both the call and put option. This would be basically betting that Altria would not stay were it is,but would either rally or breakdown. If we bought both the September 65 call and the September 65 put options, it would cost around 5.90 for both positions. This is roughly 9% of the stocks price. The stock would have to move to 70.90 or break to 59.10 for this position to break even. This strategy is betting that things will move and the price will not stay in the area it is in. This is stock is used as example, it is best to scan for stocks for this strategy were the percentage move to break even is less. This is harder to do when market volatility is moving higher, like the current condition. There are also some other factors, like delta, to use in the calculation. These will be covered in a later post.

Another strategy could be to buy Altria or another stock and then short or buy a put on the index it is a member of. Below is a list of the Dow 30. Buying some of the stronger stocks in this index and then buying puts on the Dow Diamonds (DIA), could take some of the risk and stress out of a volatile market.



Looking at suppliers to the aerospace sector lead to finding some companies that deal in carbon fiber composites. Below are a few, and they seem to be performing stronger that the overall market.

Zoltek



Cytec Industries



3M Company



Hexcel Corp.



Another stock to watch for a buy on any weakness

Chart Industries Inc.



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ZOLT - Zoltek Companies, Inc., through its wholly owned subsidiaries, engages in the development, manufacture, and marketing of carbon fibers for various applications. Its carbon fibers are used as the primary building material in commercial products. The company also manufactures and sells filament winding and pultrusion equipment used in the production of composite parts. In addition, the company produces oxidized acrylic fiber for flame and heat resistant applications; and technical fibers, which are used to manufacture aircraft brake pads and other friction applications. It has operations primarily in the United States and Europe and sells its carbon fibers worldwide. The company was founded in 1975 and is headquartered St. Louis, Missouri.

CYT - Cytec Industries, Inc., a specialty chemicals and materials company, engages in the development, manufacture, and sale of chemical products. It operates in four segments: Cytec Performance Chemicals, Cytec Surface Specialties, Cytec Engineered Materials, and Building Block Chemicals. The Cytec Performance Chemicals segment offers various products, including mining chemicals, phosphines, polymer additives, specialty additives, specialty urethanes, and adhesives. The Cytec Surface Specialties segment's product line includes radiation-cured resins, powder coating resins, and liquid coating resins, including water-borne resins, amino resins, and solvent based resins. The Cytec Engineered Materials segment offers composites and structural film adhesives. The Building Block Chemicals segment offers acrylonitrile, hydrocyanic acid, sulfuric acid, and melamine. The company serves various markets, including aerospace, adhesives, automotive and industrial coatings, chemical intermediates, inks, mining, and plastics. It offers its services in North America, Europe, Asia-Pacific, and Latin America. The company was founded in 1993 and is headquartered in West Paterson, New Jersey.

MMM - 3M Company operates as a diversified technology company. It operates in six segments: Industrial and Transportation; Health Care; Display and Graphics; Consumer and Office; Safety, Security, and Protection Services; and Electro and Communications. Industrial and Transportation segment offers tapes, coated and nonwoven abrasives, adhesives, specialty materials, supply chain execution software solutions, closures for disposable diapers, and components and products that are used in the manufacture, repair, and maintenance of automotive, marine, aircraft, and specialty vehicles. Health Care segment provides medical and surgical supplies, skin health and infection prevention products, drug delivery systems, dental and orthodontic products, health information systems, and microbiology products. Display and Graphics segment offers optical film and lens solutions for electronic displays; touch screens and touch monitors; computer screen filters; reflective sheeting for transportation safety; and commercial graphics systems. Consumer and Office segment provides office supply products; stationery products; construction and home improvement products; home care products; protective material products, including consumer health care products, such as bandages; and visual systems products. Safety, Security, and Protection segment offers personal protection products, safety and security products, energy control products, cleaning and protection products for commercial establishments, and roofing granules for asphalt shingles. Electro and Communications segment offers electronic and interconnect solutions, micro interconnect systems, high-performance fluids, high-temperature and display tapes, telecommunications products, and electrical products. 3M, formerly known as Minnesota Mining and Manufacturing Company, was founded in 1902. The company is based in St. Paul, Minnesota.

HXL - Hexcel Corporation, together with its subsidiaries, engages in the development, manufacture, and marketing of advanced structural materials in the United States, Europe, and internationally. It operates in three segments: Composites, Reinforcements, and Structures. The Composites segment offers carbon fibers; prepregs; structural adhesives; honeycomb, parts, and composite panels; fiber reinforced thermoplastics; molding compounds; and polyurethane systems, gel coats, and laminates. The Reinforcements segment manufactures and markets industrial fabrics and other specialty reinforcement products. The Structures segment produces composite structures, such as aerodynamic fairings, wing panels, and other aircraft components. Its products are applied in commercial and military aircraft, space launch vehicles and satellites, body armor, wind turbine blades, printed wiring boards, high-speed trains and ferries, cars and trucks, window blinds, bikes, skis, and various other recreational equipments. Hexcel Corporation serves commercial aerospace, industrial, space and defense, and electronics industries. The company was founded in 1946 and is based in Stamford, Connecticut.

GTLS - Chart Industries, Inc. manufactures and supplies engineered equipment used in the production, storage, and end-use of hydrocarbon and industrial gases. It operates in three segments: Energy & Chemicals (E&C), Distribution and Storage (D&S), and BioMedical. The E&C segment offers vacuum-insulated containment vessels, aluminum and air cooled heat exchangers, cold boxes, and other cryogenic components, which are used in the liquid gas supply chain for the purification, liquefaction, distribution, storage, and end-use of hydrocarbon and industrial gases. The D&S segment supplies cryogenic equipment to the bulk and packaged industrial gas markets. This segment's products include cryogenic bulk storage systems; cryogenic packaged gas systems; cryogenic components, including VIP, engineered bulk gas installations, and liquid nitrogen end-use equipment; liquid natural gas and liquid/compressed natural gas refueling systems for fleets operated by metropolitan transportation authorities, refuse haulers, and heavy-duty truck fleets; and beverage liquid carbon dioxide systems that primarily consist of bulk liquid carbon dioxide containers used for beverage carbonation in restaurants, convenience stores, and cinemas, as well as bulk fountain syrup containers. This segment also offers installation, service, and maintenance for cryogenic products comprising storage tanks, liquid cylinders, cryogenic trailers, cryogenic pumps, and VIP. The BioMedical segment manufactures medical respiratory products, including liquid oxygen systems and ambulatory oxygen systems; biological storage systems comprising vacuum-insulated containment vessels for the storage of biological materials; and MRI components that are used to transfer power and/or cryogenic fluids. It has operations in the United States, Australia, the People's Republic of China, the Czech Republic, Germany, and the United Kingdom. The company is headquartered in Garfield Heights, Ohio.

Answering The Bell - Global Turmoil

"A clever person solves a problem. A wise person avoids it."

Albert Einstein
_____________________________

In recent days there has been a lot of talk of the Federal Reserve adding liquidity to the system and/or cutting interest rates. Should the Fed come in and take action to provide a level of protection for what many seem as groups/companies that have been taking advantage of the already increased liquidity and readily available low cost capital? It is hard to know the answer until the depth of the current problems are fully known. Some hedge funds will not have firm numbers on their performance for a couple weeks still. The bigger, and possibly smarter ones, who have problems will probably be the first to confess their sins. Many funds have clauses pertaining to the time frames investors can withdraw capital. A couple mentioned in the news recently stated that August 15th was a deadline for investors to notify them if they wanted to take money out of the fund on September 30th. These redemptions are only adding to the selling as of late. There will probably be more and more to come.

The brokerage companies have transitioned themselves from toll-collectors back in the late 1990s's to very leveraged hedge funds today. A large portion of their earnings growth comes from trading. Another portion of profit comes from the hedge funds they service. This clearing business is profitable, and along with it comes the control of how much leverage they allow these customers to use. Combing through all these levels of risk will not be something that will be accomplished in just a few weeks. This story will play out for some time to come.

With the talk of a rate cut to rescue the market, below is a chart of the S&P 500 Index today and then another chart of the S&P from 1998 when the Fed stepped in to lesson the effects of the Asian Crisis.





Today's market is still above the 200 day moving average and is sitting on the red 2 standard deviation channel line. Does the Fed look at the market to determine when to act? They will say they don't, that it is only fundamental factors that determine their action. But, it does make logical sense that they will only take an action when they know things are at a support level where they have some other forces coming into to the market. In 1998 the market was well below the 200day moving average and was also 20% off its recent high. This was violent move down, and when the Fed acted, the move up was like a rocket. The result was a 33% rally in a matter of 90 days. Fortunes were lost and new ones made in the time of one quarter!

Below is the corresponding chart of the Dow 30. Will this index make it down to its 200day moving average? If it had more financial stocks in it like the S&P 500 it would be there already.



How addicted is the "market" and our economy to low interest rates? People have been hoping/predicting that the Fed will be cutting rates anytime now for over a year. Global inflation is a fact. Other economies in the world are growing at 5x the pace the U.S. economy is growing. If these global signs of inflation start to slow, then maybe there will be a rate cut. But there shouldn't be a rate cut because the S&P 500 touched its 200day moving average. If they cut rates now, what are they going to do when things get really bad. Fear from when they cut rates to 1% has now gone full swing to greed, and we are paying for another self inflicted problem now.

Which Mouse Gets The Cheese

The early bird might get the worm, but its the second mouse that gets the cheese!

It is always tempting to try to be the one who buys the low and sells the high, but in the end the goal isn't to be right, it is to make money. There are as many strategies and indicators as there are traders. That said, it is important to use tools that fit with your trading/investing personality, and to not try to find the system of the day because the market has turned choppy. Recently when combining three indicators, that I have personally used for years, into one indicator, the result is something that might be of help in turbulent times.

Below is a chart of the S&P 500 Index. The lower pane shows an indicator created from volume, the daily pivot price, a secret twist, and a moving average. This indicator is similar to other money-flow indicators, but the "secret twist" is the difference. I use this indicator to gauge the internal health of the market. If the index is trending with higher closes with good volume, the indicator tracts higher. If when the down days have greater volume that up days, it then starts to flatten out. This doesn't necessarily mean it is time to sell, but it does signal it is time to tighten stops and be more selective in positions held.



It is important to watch this indicator in relation to the zero-line and to watch the general slope. Another way to apply this is to use two moving averages of this indicator and watch for crossovers and zero-line crosses. Below is another chart of the S&P 500 going back to last year.



This chart show these moving averages in the lower pane. When the faster moving average crosses below the slower moving average it signifies it is time to tighten stops, reduce margin exposure, or trim positions. As long as the indicator is above the zero line things are still positive, but that doesn't mean ignoring the signs of slowing momentum. Below are some other charts to help get a feel for this indicator.

Nasdaq 100 - NDX


Bank of America - BAC


Goldman Sachs - GS


Applied Materials - AMAT


Juniper Networks - JNPR


Oil Service Holders - OIH


This indicator can be calculated with any charting software that allows custom indicator formulas. Telechart offers a free 30day trial if anyone is interested in applying this formula to their own charts. If you use Telechart or Metastock charting software, email me, technicaltradingpatterns@gmail.com , and I will share the specific code. If you would like to see this indicator plotted for a specific stock or index email me and I will email you back with a few charts.