Now that Fan-Fred has been put to sleep, we must now assess the impact upon the stock market. Futures begin trading at 6pm eastern time, but until then lets looks for clues in recent action:
Last week, there was a “flight to quality” as money fled stocks and poured into treasuries. That ended at 11:30am Friday. If you look at an intra-day chart of the 10-year treasury note, you will see a dramatic reversal. And that was the same moment that the stock market reversed. So, it looks like somebody big new something about the Fan-Fred deal at that time.
So, Phase 1 of the Fan-Fred short-squeeze rally began at 11:30am on Friday, and then accelerated during Phase 2 in the after-market when the Wall Street Journal broke the news. Of course, many traders didn’t realize what was happening during the day Friday, and weren’t paying attention after the close, so it stands to reason that there should be more short-squeezing to come.
In fact, on “Fast Money” after the close Friday, Karen Finerman, who is short banks, looked like she wanted to vomit. All the other traders who are short banks and homebuilders probably feel the same way. I would expect many traders to take long positions in the futures today to try and hedge their positions. So that would be Phase 3 of the squeeze, and Phase 4 would be after the open Monday morning when the short positions get barfed up.
How long will the rally last? The short answer is: not long. We are in a vicious global recession that is still intensifying. Many big funds are breathing a sigh of relief right now that they will be able to unload a lot of stock into this rally. Do you think that they are buying Paulson’s new catch phrase: “turning the corner on housing?” I don’t.
The end of the July-August bear-market rally had nothing to do with housing. It was Dell saying that global IT spending was grinding to halt that broke the rally. In case you don’t know, IT spending is a crucial economic category that was able to cause the 2000-2002 recession all by itself. Now, this new disaster is being added to the current real-estate disaster. And it ain’t going away just because some deck chairs were rearranged in Washington.
The big crack came on the first trading day of September. Once the big funds finished their month-end window dressing, they pulled their bids and the market went into free fall. At the same time that was happening, the price of oil was actually plunging as Hurricane Gustav approached the Gulf of Mexico.
As the energy sector was blowing up, other stocks fell also proving to traders that falling oil prices would no longer be a support for the stock market.
As the rush for the exits intensified, energy hedge funds saw the jobs report looming ahead on Friday. They knew they needed to be out before it hit, so the big crash occurred on Thursday.
This perfect storm of textbook bear-market action induced the flight to quality and money rushed into treasuries. That made it look like there was a financial panic going on, when in reality it was just a rush for the exits before the jobs report hit.
The surface-appearance of a financial panic caused Bill Gross to wet his pants, announce a buyer’s strike of Fan-Fred paper, and triggered the big bailout today.
In “Ho Hum, Another Bad Jobs Report,” Jim Cramer pooh-poohed the jobs report, and even tried to paint it as a postive because he thinks it gives the Fed cover to cut rates! Crazy!
Cramer also thinks that the hedge funds are done selling. That they had to get it all done before the fifth business day of the month to meet redemptions. So, his position is that it was just a little selling squall in hedge-fund land. That is simply denial.
When the first jobs-bomb blew up the March-to-May bear-market rally on June 6th, it took almost a month for the market to fall to the March low. This time, the drop from the rally highs around 1300 to the July low only took four days! This bear-market rally has been much weaker than the last one, and I don’t think that this Fan-Fred deal can revive it.
As the global economy continues to slow, the news flow will continue to be bad – even in housing and banking. Credit will remain tight, house prices will continue to fall, foreclosures will continue to increase, jobs will continue to be lost, etc. As hard as bulls-in-denial like Jim Cramer look for “the turn,” it will not be found.
The market hit a deep oversold level Friday morning, so a relief rally was likely in the cards anyway. However, I don’t believe that the market will rally as hard as it did off of the July low, the last time Hank Paulson saved the world. The crack came so quick last week that there wasn’t enough time for excessive short interest to build up. So, there is less fuel for this rally.
The financials and homebuilders may rally hard since the Fan-Fred deal affects them directly, but tech and energy? I don’t think so.
SPY closed Friday in the after-market session at $125.85, so we should expect the market to gap up to the bear-market rally breakdown level of 1265. Such a back-test of the breakdown level is not unusual. However, after the gap-up, additional short-covering should begin.
Could the market reach 1300? Perhaps, however by time it gets there it would be very overbought and due for a correction. In the mean time, more bad news is likely to hit, and I would look at such an event as a marvelous short-side entry point to ride down the rest of this bear.
While I believe that the big funds will sell this rally, they are smart traders, and I expect that they would hold back until the short-covering panic reached full-flower before leaning into it. They will likely use recent support areas to scale-in their selling: 1260, 1280, 1300.
And it’s not like the rally won’t have any headwinds. The euro (FXE) rallied after hours on Friday, and the dollar (UUP) fell. Now that the Treasury will be buying up huge amounts of bad paper, just like the Fed, overseas money may want to think twice about remaining in the USA. Also, a cessation of dividend payments on Fan-Fred preferred shares might trigger a wave of bank failures since many banks hold huge mounds of them and rely upon the dividends for a large chunk of income. Things could get exciting for the FDIC.
I have some QQQQ October puts. I will not be barfing them up. I have lots of cash, and I consider myself lucky to have another chance to deploy it short.
Note: For in-depth coverage of the Fan-Fred deal, Barry Ritholtz is on the case.
Note: If oil falls again as Hurricane Ike enters the Gulf of Mexico, be alert for another round of bloodletting in the energy sector.
SKF could finish green today! That would be the worst case scenario for the financials. What will keep them up going forward if even a socialist government bailout can’t do it?
DressGuard,
Good answer, and a great question.
I understand going in and out, long and short for trading reasons. I was wondering why anybody is buying a stock and holding it long term in this environment.
what I don’t understand is why rkh is outperforming xlf… This bailout is not good for the regionals. In the end it boils down to a concentration move in the industry.
Of course there will be a reason for all of this and time will tell.
Is the money leaving oil and tech going to cash or where does it cycle to?
is that a mini-head and shoulders on the SKF daily?
Crash,
The long play would be a bear rally to sucker in the retail investors, triggerred by Cramer’s cheerleading and the GSE bailout (reduction of financial Armegedon scenario). Also, certain people would love a pre-election rally to boost a certain party’s chances.
I don’t think anyone on this board believes in a long-term bullish play, but if they do I’d also like to hear their view.
long term …..do we inflat our way out ?
Dollar up and oil down. I only lost 5% today, was mentally preparing for 30%. I can’t explain the dollar and oil.
Tim: Do not believe Goldman, they are running low on credibility and are getting desperate. BDI fell another 3% today to 5,492 points. Now watch those August car sales in China come out later in the week and be prepared to get shocked.
We have a global credit crunch and everything is going down, incl India and China.
Charlie, maybe or the S&P500 are making lower highs and lower lows?
larry,was prepared for up to a 50% haircut actually up 10 % now, was up as high as 28% lets see if we have a nice sell off in the close
True…
Larry,
I wanted to post a link to a FT? article stating that China car sales are down, but the site didn’t update. And the Chinese seem to be most concerned about growth now.
Oil down because of Ike, dollar up because of dollar up in crisis. But what do I know. Maybe the hedgies are rallying the dollar as something has to go up.
The close should be higher for political reasons. I wouldn’t have believed it but it seems we’re still in this developing wave 3 of C scenario which would take the bottom out (Rich posted it on Friday). Too many bears in this forum…
Yerk, we will get bull one day.
Hello all,
I’ve been reading the comments, but staying away from the market, today.
I tend to agree with the view that too many vested interests do NOT want a market sell-off (panic? – how many times is it now that whenever the market sells off too quickly or is at a crtical juncture, some news/rules are instigated which cause a rally? ).
Personally I’m going to watch events play out for the next few days to see the commitment behind this last ‘rally’. There would be just too much loss of face for the ‘players’ if it were to sputter out too soon; BUT, then again, what do I know??!!
Good luck with your trades.
Matt, can you enlighten us on volume and TRINs? I cannot conceal a certain disappointment as the enthusiasm for government action does not live up to my expectations. Will I feel better later today? tom?
Pooh…
I’ve been out all day and missed some great action.
I’ll most likely have time to get into something before the close.
Hope all of you are doing well.
The TRIN and TRINQ have been above 1.0 all day, so it looks like the big funds are using this rally to unload stock as I suspected that they would.
The volume on the major ETF’s was strong. But even though the volume bars on the charts will be green, that is wrong. The volume did not push stocks up. Asking prices were simply lifted at the open, and then the volume pushed stocks down from there. So, I score today’s heavy volume as a negative.
If the Q’s can’t make it back to even, it will be the sixth consecutive day of the tech beat-down. The Bush administration is certainly doing its best to hold the market up, but I think too many people overestimate their power. Just one look at the QQQQ chart over the past week shows that nobody can hold them up.
Thanks, Matt. I start to feel better now, although I missed the move…
The Q’s are lagging SPY and IWM by 2%. That’s a huge lag, and a huge red flag. In fact, it was a red flag in the futures overnight too. The NASDAQ-100 futures trailed the S&P 500 and Russell 2000 futures by 0.5% all night. The high-growth companies are lagging because there is no growth in the economy. The pros will not buy into a market with tech doing so badly.
I agree with your analysis, Matt. The bulls had trouble right out of the gate, and looked very weak mid-day. They had a nice rally 3:00-3:30pm, but even that momentum faded into the close. Besides tthe Qs closing down, the VIX finished near unchanged (down 1%), another warning sign for the bulls. It should have been much easier if the bailout was the magic pill that some had been clamoring for.
This morning I wasa wondering if the rally would last until the election in November. Now I am wondering whether it will last until Friday, although I did clear out some of my short positions mid-day, now that the game has changed (again). I’m still scratching my head at why the USD moved up as well.
Matt, I also agree with your analysis. I was near term bullish earlier, but after seeing the way various sectors traded, i highly doubt this rally lasts. i shorted some of the indexes just prior to the close. thx for all the commentary and analysis. the site definitely helps my personal trading.
Inflation= 45% increase next year in my health care premiums.Deflation my raise for 2009 2.25 % Assets income=deflation Necessities=inflation
By the way great analysis on the close
Matt,
thanks for the analysis. BTW.. are you holding any positions right now. IMO, I think this market seemed pretty weak given the huge volume as well as the large gap up. The market never made it back to the opening levels so I question this rally. Having said that, I still think that there may be some further upside in the market as it did regain it’s recent trading range. Maybe will give it another few days to see if the bulls can push it up to the 1300 level, but that is looking to be a very momentous task at this point.
Hey guys,
Here’s another warning bell that I missed that was mentioned on “Fast Money”: Google dropped $24 today
Matt,
Call me contrarian but I think we had an exhaustion gap on the Nas. Today’s activities confirmed Friday’s gap.
On Macro Man, there is one comment by cds trader who provided some observations and thoughts on CDS settle issue. I will repost his opinion here. The following are the quotes from his post:
“From what I can see so far, it looks like both senior and subordinated CDS will have 100% recovery (this is pretty unusual), so basically all the contracts will just get torn up for “no cost”.
I see “no cost” because what ends up happening is that if you’ve traded CDS in these names profitably, you’ll actually be losing money, and vice versa if you were showing down on your CDS trades on Friday you’re in for a windfall gain. This is because your profit in CDS is the Present Value (PV) of the future cashflows, but when a CDS triggers, the premiums stop getting paid so that PV you’d assumed is actually zero.
If thats not clear, here’s a little example:
I buy FRE sub CDS, 5y, at 50bps in $100mm, a while back. Nice trade, since it then widens to 250bps, where I sell it in $100mm. What’s my profit? Well, its 200bps a year for the next 5 years, discounted at the risky rate. 200bps = 2%, and lets say 5 years worth of that is worth 8% (not 10%, as we’re discounting those future cashflows).
SO…my P+L is showing up 8% of $100mm = $8mm. Great, nice trade. EXCEPT…along comes todays event, CDS triggers, but bonds are all above par. So the PAR – RECOVERY payout (ie. getting paid 100 in exchange for “defaulted” bonds) is zero, BUT all the CDS contracts stop paying the premiums.
So now I have received no payments, but my CDS trade where I was paying 50bps has gone away, AND the CDS trade where I was receiving 250bps has also gone away, so now my P+L is zero. Unfortunately, I’d already taken my $8mm P+L, so what this means to day is that I’ve just LOST $8mm, and that was from trading well apparently!!
Quite a few people will get surprised by the effects of this today I think.
Oh, and hopefully once all this gets settled no problem, people might start to realise that the CDS market is actually pretty stable and isn’t going to “meltdown” or “blow up” any time soon.
Rgds,
the cds trader”
https://www.blogger.com/comment.g?blogID=34323687&postID=6739816255271008536
Just wondering if the government going to give us $10,000 rebates when we buy these new American fuel efficent cars.
Kevin,
I don’t think that an exhaustion gap should be confirmed. If the selling were “exhausted”, why did it continue today? The Q’s spent 4 hours below Friday’s opening gap-down price. So, I would say that it was a gap, but not an exhaustion gap.
However, I will say that since the Q’s are so dramatically beaten down here, they should be able to mount a counter-trend move soon.
Matt
Hey Matt,
there are a lot of conflicting theories out there right now. Some people believe that the S&P just made a “kiss of death” on the 61.8 retracement from the recent lows, some people think that today’s action was very bullish into the close by reclaiming the recent trading channel as well as the 1263 mark on the S&P.
I would like to get your thoughts. Are you bullish short-term and bearish longer term?
Any insight on what Institutions were doing today?
Charlie. I’m trying to figure out what the Kiss of death is.
Meaning stocks will go lower?
I got a few charts i’ll try putting up by tomorrow where i compare the indu and the trin and i came to a conclusion that soon we might see another decline to maybe the 10,800’s and then start the bullish run later next year but i’m talking long term so don;t mind me.
The “kiss of death” is basically when stocks rally almost to a existing trendline and then sellers step in and a significant drop occurs.
ok almost time for tuesday’s trading post. this is getting too long to scroll on mobile hehe.
Asian markets getting slapped pretty good tonight down 2% tonight, we should follow suit tomorrow and have a modest rally starting Wedsnday.Matt allthough the Q’s are pretty beaten up would you not think you would get a better rally with the DIA.TIA Pooch