The Market Ticker

Oh boy, did that Bear Fund blow-up get some people's attention.

And while the "mainstream TV media" did try to ignore it, it didn't work very well.

See, this funny thing called the Bond Market didn't ignore it at all, breaking out back upward.

Last night I commented that it was "do or die" for the 10 in terms of direction. Looks like the decision was "do" - at least for now.

The reaction in the market as it started to tick up was instantaneous - the parabola took off and so did the market - south. Then the rate moderated, and the market rebounded.

So far.

The hedgie blowup is nothing to ignore. This is a big deal - a really big deal. The 10 is poking back at the uptrend channel, and there's an interesting "second-level wedge" that may be setting up on the yield. If so, then the march north on rates is about to resume - it just may happen at a slightly slower pace. Still, up is up, and higher borrowing costs are what they are.

This is why I commented the other day that this was not decided on the 10's fate in terms of heading south, and that one had to watch - very carefully - that bond, because it was at a decision point, or, if you prefer, it may have been "building a base". To those who think the bond is "done" and headed down - be careful buying into headfakes!

Well, it looks like that base got built, and we're headed back north on those rates. We shall see.

Now the fun begins - did people read Bloomberg this morning? Or The Wall Street Journal? Or just the ticker? :-)

In other words, is fear back? Risk being repriced?

Not sure. But calling this "consolidation", which Bob Pisani did on CNBS, might be a bit premature. The latest sentiment reading has the lowest Bearishness since 2004. That's a contrary indicator - when everyone thinks the market is going up, guess what happens? Yep. The market is great at catching people offsides and extracting the maximum amount of pain from your wallet if you attempt to chase it rather than trade it based on what's actually happening in the fundamentals. The latter, while often short-term frustrating, is almost always right in the longer term.

Look at Home Depot for an example of idiocy. Their customers can't afford the products, the company is in fundamental trouble, they spin off their wholesale supply line and then buy back more than a quarter of their stock, levering up in the process! Why? To prevent a share price collapse. But - while this gives you a nice short-term pop in the price when announced, you'd be wise to take that profit now, because the fundamentals of that company, to be blunt, suck, and if interest rates do continue to head higher, those borrowing costs will too, which will put even more pressure on their balance sheet.

The latest on the Bear Stearns hedgie blow up as of 10:15 ET - apparently other primary dealers are selling their subprime bond assets already, trying to figure out how to get through the door before the they choke on the smoke! The fire sale started ahead of Merrill's auction, as people started to get.... well..... nervous. This is likely to continue and is now threatening to become a stampede. This leads to the obvious question - will these marks to market kick off a tsunami of margin calls at other hedge funds? Hmmm..... Latest update at 2:15 PM: JP Morgan apparently has pulled their auction, but Merrill's still appears to be on for 4:00 PM.

In other news, Bloomberg is starting to run stories that sound pretty ominous on the broader economy - and housing. "Blood bath"?

"The jump in 30-year mortgage rates by more than a half a percentage point to 6.74 percent in the past five weeks is putting a crimp on borrowers with the best credit just as a crackdown in subprime lending standards limits the pool of qualified buyers. The national median home price is poised for its first annual decline since the Great Depression, and the supply of unsold homes is at a record 4.2 million, according to the National Association of Realtors. "

Is that good?

Oh, and mortgage applications are down. That's good too, right? You don't think higher interest rates might have something to do with that, do you?

Weekly oil inventory data came in with crude stocks way up, 6.9 million barrels - much bigger than expected. Gasoline supplies also up big, 1.8m barrels. Refinery utilization declined however. This caused an almost-immediate $1/bbl downtick in prices. But - gasoline is going to remain a problem with refinery capacity issues...... Looks like the 7 handle is on hold for a short bit.... but I wouldn't hold my breath on "for how long".

Then - wow.

I go out for a few hours to help a friend with his boat, leaving all my shorts sitting out there naked and raw, and boy, did they get a nice suntan - the profitable kind! Holy smokes!

I saw it happening on my mobile (ThinkOrSwim guys - awesome, including a VERY NICE mobile platform that works on data-enabled PocketPC phones!) and just kept chuckling.

And look at how the press spun this:

"NEW YORK (AP) -- A surge in Treasury yields rattled Wall Street Wednesday, forcing stocks to give up early gains and drive down the Dow Jones industrial average more than 140 points."

God I hate liars.

Guys, the 10 hit its peak for the day at 12:30 CT today, at 5.142%. It closed at 5.123%.

But the plunge in stocks did not happen until nearly an hour later, starting just after 1:00 PM CT, or 2:00 PM ET. I was at my trading terminal at the time!

So what really happened here?

I'll tell you what I think - although I can't prove it. I think the market reacted to the impending implosion of the Bear Stearns funds, deciding that it had enough of the obfuscation, and as a result we saw a selloff.

And who else thinks that might have had something to do with it? Bloomberg. The only straight-shooters in the room.

"June 20 (Bloomberg) -- Financial shares tripped over higher bond yields, sending the Standard & Poor's 500 Index to its steepest drop in two weeks.

Growing concern that losses in mortgage securities will spread helped drive down shares of JPMorgan Chase & Co., Citigroup Inc. and Bank of America Corp. Moody's Corp., the inventor of credit ratings, fell to its lowest in two months on speculation bond issuance will slow.

Rising borrowing costs may intensify a slump in the housing market that helped spur losses in two Bear Stearns Cos. hedge funds this year. Merrill Lynch & Co.'s decision today to seize and sell $800 million of bonds held as collateral for loans to the funds added to worries that the fallout from the subprime crisis may worsen. "

Wow, someone's being honest!

Then there's Marketwatch, which clearly is saying this is not over!

"An auction by Merrill, one of several investment banks that lent money to the funds, was completed late Wednesday, but more sales are planned on Thursday, the
person added. The assets for sale include mortgage-backed securities, collateralized debt obligations and credit default swaps. "

As for our friend the ABX, it did not have a good day today, and tomorrow may be worse. Much worse. Ominously, the CMBX BB index, which recovered some yesterday, went parabolic again today. Who is out there in the commercial space that is in trouble? I am still trying to find out and still have no answer. But this much I am quite certain of - someone is!

Ok guys, let's look at this a bit in the larger market context......

Is this "the trigger"? I don't know. Nor am I going to prognosticate on that specifically. What I will give you are some "trigger points" that you can look at to know if "the big one" is starting, and I remind you that all big stock market blowups are initiated in the credit markets. So while this is not "proof", the scenario fits! The trigger events that will convince me that we either are entering or about to enter a period of severe trouble are:

• The S&P closes under the 1490 level. That's second-level support, and has been approached several times recently - but it has held.
• China blows up (stocks). If their parabolic ascent is to be believed, this may occur within the next week or so.
• Goldman, Merrill, and Bear Stearns all close under their 50s. Both Merrill and Bear have. Goldman is all that's left.
• HGX has broken trendline support (today!) This is a marker. On technicals, it appears this may continue downward.
• The Nasdaq Composite breaks the 50. This occurs at roughly 2559. The Nasdaq usually breaks down first.

So far we are not there, but if this subprime mortgage stuff spreads, we will get there and in a big hurry. With the exception of China, we could hit all the other triggers within the next two or three days. If the triggering events are all, save China, satisfied Friday, we are at risk of a really nasty Monday morning - one that could come absolutely without warning - and I will be taking my "Hail Mary" trades Friday afternoon!

Now on a chartist's viewpoint, we've got some important things going on that I want to illustrate.

Here's the Russell. Head and shoulders, verrrry bearish. As I mentioned, a break above 855ish would invalidate the pattern. We didn't get there, truncated and headed down. Thus, the pattern is still in effect. The target is thus at least 790 on the downside.

Now here's our 10 year chart, with another trendline shown there. You can't see the whole thing but it dates back to early March, and is ascending.

I had this brought to my attention a few days back, but wasn't buying it at the time, because I want to see some sort of chart support first. But, this scenario may be playing out. If so, then the trend upward is not over, it has just resumed at the longer-term rate, which is slower than the hyper-ascent that was previously in force.

If true this means "its not over" on rates. I am still not sold, because we have only two data points in the current period on-line - but we held today and yesterday, so here you have it.

We're back to "two possibilities".

Here we are as I see it.

• We saw the top. The markets are being derailed by higher interest rates and jitters in the credit markets. Soon they will have even more to worry about, and the problems will ratchet up precipitously. If the above markers continue to sprout, the odds go up significantly that this has occurred.
• We have one more stab at all-time highs, perhaps to accomplish them in the Dow and S&P, before things roll over. Yes, this means that I'm not yet buying that "this is it", even though today sure looked like a panic to me once it got lit off. In fact, the afternoon looked an awful lot like the screaming part of a roller coaster!

The next couple of days will be tremendously important.

Interesting day!

Best Buy reported this morning and their results, to be blunt, sucked.

The hidden part of this announcement (from a standpoint of press coverage) was same-store sales. Up 3%, which sounds good, but in fact its terrible. Why? Because Circuit City is bleeding market share like an open femoral artery, and Best Buy is the beneficiary of that deterioration. Yet they're not benefiting much!

If you can only pick up 3% in gross sales when your next-best competitor is doing the "gusher of blood" routine, something is wrong. When your biggest sales gains are in low-margin products, even more is wrong.

Yesterday afternoon I took a trade on the July $47.50 PUTs for $1.25 and sold them this morning for $2.20. There was probably more there - it looks like I should have held them a bit longer this morning, but that's ok - it was a nice trade and a nice profit, with less than a 24 hour holding time. What's not to like about that? Not worth talking about that one, given that I didn't put it on until the close (thus nobody could have followed me anyway) up front...... Its Circuit City's turn to screw with the market tomorrow.

In other "ignored news", the Redbook Retail Sales index came in -0.8%, below forecast (it was forecast to rebound from last months -1.0%). The ICSC Store Sales index came in -1.0% as well, below the previous 1.0% increase.

Gee, do you think Chuckie is having a problem yet? How come we keep hearing from economists saying "the consumer is strong" when we have a 1% drop in retail sales - not from one survey, but from two!

And this, by the way, is the from the same prognosticators who said consumer spending would rebound in the retail sales for the month of May. Remember? April was an aberration due to bad weather and the Easter shift?

I'm back in as of yesterday morning with my Q PUT play.

Permits and housing starts came in like dogcrap, as expected. My shorts on the builders continue to look good, and I continue to ride that wave downward. In potentially very ominous news the western region of the nation showed the biggest decline in permits and starts; the western region has held up the best so far in the housing downturn. If we are now seeing this roll through to the west, we may be now seeing "reality" intrude into the "teflon" part of the nation, which bodes ill for future trends in this sector for the next six to twelve months.

On the goofy news page WaMu is losing some of its gains from yesterday on the clearly bogus buyout rumors. This sort of thing is getting to be so commonplace that I have to wonder if the companies are actually starting or participating in these rumors on their own! That, of course, could be highly illegal - but the pattern here, now going on for months, has to lead one to wonder.......

Potentially big, the 10 has broken the trading channel to the downside on yield. But it has also decoupled from equities - this sort of move a few days ago would have resulted in a monster rally in equities - its not happening now, with all the indices ignoring it today. As a consequence we have to take the 10 off the list of "market movers" for the time being. The next few days are "do or die" in terms of the 10s direction.

Oil is down slightly to $68.62 - just under $69. I still think we're looking for that 7-handle and its going to be showing up very soon - like this week or next. Its hard to make a bullish case if you can't keep inflation under control in things that people really need to buy, and that would include food and energy. So far, no dice on that. We need a low 6 price on oil or even a 5-handle to get there, and that's not in the cards. Neither is gasoline likely to get materially cheaper. Add to that food inflation and you've got real trouble, as these act just like a huge tax increase on Chucky, and Chucky ends up with less money to spend on things he wants to buy. Ergo, "Best Buy" - and if you think that story has had the last chapter written, I suspect you're going to be sorely (and perhaps unprofitably) surprised. Update: Late in the day the oil rally resumed, with it now trading over $69. That 7-handle looks inevitable and a few traders are now chattering about an eight handle. Can you say $4/gasoline? Hope so. Wanna bet on Chucky spending like a drunken sailor with gas over $3.50 before the end of the summer, and perhaps as high as $4 - and that's without a hurricane in the Gulf?

The mainstream media is starting to really pound the table on the subprime story, almost ignoring the real backstory on this - its not subprime, it is the irresponsible lending across the plethora of homeowners, which drove the ability of the asset bubble to expand to 5x annual income.

"This isn't about the economy; it was a preventable problem, and that's what makes me so angry," says Prentiss Cox, associate law professor at the University of Minnesota. Noting foreclosures have risen even as the state's unemployment has fallen, he blames the problem on bad loans and bad regulation."

Well, yes. But this isn't a subprime problem, nor one about minorities and other "disadvantaged" people. In short, the real story is one of greed, avarice, and conspiracy, and it started with the Federal Reserve's attempt to prevent a recession following the 9/11 terrorist attacks.

And since the Fed is, legally, a private corporation, there really does need to be a discussion about regulatory failures. Of course we know that discussion won't happen at the level it needs to, because if that box were to be opened you'd never get the snakes back inside and they'd bite an awful lot of people.

So instead we get the usual media play - "oh look at those poor minorities, those poor disadvantaged people who were preyed on by these eeeeeevvvvviiiilllllleeee capitalists."

Uh huh. Cut the crap USA Today. God, what a leftist pile of trash. And by the way, historically, yes it is about the economy, because housing busts lead economic weakness - not the other way around. Do you guys actually read history in your economics classes? Or did you get your "experience" in the field from a Crackerjack box?

Note that none of this whining is going to stop reality from intruding - eventually. Its ssstttaaarrrrttttiiiinnnnggg......

"NEW YORK, June 19 (Reuters) - Bids for the main index of subprime mortgage bonds dropped to a record low on Tuesday as concerns of losses at a hedge fund and weak housing suggest a deeper downturn for the debt."

The root cause of this mess was cutting the cost of borrowing to a net negative interest rate (this occurs any time the cost of money is less than the growth in GDP and/or inflation); in a circumstance where the cost of borrowing is less than inflation you can simply borrow money, put it into anything that expands in price at the inflation rate (better is even nicer), then pay it back and pocket the difference. This is not difficult to figure out and is the genesis of the "carry trade", yet it will always produce asset bubbles, as people who have more than a couple of firing neurons will figure it out and pile in!

But when a bubble pops, you get damage. Lots of it. And when leverage is involved the damage can vastly exceed the gain - you now have a situation where negative real impacts above and beyond the gains that were made can and will occur. When that leverage reaches astronomic levels, as occurred here with common ratios being 10:1, you have the stage set for catastrophic ripple effects that travel through the credit markets and reach "across the aisle" to equities as leverage unwinds and liquidity disappears.

So let's talk about what really happened here. The Fed, by making the cost of capital negative, caused a huge pile of money to flow into the economy in an attempt to prevent a significant recession. This capital flowed mostly into real estate, because we had just had a stock market "crash" in the tech area, and people were spooked by that. This drove affordability to all-time lows and inflated the price of houses.

Unfortunately, inflating the price of houses is a severely bad thing, because in the end people really do need houses and they have to be able to pay for them too! So when this "corrects", as it is now, you get severe market dislocations. Those who believe this will not "ripple through" to the greater economy are delusional - it not only will, it must, because housing-related activity is a huge part of our GDP.

Now add to this old-fashioned corporate greed and you have the genesis of real trouble. See, lenders make money off interest rate spreads, but they really make money when you walk in the door, by ladling up the pot with fees and costs, all of which you pay - either through higher interest rates, points, or just plain old fashioned cash. So it is severely to the interest of a lender to write you a mortgage that will force you to come back in a year or two to refinance.

Ergo, the famous subprime "2/28" loan and, for people with better credit scores, the "Interest Only ARM" or, for those who really want to juggle bottles of nitroglycerine, Neg-AM "Option ARM" loans.

But what the lenders also know is that most people who have crap credit have it for a reason, and those who buy beyond safe lending levels will still be beyond safe lending levels a few years hence. Divorce. A medical catastrophe. An orgy of borrowing without concern for ability to repay. An economic collapse in the industry where you worked (e.g. automakers). A housing market that continues to accelerate, making your personal affordability index even worse when you come back and refi again than they were when you originated the first mortgage.

These causes of damage do not go away in two years, nor do the bad entries in your credit report. In fact, those entries don't roll off for five to seven years, and until they do go away, your score will not rise enough to be considered a "great" credit risk. What's worse, the structured problem with affordability will not go away at all until and unless the market suffers a major price decline, wiping out all of your equity and perhaps more than you have built up!

So by writing you a loan that will reset in 2 years to a rate they know you cannot afford they force you to come back into the office and eat another helping of fees, while at the same time destroying the equity you built and the amortization time you consumed. In short, they turn you from being a "homeowner" into a "renter-in-fact", with the bank being the landlord.

Nice, eh?

What the lenders didn't count on was that the market for houses would turn - that equity wouldn't continue to build at a 10%+ rate. See, they were extracting 10% of the house's value in junk fees and "costs", pocketing the whole 9 yards, and they were not just doing it to subprime borrowers, they were also hosing all those with GOOD credit in exactly the same fashion.

This means that you need two years to "break even", roughly, on the refinance. Never mind that you never broke even at all - you took your built equity and gave it to the freaking bank!

But now you can't refinance and are stuck with a note you can't make the payments on! The inevitability of this happening - eventually - was known to the lenders and Realtors, who are, after all, the professionals.

I have zero sympathy for the lenders, CDO buyers and swap writers who are going to get their butts handed to them in this debacle. They profited by intentionally deceiving consumers up and down the line and they deserve what's coming to them.

This is not over by any stretch of the imagination as the market must correct to a median price to median income ratio of 2.5 - 3:1 before the housing market will recover.

We've "gotten away with it" in corporate earnings thus far mostly because this same bubble severely damaged the dollar as an exchange currency, making exports cheaper for other nations to buy from us. This means that if you're a Caterpillar, your earnings go up. Earnings up, stock prices rise. Nice, right?

But that doesn't help those of us who actually live in the United States and have to earn our living here. We see real inflation because the things we buy that are imported, either as raw materials or as finished goods, go up in price - precipitously so. Our trade deficit blooms, which means our reliance on foreign governments to finance our lifestyle increases as well. None of this is sustainable without a severe economic correction to the means, and we continue to whistle past the graveyard in the equity markets, believing that it will be all ok.

Well, it won't be guys. Home prices are going to decline. Not a bit - significantly. We have never managed to get through a major housing downturn without a recessionary reaction in the broader economy.

NEVER.

Further, as real interest rates rise, as they must globally and they are, the dollar advantage seen in the last six months will disappear as the dollar recovers. Thus, now you will see FX disadvantages in companies with foreign operations. Oops! Now couple that with slowdowns in domestic sales and.......

But, but, but... what if the 10 continues to slide and interest rates go back down, and so does the dollar? Then the "China Syndrome" happens - at some point foreign governments, faced with extreme capital losses since their US bonds are priced in dollars, are forced to unload or at least stop buying as our debt turns over.

When that happens then real interest rates skyrocket as bond sales to those foreigners disappear and so does our economy.

The "talking heads" were on again today - with a clown from JP Morgan saying "its different this time." Oh really? No big hit to construction jobs eh? You're not counting all those illegal aliens are you? Let me guess - in addition to not paying taxes, they also don't spend money at the store and gas station? Oh wait - they do? Hmmmm....

Reality is that this piper needs to be paid. And as with all things, he will get his due. It is simply a matter of when, not if, the chickens will come home to roost and start crapping all over the party.

The latest on the Bear/Merrill/Blackstone hedgie Nitro Pile is that the creditors aren't all that impressed with the purported "stabilization" plan. The word "bullshit!" has been rumored to have been said more than once....... will it blow up in their faces? It just might. There are all sorts of people who don't want to see a detonation happen (like, for instance, all those bagholders with OTHER bets in that space who would be crushed by a big downdraft and forced repricing of those bonds) but it appears that The Prisoner Dilemma is beginning to play out here, with the natives getting very, very restless. The first one who breaks ranks will start the stampede.......

The key question: Are we trying to herd horses here..... or cats?

And oh, by the way, on a technical level the S&P keeps bouncing off that 1535-1540 level. One of two things is coming - a breakout north or exhaustion.

Heh Chuckie, did we just see you do one of these, given the Redbook and ICSC stats released - ignored by the "talking heads" - this morning?



How's that end, exactly, and what does it mean for the economy - and equities?

Late update: It appears that Merrill has had enough of the BS from BS. They are now going to sell not $400m worth of subslime bonds but at least $800m. They apparently have started distributing a list of the securities to potential bidders.

A great second-order question to this - if this fund was levered at 10:1 (although it looks like it might be closer to 15 or even 20:1!) and loses 25%, exactly how does that happen without generating a margin call? You see, if I have $600m and borrow to a total of $6b, once the first $600m is lost, or 10%, I am now into borrowed money! In the world of people who are watching the store, I get a margin call at that point, because I am now out of "my" money and am losing the banker's cash! Apparently, this did not happen here, and the obvious questions become "Why the hell not?" and "If Merrill and others are watching the store with only one eye, how many more billions have walked out the door in losses that they don't know about (yet)?"

Why do I have a suspicion that this is nowhere near "contained" and we're going to be hearing a lot more about it in the coming days?

The WSJ has updated this story with the following:

"Two big hedge funds at Bear Stearns Cos. moved toward the brink of closing down last night as a bailout plan developed over several days fell apart in a drama that could have wide-ranging consequences for Wall Street and investors."

Looks pretty ugly in the late update......

BTW, here's the cute part of the story:

"It would have reduced each creditor's risk profile by 15%, the fund's managers argued, but it carried with it a stiff requirement in return: that no lender initiate a margin call, or request for additional cash or collateral, for a 12-month period. Some creditors found those ground rules unacceptable, prompting them to seek a quicker exit."

Now that's balls. Here's the gist of it:

• First, we lose our $600 million dollars.
• Then, we lose a couple billion of your money. You should have issued a margin call when our $600m was gone, but you screwed up (gee, was anyone watching the store over at Merrill and friends? You have to wonder - if their surveillance and credit management is this loose, what else are they ignoring?)
• You finally wake up and issue a margin call.
• Finally, as if losing all your money isn't enough, we cajole our parent company to put up $1.5b more, but we have the balls to demand that if we lose that money, plus even more of yours, that you not issue any more margin calls for a year!

It takes church-bell size balls to put something like that on the table, and begs the obvious question - exactly what sort of shizstorm do these fund managers think will be unleashed by an auction of this toxic waste in the form of mark-to-markets in other hedge funds and/or the primary broker's own portfolios, and how much of this crap does Bear Stearns hold themselves, since they were apparently willing to risk $1.5b of THEIR money to prevent the asset auction!

There's only one reason to issue a "request" like that - you believe you have a gun to the head of your creditors in that if they say no an auction of the assets will hurt them badly enough that they're willing to risk losing several billion dollars more in order to keep it from happening!

I suspect we're about to find out, since it appears that Merrill told them to go pound sand and may auction the assets tomorrow afternoon.

Beware when you see the tide unexpectedly go out, leaving fish flapping on the mud. While that might look like a great opportunity to grab some "free fish", it may also be shortly followed by, well..... just ask the people in Phucket.......

Yow.

28? That's lower than last month, and by no means is good. Oh, to find a number that bad you have to go back to..... 1991! Aieee!

The instant reaction was a little swoon in the indices, but they're now (12:15 pm CDT) clawing back. By the way, 50 is the "midpoint" in that index. 28? That sucks; no two ways about it.

In other housing-related news Moody's is finally fessing up and downgraded 131 more mortgage-backed bonds, sticking 237 more on review (negative.) Now if they'd only review and actually rate the real risk on the rest of the crap out there. Fat chance - how much business do you think they'll do with the issuers if they start downgrading en-masse, given the known risks to the collateral and the reset schedule (which isn't exactly non-public information!)

Next, Merrill Lynch, which was going to blow the final whistle on a hedge fund that Bear Stearns spun off (and which made some bad bets in housing) appears to have put things on reprieve. Apparently a lot of additional skin (a couple of billion!) is being put in, which outlines just how bad this got - and there apparently also is a deal on "no margin calls." Oh boy is that amusing. Of course you know how the "prisoner dilemma" works right? The first guy to break ranks can win big at the expense of everyone else. It will be interesting to see if anyone takes advantage of this possibility to "rape thy neighbor" in the coming days - what I've heard so far is that this isn't quite done yet, and the natives are still restless....

In the "money doesn't make your smart" department, we have this ditty - apparently wealthy people don't think their home prices will fall (even as everyone else's do.) Make sure you tell that to the folks out on the east coast who have had to cut prices on their eight digit homes - sometimes by 20% or more - to sell them. Oh, that has to sting, no? DeNile is not just a river....

Finally, in news of the odd apparently the rumor mill is all over WaMu (WM), claiming they might be a buyout target. Yeah, right. They're not only full of toxic waste in ALT-A and Pay Option (neg-am) loans (and in fact couldn't even meet their divvy from cash flow last quarter!) but have subprime credit card exposure on top of it! You'd have to be nuts to buy them, but heh, you know how the rumors are these days, right? Buy some stock, start one, sell into the runup that inevitably follows. When are you fools going to learn - if you pile into this crap you're going to lose your ass! How many times has this rumor been going on Countrywide? Has the company been bought? No? Weeeeelllll!

I shorted TOL this morning, and had an order out for PUTs on BHS (tried to short it but no shares available) which got filled on a "magic bounce" - not sure what happened, but suddenly there was a 30 cent spike in the trading price on the stock and my below-market limit order filled. It immediately traded back to the middle of its daily range. Someone playing games with rumors again? Wouldn't surprise me. That's a fairly thin issue and as such is kinda dangerous, but I also think its likely to pay pretty big - I'm playing August on it.

TOL pissed me off; I had a vertical on them which went out Friday and the OpEx crap made it slightly unprofitable. Looks like I just got it back on the short..... that'll work.

On the broader markets we've got a major problem with oil prices right near $69, and let's not be silly about the CPI numbers - core is irrelevant, especially when "Owners equivalent rent" (a big part of the CPI) subtracts out increases in utility costs! So energy price increases actually result in core CPI decreases.

You have to be kidding me. Only in our government is a cost of living INCREASE a "decrease" in a key inflation statistic.

A 7 handle on oil is going to be most interesting; that is likely to wake people up bigtime, and I think we're headed there. Maybe sooner than later; I would not be shocked to see oil trading in the $75 area within the next 3-4 weeks. As they say "is that good?" Only if you're an oil company! In that line, you might consider USO.....

In the area of "unintended consequences", The Bush Administration's plans to mandate ethanol content increases has led the oil industry to cut back refinery expansion plans. What happens if those "alternative fuels" push doesn't pay off - or drives food prices up through the roof, forcing them to be scaled back or even abandoned? Can you say "that's gonna suck!"

We have an interesting situation developing in the 10 year bond, with it threatening to violate the uptrend channel of the last two months. However, at least at present the lower boundary looks like it is holding as support. Should that channel break then the 10 no longer can be considered as a leading indicator on equities. I would not, however, go long bonds here, even though it sure looks tempting - the secular trends all point to the need for higher real interest rates, at least in the short-to-intermediate (days to a couple of months) term. A massive cut in rates is unlikely until the evidence of a huge recession is up on us. While I believe we're going to get one, that doesn't mean I'm going to try to "front run" it - why not take the better - and higher - entry point?

Lacking the follow-through that had to be there for me to buy in, I'm not going to make any major-sector long-side bets here. I see nothing on the economic calendar that is likely to move things in a major way, and plenty of downside risk. On the internals the markets today are showing more disturbing divergences - the A/D line is slightly negative but the New Highs on the NYSE are absolutely destroying New Lows - a 10:1 ratio as of this time (1:00 PM.) This sort of divergence just adds yet one more "la la la la la" whistling-past-the-graveyard sort of color to the broader market.

As this continues, assuming it does, I am going to be very tempted to start taking some "Hail Mary" trades. Things like the 44 Q PUTs for July - a 10% down move nets you a 8 bagger, an 11% move a 15 bagger, and a 20% move.... oh boy..... (~55 bags?! Wow!) Of course these truly are Hail Mary passes, and have a 90+% chance of being worth ZERO. In other words, the only way these work on the "money odds" is if we get a blowup - not just a correction. If its a zero, do it again next month.

Why do I think this may be a good play? Because I am becoming increasingly convinced that the "trigger event" is going to be a credit market dislocation of some sort, and it is nearly impossible to predict these with accuracy. As such I am becoming more and more convinced that the right way to play this is to remain mostly in either cash or tax-advantaged yielding things, have perhaps a 5-10% exposure in oil via USO as a short-term trade (stick a trailing stop under it once we see the 7 handle show up), with a 1% play in "Hail Mary" instruments like those 44 PUTs, buying them again if and when they expire worth nothing.

On the close the markets were down, although not much. The Nasdaq Composite was down a whole 0.11, while the SPX and DJI were down 1.86 and 26 pts, respectively.

Tomorow should be interesting with permits and housing starts out before the bell. I wouldn't be surprised if both numbers suck rotten eggs - in fact, if they don't it'll be time to short the builders even harder - who in their right mind builds inventory when you already have too much?

Have a good evening!

PS: No, the PPT didn't "get me". I was helping a friend with his boat engines. See, I have multiple talents! Typing with greasy fingers.... time to stuff the pie hole. First order of business for an organism - food!

Boy, listen to those Wall Street boys whine!

Congress has introduced a bill to change the way publicly-traded private equity firms are taxed, and they're not liking it at all.

Frankly, they're not going far enough. All hedge fund managers should be taxed the way they're proposing to tax the public ones!

What am I talking about?

Here's what all the furor is about.

When you invest, assuming you keep your investments for at least 366 days your capital gains are taxed at a lower rate. For instance, if you buy a stock for $20 a share and one year and a day later sell it for $30/share, you have a $10 gain per share.

Instead of ordinary income tax, you pay a lower tax rate on that $10.

This is justifiable because investment puts people to work. That is, by investing you make possible the employment of others, who will also pay taxes. The economy grows. Therefore, this beneficial act (to the general economy) is reasonably entitled to a better tax rate than ordinary income is. In addition, when you invest you take the risk of a capital LOSS - that is, you might buy that stock only to see it decline in price to $10!

At least this is the argument.

Well, for private equity guys, the game's a bit different.

See, they get 20% of the gains when they make investments and it turns out well. But they don't share any of the losses when the bet goes bad, because they're investing other people's money!

There is also plenty of argument about whether these firms actually add value to the firm they acquire. I'll leave that for another day - certainly, in some cases, they do - so the answer is not clear-cut by any means.

But when it comes to the risk of loss of one's personally-owned capital, the case is clear.

In my view, there is nothing here for them to complain about and in fact they should thank Congress because they've been able to profit from what was a clearly-wrong classification of their tax rate for a very long time! These firms should have ALWAYS had their management income from profit sharing taxed as ordinary income, because everyone else who earns on this basis pays that rate!

If you work for a company and they pay you a performance bonus of 20% of the firm's profits (split among the sales people, for example), you pay ordinary income tax on that bonus. Why is that not a capital gain? Because you are not exposed to a risk of loss if the firm does not meet its profit targets!

This has been an incredible windfall for these guys for years - a windfall that "ordinary investors" cannot take advantage of, and not even the rich can (usually) manage to pull off! You have to be able to find other people who will let you invest their money in order to pull this trick and get away with it.

Sorry guys, you'll find no sympathy here. As a trader and investor who has to take actual risk of loss of my own capital to qualify for the long term capital gains rate, I don't see where you should be able to circumvent those rules through tricky business structures.

I say pass the law and tax those gains as ordinary income - because it is.

Well that was fun.

Ok, some more charts. Why the hell not?



Note that 1540 level that we bounced off.

How come?

Well I just saw a post on one of the boards saying that "Technical analysis is useless".

Oh really?

So let's see..... back a few days ago I said that if the S&P didn't penetrate the 50, that we were setting up for one of two scenarios (the other was in play if we did.) That's technical analysis. We didn't penetrate, and we did get a rally back towards the previous high.

Worthless? By who's measure? What a load of crap. I hope it kept you from shorting into the close yesterday, or if you did, that you did so with every intention of holding on and didn't get scared out today!

I also said we had a nice channel established in the 10, which had broken the previous (many-year) channel to the upside. And, that the run early in the week was totally overdone - parabolic, in fact, with a nasty gap or two in there as well.



Well, we pulled back and filled that gap didn't we? Are we done? TA says the trend is still up, and until that channel is broken to the downside, it remains that way. How do we know "its over"? When that channel is broken. Is there a possibility that it will break that way? Maybe - the DMI showed a momentum change (a first) and the MACD may be rolling over, but Stochastics doesn't confirm. Yet. The gap is now filled, so the next move is likely to tell us what's up. In other words, we have a sideways (indecision) signal on bonds right now. Not a good time to short, not a good time to go long. Sit on your hands if you're playing the bond market until this resolves!

But more importantly - does it matter for equities? No. The indicator is over 480. Still.

What do we need to see to "buy into the rally"? Here we go - we need GDP to head north and we need to see oil get tamed. Right now oil isn't behaving at all, and there's this little thing called a "hurricane" that can show up any time in the next few months. Oh, and the Russell hasn't yet broken that H&S pattern.

On the fundamentals that CPI number wasn't all that good. The headline was hot and what's worse is that we've got a fourth month (out of five) with declines in inflation-adjusted wages.

Now let's remember something here - Chucky (the consumer) is 70% of the GDP - the economy.

So let's review, quickly, one more time:

• Rates have moved upward, and the next question is where do bonds go from here? We should know the answer to that within days. Watch that channel on the 10; the gap is filled, so we've now satisfied that. The technical indicators are sideways.
• Personal incomes are falling. This means that the consumer is spending money they don't have. But more debt gives us more debt service, and interest compounds against you just as investment returns compound for you.
• We have higher oil prices and no reason to believe that this will materially change. Are we ever going to see $2/gallon gasoline again? Probably not. Is the $3 level permanent? It may be conservative, especially if we get a hurricane in the Gulf.
• The entire cheap financing system appears to be coming apart. Washington is trying to tax LBO firms, the ABX got even worse today for the BBB bonds (not better; no stabilization there!) and the junk CMBX spread (BB) is going parabolic. Whoever was trying to lay off risk with all that shorting of bonds this week did not accomplish their goals. Better watch out here - that's a really, really loud warning horn sounding over there...... remember, credit market dislocations produce equity market crashes, not little corrections!

So where's our upside trigger on the S&P? The all-time intraday high, not necessarily the recent closing high, although a decisive break above it will convince me that, at least in the short term, I want to play the long side of the broader markets.

On homebuilders there is not a thing to like. My shorts remain open, remain profitable, and I'm considering adding a couple more. I've got a technical indicator or two I want to see flip on those specific stocks before I enter a short on them, and until I do, I'm going to wait. But we're close on those.

As for "Subprime is contained", go run that line of crap somewhere else. The credit market indices say its not only not contained but is spreading to the commercial real estate sector, with potentially disasterous results. While - so far - that has stayed in the junkier bond grades (BB), there's no reason to believe that is likely to remain so.

Never mind that Lennar got a warning today from Moody's. Is that good? Ratings downgrades on debt eh? I thought Goldilocks was eating the Bears?

Are you sure you got the Diner and Dinner in the correct order?

You won't hear this on CNBS and you most certainly won't hear it from Kudlow - but you will hear it here.

Next week the option machinations are all gone - except for the VIX, which goes out mid next-week. Bet on volatility being back and, if oil continues to move up or the bond guys decide that they might not be done selling, all hell is going to break loose.

Late nite - Oh My GOD..

You want to talk about "massaging the news cycle"? Well shit, here it comes! You know that ABX I've been talking about? Well now you know what's going on - they're starting to eat their own. Just a few hours after option expiration eh? How do you think the market would have looked if this had come out during the trading day?

"Concerned that an internal hedge fund at Bear Stearns Cos. wouldn't be able to meet a margin call, Merrill Lynch & Co., one of the fund's biggest lenders, seized $400 million of its assets and is preparing to auction them off.

The auction, in the coming week, could trigger the fund's dissolution -- the second blowup in recent months of a hedge fund that made dicey bets on the market for risky home loans, known as subprime mortgages."

That's called "you be screwed".

Was today it? Quite possibly. This is no small potatoes and it is not confined to subprime. Something similar is happening in the CMBX indices - I just don't know who to - yet.

If the commercial mortgage world gets nailed along with the residential, then its Katie Bar The Door.

I was chatting with some contacts I have in the bond world a couple of days ago and they were mutting about some "three sigma events" that had been contained. (That's three standard deviations out from what are expected; in other words, REALLY extraordinary stuff.) They wouldn't be specific and I'm not sure they knew what they were in detail - but the mutterings are starting, and so are the rumors, which are starting to be reflected in the spreads.

I might have been off by a few days, but it sure as hell looks like I also may have been right.

Watch out guys and gals, this has a really good shot at getting real, real ugly.

More as I dig around on this.....

By the way, from the chatter I'm seeing on some of the Internet message boards, let me be clear on how I view this, so nobody makes a huge (and potentially expensive) mistake!

While this event may indeed set off a chain reaction it is by no means guaranteed to happen in this particular instance.

That is, whether this cascade of events at Bear causes a re-pricing of risk is not known at the present time. As such attempting to short into this before the situation becomes clear is an extremely high-risk move and one I am not going to do - nor can I recommend it to others.

But - clarity should come to the forefront here quickly. Watch the treasury action to see if the rapid rise in rates resumes, indicating selling and/or shorting, and also pay close attention to the ABX and CMBX indices. If we see more precipitous actions in these indicators starting Monday it means that the market is repricing risk upwards and this is very likely to spill over into the equity markets.

If not, then the blast barriers have held - for now.

Note that I most certainly do not expect those barriers to hold for a lot longer. But there are folks out there chattering about shorting heavily Friday and/or going after the market Monday. Be careful trying to catch the exact top of this run; while it sounds like a real good idea in terms of profitability the fact remains that this has proven to be a losing strategy over the last year, as I and many others can attest. If you're going to chase this, do it with small amounts of money until the trend is confirmed and make very sure you have a tight leash on those trades!

The risk here is enormous. If risk starts to be repriced upwards we will likely see a near-immediate shutdown of the LBO and Private Equity debt financing market. Since this is all that has been powering the price of stocks over the last three months or so, such an event will immediately hit equities, forcing them back to the February lows at minimum. While such a "correction" would be deemed "healthy" by the media, there is a risk that this touches off technical triggers, because the counter-trend pieces that have worked so far - LBO guys coming in and "saving the day" by announcing deals - would not happen this time around.

Summary: For the start of next week, the key indicators to watch are bond yields on the 10 and the ABX/CMBX indices, along with any news stories that pop up on the Bear/Merrill auction. If you see a precipitous spike in the 10's yield and/or continued deterioration in the ABX/CMBX, especially if both occur, watch out - it means that the Containment Field is collapsing and a "Warp Core Breach" may be imminent. No matter which way to choose to trade this (if you do), remain fleet-footed and exit any move against your position - this is not a market in which you can trade on technicals or fundamentals alone, as the risk of a "rogue wave" event is now way, way out of the normal probability range.