Wednesday, May 19, 2010

Morning Update/ Market Thread 5/19

Good Morning,

Equity futures are lower this morning falling sharply after the close yesterday and being down as much as 100 points overnight. Yesterday’s close stopped exactly on 1,120 which is the 50% retrace mark of the entire bear market and was acting as strong support. We are now underneath that mark turning it now into overhead resistance with the 1,107 pivot and 1,100 acting as support and is now the key support area. It is not unexpected to test that area from below and rising back above it would be bullish in the short term – I would not be surprised by a short term bounce that takes us back over, but believe it will eventually fall.

McHugh received a couple of longer term sell signals yesterday, including his secondary indicator and his put/call signal that had been on a buy signal for the past year. Those signals are medium term indicators and do not change often.

The Dollar is down and the Euro is slightly higher after being pummeled yet again yesterday. Merkel’s naked short ban was taken as a sign of desperation, appropriately so. Venezuela also instituted limits on the trading of their currency. Currency controls and banning short sales NEVER work. The CDS restrictions will only work if they are done in concert with other countries joining in, and so far other nations have refused to follow their lead - that’s one of the reasons restrictions of that type don’t work. Below is a chart of the Dollar on the left and the Euro on the right:

Bonds are flat after being higher overnight. Oil is down again, now beneath $69 a barrel after trading below $68. Of the past 13 days, oil has now been down 12 of them. The 13th bar is typically as far as a move will run without correction, it would be quite rare to run further from a time basis. Gold is correcting some more, now just above $1,200 an ounce. If that area is breached, $1,170 is the next support area.

The completely worthless MBA Purchase Application Index plunged 27.1% last week following the expiration of the buyer’s credit. No, I still don’t believe numbers like that, and again only report this worthless index to you so that you know what garbage everyone is being fed by the Realtor’s Association – here’s Econoday:
The expiration of second-round housing stimulus pulled sales into March and April at the very heavy expense of May. The Mortgage Bankers Association's purchase index plunged 27.1 percent in the May 14 week on top of the 9.5 percent plunge in the May 7 week to pull the index to its lowest level since 1997. These results point to very weak home sales for this month and a new weight on home prices.

Falling mortgage rates failed to limit the fall in purchase applications but they did give a big boost to refinance applications which jumped 14.5 percent. Mortgage rates, being pulled lower by safe-haven demand for U.S. Treasuries, are at their lowest level since November last year with 30-year loans down 13 basis points in the week to an average 4.83 percent.

Wider refinancing will help keep homeowners out of foreclosure and will limit distressed sales, but the purchase results point squarely to new risk for the housing sector and will raise talk for a third round of housing stimulus. Existing home sales for May will be released Monday morning.
That plunge follows a very large drop in new housing permits. Low rates are good, but just look at the expense to achieve them. Literally trillions, its nuts, its fiscal suicide.

The CPI came in lower than expected, dropping .1% month to month and falling from 2.4% to 2.2% year over year:
Inflation is hardly a problem for the Fed. In April, overall CPI inflation dipped 0.1 percent after edging up to 0.1 percent the month before. Analysts had projected a flat headline number. Core CPI inflation was flat for two months in a row, compared to the median forecast for a 0.1 percent uptick. At the headline level, a drop in energy prices weighed on costs while food was still moderately strong. The core was kept low by extremely soft shelter costs along with a decline in apparel.

Looking at detail, the energy component fell 1.4 percent, following no change in March. Gasoline dropped 2.4 percent after a 0.8 percent dip the month before. Food inflation rose 0.2 percent in both of the two most recent months.

At the core level, apparel prices fell 0.7 percent and the huge shelter component was unchanged. Providing some upward pressure were gains in recreation, airline fares, and medical care.

Year-on-year, overall CPI inflation eased to 2.2 percent (seasonally adjusted) from 2.4 percent in March. The core rate slipped in April to 1.0 percent from 1.2 percent the prior month. On an unadjusted year-ago basis, the headline number was up 2.2 percent in April while the core was up 0.9 percent.

Consumer prices inflation remains extremely low-giving the Fed plenty of leeway in its timing of unwinding its balance sheet expansion. Bond traders should like today's news and equity markets should be happy that the Fed is not under pressure to tighten sooner rather than later. But markets are still focused on Germany's new limits on naked short sales. Also, MBA home purchase applications declined sharply, suggesting a slowing in housing.

A negative CPI is interesting with oil still falling sharply. It shows just how strong the deflationary forces are.

Some very sharp guys are starting to turn very bearish. Richard Russell who writes the Dow Theory Newsletter had this to say:
Do your friends a favor. Tell them to "batten down the hatches" because there's a HARD RAIN coming. Tell them to get out of debt and sell anything they can sell (and don't need) in order to get liquid. Tell them that Richard Russell says that by the end of this year they won't recognize the country. They'll retort, "How the dickens does Russell know -- who told him?" Tell them the stock market told him.

…Just as for years I asked, cajoled, insisted, threatened, demanded, that my subscribers buy gold, I am now insisting, demanding, begging my subscribers to get OUT of stocks (including C and BYD, but not including golds) and get into cash or gold (bullion if possible). If the two Averages violate their May 7 lows, I see a major crash as the outcome. Pul - leeze, get out of stocks now, and I don't give a damn whether you have paper losses or paper profits!
Pretty powerful statement. I have followed his writing for quite some time and can tell you that he is one of those old wise voices that may not time events perfectly but is almost always on the right side of them. He knows that all is not well beneath the façade.

Then there’s Hugh Hendry, another person who absolutely gets the fundamental picture and had this to say about China:

Hugh Hendry Shorts China, Betting on 1920s Japan-Like Crash

May 18 (Bloomberg) -- British hedge fund manager Hugh Hendry is betting China’s “credit bubble” will burst, causing its economy to contract and triggering a global crisis.

Hendry’s Eclectica Asset Management has bought options on 20 companies in international markets that will profit from “a dramatic collapse” of China’s growth that’s been fueled by an unprecedented lending boom, Hendry said in a May 17 telephone interview from London.

Hendry joins hedge fund manager James Chanos and Harvard University professor Kenneth Rogoff in warning of a potential crash in China. The nation’s 13 trillion yuan ($1.9 trillion) of new lending in the past 16 months, bigger than the economies of South Korea, Taiwan and Hong Kong combined, is spurring industrial capacity expansion in the same way Japanese credit built inventory during and after World War I, Hendry said.

“There are striking parallels with Japan in the 1920s, when ultimately the whole system collapsed,” said Hendry, 41, whose firm manages $420 million in assets. “China could precipitate a much greater crisis elsewhere in the world.”

Japan’s export boom collapsed after the war amid excess global capacity, slashing growth and sparking a stock-market crash and bank runs.

Hendry’s flagship Eclectica Fund, a global macro hedge fund with $180 million in assets, may gain almost $500 million from its options if China’s economy plunges into a recession, he said. The options cost the fund about 1.5 percent of its net asset value annually, Hendry said.

Lending Binge
China’s vulnerability to a crash comes from the “inherent instability” created by a lending binge for infrastructure projects that’s “unprecedented in 400 years of economic history,” Hendry said. The country is also exposed to exports to a U.S. economy that could shrink from $14.6 trillion at the end of March to $10 trillion within 10 years, he said.

Chinese officials allowed lending to surge starting in late 2008 to fight the global financial crisis. New loans rose to a record 9.59 trillion yuan in 2009 and banks advanced another 3.38 trillion yuan in the first four months this year.

“China’s at the mercy of a credit bubble,” Hendry said. “Once you’ve unleashed the genie it’s out there. They are ultimately unstable and it’s that instability that creates their demise.”

The Shanghai Composite index of stocks has plunged 21 percent this year, the worst-performing index in Asia, as investors sold Chinese assets on concern a withdrawal of stimulus spending and a slowdown in construction could choke off growth after an 11.9 percent expansion in the first quarter.

The Shanghai is already crashing, having peeled off more than 25% from its high last year.

When I hear wise voices like these I often reflect on Minsky’s bubble stages:
Some wise voices will stand up and say that the bubble can no longer continue. They argue that long run fundamentals, the ratios and measurements, defy sound economic practices. In the bubble, these arguments disappear within one over-riding fact – the price is still rising. The voices of the wise are ignored by the greedy who justify the now insane prices with the euphoric claim that the world has fundamentally changed and this new world means higher prices. Then along comes the cruelest lie of them all, “There will most likely be a ‘soft’ landing!”
That’s stage 5 of the bubble. Personally, I think we and China are now past stage 5 and already getting into stage 6 where the outsiders are starting to get infected with the selling.

China crashing, Europe in trouble, the U.S. bankrupt, our banks insolvent and hiding toxic assets… What a mess, a central banker debt money mess.