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Since the AOL-Time Warner merger, this stock has seen nothing but stagnation and deterioration of price.  Investor confidence in AOL’s ability to execute has waned, and with good reason.  AOL’s management is the least effective in the online ISP/Search/Ad space.  Why would I say such a thing?  Because there is unimpeachable evidence that AOL-Time Warner is the weakest and most vulnerable to a total collapse.

Let’s examine their core income streams to better understand how the AOL division generates revenue.  Most of the revenue is generated from ads that Google delivers to AOL Search users and AOL’s failing dial-up ISP division.  Both of these fledgling operations are nothing less than unmitigated disasters.  On the search side, AOL has admitted that it can not muster the technological sophistication to run its own search engine or advertising, handing the reigns to Google so that AOL can concentrate on losing the rest of its dial-up business.

And losing, they are.  AOL’s dial-up business has faced a dramatic contraction in revenue growth as broadband becomes popular and dial-up prices dropped by over 50% in the last decade.  AOL hasn’t dropped their prices enough, their customer service is the worst in the industry, and many people can obtain DSL, cable or fiber and say goodbye to modems.   If they can’t go broadband, they can at least get a $5-10/month account at a faster and cheaper ISP.

AOL also suffers from another serious problem.  A talent vacuum.  This vacuum exists from the top down and has since the merger.  When’s the last time AOL did something new and original?

AOL has also lost its direction, its consumer appeal and ultimately they may face losing their remaining customer base as more appealing options are readily available.  They can’t attract new customers anymore.

Time Warner has been losing revenue in its entertainment division as movie and music sales dwindle.  Its cable company (TWC), which directly competes with AOL for broadband, has seen a slowdown in subscriber growth.

For all these reasons and more I believe TWX has the potential to retrace from this $13 level all the way back to $3-5 by mid 2009.  I suggest playing the short side as all major levels of multiyear support have been significantly broken down.  Single digits are likely as the next capitulation sell off gets under way.  I feel sorry for the folks that work at AOL-Time Warner, but there’s always ample opportunity to find another job while your company sinks!

I’m not going to blame the credit crisis on Chris Cox.  I’m not going to suggest that his inept management and incompetency regulating the equity markets caused a global rut or that his borderline illegal emergency orders exacerbated the underlying instability of a fragile market.  I’m not going to allege that he’s part of a cabal of crooked politicians that take their queues from the Wall Street Journal rather than executing their duties faithfully.

I won’t try to make him out to be some kind of puppet of the profiteers.  I won’t try to say that he’s in the pocket of big money.  I won’t allege that his motivations are suspicious at best and devious at worst.

I will say that Mr. Cox has single-handedly performed an excellent job of  staging the market for a collapse.  Abolishing the uptick rule July 6th, 2007?  Ingenius!  Way to ramp up the instability.  I’m sure VIX traders were delighted!  I’m sure short sellers were ecstatic.  Until, of course, you told them they weren’t allowed to short!  I wonder what happens when you tell one side of the trade to get lost?  Oh.  Right.  Wicked volatility.  Ah, what a nice roller coaster ride, Mr. Cox.  Care to find where I lost my lunch?

The oversold condition is correcting with a rally that lacks any conviction or merit.  Many sectors are still collapsing.  LIBOR rates are around 7%, Fed Funds have climbed to 5% and now we’re seeing credit markets start to completely lock up from the top down.  The Fed pumped nearly $700B in to the system, and it is still failing, showing that the bail out bill would do little to address the more than $5T in bad debt that’s buried in derivatives.

S&P 500 testing a key resistance level of 1150, which was our last tier of support yesterday before the market fell off a cliff.  The dollar is showing some unprecedented strength against the Euro, GBP, Yen and Franc.  Meanwhile, gold is correcting on the dollar strength.  Perhaps the dollar rally is predicated on the notion that the bill vote failure is deflationary.

Bond yields are rising across the curve as investors put some capital back to work in the equity markets.  Short term bonds are still yielding next to nothing as safety remains a high priority.

Energy markets bounce back after a vicious sell off, but oil has failed to successfully reclaim $100/barrel, while natural gas has found support at $7.

The bouyancy of equity markets entirely depends on continued injections of liquidity by central banks around the world.  Coordinated global rate cuts may be the next step as I mentioned yesterday.   Fed fund’s futures predict a 100% chance of a 25 basis point cut and a 25% chance of a 50 basis point cut for the October meeting, last I checked.

Conditions remain bleak and the path of least resistance remains to the downside.  Be very careful trading this market.  Normal market forces and logic have been surrendered as participants wait with baited breath for some kind of government intervention.

After yesterday’s record-making sell off of equities, we see US futures rallying about 3% premarket today.  That’s less than half of what they lost yesterday in value, but it is an impressive gain.  I don’t think it will last, though.  We’re still in a bear market where rallies should be faded and this is no different.  Watch for weakness midday.

In Asia, equity markets are dropping 3-6% from the continued fear sparked by the credit crisis, a lack of any resolution and the increased pressure from cash strapped institutions liquidating any assets they can.  This downward pressure is probably going to continue in Europe and the US during the Tuesday trading session, despite futures being at the highs of the session now.  Usually bounces like this end by 11am.  Be careful trading!

I am very concerned that regardless of whatever bill is passed, no matter the scope or size, it is not enough.  The OTC derivatives have already imploded, banks have already suffocated, many players and lots of liquidity forcibly removed from global equity markets.  Today’s sell off was the worst in 21 years and it’s probably not even close to the worst we’ll see in this panic.

I’ve been very bearish since late last year.  I really don’t think that many grasp just how bad it is out there.  We’re really heading off the deep end.  The potential here isn’t some multiyear lull.  It’s a decade or multi-decade long deafening silence, and that is after the panic selling has abated and the S&P 500 is in triple digits (something I’ve been calling for since late last year).  We’re looking to retrace a giant double top. Look at a decade long S&P chart.  Back to 800-850 we go, if we’re lucky.

Now, of course, the S&P 500 is priced in dollars and the dollar has seen dramatic weakness, despite the recent strength, in the last 7 years. Factor that in to the previous prices of the S&P during the dot com boom (where the highs were around 1550) and now’s prices where the dollar’s purchasing power has been dramatically reduced.  Lo and behold, we never made it back to 1550.  In fact, we’ve been in a decade long bear market so far, and now the fun part begins.  See the US dollar index chart below.

 The last inflationary bubble we saw with promiscuous real estate lending was the death throws of our bubble-based credit system.  The biggest possible bubble of all.  And now it’s burst.  The Fed and the Treasury act as though if they waste enough money they can somehow either reinflate or stablize it.   Throughout history, we’ve seen every single bubble all the way back to the Tulip mania of the 1600s, pop violently.  There is no way to do anything but provide a soft landing and even then there is tremendous moral hazard with government intervention.  As you can see below, home prices are poised to correct significantly farther down.

Given that real estate is the biggest bubble possible to inflate, we need not look farther than Japan for a model of how this may play out in the US.  Japan’s post-industrial solution to stagnant growth and deflation was to inflate the real estate market.  That ended miserably with a decade long financial crisis where many banks hid their insolvency by using accounting tricks.  Many of those companies had instruments that were tied to each other, much like we have here with all of these unmonitored highly leveraged derivatives.  Now Japan hasn’t seen growth for nearly 20 years and they’re bailing out our firms (Mitsubishi bought 20% of Morgan Stanley)?  This can’t be a good sign.

The market has deteriorated significantly as news that the House vote failed to pass the bail out package crossed the newswires.  At this point it may be unlikely that the bail out package passes or restores any confidence.  This market is very oversold, but the path of least resistance in the interim and long term remains down.  I am mostly cash and gold right now.

The Fed is quickly working with central banks around the world to increase dollar liquidity availability in an attempt to ease strains on the short term credit markets.  These moves further suggest that global rate cuts may be in the works as the stresses on growth continue to outweigh inflation concerns in many economies.

More info in the official Fed press release here: http://www.federalreserve.gov/newsevents/press/monetary/20080929a.htm

Looks like the equity markets in the US are continuing the global sell off.  I doubt any legislation will patch up the hole left by the implosion unregulated OTC derivatives.   On the S&P 500 December futures contract (ES), my system shows 1176 as Support 1 and 1162 as Support 2 for today.  The pivot is coming in at 1198 and R1 is just about 1213.  This gives us a very large trading range for today, but really only room to sell off to as low as about 1150 (near the September lows).

Risk aversion from overseas is increasing as we see the carry trade unwinding dramatically from a high of near $107 overnight to $104.80 now.  The flight to safety of gold and bonds continues as equity investors are being punished for holding the lowest quality paper of the corporate capital structure during this crisis.  Gold is testing the key $900 resistance level.

With the global economy poised for a recession, it is no surprise that energy prices are dramatically lower on the day.  Oil and natural gas are off over 5% as traders speculate energy usage will contract and inventories may grow.

As predicted, Wachovia has failed to stay solvent.  FDIC to absorb half the losses with Citi.  Depositors will continue to bank through Citi, who may choose to keep some Wachovia branches open.  Wachovia stock trading at pennies today in the premarket.

Karl Denninger is leading the charge to expose the risks of this bill to the American tax payer.  See his opinion here:

http://market-ticker.denninger.net/archives/594-MAKE-THIS-VIRAL-STOP-THE-BAILOUT!-SAVE-AMERICA!.html

Could an interest rate cut at the ECB be in the works?  We’ve seen interesting overnight activity indicating the rate dropped to 3.0% as liquidity was flooded in to the markets in an attempt to avert a panic over the bail out of Fortis and other troubled financial institutions.  Risks to growth seem to be worsening faster than the risks of inflation in the Euro zone.  Significant rate cuts by the end of the year seem likely.

Overseas the Brits nationalized some more financial institutions to “boost” confidence.  The GBP fell 475 pips to below 1.80.  Concerns about the economy are growing.  This is the biggest drop vs US dollar in 15 years.

As Washington Mutual’s collapse remains fresh on the minds of Federal regulators, pressure is increasing for Wachovia to strike a deal with its two bidders.  Wells Fargo and Citigroup have offered to buy the troubled bank.  I believe Wells Fargo will ultimately prevail as Citigroup has a myriad of its own troubled assets.

Asian and European equity markets sell off as traders speculate the US bailout plan is not big enough and won’t address the liquidity freeze up in credit markets.  This is an interesting turn of events and certainly not expected.   If US markets lose the 1200 S&P support level, we could see a retest of the September lows around 1150.  The path of least resistance remains downward.  Be careful trading!

The now familiar weekend bailout is once again underway. The Congress is approaching an agreement, which is ultimately less awful than Paulson’s completely ambiguous blank check, but still not ideal.  If passed, the temporary boost of confidence could cause global equity markets to rally in the short term, but reality will catch up as the global recession looms.  I don’t think we’ll see anything but lower highs in the S&P, but we could see a 200DMA retracement.  Watch key resistance levels around 1250, 1275 & 1300 on the S&P.  If 1300 is broken, watch the 200DMA as resistance and look to build short positions if it is unsuccessfully tested.

 Speculation is growing that the Fed may be losing its grip on the crisis and on its own balance sheet:

“In the last two weeks — if I am reading the Federal Reserves’ balance sheet data correctly — the Fed has:

Increased “other loans” to the financial system by around $230 billion (from $23.56b to $262.34b);

Increased its “other assets” by about $80b (from $98.67b to $183.89b);

Increased the securities it lends out to dealers by $60b (from $117.3b to $190.5b);

That works out to the provision of something like $370b of credit to the financial system in a two week period. And that is just what I saw on a cursory glance.

The most that the IMF ever lent out to cash strapped emerging economies in a year?

$30b, in the four quarters through September 1998 (i.e. the peak of the 97-98 crisis).

The most the IMF ever lend out over two years?

$40b, in the eight quarters through June 2003 (this covered crises in Argentina, Brazil, Uruguay and Turkey)

This is a very real crisis. The Fed’s balance tells a story of extraordinary stress. I never would have expected to see the Fed lent out these kinds of sums over such a short-period.”

http://blogs.cfr.org/setser/2008/09/26/extraordinary-times/

WASHINGTON (Reuters) - The U.S. Securities and Exchange Commission is ending its program to supervise large independent investment banks now that the five participants have collapsed or reorganized.

Obviously the program was a success.  Great job!

Washington Mutual is gone.  National City Corp is next.  Wachovia is hanging in the balance.

Pretty broad weakness right now across financials and the VIX is up nearly 10% to 35.96.  At the same time, money is flowing out of 13wk bonds, where the yield has increased 19.72% to 0.85%.   On the long end of the curve, 10 year bonds are down 1.63% to 3.79%.  We’re seeing the yield curve flatten a bit on those moves.

In foreign exchange markets the dollar has lost its luster and is now losing ground against the GBP and JPY.  Both seem to be trading in a limited channel.

In metals, gold prices are up 1% touching $890.  We’re definitely seeing $900 act as a key level of resistance.

In energy, oil has slid to $104, but seems to be finding support at that level.  Natural gas is down to $7.6, but may see some seasonal strength as we enter the Winter months.

The falling dominoes of the credit market are leading to credible potential for a global equity market disruption regardless of whether the bail out is passed.  The only thing the bill would do is delay the market capitulation.  The question is do we have some more inflation or do we experience the asset deflation crisis immediately…

As I mentioned in yesterday’s post “Corporate Welfare Wins”, Washington Mutual was struggling to survive.  The battle has ended in WaMu’s demise and much of their assets are being transferred to JP Morgan in a US Gov’t brokered deal.   This is the biggest bank failure in US history, but I doubt it will hold that title for too long.  Wachovia is at great risk if the bail out is not passed.  Money is continuing to flow from weak hands to stronger hands.  Overall there will be less market participants with less liquidity from more stringent leverage requirements.  This will likely cause wider swings from greater volatility given the reduced volume.   The outlook continues to remain bleak for the global equity markets.

When I read this quote, I thought I should pass it on to everyone who might be interested.  If it is true it has sweeping implications:

“The Federal reserve is not renewing loans it has made to banks.

They have repeatedly taken the stance that this is a crisis of liquidity
and have injected hundreds of billions into the financial system and
they are asking for another $700 billion to do the same.

However in the last several days they have removed over $110 billion
dollars; or approximately 1/3rd of all the money they have lent out
short term.

This is extremely unstable for our financial system and if allowed to
continue will result in more failures.

Many people that we’ve talked to are starting to wonder if it’s
intentional to create a crisis to get their bill passed.”

http://www.fedupusa.org/

We will probably see the bill pass by the weekend and with it will come a short term renewal of confidence that may boost equity indexes back to important levels of resistance at the 50, 100 and 200 day moving averages.  Overall, this is very bad news for the average citizen and their children who will foot the bill of the worthless paper that’s traded for cash.  US debt may face a downgrade as a result, causing further disruptions in credit markets and weakness in the dollar as foreign investors seek to diversify their money in safer investments.

Wall Street would have us believe that the rally is going to last, the bottom is in and today’s action with the Dow up at the high around 300 points shows us that certainly there is some positivity around the notion that the government will be the universal backstop to bad debt and other associated instruments.  Meanwhile, Washington Mutual’s stock is plummeting 30% at the lows of the day as the company struggles to survive.   If no one buys them, they will surely fail and cause another massive disruption.  Isn’t Washington Mutual the last savings and loan bank that has public stock?

We see equity indexes behaving as though the carry trade is back in full effect now.  As the Yen weakens against the  US dollar, we see funds pouring in to the S&P futures.  It’s a simple way for the Japanese central bank to support American market stability, while at the same time positioning their exports to be more attractive to American consumers.  Everyone wins, right?  Not if the rally is predicated on the notion that relief is within reach, which as of now it seems to be.

Remember that the SEC’s short selling ban expires October 2st and nearly 1000 companies will be open game for short sellers again unless the SEC creates new policy to address short selling.   October also brings the height of the ARM option loan resets to higher interest rates.  We could see a large spike in foreclosures and further deterioration of mortgage backed securities. There’s also the fundamental question of where valuations should be if we do return to a stable market.  Most traders would probably agree that given the deleveraging necessary to return to sustainable balance sheets, asset values are poised for further deflation.

We’ve seen bonds outperform nearly every other asset class, as the flight to safety has been fast and furious.  The short end of the yield curve is yielding 0.335%, which is actually up from the lows of the year.  The TED Spread is at record high levels, showing the stress in the credit markets is exacerbated by the uncertainty surrounding the corporate welfare bill for financial companies.  The current trend in equity indexes is lower with no sign of abatement.  Most emerging markets have been deeply affected, with China down 60% from the peak of last year to the trough of this year’s lows.  Russia’s financial crisis worsened to the point where the markets were shut down for days and in India and Brazil we’re seeing inflation continue to plague the central bank policy, causing an abrupt departure away from steady growth.

The world is in limbo right now.  Are we going to let institutions fail as capitalism would demand or will we socialize the entire free market in favor of stablizing a fearful world in the aftermath of the biggest asset inflation bubble in world history?  While the US Congress debates these issues the markets are deteriorating, as they should, given the uncertainty that forward-looking traders and investors have to factor in every day.

Right now we are on the precipice of the greatest global financial crisis the world has ever seen.  Most people are beginning to wake up to that.  We’ve seen some liquidation of mutual funds in retirement accounts, money markets become unstable because of Lehman’s collapse and AIG, the world’s largest insurer, have to be taken over by the US Federal Reserve Bank, because of balance sheet insolvency from “mark to make believe” accounting practices.  While legislators debate what implications this bill may have and how to oversee it prudently, I fear that this is by far the worst approach to solving a problem that stemmed from bad risk management and greed.  You cannot bail out the biggest banks with debt that is created out of borrowing at interest from the Federal Reserve and expect the problem to be eased.

Every government and Fed bail out so far and in the foreseeable future relies off of using public funds to bail out private sector mismanagement of capital.  Suddenly the entire financial sector’s balance sheets are reminiscent of Enron and we’re celebrating this by rewarding their worthless paper with billions of dollars from an already heavily debt-burdened Treasury balance sheet. We can’t expect this one to be any different.  Sure it may address short term credit market confidence issues for just enough to get us through another quarter, and to a new elected government in 2008, but it is not a solution.  It is a bandage on a gaping axe wound.  Eventually limbs will have to be lopped off because the infection wasn’t handled by Dr. Ben.  This is what I fear is next.

Instead of stemming the risk taking, the policies suggested and enacted thus far have actually created the opposite effect.  We give banks easy access to cheap capital as the Fed cuts rates, the dollar weakens and all of these banks target commodities as an investment, instead of putting the money to work back in the US economy.  Of course their argument is that they have a fiduciary responsibility to generate capital for their investors, and that allows them to operate in a completely apathetic manner towards the overall wealth of America.  Instead, they invest in metals, energy, grains, etc and the rally is the biggest and boldest in decades.  It was no coincidence that when credit became harder to access, hedge funds started imploding and the banks that benefited from the rally on the way up started taking profit or reversing positions while the economy slowed down, that the rally completely ceased and reversed.  The correction, like the rally, was the unprecedented in its scale and veracity.

In the midst of incredibly expensive short term capital, market participants that relied off leverage to create profits are imploding left and right.  Many models, like the ones employed by Bear Stearns, Lehman Brothers, AIG, Washington Mutual, Wachovia, etc. will not function in a world where confidence has eroded because of excessive greed and terrible risk management.  Many smaller boutique firms that receive less media coverage have also been facing redemptions, funds have been closing down at an alarming rate.   At the end of the day, there are less market participants and those remaining have less capital to employ strategies.

Many elements of the market system are changing very fast.  Be careful trading.  The risk hasn’t been higher for a long time.  Short term strategies seem to be the most feasible, but keep your eyes glued to your terminal!  I’m keeping my portfolio in cash with occasional conservative short term trades when the opportunity presents itself.  Good luck!

The world’s biggest insurer, AIG, is going under… if they can’t get some big loans they will surely implode.

This will continue to feed the downward spiral of financial markets and put pressure on every other institution, raise interest rate spreads and continue to force the market in to a state of illiquid volatility.

If you or anyone you know has policies with AIG, you may want to cancel them and move them elsewhere.
Again, I’m afraid this is only the beginning.  Washington Mutual will fail and Wachovia will fail or be bought out by a bigger bank by end of the month.

Merrill Lynch’s deal to be purchased by Bank of America is in FLUX.  It may not happen.  Anyone doing business with Merrill should closely examine how this may impact their accounts.  Especially if the deal falls through and Merrill fails.

What happens next is systemic credit risk spreads throughout the system, forcing debt to be much more expensive.  All these financials count on cheap money to leverage their operations.  This will cause the remaining independent brokers (Goldman Sachs and Morgan Stanley) to have to partner or merge with money center banks.  It will consolidate money and power to a few hands. There are about 2000 banks now.  At the end of this, there may be less than 1000.

I’m very concerned about the ever increasingly blurred line between the private and public sector. The bail out of Fannie and Freddie will serve to boost confidence in the short term, but I feel it is probably going to cost the tax payers trillions in the long run.

The FDIC is now running out of money to pay out depositors.  They will have to borrow from the Treasury.  This is going to be another financial event where the tax payers will shoulder the burden for bad banking practices.

I feel that once this crisis comes to an end, the financial landscape will be extremely consolidated and muddled.  The government will be in a position with incredible moral hazard with so many private sector investments.

The leadership that was from the strength in commodities has vanished.  Financials have bounced back but are still down on average over 30% YTD.  They are by no means leading us higher. 

As for the next bull market, I can not find a catalyst that will be suitable to stimulate a resurgence of equity values.  Financials will be strangled with regulation and unable to create structured investment vehicles with the flexibility they previously enjoyed.  Fees will be compressed and many brokers will have to find new lines of profit or fail completely.  Green energy isn’t going to find a catalyst without energy prices continuing their parabolic run.  The consumer is spent and the technology sector is going to suffer from that next.

My outlook may seem bearish now, but I feel that it is actually the most bullish outlook I can muster given the global and domestic economic conditions that are giving way to an unprecedented slowdown that is only in the first stages of affecting us.