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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.