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As reality quickly dismisses the holiday optimism that swept through markets last week, equity indexes are paring their gains and looking lower to reprice risk. The Yen is especially strong today as the carry traders give in to fear. This is likely the beginning of the next selling stage as outlined in my articles from last week. If I am correct, I expect we retest the 741 intraday lows and possibly break down below to the 600 area in the coming weeks and months.

Examining a longer term chart of the S&P 500 confirms that we are still in a falling wedge pattern, despite recent gains. Should the rally give way here, many traders will begin selling in to the weakness.

We could see the S&P climb as high as 900 without fundamentally violating this pattern. Support areas are shown with horizontal lines on the right side.

Why have we witnessed four up days of trading that rocketed from the lows of 741 to nearly 890 on the S&P 500? Is it the start of a new bull market? This would be a very pleasant scenario, but bear market rallies can last days or sometimes even weeks and months. The most violent rallies, like those as of late, are generally short lived. The last time the market was up four days in a row was April, 2008.

How are bear market rallies possible?

Lately we’ve seen anything from government appointments to bail outs of multinational banks significantly lend to positive momentum. This is quite a contrast from the traditional inspiration of good earnings or economic data.

Bear market rallies are not created by investors buying to commit capital in to a stock for the long term, but instead by short covering and trading. The short term horizon of the participants and the lack of fundamental positive catalysts usually lends to these rallies collapsing to worse levels than they had climbed from, rather than a constructive bottom forming process.

When will we see the bottom?

A) The worst must be over: House prices are still dropping, unemployment is rising, consumer sentiment pushing all time lows and credit availability is tight. There is likely another leg down coming in both commercial mortgage backed securities and consumer credit card defaults.

B) There must be a positive catalyst within sight: Green energy has been promised to be the next bull market. Is there demand for these measures when oil is at $50 a barrel? The other question is, after committing half of last year’s GDP to financial bail out programs, how will the Federal Reserve and US Government continue to finance their spending? More importantly, will foreigners continue to lend to a less credit worthy nation?

C) The Federal Reserve must complete lowering rates and change to a neutral or tightening bias: The next Fed move will likely be another rate cut. To Bernanke’s Fed, deflation is still a bigger threat and he has the helo running full time dropping cash. Until this reactionary behavior is over, there is no sign that we are out of the woods.

D) Businesses must begin buying back shares: Many buyback programs have been halted, not accelerated. We have not seen corporations step back in and buy back their own shares. We also haven’t seen many insiders provide substantial equity commitments in their companies as of late. This is an important component of building a sustainable bottom.

E) Risk indicators must begin to show signs of significantly decreased aversion: The Japanese Yen, crude oil, one and three month T-bills (and lately even the long bonds) have all shown us that the flight to quality and away from risk (or growth) remains. The VIX is still above 50 and has major support at 45. Even gold prices are back above $800. Fear still seems to be a greater motivation than greed.

What are the charts saying?

The above S&P 500 chart is not confidence inspiring. The trend lines illustrate the wedge patterns and the horizontal lines show major resistance areas.  Currently the stock market is bumping in to major resistance. My indicators confirm this rally is overbought and due for a correction soon. 

Where are we heading next?

Based off the above analysis, I don’t feel this rally will get much above 900. Instead, we need to retest the intraday low of 741 on the S&P in the next few weeks.  There will probably be support areas on the way down at 875, 850, 830, 800 and 776. If the 741 low doesn’t hold, 600 is the next level of major chart support.

If you’ve made some money on the rally, don’t fall in love with the upside.  Remember that we still have a lot of problems to work through.  Folks with investments should use this as an opportunity to raise cash. If you’re looking to trade this rally, you may want to begin adding to short positions.  FinViz.com has some great tools for screening stocks if you use technical analysis to find your trades.  Good luck and stay safe!

Once again we find ourselves in the midst of a panic. After a long series of financial firms getting bailed out because of poor risk management and greed, now Citigroup prepares to receive tax payer funds in the amount of $100B or more. Pandit, Citigroup’s CEO, has been unable to restore confidence or restructure the international banking giant’s numerous units to restore stability, let alone profitability.

Even after numerous capital injections, receiving TARP funds and having access to all of the Federal Reserve programs, Citigroup is unable to stay afloat on its own.

There is a problem, though. Citigroup is incredibly interconnected. More than Lehman, AIG, Washington Mutual, Bear Stearns, etc. If they fail it could have a cataclysmic effect on the world financial system.

With Citigroup’s shares trading below $4 on Friday, the company is in dire trouble. Down over 90% from its high a year ago with no way to restore confidence. The stock plunge has created enough of a panic to break the 2002-2003 technical support level of 776 on the S&P 500.

Bailing out Citigroup will likely be more expensive than all the other bail outs combined. It is the fifth largest US bank and has over a trillion dollars in assets, many of which are defunct. Other firms have offered to step in, but only if the US government buys all the bad debt.

What’s next? Expect more business failures and the S&P to trade down to 600 and possibly 450. Those are the next major levels of chart support. This will be the worst recession the US has seen in at least 50 years.

The global equity markets hang in the balance now, with multiple key levels of support broken. Most recently the 2002-2003 recessionary lows of 776 as we closed at 757 on the S&P 500 today. Selling accelerated in to the close with the 776 level retested for the second time in the day and this time broken, after initially bouncing in to positive territory on a bounce from the first test that traders took the opportunity to short.

You may recall that almost a year ago I wrote about this possibility. Now we have confirmed the 10 year double top. The S&P 500 may now be poised to retest between 400-600 as the selling increases. There is some chance of a bear market rally first as the broadest US index is oversold by some measures. In either case, the world remains breathless as some of the worst selling in history destroys asset values across the board.

We saw an impressive rally in the airline stocks yesterday:

AMR rose $.94 or 11.4 percent, to $9.20.
AirTran rose $.41 or 11.8 percent, to $3.89.
Continental rose $1.55 or 10.1 percent, to $16.94.
DeltaAir rose $1.56 or 19.5 percent, to $9.55.
JetBlue rose $.70 or 15.5 percent, to $5.21.
Southwest rose $.40 or 3.7 percent, to $11.24.
UAL rose $2.18 or 19.8 percent, to $13.18.

The rally was predicated on the notion that the Delta and Northwest merger would benefit the
industry.  In addition, crude prices have moderated.  Is this enough to justify a 20% rally
on half average volume in United Airlines (UAUA)?  Today we shall see if the stock can hold on
to its gains.

At this point we are watching UAUA closely as we feel it is overbought and stands to correct by
10-20%.  If major support is broken it could return to single digit levels.  The fact is that
during a major global recession, airlines are going to see a lot less business.  United has the
worst balance sheet, inept management and it is doubtful that they will find the capital to
finance any kind of merger.  They also have very high overhead, because of their high employment
and many hubs.  We expect this to take a toll on investor confidence moving forward.

We began building a short position yesterday in anticipation of an overbought market correction
today.  We feel there is still opportunity to short this stock.  Good luck trading!

Always be careful of how you invest during a bear market.  Rallies happen, but rarely are they a sign of a meaningful bottom, especially if there is no end in sight to the economic problems.  Sometimes the rallies look promising and powerful and the pundits come out of the woodwork to “call the bottom”, in retrospect, of course.  But markets don’t bottom overnight.  It is a constructive process that can take days, weeks or even months and years.

Don’t rush to invest large sums of money you can’t afford to lose in a bear market.  Remember that most money managers lose money in bear markets and they are professionals.  Unless you have a lot of experience and a lot of spare cash burning a hole in your bank account, don’t speculate too much.   A prudent approach would be to invest 5-10% of your income per month in a value-based diversified international mutual fund or ETF.  That way you aren’t attempting to call a bottom and contribute regularly when the market is in the process of revaluation.  This approach works with one necessary future component.  Growth.

Don’t get caught up in the emotion and get stuck on the wrong side of the rally’s collapse.  Technicals help, but are not perfect in this kind of market.  Remember that there are plenty of charts on the bottom of the sea, right along with the ships whose navigators trusted them.  Always watch your positions and use stops.  I don’t feel we are at a bottom yet as the economy stands to deteriorate significantly.

With or without a successful resolution to the credit crisis in the near term, we still face a global recession that can potentially compress the margins corporations worldwide.  Some have speculated that this has already been priced in to stocks during the 25% correction we’ve seen in October.  Others, including myself, have a more gloomy picture painted.

One doesn’t need to predict the future to understand the lessons of the past, the human psychology of markets and the massive borrowing that led us to the top of the biggest financial bubble in history.  The tulip mania craze will be seen as a walk in the park compared to the massive leveraged world we live in now.

Simply put, every single person, company and government will finally have to start living within its means, rather than borrowing based on the promise of future earnings.  This will break down consumerism.  Consumer spending accounts for 75% of the US gross domestic product.  What happens when the consumer isn’t spending?  Deep protracted recessions with L-shaped recoveries.

Now our national debt is larger than our GDP.  Of course the United States’ wonderful standard of living is supported by the tremendous generosity of foreign central banks and sovereign wealth funds, to the tune of $2 billion a day.

I have a funny feeling that when our treasury bills are backed by defaulted mortgages, junk credit cards and bad auto loans that our debt rating will be downgraded from AAA and foreign money will flee from the US as it never has before.  Leaving the government without the funds to support social programs or even some vital infrastructure and state funding.  The only option is massive tax hikes or huge program cuts (or perhaps both by mere necessity).

Everyone wants to have their confidence restored in financial institutions, but when I read headlines like, “SEC Loosens Accounting Rule Banks Blame For Crisis“, I have to start seriously questioning the oversight role the SEC has lackadaisically administrated and the devious flexibility that very lack of supervision gives banks.  What the above headline and the linked article illustrate to me is that the SEC had no handle over what the assets these banks held on their balance sheets may have been worth and now that they’ve taken a peak apparently they are not pleased with what they saw.

Hiding the assets from markets is only going to further ruin confidence.  Now we can no longer trust any earnings from any institution that has exposure to troubled assets.  Not only that, but we can expect them to artificially value the assets higher than their worth and foist them on the Treasury when the TARP (Troubled Asset Relief Program) begins their auctions or direct purchases.

This is a major breach in transparency and a move in the opposite direction from finding a conservative and clear accounting standard that institutions should be held to.  The opacity of today’s bank balance sheets combined with the new ability granted by the SEC to mark assets as banks see fit make this investor lose all confidence in America’s banks.  The situation here is too reminiscent of Japan’s “solution” to their own real estate bubble meltdown.  We all know that Japan’s recovery, if one can even call it that, took decades and is still underway.

Global deleveraging and a recessionary environment that engenders high unemployment will hinder equity performance.  Banks, while now more solvent, are still afraid to lend out the cash that they continue to horde.  We must see more liquid markets with more fluid lending or the 800 bottom area on the S&P 500 will not last long.  Next level of major support is 450.  Watch out below.  Keep your stops on every trade.  We still recommend fading overbought equity market rallies.

US equity markets are giving back gains seen earlier in the day and now turning negative, crossing below the VWAP (1014), testing the pivot point (990) and set to possibly retest support (960) on the S&P 500 if the selling continues at this rate. This is likely because redemptions and liquidations are continuing from individuals, banks and funds. Keep an eye on 960 as that’s an important level of short term support. We are still looking for the correction in the dollar to continue.

As global government debts climb higher at a frantic pace to bail out insolvent financial institutions, global equity markets are having an incredible rally.  Will these massive injections of liquidity, equity stakes and balance sheet asset swaps effectively quell the confidence and earnings issues, enabling banks to lend again and generate profit?  Or will new regulation clamp down on banks’ ability to make a profit?

We believe that while there has been an impressive rally off of what may be the lows for this sell off, we don’t see a new catalyst for a recovery.  We doubt financials we lead us out of the crisis and obviously another looming problem is the real recession.

Unemployment is due to spike, given that layoffs have been accelerating around the world.  Add to that many baby boomers that may not be able to retire and instead could pick up hours to rebuild their savings.  We could see a very stressed job market.

At this point we’re watching all the economic indicators, headlines about company employment force consolidation and will report back when we more information about the outlook.

I think we’re getting closer to a sustainable bottom in US equity markets. Last week looked like capitulation from hedge funds, individual retirements and banks. I went shopping for value in the afternoon when the VIX hit 75. Keep an eye on tomorrow’s trade as today was a light volume day because bond markets and banks were closed in the US.

After we see the rally play out we’ll likely see the bear market conditions resume.  Be careful trading!

As the G7, G20, IMF and World Bank members convene in a concerted attempt to buy the bottom in equity markets by endorsing the stability and availability of overnight lending, I’ve seen a flurry of headlines that vary from alarming to amazing.

Some examples include:

“IMF warns of financial meltdown” - Gee, you don’t say?

“Paulson warns emerging markets not immune to turmoil” - From what I’ve seen emerging markets are the center of the worst sell-offs.

“GM and Ford discussed merger” - Two troubled automakers to merge? Seems like a bad idea.

“Chrysler, GM have merger talks: sources”” - In an apparent attempt to stave off the collapse of GM, GMAC, the lending arm, would be sold off to Cerberus Capital Management in a swap for the stake in Chrysler. A better plan for GM.

” OPEC to IMF: Bearsh oil market likely to persist” - Will they cut production? Probably.

All this and more adds up to the amazingly fragile global economy that we find ourselves caught within. We are certainly seeing the effects of panic, deleveraging and the breakdown of confidence between banks.

As global central bankers attempt to reinflate the recessionary environment, the consequences to currencies vs. hard assets and commodities may be drastic. Don’t be surprised if you see remarkable inflation begin again during the next economic rebound.

We don’t feel that a bottom can be purchased, but with solid coordinated global rate cuts, liquidity injections, equity stakes taken in banks and troubled assets removed from balance sheets we may just see a bit of stability in the remarkable sell-off that was merely delayed, but has been scheduled for quite some time.

Bernanke and Paulson’s previous efforts to stave off crisis consisted of putting band aids on a patient with an axe wound. It did not solve the problem and in the end made it worse because the actual cause was not addressed. Illiquid worthless assets on the balance sheets of insolvent institutions that must be allowed to fail.

Poor risk management is the death of businesses, whether you are a bank or a technology firm, if you can’t make more money than you’re spending you are doomed to failure. Bail outs only endorse the idea that risk management is secondary because the government is going to save you from your own bad decisions.

Eventually when the smoke clears and the dust settles there will be some remarkable bargains. Be careful trading out there!

We made a call on LTS, long @ 1.27 on Thursday and got stopped out at 1.19.  LTS had a complete lack of buyers and some aggressive short sellers really knocking down the price.  We did not see market makers providing much liquidity, either.  It was a vicious day that closed LTS at 0.98.  Today’s trading of LTS brought it from 0.90 to 1.10.  A very wide range again because of illiquid trading and lack of market maker participation to facilitate narrow spreads and orderly execution of trades.

At this point LTS hovers around $1, which is another level of multiyear support.  The courageous may want to endeavor upon a retry of the trade, with a stop below a close of $0.90.  We do feel the market is very oversold and LTS as an equity is in a vacuum right now as far as buyers are concerned.  LTS could slip to $0.50 if this vacuum continues.  We recommend caution trading this market regardless of which side of the trade you may be on.

Global equity markets ended an historic sell off with the S&P closing the day down marginally, after selling off more than 7% on the day.  The bounce back towards the end of the day was particularly encouraging to those remaining bulls who believe redemptions were pushing the market off a cliff.  Redemptions (and margin calls) generally occur from 2pm and can accelerate in to the close.

Now the world waits with bated breath as the groups of __ (insert number) meet to discuss world financial stability.  Traders are also very concerned about the fate of Morgan Stanley, and by extension, Goldman Sachs.  Some say the US may nationalize them, others believe injections or government brokered deals may be in the works.  Either way, it seems that the investment bank model is not only broken, but it is beyond repair and now a legacy of years past.

I watched this week with complete amazement.    Trillions of dollars of global equity are being destroyed by risk aversion, deleveraging and raw panic.  We saw the VIX go to the 70s for the first time, ever.  Was this the capitulation day?  Volumes were high, there was a turn around.. but is it real?  Are we closing in on a bottom?

It’s very very hard to tell where we are.  And as the old saying goes with ships’ captains, “there’s plenty of charts on the bottom of the sea”.  So, we can’t necessarily take any single indication and say we’re at a bottom.  What I will say, however, is that the 800 area on the S&P is a major level of multi-year support.  If we fail below it significantly, though, we are in store for more vicious selling.

The rally has reversed lower and is now retesting yesterday’s lows where an appetite for risk came back at around 960 on the S&P 500. We are seeing those buyers coming back in at that level again. At this point the market is oversold.

We see a modest bounce in global equity markets, but it is not sufficient to declare any bottoming process has begun.  It looks more like the massive oversold condition is being corrected.  Short term we may see some broad gains in many sectors, but the landscape hasn’t changed and a global recession must continue to be priced in to stocks.

World markets are selling off.  US equity index futures are down over 2%.  Dow Jones is poised to give up 10k.  The Paulson plan is not working as promised.  Welcome to reality.

Wall Street poses a modest rally ahead of the promise of a bail out.  Commodities are still fairly weak after yesterday’s liquidation.  Many large firms are closing down ther commodities operations.  UBS, included, having just laid off 2000.  The only reason for this type of activity is the expectation of a prolonged global recessionary environment.  The dollar trade is mixed, as foreign exchange markets gyrate back and forth after a massive dollar rally back to major resistance around 80 on the US dollar index.  We still favor fading the equity index rallies in this environment.

The US Senate passed the bailout bill 74-25, but the market was not impressed.  Traders speculate that it’s too little too late and we’re already in a deep recession.  Investor cash flows have nearly completed halted.  Foreign debt buyers seem to be pressuring the US government to push this deal through for their own interests.  US retailers fear the worst Christmas season in three decades.

GE is down as their capital raising efforts are diluting existing shareholders.  US equity index futures are down about 1% across the board.  Commodities and other currencies also losing ground against the dollar.  Is this deflation because of massive debt destruction?

Markets have been a wild seesaw ride through positive and negative territory all day.  No sign that this indecisiveness will let up before a decision is reached, one way or the other, by the US Congress.   Commodities markets are mixed as players are uncertain of where to put cash to work.  Foreign exchange markets have shown some dollar strength vs. European currencies.  Overall, a day that most could have slept through without regret.

We’re poised for a correction after yesterday’s rally in US equity markets.  Futures are pointing to a lower open.  A strange event occurred with GOOG stock where supposedly erroneous errors caused it to break down to $330.  The NASDAQ expunged those error, repricing the stock and encouraging the CME to revalue the futures, which they did.  Europe continues to weaken in the face of their central bank making noise that inflation is still a concern.  Commodities and currencies are relatively flat this morning.

BBT, one of the most conservative banks with a very safe balance sheet, has come out in favor of a different kind of bank bail out.  They allege the bill only helps Wall Street and already insolvent banks and doesn’t make sense for sustainability or correcting the problem:

http://media.gatewaync.com/wsj/pdfs/2008/09/allison.pdf