Rhody Trader

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Want to know which financial companies are likely to be the long-term winners coming out of the current mess? Then it’s worth looking at the ones involved in the bidding for the Lehman bonds on offer today (listed below). By taking part they highlight their perceptions of being in a good position in terms of capital.

Banc of America Securities LLC 
Barclays Bank PLC 
BNP Paribas 
Citigroup Global Markets Inc. 
Credit Suisse Securities (USA) LLC 
Deutsche Bank AG 
Dresdner Bank AG 
Goldman Sachs & Co 
HSBC Bank USA, National Association 
JPMorgan Chase Bank, National Association 
Merrill Lynch, Pierce, Fenner & Smith Incorporated 
Morgan Stanley & Co. Incorporated 
The Royal Bank of Scotland PLC 
UBS Securities LLC

The poor small speculators have it well wrong again. According to the latest Commitment of Traders data for the mini S&P futures (shown below), they remained well long this market right through last Tuesday. Granted, they had cut back their longs from where they were a few weeks prior, but they were still on the wrong side of things.

No doubt some of the pick-up between September 23 and September 30 was expectation of the passing of the $700 bln bailout bill and the anticipation of a positive market reaction. Whoops. I’ll be interested to see how many are still long as of this past Tuesday when the next report comes out.

Meanwhile, the Large Speculators actually worked their way back to their most short levels in recent weeks. I’m much more inclined to watch them.

It’s not showing it now, but 30-year swap spreads reached negative levels earlier this morning. That’s the last row on the graphic below. That sort of thing is highly unusual, to say the least.

Basically, what this means is that the fixed side of a 30 year swap (remember that a swap is an exchange of a fixed interest rate stream with a floating rate one) is trading at just about level with the rate of a 30-year Treasury Bond. Given that the credit quality of the swaps are generally AA-, and of course Treasury debt is AAA, this sets up an interesting question. Why so tight? One of my colleagues has suggested it’s the market looking at the banking system (the swappers) and saying they will basically be owned by the Treasury at the point.

If you look at the front end of the curve (short dated stuff), you’ll see the money market issues in play.

For those who might be thinking that without the shorting stocks are going to be less open to major rapid declines, I present today’s chart for National City (NCC). Rumors that the FDIC was going to seize the bank knocked it down about 50% today, and of course NCC is on the no-short list, so it can’t have been short sellers in the stock doing the damage.

It’s going to be interesting to see what the after the fact research by the academic sorts has to say about the impact of the no-short rule in regards to volume and volatility.

The other day I posted a screen shot of what was happening in Treasury yields. They were falling rapidly. Now things are going the other way even faster.

These moves are some of the largest I’ve ever seen, even going back to the days when I was a fixed income analyst. To give you an idea of what these moves mean, a 4 point move in the Treasury Bond futures contract is worth $4000.  The Eurodollar contracts are up 30+ ticks. That’s a move of more than $750 on a contract, on what is the most actively traded futures contract (1 million plus volume per day).

One thing I need to correct in this whole Fed AIG loan story is the impact this has on the US taxpayer. It has none. Oh sure, you can talk about indirect impacts of money supply considerations, interest rates, etc. That’s not my point. My point is that the US federal government - and thus taxpayer money - is not involved in this deal.

The Fed is a self-contained entity. It’s income statement and balance sheet are not part of the federal budget in any way (aside from the excess interest income on Treasury securities it pays back). That means when the Fed loans money to AIG (and takes an equity stake) or backstops the JP Morgan purchase of Bear Stearns there is no implication to taxpayer money. The federal government will neither make nor lose any money on the deal. The Fed will, but not the government.

This is something that’s driving me nuts. The media is getting it wrong when they suggest this is a government takeover.  This is a little peave of mine.

Now the Fannie/Freddie situation is completely different.

In case you were wondering just how crazy things are in the markets, a look at the Treasury market will help. Check out the changes since Friday.

Flight to quality is driving the Treasury move. It’s also got Gold up. Oil is down because of major economic concerns. The Dollar move is the real thing to watch. It’s under pressure now, mostly because this is so far a US issue, but given the moves in some of the European banks (I saw HBOS down 25%), don’t expect it to remain that way.

One question I’ve heard a couple of times is “Why isn’t it worse?”

Keep in mind a couple of things. First, traders have been preparing for this for a while. Second, the financials are a much reduced proportion of the market. Had this sort of thing happened a year ago it would have been a huge negative reaction.

A reader of my trading education blog posted the following question via a comment to the Is there a way to guage when a market will break out and which way?  post. It’s a bit too specific for me to answer in that educational venue, so I’ll tackle it here.

John - Here’s one I’d be interested in your take on - AUDNZD has been in a tight sideways channel for over a week now. It appears to have a slight bias downward. Is there any way in this case to get a “tell” on which way its going to break out of the channel, other than waiting until it does so?

Now I realize I’m writing with hindsight here because AUD/NZD has already made the break lower, but I’ll carry on anyway.

The things I would have used to say that a breakdown was more likely than a breakout to the upside is the number of failed rally attempts. Look on the chart how many times the cross made attempted rallies (as note by the arrows), but wasn’t able to hold onto those rallies - seeing them very quickly reversed either the next day, or more frequently intra day. That is a real clear indication of weakness in the market.

Another way to look at this situation is to view the hourly chart (not included) to see how the action is playing out there. In the case of AUD/NZD there were a number of very sharp sell-offs as opposed to somewhat slower rallies. That means the market is having a harder time making progress higher, and relative ease falling. That’s another sign of underlying weakness.

Have We Seen A Definitive Bottom Already? was asked on Trader’s Narrative yesterday. The post takes a look at using the number of Dow stocks above/below their 50-day moving average.

Very interesting. Apparently, there were no stocks above the average back in June. That was the first time since 2003 this was the case.

These sorts of things are often viewed in a contrary fashion. Unfortunately, the timing of overbough/oversold conditions being reversed is always a bit touchy. Obviously, the Dow didn’t stop falling until mid-July - and the question of whether that was the true bottom or not has yet to be answered.

Personally, I think this market still looks pretty weak. I’m not convinced at all by yesterday’s rally. To my mind it was a weak one, and one that was to be expected anyway based on the way Friday played out.

There is, of course, a bunch of chatter and reaction this morning to the government takeover of Fannie Mae (FNM) and Freddie Mac (FRE). The markets are certainly reacting aggressively in a bullish fashion. This, of course, was always what looked like happening. The Feds were never going to put taxpayer money at risk without total control.

The question, though, is what this changes?

For me, not much - at least right now. The housing market is still in an oversupply situation. That needs to be worked off. The credit spreads are still elevated. The fundamental question of trust hasn’t been cleared up yet. Until that is, we still have a credit crunch.

Bottom line, I think what we’re seeing this morning is little more than short-covering in a market that was already recovering from being oversold on Friday. I definitely don’t see a new major rally unfolding from here.