Rhody Trader

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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.

Well, AUD/USD has done some interesting things since my last look at it (AUD/USD: Look for Some Action Soon). I told you it was going to! (Same with GBP/USD - GBP/USD: Can You Say Consolidation?)

There was a little fake break higher as I’d expected. The bigger fake break was lower, though. It happened last week on the drop below 0.9350. Now the reversal higher is taking full force with the rate through 0.9600 and running.

Could this be a move to par? I don’t see any reason what not.

The GLD call worked out to perfection, though (Gold Looks Like It Should be Finding Support Soon). A couple weeks ago the market bottomed out right in the area I thought it would. Yesterday it crossed the $90 level which was my target for the rally. Today it’s running higher still. I can see $93 getting hit shortly.

I said NSIT could move down to $14 (NSIT Not a Buy Now, But Could be Soon). It did that and then some in the latter part of April. On a valuation basis there could be a buy argument made here, though earnings estimates have been lowered from where they were when first I looked at the stock.

I’m still waiting for LPHI (LPHI: Life Partners Could See 55 and Up) to do something.

Still waiting to see the S&P 500 do its interesting thing (Something Interesting is on the Way for the S&P 500).

Euroseas (ESEA) is a stock I posted about a while back and one I’ve been playing myself. The stock has had a very nice run up in recent sessions - going from around $14 to over $17 in about a week. The stock has pushed through the latter level today on a combination of things. Firstly, the whole container shipping group is doing well. Second, the company announced an increase in the quarterly dividend. Third, the company announced the aquisition of a new ship which already has contracts locked in through 2011, and options for up to three more years.

I haven’t seen any updated analyst reports, but I’m sure those who cover the company will be redoing their estimates and target levels on the news. The new tanker will add several million in revenue, though I’m not sure what that’s going to mean in terms of profits to the bottom line. You have to figure, though, that the company wouldn’t have made the purchase if there wasn’t a profit benefit to be had.

Current FY08 forecasts are for $1.86 EPS. Price targets of $20 were previously made.

I’m up over 100% right now in my option position.