Market Outlook for September

by Stephen Tetreault, T-Waves | September 12, 2008

I’m expecting (75-25%) chance for some additional bearish pre-market and into the open as we were embroiled in a late day sell-off into the close on expanding volume (unless the initial-claims release, and export/import price data along with the trade balance numbers reports distinctly prove positive) o any disappointment we could see continued selling. Then at 10:30-11:00 I expect a market reversal and we trade up for the day into the close DOW could gain 150 Nasdog 30 and SPX 19 key world = could as My favorite dip-buys today are PBR, HES, SLB, HAL and MA

PLEASE remember my futures players that tomorrow is the rollover of the futures contracts so the front month for all equity futures contracts will become the December contracts (replace the symbol letter “U” with a “Z”)

Let’s keep our focus on the price of crude and our greenback as a continued drop in price of crude or pop in the dollar could be a positive for equities in the near-term however it could be a negative signal for the energy patch, also we will need to watch the bond market as a retracement here could result in a rotation out-of or into equities in the short term. As always I’ll be watching the Transports, Small/Mid-caps along with the SOX for early directional indicators/ signals and clues along with the overnight Asian markets

The question to be answered in this light-volume is whether we setting up for a “bear” trap or a “bull” trap that is the question. As such please take on positions very carefully as I we could be setting up for a potential multi-day short squeeze, relief rally. This recent bounce has undoubtedly pulled many new-fund-money (I call them early-dip-buyers) back into the fray (not-necessarily weak-hands) please be cautious and do not get sucked into a long-position without being very careful and hedging….we need to see follow thru (bull or bear) and some decent volume….the index price action is moderately positive but we lack true conviction and decent sustained volume! The daily VIX is confirming a mix-signals; and I am monitoring it very closely…we are at the crossroads of this recent rally and its up to the bulls to press full steam ahead of risk losing their brief flirt with bullish tonality to the bears!

Remember folks never forget the power of greed and fear, and the propensity for investors wanting to own stocks (taking long-side) remember there are usually 4-5-bulls (participants) to every bearish investor, so the propensity for bullishness is almost always stronger! However the reason that the market drops 4-5 times faster then it goes up is that liquidity and lack of buyers due to fear, which can feed on itself very quickly like a plague or a quick acting cancer. So prepare yourselves for a rollercoaster ride during the next several days as the battle ensures. Please, remember when in doubt as to market conditions/direction CASH is always king (or queen depending on your gender ) please trade cautiously and be quick to protect your profits AND PLEASE ALWAYS PROTECT YOUR CAPITAL BY USING STOPS, as if the trade goes against you will save your precious resource.

The market-participants are very-skittish and extremely confused and it is clear that we are seeing massive signs for liquidation (forced and voluntary) and it has been so heavy at times, especially the selling into any perceived strength (any-rally) it appears that we should be heading for the proverbial bomb shelter as support even in the best of stocks has at times been sliced through like a hot knife thru butter…and as such even I am getting very-skittish at buying support as in this moderately light volume environment is consistently failing when mysterious sellers continue (at times irrationally) to trigger the sell buttons. Many of even the best earnings sectors are getting crushed for absolutely no real-reason and this has led me to take some abrupt losses (or flat-trades) in out swing-trade portfolio and short-term options. We have seen that the darlings of wall-street now seem to be the lepers and are now cursed and those previously out of favor are almost dead especially if you measure them by their stock price.

The indexes ended a very temperamental and volatile session moderately higher today as traders and investors stuck their toes (as we did today) into commodity, energy and material-stocks but the buyers were as skittish as a long tailed cat in a room full of rocking chairs when it came to the beleaguered financial sector. As banks and brokerage stocks finished mostly lower after Lehman Brothers failed to live up to expectations saying that they planned to sell a majority stake in its investment management business and spin off its troubled mortgage assets.

On Tuesday, unease about Lehman touched off a broad sell-off. Bargain-seeking investors often step in as I did today to pick over hard-hit stocks that were grossly oversold after the mega pullback we have seen so some buying on yesterday’s massive dip wasn't surprising. Investors bought up energy names after they tumbled Tuesday and looked to defensive areas like consumer staples today.

The Dow ran up after the open due to a stronger dollar and weakening commodity prices again it rallied to an early morning intraday high of 11,307 running smack dab into OHR the index then dropped to 11,216 (down 95-points) by 11:00, then it turned around and churned upward to 11,380 (up 164-points) into the 2:45+/- time zone on a very-whippy tape then as usual of late due to a lack of confidence it sold off into the close and it closed (down 115+/-points from the highs) right at 11,268.92 for a gain on the secession of 38.19-points another wild rollercoaster ride for the day…if the bears return tomorrow look for them to attempt to drop the index back down to 11,155-11,175 where we have some near-term significant support if this level fails and the bleeding again turns into a ruptured artery the index could drop to 11,025-11,055….if the bulls find some courage and dip-their hooves back into the cesspool and look to by the dips after the open tomorrow they will likely emerge at or near the 11,210-11,215…. if we see additional selling after the open tomorrow…..however if they bring their COF credit cards tomorrow…and the economic news doesn’t spook them look for them to attempt to retake the 11,375-11,410 level thereafter they will run into OHR at 11,525-11,540.

Yesterday the Dow dropped a whopping 280 points and erased nearly all of Monday's gains yesterday as the Dow closed just over 11,200 and it appeared likely to retest the July lows of 11,000. I find it hard to believe that we will suddenly rebound significantly until we at least put in a successful retest of this zone so the pundits can shout at length we put in a successful double-bottom but as always anything is possible. From my vantage point the very lopsided internals show us to be very oversold but I think the continued sell-into the rallies is telling us there is more weakness ahead. The opening short squeeze spike on Monday was huge but it was quickly sold into as was the closing ramp and yesterday the Dow never tried to rally at all after the open as it bleed red for the entire secession…..It was open season on the bulls right from the opening bell. Let’s face it right now the Dow is tied directly into the health in the financials and without life-sustaining-solid-long-term fix like a Lehman buyout I doubt they are going to suddenly recover before the next set of earnings disclosures.

The Nasdog also went on a wild rollercoaster ride today and it ended up 18.89 points to close out this wild trading day at 2,228.70, and the ending could have been worse, the index was helped into the close by late day buying in the chips and high-beta names and the 4/6 horsemen into the close as shorts covered their positions and booked profits ahead of tomorrow’s open…..the index churned up to an intraday high of 2,247.63 for a gain of almost 38+/- points however it also became embroiled in late day selling/profit taking as in the last 90 minutes of trading it coughed almost 20-points as wave after wave of sellers emerged to sell into strength as I have forecasted especially in the high-beta names like RIMM, GOOG and. If the bears return tomorrow look for them to drop the index down to 2,204-2,209 where we have some near-term support, if this level fails the index could drop to 2,174-2,182….if the bulls find some courage and dip-their hooves into this bloody-crap-filled cesspool they will need to bring their COF/Visa/and MA credit card and beg for an expended line of credit on their overdrawn status tomorrow…if granted look for them to attempt to retake the 2,248-2,252 level thereafter they will run into OHR at 2,278-2,285.

Yesterday the Nasdog fell harder than the Dow yesterday and closed at a new two-month low at 2,209.81 yesterday (a drop of over 60-points) with support looming just below at is 2192-2202 and given the volume imbalance on the Nasdog there were no survivors. Down volume was 2.5 Billion shares and up volume was a miniscule 153 Million shares as this index was sold very hard on Tuesday; as this is a 16:1 imbalance going full-force into the close (As I stated this morning this was almost extreme-oversold conditions and warranted a relief-rally for at least a day or so).

The Russell-2000 was again the most resilient of the big-4 due to the strengthening dollar, and speculation of a 4th quarter rebound…[ Stocks related to the housing market, energy and solar experienced gains today] as the index ended up 9.87-point or 1.4% as it closed out the trading day at 717.16…..If the bears return tomorrow look for them to drop the index down to 704-707 (daily 50sma @ 712 and the 60-minute 350sma @ 712.50) where we have some near-term support, if this level fails the index could drop to 691-695….if the bulls find some courage and look to buy the dips look for them to emerge to buy dips after any early morning selling they will likely emerge in and around 710-712+/- also if the index presses above 720 we could see a squeeze to 733/738….If the bulls find some positive buying tonality tomorrow look for them to attempt to retake the 722-726 (20Dema = 727.20) level thereafter they will run into OHR at 735-740.

The SPX also went on a wild ride today it ended up 7.53 points, to close out the secession at 1,232.04; the relief rally was thwarted late in the day as the index rose to an intraday high of 1243.90 before a late day wave of sellers took hold after the bond-market closed as dropped the index over 11-points into the close….if the bears return tomorrow look for them to attempt to press the index down to 1,216-1,220 where we have some near-term significant support, if this level fails the index could drop to 1,198-1,203….if the bulls find some courage and come in to buy the dip tomorrow look for them to emerge in and around 1,224 on any early weakness….If they bring their credit cards tomorrow look for them to attempt to retake the 1,244-1,249 level thereafter they will run into OHR at 1,259-1,263.

The Semiconductor Index (SOX) collapsed yesterday and basically traded flat today losing 3.5% yesterday was a big-furball to cough up and it closed at another five year low. JP Morgan in a research note stated that overall deteriorating demand will bring about a correction in semiconductor earnings estimates over the next 4-6 weeks. And to add to the malaise semiconductor analyst Christopher Danely also said, “We expect almost every semiconductor company we cover to lower estimates as a result of the correction. As Danely said current consensus earnings assets are at least 9% too high; as such we will not likely see sustained strength from this sector any-time soon until the big-cap players report and clear-up the cloudy-fogged-in landscape. He went on in great detail as to why he projects such weakness and here are some of the highlights of the report (I can not link to it as it’s a paid-for-report):

Samsung: recently Lowered expectations for second half due to macro slowdown.
Nokia: Warned it will lose market share in Q3.
Richtek: Lower-than-expected guidance on weak PC demand and weaker-than-expected back-to-school.
Taiwan Semi: Below seasonal Q3 guidance on weakening semi demand.
MEMC: Q3 update noted that semi demand was weaker than expected.
Cisco: Said recovery in communications market not likely until at least (key word = at-least) the first half 2009.
Ciena: Lowered guidance on lower spending by telcos and this is very-telling for demand
Dell: Lower margins due to weaker pricing in Europe and general-lower sales.
Compal: Lowered Q3 guidance on weakness in Europe and the U.S.
Ingram Micro: Cited weak demand in Europe, Asia so far in Q3.
Corning: Cut guidance on excess display panel inventory; doesn’t bode well for the holiday season.

Lehman shares fell another $0.54 to close at $7.25, after plummeting 45% yesterday. They're trying to buy time, but it's a very dangerous endeavor on Wall Street to buy time. You need to be able to do business and make real important life sustaining decisions very promptly. I don't think we're at the end of the financial problems in the markets by a long short.
Today Lehman Brothers reported Q3 results and they announced plan to reduce commercial real estate and residential mortgage exposure, they also reduced their dividend to $0.05 they also reported a loss of $5.92 per share, $2.57 worse than consensus of ($3.35) Net revenues (total revenues less interest expense) for the 3Q08 are expected to be negative ($2.9) bln, compared to a negative ($0.7) bln for 2Q08 and $4.3 bln for 3Q07. The net loss was driven primarily by gross mark-to-market adjustments stemming from writedowns on commercial and residential mortgage and real estate assets. During the fiscal third quarter, the Firm is expected to incur negative gross mark-to-market adjustments on assets of ($7.8) bln, including gross negative mark-to-market adjustments of ($5.3) bln on residential mortgage-related positions, ($1.7) bln on commercial real estate positions, ($600) mln on other asset-backed positions and ($200) mln on acquisition finance positions. These mark-to-market adjustments were offset by $800 mln of hedging gains during the quarter and $1.4 bln of debt valuation gains... LEH announced today, in conjunction with its preliminary third quarter results, a comprehensive plan of initiatives to reduce dramatically the Firm's commercial real estate and residential mortgage exposure, generate additional capital through the sale of a majority stake of the Investment Management Division and reduce the annual dividend, in order to maximize value for clients, shareholders and employees. "This is an extraordinary time for our industry, and one of the toughest periods in the Firm's history. The strategic initiatives we have announced today reflect our determination to fundamentally reposition Lehman Brothers by dramatically reducing balance sheet risk, reinforcing our focus on our client-facing businesses and returning the Firm to profitability." Lehman Brothers took several steps to significantly reduce its real estate portfolio in the third quarter. The Firm reduced its residential mortgage exposure by 31% to $17.2 bln. Further, Lehman Brothers is formally engaged with BlackRock Financial Management (BLK) to sell approximately $4.0 bln of the Firm's UK residential mortgage portfolio and expects to complete the sale within the next few weeks. The Firm intends to spin off to its shareholders $25 bln to $30 bln of its commercial real estate portfolio into a separate publicly-traded company, Real Estate Investments Global ("REI Global"), in the first quarter of 2009. Lehman Brothers has announced its intent to sell a majority stake (estimated to be approximately 55%) in a subset of its Investment Management Division. The subset of businesses (the "IMD Business") includes the asset management, private equity and wealth management businesses but excludes its middle market institutional distribution business and the Firm's minority stakes in external hedge fund managers. The Firm is in advanced discussions with a number of potential partners for the IMD Business and expects to announce the details of the transaction in due course... The Firm has decided to reduce its annual common dividend to $0.05 per common share from $0.68 per common share, enabling the Firm to retain $450 mln annually... Book value per common share is estimated to be approximately $27.29. Additionally, through the actions taken during the third quarter, the Firm is expected to reduce its net leverage from 12.1x to 10.6x. These ratios are appropriate for the Firm's expected lower-risk asset composition.

Bank analyst Richard Bove reiterated his $20 target saying the company was now so cheap nearly anyone could afford it. Possible suitors named by Bove were Blackstone, Blackrock, HSBC and an unnamed Japanese bank. Bove said Lehman had $25 billion in assets that were currently being valued at $0.18-0.20 on the dollar and that was way too low. Bove also lowered his earnings estimate to a loss of $3.17 per share from a loss of $2.32 per share. Lehman appears to be in a death spiral and given their stock drop. After the close yesterday Goldman Sachs, Citigroup and Morgan Stanley all said they were still doing counterparty trades with Lehman. You wonder if they are still trading because they want to or because they can't liquidate the positions they hold on their books….the capital preservation and liquidity opportunities for Lehman are drying up faster than a snowflake in July. On a positive note they still have the Fed window available to them and they continue to claim they don't have any liquidity problems. (Please remember that Bear Stearns said the same thing two days before they were taken over). It’s very likely that a host of fed-heads are in contact with Lehman on a daily basis as the situation worsens. We saw yesterday that S&P put Lehman on credit watch negative citing “heightened uncertainty” about Lehman's ability to raise capital. A flurry of management departures over the weekend suggests that a new deal is unlikely imminent and people are fleeing Lehman so their name would not be tied to any future failure.

Investors continue to grappled with contagions about the financial sector since the near-collapse and subsequent sale of Bear Stearns in March. Banks such as Lehman have struggled in the past year with unwieldy amounts of mortgage-backed securities and other risky investments on their books that have plunged in value. Many traders like me contend the indexes will not be able to carve out a sustained bottom until we can determine the real scale of losses in the financial sector; currently global banks have written hundred’s of billions in overleveraged and stupid investments. There's always those hoping and praying that every time one of these shoes drops that it's the last shoe, but unfortunately for the bulls it doesn’t last long…take for example the about-face yesterday when the relief over a government bailout of mortgage lenders Fannie Mae and Freddie Mac gave way to fresh concerns over Lehman. I continue to believe that these greedy-overleveraged brokerage firms, banks and lenders they don't really all know where their real problems are; as such we need at least several more quarters to determine where the snakes and rats are hidden with their balance sheets hopefully where they're not doing all these massive write-offs. Most of these firms are still saddled with too much debt and not enough assets and they clearly need significant more capital, a plight that many financial firms could continue to find themselves in the months ahead.

The vast array of talking buttheads being pranced about on the various bubblevision-networks had thought that the removal of the Fannie/Freddie storm-cloud would release mega-negative weights on the financials and homebuilders to spark a rally led by the financials….and they were right…however it only lasted about 15+/- minutes once the market opened…and the liquidators and funds took the opportunity (could be some options unwinding ahead of the most volatile options “X” week of the year as well). There is a serious undertow in the market right now ands a complete lack of confidence and we are approaching the worst week of the year historically; and we have seen that the vast majority of funds are running for the exits in a preemptive move.

The economic reports yesterday also failed to shed any real positive light on the markets nor did it tell us anything that we did not already know. The Job Openings and Labor Turnover Survey (JOLTS) improved only slightly but the downward negative trend in employment is still intact. In July 4.1 million workers were hired and 4.3 million left their jobs; while job openings declined by 100,000 to 3.4 million. On a trailing 12-month basis there were 17% fewer job opening than during the same period in 2007; and as such this report simply confirms the Jobs Report we saw this past Friday. The Manpower global employment survey also released yesterday showed net employment had weakened but remained positive for the fourth quarter.

The Pending Home Sales report for July showed sales declined 3.2% over last years reading and this was the smallest rate of decline since December 2006; however, as we move distinctly deeper into the abyssal housing cesspool/downturn the comparisons become easier to manipulate –positively as in July of 2007 pending sales were down 14.7%. Sales are improving slightly but we are moving out of the normally robust summer selling season and into the dark days of winter where home shoppers are more concerned with staying warm and planning family events for the holidays.

Yellow Roadway CEO Bill Zollars warned, this week that the economy has softened further impacting volume levels and pricing at his firm after a solid second quarter, the current quarter started slower and has unfortunately weakened. He does not see signs of the economy improving in the near term. This warning should be heeded as shipping is an early indicator of economic activity.

There is a looming undertow to the markets and an increase of noise in the analyst community that several large hedge funds are in trouble, (maybe as many as 14-17). Remember we saw last week that the highly visible $4.4 billion Ospraie fund closure rattled investors and it was like the proverbial short heard around the world; as the firm lost 27.8% in early August approximately 40% for the year on bets that went sour in the commodity sector. The fund said it was going to return the remaining money to investors (very nice of them). Unfortunately it could take as long as two years to unwind these overleveraged positions; and lets face it my friends for such a highly reputable fund, the largest in the commodity sector to take a massive 40% haircut and it could eventually be 50+ percent when the dust clears it truly undermines the confidence in most funds seeking new investors. On Friday Atticus Capital was forced to deny market rumors that it was liquidating and shutting down and I’m not sure I totally believe their rhetoric; as their two main funds have taken losses of 27-32% so far this year and I’m betting that their redemption requests are growing; as their withdrawal window is the end of September and the founder said on Friday they have received redemption requests for less than 10% of capital, and there is quite a bit time left here to impact this fund. Mitsui and Company, Japan's second largest trading company announced on Friday they were closing their New York hedge fund business due to poor performance as well; this is a trend that can not be ignored.
As I stated this past weekend most hedge funds have withdrawal rules stating when you can withdraw your money. Some require 45-days notice and limit redemptions to once per quarter usually at the end of the quarter. Others allow redemptions monthly at months end but all require prior notice of such requests. Hence over the past couple weeks I believe that spooked money was leaving those funds with the August month end being a trigger in some of these firms. In many cases a hedge fund has to produce the cash five days after the withdrawal period. If the end of the period was August 29th then Friday the 5th was the last day to cash out the redemptions depending on how they count the Labor Day holiday; as such this suggests that the heavy institutional liquidation we saw last week was spooked money leaving funds and being placed in bonds, TIPS or under mattresses.
Since most funds are highly leveraged the impact of forced redemptions is significantly magnified. Most funds are leveraged 5:1 and many specialty funds 10:1 or better to.

Lets take the $4.4 billion fund Ospraie as an example they could be controlling $20-25 billion in overall leveraged positions; and many boutique funds are even more highly leveraged than that and closing positions to raise capital is a major pain in the ass. Remember, Ospraie said they had halted redemptions because they were seeing a run on the fund; and we know that Ospraie is a high profile-fund; however there are about 4400-4500 other out there that you have likely never hear about so logic dictates that if Ospraie was being raided by skittish investors who have been in the proverbial house of pain then you have to bet there are other funds in a similar position especially those playing in commodity-land as so many have been hammered during the past several months with the resent bear-market drop. Those not in commodities are probably a bit better but speculative money is definitely leaving for safer havens.

So let’s do some math if there were only 100 of existing hedge of $1 billion each seeing redemptions at the Atticus rate of 10% that would be $10 billion dollars of instruments being unwound. Assuming there average leverage was 5 times that $10 billion controls now we have a whopping $50 billion of instruments that are being forced to be unwound. Unwinding $50 billion in positions in a bear market like we have been experiencing on moderate to light volume would only exasperate the market malaise……granted maybe all are not seeing 10% in redemptions but its likely in this environment they are seeing 5% or better (many might see more then 10%) Nevertheless there are more than 4400 hedge funds…so what would 5% of 4400 hedge funds be (220) just do the math as it adds up to a huge amount money and a lot of highly leveraged positions to liquidate into a very illiquid market.

Another factor hitting these hedge funds and funds in general is the evaporation of available credit; as many funds borrow money to increase their returns through the use of leverage an a carry-trade. As the banks continue to take multi billion dollar write-downs it takes capital out of the available market. Banks leverage an average of 8:1 to 12:1 so every $1 billion in write-downs takes $8-$12 billion in potential loans out of the market and economy. And worse yet Investment banks like have leverage of 20:1 or 30:1 like Lehman six months ago; and those shit-heads at Fannie and Freddie are leveraged at 44:1/50:1….hence you can see my concern with this excessive leverage. So far in this so called credit-crisis debacle there have been more than $515 billion in write-downs; so let’s multiply that by you choice of leverage above and see how much credit has been removed from the markets and economy…its staggering. We continue to see that banks are actively terminating loan commitments and credit lines, to shore up crumbling balance sheets. When loans to funds roll over they are being eliminated or reduced big-time and this takes a big chunk of cash out of the fund accounts.

So I still believe we are seeing a significant unwinding of that leverage and it could last for the duration of the entire month with several knee-jerk relief rallies disbursed within for disruption. European bank HSBC reported a survey earlier this week of 12 large funds firms that manage a total of $4.2 trillion dollars in assets; and their survey showed that those funds were rapidly moving into cash and bonds and away from stocks and other instruments. I can't even imagine the amount of leverage $4.2 trillion in funds controls its staggering and as such it really undermines the health of our markets as unwinding their overleveraged positions could take several weeks and the worse the conditions for the markets (commodity and dollar-shot positions) the faster they may trigger the sell-buttons; as these overleveraged funds see their underlying assets evaporate the urgency to run for the exits increases exponentially….we saw today that:

RAB Capital, the embattled hedge fund, has threatened to liquidate its flagship $900 million Special Situations fund unless investors agree to leave their capital locked up for the next three years. The move comes after turbulent markets left the Special Situations fund, set up and run by Philip Richards, co-founder and former chief executive of RAB, down by 48% for the year. Last month, the portfolio, which contains small mining and early-stage natural resources stocks, lost 22% of its value.

Contact Information

Stephen Tetreault | Southern Maine, USA | Email | Website