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The Out look for the week ahead

by Stephen Tetreault, T-Waves | April 13, 2009

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1 Strap-yourselves in tight this week, as it is sure to be another wild rollercoaster of a ride! And as always please…..Remember rollercoaster's have ups as well as downs and their volatile rides can cause many to get whiplash or nausea if not prepared! This options-X week I will be a seller into OHR, on any pop….selling SPX as it has significant OHR at 869-875,Dow has significant OHR at 8,188-8,197 thereafter 8,270-8,290, Nasdog has significant OHR at 1,685-1,697, and the Russell-2000 has significant OHR at 479-484we are very-overbought and I believe that we are knocking on the door step of a 25-40 % correction at a minimum….I am looking for a very-weak opening on Monday

I expect that we could see some distinct volatility on the open especially and some early futures program-trading participants will certainly try to influence the market's direction. We will soon see which market emotion “Greed” or “Fear” will win out.

The market started Thursday with a big gap up, than for most of the trading secession we saw a stall and some sideward action for much of the day near the opening high and then we miraculously pushed higher into the close thanks in part to some very timely buy-programs that appeared on anemic volume. Unless you were already long the market as we were in several of our swing-trades heading into Thursday morning’s massive gap you missed most of the move. This seems to be a common event lately, and much of this last leg higher in this bear-market-relief rally appear to be happening during the overnight session, both down/up (the futures-players are moving the market sentiment at will) especially the rally legs. Whether it's 100% manipulated during the overnight sessions or not it sure has been very effective in getting everyone (especially the bulls) into a heightened state of giddiness, and the chase is on after the opening bell rings.

I have mentioned many times in the past that the Wednesday/Thursday prior to options-X is typically a head-fake day. As I have been seeing a developing trend (especially ahead of a holiday-weekend) that indicates that a lot of large market participants in the options arena roll-our or book a lot of their positions by the end of the week prior to options-X as we have seen that these large money players (especially in a light volume environment) are very capable of pushing the market in one direction or another so as to position themselves for a sling shot in the opposite direction into and during options-X. So we are left with a looming conundrum, was Thursday's rally a head-fake move or not…only time will tell. (but from my vantage point we are now very over-bought on the daily index charts with a plethora or bearish-rising-wedge patterns almost if not fully developed; and my yellow-caution flag is running at full-mast….and my Bloody-RED flag is already ½ way up the proverbial flag-pole.

Bullishness is breaking out all over like rampant- plague and from a contrarian perspective (I never want to be in the herd when it runs over a cliff) it's getting to be very worrisome. People [thanks mostly to the vast number of extremely pundits and so called guru’s being pranced about on the various bubblevision networks] have become overly convinced we've seen the lows for the year and we are off on a strong while they could be right (though my technicals and fundamentals say its unlikely) I think it really behooves us to be extremely wary of a chasing and buying into a rally that has clearly gone too far too fast. Thursday's ramp into the close as we ended near/at the highs looked like a little capitulation to me (bear-cubs being declawed) as shorts were squeezed out (they took my money). Will there be any follow through to that? Typically when this has happened there's been an immediate reversal the following day.

As you all are aware I put out a report early March I felt we were ripe for a strong-bear-market relief rally near the March lows, and suggested strongly that my perma-bear-short-traders lighten up and tighten on protective stops and to take the huge pent up profits that we accumulated. I now believe that we are prone and the markets are showing some strongly diverging signals and that we are extremely close to a significant retracement period which will take us down for at least a 50-65% retracement of this parabolic relief rally! believe we're near a reversal inflection point so take my forecast for what it's worth (I’m usually right more often than not) and if you do not implement short positions (here) simply be careful and lock in profits on your long positions; please heed my warning as its just as important as the one I issued on 3/3/09 [the warning that I sounded that shorts needed to protect profits near the March lows I think bulls need to start too be very cautious and protect profits at these highs].

On Thursday we saw that BAC/MER economist Dave Rosenburg issued a warning to their clients, stating the “economy is not even remotely close to recovery mode...it is one thing to be in a situation where the data are no longer collapsing at a 50-70% annual rate and quite another for the economy to be in a recovery-mode...”. He sincerely believes that the economy is still contracting, that April numbers will reflect that fact, and that the market is out of line with this reality (the bulls are living on a diet of greed, hope and prayers). He figures the trailing multiples on reported earnings for the SPX is near 90-100 times, “a record and double where it was during the tech bubble.” He also noted that credit is contracting at a record rate as it has “shrunk at nearly a 10% annual rate over the past thirteen weeks, which is unprecedented.”

We have seen that whenever the indexes have rallied in the face of a contracting credit market, which it did from March to May 2008 and again from October/November into January, the rally was followed by strong very-strong-selling events. The current rally has all the makings of just another bear market rally and I think the market could be setting itself up for failure again (especially during this earnings season) [not to mention the fact that the leadership group is very-overbought on the weekly/daily charts and the volume has been lackluster during this relief rally. ***Please check out the technical-section below***

Last week's rule change by the FASB is just a short-term fix that will ultimately and negatively affect the longer-term health of our economy and financial markets. The change will have the effect of discouraging consolidation in the financial sector, just like Japan in the 1990s. It has been proven time and again that attempts to delay the necessary consolidation and reduction of capacity only results in the prolonging of economic pain. Under this plan, dead-fish banks will continue to divert capital away from productive economic use which will pressure the entire industry. But clearly the Treasury, Fed-heads and Obama folks think it's different this time.

The retail sector benefited last week from hype concerning stronger than expected sales; which do not always lead toward better than expected profits (due to deep-discounting). They also benefited from some one-time events and abnormal-conditions, as we have seen that income-tax-refunds are approximately 17-20% larger than last year; one reason that we may have seen some increases in discretionary spending (Now is this a repeatable event?). Because we're heading into what could be a volatile options-X week it's going to likely be a choppy trading environment as traders/investors settle out their positions and roll out into new-ones. Movements could become exaggerated, especially if the volume is lighter than normal. After Thursday's big rally it would be typical to see at least a 65% retracement of it (and the wave count for last week's rally supports that idea along with the statistics showing market performance the week after a big rally in front of a holiday weekend). Whether the pullback will turn into something more is something we're just going to have to let price and the markets dictate that.

The severity of the recession over the past 6-8 months has been staggering both in the U.S. and globally and despite this fact which is known to equity market participants; they have rallied hard during the past month, was this a case where the bulls feasted on loco-weed (a case of March Madness) or do these investors see something that is not yet evident in the economic data…or worse yet are they banking on a turn-around way to early? It’s a difficult inflection period for so many as those who sat out the recent stock market rally now face a quandary (we only took the ride for 18-20% I have missed this last 5% myself, as I sold to early and have attempted to short-to-early) so now the $64,000 question have they missed out on a fabulous start to a new-bull market…or are they being enticed back in now where we are close to a near-term top? If so, this will just be another case of the mom & pop retail investors exited and entered the market too late. Then on the other hand, maybe in this case the investing public has a better sense of real economic conditions than the overly enthusiastic greedy fund-managers and traders on Wall Street. Maybe this is a party investors will be glad they missed.

WHO will win this battle?

Many large technology firms, hopes for significant tax relief will soon give way to fears of a potentially costly backlash due to their lack of patriotism. At a time when the United States is struggling to revive the flow of capital, corporations have stealthily maintained large portions of their cash offshore to avoid paying corporate-taxes. But companies' prized ability to defer paying taxes on that offshore money is now in peril as they lost the first battle in their efforts to win a tax amnesty (such as Bush gave…never gave the average American such a break) fell short.

Technology firms in particular have moved large cash hoards off shore, as we saw from their fourth-quarter earnings reports, several of the richest companies in the SPX were technology firms; CSCO, and MSFT as each ended the year with more than $20 billion in their coffers. The massive Bush tax amnesty in 2004 which allowed these greed lecherous firms to bring earnings home at a 5.25% tax rate rather than the standard rate of 35% did little for the greater good; as they just kept on putting the screws to our tax collecting efforts and as such they enjoyed benefits that domestic based business do not!

Its worth noting that these technology firms tend to keep a huge disproportionate amount of their cash overseas; as ORCL, for example, held about 89% of its $11.3 billion in cash and equivalents overseas as of the end of February, according to their 10-K, though ORCL regularly pulls in just 40% plus/minus of their revenue from overseas markets. eBay (EBAY) keeps about 88% of its cash overseas, while networking giant Cisco, keeps 89% abroad. Many other technology companies don't disclose how much cash they hold overseas at any given time, though amounts are generally assumed to be significant. Microsoft, which reported having $20.7 billion in cash and equivalents as of the end of last year, doesn’t even disclose how much is held overseas, however they did say that the majority is offshore. IBM finished 2008 with about $12.7 billion in cash, and said recently that since 2002 it's generated about $65 billion in free cash flow and they keep 90% or more overseas…great patriots that they are.

Now generally firms can't generally use this cash held overseas for domestic transactions such as buying another U.S. firm, without it being taxed however, they can always borrow against cash held overseas to finance acquisitions and the European banks love them for the business. I hope they tax them at 2-times the rate for their dishonesty!

Much to the dismay of the economic bulls and the bubblevision hypsters we saw that the pace of borrowing by U.S. consumers dropped in February as fewer Americans sought credit in order to make purchases amid what may become the worst recession in seven decades…basically the consumer is spending less and discretionary spending (spending on fluff and non-living essentials) is retracing. Yesterday we saw that consumer credit dropped by $7.48 billion or 3.5% at an annual rate, to $2.56 trillion, according to the Federal Reserve…however their report showed that credit increased by $8.14 billion in January, more than previously estimated; please remember this is a lagging report however I believe that demand for credit by Americans likely shrank further in March, as it was the fourth straight month that job losses exceeded 650,000; and as you remember from my writings as unemployment rises….lenders and banks remain reluctant to extend loans. The recession that began in December 2007 has cost 5.4 million Americans their jobs, crippling the consumer spending that accounts for almost 70% of our economic growth (and where is the stimulus for the consumers…we just keep throwing good money after bad into the coffers of the lecherous bankers!).

The report shows that the balances on American consumer’s credit cards fell at a 9.7% annual rate in February, the fastest rate of decline since late 1976. Total outstanding consumer credit, including both revolving and non-revolving credit, dropped at a 3.5% annual rate, or $7.5 billion, to a seasonally adjusted $2.56 trillion, the Fed said.

No other recession has seen monthly changes in consumer credit contract this many times or so deep before going back to January 1943, which is how far the data provided by the Federal Reserve goes back. This vast retrenchment reflects less available credit, less consumer demand for credit, and consumer’s propensity to pay down debt as they are increasing worried about the future.

In a separate report from the Fed, we saw that the delinquency rate for credit cards hit 5.56% in the fourth quarter, the highest in the 18 years the Fed has been tracking this data, and up from 4.54% a year earlier. Worse yet the charge-offs rose to $6 billion from $3.6 billion a year earlier.

By the way the contagion is far worse than many believe as it’s not just that corporations who extend credit (BBY, HD, KSS etc.) and banks are less willing to lend, it’s also that they’re lending at significantly higher spreads. And that has many consumers less willing to borrow. Relieving these massive overhangs and nasty contagions in credit markets and restoring the flow of credit to consumers and businesses (not banks and insurance firms) is essential if we are to see the resumption of sustainable economic growth…this is where the Federal reserve, the Treasury and Obama administration is missing the boat, they are targeting almost everyone but the responsible American consumer who is employers and not a credit-junkie.

An unreported contagion…..uncollectible debt….we saw a report yesterday that stated that uncollectible credit-card debt rose to 8.82% in February, the most in the 20 years that Moody’s Investors Service has kept records. Moody’s cited higher unemployment and forecast so-called charge-offs will exceed 10% by the end of the year; I believe this is a vast under-estimated-contagion as I believe (according to the data that I collect) the charge offs will exceed 12.75% by the end of the year.

One of the key signals that confirmed my bearishness back in 2007 was the deterioration in credit spreads. And it continued to confirm the down-trend during each bear market relief rally since the bear-market started. The price of the mortgage-backed assets and spreads between these bonds and Treasury bonds tells us how much at easy investors are with these toxic instruments. A high price and a tight spreads would basically indicate very little concern on the part of investors for the health in this market, as they would be willing to pay the higher prices for a lower rate of return because they have little fear of failure. But when prices are low and investors demand a high spread we know that the credit market is still very tight and lending very-tight. And I have always found that in the long run the health of the credit markets has been one of the better leading indicators for the both the economy and stock market as a whole.

The picture from the credit market is as worrisome as ever. Actually it's more worrisome. As you can see from the “Markit” indices which track the prices and spreads of asset-backed securities…you can see from the chart below it shows the price and spread for AAA-rated mortgage-backed security MBS and the spread has steadily risen for the commercial real estate assets. More ominously, since mid March the price has dropped sharply to new low while the spread has spiked higher….how do the likes of Kudlow and Cramer thing that this is a positive, and why are the markets ignoring this huge contagion? The CMBX index climbed 530 points to a new high on Tuesday and then rose another 79 points on Wednesday and Thursday. This is happening while the stock market continues to rally…this is very perplexing for me as an economist and long-term stock market observer! I have been studying the markets and their behavior now for the better part of 17-years and I think the credit market participants are a lot smarter than the stock market players and you can see from the data that the credit market players are clearly very uncomfortable with the premise that the economy is healing and happy days are here again.

2

The question to be answered in this light-volume environment after this stellar relief rally is whether we setting up for a “bear” trap or a “bull” trap. (this options-X week will surely be very volatile) As such please take on LONG positions very carefully as I do not see a positive bullish catalyst in the making as we head into the earnings sector other than a potential short squeeze, relief rally that should which should be sold into. This recent bounce has undoubtedly pulled many new-bulls (I call them bag-holders) back into the fray, please be cautious and do not get sucked into a long-position without being very careful and hedging….we need to see follow thru and some decent volume….the index price action is moderately positive but we lack true conviction and volume and as I mentioned this weekend the money flows suck! The daily VIX is close to confirming some 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 or risk losing their tonality to the bulls! I’m a bit concerned with the ability of the bulls to venture further ahead with out a health 25-40% backfilling retracement/correction! The charts are pointing toward a rollover in the near-future and the internal action in the Russell-2000 and SOX today are worrisome if you’re bullish as they indicated distribution was high! The charts 240/180/120/60 minute charts and the daily charts are very-overbought and we are getting quite close to a potential significant roll-over/correction! We saw a small change in the McClellan Oscillator Friday and a moderate drop today, suggesting a large price move is likely. There is a huge wave of Fibonacci Clusters (inflection points) coming between April 6th and 15th, but at this point it is impossible to tell if they are going to signal a topping or a bottoming event!

These lenders/bankers/brokerage firms better not disappoint

All have enjoyed parabolic mega runs during the past 4-5 weeks we could see a sell-into-the earnings release unless they blow away the numbers!

The in-depth technical section is for subscribers only!

Copyright © 2009 Stephen Tetreault
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