Making my point...

Here is a chart graphically showing what I posted about yesterday regarding the Fed day pattern. After 5 of the last 7 Fed days the market was significantly lower. The two that did not follow the trend still had downside. The first actually reversed ON the Fed day and the second put in a doji the following day and then moved significantly lower on the second day after the Fed.

However like I also warned yesterday it is possible that with today being EOM that we go slighly higher today and go down big on Monday.

Here is a chart that I found showing exactly what the market did after Fed day.

http://lh4.ggpht.com/_APmrYvpA45s/SfkVWK16MNI/AAAAAAAADAE/wB55_8fZ_LY/s1600-h/FOMC%5B2%5D.png

Classic Fed day, will we get follow through?

The pattern for the Fed days have been ramp job right up to the announcement and then no follow through and prices fall for at least several days. I expect this pattern to continue. It is possible that with tomorrow being the EOM that they try to keep prices elevated. If this occurs then Friday we could be very red.

Upside remains very limited. Downside remains significant.

Met with Mike Mayo of CLSA yesterday (he along with Merideth Whitney are the UBER BEAR faces of banks)

Post the meeting I went back to the slide that interested me the most to compare the results from the Great Depression to what we are seeing today (most comparisons for anything go back to then and that was the last major deleveraging period). I thought the findings were pretty interesting and the net is that if this cycle follows the depression cycle, and if the banks anticipate the peak in NPA’s by three months like they did in the 1990’s cycle or coincidently like they did in the 2000’s cycle then my guess is sometime in the beginning of 2010 it will be the right time to be more bullish on banks. The movie will not follow the exact same script but I thought this was an interesting way to look at the state of the union currently.

Details:
· 1927-1930 and 1937-1941 exhibited similar net charge offs (.41% of loans) compared to the non stressed periods in the 90’s and 00’s (.45%) (ex 90/91/92/01/02/08).
· 1931-1936 is a much different story as NCOs went from .68% in 1930 to 1.29% in 1931, 2.29% in 1932, 3.14% in 1933, 3.36% in 1934, 1.57% in 1935 and .93% in 1936.
· The peak in NPAs (the leading indicator and what I think people are again watching again this cycle) was in the end of 1932/beginning of 1933 or 1-2 years ahead of the peak in NCOs in 1934.
· Here is my logic for the beginning of 2010 as being a potentially good time to be more bullish on banks. 2008 saw NCOs of 1.56% vs. the .52% seen in 2007 and the 1.29% seen in 1931. Therefore call 2008 1931, 2009 1932, 2010 1933 and 2011 1934 (Q109 largest 20 banks put up an annualized 2.13% NCO rate vs. 2.29% for 1932 so this continues to feel right). We therefore would not see a peak in NCOs until 2011 (that feels about right given where we are in the C&I and CRE credit cycles). However NPAs would peak 1-2 years ahead of that or sometime in the beginning of 2010. If you say coincidently the banks will outperform that peak in NPAs that would mean the beginning of 2010 would be the time to turn bullish.

All of the above being said I shorted FITB today and went long PBCT in a pairs trade. There is no way FITB's equity looks next week like it does this week. That bank needs to be shot. The government will either force them to raise private capital or force them to sell assets to others or the PPIP and there is no way it will be at a premium. There are 3 buckets of banks in the stress test. Bucket A are the survivors with little or no need for additional capital from where we sit today (JPM and GS fit this bill). Bucket B are the survivors that will need additional capital (WFC, STI, BAC fit this bill). Then there is Bucket C which is those that should have already died and FITB is in that camp IMHO, maybe even Citi. The reports have gone from saying only 1 bank needs capital this weekend, to 3 by Monday, 3-4 by yesterday and now 6 today. My guess is that it moves to 8-10 when the results are released next week. Maybe I am wrong but FITB is a dead horse nonetheless. I used PBCT as the long offset as they have something like a 20% TCE ratio, which is rediculous. The major banks are around 4% and the regionals that have yet to go through the C&I and CRE cycle are around 6%. PBCT will 1) be around, 2) not have to raise capital and 3) will be able to buy loans/securities from others. I view them as a way to buy a piece of the 1990's RTC or a play on this cycle's RTC, the PPIP. Would love to hear what you all think of the above. Like Pink Floyd said is there anyone out there (other than Solwold)?

NTRS capital raise today

We will look back next week and realize that the capital raise by NTRS today was brilliant! They are using the proceeds to pay back the TARP that they did not need in the first place. The reason why it was a brilliant move is they now move out of underneath the gubment, which will allow them to be a share taker going forward as they don't have to put up with a bunch of bunk (can pay people what they want, can run their business and take risks how they see fit and they can hire people whereever in the world they want). Secondly since they are not part of the stress test they did not have a disclosure hurdle that needed to be made before this capital raise, like BAC or C would have since they currently know the results of the stress test. Next week it will come out that the banks need to raise capital and there will be a lot of supply on the market. You tell me which hedge fund or private equity fund will step up and buy a crappy bank on the bank's terms. Didn't work too well for TPG with Wamu last year and that was on TPG's terms. Net I continue expect this to be a negative catalyst for the entire market. Solwold would love to talk to you on your shorts of JPM, BIDU and AMZN. BIDU and AMZN have high multiples fo shizzle, but investors are paying up for growth right now so how do you know when that party will stop (BIDU's fundamentals last night actually made me less negative on them given that I thought they would have a few quarter hickey from having to take advertisers off of their site).

The trend has finally changed.

I believe that after 3 weeks of trading in a 50 point range we are finally poised to break out downward. Momentum has clearly been moving from the bulls to the bears. There is a legitimate EW count that puts us in the early stages of a move downward. Rumors are swirling that both C and BAC failed the stress test and several other banks, including WFC, did not do well. The whole swine flu thing, although terrible, is just noise. It is an excuse for the headline writers. It is easier to blame the weakness on the flu than on the fact that we are overbought and overdue for a correction.

Anyway if we open below 845 today could be VERY ugly. If we open over this price we may fill the gap, like yesterday, before turning down again. Today should end red.

I am adjusting my IT term outlook. The tight range trading over the last 3 weeks has muddied the IT picture and to some extent the LT picture. From an EW perspective the most probable scenario is for a shallower fall in prices before a final move up that could reach 1000+. However, since we put in such a long and solid top I am wondering if 875 will be the top. We can put in a low in the 750 area in the next couple of weeks, then push back up near 875 and satisfy the EW requirements for this bear rally. It is less common than a move over 875, but it definately could happen.

Also making things less clear is the shenanigans with the shrinking liquididty. This could add massive volatility to the markets making moves more extreme or it could be much ado about nothing. We will see and react.

Therefore I am adjusting my odds for the possible scenarios. #1 - 50%, we drop to the 725-750 range and then bounce to new highs before reversing in the next bear market. This has been my favored scenario for about 3-4 weeks. #2 - 25%, we drop to about 725-750 then bounce back to test 875 and fail. Then we start with the next bear market. #3 - 25%, The top is in and the next bear has begun. Although we technically satisfied the minimum EW requirements for this bear rally it is not very "neat". I keep an open mind, though, and the top we put in could be lasting so I have increased the odds for this scenario.

All of the technical indicators and my analysis suggest that the next 100 points is down. Therefore I am short. I have 5 short positions (CHRW, QCOM, BAC, AAPL and FAS)and I am long 4 inverse etfs (FAZ, SDS, SRS, QID). I am about 66% short. I will add to my shorts if we pullback today and try to close the opening gap. On my watchlist to short are EXPD, IBM, JPM, AMZN, BBY, SMH, GS and BIDU. Other inverse etf's I am looking at are SKF, TZA and EEV.

My plan is to stay short until the evidence points to some kind of correction upward.

BAC is a good Short here

Jay's analysis shows the deteriorating fundamentals for BAC. Now is a technically safe entry for a short position. It just broke through a line of support and tested it from the bottom. The line is now resistence. The next line of support is about $0.20 below and the next support under this is $0.60 below. Set a stop over the resistence.


http://www.screencast.com/users/J-So/folders/Default/media/06f6b2fd-a742-4a8e-98ab-04865cf35c2d

Follow up

This is a follow up to the "Tick tock" post from a few days ago. More evidence is pouring in regarding extreme market inconsistencies. Accoring to data directly obtained from the NYSE Goldman Sachs has become the only force left in the game. Their program trades have accounted for 1/3 of ALL program trades in the entire market, that's 850 million shares PER DAY just for GS! Furthermore their principal trades are 81% of all of these trades. Principal trades are trades for GS and not for a client. To put things in perspective GS is trading more shares per day than all of the other top 15 brokers COMBINED!

Couple this fact with the continuation of the dissappearing market liquidity and this trend will not end anytime soon.

According to a report from Matt Rothman of Lehman, this rally has been a historic outlier. He writes "The previous rally was driven primarily by beaten down, cheap, low priced stocks of questionable quality. An equally weighted portfolio of stocks that had prices under $5 as of close on March 9th had generated a positive return of 128.5% through April 17th, outperforming Russell 1000 by almost 2.5 times (Russell 1000 return for the same period was up 52.6%). Similarly, an equally weighted portfolio of 100 stocks with the lowest Market Sentiment score as of March 9th, yielded 116.7% during the same period."

This market has been stretched like a rubber band. One could put together a pretty compelling case that GS has been intentionally raising the prices of the most shorted (and worst companies) stock since the bottom at 666. Through this process they have managed to force several large quants to deleverage (cover their short positions) which has raised these prices on the shitty stocks forcing more quants to deleverage. A continuing process. Their goal would be to seemingly drive the competition from the market and of course profit along the way.

The tape over the last 5+ weeks shows a series of fairly significant quick ups and downs. The trend only seems to last for one or two days. What this looks like to me is a repeat of a sell-off based mostly on short selling, then buying by the "buy the dips" crowd (and apparently GS). This buying forces all of the shorts to cover which forces prices higher until the bears try to pick another top.

Ultimately this process will end. Once all of the quants have deleveraged and all of the bears finish trying to pick the top and all of the "buy the dips" crowd has gone in on stocks this will top. When it does we are set up for what could be one of the worst drops in market history.

I have no idea how long this plays out. The evidence already shows distribution by the institutional players (GS?). They may be getting ready for a fall. However this could strecth on for another couple of weeks.

Looking for continued weakness

The SPX halted its rebound yesterday (850)within sniffing distance of the 50% retrace (851). XLF halted its rebound right on the 62.8% retrace (10.60). These were expected. Today the move down should continue. My targets have not changed. I am still looking for 725-775, with the liklihood of the lower end of this range. As the move unfolds today I should be able to get some more clarity.

Playing countertrend moves is difficult. This move off of 875 is countertrend to the bear rally. It will not be easy to play this, so I will use more caution in closing out positions as the move can complete and reverse quickly and rapidly at anytime.

I am seeing two patterns develop on larger time frames. One seen on the 10 day chart should complete as early as today once the SPX crosses below 820-825. It may take another day or two to cross this line, but the pattern will still be valid. The target for this pattern is 785-790.

Another pattern is seen on the weekly chart. This pattern still needs another one to two months to finish forming so it may not complete. However if the market does what I am predicting it will precisely complete the pattern. We need the SPX to move down to the 725-750 range. Even a move near the 666 bottom or beneath it slightly keeps the pattern valid. Then move back up above about 825. This price may change slightly depending on how the rest of the pattern plays out. The target for this pattern is about 1130 on the SPX. This pattern is also pretty reliable.

These two patterns are very reliable and both amazingly fit with the scenarios I have laid out previously. The target for the second shape is higher than I originally thought, but still in the general neighborhood. I expect the first to hit. I am not sure about the second one yet. A lot can happen in the next couple of months.

Longer term forecast

FWIW I have slightly revised my longer term forecast. Short term we are going down still so don't worry. Still targeting 725-750 range.

The charts off the bottom clearly have an ABC shape. So we have several scenarios on the table right now. Most likely is we are going to get a complex shape for this bear rally. I give this 80% liklihood. We should get our big correction down that probably began today. Then another complicated pattern back up to new highs.

Another scenario (15% liklihood) is that we completed wave A up and I am just not labeling the waves correctly. The result of this is a leg down like I have been talking about and then a simple five wave pattern up to new highs. This means no complx pattern.

Last scenario (5%) is that the ABC we experienced IS the bear rally. It is over and we are now down to new lows. The only thing that gives this scenario creedance is that we already met the minimum rise in price. The thing holding this scenario back is that its only been about 6 weeks since bottom. These usually last 4-18 months.

What I am looking for is a 5 wave structure down. We appear to have one nice wave down off of Friday's high. Wave 2 up would be the test of the bottom of the wedge. Then wave 3 down. Based on the lengths of the wave 1 and 3 I can better gauge the chances of the scenario's listed above.

BTW the black swan event is still a viable scenario. It would be the 5% option to new lows. The pieces are in place, but it is still highly unlikely at this point.

According to plan...so far.

So far we bounced off the top of the ascending wedge pattern Friday late. This morning we opened right at the bottom of the wedge. We drifted lower and ae now sit about 10 points under this line. I am waiting for us to test the line again from the bottom and get rejected. That is when I feel another perfect spot to open up new positions or add to existing ones.

My gut tells me that every bear in the world is looking for the same scenario. This tells me we may not get it. The bears have been kicked in the ass for weeks trying to pick tops. Now we are scared and waiting for the sure thing. I am quite sure the market will not be so kind.

Going forward I expect selling to accelerate over the coming weeks and volume to build. Right now prices are falling on a lack of buyers. Sellers have not stepped in yet cuz of what I just said about picking tops. Once the sellers step in, volume will pick up and the "buy the dips" crowd will run for the exits. It should be beautiful.

BAC's results

Bank of America’s results just scream to be shorted, see below. And if that is not enough to get bearish on the financials then comments by Senior Presidential advisor Axelrod this weekend should (they are similar to what Guithner had said a couple weekends back). Axelrod said “some banks will show serious problems and will likely need substantially more federal financial assistance, but the government doesn’t foresee a scenario whereby an institution will be seized entirely by regulators. We're confident that, yes, some are going to have very serious problems, but we feel that the tools are available to address these problems.” Can you say Citi like preferred to common conversion, more government infusion or having to come with hat in hand to the public markets. Any way you slice it the call option of the capital structure, common stock, should get hammered at BAC and WFC over the next month. JPM and GS should be safe and I don’t have a specific call on the other 15 institutions going through the stress tests.

BAC’s results. On the surface a $.44 number vs. $.04E looks pretty good. However if you strip out the gains from their China Construction Bank sale (-$.15), Security Gains (-$.12), Merrill Mark to Market gains on MER structured notes because of a widening in credit spreads (-$.17) and then add back merger related charges from MER (+$.06) then you get $.06 vs. $.04E. Okay so that is better than expectations, but BAC’s loan loss reserve currently stands at 3.00% of loans. That compares to JPM at 4.5% and C at 4.1%. JPM is the most conservative of the group in terms of reserving, is the best positioned in terms of their loan mix and was much less aggressive in terms of underwriting on a relative basis over the past few years. So you tell me where BAC should be relative to JPM? HIGHER is the answer. If BAC were to reserve like it should their results this quarter or over the past year should not have been anywhere near what they were = equity value lower than where it is now. BAC saw Net Charge Offs of 2.85% of loans vs. 2.35% last quarter, which was worse than expected, and they saw Non Performing Assets of 2.65% vs. 1.96% last quarter, also worse than expected. Doesn’t that also call for a greater loan loss reserve? To put the 2.85% net charge offs in perspective, the worst period ever for the banking industry was the 3.4% charge off rate in 1934 during the GREAT DEPRESSION! Lastly 50% of the NPAs was due to resi construction, no surprise, but 25% was from commercial real estate. That is an area to really watch over the next 1-2 years. Solwold is there a double/triple short commercial real estate play? I know you have mentioned the triple short real estate name before but I want to make sure that is all commercial and no residential. I can argue we are much closer to a bottom in resi vs. CRE.

Tick tock, tick tock, tick tock.......BOOOM!

We are slowly approaching the brick wall known as the trendline that was support for most of Jan and Feb. I still expect this line to hold and expect us to have a sizeable retrace from here.

The blogs have been full of stories regarding dark clouds on the horizon. Nothing you read in a blog can be considered the concrete truth unless it can be backed up with fact. Usually the stories have links to stories from reputable news agencies. If it doesn't then I don't pay much attention to them. This time is no exception.

Yesterday the one year treasury note hit a yield of 0.01%. This means that bond investors are willing to take almost no return for their investment. There is only one reason this happens. Massive FEAR. Fear of substantial loss in other investments. The last time the treasury hit yields this low was in Nov. Take a look at what equities did in November! In other words the bond boys know something that the equitiy guys don't....yet.

More interesting related news. I have read in several places backed by documentation that several large quants have blown up this week. What are quants? Maybe Jay can provise some input on this. In my research I have found that they are large investment companies that rely on various mathematical formulas to buy and sell stock. Their goal is to be equally long and short. They hope to break even on their investments and make their money on rebates from the stock exchanges. They get these rebates because they provide an extremely important job for the markets. They provide liquidity on a massive scale. This liquidity provides a floor or ceiling on share prices and prevents extreme temporary swings in share prices.

For instance if a stock suddenly feels selling pressure and the share price drops the quants' computers tell them to buy. This purchasing action prevents a crash in that equity by buying the shares that are being sold.

What has happened to several large quants this past week is that they have been forced to unload massive positions on certain equities due to their own personal loss limits. The quants purchased short positions against many low priced equities with poor fundamentals as these equities prices increased off the bottom. Many of these equities have doubled off the bottom or more and forced the quants to take massive losses. This has forced several to shut their doors and forced others yet to step aside and avoid the trainwreck.

Basically many quants did not see the bear rally coming and got caught short. The effect has been lack of liquidity and artificial demand due to short covering which has caused the rally to drag on and go higher. Coincidentally as prices rose and this dragged on more quants got pinched.

Now what does this all mean? Possibly, not probably, there will be a black swan type event.

We are overdue for a pullback. If the market does not have the proper liquidity due to the disappearing quant funds the pullback could escalate into something larger. I have noted in this blog yesterday that evidence suggests that this rally has been led by retail mostly and recently the institutions have become bearish. If prices begin to fall and fall quicker than normal, the retail investors could panic and the race will be on for the exits. I am talking a market crash.

Furthermore the market has created a pattern called a rising wedge. This pattern has a very reliable outcome of extreme and sudden reversal. Once this pattern resolves and prices begin to fall we could get our black swan type event. It would be a day that would go down in history. I am not predicting it, but I just wanted you all to know that many pieces are in place for this type of event.

Edit: I'll add to this with some information that did not have any link to an article, but was reported by several hedge funds. The strategy taken by these funds has been to short the inverse etf's and go long the small crappy stocks. This has forced the quants to cover at massive losses and resulted in huge profits for the hedgies.

The administration and Jim Cramer and all the talking heads on TV and even the United Nations has called for regulation of the hedgies because they shorted the financials into the abyss last fall. I wonder what they will say now that there may be evidence that most of this rally has been manufactured by the hedge funds. I am sure Obama will not speak up for any bears out there who have been ass pounded for the last six weeks. He still thinks there are "green shoots" of recovery visible.

Have a great weekend guys.

This could last until Monday

I wrote yesterday that since we failed to breakout of the pattern we were in we may get another test of Monday's highs. Upon reviewing lots of research last night I have an idea of how this might play out.

JPM announced higher than expected earnings this morning(no surprise) as the banks continue their streak of "nothing to see behind the curtain, the recession is over" 1Q earnings "surprises". The last two major financials to report are C (tomorrow) and BAC (Monday). I believe that Friday's close will mark the top. I believe that the banks earnings are a "buy the rumor, sell the news" type event.

I have seen data of extreme selling into strength over the last 1.5 weeks. The COT data two weeks ago marked a swing in institutional buying of calls to buying of puts and in large quantity. This data tells me that the big boys are unloading the positions they bought sub-700. They are using the same process that Livermore wrote about in his book over 60 years ago that I have discussed before.

Combining the data mentioned above with the overbought signals across many timeframes gives me the confidence to predict a top is imminent. I have been expecting it for over a week. I posted yesterday that the market seems to be artificially propped up. I believe that this will end when the last of the banks release earnings.

Here is a chart that I found detailing the current pattern.

https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgVJakpB_q6UpdP2QvD6DidM6QKuS3dCW8m20ab0Pinpb8Dsg8ujDjbklR6l2ji_Uxreu0-TPgVuIesYU5emSWfiCm0YnKGOqnXI7xkRhFjBp3GL5Xg0e2Xk5Q9Sb2QG5C3vOZw0ndOFRE/s1600-h/PROPHETMinor+1.png

It clearly shows that it should peak on Friday's close. I will be looking for higher prices through most of Friday and a last five minute before close rush to the exit. That is how it played out on Feb 13. It may do the same thing this Friday.

That dark line was a line of support that withstood 11 out of 12 tries at penetration. It was a line of support that connected the Nov. 19 low with all of the lows through Jan and Feb. When it finally gave way with a gap down open after MLK day we dropped 160 points in less than one month. We do not have the momentum to break this resistence until we have a decent retrace. Interestingly when we revisit this line after the expected correction it should be over 900. It will give us some trouble to break, but when we do we will accelerate upward. But that is months away.

I predict a gap lower on Monday or a flat to slightly up open and then a crap out. I am hoping that my new account will be funded by Friday's market close so I can get in on some low risk high reward short positions.

Tuesday Recap

I had sent out an email this morning stating that the chances were good for a very red day. Well it did not happen. We were on the verge of breaking out of a very reliable pattern, but it failed the backtest. Since we failed the backtest we now have good odds at testing the highs from Monday possibly tomorrow.

This is OPEX week so we should expect extreme swings in price. Often times we'll whipshaw back and forth for most of the week and end the week close to where we began. I will use a retest of the high as an opportunity to load up the short bus. Nothing that happened today has changed my outlook for lows in the near term.

I get the impression that there are forces keeping this market elevated. I posted some thoughts in a reply to Jay the other day regarding GS. This may be part of what is happening. I have talked before about Livermore's process for selling large volumes of stocks. This may be going on as well. Ultimately the market will correct. The longer they keep it elevated the deeper the retrace. In fact the odds increase of us actually testing the 666 bottom.

Ever since we hit a high on March 20 over 800 we've had a vicious tape. Gap opens almost everyday. Fast moves intraday often back and forth ending where we gapped open. We've been trading in a 50 point range almost exclusively for almost four weeks. I can't wait to break out of this. JPM releases earnings I think tomorrow. After this C is the last major financial to report. Perhaps it is these earnings announcements that the prices are being helpd up for. Once we put them in the rearview mirror we can finally move on.

Regional Banks Starting to Crap Down Their Legs

The oft worried about Commercial Real Estate issues are finally starting to creep up. RJF last night, MBWM this morning and CBSH yesterday all announced their earnings would miss expectations and all cited CRE as one of the contributing factors to the weakness. CRE losses/NCOs are currently around 25bps for the largest 50 banks in the US and Non performing CRE loans are about 150bps. That compares to the early 90's peak of 212bps in NCOs and 600bps in NPAs respectively. Add to that C&I lending, really just a catch all investment class that has virtually no collateral, is currently at 100bps in NCOs and 100bps in NPAs compared to the prior peaks in the early 90's of 250bps/500bps respectively. You get the picture, painful, painful things ahead that I don't think people can look past until we are at least 50% of the way through the pain and this is really the first of maybe 8 quarters of pain. (RJF and MBWM are underperforming the SP500 financials index today by -1800bps and CBSH has underperformed by -1100bps yesterday and today).

Fundamental Thoughts on the Credit Markets support Solwold's technical analysis

See the end of this post for the conculsion if you don't want to read how I construct my credit market index.

I am going to start posting the results of my weekly look at the credit markets on Fridays or Mondays. It is an index I created a few months back to look at the health of the credit markets. It looks at 58 datapoints, some of which happen weekly, some monthly and some quarterly. It is broken down as 28% RISK, 18% RETURN, 30% CONSUMER HEALTH, 18% BUSINESS HEALTH and 6% INFLATION. The thinking goes risk/return is the leading indicator for overall health of the markets so it carries 46% of the index or as much as consumer/business consumption ability of 48%. 60% of the risk/return weight is in risk given that the market is focussed so much on risk right now and will be for some time and 60% of the consumer/business health is weight is in consumer given the larger importance of consumer on consumption. The remaining 6% is inflation with deflation a negative as it shows policy steps are not working as intended. The index is a weighted average result of these 58 datapoints based on 3, 1, 0, -1 and -3 or incrementally getting much better, incrementally getting better, no change, incrementally getting worse and incrementally getting much worse. It is not based on levels or vs. expectations rather the second derivative move in the underlying datapoint.

Net, net the index has been positive for the past 5 weeks meaning things are getting better vs. getting worse. That compares to only 2 positive results in the prior 14 weeks! So even though it feels really bad out there things like issuance of debt, terms of that debt, the Ted Spread, Libor/OIS Spread, VIX, Yield Curve, trading of derivatives on the CME, $ to Yen, $ to Euro, Returns in China, Brazil and South Korea, performance of early cycle stocks vs. late cycle and vs. defensive stocks, consumer confidence, all the housing stats (affordability, mortgage rates, mortgage applications, new and existing home sales and supply & Freddie Mac Delinquencies), gas prices are all getting incrementally better. Unless we start to see these metrics crater and move the other way again heading to where we were post Lehman I don't think that we re-test cycle lows. That being said as you have seen from my prior posts we are definitely going lower from here over the short term.

Wave 2 Down is Underway

At this point I am 99% certain that the wave 2 correction is underway. As stated several times on this blog my targets for the wave 2 bottom is in the 725-750 range. This wave 2 should take an ABC shape. That is a five wave structure down, followed by a 3 wave B up and finally another 5 waves down for C. Time frame should be 2-3 weeks, but this is really just a guess.

Going short from here is a low risk-high reward play. The inverse leveraged etf's will be porfitable, but caution should be used in exiting the positions near the top end of the range listed above.

There are several signs that the bottom of this wave may be closer to the 750, even 765 range than the 725. I'll keep monitoring these signs. I am playing this by shorting mostly the financials and RE. I will begin scaling out of my positions near 775 unless I get signals that the retrace should be deeper. I will keep all of you informed of course.

Once wave 2 down completes we will begin wave 3. Tentative targets for this are over 1000. This wave will be the easiest wave to play in the next several years. This is the period in which one can literally throw a dart at a list of stocks and make money. However by choosing the right plays one can make MORE money! This is still several weeks away and most of the major moves will be in late spring or early summer.

GS Earnings

It will be interesting to watch how GS and the rest of the financials trade today. GS had a blowout quarter on revenues and earnings because of trading in their fixed income, currency and commodities book. However the rest of the statement was just okay and people were looking for more there. In addition GS just switched to a calendar quarter so these results are for Jan-Mar, leaving December in no man's land because that was after their last quarter of November 2008. Results in December were worse than what people were looking for and so book value, the key metric to value financials, did not grow sequentially even with these good results. Net, net these results are not enough to keep people in place in GS in the short term. However I would go long the financials that can and will pay back the TARP and short those that will not be able to do that. The reason is those that pay back the gubment will be able to 1) pay fair market value for talent and will therefore see an inflow of talent, 2) not have to run their business with the government over their shoulder telling them what to do and therefore will be able to take appropriate risks and earn an appropriate return and 3) will be able to participate in the PPIP program to buy distressed securities while using the government as the prime broker to let you lever up. So go long GS and JPM and maybe even MS and short BAC, C and WFC. I still think slight upward bias to the market through earnings season but early to mid May when the government requires many banks to riase capital will be the start of a retrace of some of the recent gains.

Topping Process

SPX hit the range of a high confidence top for wave 1 up of this bear rally on Friday. I had been looking for 850-860 since the week before. XLF hit it's high probability top today at $11. I had not posted a target for XLF since I had not applied the EW principles to it. I ran across someone this weekend that had and they had an $11 price target.

Since SPX topped Friday and XLF today early, both appear to be making moves down that are consistent with a new wave down. If this is true we should see some acceleration downward later this afternoon on both SPX and XLF.

The wildcard out there right now is the GS earnings scheduled to be released tomorrow before the market open. It is possible that we trade in a tight range for the rest of today and tomorrow the GS earnings (which are rumored to be atronomical) is the catalyst for the selloff. A "buy the rumor, sell the news" type selloff.

One thing is certain from last Friday's surge. Record profits are now ALREADY PRICED INTO ALL FINANCIALS. When WFC announced their fake record earnings all of the other financials rose along with them near the 30% range (with the expection of C which only rose 10%). So anything short of record profits will take the finnies DOWN. Record profits just keeps them where they are now. This also fits well with the EW forecast.

Now would be an ideal time to open up short positions against the financials, real estate and the SPX. It is a very high reward, low risk setup. I would suggest FAZ, SRS, SDS and SKF. My target for the SPX is in the 725-750 range and my target for XLF is 7.80-8.45 range. If XLF hit this target FAZ would more than triple from it's current price. This wave 2 down should take about 1-2 weeks to play out.

Thursday Market Analysis

I finally had a chance to digest today's market action so far. The SPX hit the target I had been expecting for a few weeks (850-860). Market volume remains light as it has all week.

The structure now looks complete for an EW wave 1 off of the 666 bottom. I now expect a retrace of 50%-62.8% minimum. Running the numbers puts us in the 734-758 range. The momentum indicators are running on the overbought side on most time frames now. We are also going to put in our fifth straight up week in a row. to put this into perspective we only had ONE strecth of five or more down weeks in the entire bear market. June to July of '08 had six straight down weeks.

The price structure on XLF looks even better. A retrace from today's high of $10.10 takes us down to $7.41-7.96.

I studied the market action during the period off of the Nov. 23 low to the high on Jan 6. I looked at this period because the time frame matched the time frame from the March 6 bottom to today (a little over a month), both periods started with a bear market low and ended with a 3 day weekend. You can see this in the following chart:

http://stockcharts.com/def/servlet/Favorites.CServlet?obj=ID3095409&cmd=show[s155003437]&disp=P

Jan 5 and 6 were the first two days after the New Year holiday period. We put in back-to-back doji candles. We also put in a top and went down 280 points in the next two months.

If this scenario were to play out again, then next week Monday and Tuesday will be narrow range trading days and give us a top slightly higher than today. Which would still fit with my expected top in the 850-860 range.

Also note in the chart above that we are close to hitting a major resistence line. I believe we test the line and fail there. Then we pull back to the next resistence line that connects the tops on jan 6 and Feb 13. This line conveniently sits right in the range of the expected pullback (734-758).

Once my new brokerage account is funded I will go heavily short for the expected pullback. I will scale out of shorts as we approach the 750 area and then scale into longs when it is apparent we are near a bottom.

The most difficult time to be short is at the top. The most difficult time to be long is at the bottom. Yet these are the times to be a contrarian. Going short now will pay handsomely in the next few months.

WFC announcement

Credit markets have generally been decent over the past few weeks and it sounds like the 19 banks under the "stress" test (not that much of a stress) will pass the test. Add to that the news from WFC today that they will blow away consensus expectations for Q109 and the short covering rally is on today. Liquidity will be low in the market given the holiday tomorrow so it will be more extreme than it should be. It will be tough to be short the financials group through earnings season given that this WFC trend should also benefit JPM, BAC and PNC. This should give a general lift to financials overall since this is one of the most hated and therefore underowned groups out there. This should be a broad positive for the markets overall as well. However once earnings season is done (mid May) I think we are in for a market pullback given that the Fed/FDIC will push the banks that need more capital to get it and we may have another GM like boot out of a bank CEO, Pandit at Citi? The push for more capital means the conversion of government preferred to common and that will dilute the heck out of the common shareholders. In addition there will be arbing to short the stock of the bank who will have preferred converted into common like we saw with Citi. I would ease up on WFC, BAC and C here and then come in after earnings season to put the shorts back on them. Good pair trade is to use JPM as the long.

Critical Error in my Long Term Outlook

I must admit I am a little embarrassed. I made a critical error in my long term outlook. As you may have known I have been reading a book on EW theory. Anyway I got to the section regarding corrective periods like we are currently in. The critcal idea is that market corrections of ALL magnitudes contain three wave structures. So the expected wave pattern for the current bear rally is a THREE wave NOT FIVE wave structure. This will significantly lower my IT target from over 1000SPX to most likely under 1000SPX.

In the short term nothing is changed. I am still expecting the second wave of this rally (which is now called B and not 2) to retrace to 750 or lower. The change is now the next wave up will be the end of the bear rally. Corrections are very difficult to play and to predict with much confidence where they will end. This C wave up could go higher than the top of the A wave, or it could not reach that high. It should take a five wave structure though which will help tremendously in setting a target for the top. The problem is we will not have much warning for this. We'll have to set the targets as the wave C moves up.

If I had to guess, which of course I will, I would say that the C wave traces to at least the top of A (currently is about 845). It will probably go beyond A to the 900-950 area.

Corrections in general can be messy complicated structures that tend to stay in a trading range. The reason for this is that these periods are when most investors take profits. Once the profits have all been taken then the larger trend (down in this case) can continue. They can take much more time to complete than impulsive waves. I have referenced the period between December and early February as an example.

I expect this correction to last throughout the earnings period. This is the rest of April. I also expect prices to remain mostly in the 800-850 area. I may take a more active trading approach during this period going long near 800 and short near 850. I will use trading stops as a safety net to avoid becoming trapped in a position. I probably won't make much money doing this, but I'll probably learn alot and use this period to become acquainted with my new broker.

Everything Falling Into Place

Yesterday was an important day in the worldwide markets. There were signs that many important worldwide markets have topped in unison. This is possibly a very powerful indicator that we are at an IT top.

The EUR stocks opened with a gap up, traded above the IT high from last Friday, then reversed and closed at the LOD on volume. Also yesterday the EUR, GBP and CHF all had similar topping patterns. At a minimum I expect these currencies to test the lows set earlier this year. Our own stock market failed to set higher highs than Friday.

As you guys have known I have been expecting a top in the 850-860 area. We have not gotten there, but we got close. Overnight trading on Sunday night reached 848. It is possible that the fifth wave of our fist bear rally leg up will end short. However keep in mind that this is a holiday shortened week. The markets are closed and volume on Wed and Thurs will be light. Because of this it is possible that the mostly retail crowd will push prices into the area I have been expecting.

There is a very good possibility that next Monday's open is down significantly similar to the last threeday weekend we had at MLK day.

Looking forward I still have my target at 750, which is roughly the 50% retrace of the move off the bottom. Just as likely is a 62.8% retrace (732). Less likely is a 38.2% retrace (777). I am reducing the odds for this due to the worldwide market activity yesterday. That was a powerful signal that this correction will be significant, as most wave 2 retraces are. I am also moving up a small notch the possibility that the retrace is 100% or even over 100%. At this point I am only keeping these possibilities in the back of my mind. As prices fall I will get a better indication of where prices are likely to fall to.

The way I am going to play this is similar to the plan I have had in the last few weeks, except that I will not begin scaling out of my shorts until closer to the 750 area, not the 775 area.

Holding Frim

My post on Friday is still my primary view. I thought we'd get to 850-860 as a high, we actually hit 848 in overnight trading last night. It appears today that the bears are in control, for awhile anyway.

The prices today suggest we are now in wave 2 down. The targets I posted last week are still valid.

I am feeling much better today than last week so hopefully I am finally kicking this bug out of me. You can expect more frequent posting when I am fully recovered.

New Wave Targets

I think I was a bit rpemature in ending wave 1 when I did. It is looking to me like we may get one more push up to new highs before ending this wave 1. EW target would be 860. Could end sooner, could end later, but most probable is 860. Gauging the length of the beginning of a new trend is difficult. Once the first leg is clear then a true EW'er can set high probable targets for the rest of the waves.



As it stands now My targets are ending this wave 1 in the 850-860 range. Wave 2 down goes to near 750. Wave 3 then will go to a minimum target of 950 to 1050. Wave 4's are usually long and boring. (the wave 4 from the past bear market lasted from late Oct to mid Feb and spent most of that time in a 150 point range.) Wave 5 could take us 100 points higher than wave 3. Kind of early to project wave 5 since it is possible that wave 1 extended.



The way I am trading this is per my previous plan. Stay short until the end of wave 2. i will scale out as we approach the wave 2 down target.



If I am wrong about where we are in the wave count, it will become apparent that we are in wave 3 already if we push up past 860 towards 900 in a steep, fast line. I highly doubt this since there is so much resistence above from a trend analysis. I really think we need lower prices to "refuel" the momentum gauges as we are currently oversold.