WHICH WAY THIS MARKET IS HEADED
The markets had a hard time last week and you can
see that the SPX is actually trading below its downtrend line. There has
been a lot of talk about a big rally off the bottom ‘any minute’ but the
VIX at 27.49 still isn’t anywhere near the capitulation highs at 35.00
we saw in January and March. And the irony is we sure have reason to be
there—when the big banks start failing it’s time start hording potatoes
in the root cellar (right next to the cardboard box the big screen TV
came in).
If market watchers weren’t worried before they’ve
sure got reason to be now--IndyMac became the biggest casualty of the
subprime mortgage crisis Friday as federal regulators shut down the
disastrous Pasadena based savings bank in one of the largest U.S. bank
failures ever.
The Federal Deposit Insurance Corp. said in a
statement it will take over operations of IndyMac (IMB) which will open
for business on Monday as IndyMac Federal Bank. The thrift - the fifth
U.S. bank to fail so far this year -- had total assets of $32 billion as
of March 31.
The problem is this is just the beginning—you know
there will be more failures to come. Even the ‘Everything’s okay Polly
Annas’ have to shake their heads when the biggest government backed
financial institutions become insolvent.
After years of easy credit, the pendulum has now
swung radically in the other direction, threatening to choke off the
life blood of growth going forward. All the other sources of lending in
the economy -- the banks, the broker-dealers, the securitizers, the
shadow banks and the commercial paper market - are dead in the water,
leaving Fannie and Freddie as the lenders of last resort to the economy.
But Fannie and Freddie got in a train wreck called
the subprime meltdown and as of Friday night they were declared
‘insolvent’. This is serious business for a pair of
agencies that have grown
to such mammoth size--they now own or guarantee $5.2 trillion of U.S.
home mortgages.
Of course the government
can’t let these two institutions fail no matter how incompetently
they’re being run--at the eleventh hour (earlier today) the White House
and Federal Reserve moved to
open up the emergency discount window
to Fannie and Freddie to infuse the cash needed to keep them going. In
addition, Treasury Secretary Paulson announced that he will seek
Congressional authorization to buy stock in the two companies and
increase the government's credit line to them.
Obviously the government
can’t let these two giants fail or we really will spiral into a
depression but at what cost is this bailout coming? The dollar will take
another huge hit—and once the world figures out no rate hike is coming
in the foreseeable future the dollar will take another plunge driving
the cost of food and oil even higher.
Speaking of which crude
for August delivery closed up $3.43, or 2.4%, at $145.08 on Friday on
the New York Mercantile Exchange after hitting an all-time record of
$147.27 a barrel earlier in the session. In other action on the Nymex,
August reformulated gasoline rose 5.23 cents, or 1.5%, to $3.56 a gallon
and August heating oil added 3.92 cents, or 1%, to $4.08 a gallon. In
other words the energy drags on the economy are ratcheting up to even
higher levels and we’ll see that dramatically unfold as the earnings
confession begins in earnest this week.
A number of big
brokerages are announcing earnings this week and that should reveal much
about how much damage lies ahead. Earnings at consumer
discretionary firms are expected to have plunged 20% from the year
earlier, weighed by results from automakers and department stores,
according to Thomson Financial. Overall, earnings from S&P 500 companies
are expected to come in 14.7% lower than in the second quarter of 2007.
So we’ve got a massive bank failure, a government
bailout in the works, continuing record increases in oil and gasoline,
and a flurry of earnings reports—the question is…
HOW DO WE MAKE MONEY ON IT?
We’ve got two super high-potential plays lined up
this week and they are both bearish. The first is on a sector with a
projected 72% earnings shortfall this quarter—if you are looking for a
high profit short THIS is the sector to be in. Fortunately for us the
puts are cheap which means the potential of BIG profits is right there
in front of us—all we have to do is grab it—something we’ll be doing
with some well place puts first thing Monday morning.
Our next play is on a metals producer that is
really hurting—both their raw materials costs and energy costs are going
through the roof yet the company has little ability to pass on those
costs to their industrial customers—the net result is shrinking margins
and a plummeting stock price. We just got the trigger to climb on board
this downhill racer as the stock just broke below another critical
support level on Friday.
We’ve got two excellent looking plays lined up and
a market that wants to move—so let’s get started…
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