How I wounder what you are...?

Clearly, the various markets are currently grappling with how events will play out in the coming year.

There are four possible outcomes:-

Scenario 1: The Fed sticks to its assertion that the risks for inflation and growth are now in balance, does not cut rates any further, and the U.S. economy grows past its credit crunch. If this happens, it would be massively bullish for the U.S. dollar, massively bearish for gold and potentially bearish for Hong Kong and Chinese equities (which are now anticipating more rate cuts). It would also be very bearish for U.S. Treasuries and government bonds around the world. Additionally, we would also most likely see a rotation within the stock markets away from commodity producers and deep cyclicals (which have been leading the market higher for years) toward the more traditional "growth” sectors, such as technology, healthcare, consumer goods, and maybe even Japanese equities.

Scenario 2: The Fed sticks to its guns, does not cut rates, and the U.S. economy really tanks under the weight of the credit crunch. In essence, the U.S. would move into a Japanese-style “deflationary bust.” In this scenario, equities around the world, commodities, and the U.S.$ would collapse, while government bonds would go through the roof.

Scenario 3: The Fed ultimately cut rates, but this fails to rejuvenate the system and get growth going again. This would likely mean stagflation. As such, gold and other commodities would do well, while stocks and the U.S.$ would struggle. Excluding bonds, this is increasingly what the market is pricing in today.

Scenario 4: The Fed ultimately cuts rates, and succeeds in reigniting the economy. This would be good news for equity markets, commodity markets, and the U.S. dollar (as world trade and foreign buying of U.S. assets would again expand, increasing the need for U.S. dollars). Of course, this scenario would be terrible news for bonds.”

The bet is on Scenario 3 and thus one has to be concerned that the Fed’s hand could be forced by the market to cut rates. Cut rates indeed, yet history shows while the first rate cut has an impact, the second and third tend to not have so much of one. This is demonstrated once again by the fact that the S&P 500 is below where it was when the Fed cut interest rates for the third time on October 31.

"Economic history is a never-ending series of episodes based on falsehoods and lies, not truths. It represents the path to big money. The object is to recognize the trend whose premise is false, ride that trend, and step off before it is discredited." - George Soros.

Abu Dhabi to CITI rescue.

When I look at this deal it is quite interesting. First of all, it must be understood that this is effectively an equity deal because of the mandatory conversion provision. From the limited information I have been able to retrieve, it seems that Citigroup is selling just under 5% of the company for approximately $5.7 bln. Why is it not the $7.5 bln that it is getting from the investors? Because Citi will have to pay interest on the $7.5 bln for just over two years, which will come out to approximately $1.8 bln. $7.5 - $1.8 = $5.7.

By my estimate, Citigroup has basically issued restricted equity (to be officially issued in two-plus years) at a price per share around the mid 20's when you take into account the 11% interest it is paying on the $7.5 bln. Additionally, Citi does get the benefit of using $7.5 bln now instead of only getting $5.7 bln now (if it had just done a straightforward equity deal), while paying $1.8 bln over the next two-plus years in interest.

All in all, this deal is a tough deal for Citi in my opinion because it smells like desperation. But don't be confused about the 11%. It is clear since the deal has mandatory conversion prices that the 11% interest rate is basically a discounting mechanism for the conversion price, which is why I say the equity was effectively issued in the mid 20's. It also must be noted that doing a convertible may have certain tax advantages for Citi instead of doing a straight equity deal in the 20's.

Week ahead.

Tuesday November 27
10:00 Consumer Confidence: 91.5 cons

Wednesday, November 28
8:30 Durable Orders: 0.0% cons
10:00 Existing Home Sales: 5.00 mln
10:30 Crude Inventories: 1071 k prev.
2:00 Fed’s Beige Book

Thursday, November 29
8:30 GDP-Prel: 4.8% cons
8:30 Chain Deflator: 0.8% cons
8:30 Initial Claims: 330 k prev.
10:00 New Home Sales: 750 k cons

Friday, November 30
8:30 Personal Income: 0.4% cons
8:30 Personal Spending: 0.3% cons
8:30 Core PCE Inflation: 0.2% cons
9:45 Chicago PMI: 50.5 cons
10:00 Construction Spending: -0.2% cons

Will this bull kick save the market ?

A brilliant observer of things, W. D. Gann’s sheer genius led him to comment that : “God geometrizes!”

If the geometrical notion of "as above,.. so below" is true, then the key reversal at the 1576 S&P high on October 11 may be a mirror image of Tuesday’s, 20th Nov's, reversal at 1420 S&P. This is the level I have identified for weeks now as the pivot of the year.

Simply put, 1420-ish is 360 degrees down from the 1576 high on the Square of Nine calculator. The Square of Nine Calculator is simply a way of measuring price movements on a square root
basis as opposed to a simple linear basis.

Ha ha.., the straight line sometimes speaks with a forked tongue – otherwise everyone with a ruler would be executing trades from their yacht.

If intraday rapidity, accelerated volatility and ferocious price swings are the hallmark of turning points then Tuesday’s whipsaw and tag of 1420 S&P underscores the significance of the level in the same way that the outside day down from 1576 called the top. The problem is not all turns are created equal: it remains to be seen how much traction the 1420 level will have.

Despite more than a 10% S&P decline in five weeks, no matter how much religion you may have had about this rather quick slide to 1420 if you were trading individual stocks and taking positions home overnight, the zigs and zags would have stopped you out. And if your conviction was such that you didn’t adhere to protective stops or trailing stops then your gains are dirty money. Why? Because the bad habits learned from avoiding stops will dwarf any gains made in the long run.

The larger question to me seems to be that with so many looking to buy the dips and thinking the absolute worst is over that, it smells like the perfect ingredient for a collapsing bear market for a minimum of six months counting from the October high.

Despite the turnaround on Tuesday, stocks remain in a liquidating and in dangerous mode. Remember how quickly the stampede from Monday a week ago turned tail. That low near the mid 1450’s on the S&P now carves out initial resistance. As far as strategy is concerned, I would look to trade with the shorts into Friday’s close prior to the next plunge to start next week. That will probably coincide with something big being uncovered and someone big owning up and going under.

Critical mass was reached at 1420 on Tuesday and a break of Tuesday’s low triggers a substantial number of technical dominoes laid out in this space.

"That's me in the corner,
that's me in the spotlight...
Losing my religion.
Trying to keep up with you.
And I don't know if I can do it...."
- R.E.M

Embrace The Volatility Or Ignore It..!

As I was going through charts last night, it dawned on me that unless you are intimately involved in the financial markets all throughout the day, you may not see the incredible volatility that is taking place.

Taking a step back, it is quite clear to see that we have corrected and now we are bouncing: it's as simple as that! For people with money on the sidelines, their thought process is probably something to the effect of "Looks like the markets are still OK. If a sell off happens again, I am going to buy."

It’s only when one drills down deep, one begins to truly understand just how chaotic and volatile things are, but as I was pondering this I couldn’t help but think just how beneficial it would be for people to either embrace the volatility, or ignore it altogether.

I know that sounds a bit silly, but let me explain. I often hear things throughout the day such as : just how challenging the environment is, or how wacky the action is underneath. These statements are arguably accurate, but there is no question they come across as negative to traders when in fact traders should look to find the positive opportunities that lie within and take advantage of them for their benefit. It sounds rather selfish, but that is what trading is all about.

There are many times when trading for a medium term time frame does quite well. Trades that last a few days can add healthy gains as markets follow basic technical patterns, however we are quickly learning this is not one of those times. This is a time period where I don’t believe there is any room for the middle ground.

One can do quite well as an extreme short term trader looking to take advantage of the intraday price swings that have been very extreme, either on the long or short side. If you recognize this and set your mind on such activity, you can do quite well. Just like today in the FKLI, untill it's suspended by the exchange on YET ANOTHER technical glitch!

At the same time, I do believe we are starting to see stocks become extremely attractive as long as your time frame is much longer than a few days and possibly even a few weeks. Taking a step back to see the bigger picture, you can see many stocks returning to their longer term support or retesting levels at which the stock previously broke out from. This, in my opinion provides excellent points of entry however one should be fully aware that micromanaging these positions will only frustrate you and have you succumbing to the emotional roller coaster that is brought on by the recent volatility.

As I look back over my trading sheets the last few days, these two styles make themselves very clear. I see quite a few intraday trades that have added some excellent gains, while I also see longer term positions I am building starting to creep into the decent gain area despite some significant gyrations along the way. The overnight or multi-day trades, however, aren’t so hot and I see red littered throughout on these attempts due to bad-boys morning-gappings.

Trading is all about flexibility and quite possibly by the time this is read, and digested, we may be facing another change. One of the biggest lessons I have learned is while being flexible is a must, it is the speed at which one realizes a flexible change is needed that sets one apart from others.

Week ahead.

Tuesday November 13

10:00 Pending Home Sales: -2.0% cons
2:00 Treasury Budget: -$53.0 bln cons



Wednesday, November 14

8:30 Retail Sales: 0.2%
8:30 Retail Sales ex-auto: 0.3%
8:30 PPI: 0.2% cons 8:30 Core PPI: 0.2%
10:00 Business Inventories: 0.3% cons
10:30 Crude Inventories: -821k prev.

Thursday, November 15

8:30 CPI: 0.3% cons
8:30 Core CPI: 0.2% cons
8:30 Initial Claims
8:30 NY Empire State Index: 21.0 cons
12:00 Philadelphia Fed: 6.0 cons

Friday, November 16

9:00 Net Foreign Purchases: -$69.3 bln prev.
9:15 Industrial Production: 0.1% cons
9:15 Capacity Utilization: 82.1% cons

Seasonal bias.

There are many statistics about the upside bias for November. I noticed the extremely positive historicals for November through December when the Dow was up 10% year to date by October month end. But the November carnage calls into question the seasonal bias for the remainder of the month.

Over the last 50 years, the S&P 500 finished November higher 70% of the time by an average +1.62%. Of those 50 years, however, the index managed a monthly drawdown of more than 5% (as we’ve already seen) just eight times before. And the index was never able to mount a comeback to close the month positive.

If we isolate the above occurrences to those years where the 5% decline occurred over the first 10 days of November, we’re left with just three occurrences: 1973, 1987, and 2000. Worse yet, it’s worth noting that of all the November returns for the last 50 years, those three years were the worst. Will 2007 reverse that trend?

Year/ Max Nov Drawdown/ Nov Close /Dec Close

1963/-5.95 /-1.05 /2.44

1973 /-11.63 /-11.39 /1.66

1974 /-8.12 /-5.32 /-2.02

1987 /-10.34 /-8.53 /7.29

1988 /-5.58 /-1.89 /1.47

1991 /-5.31 /-4.39 /11.16

1994 /-5.96 /-3.95 /1.23

2000 /-9.41 /-8.01 /0.41

AVG /-7.79 /-5.57 /2.95

% +ve /0 /0 /2.95

% -ve /100 /100 /12.50

NASDAQ, your turn now!

So where from here? In the tech-heavy, Nasdaq 100, the 2040-2050 range is obviously huge and I suspect that exogenous market forces (Plunge Protection Team) can read the charts as well as anyone else. I am not setting forth conspiracy theories here, as any bear who has listened to Mr. Paulson and Bernanke speak of late would be “imprudent” not to factor the government into the trading equation.

Below 2040, the next stop resides at the 2000 round number.

For the S&P 500, things are a bit less clear with the 200 dma already above head at 1483, and no obvious support areas until the 1425 area (Friday closed at 1453). If the S&P closes below the fulcrum or the midpoint of the summer lows and the October high which is approximately 1474/1475, yesterday's close coincidentally, does that suggest a Black Monday?

However, while prices may be manipulated, the underlying sense of anxiety cannot, and will likely keep the volatility index (VIX)– and by extension option prices – nicely goosed up even if we were to have occasional magical rallies.

Oh, one last thought.., before the madness kicks off: Reacting to prices going against you (except for stop losses) is often a recipe for more losses. If you were not set up for what’s happening right now, there are three things that can be done: buy, sell, but perhaps more importantly, nothing.

"Paper losses don't exist until you sell."

The resignation of Citigroup chief executive Charles Prince and news of additional writedowns at the firm have raised the profile of hazy Wall Street phrases such as Collateralized Debt Obligations and Mark-to-Model.

Why aren't losses being seen? Even now, they aren't being seen.

The answer, we now know, is mark-to-model. What does "mark-to-model" mean? Let's use something even we can understand - a sports card example. Suppose you and I are collectors (investors) in sports cards, but not baseball cards, the "prime" sports card market. No, we collect professional golfer cards - the "subprime" sports card market instead.

Why would we collect professional golfer cards? Simple.., we're looking for an a fancy way of saying "excess return" - and by using leverage we believe we can buy these illiquid sports cards and sell them later to someone else for more money. Ok, ok, there are a couple of problems with this scheme you can see already.

*First, the market for professional golfer cards is far, far riskier and smaller (illiquid) than the market for professional baseball player cards.

*Second, since they so rarely traded, it's difficult to value the cards on a day-to-day (even week-to-week) basis.

Ok, so back to the sports card market. Let's say that baseball cards are "highly liquid," meaning that, like stocks or U.S. Treasuries, they trade every day. These trades provide a way to instantaneously value our portfolio of baseball cards at any time. To value our baseball card portfolio, we simply look up the most recent trade and record the value. This is called "Mark-to-Market."

This "liquidity" is particularly helpful if we are using leverage (meaning, if we are using borrowed money to buy baseball cards with the hope that the borrowed money will increase our return when we decide to sell) since it allows us to closely monitor and track exposure and adjust the amount of leverage we are using accordingly.

So how do we know, at any given time, what our leveraged portfolio of professional golfer cards are worth? They rarely trade, so we can't look up similar cards that have recently traded in the market! Well, unfortunately, in our professional golfer card portfolio we can't mark-to-market because these cards trade so infrequently!

So how do we value our portfolio then?

Simple, we have some mathematicians build us a model that values the cards based on how each golfer performed last year, the tournaments in which they made the cut, their overall earnings and rankings among their peers, and rating.

Wait, did I say, "a model that values the cards based on how each golfer performed last year"? Yes.

But what if a professional golfer's card in our portfolio is a guy who last year ranked fourth overall in earnings and won two tournaments, but suddenly gets injured this year, fails to finish a few tournaments, and slips down to 40th in overall earnings?

Hmmm.., good question. For that we would rely on that separate "professional golf card agency" we mentioned to "re-rate" this card. Then we would simply input that revised rating into our models and adjust the value accordingly.

But what if the rating agency, for a variety of reasons, chooses not to re-rate the card?

Then we have a situation where the value of the card that is being spit out by our model is in no way even close to the true market value of the card.

Wouldn't that be a problem if we suddenly feared that all the ratings of our cards were too high? Wouldn't our model be insufficient? Might we not be over-leveraged in cards that have very little real market value? Yes, yes and yes.... That's when the shit start hitting the fan !

And that is precisely where we are right now with respect to CDOs.

The credit ratings agencies' ratings are key in the mark-to-model values, and so far very few CDOs have been re-rated in a way that reflects the surging subprime default rates.

There's an old investment saying that says: "Paper losses don't exist until you sell." That old saying is being tested in real time, right now!

Citigroup + a crack in Hang Seng = A perfect storm!

The market is supposed to be an auction place where things can be valued. But things aren’t always what they seem. The long road from an auction place to a casino starts with one small step which can ultimately metamorphose into one giant leap backwards for investing mankind. Where that step began is part of an Orwellian nightmare maned by computers and lionized by financial engineering.

The market is supposed to be an auction place but fear trumps value. The problem is there is currently a lot of paper that can’t be valued. The market is supposed to be a value game and they tell us the market is always right. But how do you reconcile the myth of valuation with the fact of volatility? In my experience, the market is an information game - not a value game.

In my view there are few reasons for the current accelerated volatility. At significant turning points, if that’s what this is, it is typical for the market to flip around violently. After a period of years of persistent dampening of volatility, reversion to the mean is only normal. And with such a long stretch of low volatility and such a persistently low period of low volatility it seems reasonable to expect volatility to growl ferociously when it awakens from hibernation, as it started to this July.

Fear trumps value: there is an underlying sense that no one knows what some paper is worth in the market, when paper is marked to a model. There is an increasing sense that we don’t have enough information as to the issues affecting the financial sector and the credit market. Moreover, there is a fresh sense that whatever information there is, is not being shared with equanimity. Wat do you think?

I suppose a picture is worth a thousand words. Believe what you see in price action, until proven otherwise. At the moment, the markets looked increasingly precarious, while the storm is brewing a notch higher when Citigroup revising 3Q write-down t0 $11bln. To add salt to wound, the Hang Seng has cracked the 29836 trend line today (chart above), with fear creeping into the consciousness of fund managers, this breach would kick start a cascade as fund manager would scramble to protect year end bonuses.

I wounder why Citigroup uses the umberella..ella..ella..as their corporate logo? Hmmm...!

Wat's ahead..

Monday, November 5
10:00 ISM Services: 54.0 cons

Wednesday, November 7
8:30 Productivity – Prel: 2.5% cons
10:00 Wholesale Inventories: 0.1% cons
10:30 Crude Inventories: -3894k prev.
2:00 Consumer Credit: $8.0 bln cons

Thursday, November 8
8:30 Initial Claims: 327k Prior

Friday, November 9
8:30 Export Prices ex-ag: 0.0%
8:30 Import Prices ex-oil: -0.2%
8:30 Trade Balance: -$57.6 bln
10:00 Michigan Sentiment-Prel: 81.0 cons

Brace for another volatile week ! -especially on Tuesday!

Go east, old man..

Jesse Czelusta Nov 2, 2007.

The Chinese stock market continues to soar, despite repeated warnings of a bubble.

While you should expect a bumpy ride, China is still poised to grow rapidly for at least the next several decades. In fact, I will go so far as to issue the following prediction: By the year 2050, China will be a more important and more powerful economy than the United States.


On paper, the evidence is mounting. From gross domestic product growth, to education, to investment, to health, to technology, China's trend lines point uniformly upward. In person, the case is even stronger. The gleaming, modern Chinese cities that dot China's Eastern seaboard make all but a few American cities seem almost underdeveloped (or at least unsightly and technologically unsophisticated) by comparison. All indications are that the newest superpower will surpass the U.S. by mid-century -- if not sooner.

This shift in global leadership will occur because China's communists are beating U.S. capitalists at their own game. China is determined to achieve wholesale economic transformation, and its leaders are drawing on historical lessons from the West: Innovate, if you wish to grow. Educate, if you wish to innovate. Enforce property rights in activities that demand investment, but do not put property rights ahead of all else (especially if most of the property in question belongs to foreigners). Give entrepreneurs access to markets and credit. Build infrastructure, if you wish to keep the economic machine functioning smoothly. China is doing all of these things, arguably better than its trans-Pacific rival.

Of course, China currently lags the U.S. by a substantial margin in the one column typically given the most weight on the economic scorecard: GDP per capita. In 2006, the U.S. produced GDP per head of $44,244; the corresponding Chinese statistic was a mere $2,055.

But consider this calculation: Assume that China and the U.S. grow indefinitely at the respective average real annual rates predicted by the Economist's Intelligence Unit for the years 2007 through 2011. This would imply 8.8% per annum growth in the case of China, and 2.8% growth in the U.S. Assume, for simplicity, that both countries experience zero population growth (this assumption probably biases the calculation in favor of the US and against China, given the latter's lingering one-child policy). Under these assumptions, China will pass the U.S. in terms of GDP per capita in the year 2061. If we perform the same calculation in purchasing power parity terms, China will take the lead much sooner -- in 2038.

Even if (as seems likely) China's recent red-hot growth cools, China's GDP (currently $2.7 trillion, vs. $13.2 trillion in the U.S.) will probably surpass that of the U.S. by the mid-century mark. Some of this growth will come about via payoffs to Chinese investments in infrastructure and education. In addition, China can still do a great deal of catching up simply via technological borrowing (and stealing). It will do so with an educated, hard-working, like-minded population of over 1 billion eager to make the necessary investments, and without the barrier of an outdated installed capital base. Whether or not you think China will eventually be the world's economic king, you might want to brush up your Mandarin.

But what does this mean to you, the U.S. investor (and future resident of a less-developed country)?
First, be willing to look farther (much farther) west than the Silicon Valley when making investment decisions. While for at least one-half century Americans have taken for granted that the U.S. would be the most reliable source of investment opportunities, this presumption is beginning to crumble.

Finally, although the region appears to be a solid long-term play, be prepared for large and inevitable corrections. There are signs that China's stock market is currently overvalued, and recent swings demonstrate that when the bubble bursts, it will do so quickly.
How then, should you play China?

Carefully. China is still very much an emerging financial market, and many segments of the Chinese economy are not yet publicly traded. While we have come to expect broad diversification from ETFs, over ninety percent of FXI's holdings are concentrated in just four sectors: energy, industrial materials, telecommunications, and financial services -- with over forty percent in the latter.

Here's one last point to bear in mind, as worry about a "Chinese bubble" increases: Bubbles often inflate well beyond the maximum proportions envisioned by efficient markets theorists. One need look only as far back as 1997 to recall an overvalued U.S. stock market that continued to soar for another four years. Had you sold in 1997, you would have missed one of the biggest bull markets in history. For those currently claiming that China is experiencing a bubble, it could be a case of being right at the wrong time -- always a costly proposition.
Better to enter China cautiously, for example, through dollar-cost averaging.
And regardless of what happens in the short run, China is here to stay!

Tales of the future.

What’s the market talking about?
If the market trades on fundamentals it must be setting land speed records for metamorphosis: from the Goldilocks Butterfly to the Credit Caterpillar crawling over speculative psychology. Do things change so much overnight to cause a 360-point drop in the DJIA based on Exxon Mobil earnings and a Citigroug downgrade? Was Thursday’s shakedown the lost third “Cha” in the FOMC Cha-Cha-Cha Pattern?

Typically volatility after an FOMC announcement- there are usually three distinct moves of increasing amplitude in opposite directions from the preceding swing, with the third move giving the genuine directional bias. Wednesday the market sold off initially after the Fed ease. Then, stocks rallied strongly while Thursday’s decline eclipsed Wednesday’s swings entirely.

Was Thursday’s sell-off related to fiscal year end for many mutual funds that could “legally”? Was Thursday just another shakeout like we saw on October 19?

The difficulty in any particular situation is knowing whether or not news and fundamentals have been baked into the cake – whether good news will be bought or sold – whether the buy the rumor and sell the fact trade will rule the day; or whether the momentum freaks and quant cowboys will drive good news even higher, or bad news even lower.

Just as volatility is a gift from the gods for traders to pay the rent, momentum is a beautiful thing for a trader. Almost as beautiful as is hindsight. In hindsight, almost everything about the prior session seems so crystal clear.

It seems crystal clear to me that the market is evincing a sea change. With the Fed having pulled the net of last resort for the time being, and Ben having put the put back in his hip pocket, we need to be very precise about grabbing the trapeze when it comes to buying into downswings. Why? Because for the near future at least, good news will be good and bad news will be bad. The bulls may not charge in so ferociously to scoop up the babies thrown out with the bathwater, or to catch falling daggers between their teeth. The action recently in some of the glamors may be telegraphing this change in character.

Tales of the future.mp3.http://videocalibration.com/soundsnew/user%20controls/Tales%20Of%20The%20Future.mp3