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Our newsletter for tomorrow discusses some of our core concepts and has a more educational bent to it than usual.

If you're interested in receiving it just e-mail us at info @ highchartpatterns. com and we'll be happy to send it to you.

Game Over?

Brutal sell-off today as the market didn't like what Geithner had to say. We'll be watching our favorite short vehicles FAZ SRS SMN DUG EEV tomorrow to see if they can break their respective short-term down-trend lines.

Excerpt from today's newsletter:

SPY reversed in front of 88 (and 50dma) and now is very close to breaking down through the up-trend line (around 82) with further support at 80. Note volume on today's reversal. Tomorrow is very important; if the bears gain momentum here (likely scenario) we could cascade down easily for another 10-15%. If the bulls want to stay in the game then they have to make a Herculean effort to keep the support lines intact and undo some of today's damage (unlikely scenario).

Mixed Signals

This should be an interesting week with three very important points to remember:


a) we have stimulus/bank news pending early this week
b) support on financials, real estate, and oil thus far have held
c) market heading straight into resistance

Bullish argument:

Take a look at the following charts: USO/URE/XLF (representing crude, real estate, and financials).

All three went through support, but instead of cratering, reversed back up on very good volume. So far, so good.

Huge move through 28 support on USO on Friday.


IYR is a better representative than the leveraged URE but this chart shows the reversal through the lows in a more clear fashion.


As we wrote last week in the blog; that XLF would break that recent support was a given. What was up for grabs is whether it reversed back up or cratered to the next support level. Thus far, it's the former.


Bearish Argument:

We're heading right into SPY 88 resistance in the market. We've had one failed break-out after another in this bear market and there is no reason to think that this one will be any different. A break-out/hard failure of 88 most likely will result in a reversal back through the trend-line. However, the bullish reversals of the three key sectors of financials, oil, and real-estate indicate that indeed, this time it might be different.




As you can see, there are bullish and bearish arguments to be made. We're just happy we are day-traders and don't have to pick a direction for more than a day.

Five Rules for Life

Trader-X did a post about this site: Five Rules for Life. Check it out and especially Trader X's contribution.

Read others, think about your own; if nothing else, it will give you a chance to reflect on where your own priorities are right now in life. Basic introspection, we believe, is key not only to successful trading, but evolving as human beings.

On less spiritual matters: a close on XLF over 9.2 would be a good start for this market.

XLF talk

As we wrote yesterday, bullish or bearish, XLF had to break-down. Thus far the bullish scenario of "We break-down, and then reverse higher setting up a strong bear trap" is playing out with XLF over 8.87 again. We'll see how they close it but for now, but unless we go back through support, the ball is in the bull's court.

Bear Flag

It would be very surprising for this flag not to break sometime soon. Watch financials to lead the way with XLF through 8.87 and then 8.07.

Bearish Scenario: We break-down through this up-trend line and then possibly test the lows of last year.

Bullish Scenario: We break-down, and then reverse higher setting up a strong bear trap.

In either scenario, we break-down first.

The Plot Thickens

BAC already broke down; but XLF above support. Some kind of resolution coming soon as the range has tightened considerably.





Financials on life support with two breaths left at 8.87 and 8.07 on the XLF.


Don't bet the farm until there's some resolution to this trading range.

Divergence

Without a doubt we make more money in bull markets. And we wish every day that we could start another bull market. However, reality sets in like a knife through the abdomen upon looking at the financials. For you tech lovers, yes, things are looking better. But tech won't make it out alive without the banks.

This is looking better:


But don't forget about this:



They both can't be right. One has to give. Either financials are going to reverse on support and rally up like tech, or the general market is going to cave soon to catch up with the financials.

Reality Check

Here's an economist who gets it (our favorite parts in bold)

By THOMAS L. FRIEDMAN

Published: January 31, 2009

In its own unpredictable way, the Davos World Economic Forum usually serves as a crude barometer of the latest mood or mania on the world stage. This year did not disappoint. What has struck me is the quiet urgency that infused so many panel discussions and private conversations here between investors, politicians and social activists. To put it crudely: everyone is looking for the guy — the guy who can tell you exactly what ails the world’s financial system, exactly how we get out of this mess and exactly what you should be doing to protect your savings.
But here’s what’s really scary: the guy isn’t here. He’s left the building. Elvis has left the mountain. Get used to it.
What do I mean? First, if it is not apparent to you yet, it will be soon: there is no magic bullet for this economic crisis, no magic bailout package, no magic stimulus. We have woven such a tangled financial mess with subprime mortgages wrapped in complex bonds and derivatives, pumped up with leverage, and then globalized to the far corners of the earth that, much as we want to think this will soon be over, that is highly unlikely.

We are going to have to learn to live with a lot more uncertainty for a lot longer than our generation has ever experienced. We keep pouring money into the dark banking hole of this crisis, desperately hoping that we will hear it hit bottom and start to pile up. But so far, as hard as we listen, we can’t hear a thing. And so we keep pouring ...

A broker friend told me it reminded him of when he was a teenager and his doctor first diagnosed him as unable to digest wheat products. He said to the doctor, “Well, just give me a pill.” And the doctor told him: there is no pill. “You mean I’m just going to have to live with this?” he asked. That’s us. There is no pill — not for this mess.
The fact that there is no single pill doesn’t mean there’s nothing to be done. We need a stimulus big enough to create more jobs. We need to remove toxic assets from bank balance sheets. We need the Treasury to close the insolvent banks, merge the weak ones and strengthen the healthy few. And we need to do each one right. But even then, the turnaround will be neither quick nor painless. Indeed, the whispers here were that what has been an exclusively economic crisis up to now may soon morph into a domino of political crises — as happened in Iceland, where the bankruptcy of the banks toppled the government on Monday.
(Davos humor: What is the capital of Iceland? Answer: $25.)
Second, we’re going to have to get used to a loss of trust. All those rock-solid people and institutions that we trusted with our money, our pensions and our kids’ piggybank savings — like Citigroup, Merrill Lynch, Bank of America — do not seem trustworthy anymore. Never before in my adult life have I looked around at every bank in my town and said, “I’m not sure I wouldn’t prefer to put my paycheck in a mattress.”
The Bernard Madoff scandal, of course, has only reinforced that loss of trust. His degree of betrayal — his alleged willingness to embezzle the life savings of people whom he had known his whole life — is so coldhearted that it charts new territory in human behavior. He’s on his way to becoming an adjective. Money managers are already being asked prove to prospective new clients that their internal safeguards are “Madoff proof.”
I’ve written a lot about the Indian outsourcing community, so I knew B. Ramalinga Raju, the Satyam chairman accused of embezzling $1 billion from his own company. What’s really sad is that I didn’t get to know him through his business but through an interest in his family’s charitable work. They created India’s first 911 emergency system in their home state and call centers in Indian villages, so young people there could get service jobs. Was all that a fake, too? Or was he just an embezzler with a good heart? Don’t know. When you can’t even trust a person’s charitable work, you’ve hit a new low.
“We’re all going to have to learn to live with a lower level of trust in our lives,” an African banker friend said to me here. But the mind recoils at that, which may explain why so many people I talked to here are hoping that President Obama will turn out to be the guy.
Like Harry Truman, Obama is definitely present at the creation of something. He is arriving on the scene “not after a war but after the same kind of shattering of institutions that a war does,” said Peter Schwartz, chairman of the Global Business Network. “His job is to restore confidence to these institutions that have been at the foundation of our economy.”
That may be President Obama’s most important bailout task: to educate the country that there is no easy escape here, except taking our medicine, getting our fundamentals right again and working our way out of this, brick by brick, by getting back to making money — what was that old Smith Barney ad? — “the old-fashioned way” — by earning it.


Check out Meridian for more information about a high interest saving account.   

The Origins of the Financial Crisis

An excellent summary by The Brookings Institution. Read this short introduction, and then hit the pdf link at the end to the full 47 page discussion.


The financial crisis that has been wreaking havoc in markets in the U.S. and across the world since August 2007 had its origins in an asset price bubble that interacted with new kinds of financial innovations that masked risk; with companies that failed to follow their own risk management procedures; and with regulators and supervisors that failed to restrain excessive risk taking.

A bubble formed in the housing markets as home prices across the country increased each year from the mid 1990s to 2006, moving out of line with fundamentals like household income. Like traditional asset price bubbles, expectations of future price increases developed and were a significant factor in inflating house prices. As individuals witnessed rising prices in their neighborhood and across the country, they began to expect those prices to continue to rise, even in the late years of the bubble when it had nearly peaked.

The rapid rise of lending to subprime borrowers helped inflate the housing price bubble. Before 2000, subprime lending was virtually non-existent, but thereafter it took off exponentially. The sustained rise in house prices, along with new financial innovations, suddenly made subprime borrowers — previously shut out of the mortgage markets — attractive customers for mortgage lenders. Lenders devised innovative Adjustable Rate Mortgages (ARMs) — with low "teaser rates," no down-payments, and some even allowing the borrower to postpone some of the interest due each month and add it to the principal of the loan — which were predicated on the expectation that home prices would continue to rise.

But innovation in mortgage design alone would not have enabled so many subprime borrowers to access credit without other innovations in the so-called process of "securitizing" mortgages — or the pooling of mortgages into packages and then selling securities backed by those packages to investors who receive pro rata payments of principal and interest by the borrowers. The two main government-sponsored enterprises devoted to mortgage lending, Fannie Mae and Freddie Mac, developed this financing technique in the 1970s, adding their guarantees to these "mortgage-backed securities" (MBS) to ensure their marketability. For roughly three decades, Fannie and Freddie confined their guarantees to "prime" borrowers who took out "conforming" loans, or loans with a principal below a certain dollar threshold and to borrowers with a credit score above a certain limit. Along the way, the private sector developed MBS backed by non-conforming loans that had other means of "credit enhancement," but this market stayed relatively small until the late 1990s. In this fashion, Wall Street investors effectively financed homebuyers on Main Street. Banks, thrifts, and a new industry of mortgage brokers originated the loans but did not keep them, which was the "old" way of financing home ownership.

Over the past decade, private sector commercial and investment banks developed new ways of securitizing subprime mortgages: by packaging them into "Collateralized Debt Obligations" (sometimes with other asset-backed securities), and then dividing the cash flows into different "tranches" to appeal to different classes of investors with different tolerances for risk. By ordering the rights to the cash flows, the developers of CDOs (and subsequently other securities built on this model), were able to convince the credit rating agencies to assign their highest ratings to the securities in the highest tranche, or risk class. In some cases, so-called "monoline" bond insurers (which had previously concentrated on insuring municipal bonds) sold protection insurance to CDO investors that would pay off in the event that loans went into default. In other cases, especially more recently, insurance companies, investment banks and other parties did the near equivalent by selling "credit default swaps" (CDS), which were similar to monocline insurance in principle but different in risk, as CDS sellers put up very little capital to back their transactions.

These new innovations enabled Wall Street to do for subprime mortgages what it had already done for conforming mortgages, and they facilitated the boom in subprime lending that occurred after 2000. By channeling funds of institutional investors to support the origination of subprime mortgages, many households previously unable to qualify for mortgage credit became eligible for loans. This new group of eligible borrowers increased housing demand and helped inflate home prices.

These new financial innovations thrived in an environment of easy monetary policy by the Federal Reserve and poor regulatory oversight. With interest rates so low and with regulators turning a blind eye, financial institutions borrowed more and more money (i.e. increased their leverage) to finance their purchases of mortgage-related securities. Banks created off-balance sheet affiliated entities such as Structured Investment Vehicles (SIVs) to purchase mortgage-related assets that were not subject to regulatory capital requirements Financial institutions also turned to short-term "collateralized borrowing" like repurchase agreements, so much so that by 2006 investment banks were on average rolling over a quarter of their balance sheet every night. During the years of rising asset prices, this short-term debt could be rolled over like clockwork. This tenuous situation shut down once panic hit in 2007, however, as sudden uncertainty over asset prices caused lenders to abruptly refuse to rollover their debts, and over-leveraged banks found themselves exposed to falling asset prices with very little capital.

While ex post we can certainly say that the system-wide increase in borrowed money was irresponsible and bound for catastrophe, it is not shocking that consumers, would-be homeowners, and profit-maximizing banks will borrow more money when asset prices are rising; indeed, it is quite intuitive. What is especially shocking, though, is how institutions along each link of the securitization chain failed so grossly to perform adequate risk assessment on the mortgage-related assets they held and traded. From the mortgage originator, to the loan servicer, to the mortgage-backed security issuer, to the CDO issuer, to the CDS protection seller, to the credit rating agencies, and to the holders of all those securities, at no point did any institution stop the party or question the little-understood computer risk models, or the blatantly unsustainable deterioration of the loan terms of the underlying mortgages.

A key point in understanding this system-wide failure of risk assessment is that each link of the securitization chain is plagued by asymmetric information – that is, one party has better information than the other. In such cases, one side is usually careful in doing business with the other and makes every effort to accurately assess the risk of the other side with the information it is given. However, this sort of due diligence that is to be expected from markets with asymmetric information was essentially absent in recent years of mortgage securitization. Computer models took the place of human judgment, as originators did not adequately assess the risk of borrowers, mortgage services did not adequately assess the risk of the terms of mortgage loans they serviced, MBS issuers did not adequately assess the risk of the securities they sold, and so on.

The lack of due diligence on all fronts was partly due to the incentives in the securitization model itself. With the ability to immediately pass off the risk of an asset to someone else, institutions had little financial incentive to worry about the actual risk of the assets in question. But what about the MBS, CDO, and CDS holders who did ultimately hold the risk? The buyers of these instruments had every incentive to understand the risk of the underlying assets. What explains their failure to do so?

One part of the reason is that these investors — like everyone else — were caught up in a bubble mentality that enveloped the entire system. Others saw the large profits from subprime-mortgage related assets and wanted to get in on the action. In addition, the sheer complexity and opacity of the securitized financial system meant that many people simply did not have the information or capacity to make their own judgment on the securities they held, instead relying on rating agencies and complex but flawed computer models. In other words, poor incentives, the bubble in home prices, and lack of transparency erased the frictions inherent in markets with asymmetric information (and since the crisis hit in 2007, the extreme opposite has been the case, with asymmetric information problems having effectively frozen credit markets). In the pages that follow, we tell this story more fully.

Read the full discussion here

Blog links

If you have a blog which you think would be of interest to our readers, please e-mail us at
info AT highchartpatterns DOT COM. We'll review your blog and if it's a good fit for our readers, we'll be happy to add it to our blog roll.

Market Talk

It was a wild week. Monday/Tuesday started slow but Wednesday we gapped up hard thanks to the "bad bank" news. We became bullish on Wednesday and rode some nice longs (A). Then on Thursday the market gave it all back and we fought the trend all day churning our wheels (B). After Wednesday's bullish price-action we thought, like idiots in retrospect, that the dip was to be bought. Wrong! However, on Friday we got our mojo back and stayed short all day (C) with the help of our leveraged ETF favorites and a few stocks. Looking at the SPY we can safely say that it would be very surprising if this market does not at least test the lows of 80.5 (resistance now clear at 88). Ideally we base over support and then break-down hard for a final wash-out. Too cute? Possibly. But we can hope.

A side note: the way this "bad bank" news has been dealt is absurd. Is CNBC the televised National Enquirer of finance?

More SPY talk

Today was the day the bears should have pushed the market down through support: they had the gap-down weight and momentum right at the open with the GE news. The following 4 day chart shows how pivotal/dramatic this week was: On Tuesday we close at the lows and through 82 support; all very depressing complete with "end of the market as we know it" calls. On Wednesday we gap-up, test that same support, but close at the highs, producing numerous "this is the bottom!" calls. On Thursday we again tested the 84 resistance. And today, the best day of all, we opened at support and rallied all the way back to 84 before closing off the highs. Please note that we also enjoyed poor economic/earnings news on Thursday and Friday. We'll hold off our enthusiasm until we close over 84 (and swing like mad to the bearish side on a break of 80.5-80) but so far, so good.



Added bonus of down-trend line break now coinciding with daily 84 resistance.


Note similar chart in XLF.


As you can see we're still very much in a danger zone and if this rally has any chance then financials have to pull-up and away from 8.7 area support.


FAS gives a more clear picture than XLF of how important our current level is: A conclusion is coming soon as we either break up through this down-trend or reverse down.

How to spend 1 million + redecorating your office

Hat Tip to The Daily Beast

Ex- Merrill Lynch’s CEO John Thain's re-decorating expenses

1) $2,700 for six wall sconces.
2) $5,000 for a mirror in his private dining room.
3) $11,000 for fabric for a "Roman Shade.”
4) $13,000 for a chandelier in the private dining room.
5) $15,000 for a sofa.
6) $16,000 for a "custom coffee table.”
7) $18,000 for a “George IV Desk.”
8) $25,000 for a "mahogany pedestal table.”
9) $28,000 for four pairs of curtains.
10) $35,000 for something called a "commode on legs.” (toilet)
11) $37,000 for six chairs in his private dining room.
12) $68,000 for a "19th Century Credenza" in his office.
13) $87,000 for a pair of guest chairs.
14) $87,000 for an area rug in Thain's conference room and another area rug for $44,000.
15) $230,000 to his driver for one year’s work.
16) $800,000 to hire celebrity designer Michael Smith, who is currently redesigning the White House for the Obama family for just $100,000.

Perverse and just utterly wrong on so many levels.

Link

We've been reading ClusterStock these past few weeks and like what we see in terms of news and editorials. We find ourselves to be in sync with a lot of their opinion pieces, like this one

Wall Street’s Sick Psychology of Entitlement

Edited by Henry Blodget (yes the same one that made the AMZN $400 call back in '98.... he's grown up since then :-)

Transcript of Buffett interview

Wouldn't it be great to have more men like Buffett and fewer men like Ken Lewis, Dick Fuld, John Thain (feel free to substitute investment banker exec name)...in the world?

Transcript of interview with Warren Buffett by NBR's Susie Garib:



SUSIE GHARIB, ANCHOR, NIGHTLY BUSINESS REPORT: Are we overly optimistic about what President Obama can do?
WARREN BUFFETT, CHAIRMAN, BERKSHIRE HATHAWAY: Well I think if you think that he can turn things around in a month or three months or six months and there’s going to be some magical transformation since he took office on the 20^th that can’t happen and wouldn’t happen. So you don’t want to get into Superman-type expectations. On the other hand, I don’t think there’s anybody better than you could have had; have in the presidency than Barack Obama at this time. He understands economics. He’s a very smart guy. He’s a cool rational-type thinker. He will work with the right kind of people. So you’ve got the right person in the operating room, but it doesn’t mean the patient is going to leave the hospital tomorrow.
SG: Mr. Buffett, I know that you’re close to President Obama, what are you advising him?
WB: Well I’m not advising him really, but if I were I wouldn’t be able to talk about it. I am available any time. But he’s got all kinds of talent right back there with him in Washington. Plus he’s a talent himself so if I never contributed anything for him, fine.
SG: But I know that during the election that you were one of his economic advisors, what were you telling him?

WB: I was telling him business was going to be awful during the election period and that we were coming up in November to a terrible economic scene which would be even worse probably when he got inaugurated. So far I’ve been either lucky or right on that. But he’s got the right ideas. He believes in the same things I believe in. America’s best days are ahead and that we’ve got a great economic machine, its sputtering now. And he believes there could be a more equitable job done in distributing the rewards of this great machine. But he doesn’t need my advice on anything.
SG: How often do you talk to him?
WB: Not often, not often... no no and it will be less often now that he’s in the office. He’s got a lot of talent around him.
SG: What’s the most important thing you think he needs to fix?
WB: Well the most important thing to fix right now is the economy. We have a business slowdown particularly after October 1^st it was sort of on a glide path downward up til roughly October 1^st and then it went into a real nosedive. In fact in September I said we were in an economic Pearl Harbor and I’ve never used that phrase before. So he really has a tough economic situation and that’s his number one job. Now his number one job always is to keep America safe that goes without saying.
SG: But when you look at the economy, what do you think is the most important thing he needs to fix in the economy?

WB: Well we’ve had to get the credit system partially fixed in order for the economy to have a chance of starting to turn around. But there’s no magic bullet on this. They’re going to throw everything from the government they can in. As I said, the Treasury is going all in, the Fed and they have to and that isn’t necessarily going to produce anything dramatic in the short term at all. Over time the American economy is going to work fine.
SG: There is considerable debate as you know about whether President Obama is taking the right steps so we don’t get in this kind of economic mess again, where do you stand on that debate?
WB: Well I don’t think the worry right now should be about the next one, the worry should be about the present one. Let’s get this fire out and then we’ll figure out fire prevention for the future. But really the important thing to do now is to figure out how we get the American economy restarted and that’s not going to be easy and its not going to be soon, but its going to get done.
SG: But there is debate about whether there should be fiscal stimulus, whether tax cuts work or not. There is all of this academic debate among economists. What do you think? Is that the right way to go with stimulus and tax cuts?

WB: The answer is nobody knows. The economists don’t know. All you know is you throw everything at it and whether it’s more effective if you’re fighting a fire to be concentrating the water flow on this part or that part. You’re going to use every weapon you have in fighting it. And people, they do not know exactly what the effects are. Economists like to talk about it, but in the end they’ve been very, very wrong and most of them in recent years on this. We don’t know the perfect answers on it. What we do know is to stand by and do nothing is a terrible mistake or to follow Hoover-like policies would be a mistake and we don’t know how effective in the short run we don’t know how effective this will be and how quickly things will right themselves. We do know over time the American machine works wonderfully and it will work wonderfully again.
SG: But are we creating new problems?

WB: Always
SG: How worried are you about these multi-trillion dollar deficits?
WB: You can’t just do one thing in economics. Anytime somebody says they’re going to do this and then what? And there is no free lunch so if you pour money at this problem you do have after effects. You create certain problems. I mean you are giving a medicine dosage to the patient on a scale that we haven’t seen in this country. And there will be after effects and they can’t be predicted exactly. But certainly the potential is there for inflationary consequences that would be significant
SG: We all know that in the long run everything is going to work out, but as you analyze President Obama’s economic plan, what do you think are the trade-offs? What are the consequences?

WB: Well the trade-off… the trade-off basically is that you risk setting in motion forces that will be very hard to stop in terms of inflation down the road and you are creating an imbalance between revenues and expenses in the government that is a lot easier to create than it will be to correct later on, but those are problems worth taking on, but you don’t get a free lunch.

SG: What about the regulatory system, is it a matter of making new rules or simply doing a better job at enforcing the rules we already have?

WB: Well there are probably some new rules needed, but the regulatory system I don’t think could have stopped this. Once you get the bubble going... once the American public, the U.S. Congress, all the commentators, the media, everybody else started thinking house prices could go nothing up, you were creating a bubble that would have huge consequences because the asset class was so big. I mean you had 22 trillion dollars probably worth of homes. It was the biggest asset of most American families and you let them borrow 100% in many cases of the price of those and you let them refi up to where they kept taking out more and more and treating it as an ATM machine.. the bubble was going to happen.
SG: But everybody is saying we need more rules, we have to enforce them, we need to go after every institution, every financial market. Do you think that new rules will do the trick or do we have enough rules that we just need to enforce them?

WB: Well you can have a rule for example to prevent another real estate bubble; you just require that anybody bought a house to put 20% down and make sure that the payments were not more than a third of their income. Now we would not have a big bust ever in real estate again, but we would also have people screaming that you’re denying home ownership to all these people that you got a home yourself and now you’re saying a guy with a 5% down payment shouldn’t get one. So I think it’s very tough to put rules out... I mean I can design rules that will prevent it but it will have other consequences. It’s like I say in economics you can’t just do one thing and where the balance is struck on that will be a political question. My guess is that it won’t be struck particularly well, but that’s just the nature of politics.
SG: You’ve said that we’re in an economic Pearl Harbor, so how bad are things really?

WB: They’re bad, they’re bad. The credit situation is getting a little better now. Things have loosened up from a month ago in the corporate debt market. But the rate of business descent is at a pretty alarming pace, I mean there is no question things have really slowed down.
Peoples’ buying habits have changed. Fear has taken over and fear is a tough thing to fight because you can’t go on television and say don’t be afraid, that doesn’t work. People will get over it, they got greedy and they got over being greedy. But it took a while to get over being greedy and now the pendulum has swung way over to the fear side. They’ll get over that and we just hope that they don’t go too far back to the greed side.
SG: What’s your view on the recession? How much longer is it going to last?
WB: I don’t know. I don’t know. I don’t know the answer to these things. The only thing is I know that I don’t know. Maybe other people think they know, but I have no idea.
SG: The last time we talked, you said back in the Spring, you said the recession is not going to be a short-haul thing. What is your feel for it right now?

WB: It isn’t going to be short, but I just don’t know Susie. There’s no way of knowing.
SG: Berkshire Hathaway is in a lot of businesses that are economically sensitive, like furniture, paint, bricks. Do you see any signs of a pick up?

WB: No. No. The businesses that are either construction or housing related, or that are just plain consumer businesses, they’re doing very, very poorly. The American consumer has stepped back big time and it’s contagious and there’s a feedback mechanism because once you hear about this then you get fearful and then don’t do things at all. And that will end at a point, but it hasn’t ended at this point. Now fortunately our two biggest businesses are not really tied that way- in insurance and in our utility business we don’t feel that, but everything that’s consumer related feels it big time.
SG: Do you think that the psyche of the American consumer has changed, becoming more savers than spenders?

WB: Well it certainly has at this point and my guess is that continues for quite a while. What it will be five years from now, I have no idea. I mean the American consumer when they’re confident they spend and they’re not confident now and they’ve cut it back but who knows whether.. I doubt that that’s a permanent reset of behavior, but I think it’s more than a one day or one week or one month wonder in that case.
SG: Is that a bad thing?
WB: Well it just depends who the consumer is. I mean consumer debt within reason makes sense. It makes sense to take out a mortgage on a home particularly if you aren’t buying during a bubble. You are normally going to see house price appreciation if you don’t buy during a time when people are all excited about it. So I don’t have any moral feelings about debt as to how people should.. I think people should only take on what they can handle though and that gets to their income level…

SG: Let me ask it this way, with Americans saving more may be good for consumers, but is that bad for business?

WB: Well it’s certainly bad for business in the short term. Now whether it’s better for business over a 10 or 20 year period... if the American public gets itself in better shape financially that presumably is good for business down the road, but while they’re getting themselves in better shape, its not much fun for the merchant on Main street.

SG: One thing that Americans aren’t buying these days is stocks. Should they be buying?
WB: Well just as many people buy a stock everyday as sell one so there are people buying stocks everyday and we’re buying stocks as we go along. If they’re buying into a business that they understand at a sensible price they should be buying them. That’s true at any time. There are a lot more things selling at sensible prices now than they were two years ago. So clearly it’s a better time to buying stocks than a couple of years ago. Is it better than tomorrow? I have no idea.

SG: This financial crisis has been extraordinary in so many ways, how has it changed your approach to investing?

WB: Doesn’t change my approach at all. My approach to investing I learned in 1949 or ‘50 from a book by Ben Graham and it’s never changed.

SG: So many people I have talked to this past year say this was unprecedented… the unthinkable happened. And that hasn’t at all impacted your philosophy on this?
WB: No and if I were buying a farm, I wouldn’t change my ideas about how to buy a farm or an apartment house or a business and that’s all a stock is. It’s part of a business so if I were going to buy stock in a private business here in Omaha, I’d look at it just like I would have looked at it two years ago and I’ll look at it the same way two years from now. I look at how much I am getting for my money, how good the management is, how the competitive position of that business compares to others, how durable it is and just fundamental questions. The stock market is... you can forget about that. Any stock I buy I will be happy owning it if they close the stock market for five years tomorrow. In other words I am buying a business. I’m not buying a stock. I’m buying a little piece of a business, just like I buy a farm. And that doesn’t change. And all the newspapers headlines of the world don’t change that. It doesn’t mean you can’t buy it cheaper tomorrow. It may turn out that way. But the real question is did I get my money’s worth when I bought it?
SG: One of your famous investing principals is, “be fearful when others are greedy and greedy when others are fearful.” So is this the time to be greedy, right?

WB: Yeah. My greed quotient has risen as stocks have gone down. There’s no question about that. The cheaper something gets that you’re going to buy, the happier you feel, right? You’re going to buy groceries the rest of your life; you want grocery prices to go up or down? You want them to go down. And if they go down you don’t think gee I got all those groceries sitting in my cabinet at home and I’ve lost money on those. You think I am buying my groceries cheaper, I am going to keep buying groceries. Now if you’re a seller, obviously prices are higher. But most people listening to this program, certainly I, myself, and Berkshire Hathaway, we’re going to be buying businesses over time. We like the idea of businesses getting cheaper.
SG: So where do you see the opportunities in the stock market right now?
WB: That one I wouldn’t tell you about.
SG: Let me throw out some sectors and you just tell me quickly how you feel about these sectors.
WB: Susie, I am not going to recommend anything…
SG: Even in general, for example a lot of people now are looking at infrastructure companies, is that a sector that you find attractive?
WB: I wouldn’t have any comment. What they ought to do is look at businesses they understand. They‘d be happy owning for years if there was never a quote on the stock. Just like they buy in privately into a business in their hometown... They ought to forget all about what somebody says is going to be hot next year or the year after, whatever… because what’s going to be hot you may be paying twice as much for as something that’s not going to be hot. You don’t want to think in terms of what’s going to be good next year, you want to think of what’s a good business to be in and then buy it at an attractive price. And then you can’t lose.
SG: Do you see more opportunities in the U.S. compared to overseas?
WB: Well I am more familiar with the U.S. We have such a big market. I see lots of opportunities here and I see lots of opportunities around the world.

SG: Investor confidence was so shattered last year, what do you think its going to take to restore confidence?

WB: If people were dependent on the stock market going up to be confident they’re in the wrong business. They ought to be confident because they look at a business and think I got my money’s worth. They ought to be confident if they buy a farm, not on whether they get a quote the next day on the farm, but they ought to look at what the farm produces, how many bushels an acre do they get out of their corn or soybeans and what prices do they bring. So they ought to look to-the business as to whether to be confident compared to the price that they paid and they ought to forget about what anybody is saying, including me on television, or what they’re reading in the paper. That’s got nothing to do with whether they made a good decision or not. What’s got to do with whether they made a good decision, what kind of business they bought and what they paid for it.
SG: People are reeling from this whole Bernie Madoff scandal. What would you say to people who have lost trust in the financial system?
WB: They shouldn’t have lost... you don’t need to lose trust in the American system. If you decide to buy a farm and you pay the right price for it, you don’t need to lose faith in American agriculture you know because the prices of farms go down…
SG: But you know what I’m saying. People lost money last year in companies that they thought were rock solid. As I said the unthinkable happened and then on top of it, this whole Bernie Madoff scandal. It has undermined people’s sense of well being about our system. So what do you say to people who have lost trust?
WB: Well they may be better off not being in equities. If they’re really depending on somebody else and they don’t know anything about the somebody else, they’ve got a problem. They shouldn’t do that. I mean there are going to be crooks out there and this guy was a crook on a scale that we’ve never seen before. But you ought to know who you’re dealing with. But if you’re going to buy a stock in some business that’s been around for a 100 years and will be around for 100 more years and it’s not a leveraged company and it sells some important product and it’s got a strong competitive position and you buy it at a reasonable multiple of earnings, you don’t have to worry about crooks, you’re going to do fine.
SG: Is there any take away lessons from the Bernie Madoff story?
WB: Well he was a special case. I mean here is a guy who had a good reputation for 30 years or something, and the trust of a lot of people around him. So it’s very easy to draw assurances from the fact that if fifty other people that are prominent and intelligent trust the guy, that maybe you should trust him too. But I wouldn’t put my trust in a single individual like that. I would put my trust in a very good business. I would want a business that was so good that if a social guy was running it, it would still certainly do well and there are plenty of businesses that are like that.
SG: So are you saying that investing has gotten so complicated that investors should stick to what they know? Is that the take-away lesson?
WB: You should always stick to what you know. I say the “know-nothing investor” and there’s nothing wrong with being a “know-nothing investor”. I spend 60 hours a week, thinking about investments and most people have got jobs and other things to do. They can buy index funds. And they’re not going to do better then an index fund if they go around and trust some guy who’s promising them very high returns. If you buy a cross section of American business and you don’t buy it during a period when everybody is all enthused about stock, you’re going to do fine over 10 or 20 years. If you buy something with the idea that you’re going to do fine over 10 months, you may or may not. I do not know what stock is going be up 10 months from now, and I never will.
SG: What about Berkshire Hathaway stock? Were you surprised that it took such a hit last year, given that Berkshire shareholders are such buy and hold investors?

WB: Well most of them are. But in the end our price is figured relative to everything else so the whole stock market goes down 50 percent we ought to go down a lot because you can buy other things cheaper. I‘ve had three times in my lifetime since I took over Berkshire when Berkshire stock’s gone down 50 percent. In 1974 it went from $90 to $40. Did I feel badly? No I loved it! I bought more stock. So I don’t judge how Berkshire is doing by its market price, I judge it by how our businesses are doing.
SG: Is there a price at which you would buy back shares of Berkshire? $85,000? $80,000?
WB: I wouldn’t name a number. If I ever name a number I’ll name it publicly. I mean if we ever get to the point where we’re contemplating doing it, I would make a public announcement.
SG: But would you ever be interested in buying back shares?
WB: I think if your stock is undervalued, significantly undervalued, management should look at that as an alternative to every other activity. That used to be the way people bought back stocks, but in recent years, companies have bought back stocks at high prices. They’ve done it because they like supporting the stock…
SG: What are your feelings with Berkshire. The stock is down a lot. It was up to $147 thousand last year. Would you ever be opposed to buying back stock?

WB: I’m not opposed to buying back stock.
SG: Everyone wants to know your plans. What you’re going to do with all of Berkshire Hathaway’s cash, some 30 billion dollars? Is this now the right time to do a big acquisition?
WB: Well we’ve spent a lot of money in the last 4 months. We spent $5 billion on Goldman Sachs, $3 billion on GE, $6.6 billion on Wrigley, we’ve got $3 billion committed on Dow. We’ve spent a lot of money. We’ve got money left, but I love spending money. Cash makes me very unhappy. I like to always have enough and never way more than enough, but I always want to have enough. So we would never go below $10 billion of cash at Berkshire. We’re in the insurance business - we got a lot of things. We’re never going to depend on the kindness of strangers. But anything excess in that, I love the idea of buying things and the cheaper they get the better I like it.
SG: You’ve been talking about doing a big acquisition for a while now, what are you waiting for?
WB: Well we’ve spent $20 billion dollars... that might not be.
SG: I mean in terms of a company…
WB: Well we’ll wait for the right deal. We had a deal to buy Constellation for roughly $5 billion and then events with the French coming in meant we didn’t do it. But I was delighted to commit to that $5 billion dollars for Constellation Energy. And it could happen tomorrow. That one happened on a Tuesday afternoon I mean it happened like that. Constellation was in big trouble and we flew back that day, talked to the people at MidAmerican that Tuesday and made them an offer that night.
SG: It seems that you’re pretty optimistic about the long term future of the American economy and stock market, but a little pessimistic about the short term... is that a fair assessment of where your head is right now?
WB: I am unquestionably optimistic about the long term. I’m more than a little pessimistic about the short term, but that doesn’t mean I am pessimistic about the stock market. We bought stocks today. If you tell me the economy is going to be terrible for 12 months, pick a number, and then if I find something that is attractive today, I am going to buy it today. I am not going to wait and hope that it sells cheaper 6 months from now. Because who knows when stocks will hit a low or a high? Nobody knows that. All you know is whether you’re getting enough for your money or not.

SG: As you know it’s the 30^th anniversary of Nightly Business Report. As you look back on the past three decades, what would you say is the most important lesson that you’ve learned about investing?
WB: Well I’ve learned my lessons before that. I read a book what is it, almost 60 years ago roughly, called The Intelligent Investor and I really learned all I needed to know about investing from that book, in particular chapters 8 and 20 so I haven’t changed anything since.
SG: Graham and Dodd?
WB: Well that was Ben Grahams’ book The Intelligent Investor. Graham and Dodd goes back even before that which was important, very important. But you know you don’t change your philosophy assuming you think have a sound one and I picked up I didn’t figure it out myself, I learned it from Ben Graham, but I got a framework for investing that I put in place back in 1950 roughly and that framework is the framework I use now. I see different ways to apply it from time to time but that is the framework.

SG: Can you describe what it is? I mean what is your most important investment lesson?
WB: The most important investment lesson is to look at a stock as a piece of business not just some thing that jiggles up and down or that people recommend or people talk about earnings being up next quarter, something like that, but to look at it as a business and evaluate it as a business. If you don’t know enough to evaluate it as a business you don’t know enough to buy it. And if you do know enough to evaluate it as a business and its selling cheap, you buy it and don’t worry about what its doing next week, next month or next year.
SG: So if we asked for your investment advice back in 1979 back when Nightly Business Report first got started, would it be any different than what you would say today?
WB: Not at all. If you’d ask the same questions, you’ve gotten the same answers.

SG: Thank you so much Mr. Buffett … Thank you so much, always a pleasure talking to you.
WB: Thank you, been a real pleasure.


Take a look at these tips on saving money from Reader's Digest.  

Financials broke through their November lows yesterday. Note the divergence with the S&P 500 which is still significantly above last year's lows.


A minor support at 80 is now being formed with major support in the 75 zone.


If the financials can pull up over previous support (now resistance) over the next few days then we could be setting up for a decent rally with a higher low in the S&P 500. If however financials start selling off again and move away from XLF 8.67 then it's very likely that we'll be in for a move down to SPY 75.

As has been the theme for the last year: it's all about the banks.

Market Talk and some broader thoughts

In previous posts we wrote about different support levels, 89,85 and 82. The first two minor levels gave out easily while 82 major support thus far has held.

We don't particularly feel confident on the long side these days as we watch banks blindly march through fields of landmines on a daily basis. However, there is one bullish divergence that has emerged.

Note the following two charts:




What sticks out is the divergence between the market and the financials. To put it simply, the financials are sprinting towards last year's "panic" lows while the S&P 500 is attempting to hold support. What does this mean? It signifies that the broader market is trying to hold support and not cave into the lows; but it's doing so against the constant weight of the financials dragging it down while they flirt with the dance of death.

As an aside note: in our decade + of trading/investing and to put it more broadly, in all our adult lives, we have never felt the disgust and frustration that we currently feel in regards to the incompetencies of the financial system that got us here, and the foolish way the "solution" a.k.a. bailouts have been handled. The ongoing mockery of taxpayers (an example being banks paying bonuses to executives with bail-out money) brings out visceral rage. Personal visions that would have startled us only a year ago with their atavistic violence are now commonplace in our minds. However, we understand that we live in a modern, civilized democracy and the days of public humiliation/punishment in the town square are over. The only mode of revenge, albeit a hyper-sanitized one, is FAZ, a 3x short financial ETF that every trader we know actively trades. Our ability to short the financial system is our only protection against a corrupt, incestuous system that long ago ceased to work in the best interest of the nation.

Without a doubt to a large extent it will be wishful thinking, but our hope at least is that we go forward from this financial disaster with a bit more wisdom, more foresight, and less greed.

Market Talk

Unless there is some fantastic news that temporarily diverts the attention of traders from the world's ills, be it catching Osama (remember him?) or magical earnings from some important names, then it will be just a matter of time before we break SPY 85.5. Once that occurs then the bulls have to either make a stance at this important support zone or be prepared for a retest of December lows (82) and subsequent November lows (74).

SPY talk

Market is at a critical juncture and bulls have to step up to the plate tomorrow morning to hold SPY support at 89 which is daily support, up-trend line and convergence of 20/50dma. If this level does not hold next stop will be 85. A strong bounce will be needed to get away from this support zone as soon as possible. If we do not pull away from SPY 89, and instead remain at this level, forming a horizontal base, then the market will likely just be delaying the inevitable and breaking down through this level later this week.



We're day-traders who trade around support/resistance but we always have an eye on the longer-term picture. We find the following chart terrifying. Unfortunately it is the chart of the S&P 500. How would we interpret this chart? We bounced on multi-year support, now we're basing above, and sometime this year will go back and break-down below last year's lows. However this time it will not be an electrifying vertical drop down like it was in 2008 but an exhausting day to day grind down on diminishing volume. And after months of months of slow losses, of investor hopelessness, of dwindling income and attrition from our ranks, including finally some of the best and brightest, then we will be close to finding the next multi-year bottom, possibly in late 2009 or 2010. And that is our optimistic view. Of course, we have our share of wrong calls and we hope this is one of them. However, note that our market prediction for 2008 made in Jan 2008 was a 20% hair-cut for the market, again, too optimistic.

Newsletter Excerpt

Two equally compelling set-ups, one in a leveraged ETF, one in a stock, we will always choose the leveraged ETF (our favorites being DIG/DUG, UYM/SMN, FAS/FAZ, URE/SRS) over stocks as we feel they are much more "true" -- that is fewer headfakes, more telegraphed, sustained moves.

However, big caveat: without set-ups around support/resistance these leveraged ETF's can destroy your capital more quickly than you can say Bernie Madoff. Don't touch these vehicles unless you're trading around clear multi-day/month support/resistance zones (which we will always provide in the newsletter).

Hyper-Speed

The market went from SPY 155 to SPY 80 in two years (2000-2002). Then it took five years (2002-2007) for it to simply recoup the losses and go back to the highs. However, it took only one year for the market to go from the highs to the previous lows. If someone showed us this chart with the title of some unknown stock and asked us our opinion, we would say, "What a mess! Stay away!"


Looking at the following chart it's hard to imagine that we're not in for a difficult time in 2009, either in the ways of new lows or months and months of consolidation or grinding action. It's going to be tough slogging for the bulls in 2009 as the long-term trend is clearly still with the bears until proven otherwise.

Last week the market tested the lower range of support, bounced hard, went straight through short-term resistance we had shown the week before, and never looked back. All bullish. Real test will be what happens when volume pours in the market again come Monday.



The recent move has been strong and the sentiment bullish but keep an eye on the bigger picture: an up-hill battle in a completely broken market. Our guess is that this holiday-induced light-volume rally will be tested sometime this coming week.


If you, like us, haven't traded much in the last 2 weeks then take it easy on Monday as reflexes tend to be slow down somewhat after being away from the market. Make sure to "warm up" first with smaller positions on Monday morning. For you addicts that traded straight through the last 2 weeks, then of course, it's business as usual.

Range-bound

Yet another day in which the range was inside the last higher-volume/broader-range day, which was Monday, December 22. We would be happy if we could stay within this range until next Monday (not likely but would be nice). Watch to see how stocks react if SPY breaks 85.5; next time around at this zone support will most likely not hold and shorts will gain momentum. If the bulls want to end the year on a more positive note then they have to rally the troops and pull away from support towards the top of this range near 89.5.

Dinosaur Trader's Best of 2008

Check out the post for Dinosaur Trader's best of 2008. Good stuff.

Update

Believe it or not, even after all the recent volatility, we've been in the same trading range for the last two weeks. Over 90 and it we could easily go to 100 resistance. Major support at 82 meaning we break that zone and we will most likely revisit the lows. Right now the bulls have the momentum and they need to make their move. Our fantasy scenario? A few days consolidation under SPY 90 and then a significant break-out into the holidays. So far the banks have led (good) and the oils have been dragging behind (bad). Bulls need the oil stocks to firm up for this rally to survive.

Market Talk

Trading range now is 90 resistance and 75 support on the SPY. Previous support was 82, which again, was hit today. Market above 82 and bulls have a chance. Below 82 and bears become more confident. Through 75 and it's going to be a very depressing Christmas for investors.

This might be the trading range for the next little while so saddle up and stay smart.

Blog Status Update

We're thinking of firing up our blog once again but this time we'd like to make it a more community effort; we're opening up the blog to guest contributors. Possible ideas are: trades that you took on a certain day with chart and commentary; trade styles; op-ed pieces, data feed reviews, etc. The posts will of course be put under your name and it will be up to you whether to have the comment section on or off.

Base and Break: DRYS

Grasp the following, and you will comprehend the base and break, which is the primary system in which we make our living.

1) A great daily that has been in our newsletters repeatedly over the last week.

2) Today the stock gaps up with volume: probably the best combination of all is a gap-up, base and break to target.

3) base and break - failed

4) base and break to target - successful

As soon as the stock gapped up (3%) it became our focus for the day (we're only watching around 10 stocks, so it stuck out easily). It was the only stock with volume on our list. The stock set-up at 86 for a base and break. First entry was to buy the break, and as usual, stop at any reversal.

Step 1: Buy this base and break at 86.

Step 2: Get out immediately as the stock has reversed back into the base.

If you can't move fast, then our type of trading is not for you. This is not the type of system in which you put on multiple positions and go get a coffee. This system requires attention and the ability to move quickly. If you freeze the 20 cent loss could turn into a 1.4 point loss.

As long as the stock does not fill the gap, and DRYS did not, do not lose sight. The stock set-up very well again at 86 in less than 20 minutes. Note how the stock was bought up from that deep spike down. This is a very good sign and shows how much buyers want this stock.

One more time, buy the break of this base at 86 with stop on any reversal. The primary target is, as always, the daily number.

Very smooth move straight from 86 as buyers tripped over themselves buying the stock.

As usual, the stock goes to target, spikes over, and reverses. Sell partial at target, and hold the rest for possible continuation with stop at the new intraday base. The new intraday base at this point was 87.6. Therefore, buy 86, sell partial at 88, then move stop to just under 87.6 in case the stock continues upward.

This is a perfect example of buying the base, and selling the vertical line. The stock set-up 2 points under the 88 daily spot. Active day-traders who bought at 88, which was actual resistance, made the mistake of buying on top of a vertical move a stock that is far away from the base. Swing-Traders have much wider stops than we do (for example 2 points compared to 20 cents) and can be more flexible with entry points.