New Normal in Currency Movements Charted

Note how previous resistance of ATR (Average True Range) of Euro Futures ($6E_F)  has now become support –  wild moves really are the “new normal”.

EURUSD rip/death

Picture says it all — click to enlargen  $6E_F Euro Futures

This is how we trade reversals

We’re all about looking for a tradable spot for reversion to mean trades, and then waiting for it to hit.    Sometimes it hits, sometimes it doesn’t, but it’s how we trade.
An hour ago we wrote: 
What do we mean buy “buy on reversal, stop under”?   This means that you wait until the stock/future hits your support level and reverses — you buy your number with stop at the low.  In this case the buy was the reversal back to 1710 with stop just under 1707.7
Our first target usually is the 9EMA (in this case 1718 as we posted).    8 point target trade for just over 2 point stop.  Good risk/reward.
That’s exactly how we trade support long/resistance short  reversion to mean trades.  The up-side is that it gives you a defined stop and good odds at a win.  The down-side is sometimes the stock doesn’t hit your level and you miss the trade.

What started as boring night

Yen intervention causing lots of fun and games in the overnight session — here are some levels we have on our radar:


Let’s start with gold ($GC_F):     first support to come is around the 1710 zone.

Next support comes up on daily on trend-line near 1640

Euro Futures ($6E_F) has lots of stickiness in this 1.40 zone.

And last but not least the “widow-maker” as @stockjockey refers to it, $SI_F has minor support — blue line near 33.15 zone.

And on daily more substantial trend-line support — blue arrow near 31.5 zone.

 

The most common pattern

Looking through charts this weekend really brought home the new “correlation 1″ meme constantly written about these days in the finacial blogosphere.    Patterns look very similar across the board.    Here is the most common one we can find:

V type moves like #1  often retrace and have high failure rates.   Moves from more based/rounded bottoms like #2 have much higher break-out success rates.     $XME right now (#3) is very V-sh/extended, stalled near 60 resistance.   Any basing (handle for the V at least) would be bullish and set this up long.    However that being said the momentum is so strong right now that nothing would surprise us but at these levels we’d rather buy the pull-back than new strength.

We’ve entered a very forgiving bullish tape — Euro bailout rumors were everwhere for the October rally and yet when news came out on Thursday, it was bought.   $AAPL missed.  $AMZN missed.  $GMCR and $NFLX massacred.  Yet no one cares. Bulls are in control and it’s their game to lose.

We’re extended and for us the most bullish scenario would be just to hold the line/or even pull-back but not any further rippage, at least early in the week.  And in the unlikely event the bears really start to push then the big gap to fill of course is  $SPY 124.5  as the first signiciant support on daily.

Gold and Silver: Helloooo I'm Back!

Silver ($SI_F) looking like it wants higher as it’s poking out of its range — has room to the 200SMA.

Gold ($GC_F) reversed at 1705 resistance — but looks like it has room until 50SMA.

We wanted $SPY at 126.2 for short and went to 126 in pre-market before reversing.   As for support it’s all about gap fills — 122 and 117.5.

We had $IWM as a short on our newsletter at 74 for days (and tweeted several times)– today it hit the level pre-market and reversed hard.   We see that happening a lot lately — hitting resistance overnight futures/pre-market and not in regular session.   Note that was first test — next test will likely break-out of the range.

Copper ($HG_F) failed break-down last night through 3.50 but through there and has room to 50SMA and daily resistance near 3.65.    Copper has been wild lately and we’ve been staying away — massive death days followed by rip days.   Lots of things going on in the background there and too volatile for us to get involved.

Huge move in crude ($CL_F) that stalled at the 200SMA today.   Lots of congestion ahead — further upside should be tough as lots of stickiness around 95.

MoMo getting murdered left and right ($GMCR $NFLX $AMZN), market extended into resistance:  we’re happy to hone those intraday trading strategies.

Updated Game Plan

Our resistance short spot was taken out in the overnight session. Our $SPY 123.5 short roughly corresponded to ES_F 1230-1233 zone which we wanted to short last night :

The most frustrating part about futures is that some of the best spots are triggered in the middle of the night. Perfect reversal at our 1230-1233 resistance short zone — we loved that spot and contemplated putting in offers at 1230/1233 with stop at 1235 in case it triggered during the night but alas didn’t, and were left with a gorgeous chart that justified our call but no trade.

Note that ES_F fulfilled the SPY trade we were looking for — 100SMA/daily resistance test and roll. This makes the SPY resistance short more complicated and we’ve lost interest in the trade due to it being a second test– but let’s cross that bridge later.

Trend-day down today — and bulls got lots of little cuts trying to buy the dip. Our rule of not going contra-trend on first day of sell-off has saved us countless dollars over the years. The first day of a sell-off often is a trend-day — and going mean-reversion on a trend-day is often a frustrating and losing experience. Stick to the direction of the EMA on trend-days, which meant today shorting the rallies back to the descending EMA.

Bulls were shot down on every touch to the EMA except for the last one, which in turn reversed against underside of S2/15 min-20EMA. Typical trend-day action which kills reversion to mean traders.
We have a lot of decent longs now that are getting ready if/when market regains strength; and $SPY 117-117.5 will possibly offer decent opportunity as a day-trade long.   In between those two scenarios, howeve, we will be mostly chilling.

Game Time

Very bullish close for the market as it easily closed over 122 resistance on the $SPY.   Next up is 123.5 which also coincides with 100SMA, daily resistance and as a bonus, $TLT will likely hit support at same time.  Game time!

Thus far from the October 04 bottom there have been two good day-trade short opportunities; the first was the jobs data pop last Friday, and the second was Wednesday’s 122 reversal.    Will the third be 123.5?     We’ll definitely try it short  (we usually wait for 10 -20 cent reversal before we enter and then  stop on high — and it often takes 2-3 tries to get it right but we always have stop on high –no hero trading).

As for longs we’ll be focusing in the basic material sectors for new opportunities even though the close of the $OIH extended into 50SMA makes us think we’re not going to find too many good set-ups without some further basing.   Melt-up market indeed.

Have a good weekend everyone.

Our time frame is short

We’re realizing, through comments left on our previous post, that there are readers of our posts who do not know our time-frame.   We are primarily day-traders.    If we short a stock at 100 and it goes to 98 we call victory.   If it reverses and then goes to 200, great.  Hopefully we caught some of that too.   Our job is to trade against  levels which we believe will offer good risk/reward, be it short or long.   If we have a 20 cent stop on the $SPY and we bank 1 point then that’s the same to us as traders who have 2 point stop and bank 10 points.
Day-traders who shorted against 122 resistance on $SPY, a level we’ve written about for days, did very well — (after-hours sitting at 120.5).    Number one rule for financial blogs/social media — know the time-frame of the writer.
We have no idea which scenario plays out (hoping for the late year rally one –  but will trade accordingly to whatever happens).     As we posted before the most bullish scenario would be a pull-back/base under 122 and then rip higher.

Watch who you fade

We can’t remember a time where levels worked so well –  anecdotally speaking — it seems to us that market just keeps getting more technical.   Praise HFTs?   Since this rally started we have had only 2 fade spots on our newsletter (and both were posted also on stream) .  The first was to fade the jobs number pop last Friday, and today was 122 $SPY resistance.

Pretty amazing how these “obvious” spots are working.   Also a note of caution for those who we have heard  like to use the stream as a contrarian indicator — we were pleasantly surprised to see the short bias today.    Watch who you fade!


First gap fill is near $SPY 120 and second support is near 50SMA (and second gap fill near 117.25).   Let’s see how much the bears can push.       The most bullish scenario for us would be a fade to around 117.5 to put some fear into the bulls and then a reversal higher out of this range.

 

Hysterical Market Needs to Chill

V type markets can be tough as they don’t let the “wrong side” traders out to breathe — when we went down the poor longs couldn’t get out on any bounce, and now the  shorts didn’t have a chance to cover as we ripped through the 50SMA.     These can be vicious markets for contra-type traders.

Perfect V in $SPY — looking for mini Ws to come next.

However, that being said we had 8 out of 9 alerts (all long) trigger today from our newsletter– often when that happens and we run out of alerts it also coincides with a consolidation period in the market.    V type moves never last — the healthiest thing for the market would be to enter a consolidation period near the 50SMA.    Any such basing would set up many new longs, while continued running would create a higher probablity of a sharp move down.

The easy trade, the fade, and now what

We always regret not calling ourselves “Base Trading Group — BTG” instead of HCPG.   Everything in our strategy circles around how we trade around the base.     Friday was as text-book bread and butter HCPG trade as they come — short the first touch of the descending 50SMA after extended run.  We’ve written about this for years and we imagine most of our subscribers were involved somehow in this trade.
We wrote on Thursday on our stream to “fade the job’s number pop” and we wrote emphatically in our newsletter to short 118.     The jobs number came at 8:30 –   short the 50SMA on the $ES_F at 1174, or short the pop to 118 on the $SPY pre-market.    For our way of trading–this was as “easy a trade” as they come — what comes after is a bit more complicated.    Is the rally over or are we just basing for higher run?   We have some decent set-ups long that just need a bit of time (3-4 days would make them look fantastic) so we’d be in the camp that would argue that the rally is not over yet — but we wouldn’t put any swing money on that either, we’re still in daytrade mode.

Perfect ES_F touch and fade from the 50SMA.   Very extended run straight into first touch of the descending 50SMA.   This is as essential HCPG type trade as they come and hopefully a lot of our readers/subscribers nailed this trade.

Here is the 5 min chart — note how extended it was from the 20EMA — again, lay up as it follows everything we teach — extended from base on every time-frame we follow.

And $SPY in pre-market short against 118, text-book.   These are the types of opportunities that don’t come often — when they do they deserve much more aggressive type of size positioning.

For weeks we wrote in the newsletter that we were looking for a bounce scenario in which the August $SPY lows would be broken and the 1077 $ES_F overnight lows would be tested, hold, and bounce.   That’s exactly what we got with a 10% bounce that was sold into the 50SMA.   Both these trades, in one week,  were easier to predict (because of their extreme oversold/overbought nature) than the range we have experienced for the last two months and we imagine what will come in the next several months.      What we are looking for now is a flattening of the 50SMA — a multi-day base under the 50SMA would be ideal– and then a rip higher (and we have multiple long set-ups already setting up giving some credence to this scenario) out of the range.   Note the taking of the 50SMA would be quite important technically as 1) it has not been overtaken since the correction started and 2) it is steep slope descending, making it quite strong.
(If you want to learn more about fading first touch of 50SMA, and waiting for flattening of the SMA –again, critical to how we trade—- google “flattening”  or “first touch” in the search box of our old blog at www.highchartpatterns.blogspot.com )
New lows of course are always a possibility — and the action in the banks are probably the biggest argument for this scenario.    Long term visibility is low meaning conviction for longer time-frames is low — we’ll be sticking to day-trading until we return to a trending market.

Miscellaneous thoughts including market talk, strategies, and a defense of dip buyers who didn't get their heads bashed in

We're short-term traders and probably a good 50-60% of the people we follow in our stream also share the same time-frame.      It's our nature to always want to yearn for resolution of ranges even though our rational side tells us that we could be in this trading environment for a good while longer.   Take a look at the following chart -- we left on the 50SMA (the black line) and simply drew arrows with every big move up and down.    The range was basically established between two trading sessions: Friday, August 05 (rumors of US downgrade) and Monday, August 08 (first trading day of confirmed US debt downgrade).
We have not trended the last 2 months, we've been completely range-bound.  On Friday even with the incredibly bearish close we still are above where we were on August 08.
If someone presented us with this chart we would say:   Wow, ugly chart.  Steep, descending 50SMA that hasn't even been tested once since the sell-off began.   Usually what happens in these situations is that the stock remains in range until the descending 50SMA starts to catch up and then price is pushed down, thus transforming from a  range-bound price-action to a down-trending one.

Just as buying the dip worked well for a long time (ceased to work as well once we broke 2009 trend-line) the motto is short every rip until it stops working.    Shorting break-downs in broken charts also work (witness $NFLX through 125 support this week) but it's not our preferred strategy (shorting resistance is our prime strategy for this type of market).  One day it will stop working -- but likely not until we break the range and/or 50SMA.

When the market was above the 2009 trend-line and traders were buying dips (successfully) many would say "one day buying the dip won't work and they'll get their heads bashed in".  We never understood that thinking.  The idea of buying dips is to do it on shorter-time frame within a larger trend.    That is,  buy pull-backs if longer time-frame trend is intact.   We were known as consummate support buyers and over last two years made many live calls buying support.  However, on August 02 in "Time to Re-assess" we wrote that:

"We have written for months that we would buy the dip until we broke the 2009 trend-line.   Well, today we broke the 2009 trend-line."
In our outline of "How to catch a falling knife" written in May we wrote about the three errors traders often make in "catching falling knives".   Error number two we wrote in this post was:
" Buying a broken stock instead of  buying oversold into support on longer-term bull trend.     We would never get into a broken stock just because it’s “cheap”.  In our business nothing gets cheaper faster than an already cheap stock.    When we say we’re buying on “support”,  it automatically means that the long-term bull trend is intact.    If it’s a broken chart, by definition, there is no support."
Once the March 2009 trend-line broke then the game for buying support was essentially over.   The 2009 trend-line for us was "the big kahuna" and we wrote a dozen posts before the break referring to it as the big level that would change everything.  Traders like ourselves, and many that we respect on the stream, did not get their heads bashed in -- they realized the trend was broken and they shifted strategies.
Of course we speak about ourselves and about other professional traders like us -- it's likely many retail investors who did buy the dip for the last two years and kept on doing it in the last two months in fact did get hurt.    However, the accusations about dip buyers were often made against traders making support calls on the stream, not the average Joe buying dips from his E-trade account.
Now we're on the other side and in a bear trend meaning that the modus operandi is to short resistance until it's proven otherwise (break of range/break of 50SMA).      In our experience this has been the best combination we have found -- trend-trade, and employ counter-trend strategies (reversion to mean), but always in the direction of the longer time-frame trend.     Not always easy to execute, but that's the foundation of how we trade.

No Balls to the wall here

We’re trading shy thanks to the amount of confusing information that we are seeing.  The most confusing of all is why the hell are we still above August 05 lows?   Commodities/China started this sell-off and normally we’d want them to bottom first yet US markets are holding firm while they keep grinding lower.   We’d prefer to see the opposite:  US markets make new lows, get panicky, while commodities firm up and show strength — that would get us interested in long trades.
There’s obviously two issues at hands, Europe and China, and they are making the lines somewhat hazy.    On one hand it looks like the S&P is pricing in Europe, while commodities are pricing in China.

We were waiting this week to short the 50SMA — we didn’t even make it there as the 20SMA on the $SPY  served as enough resistance.   The range is now tightening short term.

Copper ($HG_F)  still above the crazy Sunday commodity night but threatening it every day it seems

$CLF used to be one of our favorite trading stocks.  Now it trades like a dead internet stock from the bubble days.  Amazing.

$WLT was another super-star, one of our most loved trading stocks.  Again, trades dead.  Bid-less.    We want these to come back to the realm of living again before we start feeling the urge to go long.

We’ve noted our frustration this week on our stream.  Every night we send out our plan for the next day to our subscribers.  The plan has worked well (early in the week buy commodity to gap fills which all filled, later in week, short to support targets, which again worked) — basic range-bound reversion to mean strategy.  But our execution has been anything but stellar.  The gap between the plan and the execution is the hardest part of trading — when trading is bad the gap is wide. When you are in the Zone, then there is no gap.  Right now we’re in the gap area.  Why?  Because of all the mixed signals we can’t feel conviction about anything, thus we trade nervously.   We’re going for singles.  But maybe that’s not a bad thing.

Remember this chart we posted a few weeks ago under the title “How not to trade” — well update it at your own pleasure.  We’re still stuck to the range.    Peter L Brandt has an excellent post out today which covers this (lesson #3).   Don’t miss it.

Tough tape and people are getting impatient to see the range resolve.  It might happen next week or it might not happen for months.    If there ever was a time to be zen-like in your approach to the market and accept whatever the market brings, it’s now.

Dead cat bounce or the real thing?

he Euro-tarp rumor came out on Saturday and commodities were thrashed Sunday night before they bottomed.  We don’t think the rally has anything to do with a Euro Tarp rumor (since the real selling in for example copper came a day after)  but a simple squeeze continuation from yesterday’s commodity bottom.      Tech, which has held better than any other sector we follow, is not surprisingly underperforming today as it stands aside and let’s the commodity squeeze take place.     Take note that $AAPL is only up 1%, and for example $CMG $AMZN are both red.    This has all the makings of a vicious dead cat bounce, something we wrote about yesterday.
So how can one tell the difference from a dead cat bounce and the real thing?  Well we can’t.  They both start the same but the latter bases and then keeps making higher lows while the former gives it all back.   If you feel like the leaders should lead the bounce, well, it’s not that simple either since “leadership” is dynamic in the market.   It’s too soon to tell what this market wants to do (the reaction against the 50SMA should yield some information) but we do respect the fact that commodities, which started this whole sell-off, have now short-term  bottomed.
Charts are in a world of chaos and there’s not much to do today for new positions if you trade off patterns.  Don’t fall into the other side of the fear of loss which is the fear of missing:   if this rally is for real then there will be many excellent risk/reward set-ups in the near future.

A feeling of safety

The market has held the August lows admirably, while  commodities all broke down through August lows, and today hammered from incredible overnight sell-offs.    This to us is a very positive first step — but continuation will be key.   What will be necessary is a “feeling of safety” as traders who have had their limbs blown off by the sell-off start to come back into the market for “fear of missing the rally”.    Once that happens we could get a monster squeeze.

Right now tech is a lightweight — as noted this weekend we wanted $AAPL to be hit before we saw signs of a bottom.  We saw that today.   The real soldiers in the trenches right now are the four horsemen of commodities,  crude ($CL_F) , copper ($HG_F),  silver ($SI_F) and gold ($GC_F).     We’re keying off these for the immediate future.

The hammers in the four horsemen today are exceptional — but as we all know one day hammers don’t have much significance — it will be all about continuation.  We think this week will be the most important week since this sell-off started this summer.    The market held the range, the commodities bottomed — now if traders feel the fear of missing a rally and step up we could have a vicious bear market rally.    If today was a one day wonder and market pulls back tomorrow then fear of losses will outweigh fear of missing profits and we will go lower.   As said, this week is pivotal.     Bring your A game to the table.

Some positives

It's hard to get an edge on this market as computers trade to each other from one rumor to another but there are a few positives we'd like to point out today. The most obvious of course are the reversals on silver ($SI_F), gold ($GC_F) and copper ($HG_F) from their overnight lows. We also like the action on the refiners (which have been good tells lately) with $HFC $TSO $WNR holding gains.



As we noted this morning we think the rally could take us to the first target of gap fill near 116.5 on the $SPY -- that first test will likely be faded. The reaction to the fade will give out short-term direction information.

We noted a gap fill trade on $OIH in our newsletter this weekend and we have the first positive step towards that target today. We expect the first test of the fill to be faded.

Visibility is low and traders are flying pretty blind -- taking it one day at a time and trusting only moves short-term is our motto right now.

Market Thoughts

The market rallying while silver and copper get raped makes no sense to us — we see it as Friday version of musical chairs. The bulls are trying to keep the range ($SPY August low 110.27 still hasn’t been breached) and traders are nervous that they will miss out on a potential rip due to weekend fiscal intervention headlines. That’s definitely a possibility but nothing we’d want to bet our money on (short or long)– especially if the recent past is any example.

We don’t think holding the lows now would be a good thing for the bulls — it would just extend the range-bound tape. We want a flush, new lows, and a cleansing. And most importantly we want the commodities to show strength first — they started the down-fall and we want them to start the rally, whenever that may be.

If you are an investor/swing-trader who got clipped this week — remember — the more you try to make it back the harder and more dangerous your trading will become. The market doesn’t care about your PnL. Get involved whenever there’s good risk/reward set-ups, whenever that may be, regardless of how much you have to “make up”.

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Russell Divergence

We’ve been writing about the divergence between the Russell and the Nasdaq for a while now but wanted to put out a few figures out there:

The $QQQ is 2.19% over its 50SMA

The $SPY is 1.96% under its 50SMA

The $IWM is 5.96% under its 50SMA



Here’s an update of the chart we posted yesterday showing divergence between the Nasdaq and the Russell:

We have no idea what’s going on — is this some new paradigm in which small-cap stocks, financials, coals, oil stocks, and copper all sit dead in the water while momentum “decouples”? We don’t think so. One will soon revert to the other — that is either the laggards start to stabilize or the momentum stocks will start to fade. We’ve been through markets where tech/momo take the lead and commodities/more conservative sectors grundgingly follow but we can’t remember a time where copper (fresh new year lows again today) was an inverse indicator for the market.

For short-term traders it’s business as usual (we had six successful momentum daytrade alerts from our newsletter trigger in last two days) but it has been keeping us even more short-term than usual, constantly worrying about sudden reversals and death traps.

It is not the critic who counts....

Too long to tweet – what a fantastic quote.

“It is not the critic who counts; not the man who points out how the strong man stumbles, or where the doer of deeds could have done them better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood, who strives valiantly; who errs and comes short again and again; because there is not effort without error and shortcomings; but who does actually strive to do the deed; who knows the great enthusiasm, the great devotion, who spends himself in a worthy cause, who at the best knows in the end the triumph of high achievement and who at the worst, if he fails, at least he fails while daring greatly. So that his place shall never be with those cold and timid souls who know neither victory nor defeat.” – Theodore Roosevelt

Which one is telling the truth?

The divergence between tech/consumer discretionary and almost everything else has been a recent theme for a while. When tech started rallying last week we were looking for basic materials to catch up (and didn’t have much luck there as very few broke-out of our set-ups). Here’s a nice little chart $AAPL overlaid with copper (via $JJC) to show you how surprising this divergence is becoming:

AAPL at year high while copper at year lows.

We’d be happy with a market led by tech/momo names but the other sectors still usually go in more or less the same direction. A real up-trend is not going to happen with a dying basic material/financial sector. So which one is telling the truth? Will the momentum names pull up the whole market or will the laggards anchor down the healthy sectors?

Trading and washing toilets

The constant evolution of a trader comes from the attempt to minimize the distance between what one should do (strategy) and what one actually does (execution). The endeavor to close the gap between these two is a career-long challenge. After multiple years of trading your tool-box of strategies should be brimming, your risk-management skills solid, but what constantly differntiates the mediocre traders and the great traders is this distance between what they know they should do, and what they actually do. Ideas are a dime a dozen, but it’s the execution that will make or break you.

Treat trading as a job. Imagine washing toilets for 8 hours straight and then your boss coming to you and saying, well actually I’m going to take back the last 5 hours of your pay and will only pay you for 3 hours. Losing in trading is inevitable, but it has to hurt you — if you’re going to lose money it has to be on a trade that set up great but just didn’t work. Those are the losses that we like — they don’t put us in a bad mood. A loss from a trade that you would not hesitate in taking again. Most traders like trading, for them it’s a great job, much better than for example, washing toilets. And the money can come in fast — the normal correlation between time spent working and income occurs at a much different rate than in other jobs (at least from an hourly/daily point of view for daytraders). And maybe because of this they act fast and loose.



This is the reason we like having a pre-defined plan from the night before — it helps us execute well. A pre-defined plan gives us conviction and conviction and good execution (trading tight and disciplined) go hand in hand. Every single trade should count — and you should take the money earned from the job as seriously as the guy counting the hours washing the toilets at the city park.

The Game Plan

This morning the market reversed at 121 $SPY resistance (and $ES_F 1200). Day is still young and we could base intraday and take out 121 before the close –even though we’d prefer a close under 121, a few days basing, and then a breakout of 121 and into next resistance of 123.5 which would be top of channel/50SMA.

Of course in this market you have to be open to all options — and reversing back down is also one of them. However, this scenario is looking less likely in light of recent market action.

Tech, retail and trannies are acting well, but basic materials and financials have to start pulling their own weight soon if this rally is going to have any standing power. The daily chart is technically still in the bear camp until we break out of this range but short-term the price action is with the bulls. Our focus into the next few days will be the catch-up sectors (especially basic materials) as tech takes a rest.

Rip or Die

We’ve written before that this range-bound market seems to only know how to rip up or die down. There’s very little chilling in between. If we do want to finally leave this range then the market needs to digest the moves and start to build bases — something that has been missing since the correction started in August.

Note how we keep bouncing off the lower range and reversing off the higher range (and today no exception as market screeched to a halt and reversed down as we hit the higher range in the $ES_F, and the 50SMA in the $SMH).

Who do you believe?

Listening to the CEO of Societe Generale one can’t help but to feel re-assured that all will be well:



And just when you’re lulled into complacency this report by Jeffries’ market strategist  David Zervos smashes any sense of calm:
In most ways the excess borrowing by, and lending to, European sovereign nations was no different than it was to US sub prime households. In both cases loans were made to folks that never had the means to pay them back. And these loans were made in the first place because regulatory arbitrage allowed stealth leverage of the lending on the balance sheets of financial institutions for many years. This levered lending generated short term spikes in both bank profits and most importantly executive compensation – however, the days of excess spread collection and big commercial bank bonuses are now long gone. We are only left with the long term social costs associated with this malevolent behavior. While there are obvious similarities in the two debtors, there is one VERY important difference – that is concentration. What do I mean by that? Well specifically, there are only a handful of insolvent sovereign European borrowers, while there are millions of bankrupt subprime households. This has been THE key factor in understanding how the differing policy responses to the two debt crisis have evolved.
In the case of US mortgage borrowers, there was no easy way to construct a government bailout for millions of individual households – there was too much dispersion and heterogeneity. Instead the defaults ran quickly through the system in 2008 – forcing insolvency, deleveraging and eventually a systemic shutdown of the financial system. As the regulators FINALLY woke up to the gravity of the situation in October, they reacted with a wholesale socialization of the commercial banking system – TLGP wrapped bank debt and TARP injected equity capital. From then on it has been a long hard road to recovery, and the scars from this excessive lending are still firmly entrenched in both household and banking sector balance sheets. Even three years later, we are trying to construct some form of household debt service burden relief (ie refi.gov) in order to find a way to put the economy on a sustainable track to recovery. And of course Dodd-Frank and the FHFA are trying to make sure the money center commercial banks both pay for their past sins and are never allowed to sin this way again! More on that below, but first let’s contrast this with the European debt crisis evolution.
In Europe, the subprime borrowers were sovereign nations. As the markets came to grips with this reality, countries were continuously shut out from the private sector capital markets. The regulators and politicians of course never fully understood the gravity of the situation and continuously fought market repricing through liquidity adds and then piecemeal bailouts. In many ways the US regulators dragged their feet as well, but they were forced into “getting it” when the uncontrolled default ripped the banks apart. Thus far the Europeans have been able to stave off default because there were only 3 borrowers to prop up – Portugal, Ireland and Greece. The Europeans were able to do something the Americans were not – that is “buy time” for their banking system. And why could they do this – because of the concentrated nature of the lending. In Europe, there were only 3 large subprime borrowers (at least so far), so it was easy to front them their unsustainable payments – for a while. But time is running out. Of couse, the lenders (ie the banks) have always been dead men walking!
At the moment, the European policy makers – after much market prodding – have finally come to grips with the gravity of their situation. And having seen the US bailout movie, they know all too well what happens when a default of this caliber rips through the financial system. The reason the EFSF was created in the first place was so that there could be some form of a European TARP when the piper finally had to be paid and the defaults were let loose. Certainly many had hoped the EFSF could be set up as a US style TARPing mechanism (like our friend Chrissy Lagarde suggests). The problem of course is that there are 17 Nancy Pelosis and 17 Hank Paulsons in the negotiation process. And while the Germans are likely to approve an expanded TARP like structure on 29-Sep, it increasingly looks like it may be too little too late. The departure of Stark, the German court ruling on future bailouts/Eurobonds, the statements by the German economy minister and the latest German political polls all suggest that Germany is NOT interested a full scale TARPing and TLPGing process across Europe. They somehow think they will be better off with each country going at it alone.
The bottom line is that it looks like a Lehman like event is about to be unleashed on Europe WITHOUT an effective TARP like structure fully in place. Now maybe, just maybe, they can do what the US did and build one on the fly – wiping out a few institutions and then using an expanded EFSF/Eurobond structure to prevent systemic collapse. But politically that is increasingly feeling like a long shot. Rather it looks like we will get 17 TARPs – one for each country. That is going to require a US style socialization of each banking system – with many WAMUs, Wachovias, AIGs and IndyMacs along the way. The road map for Europe is still 2008 in the US, with the end game a country by country socialization of their commercial banks. The fact is that the Germans are NOT going to pay for pan European structure to recap French and Italian banks – even though it is probably a more cost effective solution for both the German banks and taxpayers.
Where the losses WILL occur is at the ECB, where the Germans are on the hook for the largest percentage of the damage. And these will not just be SMP losses and portfolio losses. It will also be repo losses associated with failed NON-GERMAN banks. Of course in the PIG nations, the ability to create a TARP is a non-starter – they cannot raise any euro funding. The most likely scenario for these countries is full bank nationalization followed by exit and currency reintroduction. Bring on the Drachma TARP!! The losses to the remaining union members from repo and sovereign debt write downs at the ECB will be massive (this is likely the primary reason why Stark left). It will require significant increases in public sector debt and tax collection for remaining members. And for the Germans this will probably be a more costly path. Nonetheless, politics are the driver not economics. There is a reason why German CDS is 90bps and USA CDS is 50bps – Bunds are not a safe haven in this world – and there is no place in Europe that will be immune from this dislocation. Expect a massive policy response in Europe and a move towards financial market nationlaization that will make the US experience look like a walk in the park. Picking winners and losers will be VERY HARD but let’s look at a few weak spots –SocGen 12b in market cap (-70% this year) with assets of 1.13 trillion BNP 31b in market cap (-55% this year) with assets of 2 trillion Unicredito 13b in market cap (-70% this year) with assets of 1 trillion Intesa 14b in market cap (-70% this year) with assets of 700b Compare this with the USA where we have – JPM 125b in market cap with assets of 2.1 trillion BAC 70b in market cap with assets of 2.2 trillion
Importantly, France GDP is only 2 trillion and in bank balance sheets are some 400% of that number. The banks are dead men walking with massive leverage to both home country income as well as assets. The governments are about to take charge and Europe as a whole is about to embark on a sloppy financial market socialization process that has been held back for nearly 2 years by 3 bailouts. The weak links will not be able to raise enough Euros/wipe out enough private sector equity to get this done, so there will be EMU members that need to exit and use a reintroduced currency for this process. We put a Greek drachma on the front cover of our Global Fixed Income Monthly 20 months ago for a reason.


Who do you believe?

Source/ h/t: Reformed Broker via BloomBerg, ZeroHedge

SPY US downgrade range

The blue rectangle represents the price range for $SPY  between Friday August 05 (downgrade didn’t come until that evening but rumors were already flying) and the Monday/Tuesday reaction.   Three days carved out the range for the next 6 weeks (+).

Cry Wolf Market

A fantastic squeeze into the close to end the day with a gorgeous green candle.      It’s hard not to get excited by such action, especially considering we gapped down below the trend-line.   But we’ve heard this story now multiple times in the last month.  Take a look at the following chart of the $SPY and the blue circles and note how many close at high candles there have been in this period:

Note that there was even follow through on some of these green candles, only to get it whacked down again and again.  We have no idea whether this is IT, and for day-traders it doesn’t really matter (we’re long $ES_F overnight ourselves), but if we were swing traders we’d put out a few tester longs, have a lot of dry ammunition (cash), and accept that we would pay up in price in exchange for more evidence/confirmation.

For you Fib lovers out there

We bounced in August on the important 61.8% retracement, next support is at the 50% retracement which also happens to be major daily support near $SPY 102.    We have no idea whether we’ll actually pull back to that area but we’re open to the idea and believe the possibility is definitely on the table.   However, it doesn’t really affect our type of trading as our time-frame is too short (i.e. even if we get there it won’t be a straight line and will give lots of opportunity short and long).   But for you longer time-frame position traders — keep an open mind.

Backing Off

In the conclusion of the newsletter this weekend we wrote, “We have been pretty active since this whole correction started but we are stepping back now for the first time and seeing how Monday shapes up”. We basically couldn’t think of any plan coming into today: we weren’t interested in buying the bottom trend-line test this time (too many tests in short period of time) and we felt like we were too oversold to initiate shorts. Basically, we had no conviction in either direction coming into today.

We broke the flag today — next support is 112 on the $SPY. Breaking that bottom trend-line removes a lot of our edge as we were trading against that for the last month. We mentioned in our post The Big Road Map the possibility of creating a new range and it’s quite possible we’re in the process of carving out new pivots for that scenario.

August was a good month for us as range-bound strategies ruled supreme. However we feel now (and hope that we’re wrong) that we are entering a more difficult stage of “slim pickings” and are backing off and going into more defense mode. Basically, we are protecting recent profits and refuse to give them back in what very well could be an edge-less trading time. To be continued….