Give This Market Credit

July 27, 2007

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I don't even know where to start, so I will point you to several articles that say it all for me:
July 26th Recap: Technical Damage on Record Volume
Around the globe, rout in credit markets accelerates
Charges drain home-builder earnings: More red ink flows as companies write down land values
Inflation no longer Fed's only problem: Data and stock market sell-off signal softer economy

The on-going recession in the housing industry continues in full swing and appears to be accelerating. Homebuilders cannot even find bottoms in their book values. My remaining homebuilding plays blew up long ago and only the pair trade is worth my time now (see disclaimer here). Particularly distressing was the stubbornness of WCI's management to take up Icahn on his bid to buy the company for $22 just a few months back. Thursday WCI announced it could not find a buyer (noooo - really? Imagine that?!?) and the stock took yet another of its regular beatings. It now looks like any number of two-bit mortgage companies on my housing industry watchlist that are sure to go bankrupt any moment now. Contrary to conventional wisdom, the troubles in the housing industry are having an effect outside of housing. Housing woes may not directly drag down the economy, but the related aversion to risk in the credit markets may yet do enough damage to cry about. Liquidity is drying up, risk aversion is increasing, and the ripples are noticeable. We should expect that all over-leveraged bets to continue suffering - this includes my beloved commodities. Did you notice how a position in gold has had almost no cushion effect in the midst of the market sell-off? Thanks for nothing! The markets need credit. Give them credit, and the cash levitates many. Take it away, and gravity punishes anyone without a currency printing press.

Let's take a look at the VIX (below). In simple terms, the VIX measures volatility in the stock market. Note how the VIX had persistently declined since late 2002 until the large spike that accompanied the big sell-off in 2006. 2007 has been a different animal. Note how the VIX did NOT make new lows after the spike in February's sell-off. And now, this latest spike marks the first significant "higher high" in the VIX in a given year since late 2002. All this to say that it seems to me that the VIX has finally bottomed here. And if credit continues to dry up as risk gets (properly) priced higher, then a bottom in the VIX makes sense. The market will no longer treat the wall of worry as a playground.


That being said, this is not a time to panic. Give the market some credit. The major indices are still up on the year and are still well-within major bullish, multi-year up-trends. The problem now is that we probably have a higher chance that we will fall to the bottom of the channel of those longer-term up-trends sooner than later. If the destruction of financial stocks continues, I suspect we could see such a calamity by the Fall. Such a drop will certainly shake out a lot of sellers and make way for the next run upward. Folks are already holding their collective breath watching the S&P 500 teeter around the June lows. A lot of sell programs are poised to dump stocks upon a clear break of that important support. As I mentioned last week, I am trying hard to be a bull, and there you have my attempt at encouragement. TraderMike also gives us technical evidence that a bottom could be upon us soon.

Where does a bull focus his/her attention? Well, the U.S. economy is a global laggard. We no longer have our homes self-inflating our balance sheets with more and more play money from imaginary valuations. The dollar continues to fall like rain in Spain. I am hearing the S&P 500 now derives 44% or so of its revenues from outside of the U.S. This all means that you want international stocks and U.S. stocks that are big, have international reach, and can take advantage of the currency differentials to goose up earnings. It seems big-cap tech is also in favor as the market slowly but surely gives up on the consumer and focuses on corporate spending. It seems I will also have to give up on my often repeated claims that the Fed will raise rates again before it lowers them. Interest rates are on their way back down and seem to have made a false break-out of the decades long downtrend. I can't say stagflation, and I can't say recession. But if the Fed does cut rates sometime this year, as the Fed futures are saying again, the "bottom" will surely drop out of the increasingly worthless dollar. Stay tuned...

Be careful out there!

DR. DURU®, 2007