8/25/09 (Russia Trumps! Lehman's Ride, Credit Where?)

Traders,

We saw a huge upward jolt on Friday – oil came back off and the dollar started rally - it’s like the day before never existed. These kinds of moves are indicative of the Volatility in the market. One thing that is a little alarming is how low the VIX is getting – as if there is no concern. The VIX has dropped below 19 (down 5% on Friday). Yet – we continue to see daily huge moves in the market. Seeing premiums retreat is alarming – meaning there is NO FEAR. I think – like we have twice this year already – see another big move up in volatility and it will come when we least expect it.

The big mystery to who Obama’s VP is was made clear this weekend. The big question (according to NPR) is going to be the Hillary Wildcard. Initially – they were not going to have a roll call, but they probably thought that would inject a huge amount of resentment at the DNC convention. Pelosi this morning on NPR said that they WILL have roll call and they will not expect any problems. Hillary is a good soldier and will get her supporters in line (I like how NPR referred to Hillary as a soldier). Anyway – it should be worth watching. I think Obama did right by picking Biden, his catholic background and political experience will add to the ticket. The wildcard IS Hillary – it will either be very peaceful and supportive or not. While I don’t think we will see a 68 Chicago DNC – there could be some volatility at the DNC. Does Hillary have control of her troops?

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Russian plays the trump card!

Russian’s Parliament votes to recognize South Ossetia. While I posted a very informative article about the situation in Georgia

– this is the first public (and official) step for Russia to support the separatist state in Georgia. This means tensions will be high – Georgia launched an attack to keep their two separatist states under their control (obviously with the unspoken support of the US – their largest ally). However, Russia squashed the invasion and pushed them back. Now they publically are supporting these two separatist states – the ball is now back in Georgia (and the US) court. It’s a face off!

The big economical questions are: How does the West (Europe) and NATO respond? What is the oil premium risk (the world’s second largest oil pipeline runs through the region and it one of the life blood arteries of Europe)?

http://www.stratfor.com/weekly/russo_georgian_war_and_balance_power

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Lehman's Rollercoaster

Last week we heard rumors of two banks (Korean and Chinese) that were interested in purchasing up to 50% of Lehman – stock rises. Then they walk away – stock falls. Then the Korean bank is rumored to buy out the whole firm – stock rises. Then Korean regulators warn about the risks of investing and a couple more banks in the US fail – stock falls.

The volatility in this stock is HUGE from day-to-day. It’s clear that Lehman is in serious trouble. They are borrowing from the Discount Window – looking to sell huge tracks of their stock, have raised money from anyone and everyone. They now fast a last ditch effort to get out from under this credit debt.

When you see this kind of volatility in a stock – there is more troubles and rumors and less certainty. We really don’t KNOW what the value of Lehman is because the balance sheet is so murky with the illiquid mark-to-market positions. We also don’t know if they can stand on their own feet – if they are constantly at the Discount Window – keeping them alive.

Expect lots more volatility in this stock. This is a traders stock – investors stay away. It could easily go under, get taken over, or continue to flop around like a fish on the dock. Note: Another bank fails this weekend – Columbian Bank and Trust (Kansas).
Stock is back-down in the pre-market.

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Credit Tightens

With everyone that CAN go to the Discount Window going to the Discount Window and the GSEs facing nationalization – money is getting tighter. If you didn’t know better – you would think interest rates were UP and the Discount Window close by looking at how tight lending is. But we are seeing the exact opposite – Discount Window is lending 100s of billions, money is pouring out of the FED, leverage is getting extended (primarily to the GSEs), and interest rates are very low. So why is money (credit) tightening – it doesn’t seem to make sense. However – if you step back and look at the deleveraging going on – it is clear. As write downs continue the money being flooded into the system is just make up the losses – there is not enough to fill up that massive hole. Banks are shutting down lending to keep what little they have on the books against more write-downs.

The Economist printed a article last week: Ticking Time Bomb! http://www.economist.com/finance/displaystory.cfm?story_id=11921871 – Here is a quote:

Delinquencies are already rising fast. Write-offs for option ARMs at Washington Mutual, a stumbling thrift, have zoomed from 0.49% in the last quarter of 2007 to 3.91% in the second quarter. But the real crunch will come when the mortgages“recast”, forcing borrowers to start making full payments. The loans recast after a set period (typically some five years after origination) or when the principal hits a predetermined ceiling. The biggest wave of recasts is due to happen in 2010 and 2011. By some estimates, borrowers’ monthly payments will then surge by 60-80% (see chart), at a time when property values may still be at, or close to, their trough.

Rating agencies were unusually alive to the dangers of option ARMs: they demanded more collateral to protect holders of securitised-mortgage bonds. Banks were slower to wake up to the danger. An option-ARM product called Pick-a-Pay (a name that gave fair warning it could lead to trouble) accounts for 45% of consumer lending at Wachovia, a large bank. Wachovia stopped originating loans that allow negative amortisation in June, and is setting aside heftier reserves to cope with expected losses. It has also waived prepayment penalties for existing product-holders and is marshalling its employees to help move these customers on to conventional mortgages. Such efforts are welcome. But they also signal just how protracted America’s housing woes are likely to be.

Now Libor is getting tighter as premiums banks charge each other are rising. Banks want to keep cash and don’t want to lend it as they see things getting worse before it gets better. Stories like the ones in the Economist and also the future of the GSEs is getting banks (those with money) very concerned about extending credit.

``These problems going into year-end are likely to be worse this time round because of the amount banks have to refinance in December,'' Stuart Thomson (Resolution Investment Management) said, citing a figure of $88 billion. ``The suspicion is that banks are still hiding losses. The banking system relies on trust and at the minute there quite simply isn't any.''

Those that are lending are charging 77 bps over what the Fed’s target will average. The spread is expected to expand – rather than contract. This will put more pressure on the Discount Window as banks will have no choice but go back to the Fed to borrow. How much MORE will the FED (tax payers) lend? Who knows – but if they can’t get money from each other or else where the already heavily burdened Discount Window is going to turn into the biggest lender on the block. I think we will see a push out of that January date to close the window.

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Futures Pre-Market

The futures are getting hit as more credit concerns surface, a bank fails, and the future of the GSEs come into question. The futures are front running the cash – if the spread remains expect a gap to the down side.

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Support / Resistance

We saw a hyper move on lower volume to the up side – oil coming off (after a massive move to the upside the previous day) helped fueled the excitement. Short interest also saw contraction – so there was some short-covering going on as well that helped fueled the rally.

INDU 11500 / 11800-12000 (As expected that narrow 3 day range saw a huge bust out – it was to the upside. 11800 seems to be a resistance area – but if you follow the stepping volatile trend then 12000 could be in the cards. However this morning seems week. If we don’t close above the 11500 area – then Friday was just a fake-out. Watch the close.)

NDX 1900 / 1950 (We move back into the mid-range. 1900 or 1950 is in the cards – this morning shows some weakness. The 50 point range needs to be broken to see any trend be set. Right now expect volatility.)

SPX 1275 (1300) 1325 (The 1300 area is a straddle area – we will move away from it fast and hard. We either break out and go higher continuing a trend from mid July or we head back down to the 1275 (and lower) range and break the trend. It looked like we broke the trend last week – if not for a big rally on Friday.)

RUT 720 (740) 760 (We are right in the middle of this high volatility range – low volume not lots of thick price action all means more hyper up and down moves in this typically low volatility issue. 740 is the straddle area. Expect violent moves away (up or down) from 740.)

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Conclusion

The dropping (and low) VIX has me concern – uncertainty is around every corner (credit crisis, GSEs, banks, election, etc.) – the market is moving up and down big (even intraday). Statistical volatility (measured continually) is out stripping the VIX. That means the hidden volatility is ramping up and getting ready to explode and that is not a comforting thought. Usually volatility explodes means the market pulls off pretty hard. The skew (volatility smile) is smirking and we are seeing some increase in the skew – but not enough – yet. If the VIX continues to drop the louder the black swan’s wings flap.

The credit tightening is getting alarming as well – and it’s only a matter of time before we see the GSEs nationalized at this point. That seems to be where they are headed. Lehman could be the next Bear Stearns and that could cause more concerns.

I was hoping that we would see the credit crisis ease and the housing situation get under control going into the 4th quarter. My expectations were for a mild 2009 and we start to stabilize after a volatile 2008. However – it seems like we keep pushing off the problems rather than to sort them out and face them today. The GSE issue has not been resolved and that could mark the bottom (for now). However – what does that mean for the dollar?

There are too many uncertainties not to be hedged and pushing the problems out (Discount Window till Jan, from Sept.), the long drawn out story of the GSEs, the election games, etc – means that my hope to see a bottom in the 4th quarter is looking less likely.

Stay hedged!