Daily Wrap

Tonight, for me at least, is very interesting as we get a look at what some big hedge funds have been up to and some very ironic statements that have been echoed here at WOWS recently.

First, tomorrow should be a volatile day as we expect to get numbers on German, Italian and French GDP. It's an Expiration week this coming Friday and then a holiday week thereafter (Thanksgiving November 24)

I want to lead off with a report by Phoenix Capital Management and in particular, the very first sentence which should be familiar to WOWS members.

"Without trust, the financial system cannot work."


You may recall that is exactly what I wrote a week or so ago when I talked about my experience trading the 2008 market crash, I said the tipping point was when no one trusted their counter parties and all liquidity and credit froze in the markets which was the beginning of the crash.


They go on to echo my post nearly verbatim,


"Nowhere is the lack of trust more apparent than in the financial sector. Indeed, it was a lack of trust between banks (inter-bank lending) that caused the credit markets to jam up in 2008, which resulted in the Crash."


I want to continue with a little more from the report because I think it really sets the stage for what we should expect and it goes on to further echo my sentiments, especially in regard to MF Global which is an event that you may not appreciate now, but it will be in the history books as the Bear Stearns of 2011.

That lack of trust continues to this day. In the post-Lehman collapse, instead of forcing real derivative and credit risk out into the open, the Federal Reserve and regulators instead suspended accounting standards and allowed financial firms (and other corporate entities) to continue to lie about the true state of their balance sheets. (This is another subject that has been covered here in bank earnings and their use of marking assets to model rather then market and why I am most bearish on financials)

As a result of this, the financial sector remains rife with fraud and impossible to accurately value (how can you value a business that is lying about its balance sheet?)

Indeed, we got a taste of just how problematic a lack of transparency can be with MF Global’s bankruptcy, in which a firm with $42 billion in assets lost over 80% of its value since August only to reveal in bankruptcy that it had stolen over $700 million worth of clients’ money.

That MF Global engaged in fraud and stole clients’ money is noteworthy. However, the far more important issue is:  HOW did this company receive primary dealer status from the NY Fed this year?

The Primary Dealers are the banks that actively engage in day to day activities with the New York Fed regarding the Fed’s monetary policies. Primary Dealers also participate in US Treasury auctions.

Put another way, Primary Dealers are the most elite, well-connected financial firms in the world.  They have unequal access to both the Fed and the US Treasury Dept. In order for MF Global to have attained this status it must have passed through a review by:

1)   The New York Fed

2)   The SEC

This is not a quick nor superficial process.

A final note on this: the NY Fed is the single most powerful entity in charge of the Fed’s daily operations. How can any investor believe that the Fed can manage the system and restore trust when the NY Fed granted MF Global primary dealer status a mere nine months before the latter went bankrupt?

If the NY Fed cannot accurately audit a financial firm’s risks during a six month review, then there is NO WAY an ordinary investor can do so.

So if you have not already taken steps to prepare for systemic failure, you NEED to do so NOW. We're literally at most a few months, and very likely just a few weeks from Europe's banks imploding.


I really couldn't have said it any better, except to add how much more inept European banking regulators are and that is where the crisis is coming from this time, the proverbial "Second shoe to drop".

If you go to Ron Paul's website (I like the guy) he has some interesting numbers and facts to add to the equation in his recent write up, "European Debt Crisis Threatens Dollar".

I won't quote the entire article, just a few key passages:

The global economic situation is becoming more dire every day.  Approximately half of all US banks have significant exposure to the debt crisis in Europe.

The US has a relatively small exposure to overwhelmed Greek banks, but much larger economies in Europe are set to follow and that will have serious implications for US banks.  Greece is technically small enough to bail out.  Italy is not.  Germany is not.  France is not.  It is estimated that US banks have over a trillion dollars tied up in at-risk German and French banks.  Because the urge to paper over the debt with more credit is so strong, the collapse of the Euro is imminent.  Will the Fed be held responsible if the Euro brings the US dollar down with it?

As for the Technical action today, it should be noted that today saw the lowest NYSE total daily volume for the entire year, this may have been part of the reason the DOW was so far off correlations today.

Today we also get a look inside some major hedge funds and we can CLEARLY see why volume has been lower and we can clearly see why 3C has looked as bad as it has, keep in mind that hedge funds tend to flock together, unfortunately we only have a sample of 2, but it should be indicative of the industry trend, which easily explains 3C's horrible looking stance as this is the kinds of transactions 3C is meant to track in underlying trade.

David Tepper's Appaloosa Fund (just for perspective, in 2010 Tepper was the top earning hedge fund manager in the world, this is no small operation) released publicly known positions, of which there are 63 in equities, in Q3 he sold part or all of his holdings in 59 of them! There were complete 

liquidations in Bank of America, Wells Fargo, Fifth Third, as well as Yahoo, Pfizer, Walter Energy, Metlife, Merck, Medtronic, Marathon Oil, Manitowoc, Frontier Oil, DR Horton, Alpha, ConWay and Cliffs Natural.

In addition, he started 4 new positions, that was it.

That is MASS liquidation of equities.

Then we also get Dan Loeb's Third Point Fund with Assets Under Management of $7.5 billion, until last quarter... Third Point is now at $7.1 billion AUM, but the real story is the same as above, selling risk or stocks;  he sold off his entire positions in BP, Cablevision, Freeport McMoRan, Freescale, Lyondell, NXP, Pall, ON Smi, Pall, Potash, Quest, Safeway, Swift, and Whirlpool. You can see by the graphic below, the theme is delveraging equity risk and moving to cash.

What have I been saying all this time? INSTITUTIONAL MONEY SELLS IN TO STRENGTH AND THEY ARE MOVING AGGRESSIVELY OUT OF THIS MARKET.

Most importantly, this is information, that while not specific, 3C has been showing you for the better part of a month, while others have to wait to see what smart money is doing, we can see it early and thus be ahead of the market, such as using day's like Friday's strength to enter short positions knowing that institutional money is likely doing the same, or at least removing large amounts of support from the market making it more likely to fall and fall hard.

Also released today was the CFTC's  (Commodity Futures Trading Commission) weekly COT report (Commitment of Traders) and it had some interesting perspective on the Euro.

It wasn't too long ago that the Euro had huge short side participation, helping to drive the market higher through October, but this is the 4th consecutive week that the net bearish position on the Euro has dropped; in total about a 30% decline from the start of October, which means short squeeze Euro rallies are going to be harder to pull off and last week's NYSE Short Interest also saw a sharp drop, meaning the same and also taking away the covering bid should the markets fall as there are fewer shorts to take profits, there is less natural support. However, that's not all, take a look at the graphic...

Th Euro short Interest has declined, but the Dollar short interest has gained, making a dollar short squeeze more likely, which has the opposite effect on stocks, moving them lower. 

Here are the 3C charts of the Euro and Dollar...

 Here's the 5 min chart of the Euro/FXE showing broad weakness Friday and in line today.

 However the 30 min chart is moving quickly down in a leading negative divergence, exactly as the graph above would suggest, it looks like the Euro is set to lose a lot more ground shortly.

 The $USD/UUP saw broad strength short term on Friday and held its own today.

The 5 min chart is showing the same strength. The real surprise though has been brewing for some time...

The daily chart is seeing a positive divergence it hasn't seen since the last one that preceded the 2009 dollar rally.

Financials have been mostly what I've been interested in and as the market starts moving away from directional trades, as I have mentioned, it's the first sector where I think "stock picking" makes sense rather then using broad ETFs. Take a look at the recent performance of financials.

Over a longer term then we usually look at, look how bad financials have performed relative to the S&P and the main S&P industry groups. The rotation in financials at the bottom is nearly invisible recently, they are trailing badly. MF Global was the canary in the coal mine.

 This is XLF (financials) in green vs the Dow-30, look at the correlation in the green box vs the lack of performance in the white box.

The S&P's performance (green) vs the Dow as the S&P has more financial components, it went from nearly identical to lagging. 

 Even the S&P (green) vs Financials (red)

 Here's Industrials vs Financials

And Tech which has also been underperforming vs financials.

This should tell us something very important about the market's change in character right now.

As for leading indicators...

 Look at the short rally in JJC, DR Coal. 3C is leading negative here which doesn't bode well for the market and as an aside, likely says something about China that few people recognize yet, namely that commodities are underperforming, being distributed and that weakness can largely be traced back to the Chinese economy; think about that as the EU crisis deepens.

 JJC/Coal on an hourly chart has topped, just like in July.

 On a daily basis, if this doesn't spell trouble, I don't know what does, leading negative hitting lows below the 2009 market low!

 The FXA/Australian dollar has also been a leading indicator for equities, its strength in September was manifested in equities in October and now it is showing weakness vs the S&P at what I call the October rally top.

 Looking inside FXA for hints of where it is going, this 30 min 3C chart has nothing good to say for the broad equities market.

 Back to the economy, market and China specifically, this is the SPY (green) vs the CCI (Continuous Commodity Index). Not only did CCI top before the S&P in summer 2011, it showed early strength before the October rally and is now showing weakness as the market begins to rollover from the October rally.

 Treasuries have seen massive selling, primarily from Europe as I have covered numerous times, China which is peeved with the US for many reasons, most recently Obama telling our biggest creditor to "act like an adult" is also probably contributing to treasury weakness, however, through all of those headwinds, TLT, the long treasury is showing signs of a move from stocks to the safety of treasuries recently.

 We saw some late day negative divergences in the 5 min chart, which were in line with the equity markets showing some positive 5 min divergences that seem very out of place, however...

 TLT 15 minute, exactly the opposite of the major indices showed surprising strength today in a leading positive divergence, which lead me to believe we are setting up for a major bearish event.

 Furthermore, look at how much the 30 min chart moved in 1 day! And that is all leading positive. 

 Even stranger, as Treasuries and equities move opposite to each other, look how TLT managed to still rally at the EOD with the market despite the inverse correlation!

 VXX/Volatility, which moves opposite the market also showed us strength on Friday, partially leading to my all to consider shorting Friday's strength. Right now it is leading positive, which would have a negative impact on stocks/the market.

 Again, the 15 min charts were the story of the day and VXX as no exception, making a serious move up in a rather flat range.

Even more surprising, the progress the 30 min chart made today, that's a lot for it to move in a flat intraday environment.

Technically, Friday changed nothing and the S&P is just barely above the hourly 50 ema as you can see, the October rally is rounding over. As I try to remind everyone, tops and bottom are a process, not an event and we are in an exceptionally volatile market that moves 1000 Dow points a week and the weekly change is nearly flat. This as well as low volume, as we saw today (the Dominant Price/Volume Relationship for every major average was price down / volume down) are both hallmarks of a bear market environment, the first being early in a bear market and the latter lasting throughout a bear market, that's right, low volume characterizes a bear market.

I hope this post lends some perspective and I think it is one of the best examples of 3C detecting the underlying action of institutional money, which clearly is showing a risk off environment and almost panic to get out of long positions.

As for the ES market and the FX market after hours...

 ES shows the ramp/positive divergence to close ES almost exactly at the VWAP (Volume Weighted Moving Average). Since, we have seen a negative divergence develop along the lines of what was seen late Friday, I'll update this chart later is there are any major developments, but with AH trade closed, I would expect that negative divergence to send ES lower shortly.

 Here's the EUR/USD open this week, clearly it's trending down and the market has some downside catching up to do as I posted earlier with the EUR/Dow-30 correlations.

The green arrow is about the same time as the late day ramp in stocks, but still is a countertrend move against the prevailing downtrend. 

Oh and as far as my recent preference to short XLE/Energy over USO, take a look at the percentage losses in each today, I still like Energy more broadly as a short over USO for the time being.