Banking system health

The world of banking analysis is focusing on the sit­u­a­tion with CIT as the ulti­mate test of banking system health. This isn’t wise, but its the way it is.

CIT received $2.3 bil­lion in TARP funds last year, but the gov­ern­ment refused to pro­vide a more com­pre­hen­sive bailout this month. Now, CIT must try to rescue itself in any way it can.

It’s good that CIT must get cre­ative (and des­perate) to sal­vage what is left of itself. The problem is that it is swim­ming in debt. Bond holders are coop­er­ating with the com­pany thus far to buy time for fur­ther reor­ga­ni­za­tion, but there is no guar­antee that bank­ruptcy can ulti­mately be avoided.

So, CIT has become the underdog that everyone is rooting for to rise up from the ashes, and show the world that the U.S. finan­cial system is a won­derful place after all.

Of course, CIT not truly the ulti­mate bell­wether of finan­cial nor­malcy, but it bears watching because everyone else is watching it.

Defla­tion vs. Inflation

The argu­ment will rage on until his­tory finally set­tles the issue, but the side upon which you bet your money could make all the dif­fer­ence in the world to you.

I encourage you to read this report by Hois­ington & Hunt to get a more defen­sible idea of what I am talking about.

Infla­tion has rewarded investors as rising prices build equity in fixed assets, and have pro­pelled stock prices higher — for almost 100 years since the Fed­eral Reserve has been in charge of the mon­e­tary engine of our country.

The Fed has been hinting that it is wor­ried over defla­tion since the middle of last year. Even the Bank for Inter­na­tional Set­tle­ments has been “con­cerned” about deflation.

Defla­tion is a killer. It kills bor­rowing. It kills eco­nomic devel­op­ment. It causes debt col­lapse because loans must be paid off with more expen­sive dollars.

As you under­stand the require­ments to defeat the defla­tionary spiral. you will realize that this is not and cannot happen in the cur­rent polit­ical, eco­nomic and finan­cial environment.

Mar­kets

After a brief pull­back this morning, the DJIA pushed higher to finish less than 30 points from a new Pri­mary Wave 2 recovery high. The NASDAQ is the only index that has been in new high ground since last week. The DJ Trans­ports are on a tra­jec­tory toward a new high, but are still 50 points away.

Market inter­nals are over­bought to the extreme, which is not likely to con­tinue without more relief. The Elliot Wave pat­tern also seems com­plete or almost so for a clear five wave advance.

With today’s NASDAQ close of 1,909.80, note that it is very close to the begin­ning of my ulti­mate target range at 1,910. This may offer resis­tance until it is cleanly broken to the upside. The NASDAQ could cer­tainly reg­ister its final high days or weeks prior to the other indexes doing so.

This 15 minute chart of the DJIA is amazing. If you thought that Speed Resis­tance Lines (SRLs) were mere snake oil, then this chart will change your mind forever.

The first leg of this rally was iden­ti­fied by (i), with (ii) rep­re­senting wave two. We did not count this as such when it was hap­pening, but we always know that hind­sight is better than fore­sight. Still, this is how is appears now, and it’s very clear.

The SRL’s are drawn from the bottom on 7/8 to (i) on 7/9. These SRL’s seemed ridicu­lous at the time, but look how they mea­sured and paced the sub­se­quent rally.

After fid­dling with the lower SRL on 7/13, prices rose to the middle, or 50 per­cent slope line. for two days, the DJIA weaved along the line until 7/15, when it gapped to the upper SRL.

For four days since then, the DJIA has tightly held to this upper SRL, finding almost mag­ical sup­port and energy.

The first test of the SRL came at the blue arrow. After three rising bars of lier­ally sit­ting on the bar, it skipped upward again.

A clean break below the upper SRL will call for a drop back to the lower SRL, which could pro­vide sup­port for another bounce up.

The lesson to be learned here is to expect the unex­pected, but within the bounds of what we could see looking backward.

By Patrick Wood, Editor

Economy

2009 Dumb State­ment Award: “We have to spend money to keep from going bank­rupt.” – Joe Biden, talking to AARP mem­bers.

Actu­ally, this was a photo-op gone awry. Most of the atten­dees at the meeting were bussed in. Some, but not all, were AARP mem­bers. The CEO of AARP was there, along with Kath­leen Sebe­lius (Sec­re­tary of Health and Human Ser­vices) and Nancy Ann DeParie (Director, White House Office of Health Reform.)

Basi­cally, Biden’s pitch was in order to save the economy, we must pass Obama’s health reform package. If we don’t, he said that “We’re going to go bank­rupt as a nation.” Then he stated,

“Now, people when I say that look at me and say, ‘What are you talking about, Joe? You’re telling me we have to go spend money to keep from going bank­rupt?’ The answer is ‘yes’, that’s what I’m telling you.” (Listen to Audio)

What’s even stranger than Biden’s tom­foolery is that the entire meeting was staged from the ground up for some kind of PR stunt.

A record 1.53 mil­lion prop­er­ties were offi­cially in fore­clo­sure during the first half of 2009, beating the same period in 2008 by 15 per­cent. Banks repos­sessed 386,000 prop­er­ties rep­re­senting some $75 bil­lion in poten­tial losses. Fil­ings in June were up 33 per­cent from June 2008.

Gov­ern­ment efforts to stim­u­late the real estate market are a total failure, as I pre­dicted they would be. Fannie Mae and Freddie Mac said that in April, they had mod­i­fied  13,800 mort­gages that pre­sum­ably would avoid fore­clo­sure. On an annual basis, FM&M may restruc­ture as many as 175,000 mort­gages, but that is a very small frac­tion of those who hit the wall.

Nobody is talking yet about the toxic waste dump under­lying the com­mer­cial real estate market. When it blows, it will be as big as every­thing we have seen to date.

The giant retail financier, CIT, has been refused a gov­ern­ment bailout, leaving it to fend for itself. So, it is already talking with poten­tial buyout can­di­dates like JP Morgan Chase and Goldman Sachs. Either would prob­ably like to get their hands on CIT and its one mil­lion retail/merchant cus­tomers around the country.

The retail industry is still in a death spiral. The U.S. Labor Depart­ment reports that there are an addi­tional 600,000 jobs at risk in the already clob­bered industry.

Loss of jobs reflect loss of con­sump­tion. Many retail ana­lysts are already saying, for a number of good rea­sons, that con­sump­tion will not return to former levels again. To the extent that shop­pers stay away from the mar­ket­place, retail will dry up right along with com­mer­cial real estate, shop­ping malls and manufacturing.

Yes, this is quite pes­simistic, but it doesn’t com­pare to the national bank­ruptcy that is cer­tainly on the horizon. If Biden really believes that the gov­ern­ment must spend to avoid national bank­ruptcy, then its right on the doorstep.

Even the Con­gres­sional Budget Office believes that we are on the verge…

“Under cur­rent law, the fed­eral budget is on an unsus­tain­able path, because fed­eral debt will con­tinue to grow much faster than the economy over the long run.”

Appar­ently, Biden doesn’t take his cues from the Con­gres­sional Budget Office.

Market

After a huge surge, the market is sig­nif­i­cantly over­bought and ready for a breather, which should bring prices down early next week. The NASDAQ has led the way to new recovery highs in Pri­mary Wave 2 up.  Other indexes should follow suit before Pri­mary Wave 2 is completed.

Let’s step back and look at the bigger picture.

The declining SRL’s are from the peak in Sep­tember 2007 to the bottom in March 2009, rep­re­senting Pri­mary Wave 1 in the con­tin­uing bear market. The rally since then is con­sid­ered to be Pri­mary Wave 2 up and should be cor­rec­tive in nature. That is, it should have a A-B-C pat­tern rather than an impul­sive pat­tern. Thus far, this is what we see.

Note how the B wave bounce from the upper SRL that is drawn from the A wave. The expec­ta­tion is that the upper declining SRL will be met, and it is cur­rently around 2,175. It could go beyond that.

In April, I sug­gested that the DJIA’s upper target for Pri­mary Wave 2 was between 9,000 and 10,000. This is still very plau­sible. We now see that the upper SRL from Pri­mary Wave 1 is cur­rently crossing 10,400 and is falling about 8 points per day.

The DJ Trans­ports tell a sim­ilar story.

The Speed Resis­tance Lines reflect the bottom in early March. Note the cir­cled area where the index played with the lower SRL; after testing the blue 50 per­cent SRL, it fell back before mean­dering side­ways into the present. Note the shelf rep­re­sented by the heavy blue line; it bounced from it no less than six times before the recent advance. On the way down later (Pri­mary Wave 3), expect the 3,000 level to pro­duce sig­nif­i­cant support.

If breaking the lower SRL calls for reaching its upper com­panion, then the Trans­ports are likely headed to at least the 3,500 – 3,600 range.

The caveat is to watch out for volatility in both direc­tions. We are not too close to a major top in terms of price and time. The best this Pri­mary Wave 2 cor­rec­tion will offer is a chance to unload the long term posi­tions that you wish you didn’t have in the first place.

The next major event will be Pri­mary Wave 3 down, and I expect it will make Pri­mary Wave 1 look like a walk in the park. We want to be cor­rectly posi­tioned before Pri­mary Wave 3 down starts.