Just Another Manic Monday

I'm not seeing any big mergers today.

Couple that with HD taking a 20% cut on the sale of its distribution unit and one might get the impression that some of these deals may be a tad overvalued.  HD also had to guarantee $1Bn of they buyer's debt – these are pretty major concessions!

Back on July 26th I said (in large typeface!): "When the M&As start to unwind it is time to be all cash or short the market – this is that time!!!"  We've had a little bit of unwinding and don't mistake a $2Bn discount from HD as a deal going through, they took a kidney punch on this one.  We've already had a nice pullback since I made that call for members on the 25th at 13,800 and we rest right at the 50% retracement level of the sell-off from 14,000 to 12,500.

Option Sage points out that we are getting a negative divergence (more un-merging) between rising price action and falling volume and that "the number of new highs in the market and price-volume divergence are still reasons to remain cautious."  If we begin to see a divergence of the correlation between the VIX and the Dow (the VIX heats up on any down move) we may have a VERY serious indicator of another leg down.

One acquisition that did go through is Gateway, who accepted a $700M buyout from Acer.  Although this is a 60% premium on the current stock price, this is  a market share play for Gateway's $4Bn in sales, not for its $10M in profits!

There are about $400Bn worth of deals in play and those amounts are already priced into the values of the companies AND the brokers who are handling the financing.  GS had to replace LEH to finish the HD deal as LEH backed out of the financing end.  Also of concern on the value front is still Sub-prime and the lenders who peddle them.  The NYTimes wrote a scathing, must-read article on CFC this weekend with a couple of key points being:

• "One former employee provided documents indicating Countrywide’s minimum profit margins on subprime loans of different sizes. These ranged from 5 percent on small loans of $100,000 to $200,000 to 3 percent on loans of $350,000 to $500,000. But on subprime loans that imposed heavy burdens on borrowers, like high prepayment penalties that persisted for three years, Countrywide’s margins could reach 15 percent of the loan, the former employee said.
• “As recently as July 27, Countrywide’s product list showed that it would lend $500,000 to a borrower rated C-minus, the second-riskiest grade. As long as the loan represented no more than 70 percent of the underlying property’s value, Countrywide would lend to a borrower even if the person had a credit score as low as 500. (The top score is 850.)”

So how out of whack is their valuation if. on a go forward basis when only 10.2% of their total loans were prime last year?  Angelo Mozilo (CEO) must think it's a bit high as he holds just $29.4M worth of stock, after dumping $406M worth of it since it's public filing in 1984 with $129M sold in just the last 12 months! 

So caution, caution, caution is still going to be our watchword, I said last week that I thought $70 oil would put a damper on our rally, as will next week's ECB rate hike, and I don't change that opinion just because we gained 150-points while oil broke up to $71 (although it does make me look silly). 

We have a lot of critical levels to keep our eye on this week including Dow 13,600, Nasdaq 2,600, NYSE 9,800, Russell 800, SOX 500… but it will be the S&P that holds our attention as it rests just under 1,480 and needs to show us 1,500 to convince us to add more length to our virtual portfolio:

Not reading Happy Trading's charts daily may be hazardous for your virtual portfolio in this critical market juncture.  Last week, Happy closed out 26 positions with no losses and it simply amazes me that he isn't more famous as that's a pretty typical week at Wang's World!

The Hang Seng gained another 655 points today (I know… yawn!) and the Nikkei held steady at 16,301 as long as you call gapping up 250 points at the open and dropping 200 points down all day long holding steady.  Asian hedge funds are feeling our pain and that is rippling through the markets over there.  It just doesn't matter to the Hang Seng though, now up about 4,000 points (20%) since the 17th.

Europe is trading basically flat, which is not encouraging as we left them with a very nice looking gain on Friday to work with and we will watch them closely this morning.  German state-owned Sachsen Bank got caught up in sub-prime mania and seems to have made $37Bn in bad loans and will now sell itself to another state-owned bank.  $37Bn at one bank is a lot of money people!!!  According to the WSJ:

• "The conduits issue commercial paper, a type of debt with a term of less than a year, and buy longer-term bonds that pay higher interest rates. The bonds include securities such as residential mortgage-backed securities or collateralized debt obligations and are underpinned by mortgages or credit cards.
• "In the past several weeks, the conduit model broke down. Bank conduits as well as SIV-lites operated by banks and hedge funds ran into difficulties because investors quit buying the paper, concerned the loans had been used to buy securities backed by U.S. subprime loans. That forced conduit sponsors such as Sachsen to quickly come up with funds to pay off the loans."

 We've made some progress since last week but it's still not enough to tilt us into bull mode:

If you go back to my chart last week, you'll notice we did little more than retrace our losses of the prior two weeks.  The Russell and the NYSE are very disturbing so we'll be looking for good moves there in addition to the S&P but we will have virtually no tolerance for losing levels at this point.

This is why we have protective puts, we are willing to ride out a dip back to 13,200 but we'll have to make a call down there (IF) as to whether we are going to add to the positions we picked up last week or if it is time to cut and run again. 

Until Europe at least retakes our "Must Hold" zone we continue to be globally concerned.  We are still just shy of the 295 mark on the DJ World Index I discussed last week and we simply can NOT afford not to make that critical level.  A LOT of money was pumped into the global markets last week (and the week before) and the Fed has a conference this week and we can expect word from the ECB as to whether they intend to continue to support the markets but, as I often say – it is not the job of the Central Banks to bail out speculators who bought at the top of a bubble!

Demand destruction continues apace as business makes major efforts to cut energy costs but you wouldn't know it from the movement of oil and gas which are enjoying the usual pre-holiday pump.  The last holiday drive was a big disappointment and I think this one will be the same so I'm starting to look at oil companies we can short into strength.

We'll watch gold and the dollar as gold breaking $680 will give us further indication of a global loss of faith in the markets while the decline of the dollar has already painted that picture for our currency!

It's still possible to shake all these concerns off and continue to rally – stupid, but possible…