Wednesday, January 21, 2009

Technical Update 2.09

I've been following the recent downtrend of the major averages since the early days of the New Year when I suggested the corrective rally may be nearing it's end. Last week, with the S&P at 870, I pointed out some support around the 820 level:

As for the major averages, I am leaning towards a fairly significant bounce from around the 820 area - perhaps all the way back up to 920. However, being in a bear market, the potential is great that we just plough through 800 on our way to new lows.

The 820 level did provide some short term support, creating a 5% short covering rally into the long weekend. However, early Tuesday morning, the tires burst and markets gave up all of that 2 day gain and closed at it's lows of the day for a total loss of over 5%. This all occurred as inauguration festivities were supposedly injecting new optimism in Americans.

Tuesday was a perfect example of how markets do not react to the news, rather the markets determine the news. If markets had rallied, it would have been because of Obama's inauguration. Instead, markets fell because of poor earnings by State Street, a 8 cent drop in the British Pound or the potential nationalization of British Isle banks. I always find it hilarious when major media outlets scramble to find the reason for why markets moved on a slow news day. It's the same on days like yesterday when there are contradictory bits of news. How many papers would they sell if they simply told the truth and reported, "Traders and investors reacted to subliminal, endogenous signals that stock prices were too high, and felt they could benefit from purchasing shares at a lower price sometime in the future. Traders and investors with the opposite sentiment were overpowered by the former."

But I digress. The news is more interesting. Even if there is no way to measure how it effects our decision making.

A number of technicals experts I subscribe to or follow closely have been eyeing the 787-791 area as potential support for a multi-day rally. So I'll be watching that level closely. If it provides a bounce back through 800, I would consider covering some of the short exposure I took at the highs. If it does not provide support, or if a bounce is on low volume, or if financials do not participate (!), I will continue to eye new lows. I do not give the possibility of a double bottom a very high probability. Meaningful double bottoms typically take place over far longer timeframes than 8 weeks. My first target remains 600, which will be refined as time and price develop.

In my Currency Outlook for 2009, I wrote:

The British Pound may be in an even worse situation. Home prices are crashing all over the UK, putting even more pressure on the already ailing financial system. The pound lost 25% of it's value to the USD over the course of 2008. I can see that happening again in 2009. I would not be surprised to see the pound trade at par with the USD.

Over the weekend we learned that the big UK banks were going to require yet another government bailout to stay 'affloat.' The government increased it's stake in the Royal Bank of Scotland, and fears are that Barclay's and Lloyd's will be next. Of course, the pound got clobbered - again. Apparently, throwing a life preserver to a rotting corpse is not seen as proactive. I stick to my 2009 target of 'par' with the Greenback and will likely go under compared to the Euro. See the carnage:

Gold did not react negatively yesterday to the large uptick in the dollar. That is the type of divergence one would expect to see if the yellow metal were to continue higher. I remain intermediate-term bearish on gold, but understand that as it is still in a long-term bull market, surprises will come to the upside. A close above $900 would likely have me buying.

That's all for now. I'll try to make this a weekly post.


EconStudent said...

Nice Post.

Yesterday, Bank of Canada lowered overnight rate by 50 basis points to 1%. As a result, the effective prime rate offered by most banks are 3%. Many people in Canada are on variable rate mortgages that are between prime rate - .6% to prime rate - .9%, which is 2.4% to 2.1%. This is a stark contrast with August 2007, where overnight rate was 4.5%, prime rate was 6.25%, and effective variable mortgage rates are between 5.65% to 5.35%. As a result, most Canadians are paying less in mortgages with the rate cut, while in the US, people have difficulty refinancing their mortgages with a lower rate.

Because mortgage payment has lowered significantly in Canada unlike the US, is it possible that overheated markets in Canada like Vancouver, and Toronto will not correct further?

Matt Stiles said...


Yes, lower mortgage rates will have a positive effect.

However, if mortgage rates are low and the bank is not willing to lend, how much will that help? For people refinancing, this helps only IF they are not underwater on their mortgage. With prices down 20% in some of the hot markets, this will be a problem for 2007 and 2008 buyers.

Additionally, there are the social debt-aversion patterns we are witnessing with less-numerous younger generations not willing to go into debt to buy homes from their more-numerous parents.

Not to mention the unemployment pressures with people selling their assets as they get laid off, or put off buying because of uncertainty.

I'm guessing one of your profs has said that because interest rates are low, another asset bubble can be inflated. This is orthodox keynesianism at it's heart. People don't want to borrow, and banks don't want to lend. At any rate. Not yet, and likely not for quite a while. They are assuming that the economy is at equilibrium, and then saying lower rates will attract buyers. The economy is not at equilibrium, therefore their conclusion is faulty.


EconStudent said...

Nice response. Thanks for pointing out other factors that may affect the Canadian real estate market.

I think Vancouver housing prices will be ultimately compared to US West Coast prices with the closest being Seattle. Seattle has a very productive economy (Boeing, Microsoft, Amazon, AT&T) in comparison with Vancouver.

By the way, I don't have any neo-Keynesian professor this term. My intermediate macro is focused micro foundations, which is based on neo-classical theory rather than neo-Keynesian theory.

Let take the numbers from my previous post, present mortgage rate is 2.1% and the previous high was at 5.35%. So for a 750,000 mortgage in Vancouver, it used to be 3343.75 a month for mortgage payments, but now, it is only 1312.5 a month. The difference is huge and there is still chance that Bank of Canada will lower interest rate by another 50 basis point.

I expected the Vancouver real estate market to crash but from my own analysis, this won't happen any time soon.

mannfm11 said...

It is hard to combine college economics and the economic truth, as I think most of the people here realize. The more I think of it, the more bizzare the ideas that are bandied around become. For one, debt from the stand point of the creditor is in a very doubtful position and the only solution is to lend more, meaning the absurd has to win out. The same is true of the debtor. Can't pay, so why not borrow more to get through. Gasoline prices are falling because consumers don't have money to buy, not because they are going to have more money to spend once it falls. It hasn't been long ago that $1.60 a gallon was the high side of history, not the cheap side.

The real paradox was what mainstream thought ruined the economy kept it going as long as it did. High gasoline prices put more borrowed money into the system, especially the international system. Higher mortgage payments and higher house prices created a pedestal for more lending, thus putting more borrowed money into circulation. If there was still equity left, this would make sense now that rates are lower, but there isn't. A cash out sale was the same as a cash out refinance and now a no cash out sale is like no sale at all. The non-liquidating debt has come due and anyone with a brain wouldn't get too deep in debt right now unless you are one that can't pay back what you already owe. Then it really doesn't matter except in matters of fraud.

EconStudent said...

Continuing from my previous post.

New variable mortgage renew rates that I have seen are prime + .5% to prime + 1%. The people who are facing renewals are really unlucky since they would jump from 2.1% - 2.4% to 3.5% - 4.0%. Would this increase the foreclosure rate in Canada? I am not sure.

Unlike the US, I feel quantitative easing in Canada is working. Saving rate and prime rate has dropped significantly. Banks have enough money to lend and are lending to a certain extent. According to neo-Keynesian models on small open economy, quantitative easing will lead the depreciation of the Canadian dollar, which is good for Canadian export. I guess it is a wise choice on your part to keep most of your savings in US dollar.

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