The Precise Take – ES finding value at lower price levels

Leaders Analysis:   With a strong 7 Year auction yesterday, Treasury has wrapped up another highly successful auction week.  The 30 Year continues to be sandwiched between two anchored VWAP lines, one from the announcement date of QE on Mar 18 09 and one from the Jun 11 09 low (below).  The 30 Year T-Bond continuous futures contract is a good proxy for the long bonds’ underlying price action and we use the 30 Year itself as a proxy for the entire longer end of the Treasury market.  The 30 Year is clearly consolidating in a battle between the bond bulls and bears, which can continue for some time, but not indefinitely.  An eventual break up through the 122 level would be an indication that Treasuries will compete with equities on a more serious level for liquidity dollars.  Continued oscillation in the trading range is sufficient to see equities move higher, as they have for months.  The EuroYen is down materially overnight, confirming risk aversion.

Liquidity Analysis:  The first week of unwinding of Treasury’s Supplementary Financing Program (SFP) took place yesterday, with $35 B (of which $24.3 B was primary dealer purchased) not rolled over (at least with respect to the SFP program) and available in the markets.  Part of our theory is that Treasury wishes to lengthen the average maturity of its debt portfolio, and the increase in longer term Note and Bond auction offering amounts is indicative of this.  Another part of our theory is that at least some the unwinding amounts will be pumped into equities because of the similarity to the permanent open market operations of the Fed.  However, as we wrote yesterday, the exact timing of rallies as a result of increases in bank non-borrowed excess reserves has become more erratic and so, while we remain generally bullish until we see otherwise in the statistics published by the Fed, we cannot say that on such and such a date we expect an up day because of liquidity injections, etc.  In fact, we expect the corrections to become more, not less, violent as the subsequent short covering rallies will be the drivers to new highs.  With the world expecting a correction into October, this is the ideal time of year to shake out weak holders on both sides. 

Trading Today:  As we write, Durable goods has disappointed and the ES has entered our intraday bearish area that begins below yesterday’s low of 1041.00.  The ES is finding value in the area centered around the long term market profile point of control at 1037.75, which is a natural price target today.  If price trades below there by more than a couple points, the ES could eventually head as low as…

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This just in from the Fed:

Credit Quality Declines in Annual Shared National Credits Review

 Credit quality declined sharply for loan commitments of $20 million or more held by multiple federally supervised institutions, according to the 32nd annual review of Shared National Credits (SNC).

The credit risk of these large loan commitments was shared among U.S. bank organizations, foreign bank organizations (FBO), and nonbanks such as securitization pools, hedge funds, insurance companies, and pension funds. Credit quality deteriorated across all entities, but nonbanks held 47 percent of classified assets in the SNC portfolio, despite making up only 21.2 percent of the SNC portfolio. U.S. bank organizations held 30.2 percent of the classified assets and made up 40.8 percent of the SNC portfolio.

So, it looks like the large financial institutions have effectively offloaded nearly half of their bottom of the barrel commercial real estate and other garbage loans to the likes of AIG, CalPERS and the Norwegian Government Pension Fund.

The 2009 review covered 8,955 credits totaling $2.9 trillion extended to approximately 5,900 borrowers. Loans were reviewed and categorized by the severity of their risk–special mention, substandard, doubtful, or loss–in order of increasing severity. The lowest risk loans, special mention, had potential weaknesses that deserve management attention to prevent further deterioration at the time of review. The most severe category of loans, loss, includes loans that were considered uncollectible.

Key findings were:

• Criticized assets, which included SNCs classified as special mention, substandard, doubtful, or loss, reached $642 billion, up from $373 billion last year, and represented 22.3 percent of the SNC portfolio compared with 13.4 percent in 2008.
• SNC commitment volume increased $92 billion, or 3.3 percent, while the number of credits remained virtually unchanged.

• Classified assets, which included SNCs classified as substandard, doubtful, or loss, rose to $447 billion from $163 billion and represented 15.5 percent of the SNC portfolio, compared with 5.8 percent in 2008. Classified dollar volume increased 174 percent from a year ago.
• Special mention assets, which exhibited potential weakness and could result in further deterioration if uncorrected, declined to $195 billion from $210 billion and represented 6.8 percent of the SNC portfolio, compared with 7.5 percent in 2008.

The decline is because they are now in the bottom category.

• The severity of criticism increased with the volume of SNCs classified as doubtful and loss rising to $110 billion, up from $8 billion in 2008. Loans in nonaccrual status also increased nearly eight times to $172 billion from $22 billion. Nonaccrual loans included $32 billion in credits classified as loss and $56 billion classified doubtful.
• The distribution of credits across U.S. bank organizations, foreign bank organizations, and nonbanks remained relatively unchanged. U.S. bank organizations held 40.8 percent, while FBOs and nonbanks held 38 percent and 21.2 percent, respectively. Nonbanks continued to hold a disproportionate share of classified assets. Nonbanks held 47 percent of classified assets and 52 percent of nonaccrual loans. Federal Deposit Insurance Corporation-insured institutions held 24.2 percent of classified assets and 22.7 percent of nonaccrual loans.

Good luck, CalPERS.

• Criticized volume was led by the Media and Telecom industry group with $112 billion, Finance and Insurance with $76 billion, and Real Estate and Construction with $72 billion. These three groups also represented the highest shares of criticized credits with 17.3 percent, 11.7 percent, and 11.2 percent of criticized credits in the SNC portfolio, respectively.

Watch out CNBC.

• The review identified significant deterioration in credit quality of leveraged finance credits, with these loans representing more than 40 percent of the dollar volume of total criticized assets. About 72 percent of the dollar volume of the 50 largest leveraged finance SNCs were criticized, which represents one-third of all criticized assets.

Good thing for follow on offerings.

• Underwriting standards in 2008 improved from prior years, with examiners identifying fewer loans with structurally weak underwriting characteristics compared to credits written in 2007 and 2006. However, the SNC portfolio contained loans with structurally weak underwriting characteristics that were committed before mid-2007 that contributed significantly to the increase in criticized assets.

The SNC program was established in 1977 to provide an efficient and consistent review and classification of SNC, which includes any loan and or/formal loan commitment, and any asset such as real estate, stocks, notes, bonds, and debentures taken as debts previously contracted, extended to borrowers by a federally supervised institution, its subsidiaries, and affiliates that aggregates to $20 million or more and is shared by three or more unaffiliated supervised institutions. Many of these large loan commitments are also shared with foreign banking organizations and nonbanks, including securitization pools, hedge funds, insurance companies, and pension funds.

In conducting the 2009 SNC review, agencies reviewed $1.2 trillion of the $2.9 trillion credit commitments in the SNC portfolio, or 41 percent of the credits by dollar volume. The 2009 SNC sample was heavily weighted toward non-investment grade and criticized credits. The results of the review are based on analyses prepared in the second quarter of 2009 using credit-related data provided by federally supervised institutions as of December 31, 2008, and March 31, 2009.

Do you think the loans are performing better or worse since March 31, 2009?

Full PDF is here.  Nice chart illustrates the parabolic rise in low quality loans.

Sector analysis is here:

11:08 am EDT:  The ES clearly failed at key resistance this morning, which was the daily pivot and highest volume market profile point of control at 1063.00 (actual ES high of 1064.00).   It has found support at the upper boundary of the next lower market profile value area, which extends from 1033.00 to 1044.00 and has 1037.75 as its point of control (actual ES low of 1043.25).  There is also powerful pivot support at the current low in the form of monthly R1 and daily S2 at 1042.50 to 1042.75.  A rebound from this area (with no material new lows) is a very bullish rejection of this value area that will likely see a quick return to the higher value area.  However, new material lows today signal acceptance of this area and a longer pause before resumption of the longer term uptrend (and makes us medium term neutral as opposed to bullish into next week).  See the chart on page 1 of this morning’s report to see the two value areas we’re discussing (shaded in blue and gray).

Daytrading other than scalping will be difficult until the markets signal acceptance or rejection of the lower value area.  Aggressive longs can wait for another test of the ~1042-1043 area or a precise 50% retracement from the low (we want to see it respected within one tick), but we would use very tight stops.  Similarly, aggressive shorts can enter between 1046.50 to 1048.00, but we would similarly not allow price to move much above.  The next downside target is the point of control at 1037.75. 

7 Year auction is at 1:00 pm today and not likely to move equities unless it goes very poorly.

As we wrote last week, the wind down of Treasury’s Supplementary Financing Program (SFP) begins today, with $35 B in the program not being rolled over, $24.3 B of which was initially allocated to primary dealers.  We have speculated that the effect will be similar to that of the quantitative easing/permanent open market operations (POMO) of the Fed whereby the resulting excess reserves are plowed into equities.  The impossibly high correlation of paint-the-tape closes to POMO days in the first few months of the rally made for an easy trading edge.  Equities have, of course, continued their tear, but the timing of equity ramps has become increasing erratic and can no longer be easily correlated with Fed operations.  This is expected because an easy trade cannot exist for too long when many know of it.  At best, for now we can only remain generally bullish until the operations are scheduled to stop.  For SFP, this will be the last Thursday of October.  However, the FOMC announced yesterday that Agency (Fannie/Freddie) and mortgage backed securities (MBS) buybacks (both permanent liquidity ops) will continue until the end of March 2010, with a gradual wind down.  The Fed may purchase a further $75 B in the former and another $600 B in the latter.  All in all, there is much more liquidity coming down the pipe.  We will likely not become long term bearish again until we see a steep drop in bank non-borrowed excess reserves, indicating the juice for the rallies has dried up.  Until then, corrections will be buying opportunities, though we expect some will likely be violent.

The Precise Take – Longs looking to reverse FOMC day weakness

Leaders Analysis: Whatever strength was gained in the US Dollar following the FOMC Announcement has been lost overnight, with most of the leaders consolidating on the daily charts.    

Trading Today: The bullish FOMC bias was short lived yesterday, with the run-up following the Announcement dying quickly in the first 30 minutes after a nominal new high in the ES at 1075.75.  Overnight, the weekly pivot has provided support (low 1052.25) and a close below will change our medium term (into next week) bullish posture.  The key test of strength today will be for…

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11:25 am EDT:  With a bit of weakness so far, the ES has found support around the major market profile point of control at 1063.00 (low of 1062.25).  If we see new lows, we would not stick around in daytrade longs.

The FOMC Announcement is usually a few minutes late, so don’t confuse a spike in the illiquid moments around the release at 2:15 pm with an actual reaction to the Announcement.  The pattern for equities is usually for a three wave move–a spike in the initial direction (mostly up for the last two years), a quick reversal, and then a continuation of the initial direction into the 3:00 pm time frame, which is the likeliest time for another reversal, should it occur.  After 3:00 pm, if price continues in the original direction, it will likely continue into the close.  Otherwise, it will likely retrace most of day’s movement.

The Precise Take – Expected strength into FOMC day

Leaders Analysis: US Dollar weakness led the day yesterday, allowing gold and equities to gain.  We do not yet see gold as leading the charge because strength is not reflected in gold priced in other currencies, such as the Euro, Canadian Dollar and Australian Dollar. 

General Analysis: This week’s auctions have so far been well received, and the 7 Year is on the block today at 1:00 pm, not far from the FOMC Announcement at 2:15 pm.  If the markets behave according to their historical norm today, as they did nearly perfectly last month, we should see early strength in equities today followed by another surge on the announcement, with some long covering after 3:00 pm.  The Time Profile generator is on the fritz today, so below is the Time Profile for FOMC days reprinted from our August 12 2009 report.  We don’t expect it has changed materially.  Nor do we expect the FOMC to materially alter the language in the Announcement, preferring instead to dribble policy changes surreptitiously through interim press releases.

Trading Today: Given our bullish bias today, we’ll be looking to buy an early dip in the daily gap/pivot area of 1065.25 to 1067.25 or, on a dip to the highest volume market profile point of control for the ES Dec 09 contract at 1063.00.  If price trades below 1063.00, we will likely not trade until after the FOMC Announcement at 2:15 pm, taking the weakness as a sign…

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The Precise Take – Equities up on US Dollar weakness

Leaders Analysis: The US Dollar is down materially overnight, making fresh monthly lows against the Euro and Swiss Franc.  Not surprisingly, gold and equities are up, with the ES retesting contract highs and confirming the EuroYen breakout through resistance yesterday.

Treasury Analysis: Today is the first of the Note auctions this week, with the 2 Year at 1:00 pm.  A poor showing could propel equities higher, but the reverse is unlikely to move equities materially.  The end of month auctions went well last month and we expect no different this month.  If there is to be any weakness, it is likely to be today, with the 7 Year on Thursday expected to be the strongest.  Tomorrow is FOMC day, historically bullish.  Assuming no disaster today, we would expect to see new highs in the ES- tomorrow early, if they are not achieved today.

Trading Today: Shorting into the daily gap/pivot area of 1058.25 to 1060.50 is a bit dangerous at these levels and we would prefer to go long at 1063.00, if it is reached within the first hour.  Above contract highs at 1071.50, and we are outright intraday bullish, watching 1080.00 to 1080.75 as a potential reversal area, but not willing to…

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10:50 am EDT

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ES Trading:  A six point range so far with no remaining news for the day suggests a low range day.  We’re still willing to fade short 1060.50 to 1062.50, but need to see a quick rejection of the area to stay in the trade.  Also, willing to fade long at 1046.50 to 1048.00.  Beyond this range and we don’t pick tops or bottoms.  Ideal entry for a swing long would be 1038 to 1040 tomorrow afternoon.

The Precise Take – ES trades down into weekly pivot overnight

Leaders Analysis: 30 Year T-Bond futures are flat overnight, with gold and crude down, and the US Dollar up materially, which are all in line with lower equities.  The lone dissenter is the EuroYen forex cross, which has strongly advanced through resistance overnight, indicative of increased risk appetite.  Whether this is merely temporary overall Yen weakness (the USD is strongest against the Yen this morning), or is a sign of equities strength remains to be seen; however, it is a warning to the equities shorts.

Trading Today: Overnight, the ES has found support around the weekly pivot (low of 1052.00) and, below this level today, we are intraday bearish, watching combined session S2 at 1049.75 and day session S3 at 1046.50 as potential reversal areas.  The Leading Indicators report is released at 10:00 am  and is the only scheduled news of the day.  An upside surprise is more likely to move markets as excitement over the “end of the recession” will build.  We’re willing to fade short a move in the daily gap/pivot area, that also contains contract and prior day points of control from 1061.00 to 1063.00, but want to see a quick rejection of the area to stay in the trade.  Price lingering in the upper daily range has seen many afternoon rallies recently.  If longs can get through 1063.00, there are two potential reversal areas above that will provide formidable resistance, 1065.65 to 1067.75 and 1070.00 to 1073.25.  We won’t fade long if the market heads lower until after 10:00 am, waiting to see if a directional move develops, not wishing to…

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