Monday, August 24, 2009

Some uplifting links for a Monday

Extreme bullishness is not a good thing for a sustained rally: Let me remind you that I am not a technical guy. I don’t watch the charts or put a whole lot of thought into what others say about them. However, the trader at my first fund always suggested that I don’t completely dismiss indicators that suggest extreme overbought or oversold conditions. While many times I did see stocks continue to go down from oversold levels, I think the fact that a lot of people watch for the same signs has the potential to cause short term reversals. With that in mind, take a look at this chart and brief discussion regarding how overbought bank stocks appear:

Writing for The Growth Stock Wire (, Clark brought out some salient points.

Take a look at this chart of the Bullish Percent Index for the Banking Sector ((BPFINA))...

A bullish percent index is an indicator of overbought and oversold conditions. The BPFINA measures the percentage of banking stocks trading with bullish technical patterns. It can range between 0 and 100. The index is oversold below 30 and overbought above 70.

Back in March, BPFINA dropped below 5 – meaning fewer than 5% of all the stocks in the banking sector had bullish technical patterns. While not necessarily a buy signal, an oversold reading that extreme is a pretty good sign that the downside is limited.

Today, we're looking at the exact opposite situation. Last week, the BPFINA touched close to 90 – meaning 90% of the stocks in the financial sector are trading with bullish chart patterns. This is one of the most extreme overbought readings of the past decade.

My old trader friend used to swear by what I would call the 70-30 rule. Be careful buying stocks with a reading over 70 and be careful being short stocks with a reading below 30. Along the same lines, I think anyone buying a basket of bank stocks and ignoring the run they have had, the very tenuous economic situation, and how overbought they look is taking a lot of risk.

Another sign of a top: I know we have had a large drop in the markets that caused a lot of people to pull money out, but when I see retail investors pouring money into mutual funds like they did in July, I get a little worried about being very near a top in the markets:

Equity mutual funds posted gains of 7.92%, their strongest July gain in more than 40 years. Within that group, stock and mixed-equity funds posted gains of $14.6 billion for July, up from $12 billion in June. Of Lipper’s four major equity macro-groups, the World Equity Funds attracted the largest draw of net new money. Minus outflows, it took in about $8.5 billion for July.

Confirmation of the garbage rally: Hat tip to Seeking Alpha for finding this piece from Morningstar. The analysts at Morningstar separated high quality companies from lower quality companies by the size of their moat. The goal was to try to single out companies that have high returns on capital and should be able to fend off competition. So, within that framework, what stocks have done the best since the market lows?

Since the S&P's bottom and the end of July, firms with wide moats have seen a 4.81% total return, narrow moat firms are up 16.6%, while no moat companies are up 26.1%. So has this outperformance been justified? We think not. No-moat companies were not trading at significantly lower discounts to our fair value estimates versus wide- or narrow-moat firms at the market bottom. We thought our entire stock coverage universe was about 40% undervalued before the rally.

Given the no-moats' relative outperformance since the bottom, it isn't surprising that our analysts now think that as a whole no-moat firms are about 15% overvalued. Wide moats in aggregate look much more attractively priced--about 15% undervalued.

The first implication is that the rally has been led by gains in the no-moat stocks and thus may not be sustainable. However, since the wide moat companies have not participated there could still be some bargains to be found. So, for investors who have to be fully invested I would suggest looking in the wide moat space and staying far, far away from the no-moat sector.

If foreigners stop buying, who is going to buy all the US’s debt? Hat tip to Karl Denninger for finding this chart and associated commentary. The data unequivocally indicates that foreigners have slowed their purchases of US bonds, especially among corporate bonds and agencies. While it appears that Treasury buying has not fallen much, I think there is reason to be concerned that foreigners’ shunning of other US bonds could be a prelude of what it coming for Treasuries:

The foreign creditors are moving away from the United States, plain and simple. The big bold red series shows the Grand Net US$-based bond reduction in net flow change from a high around $950 billion in early 2007 to a figure now approaching only $200 billion, thus a severe cut in net inflow. The greater alarm comes from the US Corporate Bonds in the yellow series, whose net flow change is down from a plus $600 billion high at the same time to a slight net outflow negative figure now. The US Agency Mortgage Bonds in chartreuse/mauve/pink have net flow change with peak of plus $300 billion at the same time to a net outflow of a frightening $150 billion now.

We know that US consumers are starting to save more, so could they be the ones to pick up the slack? That’s a tough one. With all of the de-leveraging that has to be done consumers may not have a whole lot of excess capital to put into bonds. In any case, the data leads the author to the conclusion that the US dollar is in a precarious position:

If not for the US Fed buying most of the US Treasuries issued, the long-term interest rates would be rising quickly and with alarm. If not for the US Fed heavy buying, the US Dollar would be doing a swan dive off a cliff into rough waters. As has been claimed in past work, the US Gov’t stewards of the wrecked buck can save the US Treasury or save the US Dollar, but not both. Their monetization efforts here and abroad indicate a clear intention to save the US Treasury Bond. They put the US Dollar at grave risk.

Too big to fail for dummies: Another hat tip to Seeking Alpha for finding this article and purposefully cheesy video in which the Cleveland Fed describes the way it tries to find institutions that are too big to fail (TBTF). The video is only about 9 minutes and despite the silliness, it offers a pretty interesting model of how to determine if an institution is TBTF. Let's hope the leaders in Washington ask for input from the people at the Cleveland Fed before crafting legislation to attack the TBTF problem.

His model focuses on five characteristics, with an emphasis on the latter four:

· 1. Size (Mr. Thomson says, “The simplest — and potentially most flawed — way to classify SIFIs is a size threshold, whether it be asset-based, activity-based, or both.”)

· 2. Contagion

· 3. Correlation (also known as the “too many to fail” problem)

· 4. Concentration (referring to “the size of the firm’s activities relative to the contestability of the market”)

· 5. Conditions/Context

(Picture courtesy of