The Dominos Are Falling and A Retest Of SPY 125 Is Very Likely

After a day of panic selling on Monday, it looked certain that the stock market would test the capitulation low from January. Thanks to the Fed, the market gapped higher on Tuesday, staging the largest one day rally in over five years. They paved the way by offering banks access to $400 billion in US treasuries. On a short-term basis, the Fed would accept AAA rated mortgages as collateral for a loan. I view this as nothing more than a bridge loan to help banks through a difficult period. While the Fed’s action was helpful, it did not address the greater issue. Americans are behind on their debt and with a weakening economy, rising unemployment and higher inflation, the situation will get worse. Delinquencies and foreclosures on all outstanding mortgages have climbed to a 20-year high. Thursday morning, Carlyle Capital announced that it is on the verge of collapse. The fund’s securities consist entirely of Fannie Mae and Freddie Mac mortgages, which supposedly carry a government guarantee. This morning, we learned that Bear Stearns is using JP Morgan as a conduit to gain access to the Fed’s liquidity. Traders have been expecting at least one major failure and this could be it. Rumor has it that Bear Stearns is shopping for a buyer. Distress sales never end well since the risk is elevated and the bargaining power of the seller is minimal. The dominos are starting to fall and this problem could get much worse. Countywide, Thornburg, Ambac, MBIA, Carlyle Capital and Bear Stearns are casualties on a list that keeps growing. Negative news lurks around every corner and we are on the verge of panic selling. I truly believe this market could have a meltdown. In February, investors pulled their money out of the market at an unprecedented rate of $2B per day. Margin calls and forced liquidations can drive the market down to unimaginable levels since all holdings need to be sold to generate cash. Consequently, value won’t mean a thing until all of the blood has been spilled. The gains from Tuesday have vaporized and that was a very temporary bounce. Next week, we will have the FOMC. That almost seems like a non-event since we have been hearing from the Fed on a daily basis this week. A .5% rate cut is expected. LEH will announce earnings and that is likely to be a negative influence. The market is closed on Friday and expiration will come a day early. We are near the low end of the one-month range and I am expecting quadruple witching to have a negative bias. I see tremendous values in the market and I look forward to a bona fide support level. If you are option trading the bounces, take profits along the way and stick to commodity stocks. While that strategy has been working, I believe that shorting the rips once they stall is the best strategy for the next few months. My favorite shorts include financials, restaurants, healthcare and retail. Use the SPY 125 level as your guide.

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