The Saga of Lenny Dyksta's House

As the market continues to speculate about an imminent recovery, keep your eyes on California's struggling economy, and the coming wave of Alt-A loan defaults. Mr. Mortgage has been giving warnings on Alt-A for well over a year. He has been consistently right, so pay heed:

Here we sit again but this time with the mid-to-high end properties staring into the abyss. They have not fallen anywhere near what the low-end has mostly because high-end borrowers were given more exotic, high-leverage loan programs such as Pay Option ARMs, 5/1 interest only loans, and 100% HELOCs to live off of. Arguably they have more reserves and better jobs, which have kept them paying for the depreciating asset much longer than with Subprime borrowers. The Alt-A and Jumbo Prime borrowers simply have loans that afforded them more time. But that has all changed and defaults across this space are surging. Foreclosures are coming, but not before the market begins its slide that ultimately will take the mid-to-high end market down 50% to 70% from its peak 2007 levels.

Here is Mr. Mortgage talking about the Alt-A crisis back in April of 2008. He notes that the universe of Alt-A is vastly bigger than subprime, with a multitude of exotic loan types. And negative equity abounds. As he says, "We know now that negative equity is the leading contributer of loan default." Highly recommended.



Karl Denninger points us to a WSJ article on the subject:

For the third straight month, option adjustable-rate mortgages are generating proportionally more delinquencies and foreclosures than subprime mortgages, the scourge of the housing crisis.

A further acceleration of troubles among the loans could mean higher-than-expected losses for Wells Fargo & Co. (WFC) and JPMorgan Chase & Co. (JPM), as well as the Federal Deposit Insurance Corp.'s own insurance fund.

"The realization of the issues related to option ARMs is just beginning," says Chris Marinac, director of research at Atlanta-based FIG Partners.

Denninger comments:

Wells "acquired" $115 billion of these things when they "bought" Wachovia. They claim they're worth $93 billion. Oh really? A bunch of loans that were mostly at or near 100% Loan-to-value (that is, near zero equity) when originally written, in markets where prices have declined by half? Oh, and in May, the firm said that 51% of the balances out were being paid only on the minimum - that is, they are still negatively-amortizing even as house prices fall! Talk about double-screwed!

JP Morgan, for its part, has nearly $90 billion in exposure through both its "acquisition" of WaMu and a pretty set of off-balance sheet "vehicles" (which of course are being shielded from having to be accounted for, and who knows how well those are performing!)

Here's a quick look at the WFC chart, which shows signs of topping with price trading just below the 50 and 200 day moving averages.



Which brings us to the story of Lenny Dykstra's house. Dykstra, the former Mets and Phillies outfielder turned investment guru, has been hailed as a "stockpicking genius" by the likes of Jim Cramer. Except now he's bankrupt.

Mr. Mortgage's SoCal counterpart Dr. Housingbubble tells us the story of Dykstra's mortgage default as an illustration of what is happening in Westside Los Angeles. Dykstra bought his Thousand Oaks house from Wayne Gretzky in 2007, and reportedly has "between $10 and $50 million in debt" against $50 thousand in assets. I'll let the doctor take it from here:

According to the bankruptcy petition, Dykstra’s largest unsecured creditors include units of JPMorgan Chase & Co., owed $12.9 million, and Bank of America Corp, owed a combined $4.2 million.

Hackett said Washington Mutual, now part of JPMorgan, was the main lender on the 2007 home purchase, and that the bank misled Dykstra about his ability to afford the property. The lawyer said the bank deserves nothing on its claim.

JPMorgan spokesman Tom Kelly said: “We don’t comment on individual cases, but we expect our customers to repay their legal obligations under their mortgages when possible.”

Bwahaha! $12.9 million plus $4.2 million comes out to $17.1 million! You mean to say on a $17.5 million dollar place Washington Mutual and Bank of American allowed virtually a zero down play? I was searching for the home in the MLS but it doesn’t seem to be there given the bankruptcy filing which will now forcibly sort things out. In April it was reported by Zillow that Sotheby’s International had the home listed at $25 million which obviously did not sell. The current Zestimate is $13.1 million. Apparently, multi-million dollar properties are not immune to the busting housing market.

The post goes on to discuss other aspects of the SoCal housing bubble, including a Culver City home currently in default:

This is a nice 5-bedroom home with 3 bathrooms. It is definitely a good home for a higher income professional. Yet even these kind of homes are not immune to the housing bubble bursting. The home has been on the MLS for 67 days. It is currently a short sale but at this range, you don’t have a big client base like you would with some Real Homes of Genius. It is a larger home with 3,017 square feet and is listed as being built in 2005. This home has a last sale in 1992 for $206,000. But once again like the Culver City home example, it looks like this home was the ultimate California equity withdrawal machine.

This home was tapped out like a keg. Keep in mind the last sale occurred in 1992 for only $206,000 and somehow managed to end up with a $1,030,000 first mortgage on the place. Looking on the history you will see how notorious Wells Fargo was in this California housing bubble but also First Federal Bank, an option ARM specialist. The notice of default was filed on July of 2009 so this is a fairly new listing but given the enormous amount of notice of defaults being filed, we are going to have an epic Alt-A and option ARM wave hitting like a ton of bricks later in 2009 and into 2010. The public-private investment program better stay away from these California loans because you can rest assured these are the kind of loans that will be pushed into it.

As you can see, the current borrower is now behind by $19,395 and this of course will be growing each day the home doesn’t sell. And it isn’t selling.

Keep in mind that California is a huge component of the US economy. With the country's biggest economic engine writing IOU's and experiencing a still-growing mortgage crisis, talk of economic recovery seems premature.

Short Picks for Friday

It is looking to be a weak open this morning, with some good chart setups for the short side. Here are some to watch, most of which I am already holding short:

- IYR has broken below the neckline.



- ARO: Note the bearish engulfing pattern from yesterday.



- LNC



- OFG



- SAH



- FL



- WYN



- ICON



- FCX



- AFAM

Sector ETFs in Head and Shoulders Formation

Several sector ETFs have formed head and shoulders patterns, or are sitting beneath a cluster of moving averages. Considering the increased selling activity of late, the frequency of this pattern through several sectors should be a strong warning of further downside to come. First, many people are watching the head and shoulders in S&P charts. Personally I don't think it's the cleanest pattern, but here's a look at SPY (these charts are taken from approximately 30 minutes before the close):



- XLI is much cleaner, and price broke below the neckline today. Also note the declining 200 day moving average.



- IYT: Not really a great h&s, if one at all, but certainly a weak chart, and also worth looking at for those who give credence to Dow theory.



- IYR: A cleaner h&s, but not yet broken. I think it's just a matter of time. Also note the 50 and 200 day moving average clustered above current price, providing resistance.



- XLF: Price is on the verge of breaking key support.



So that's the industrials, transports, real estate, and financials in some real trouble here. If we look at commodity-related ETF's, many have already broken down, and if anything are oversold. Given that we've had some big selling on Thursday and today, an oversold bounce may be due for tomorrow. Looking at the slightly longer term, it's difficult to see the market rally for long under these circumstances.

Here's some potential short picks:

- WYN



- ACS



- SBUX



- SAH



- CHS



- ISLE



- FL



- OFG



- GES



- BKE



Most of the above are companies that have risen high above the March lows, and rely on consumer spending.

Awaiting a Directional Signal

At the outset of a new quarter, market signals remain mixed, making it difficult to find a reliable trading edge. Just to reiterate my longer-term thesis, I think talk of economic recovery is premature. We still have a number of shoes left to drop, including consumer deleveraging, commercial real estate woes, economic calamity in California, falling state tax revenue across the board, still-expanding toxic debt issues with banks, and a financial sector that retains most of the essential systematic problems that caused the crisis in the first place. As the architects of the disaster (e.g., Larry Summers) seek a solution, too-big-to-fail institutions continue to speculate heavily in risky investments, meanwhile lobbying in Washington with your tax dollars to further rig the system to their benefit.

Of course, the redistribution of our collective wealth to the bankers may push equity prices still higher in the short term. Meanwhile, at some point financial realities will manifest themselves. For instance, AIG, Ready to Blow Up Again:

"American International Group Inc., the insurer bailed out by the U.S., said that valuation declines on credit-default swaps sold to European banks could have a “material adverse effect” on the company’s results.

The risk of losses on the derivatives may last “longer than anticipated,” the New York-based insurer said late yesterday in a regulatory filing updating the “risk factors” in its 2008 annual report. The firm had $192.6 billion in swaps allowing lenders to reduce the funds they had to hold in reserve as of March 31, AIG said.

“They’re guaranteeing close to $200 billion in assets in probably the riskiest environment in our lifetimes,” said David Havens, managing director at investment bank Hexagon Securities LLC. “It’s a huge number -- if there was any surprise, it’s that this hasn’t been flagged before.”

Now, I don't know why the US government doesn't simply nationalize or break up an insolvent institution like Citigroup, but instead chooses to guarantee its bad assets and allow it to continue business as usual. Maybe admitting these large institutions are insolvent would trigger massive CDS losses at places like AIG. Not sure. But the worst-case stress test scenario is already a reality, and we can expect bank losses to grow further as the economy and the real estate market continue to struggle.

As of the premarket on Wednesday morning, the bulls look like they want the party to continue, so there is no reason to trade counter to their delusional fantasies of green shoots. As we look at the chart for SPY, we can see that price need to get below 87.50 for bears to truly gain the upper hand. The bulls don't have far to go to move the market to a new high, and given high bearish sentiment, we could see a hefty short squeeze over the 95.50 level.



I have no idea which way it will go. At the same time, it is worth noting that a number of important sectors and individual stocks have developed a bearish orientation, and SPY is currently trading sideways as opposed to higher, at least for now. In Monday's sector overview, I ran through a number of these charts. For the most part, they look essentially the same today. Looking at some individual stocks, here are some major players that don't look so hot:

- WFC



- COF



- BAC: This is more of a neutral chart, but I think important to watch.



- HD



- MET



- AFL



Again, I don't necessarily advocate shorting here, but I'd be careful on the buy side considering the orientation of some of these charts. Looking further at some consumer stocks, a number of formerly strong names are showing cracks.

- DRI



- CBRL



- JWN



Meanwhile, a lot of garbage stocks seem to be leading us higher, especially those related to automobiles. Energy and commodity stocks are weak. If the market wants to move higher here, there will need to be some new leadership emerging, and I'm not sure from where.

I'll close with a few long side charts I like:

- WYE



- EQIX



- DL

Sector Overview

Last Wednesday I remarked that a strong rally to end the week was unlikely. The next day we promptly had a strong rally, which kept index charts in a bullish orientation. At this point, I do not see a great edge in either direction. In my mind, the end-of-quarter window dressing will be a non-issue after tomorrow, and then we'll get a better idea of market direction. We really have some mixed signals here.

- SPY got a boost on Thursday, pushing it above the 50 and 200 day moving averages, and maintaining a higher low. One could make exactly the same comment about IWM and QQQQ.



Looking at individual sector ETF's, things are not quite as rosy, with several trading below important moving averages, and new lower lows in place:

- XLI



- XLB



-XLF is not in the lower low camp yet, but neither would I call this a bullish chart. This is the one I am watching most closely.



- IYT: The transports are providing a mixed picture, trading below a double top, and just below the 200 day moving average, but as of yet not setting a lower low. Thursday's jump in volume could signal a move higher, but price needs to get above that double top.



So to me the index ETF's appear more bullish than the ETF's for key sectors. And what's leading here? Rental cars:





Sometimes a huge volume increase at such extended levels can signal a top, but we'll see with the rental car companies. To me this mainly looks like end-of-quarter, squeeze the shorts trading games.

Anyway, as I've mentioned many times, I'm bearish on the longer term prospects, but in the short term anything can happen here, especially given market manipulation and the possibility that the government is propping up the market.

Today I'll be watching the energy sector, following passage of the cap-and-trade bill in the House. EXC would benefit from increased focus on nuclear energy, which seems very likely.



Millions of people over the weekend were watching prisoners in the Philippines doing an impressive version of Michael Jackson's Thriller. I really enjoyed it, so here it is:



And here is The Hustle:

Buyers Not Stepping Up

This morning we saw an oversold rally which seemed to be more about short covering than anything else, although there was some encouraging news with the durable goods report. The FOMC announcement didn't provide any spark, and late day action saw the sellers in control. We still have GDP and jobless claims before the open tomorrow. If neither are surprisingly good, the bulls will need to hope that end-of-quarter window dressing and overly bearish sentiment will provide the fuel for a rally. Maybe these circumstances can hold the market steady, but it's difficult to envision a strong rally to end the week.

Looking at 20 day charts for IWM and SPY, in each case price remains in a short-term descending channel.




Taking a longer view, SPY sits just above the 50 and 200 day moving average. We can say it has support here, but price is trending lower, and support can quickly become resistance. SPY has little support below 87.50.



Checking out the financials, Tuesday's low represents important support for XLF. The financials are the headliners in this market, so it pays to watch the price action closely.



- WFC: As California's economy implodes, WFC's chart appears clearly bearish, with price trending lower below the 50 and 200 day moving averages. I am short.



- BAC has been much more stable, and is trading in a narrowing range. Watch to see whether the range expansion takes us higher or lower. This is not something I want to trade, but I see BAC as a bellwether stock.



- COF: Consumer deleveraging is going to get COF in the end. I am short this one, which shows lower highs and lower lows beneath the 50 and 200 day moving averages. I will give it room.



It's still a bit early to be shorting aggressively, but watch those key levels, especially the SPY and XLF support levels mentioned above. Here's a list of possible short setups: SAH, EAT, FDML, DRI, CAKE, ENOC, GPI, SOLR, LNC, PFG, LULU, IPCS, IPI, SFY, TMRK, TNS, PAR, ISLE, CLW, CNW, JAH, MVSN, CTRN.

Meanwhile, over at Credit Writedowns, Edward Harrison asks, now that banks are getting out from underneath TARP, how soon will they be taking back their toxic assets?

So, then, when will these institutions give back the Treasury securities they borrowed from the Federal Reserve in exchange for the toxic waste they used as collateral? Let me remind you of what I am talking about. Do you remember when large financial institutions were forced to go hat in hand to the Federal Reserve when asset markets seized up post-Lehman? Well, these companies had all sorts of Asset backed securities, CDOs and CDOs of CDOs – generally known as toxic waste and euphemistically called ‘hard-to-price assets.’ They off-loaded these assets onto the Fed ‘temporarily’ through mechanisms like the discount window, the Primary Dealer Credit Facility and the Term Securities Lending Facility. The goal was to give the markets time to return to normal, to allow ‘liquidity’ to return to the markets so that these assets could start being traded again.

Why isn’t this happening now?

...But, I am sure you know this is not going to happen. This has not been a liquidity crisis. It is a solvency crisis. The banks are not well-capitalized because the stress tests were just a big charade and an effort to buy these firms time. Moreover, it is painfully obvious that the banks are very much dependent on the government still – or they would be getting their dodgy assets back.

Tyler Durden at Zero Hedge has posted a letter by Rep. Alan Grayson to TARP Inspector General Neil Barofsky. To review, Citigroup paid the US Government $7 billion to "insure" $234 billion in mortgage-related assets. If they're bad, we own 'em.

Among the questions that Grayson is seeking the SIGTARP's assistance on are:

1. How was the deal negotiated by Citigroup, the Federal Reserve, and the Treasury? How does this loss-sharing arrangement benefit taxpayers?
2. What are current mark-to-market losses to the Federal Reserve in this loss-sharing arrangement?
3. What is the current cash flow from these assets? Are these asset performing?
4. Who should be held accountable for the reckless acquisition of a third of a trillion dollras in assets that ended up requiring a government guarantee? [emphasis mine]
5. Which vendors are pricing these assets, and are there conflicts of interest present in these vending arrangements?
6. Is the Federal Reserve guaranteeing assets generated from lender-induced mortgage fraud and predatory lending practices?

Once again, a classic:



I hear so many people, experienced investors included, complaining about the socialization of medicine when their pockets just got picked clean by the crooks on Wall Steet. People gnash their teeth over stimulus expenditures, which actually create useful infrastructure and jobs, and meanwhile megabanks and the Fed in tandem use sleight of hand to rob the taxpayer of sums that far exceed the stimulus and healthcare packages combined. The horror, some poor kid might get free healthcare, but by all means, those, banks, they need our money...

Meanwhile, Jim Grant of Grant’s Interest Rate Observer continues to tell us that the Fed is severely undercapitalized.

A quick note: I just became a Gold subscriber at Rob Hanna's Quantifiable Edges. If you are not yet making this site a regular part of your trading routine, I recommend the free trial. You get a nightly overview of key indicators (which is an education in itself), plus the relevant statistical studies for the day. This morning's post examines historical price action when a SPX experiences a 2%+ point drop, followed by a weak rebound the next day, which describes the Monday-Tuesday action. I believe you still get the nightly newsletter with the Silver subscription, which is a bargain.

Jimi plays us some acoustic blues:

Short Picks, Including Ultra ETFs

I wanted to talk a bit about strategies for trading ultra ETFs. For the most part, I trade the ultras sparingly, and the 3x ultras not at all. I have not traded them effectively in the past, providing one reason for my avoidance. More importantly, the ultra ETFs frequently fail to track their intended target effectively, making it technical analysis less predictable. This will not be a revelation for many traders, but it is worth considering at this possible market top. Robert Zingale explains:

The problem with these Ultra ETFs is that their long-term performance will diverge from the underlying performance of the index that they track. The reason for this divergence is the fund’s use of leverage and volatility in the underlying index. The leverage used in the funds successfully allows them to track the daily price movements of the indexes that they are supposed to track, but leverage will also play against them over multiple periods if the index is extremely volatile.

As Zingale mentions, the ultra ETFs have a downward bias due to these leverage factors. To illustrate, let's take a look at the chart for SRS, with IYR superimposed:



As you can see, both the long real estate ETF and the ultrashort real estate ETF are down significantly during the last 52 weeks. At certain market stages, I want to gain the extra potential returns provided by ultra ETFs, particularly when a top or a bottom is likely. Instead of going long SRS, I have chosen to short URE, as I mentioned this morning. Similarly, this afternoon, I shorted UCC, the consumer services ultra long ETF. While I may not have the potential upside (going long an ultra can provide 100%+ return, going short cannot), I consider shorting a more predictable play, and the potential returns adequate.



This morning I also mentioned that the financials were at an important crossroads. Today XLF dropped below the 50 day moving average, indicating further downside ahead. The broader market will have trouble with a weak financial sector.



Today I went to the Motley Fool CAPS site, and did a screen for 1 and 2 star stocks up over 200% in the last year, providing me with some good short candidates. I consider the bullish mania for automotive stocks and restaurants during the past few months to be cases of misplaced enthusiasm. Beware that if too many people move short too quickly, we could get a oversold short squeeze at any time.

Here are some charts:

- DTG



- PFG



- LNC



- AN



- CAKE



- WYN



- EAT



- ENOC



- GT



- NSIT



- SFY



- TMRK



- TNS



- VPRT



Some Brazilian tunes for your Monday evening:

Watching the Financials in a Rangebound Market

As we head into a new week, the key word to describe this market is "indecisive". Neither the bulls nor bears have been able to establish momentum during the past two weeks, leaving market participants in a wait-and-see mode. The major index charts remain in a bullish orientation, with higher lows and higher highs and price sitting above 200 day moving averages. At the same time, there seems to be a lack of news to drive the market higher.

On one hand, should bears fail to follow through on last week's selling, bulls could gain confidence and initiate another leg up. Last weekend I posted some critical price levels for buy signals on index and sector ETF's. I still have alerts at these same levels.

Looking in the other direction, I do not think the underlying economic realities support current prices. I am holding some core short positions (DTG, SAH, SYMC, OFG, URE, FDML, DDR), which I will hold as long as we do not break above the critical levels mentioned above. I am also watching XLF closely, since the financial sector is central to this crisis. Looking at XLF, price broke down out of a wedge, and then found support at the 50 day moving average. It is now trading at the underside of the wedge trendline, and just below the 200 day moving average. All of these factors indicate we are at an important juncture for the financials. We can gain some valuable insights by watching how XLF reacts to this confluence of support/resistance levels.



Looking at the transports, we can see price formed a double-top, followed by distribution. This would appear to be a bearish signal, but price is still trading between two major moving averages. A break below 55.00 would make a new low, and provide a convincing sell signal.



Going into Monday, futures appear weak, and indexes are approaching support levels. Here are a few bullish charts I am watching for today. Note that strength in medical and gun stocks during summer trading does not mean much for the broader market.

- MEDX



- ISRG: I already have this one.



- CTDC: ditto



- TRAK



- RGR



- WYE



- FIRE



And for some current short holdings. Note the magnitude of the move off of lows for each of these stocks, most of which do not have stellar fundamentals.

- DTG



- FDML



- URE: Given the dynamics of ulta ETF's (they will all gravitate lower over time), and the overvaluation of real estate stocks, this seems like a sure thing, although it may require patience. I will add short on strength, assuming I can find the shares.



- SAH: As you can tell from this short list, I do not buy into bullishness in the automotive sector.



- OFG