Daily Form July 30, 2007

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MONDAY JULY 30, 2007       05:47 ET

The indices eroded further in Friday’s session as traders and fund managers struggle to understand the severity of the tumltuous conditions in the credit markets. The S&P 500 (^SPC) came to rest very close to the level that it had attained immediately prior to the first sub-prime induced sell off that began on February 27th. The 200 day EMA lies just below this and may provide some further reason for buyers to step forward to arrest the decline.

Just how much further down we will go from here depends on one of the features of the current malaise in the credit markets that is not really being addressed by the mainstream media which are using more traditional notions like "credit crunch" and "re-pricing of risk".

Far more troubling is the complexity and opacity in the pricing mechanism of the collateralized debt obligation instruments that underlie not only the mortgage market but most of the leveraged finance used by most institutions including hedge funds and private equity groups.

Illiquidity and opacity can be an advantage to holders of these asset as this usually means that these derivatives are marked to the model rather than as in the case of most assets, marked to the market. The problem that holders are now facing is that, when some sub-prime portfolios are effectively being written off as worthless, there is growing anxiety that the way these instruments work may not have been fully comprehended and sanity tested by the engineers that devised them. Markets do not perform the same way under stress that they do under "normal" circumstances and standard probability assumptions which are the bedrock of much risk assessment and quantification are no longer appropriate.


I shall be most keen today to watch the performance of the banking index. Just for the record I thought it would be good to look at a longer term chart for the sector which focuses on the weekly closes of the index since the beginning of the bull market that emerged following the second Gulf War in March 2003. As can be seen the trend line through the lows was broken recently (one of the very few indices to reveal such a breach) and the index is now headed towards a critical test at the 105 level.

This key level was tagged in Friday’s trading and this marks the level of the 200 week EMA as well as a key area of previous support/resistance that extends back to 2004. We may well find out in the next few sessions whether the rumors of hedge fund collapses and abandonment of some large previously announced acquisitions have substance. If there are big surprises to come in the world of collateralized debt obligations (CDO’s), the banking sector could lead the way in bringing the whole market much lower. An alternative scenario is that we will see a week of whipsaws and much enhanced intraday volatility but no great shocks. If stocks like JP Morgan (JPM), Lehman Brothers (LEH), Bear Stearns (BSC), Wells Fargo (WFC) and Bank of America (BAC) do not find support near to where they closed on Friday we should expect that any respite in the selling is a temporary reprieve.

Much of the focus at present will be on the US markets which are perhaps most vulnerable to disruptions in the smooth functioning of the credit markets. The bid premium which has arisen in equities has been most prominent in the US market but the UK market has also seen more than its fair share of private equity financed acquisitions.

The FTSE has suffered more, in recent days, on a relative basis than the S&P 500 and the index failed to find support at the comparable level (i.e. the pre February 27th level) that is still intact on the S&P 500. Interestingly taking March 2003 as a base line index for both the US and UK index they both finished on Friday at almost identical levels. But this was after some notable outperformance by the FTSE during much of 2005 and 2006.

The following chart (apologies for the lack of color clarity) shows how all three indices that we have looked at today have performed since March 2003. By rebasing each index itself in terms of a common index of 100 for that base period it is possible to highlight their relative strengths and performance. Apparent is the re-convergence of the FTSE and the S&P 500 after the UK index outperformed over much of the last year and one half. Also very clearly revealed is the notable underperformance of the US banking sector during 2007 and the chart provides another perspective on the broken trend line for this index that I alluded to above.

This is one of the charts that I shall be discussing further today when I shall be a guest analyst on CNBC’s European Closing Bell around 16.20 (London time).

TRADE OPPORTUNITIES/SETUPS FOR MONDAY JULY 30, 2007



The patterns identified below should be considered as indicative of eventual price direction in forthcoming trading sessions. None of these setups should be seen as specifically opportune for the current trading session.
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GS  The Goldman Sachs Group Inc.  

Goldman Sachs (GS) dropped straight through any potential support at the 200 day EMA level but in Friday’s action the inside day that was registered leads some plausibility to the view that the stock will find some support at the previous lows for the year seen in early March.



WFC  Wells Fargo and Company  

As I discussed in Friday’s commentary the action in the mainstream banks has been even more troubled than for the investment banks. Wells Fargo (WFC) with exposure to real estate woes as well as broad participation in the securitization markets has also come down to a level where I shall be watching today for some kind of buying support to arrest the recent decline.



PFG  Principal Financial Group  

There are so many charts in the financial services area that tell their own story of a breakdown in constructive dynamics. Principal Financial Group (PFG) suffered steep losses last week and it is not easily discernible where support might arise on this long term chart.



HSY  Hershey Foods Corporation  

Hershey (HSY) broke below its 200 week EMA in Friday’s trading.



ULBI  Ultralife Batteries Inc.  

One of the only stocks that I would consider on the long side is for Ultralife Batteries (ULBI) which looks constructive on both the weekly and daily charts.

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