Wednesday, March 14, 2007

Equity Index Update

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Brad Sullivan

Was it the other shoe…or did we just untie it? That is the question, and the only question that really matters facing the domestic and global index markets over the next several weeks. Yesterday’s severe decline was the 2nd such implosion over the last 11 sessions and laid to rest the silly notion that the massive selling from two weeks ago was due to a computer glitch revolving around the DJIA pricing. Given the complete lack of volume on any of the higher sessions during this bounce phase, yesterday’s action does not come as a total surprise. Sooner or later something would trigger another round of selling and the fact that it happened during expiration only exaggerates the move. More importantly, this downdraft may continue to spiral lower due to the expiration of options and futures this week. I have continued to point out that the favorite fund game on the board over the last 3 trading years has been to sell naked puts…when the jig is up on expiration week the moves, potentially speaking, can become quite severe. Yesterday morning I commented that this market had about 5% of downside risk by Friday. After yesterday, we are only 3% away. While I felt the odds of such a trade were remote, they have increased dramatically after yesterday’s action and those that are speculatively short --- particularly those that have watched out of the money puts become in the money --- are faced with the decision as to take in some of the position, all of the position or none of the position. Personally I took in enough yesterday to give me a free roll + profits no matter what plays out from here.

Subprime...I am wondering if it will become a verb in the next few years, like “Homer” in the classic Simpson’s episode where Homer’s constant idiocy becomes a cult classic of “ oop’s I did a Homer” when making a mistake. Only time will tell. But, there is no question that this fiasco lit the fuse yesterday. Accredited Home Lenders (LEND) got the ball rolling saying it was in financial trouble and in need of waivers on outstanding debt. New Century (NEW) was delisted from the NYSE and closed at .85 on the pink sheets. Bear Stearns is the supposed target of subpoena’s on bullish research in this zone. Essentially, we are watching a implosion of a financial product that created affordable homes and thousands of jobs – Savings and Loan scandal anyone? This will end when there is no longer a purely subprime lender left in the building, and at the rate of descent, that may happen sooner than one can imagine. The only question that matters within this arena is will this meltdown trickle through the broader economy? If it does, as many of the bears are forecasting, the result will be recessionary in nature. After a choppy overnight session, the indices have caught a bid from their respective lows and are called to open around UNCH. The Yen/Dollar is trading around UNCH as well after having been well bid earlier in the evening session. Keep a close eye on all product classes today as yesterday’s equity market action drove prices lower in grains, gold, crude and higher in treasuries. Funds are forced to push out positions in one market as their other positions lose value…sell beans, sell SPM7 for example. I don’t expect that to change anytime soon.

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