aarc

Bank Stress Test: The Cheat Sheet

Banks don't want to borrow from the TARP anymore. Some of them would want to pay back their loans in order to avoid government control.

Problem is, the government don't want them to pay back the loans.

Why? Because the government will be left holding the bag. The government must have borrowed the $700B TARP from the likes of China and will be paying annual interest rates on those loans.

Stress testing the banks might force them to borrow more from the TARP and thus the government can have their 5% annual interest from most if not all of the $700B TARP allotment. But the government will have to give assurances they will not use command and control over the banks.

The more the government gets it teeth sunk into the banking industry, the more chances the banks will not fail in the furture since the government can always legislate new "projects" or initiative to help out the banks in particular and the economy in general. Meaning, the government has the power to make the banks profitable in the future and will not hesitate to use that power in order to protect it's own $700B investment. Since the taxpayers money is on the hook, the public will be more hesitant to oppose of new legislations that will benefit the banks in particular and the economy in general even if such legislation can potentially adversely affect the US consumers.

Since most of the $700B TARP has been deployed into the mega-banks who has more exposure all over the world, it would be beneficial for the banks if the government will pass legislation toward further easing of trades specially to that of the developing countries.

The developing countries will still need lots of capital for their basic infrastructure projects such as electrification, water supply systems, roads, etc. - specially the smaller ones in order for them to sustain their industrialization efforts of the last 2 decades.

They are going to need the assistance of the mega-banks such as Citigroup, BAC, JPM, and WFC who are among the most liquid banks in the world and are therefore in the best possible position to provide financing to the developing countries once this global economic downturn has turned around.

China is the first one to make a credible turn-around since Oct 2008. Most other developing countries has been making substantial gains since Oct 2008 while the US and Europe had been going downstream until March 2009.

There is a big world out there. The United States local market may have shrunked but the consumer markets in China, India, Brazil, Russia, Indonesia, Thailand, etc. are still a vast untapped markets the US can cultivate in the decades ahead.

The US and it's mega-banks have vast $trillions of liquidity, albeit borrowed from the likes of China, at very low interest rates.

Those trillions of dollars cannot be deployed in the United States since the US is already a well developed country and it's own consumers have already learned the lessons of how bad things can go if they spend beyond their means - meaning, no need for multi-billion infra-structure projects and less consumerism in the US and thus much less new companies (who will need financing from the banks) setting up in the US.

Thus, the mega-banks $trillions of cash reserves cannot be deployed in the US but rather most of them should be used as assistance loans to the developing countries.

This will be a good alternative on how the US can generated "export" income while the US is not in a viable position to gain substantial market shares in the developing countries through the "traditional" export earning industries such as agriculture, mining, manufacturing, and technology.

The US is in the most viable position in garnering a substantial portion of the profit from the global marketplace by Financing the industrialization projects of the developing countries rather than try to fight teeth to toe in the highly competitive consumer markets of China, India, Brazil, Russia, Indonesia, etc. where the profit margins on consumer products are absurbly tiny as compared to that being enjoyed by US companies from the US consumers.

For example, a retailer in the US can easily make 30% gross profit margin while in Asia a 10% gross profit margin is already acceptable if not desirable. They achieve more profit through fast turn-overs and economies of scale rather than through percentages. Add the cheap labor to the equation and the United States' manufacturing companies have very little chance to compete effectively in the consumer products markets to those produced by the developing countries.

Thus, the US has to deploy those $trillions of "borrowed" money into financing industrialization projects in the developing countries.

Borrow at low interest rates from cash rich countries such as China and lend the money to cash-strapped but viable developing countries at much higher interest rates - that way the US can use it's global leadership and credibility for maximum profit in the field where it commands the most - the banking and finance/insurance sectors.

There are only 2 sectors by which the US has commanding lead in the global marketplace:

- Military hardware/software, and

- Banking and Finance/Insurance

Thus the government cannot afford to lose the banking/finance sector to the "western world's" CDO/CDS crisis.

Develop new means and ways later on in order to become competitive again in manufacturing and/or technology as we try to solve this unemployment problem primarily caused by the stock markets meltdown and the crunchdown in consumer spending.

Can a Stock Market Meltdown Happen from Here?

We have finally reached the part of market confusion after 18 months of sell-off conviction.

Following the bounce off Oct 2008, very few analysts would consider that a bottom has already been set. Most, including myself, have concluded that the worse were yet to come. The sell-off into Oct 2008 has so much conviction in it that all momentum charts in weekly and monthly time-frames went into extreme ranges including the VIX. Extreme momentums don't dissipate suddenly, they have to be "worked out" first before a recovery can happen.

Time flies and many predictions following Oct 2008 bounce did happen. Dow Jones went down further to 6,500 and SnP to 666.

After the March 2009 bounce, we have a conundrum, if you will, we really don't know what is going to happen next.

One thing is of higher probability in technical analysis; the monthly charts for Dow Jones, SnP, and Compq are either at or entering the 4th-wave of the C wave that started Oct. 2007.

For those technically inclined, 4th wave is the most confusing part of a C wave. This usually results in a lower low for the final capitulation sell-off we call the 5th-wave. There are too many technical problems to be worked out (much like fundamental problems the American economy is facing). Nothing is for certain at this stage. 4th-wave cannot happen without any sign of hope. Now we do have signs of hope. Nor is it a stage where problems have already been solved. We still have tons of problems to work out. Whether nor not most of them are on the mend with the massive Fed and Treasury bail-outs is a major question that will be answered in time.

Seasoned traders and investors are not going wait until all of them got solved before buying stocks and funds. They call it either the glass is half-full or half-empty.

One thing is for sure despite being a neophyte investor as I am:

This current "crisis of the century" is another "opportunity of a lifetime" similar to the 1929 to 1932 market market meltdown. Investors who bought stocks in 1932 were never given any chance to buy stocks at such unprecedented discount after only 3 years of correction. Likewise, without government assistance, many companies went into wholesale bankcrupcy during and after 1929 to 1932 market meltdown - taking investors with them. Overall, it was a one-time "investment opportunity of the 20th century" for the lucky ones.

Stock markets and the American economy have considerably matured since then. Mistakes, big and small, had been made and more mistakes will be committed in the future. It is a never-ending learning process until mankind no longer exist.

Unlike the 1929 to 1932 stock market correction. We are now in the 9th-year of stock market correction that has started since year 2000. The Tech Meltdown of 2000 to 2002 was the initial correction to the sustained rally of 1980's to year 2000 where Dow Jones went parabolically up from 1,000 to 11,750. Such a bubble rally of 1980-2000 have proven throughout history to be unsustainable in the long run and will have to correct one way or another.

The rally from year 2002 to 2007 was not an impulsive rally or a bubble rally but rather a corrective rally. We call it a bear market rally and as such was not sustainable for a prolonged period of time. This market sell-off of 2007 to 2009 confirmed the rally from 2002 to 2007 was a bear market rally, it was a short-lived rally.

The sell-off from 2007 to 2009 was not confined to a single sector but rather involved the housing, banking and finance, retail, manufacturing, etc. But the experience of 2000 to 2007 is not lost; they provided a buffer in order to prevent a shock correction to the 1980 to 2000 rally. Many companies (outside of housing, banking and finance, and retail) were able to implement conservative corporate policies that should enable them to survive the current crisis. Banks and the housing sectors, who are at the most risk, likewise, got massive government assistance that should enable them to survive in an otherwise dire situtation. The lessons of the Great Depression is not lost to the Fed and the Treasuries. Unlike Bush who left everything to Paulson and Bernanke; Obama is doing a fine job of trying to change public perception of the current crisis in order to prevent the onset of a self-fulfilling prophecy of us digging ourselves further into this mess. What is still lacking is a credible sign of leadership needed in order for us to dig ourselves OUT of this mess.

If Obama gives us the much needed Credible Leadership at this dire hours of American history, it is going to change the stock markets overnight and specially the American psychology over time on global economics not seen since after WWII.

One big missing piece of the puzzle at the current stage of American economics history that was founded on consumerism but is now entering the tailspin of an aging baby boomer population.

Ronald Reagan's SDI was for defence psychology that propelled America into a global military dominance. We need something akin to SDI but on the economics side in order to usher a "new world" for the American economy.

A deeper look into China which is now undergoing a credible economic revival sans US and European consumers and that of the developing countries that are starting to follow China's lead might provide him enough insight into what lays ahead for the future of American capitalism.

This is "World War 2 or 3" as far as the US capitalism is concerned in this rapidly expanding global marketplace of the 21st century. The baby boomer consumerism of the Western World has come and gone. It is going to be replaced by more than 2.5 billions of young baby boomers in China and the developing countries for decades to come.

Either the US companies compete in this global marketplace or be left behind and the United States becoming the next England or Spain of the future.

So far, based on 2000 to 2007 Bush MBA performance; the US decided to look inward by proping up the housing sector rather than energizing the manufacturing and technology sectors that were and still are needed to compete against China, India, and the other developing countries.

Too many competitors for global economic dominance? It's not a simple Gulliver vs. Liliputans. It is a Giant Gulliver vs. Two Mid-sized Gullivers and the Liliputans.


The over-extended rallies of the early 1920's to 1929 suffered a punitive correction.

Comparing this current 2000 to 2009 market correction to that of 1929 to 1932 is not correct. Time correction usually prevents punitive sell-off such as the 91% meltdown of Dow Jones in 1929/32 that led to the Great Depression. Thus, the call for wholesale punitive bankcrupcy proceedings for troubled companies are unwarranted at this time.

Dow Jones has gone down 54.23% from Oct 2007 to March 2009. I don't expect it to go much more than 62.8%. Baseline - Dow Jones 5,293 bottom if and when it does happen.

Now that we have finally reached the potential end-game to this 9 years of corrective process. It is hightime to invest in the "investment opportunity of the 21st century".

The bigger problem at this stage is not whether the markets are still going to make the much anticipated capitulation sell-off or not.

It is whether we will be able to invest at the most opportune time and at the right price and which companies are going to go bankcrupt and which surviving companies will provide the most bang for the buck.

This massively confusing conumdrum makes such a task so daunting that many of us will not be able to accomplish our objectives. Many of us may even end up not being able to invest or only be able to invest at much higher prices than we wish to pay in case the expected capitulation sell-off never happens but in fact may already have happened as of Jan to March 2009 sell-off.

Dow Jones gave 40% discount during the 2000 to 2002 sell-off. 54.23% discount is not bad at all this time around just in case we don't get additional discounts.

I'd say BUY the DIPs if they happen.
Buy the breakouts if unable to buy the dips.

Whether we go down to SnP 450 or not, the upside risks of a rally to 1553 and beyond far outweights further sell-offs.

Daily momentum was already able to achieve extreme reading to the upside and is now being "worked off". While that of the weekly has just been able to achieve reasonable extreme momentum to the upside for both DJ, SnP, and Compq. They will have to be "worked out" as needed.

Problem is the monthly momentum which is still trying to work itself out of extreme level to the downside. A small double bottom for the momentum indicators using either a fast MACD or the normal RSI will become a major catalyst for a sustained rally on the monthly chart. It is the shortest path to ending this conundrum in no time. A huge divergence buy signal on the monthly chart will result in a capitulation sell-off called the 5th-wave. Huge divergence needs considerable time to work itself out. It remains to be seen which one is going to happen. A third scenario with much lesser probability is that price simply goes up un-abated thus momentum indicators not providing double bottom nor divergence buy signals to technical traders.

SnP is a double top on the monthly, quarterly, and yearly charts.

They say there is no such thing as a double top. True, since almost all of them end up going higher.

Dow Jones is an expanding flat on the monthly and quarterly charts. Expanding flats have one major characteristic - the ensuing rallies are usually fast and furious that tend to rival that of the last sell-off or the C-wave of an A-B-C consolidation as we call it. Trying to chase the rally with pullbacks will prove futile to many traders and investors who are used to significant pullbacks to the ensuing rallies after a massive sell-off has completed.

This Rally May Have Legs - Bespoke

Speculation is the stock market all about.

Here's one long-shot speculative scenario:

BKX has a 1-2-3-4-5 acceptable downside pattern on the weekly chart - meaning - potential bottom in Elliott Waves parlance. If and when a 12345 downside pattern has been completed on a higher timeframe, and a reaction rally has started in the lower timeframe - the next pullback on the lower timeframe, which is the daily chart, is a BUY.

BKX is now consolidating within a very tight range for 8 days after making a 9 days rally. Consolidation usually last more than 100% to 300% of the rally time and 161.8% the usual time it takes for the consolidation to last before the next rally starts.

BKX has a potential to rally back to 83.43 in the next seven months from the 17.75 low IF the stars got properly aligned - so to speak.

A massive 370% price appreciation from the early March low. Something not to be sneered upon given the not so low but relatively high probability rate. I would give it more than 35% chance at this stage and will increase the probability if and when BKX makes further progress using Elliott Waves analysis. IF BKX is able to form an inverted Head and Shoulders pattern on the daily chart and be able to achieve or exceed the potential target of 45.48; then I would give it a 65% or more probability of reaching 83.43.

370% is basically the linear equivalent to 37 years price appreciation expectation by most conservative investors speculating in SnP being able to achieve a high 10% rally every year for 37 years (much less than 10% per year by compounding - forgot the formula A = B+B(1+i)^n?). 7 months or more of high risk speculation is more than worth the 37 years of conservative speculation for the SnP500. Just don't bet the farm.

Use XLF as a trading vehicle for the conservative traders/investors. Use UYG if you have enough trading experience to handle a doubleX ETF. Use FAS if you have more than enough trading experience with proportionate stop loss provision against minimum potential gains since FAS is a 3X ETF of BKX.

For non-traders. I consider a 100% "do or die" capital loss is a good enough bet against a potential 370% gain if done perfectly from the low of 17.75. At current BKX price level of 26.16; the potential gain is now reduced down to 219%.

The discount from the high 121.16 price of year 2006 is still a healthy 78.4% from the last high 85.33% discount. UYG and FAS went down with higher percentage discounts due to price compounding effects of xETFs but are a lot riskier to buy and hold due to counter-party risks.

This Rally May Have Legs - Bespoke

Traders and investors are microscoping the Financials and BKX in particular as the leading indicator for this most recent "bear rally" as we call it.

BKX was able to make a rally from 17.75 to 31.01 trough to initial peak or almost 75% price appreciation. A massive advance in just 9 days from the early March low.

It is now consolidating for 8 trading days since March 19 with a shallow correction and a tight trading range. A very encouraging performance so far.

This bodes well for more upsides as long as the trading range don't expand dramatically before the next BKX rally can start.

Dow Jones and SnP daily and intraday chart patterns are still in a flux with no definitive corrective processes I can hang my hat on.

I expect BKX to lead the way for DJ and SnP to follow.

If Only Hope Were an Investment Strategy

1929 to 1932 crash was only a part of a rally into 12,000 of Dow Jones of the year 2000 that ended the century old rally.


Dow Jones is now defining an expanding flat correction with a price target of 4750 somewhere in the middle H2 of 2009.

DJ quarterly and yearly chart is similar to MER quarterly chart only that MER has gone well ahead of DJ because it was one of the first ones to drop like a rock. MER has a price target of $9 while DJ has a price target of $4750.

Expanding flats are ABC corrections with the C wave defining a 1-2-3-4-5 pattern similar but not the same as an impulsive rally 1-2-3-4-5 to the upside. The main difference is that in the 3rd wave of an impulsive rally is subdivided by minor corrections similar to DJ 1932 to 1965 rally; while a C wave correction has no discernible minor corrections during the 3rd wave run down except during the early stage and the final stage of the vertical sell-off. DJ and SnP run down during Sept to Oct 2008 is a prime example on the monthly, weekly and even daily charts. Basically no pullback while the iii-rd wave of the 3rd wave of the C wave was in progress. We are now in the iv-th wave an/or 4th wave of the C wave with the iv-th wave questionable whether it has been completed or not since the iii-rd wave is an extended wave that usually produce a truncated v-th.

At any rate; next target is 7300-7500 conservatively for the 3rd wave of the C wave that is projected to happen within the next few weeks. Then another consolidation range that should last for several months before the final 5th wave run down of the C wave to 4750 target in Q2 to Q3 2009.

There is a 20-30% chance of an expanding flat for DJ to morph instead into a running triangle and not be able to reach the tentative normalized target of 4750. This usually happens when the 3rd wave has been completed and the usual relief rally turned into a bullish rally. It is called a C wave failure because the 4th and 5th waves of the C wave failed to materialize.

Very low probability but it can happen - only if Dow Jones is able to break above 11000 and possibly reach 12000 on the first run up. 7200 low of Oct 2002 must not be broken for this scenario to work. Then the next scenario would be a running triangle. Running triangles do happen with strong stocks.

It can happen with DJ if the govt can find an effective market intervention strategy with instantaneous effect to prevent the economic weakness deteriorating beyond what it is now.

Apocalypse is if the C wave over-extends to the 700-1000 area of the 1965-1980 consolidation range. C waves do over-extend due to its viciousness. 50-50 chance the run down to 5000 psychological support will not hold due to global chain reaction panic. We dont have the 5 horsemen of Wall Street (GS, JPM, MER, LEH, and BS) to save us this time. Those that still survive are now trying to acquire banking mentallity and are still deleveraging their trading desks - which are needed to countertrend the market.

Investors do not buy bottoms and the govt usually act once everything has gone beyond cost-effective repair. With Paulson (who understands the stock market but not the investors) discredited and will be gone next year; who is gonna save the stock markets by Q2-Q3 2009.

Expanding flats are bullish specially on shorter time frames but can become a killer on longer time frames. It killed MER, can it kill Dow Jones as well?