Entries by Ivan Martchev

The Goldman analyst says sell Citi, then he lowers price targets on many other brokers. Question: given that Goldman and Citi are in many overlapping businesses, what would that same analyst say of his own company?

Also on Friday their chief economist – Jan Hatzius – came out with this report. Now, Jan has been cautious for all of 2007 and he has been basically right. Goldman is the only major broker who made money on the way up in the subprime repackaging boom and did not lose money as the firm was short on the way down. They actually probably made some money as subprime CDO prices collapsed.

The market so far was moved on both days by the two Goldman reports. There should be another attempt to rally before the S&P 500 reaches 1400, but the tone of this market action is fairly clear (look at FRE/FNM which were supposed to save the day for CFC and the like).

What the good doctor thinks about a necessary pullback in gold bullion and his friend A. Gary Schilling on the US economy and financial sector.

And Jimmy, who is sounding more and more like Marc Faber of late.

This was a pretty good bounce on Tuesday, but so far it appears to be a one day wonder. Low to high, the S&P 500 bounced 50 points and fizzled right at the gate of the 1490-1500 resistance zone (see chart).

Key market sectors like banks have long ago taken out their August lows, so it will not be out of the question if the S&P 500 does the same. Even bears like Doug Kass were looking for a bounce into the end of the year, but if the August lows go (the index never closed below 1400 on the summer selloff), you have to look the bear in the eye and call it the grizzly kind. So much for that positive seasonality in November.

The last time we saw such reckless disregard of positive seasonality was in the fall of 2000. Given that the bank loses taken so far – Merrill, Citi, etc. - are only the tip of the iceberg, the Maginot line becomes the 1400 level on the S&P.

Do you know what is inside your money market fund? Or do you feel that your state pension is secure (if you have one)? Orange County ring a bell?

video (4 min.)

The bounce we see today is certainly due to Wal-Mart. Those $350 Acer laptops sure sold out pretty fast. But WMT has been an inconsistent performer, so it is more likely a relief that things are not falling apart in the economy. No one suggested that they were at present.

But Goldman is still net short in the credit markets and other experts think that the turmoil will get a lot worse before it gets better. The experts also suggest that investors do not comprehend the magnitude of the issues – this is something that I have been saying all along, not that I consider myself a credit market expert -- which is why the stock market reaction has been relatively calm.

So, we have a relief rally in an options expiration week, which makes things less predictable. Unexpected news generally gets a more magnified response. For the time being an oversold market is finding hope in Wal-Mart. Hope always dies last.

 www.stockcharts.com

Why it is difficult to say where the floor is in banks (bounces notwithstanding):

Nov. 12 (Bloomberg) -- Goldman Sachs Group Inc. held a bigger proportion of hard-to-value assets at the end of the third quarter than Citigroup Inc. and Merrill Lynch & Co., two of the firms hardest hit by subprime mortgage losses.

Goldman's Level 3 assets, for which market prices are so scarce that companies use internal models to gauge their value, accounted for 6.9 percent of the New York-based firm's $1.05 trillion total at the end of August, according to a filing with the U.S. Securities and Exchange Commission. Citigroup classified 5.7 percent of its assets as Level 3 on Sept. 30 and Merrill reported 2.5 percent.

Investors have grown wary of banks and brokerages with difficult-to-sell securities on their books, after profits at Citigroup and Merrill were crippled by at least $19 billion of writedowns, mostly from bonds backed by home loans to borrowers with poor credit histories. While Goldman officials say the firm won't report an ``extraordinary'' drop in its subprime holdings, investors have remained skeptical, pushing its shares down 15 percent this month in New York Stock Exchange trading.

``It's hard to believe Goldman is perfect,'' said Jon Fisher, who helps oversee $22 billion at Minneapolis-based Fifth Third Asset Management and sold his Goldman, Merrill and Morgan Stanley shares in the past 12 months. ``Their losses might be smaller than others, but that doesn't mean they don't have a problem.''

Goldman posted a 79 percent increase in third-quarter profit, the biggest on Wall Street, even after shaving $1.48 billion from the value of high-yield loans. Morgan Stanley, Lehman Brothers Holdings Inc. and Bear Stearns Cos. reported declines, and Merrill Lynch & Co. said $8.4 billion of writedowns led to a $2.2 billion loss, the biggest in the firm's history. All the companies are based in New York.

LBO Market

``Just because they're in Level 3 doesn't mean we're not pricing them correctly,'' Goldman Chief Accounting Officer Sarah Smith said in a Nov. 9 interview. ``We mark our positions to the point where we could exit at that moment.''

The 33 percent increase in Level 3 assets in the third quarter was mostly due to the freeze in the leveraged buyout market, which left firms including Goldman stuck with loans, Smith said. Goldman wrote down the value of those commitments when the debt was moved to Level 3. As the buyout market recovers, the loans may be upgraded to Level 2, she said.
Goldman's Level 3 holdings totaled about $72 billion at the end of August. Stripping out stakes owned by others, Goldman's ``exposure'' was $50.9 billion, or 4.9 percent of the firm's total assets. A ``substantial percentage'' are private equity and real estate investments, said Goldman spokesman Lucas van Praag.

FAS 157

While those typically fall into the Level 3 category, assets such as leveraged loan commitments shift from one level to another depending on market conditions, Smith said.

``We take issue with the notion that all assets in Level 3 are hard to value,'' said van Praag. ``Given the disclosure rules, it is inevitable that any firm with a large private equity and real estate portfolio would have significant Level 3 assets.''

All the firms have adopted a Financial Accounting Standards Board rule, known as FAS 157, which requires public companies to disclose a breakdown of their asset valuations.

Under the rule, Level 1 assets are those for which market prices are readily available. Level 2 holdings are valued based on ``observable inputs,'' or prices of similar assets traded in the market. Assets fall into the Level 3 category when there aren't even any observable inputs, and the firm has to rely on in-house models to calculate potential gains or losses.

www.stockcharts.com

I already gave you my guess what Jimmy has already done in this situation. The above is the reincarnation of the marked-to-myth strategy detailed here. It will take a long time before this unwinds because people have the tendency to "hold and hope", even if they work at Goldman (at least some).

The yen took out the August lows today. See why that is important. Add to that banks and retailers that have long ago done so.

The market will bounce, but until 1500 on the S&P 500 is recaptured, I am very skeptical.

www.bloomberg.com

I have seen this in proprietary research that I cannot quote. But the missive below is in the public domain and would give you a good idea what it means to make up earnings and hide loses. Make no mistake, the losses will be realized. But they will be amazingly large, threatening wipeouts of big Wall Street firms.

Caldwell & Orkin (PDF):

In July 2007, we were told by the banks and brokers that the poor investments they made in subprime mortgages, CDOs and CLOs would not harm their balance sheets and would lead to, at most, minimal charges recognized in the second quarter (see September 2007 Update). Then we learned that the banks and brokers were valuing these securities at 97 cents on the dollar, even while the bonds held by these securities had lost more than half their value. These charges were justified via internal valuation models that clearly had no basis in reality. The sum of the parts did not equal the whole.

When valuing hard-to-trade securities, institutional investors are allowed to classify assets as Level 1, 2, or 3. Level 1 asset values are the most transparent, as they are frequently traded and have readily available pricing. Level 2 assets are less frequently traded, but are marked to market-listed prices. Level 3 asset values are the least transparent as they seldom trade and are, therefore, dependent upon subjective inputs determined by the asset holder, or what Warren Buffett calls “marked to myth.” According to Portales Partners, three of the top five brokerage firms increased their Level 3 “marked to myth” asset classifications by over 30% during the third quarter of 2007. “Everyone has an incentive in the short run to put the best face” on valuations, says Peter J.  Solomon, a former Lehman Brothers vice chairman. “Their compensation is totally based on it. In securities that don’t have ready markets, particularly when the markets are troubled, it makes one totally suspicious.”5  Executives at UBS AG fired hedge fund manager John Niblo for his refusal to play along with this “mark to myth” game. According to The Wall Street Journal, Niblo was fired after marking some of the mortgage-backed securities in his fund in the range of 50 to 80 cents on the dollar. The problem: UBS held similar securities in other accounts that they had valued in the range of 80-89 cents on the dollar. Mr. Niblo is alleged to have asked his bosses at UBS how they could value the securities at a higher level “if [they] can’t sell them at these prices?”6 “Good question,” his bosses probably responded. “Now go find another job.”

J.P. Morgan Chase & Co. analyst Kedran Panageas estimates that 29% of lower-quality CDOs  and 12% of higher-quality CDOs will eventually lose all of their value. Overall, she estimates the lost value is roughly $85 billion of the $475 billion of such securities outstanding, with investors having only recognized a fraction of those losses. Even with the additional write-downs that accompanied the firing of a few brokerage firm CEOs in late October 2007, we are yet to see realistic, market-based charges taken against subprime mortgage, CDO and CLO holdings. [emphasis added]

If losses are too big, put them in the footnotes. And fire that whistleblower.

 www.markit.com

I would be the first to tell you that Citigroup – the biggest US bank and a great example of the current situation – is overextended to the downside. But, if one cannot trust the earnings, book value, etc. for the above mentioned reasons, who's to say how low is too low?

 www.stockcharts.com

The S&P hit 1450.31 intraday and it never closed below 1400 in the August selloff.  The bears that looked for a selloff in October, now look for a rally (bounce), but are reluctant to say "when".

My personal opinion is that it is a little early to call for a rally as the majority just discovered it was not properly positioned in the market (see GOOG).

Now, no matter how great the market looked the other day at the close, yesterday the market took out 1500 on the S&P, which I believe is meaningful. I didn't pull that number out of thin air. In the July-August selloff the rallies stalled right around that level. Resistance becomes support, which when broken becomes resistance.

www.stockcharts.com

Support did break yesterday. If you are interested in more important S&P 500 levels, see them here. I don't understand how Jeff Copper gets his numbers, but I know he is a good trader. And that's hard to achieve.

It has been my opinion for a long time that the market cannot run far without the banks. It sure looks like it now.

Let see what tricks Ben pulls out of his hat in his Congressional testimony. Read it, it is amazingly clear in comparison to his predecessor.

Given that China is over $1.43 trillion on the chart below, where exactly is the surprise?

 www.marketoracle.co.uk

(not the best source as the chart is a little old, but you get the picture)

Notwithstanding the great close and a market that itches to go higher, Barry's food for thought.

A difference of opinion.

UPDATE 4.15 pm:

Great SPX close for a second day in row. There is your "wall of worry" rally to attack the highs (Barton is winning here). I would have never guessed it with Citigroup trading under 35 today. Unless 1500 is taken out, I favor the upside here.