Monday, April 19, 2010

Market Sell Off on Goldman News Has Deeper Roots

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

The SEC's announcement on Friday (April 17th) that it was investigating Goldman Sachs on fraud charges seems to have been the cause of a serious market sell off, but other factors were at work as well. While major financial stocks took a hit, so did gold, gold miners, and oil. The tech heavy Nasdaq also had a sharp decline. The market was overbought and options expiration added an extra impetus to the volatility.  In such circumstances, any bad news can cause contagious selling.

While selling was broad based, large cap financials were indeed the epicenter of the damage. Goldman (GS) itself closed down 13% on the day. JP Morgan (JPM) was down 5% and Morgan Stanley (MS) down 6%. XLF, the financial ETF, was down 4.5%. Inexplicably, the gold mining index HUI was down 4.4% and gold and oil were each down over 2%. Gold should have seen safe haven investing flows, but did not.

As for the major market indices, the financial heavy S&P 500 had the biggest drop, falling 1.6%. The Dow Jones Industrial Average was down only 1.1% and the small cap Russell 2000 ended 1.3% lower. Nasdaq lost 1.4%. On the daily charts, the S&P 500 and Russell 2000 reached overbought territory in the middle of last week. Nasdaq became extremely overbought at the same time. If selling hadn't started on Friday, it would have done so probably at the beginning of this week.

Although the Dow has not gotten to overbought territory, it has other technical issues, namely volume or lack thereof. The Dow finally had a high volume trading day on Friday ... on heavy selling, which added even more weight to the technically negative picture. Overall volume on the Dow has been dropping since the bottom was put in last March, something that should not be taking place during a rally. Even worse, selling has been occurring on above average volume recently. This is known as distribution and indicates big money is getting out of the market. The only above average volume day so far in April was last Friday. The only high volume day in March also saw selling. February was more mixed, but the four highest volume days in January, all well above average, saw selling. 

Where the buying has been taken place in the market is also not encouraging. Only six stocks frequently account for up to 30% of the buying on the NYSE - Citigroup (C), AIG (AIG), Ambac (ABK), Bank of America (BAK), Popular (BPOP) and Fannie Mae (FNM). Considering that AIG and Fannie Mae are nationalized enterprises owned by the U.S. government and Ambac, Citigroup and Popular were penny stocks selling for 1.00 or less during the Credit Crisis, this is not exactly a sterling list of solid growth companies leading the market.

Liquidity is what makes markets go up (good earnings are the result of liquidity, although in the current rally, liberalized accounting standards may be even more important). The fed and other central banks throughout the world have pumped an almost unlimited amount of it into the world financial system since the Credit Crisis began. Too much liquidity over too long a period of time though pumps up stocks to unsustainable levels as happened in 1929, 1987 and 2000. Under such circumstances withdrawing even small amounts of liquidity can have the effect of sticking a pin in a very over inflated balloon.

Disclosure: Long oil.

Daryl Montgomery
Organizer, New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

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