I have to admit that I wasn’t expecting the real estate and financial sectors to hold up as well as they have over the past few months. My ultra-short positions (SRS and SKF) have taken a beating and readers have been emailing and asking what gives. How can these sectors be stabilizing and advancing amidst the flurry of bad news? Here is a quote from an AP article detailing the phenomenon:
“Housing stocks rose across the board Thursday, defying a bevy of industry and corporate data that showed the housing market continued to erode in the first part of the year.
Most major builders added at least 2 percent in midday trading. Lennar Corp. led the gainers with a 6 percent jump to $17.99. D.R. Horton Inc. and KB Homes each added 2 percent. The gains came on a day when the Commerce Department reported that sales of new homes plunged in March to the lowest level in 16 1/2 years — right in time for the start of the spring sales season.
The median price of a home sold in March dropped 13.3 percent compared with March 2007, the biggest year-over-year price decline since a 14.6 percent plunge in July 1970.”
Here we witness major home-builders advancing on a day when the statistics show the worst year-on-year price decline in nearly 40 years! And we have witnessed similar trends in the financial sector, where weekly news of massive write-downs, bailouts and bankruptcies are met with sideways training and gains in some cases. Are investors really so optimistic to think that the worst of the crisis is behind us?
In financial news last week, Washington Mutual (WM) reported earnings that were some 35 cents below consensus expectations. The Seattle-based thrift lost $1.40 per share, compared with a profit of $784 million, or 86 cents per share, in the first quarter of 2007. This is a huge miss and a massive decline in earnings for such a large bank. Yet, WaMu stock is up nearly 22% since reporting the news. But this really can’t last and even Morgan Stanley sees big bank woes just beginning.
NEW YORK (Reuters) – Morgan Stanley analysts on Monday told clients to “sell the rally” in financial stocks, slashing forecasts for big bank earnings and warning that the current credit crunch is only just beginning.
In aggregate, Morgan Stanley reduced its estimates for 2008 large bank earnings by $17 billion, or 26 percent, and reduced 2009 forecasts by $13 billion, or 15 percent. The analysts expect higher loan losses and expenses, offset by higher net interest income, though profits could fall further still if the Federal Reserve stops lowering interest rates.
“More capital hikes and dividend cuts (are) coming as our credit deteriorates and forward earnings decline,” analysts led by Betsy Graseck wrote in a report. “We think we are only in the third inning of the credit cycle and expect this credit cycle will be worse than (the slump in) 1990-91.”
I know that markets are swayed by sentiment and can act irrational from time to time. But sanity typically prevails as excess moves in any direction are brought back to some reasonable level of equilibrium. And with that, here is a look at what could be a tremendous trading opportunity unfolding. Both the Real Estate and Financial UltraShort ETFs are way oversold and both of their charts are showing a falling wedge pattern. Falling wedge patterns are typically very bullish as they are generally resolved to the upside. Volume expansion helps to confirm that the falling wedge is a reversal pattern and the widest portion of the wedge may be added to the breakout level to determine the upside move which follows. If we use the widest portion of the wedge, we could forecast an upward move of about 40% for both of these ETFs. That is some explosive upside potential that could net very hefty profits in a very short time period.
The falling wedge pattern is easily identifiable in the SKF chart below. We also see the 200-day moving average just about to meet the current stock price and provide support for the anticipated move up. Stochastics are oversold and look ready to turn up.
The UltraShort Real Estate ETF is also showing a falling wedge pattern and oversold stochastics. However, the recent crossing of the 50-day moving average down through the 200-day moving average provides mixed signals. If SRS can bounce off 80 with conviction, we could see it quickly move back above 100.
Keep in mind that volume is an essential ingredient to confirm a falling wedge breakout. Without an expansion of volume, the breakout will lack conviction and be vulnerable to failure. Technical analysis should never be used in isolation, but we are now at a point where both the fundamentals and technicals are pointing toward lower prices in the financial and real estate sectors and much higher prices for the UltraShort ETFs discussed within. Traders would be wise to wait for confirmations and set tight stops to avoid any potential head fakes. But if things unfold as expected, the profits will be well worth the wait.
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