Dow Resistance Area 12,500 - 12,700

The Dow has gained about 1,100 points since January 22nd's low of around 11,500. This no doubt has been a powerful rally as the builders and the financials have jumped sharply. The area the Dow is in now, between 12,500 and 12,700 is important since this is a support area that had previously held before the markets eventually cratered. However as the index moves up, the previous support becomes an area of resistance. It also makes sense for the Dow to pause in this area of resistance and digest the 1,000 points the Dow has quickly leaped. My thinking is more along the line that this bounce has been a sharp counter trend rally from a much oversold condition. The test will be where the indexes go tomorrow. If the Dow is able to march through this area and approach 13,000 then the bulls may have a fair argument. If not then at the minimum a small pull back is at least warranted. Again, the jury is still out and much will be determined before the open when the employment numbers are released. At a minimum it will likely be interesting, just as the past month has been. That may be the understatement of the year.

Kerviel Went From +$2 Billion To -$7.2 Billion

Let me get this straight, Jerome Kerviel the Soc Gen trader who wound up losing $7.2 billion of the bank's capital, was actually up $2 billion on December 31, 20007! Wow that must have been a brutal 2 weeks. I thought I was having a tough couple of weeks but he had two weeks for the ages. Crazy that $9.2 billion wiped out in 2 weeks!

Here is what I would say to Kerviel, if I were interviewing him:

You are up $2 billion, why not call it a day, close the positions and ring up the register? Bonus time was coming as this was late December. You could then show the results to your managers and collect your bonus. Although one question I wonder about is what would have happened if you showed your managers that you had taken such large and risky positions even if you had made $2 billion. $2 billion is Soros like. Man you were the king, to be able do it all over again; all you had to do was tell your bosses. Or maybe what you could have done is close the positions and then see what happens as the books were tallied and an extra $2 billion popped out. Couldn't you just tell your bosses what was going on? Maybe you were not that close to your bosses. But you had to assume that at some point even if you were up a couple of bill that someone would have found out. Too bad for your sake and theirs that they did not find this out on Dec 31st when you were up $2 billion.

I read many article on this subject but this one from CBS market watch was the best one:

http://www.marketwatch.com/news/story/kerviel-wanted-make-money-my/story.aspx?guid=C603307D-4E88-4776-8C6C-D04D84A52607&dist=SecMostEmailed

GDP and ADP Tomorrow

The first estimate for GDP will be released tomorrow. In December the economy seemed to weaken as the consumer pulled back. The monthly employment figures and the retail sales point to a slow down for GDP. How slow remains the question.

The staffing firm ADP will announce their monthly employment numbers tomorrow. These numbers are important because they give a hint to which way the economy is leaning. Also there are times the numbers accurately predict the government's monthly payroll numbers which are released on Friday.

From the ADP web site:

http://www.adpemploymentreport.com/ner_faq.aspx#what_is_adp_ner ), " The ADP National Employment Report is a monthly estimate of private nonfarm employment in the United States based on aggregated and anonymous ADP payroll data... The ADP National Employment Report was developed to help meet the need for additional, timely and accurate estimates of movements in the national labor market among economists, financial professionals, government policymakers and academics. Because ADP pays 1-in-6 private sector employees in the United States every pay period across a broad range of industries, firm sizes, and geographies, it has a unique and significant perspective on the U.S. labor market. "

McDonald's December Sales Indicate Sharp Slow Down

McDonald's reported their quarterly earnings yesterday and said that December US same store sales were flat. This is another piece of evidence that shows how sharply the US consumer has retrenched since last August when the credit squeeze began. We will get a clearer picture of where GDP finished late last year as Q4 GDP will be released this week. This statistic is likely to change a number of times as this is the first estimate for GDP. That number and the January employment report to be released on Friday will be of high importance for the equity markets this week.

* Disclosure: I have no position in McDonald's and I am unaware of any position at the firm I advise.

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The strong durable good numbers just released indicate business spending still looks OK. These durable good numbers are notoriously volatile on a month to month basis though.

A Dichotomy In Housing - Texas and California

NBC news had an interesting report tonight on the boom in the Texas housing market. In an earlier post I wrote about the booming Texas economy due to the high price of oil. So even as the housing market deteriorates across the country Texas's housing market stands out as one of strength. Texas has had these boom bust cycles before. In the early 1980s after the price of oil collapsed the Texas housing market went with it. But at least for now Texas stands as a beacon of hope for the housing market.

Last week I was on the Wachovia Bank earnings conference call and was a bit taken aback by what I heard. The bank is facing losses from home owners who could afford to make their mortgage payments but chose not to. These home owners have taken this route because they owe more on their mortgage than what the house is worth. So they are getting up and leaving. Now I was a bit astounded by this when I heard it and did not want to write about this until I was able to confirm this. There are so many things said on a conference call that some times it is easy to make a mistake. Well it was no mistake as CBS's 60 Minute's tonight confirmed it in their feature. They interviewed a California couple who could afford their monthly mortgage payment but have decided that since the price of the home has dropped they were going to walk away from the home. Now Wachovia was not mentioned in this report so I imagine that they are not the only bank facing this problem so I do not wish to single out Wachovia. Note too that even with California's large oil presence, its housing market does not seem to be benefiting from it.

Before I get into this further I would say that most banks' lending practices played a large role here as well. Had the banks never issued no money down loans and instead stuck with the tried and try standard mortgages in which a down payment of about 20% is taken it is unlikely that the home owner would walk away from a house she could afford to make payments on as the prospect of losing the down payment is not very appealing. How in the world does a bank not take collateral when issuing a loan? Let me switch my attention back to the home owner. If you can pay your mortgage payment, even if the price of the home dropped, you have an obligation to make that payment.

At some point house values will stop dropping and people will stop walking away from their homes. Unfortunately until that time as long as house prices keep dropping those with little or no equity in their homes will continue to walk away from their homes, even the ones who can afford to make the payments. It is hard for me to believe that this is actually going on and it saddens me. At least Texas is booming so that is the bright spot I leave on.

* Disclosure: I have no position in Wachovia nor am I aware of one that the firm I advise holds.

What Does Bill Poole Know?

Bill Poole heads the St. Louis Fed and formally dissented when the Fed cut rates last week. It was reported that he preferred to wait until this week's scheduled meeting to cut rates. I am not sure if there were other reasons behind Dr. Poole's decision. If there were I would like to know what they were. For a Fed president to dissent at an inter-meeting cut seems a bit odd. It would seem that the evidence to support an inter-meeting action by the Fed would be so overwhelming that everyone who was voting would support the move. That Dr. Poole voted against the move is very curious.

Lack of Risk Management Led To A $7 Billion Loss

Jerome Kerviel, now there is a name you don't hear every day. Well get used to hearing it because that name will be spoken repeatedly during the next month or so. Mr. Kerviel is the 31 year Frenchman who worked as a trader for Societe General and who reportedly lost $7 billion for the bank on unauthorized trades.

How does this happen? Who is minding the store at SG? How can Societe Generale allow an employee to lose $7 billion? The question is about risk management, and where was it? Losses happen and even at times large losses take place. What is mind boggling is that the scope of this employee's trading activity was unknown. How on earth can the amount that this guy was trading go unnoticed? Where was management? Again I stress - losses happen, yes even $7 billion worth, but to have unauthorized trades occur in such size is startling. What would have happened if the losses continued to go unnoticed and the losses became larger?

Lets suppose for a second the opposite happened. Let's say no one caught these trades but that eventually the trades turned profitable. Actually quite feasible since the world's equity market did rally sharply from Tuesday's bottom. Also it was only after weeks of trading that a compliance officer at the bank found out what was going on. So if a compliance officer had not stumbled onto these trades then what could have happened? Might the trader actually have made tons of money? He reportedly was long equity futures which had been going his way until the start of 2008. But the start of 2008 pretty much turned gains into massive losses as the world equity markets collapsed. But ever since the Fed rate cut the equity markets made up tremendous ground. Makes you wonder had this trader had more time would his trades eventually have turned profitable? Maybe he would have made SG billions instead of losing $7 billion.

Risk management, risk management risk management. I can not stress these words enough. Unless an individual has the skills of a Warren Buffett or a Peter Lynch a trader should not make a habit of averaging down. Actually in almost all cases averaging down should be avoided. A trader that makes a habit out of averaging down on a bad trade will eventually get carried out. Mr. Kerviel was carried out today if only figuratively as he is currently missing.

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Update on Saturday. I stand corrected. Mr. Kerviel is not on the run but has been with his lawyer all week.