Friday, November 30, 2007

Screening to Win: MACD (Moving Average Convergence / Divergence)

The overview below describes one of the common technical indicators – MACD and provides insights on how to utilize it in your stock selection. Hopefully this outline will provide traditional fundamental investors with some solid insight on how to incorporate technical indicators into their screening. The free HingeFire Stock Screener which can be found at is one of the few tools available that includes a wide selection of fundamental and technical criteria for selecting stocks. Using a combination of fundamental and technical screening is a powerful tool for winning in the market.


Moving Average Convergence / Divergence Overview

The MACD indicator was originally developed by Gerald Appel, and is considered to be one of the most reliable center line oscillators. MACD is formed by taking two moving averages, and subtracting the longer timeframe moving average from the shorter. This creates a leading momentum oscillator from underlying moving average indicators which are lagging. Typically a 26 and 12 day EMA are used to form the standard MACD indicator. The selection of these periods appears to provide the best trade-off between the reliability and speed of the MACD signals.

MACD is a centered oscillator; it rises and falls below a Center Line which is the zero level. Generally, territory above the center line is deemed bullish, while the area below is considered bearish. Centered oscillators are useful for identifying strength and weakness, but not overbought or oversold extremes.

A Signal Line is created for the MACD indicator by plotting a 9 day EMA of the MACD values.
The HingeFire tool provides support to incorporate MACD in your creation of screens for stocks. Users can scan to determine if the MACD indicator is greater than or less than the Center Line or Signal Line, and also establish if the MACD value has just crossed above (JCA) or below (JCB) these thresholds.

How to use MACD in screening

Most investors use MACD to determine if the general trend is bullish or bearish for the stock. Conventionally levels above the centerline are generally considered bullish, and those below bearish. A similar situation holds for the signal line. However most investors are focused on when the MACD indicator crosses these levels indicating a change in trend. The existence of the indicator above or below these levels in itself is not viewed as conclusive regarding the trend for the stock. Most investors screen for bullish or bearish crossovers of the MACD indicator of the Center Line and/or Signal Line.

Bullish MACD Crossovers

One common bullish scenario is when the MACD indicator crosses above the Centerline (zero level). The HingeFire screener supports looking for these crossovers. A screen in late October found Abbott Labs (ABT) when the MACD indicator (blue line) crosses over the Center Line. This was shortly after Abbott also crossed the red signal line. Since this time ABT has continued to generally increase in price.
As shown above, another bullish indicator is when the MACD Indicator crosses the Signal Line. This event may lead or lag the crossing of the centerline. Many investors focus on signal line crossings to time their entry or exit points. Many times the cross above the signal line indicates a change in trend.

Conagra Inc. (CAG) recently reversed a downtrend when the MACD indicator (blue) rose above the Signal Line (red). This occurred while the MACD indicator was still well below the centerline, providing investors an early signal to take a long position. The HingeFire screener discovered this setup when screen for the MACD indicator JCA the signal line earlier this week.

Bearish MACD Crossovers

One common bearish indicator is when MACD crosses below the centerline. This confirms that the trend has shifted from bullish to bearish. The previous history of MACD on a chart many times serves to underline the intensity of a cross below the centerline. A situation where the indicator dives from a high positive level down below the centerline indicates sharp downside price momentum. Scenarios where the MACD wobbles below the center line after several recent crosses usually indicates less conviction in bearish potential.

Tennant Co (TNC) had its MACD cross below the Center Line today. Despite entering bearish territory, the deficit of impetus in the indicator as it retraces below zero demonstrates a lack of conviction in the signal. While the HingeFire stock screener has picked up this cross below the Center Line, many traders would review the chart and search for other MACD cross below opportunities. This underlines the point that a screener is a tool that is focused on providing potential candidates, it is important for investors to do additional fundamental and chart research when selecting their stocks.

When the MACD Indicator crosses below the Signal Line it is usually a start of a bearish trend. The HingeFire screener found AK Steel Holding Corp (AKS) in a scan of MACD just crossed below (JCB) the signal line in late October. As the chart demonstrates AKS has continued to drop in price since this crossover. Many investors view that a MACD cross below is a good indicator of the start of a bearish trend, while an additional cross below the centerline serves as confirmation.

Combining MACD Signals

Many investors utilize MACD by combining signals. Some will screen for a bullish condition of the indicator above the signal line and just crossing the centerline. This looks for the confirmation of a bullish trend. Others may look for bullish conditions when the MACD indicator is already above the centerline and has just crossed above the signal line.

Inversely, bearish MACD signals can be combined in a similar manner. Investors may look for setups where the indicator is already below the signal line and just crossed below the centerline; or scan for conditions where MACD is below the center line and just crossed below the signal.

MACD Summary

Many investors also review charts for divergence between MACD and price. This situation usually indicates a significant disconnect in the market, implying that the equity is mis-priced based on market action. Some followers of the MACD indicator also review stock charts for the level of the MACD indicator, searching for key levels such at 0.5, 1, -0.5, and 1, as a pointer for future price action.

However the usual focus for MACD is on the Center Line and Signal Line. When the indicator crosses over these levels it usual serves as an important signal about a change in momentum for a stock. The HingeFire tool can be used to screen for the following significant events for the MACD indicator:
  • Bullish Crossovers of the Centerline
  • Bullish Crossovers of the Signal Line
  • Bearish Crossovers of the Center Line
  • Bearish Crossovers of the Signal Line
  • Combinations of Bullish or Bearish MACD signals

Combining technical indicators such as Moving Average Convergence / Divergence indicator with commonly used fundamental criteria when selecting your investments helps put the market edge in your corner. The MACD support in the HingeFire Stock Screener adds a powerful tool for determining the momentum in the market so you can enter or exit your investments at the correct time.

Thursday, November 29, 2007

Time to Renovate

There is a silver lining to the housing crisis. Contractors are being more realistic about your home improvement projects.

For a while now, I have been looking to get a room in our attic finished. The room is about 20 by 16 in size, and does not require anything fancy; no bath, upgraded features, or anything very expensive. About a year ago, I put the project out for bid and most of the contractors did not even call back. The contractors that did respond provided outrageous quotes and did not even seem to be reliable.

Fast forward the clock to today, I recently started to explore this project again. The return calls are much quicker and the price estimates down more than 30% from the outrageous expectations from a year ago.

This phenomenon appears to be common and nationwide. It appears the time is now to get moving on that home renovation project which your spouse yearns for.

The Upside to the Downturn
Contractors Return Calls, Materials Cost Less; Mr. Bowes's Half-Price Renovation

U.K. Housing Update

Press reports came out today that emphasize the demise of the U.K. housing market. The cost of homes dived 0.8% from October. Banks have cut back on loans with the volume dropping significantly from September. The Bank of England now views the banking crisis as the top concern according to a statement from Governor Mervyn King while offering emergency funds to impacted institutions today.

U.K. Home Prices Drop Most Since 1995, Loans Decline
"There are clearer signs that the slowdown in the housing market is gathering pace,'' central bank policy maker Rachel Lomax said on Nov. 22."

King Says Market Rate Increase Caused by Bank Capital Concern

See the earlier U.K. Housing post:

Wednesday, November 28, 2007

Screening to Win: Fast and Slow Stochastic

This is the third installment in the series "Screening to Win". This article discusses utilizing the Stochastics technical indicator in your screening. The earlier commentary about Moving Averages and RSI can be found at:
Moving Averages

The overview below describes one of the common technical indicators – Stochastics and provides insights on how to utilize it in your stock selection. Hopefully this outline will provide traditional fundamental investors with some solid insight on how to incorporate technical indicators into their screening. The free HingeFire Stock Screener which can be found at is one of the few tools available that includes a wide selection of fundamental and technical criteria for selecting stocks. Using a combination of fundamental and technical screening is a powerful tool for winning in the market.

Slow and Fast Stochastic

Slow and Fast Stochastic Overview

The Stochastic indicator was originally developed by George C. Lane in the late 1950s and has gained wide-spread popularity since this time. The Stochastic indicator is a momentum oscillator that reveals the location of the current close relative to the high-low price range over a defined number of periods. Generally, levels that are near the top of the range indicate accumulation and those near the bottom of the range indicate distribution.

Stochastic oscillators normally utilize a 14 day formation period and a three day smoothing filter. The indicator is presented as a percentage running from 0 to 100. Stochastic indicators normally have two sub-components; %K line which is the unsmoothed relationship of the price to the highs and lows over a 14 day period, and %D line which applies a 3 days smoothing filter to this data.

There are two common stochastic oscillators; fast and slow. The fast stochastic oscillator adjusts more quickly then the slow stochastic. This is understandable because the slow stochastic indicator is normally created by applying an additional 3 day filter to the %D information associated with the faster indicator. As expected, the fast stochastic oscillator is more prone to whip-saws and quicker movement then its slower cousin.

The HingeFire stock screening tool provides support for both Slow and Fast Stochastic indicators. Support for the 20 (oversold) and 80 (overbought) levels is incorporated. Users can scan to determine if the stochastic reading is greater than or less than a particular level, and also establish if the fast or slow stochastic just crossed above (JCA) or below (JCB) these thresholds.

How to use Stochastics in screening

Most investors utilize stochastics to identify oversold and overbought conditions. Stochastic levels below 20 are generally considered oversold and above 80 are considered overbought. However a reading below 20 is not necessarily bullish, nor a reading above 80 bearish. Stochastic indicators can remain at these levels for lengthy periods of time. It is more important to focus on situations where the stochastic crosses below 80 indicating an exit from an overbought condition, or crosses above 20 indicating an egress from an oversold condition.

Both the %K and %D for stochastic indicators are normally displayed on charts. The recent chart of 3M Corp (MMM) shows an example of a slow stochastic that recently just crossed above (JCA) the 20 level. This is one of the stocks recently found using the HingeFire tool to screen for stocks whose slow stochastic just crossed above this level. Normally this is taken as a sign that the selling pressure is exhausted and the stock price is poised to rise.

As a point of interest notice the earlier price drops in the 3M chart that occurred when the slow stochastic level fell below 80. The drop below 80 indicates an exhaustion in buying and commonly leads to either a brief retrenchment or more significant drop in price

A fairly volatile stock Amerco (UHAL) recently had its fast stochastic just cross below (JCB) the 80 level. This cross below was followed by a price drop of more then $8 for the stock. Many traders utilize fast stochastic to get in on moves early.

Note the lag of the slow stochastic as compared to the fast stochastic for the volatile stock in the diagram above (both are plotted). A trader using the fast stochastic would have caught the recent move down near the peak; while an investor using the slow stochastic would have gotten in on this move much later. This is a solid demonstration of the difference between the two indicators; note that the slow stochastic is still a very reliable indicator for timing buys and sells for long term investors focused on non-volatile instruments.

It is generally deemed that investors should use a fast stochastic for the timing of medium term trades with volatile stocks. The slow stochastic is more useful to determine entries and exits for longer term investments, or if you find that the fast stochastic causes you to over-trade.

There is one school of thought that states that investors should look at charts and focus on the divergence between price and stochastic level near oversold and overbought levels. Many times the second time that the stochastic indicator crosses out of an overbought or oversold condition in a short period of time is deemed a better indication of final exhaustion in buying or selling.

In summary, many investors use the HingeFire tool to screen for the following situations with Stochastics.

  • Break Above Oversold with Slow Stochastic – Screening for stocks that JCA the 20 level as entry points for long term investments on non-volatile stocks.
  • Break Below Overbought with Slow Stochastic – Screening for stocks that JCB the 80 level as exit points for long term investments on non-volatile stocks, or possibly to short.
  • Break Above Oversold with Fast Stochastic – Screening for stocks that JCA the 20 level as a long entry points for trades on more volatile stocks.
  • Break Below Overbought with Fast Stochastic – Screening for stocks that JCB the 80 level as an entry point to get short.

Combining technical indicators such as Stochastics with commonly used fundamental criteria when selecting your investments helps put the market edge in your corner. The support for Slow and Fast Stochastic indicators in the HingeFire Stock Screener adds a powerful tool for timing your transactions.

Tuesday, November 27, 2007

Citi Gets a Bailout

Wall Street rebounded today on news that Abu Dhabi bailed out Citi to the tune of $7.5 billion. The news was viewed as relief from the continual negative disclosures coming out of the financial sector.

The deal actually underlines the severity of the crisis facing the banks. Without this infusion, Citi would be in a situation where it would probably be forced to merge with investors (including many in the Middle East) receiving pennies on the dollar. The situation still is not attractive for Citi; the bank still does not have a CEO and will shortly be laying off 45,000 employees. A good portion of assets are still impaired and need to be written down.

The upside is that the bank managed to swing this deal despite the dismal environment. It brought hope that Sovereign wealth funds may rescue other large financial institutions.

Citigroup Sells Abu Dhabi Fund $7.5 Billion Stake

Citigroup Plans New Round Of 'Massive' Job Cuts

Stocks Higher After Citi Secures Capital

Quick Takes: U.S. Real Estate Crisis Score Card

  • $500B in loan related write-downs at banks and rising.
  • $2 Trillion in economic credit impairments in lending.
  • 446,726 homes currently in foreclosure (1 for every 196 households).
  • 1.4 Million or more homes expected to enter foreclose in 2008.
  • Foreclosures increasing at over 34% per quarter.
  • U.S. GDP projection for 2008 lowered to 1.9% due to mortgage problems – down a full percentage point.
  • Likelihood of 6.4% unemployment with an additional 3 million jobs lost.
  • Property value drops nationwide estimated at 7% for 2008 – a loss of $1.2 Trillion to homeowners.
  • U.S. Home Prices fall 4.5% nationwide in Q3 of 2007 – the largest decrease ever.
  • 191 Mortgage Lenders out of business.
  • Cities expected lose a minimum $400B of economic activity due to the housing crisis.

Was loosening the traditional lending standards really worth it?


S&P: 3Q Home Prices Fall by 4.5 Percent
S&P Says 3rd-Quarter Housing Prices Dropped by Sharpest Rate in Index's 21-Year History

Report: Foreclosures Will Sap U.S. Cities

Since late 2006 - 191 major U.S. lending operations have "imploded" (11/27/2007 figure)

Have We Seen Worse of Mortgage Crisis?
New Wave of Mortgage Failures Could Create a Nightmare Economic Scenario

Housing to slow growth in 2008
A report warns of 20 percent hit on Triangle economy; U.S. growth may slow 25 percent

Increasing Risk: Real Estate in China

There is one real estate market where a meltdown would comparatively make the situation in the U.S. appear to be minor league. Only one country has both the population and rising speculative real estate values to claim this distinction – China.

A number of economists such as Yi Xianrong are sounding the alarm. There are two primary issues, the first being the false data on many mortgage applications. This is somewhat tempered by the requirement for large down payments on many real estate loans in China.

"I estimate that the large majority of mortgage holders would not meet the standards for even subprime loans," Yi said in an interview with the state-run magazine Oriental Outlook.”

The second risk is the speculative real estate spiral. A good number of owners view real estate as a money-making scheme, similar to the “flip this house” phenomena in the U.S.

“Many Chinese families are already deep into speculating on property, a main driver of the surging prices that have Chinese authorities worried that a bubble might be forming.”

It is still an open question regarding how long the situation can continue and how badly this speculative cycle will end. There is still a huge demand for housing in China, this has to be countered with the huge price increases and questionable credit practices for personal housing loans.

Housing market, risk surge in China

Monday, November 26, 2007

Black Friday: Not So Happy for Retailers

It appears that the spending on Black Friday was not enough to hold up the retailers today, despite the best effort of the ladies in my family to boost the retail index by heading out at 3am.

Despite initial estimates that sales increased 8.3 percent from a year earlier to $10.3 billion by research firm ShopperTrak RCT Corporation based on a measurement of foot traffic, in reality each customer spent an average of 3.5% less according the National Retail Federation.

U.S. Consumers Spent Average of 3.5% Less on Shopping

As expected this news caused the retail sector to plunge nearly 2% today, combining with continued credit fears to drive the market to the downside.

Retail Stocks Fall; Black Friday Spending Seen Lower

Sunday, November 25, 2007

Screening to Win: RSI (Relative Strength Index)

This is the second installment in the series "Screening to Win". This article discusses utilizing the Relative Strength Index technical indicator in your screening. The first article about Moving Averages can be found at:

The overview below describes one of the common technical indicators – Relative Strength Index and provides insights on how to utilize it in your stock selection. Hopefully this outline will provide traditional fundamental investors with some solid insight on how to incorporate technical indicators into their screening. The free HingeFire Stock Screener which can be found at is one of the few tools available that includes a wide selection of fundamental and technical criteria for selecting stocks. Using a combination of fundamental and technical screening is a powerful tool for winning in the market.


Relative Strength Index Overview

First if is important to not confuse the RSI (Relative Strength Index) technical indicator with the Relative Strength fundamental criteria. Relative Strength compares the price of a stock to an index (or another stock) over a period of time and performs a comparison; while the RSI momentum oscillator compares the magnitude of a stock's recent gains to the magnitude of its own recent losses and transforms that information into a number that ranges from 0 to 100.

Relative Strength Index was developed by J. Welles Wilder and introduced in his 1978 book, New Concepts in Technical Trading Systems. The basic components include the Average Gain, the Average Loss, and the calculated RS values over a period of 14 days. RSI converts the underlying information as an index that runs from 0 to 100. High values of RSI are generally considered an indication that the stock is overbought while low values are regarded as oversold.

The HingeFire tool provides support to incorporate RSI in your creation of screens for stocks. Support for multiple common levels is included. Users can scan to determine if a Relative Strength Index is greater than or less than a particular level, and also establish if the RSI just crossed above (JCA) or below (JCB) a threshold.

How to use RSI in screening

In his book, Wilder recommended using 70 and 30 and overbought and oversold levels respectively. His work postulated that if the RSI rose above 30 then it is considered bullish for the underlying stock. Conversely, an RSI dropping below70 is a bearish signal. Some traders identify the long-term trend and then use extreme RSI readings as entry points. For example if the long-term trend is bullish, then oversold RSI readings could denote possible entry points.

Since the time of the original RSI work from Wilder, many traders have adopted the 20 and 80 levels of RSI as the levels of most interest instead of 30 and 70. Which levels are of most value is regular subject of theoretical debate. The 20 and 80 RSI levels represent greater extremes that operate better in more volatile markets. Investors should try both and determine which are most useful for their stock selection process. The HingeFire tool provides support for all of these levels.

RSI is a momentum oscillator and a solid indicator of medium term trends. Investors normally use RSI to time transactions or to filter stocks to exclude.

Oversold Territory

Stocks with an RSI below 30 or 20 are considered to be oversold. Some oversold stocks are due for a bounce back. Others have negative fundamental and trend information associated with them and may continue to dive in price. A number of investors screen for stocks with low RSIs and then sort through the results to see if any gems are available at attractive prices.

Avnet Inc (AVT) recently endured a downtrend and has arrived at an RSI level below 30 which indicates that the stock has entered oversold territory. If an investor believes that the long term fundamentals associated with the stock are sound then they may select this as an entry purchase point and expect the stock to reverse the trend as the selling fizzles out.

Overbought Territory

Stocks with RSI levels above 70 or 80 are considered over bought. A number of these stocks may continue to rise and exhibit high RSI readings for a period of time. A good quantity of these stocks are due for a tumble however as they approach an exhaustion level of available purchasers in the market. A number of traders screen for high RSI levels and then review the charts for possible short candidates.

The RSI for Suntech Power Holdings (STP) recently crossed above 70 again. Note the previous price retrenchments of more then $8.00 when the RSI indicator rose above 70 in late October and early November as buying was exhausted.

Filtering Buys

A number of investors filter their potential purchase decisions with an RSI level of above 20. This will exclude stocks that are demonstrating continually lower days which have the possibility of dropping further over the upcoming weeks.

Filtering Sells

Investors focused on shorting stocks will filter the market for candidates with an RSI below 80. This avoids stocks exhibiting continually higher days that may continue to increase in price for a period of time (until exhaustion occurs).

Break above Oversold

One of the most common uses for RSI is to scan for stocks that just broke above the oversold condition and now should continue to rise. The HingeFire tool supports searching for stocks that just crossed above (JCA) various thresholds. A breakout above 20 or 30 indicates a solid change in momentum for a stock as it exits an oversold condition while increasing purchases occur.

Wyndham Worldwide (WYN) recently experienced a spree of selling with an associated drop in price over the past several weeks. The RSI just crossed above the 30 level which may be a signal that the downward momentum is broken and the stock price has potential to rise.

Break below Overbought

Inversely, another common use for RSI is to look for stocks that have just crossed below (JCB) the overbought condition at the 70 or 80 level. This normally serves as notice that the stock may continue to fall over the upcoming few weeks. Sometimes the stock will revert on increasing volume into the overbought condition again if new buyers flood the market; more normally this indicates the start of a medium term reduction in purchasers for the equity.

The RSI for Saul Centers (BFS) recently just crossed below (JCB) the 70 level. Note the several week downtrend that occurred with the stock after the RSI dropped below70 in mid- October. At this point the buying was confirmed to be exhausted and BFS continued to drop in price.

Avoiding Extremes

Some investors simply want to avoid extremes when timing their stock transactions. These investors will filter their decisions with an RSI >= 20 and < 80 (or use 30 and 70). This type of filter enables investors to avoid stocks that are currently in greatly oversold or overbought conditions. In many ways, this is a method of reducing volatility risk for long term investors.

RSI Summary

A number of investors look at RSI on charts to scrutinize for divergences between RSI and the price trend of the stock. There are also investors who utilize the mid-point of 50 as a single break level between rising and falling prices; however most screens based on midpoint show no real potential unless the investor evaluates the associated chart information. The most common utilization of RSI however is screening for oversold and overbought levels as outlined above.

Summing up, many astute investors use the HingeFire tool to screen for the following situations with Relative Strength Index.

Oversold Territory – Screening for stocks with RSI levels below 20 or 30.
Overbought Territory – Screening for stocks with RSI levels above 70 or 80.
Filtering Buys – Looking to purchase stocks only with RSI levels above 20.
Filtering Sells – Looking to only short stocks with RSI levels below 80.
Break Above Oversold – Screening for stocks that JCA the 20 or 30 level.
Break Below Overbought – Screening for stocks that JCB the 70 or 80 level.
Avoiding Extremes – Screening for stocks only between 20 and 80 (or 30 and 70).

Combining technical indicators such as Relative Strength Indicator with commonly used fundamental criteria when selecting your investments helps put the market edge in your corner. The RSI support in the HingeFire Stock Screener adds a powerful tool for timing your buy and sell transactions to pull excess alpha out of the market.

Wednesday, November 21, 2007

Happy Thanksgiving

Best wishes to everyone for a happy and safe Thanksgiving. Our entire family will be visiting my in-laws up at the lake this weekend and I expect to be off-line relaxing till Sunday.

The big event never seems to be the turkey anymore, it is Black Friday. All the ladies in our extended family will be up bright and early on Friday to make our family’s direct contribution to the retail spending index.

Just a couple quick articles before the Black Friday festivity…
Consumers glum on eve of key shopping season

Leading index growth rate at a 63-week low: ECRI

Now Shop Hard! …. You can make a difference. :)

But more importantly, enjoy the holiday and focus on what is really important… your family and friends.

Retro: The Dumbest Retail Business Move of 2007

In what many have labeled the dumbest business move of 2007; Circuit City fired more then 3000 high paid workers in March and replaced them with lower-paid staff.

Fast forward the clock to eight months later and Circuit City is begging these former employees to come back. Circuit City has tried to improve its employee image; pushing the concepts of career path, better work environment, improving morale, and superior pay. For the most part most of the former employees are not buying any of it and have told the retailer to get lost.

Most analysts view that Circuit City was on the exact wrong track and the recent changes will not improve the situation. The survival of the company is in doubt unless a strategic partner gets involved; but no outside investors have been willing to step up to the plate to get involved with this dismal retailer.

Circuit City asks ex-workers to return

Just remember the two golden rules for struggling retailers:
1) Shut down underperforming locations if you must scale back.
2) Make sure that you keep experienced, higher paid staff in place.

Circuit City managed to ignore both of these rules, and both eliminated and infuriated the top portion of its workforce in the process. Some retailers don’t deserve to survive, and according to most analysts this may be one of them.

Sometimes the one year chart says it all:

Foreclosures increase crime and drop property values

Suddenly foreclosures rather than “how to flip your home to make millions” is the focus of the majority of homeownership articles. It only took a mere six months to go from one extreme to the other in the financial press.

In a tribute to “Captain Obvious”, recent articles hawk the reality that foreclosed homes are a magnet for crime and cause neighboring property values to drop. One figure to note, each foreclosed house in your neighborhood will cause your home value to drop by 1%.

In the meantime, those turning off the lights at bankrupt mortgage companies wring their hands and exclaim, “Who would’ve thought that lending money to people who never could have repaid it would cause a crisis in neighborhoods across America.”

Empty Houses Home to Crime As Loans Fail
Neighborhoods Suffer As Crime Follows Foreclosures Into Vacant Houses

Protecting your Home’s Value in the Era of Foreclosures
Foreclosures can affect the value of your property even if you've been paying your mortgage faithfully. Here are some ways you can protect your home's worth if your area is hit hard by foreclosures.

Tuesday, November 20, 2007

Dismal Housing: No End in Sight

Fannie, Freddie, Countrywide, and some builders crowded the front page of the financial press today as their stocks dived to new significant lows.

Freddie Mac (FRE) reported a $2 billion dollar loss as the fair value of its assets dropped by $8.1 billion. Freddie indicated that it must seek outside funding in order to meet regulatory liquidity requirements; meaning an immediate infusion of up to $4 billion is needed to keep the government sponsored mortgage entity afloat. Additionally, the firm was forced to increase its provision for credit losses to $1.2 billion, from $112 million, a year ago. Most investors view Fannie Mae (FNM) as being in a similar situation. The speculation is that the issues will just keep getting worse in upcoming quarters.

Countrywide (CFC) spent most of the day denying bankruptcy rumors as their stock tumbled below $10 for the bulk of the trading day. This is a case of the stronger and more frequent the denials, then the greater the probability of the filing occurring sooner rather then later. Many local investors give them less than six weeks in our bank “death-watch pool”. The situation may possibly end with some sort of merger with another bank in which assets are valued for pennies on the dollar as the last resort

On the homebuilding front, D.R Horton reported (DHI) reported huge quarterly losses today. While there is speculation that many builders will go under due to liquidity issues, Standard Pacific (SPF) sunk over 20% today on this type of concern. Many more will surely follow.

Some traders would look at the huge tumbles of FNM and FRE as short time buying opportunities as the market was over enthusiastic in punishing both stocks for the negative news from Freddie. There is a good likelihood of a short term rebound. However the recent news today that drove the stocks to 10 year lows is just the leading edge of further write-downs that will occur in upcoming quarters. Leaving both government sponsored entities drained of capital and desperately seeking financial assistance. This may amount to further issuing of preferred instruments which smacks the existing common shareholders, to the straight-out begging for a bailout from the federal government (read as “possible bail-out with your tax dollars”).

Housing's Roof Collapsing

“The drop in housing prices is causing most of the pain. A report from real estate information firm released Tuesday shows that U.S. home values fell 6% in the third quarter, the largest decline in the last 10 years.”

“On top of that, nearly 16% of homeowners who bought houses in the past year now have negative equity in their homes, meaning they owe more than what their homes are currently worth, the report says.”

The turmoil leaves many of those focused on mortgages or housing with a knot in their stomach. The question for many active investors will be “when will it be time to start bottom feeding and grabbing the survivors at rock bottom prices”. Who wants to catch the falling knife or should we just let it bounce off the floor and grab the handle down the road?

Quick Takes: More Economists Predict Recession

The number of U.S. economists predicting a recession in early 2008 has nearly doubled over the past two months. The impact from the housing slump, credit crunch, reduced consumer confidence, and higher energy prices will reduce economic growth in the upcoming quarters.

More Economists See U.S. Recession Ahead, NABE Says

International Housing: Home Prices Drop in U.K.

The housing tumble is not a phenomena contained to the U.S.; the housing prices in the United Kingdom dropped in the most recent report. The U.K. market shared many undesired similarities with the U.S. market over the past few years; weak lending standards, out-of-control speculation, rampant price increases, a bank-driven secondary derivative market for mortgages, and other disconcerting parallels.

Resembling the U.S., the situation is now coming home to roost in the U.K. Many British banks are under pressure from mortgage defaults and there is an increasing likelihood that several will have to be bailed out; potentially leading to more bank runs similar to the recent panic where British mortgage lender Northern Rock PLC saw unnerved customers withdraw billions of pounds from their accounts.

U.K. Home Prices Fall; Sellers Told to Ask for Less
U.K. home values dropped this month in every part of the country except London and sellers shouldn't hesitate to reduce prices further because a more protracted slowdown is on the way.

“If you have to sell, then seriously consider dropping your price and taking an offer now rather than holding out,'' Miles Shipside, commercial director at Rightmove, said in a statement. ``You could be offered even less in a few months. Prices are set to flat-line.''

Quick Takes – Wall Street

Q: So what do you get when you have lost $74 billion of your shareholder’s equity?

A: Record Bonuses of $38 Billion.

The large investment banks appear to be out of touch with the overall dissatisfaction with their performance. Once again as shareholders of Goldman Sachs Group Inc., Morgan Stanley, Merrill Lynch & Co., Lehman Brothers Holdings Inc. and Bear Stearns Cos get crunched, while the insiders walk away with record bonuses. Where is the alignment of share performance and financial compensation?

Wall Street Plans $38 Billion of Bonuses as Shareholders Lose

“They're paid very handsomely in good times because they're supposed to take a hit in bad times,'' Fitzpatrick said. ``Performance has dwindled this year, and I think they should feel that.''

Monday, November 19, 2007

What to do if your rental is foreclosed on

The mortgage crisis is not restricting its pain to owners; many renters are being evicted from their homes when foreclosure occurs. Many are only given a few hours notice when a sheriff shows up at their door. The New York Times had an article over the weekend that discussed this now prevalent situation.

As Owners Feel Mortgage Pain, So Do Renters

The immediately critical question for many renters is "what should you do if they want to evict you during foreclosure proceedings?" Taking the right steps can buy a renter critical time to find a new place to live.

Many times a bank will be the new owner after a foreclosure. Sometimes the home is sold at auction and you will be dealing with a private individual. In the current environment a renter probably has more leverage with a bank from a regulatory and practical perspective. A bank is normally interested in cutting a deal to get you out of the home in a reasonable timeframe without having state banking regulators pestering them. A private individual who purchased a home at a foreclosure auction simply wants to move in to their new home as soon as possible and will get a much more sympathetic hearing from any third party such as a court.

What grounds do you have to avoid eviction?
First, let’s start with the assumption that you have consistently paid your rent on time, there is a written lease in existence, and the lease does not end shortly. Most leases have a requirement that either party must give the other 30 days notice prior to taking action. Some states view that properties are still encumbered with existing lease agreements if the house changes hands. If you are a renter in good standing and are given less then the notice period to evict the property then you have solid legal ground in many states to stall the eviction proceedings and threaten to take the situation to civil court. Most banks and purchasers very much want to avoid court and normally will consider providing a more reasonable timeframe to relocate then a few mere hours.

What regulators can help?
The most valuable people to call, if a bank is threatening to evict you, are the State Banking Regulators. Demand action to prevent your eviction for 90 days from the bank. In many states these regulators are very helpful in these situations; others view it as outside the scope of their oversight. Regularly call to follow-up and ask for details on their interaction with the bank. Calls to the state AG’s office or BBB are not likely to have much impact on a situation that is effectively a non-fraud related civil dispute. Banking regulators have more influence over the actions of banks.

Call the eviction authority
Call the enforcement agency in charge of carrying out evictions and demand that they not proceed with the eviction because you have not been given proper notification as the renter. Different states have different rules about notification period requirements to people actually living in a home. A simple phone call with a follow-up letter may stop the authority from carrying out eviction proceedings until the bank can definitively prove that they have properly served you with an eviction notice and met the timeframe standards.

Pressure the banks for more time
Call the bank or mortgage company and demand 90 days notice. Under pressure from regulators and politicians a number of banks have implemented an unannounced adoption of this policy before it can be imposed on them from the states and federal government.

Demand your deposit back prior to leaving
Demand the deposit back from landlord and the bank in writing via registered mail prior to moving out. If they fail to return the deposit then they have failed to meet the terms of the lease. This will normally slow down the momentum of the eviction proceedings; however many banks will simply tell you to sue your old landlord for your deposit and it’s not their problem. On the positive side, the letter will provide a firm evidence trail for any further action after you leave.

Demand proper compensation to move out quickly
Many banks will pay you to move out quickly. A number offered is usually a measly amount like $500. Demand a sum that covers your entire security deposit back plus moving expenses to move with any urgency.

Be Prepared!
Be prepared to move out quickly if necessary. Line up a place to put your stuff on short notice, such as storage unit or at a friends/families garage if possible.

The Final Rent payment
If the eviction is inevitable within 30 days with no chance of extension and you have no commitment about the return of your security deposit, then stop paying rent. This is one of the very few real estate situations where you should consider withholding rent. Send registered letters to the landlord, management company, and/or bank stating that you are doing this, and you will take them to court if any negative references show up on your credit report relative to the final rent payment. Keep in mind that an owner that can’t pay their mortgage is unlikely to ever return your security deposit; nor will a bank or new owner return money they never collected. At worse the landlord or bank will take you to court about this, in the same hearing you can demand your security deposit back in front of a judge who will probably view the situation as a wash.

Contact the management company
Lean on the management company (if there is one) to strictly adhere to the terms of the lease in regards to eviction and notification. If you live in a state where management companies are regulated (usually by real estate boards) and the management company is not being cooperative in defining timelines in regards to when the home will be repossessed and when you have to leave, then explain to them that you will be contacting the agency that provides oversight and make a fuss. This may make the management company more cooperative. You would think that management companies would have a human interest in doing the right thing, but most don't.

If the management company is cooperative, you may want to ask them about other equivalent homes that you could potentially move into which are listed in their available inventory. You also may be able to cut a deal for the deferral of an upfront security deposit on the new residence if the management company has a conscience about your situation.

Leave the home in good order
Despite your dismay at being evicted for no good reason, it does not make sense to take your anger out on the rental home. Leave the home “broom clean” and in good order. It is not worth the headaches of having the bank or new owners come after you for ripped out light fixtures, broken plumbing, or other destructive problems. Nor would this benefit you in any civil legal action after you leave. Document any existing problems in the rental that are due to normal wear and tear (worn carpet, etc.) or other causes (water damage due to leaks from the roof, etc.) that are not your fault prior to leaving.

Keep Records!
Keep notes of all conversations and the full names of who you communicated with regarding the eviction situation.

Be Proactive
If you have any concerns that the home that you are renting may be at risk of foreclosure then it is important to search online to determine if the home is due to be foreclosed upon. There are a number of websites that provide this information for a small fee.

Taking the steps outlined above can help slow your eviction as a renter in a foreclosure situation, and provide you with critical time to find a new place to live. Always be polite when dealing with all the parties, but still be demanding and understand your rights as a renter within the state that you live. Many states have web-pages and government agencies that provide an overview of the rights of renters and landlords. The reality is that your eviction is inevitable in most foreclosure situations; the best you can hope to do is buy time. Rarely will you get the opportunity to stay with the property unless it is immediately sold to a private owner who plans to rent it.

Sunday, November 18, 2007

Screening to Win: Moving Averages

This is the start of a series of articles that describe how to successfully screen for stocks. The initial essays will cover some common technical indicators. The follow-up articles will provide examples of winning screens that utilize both fundamental and technical indicators. This material will eventually be placed on the HingeFire website.

At HingeFire, we believe that investors should take advantage of every aspect of screening to put the market edge in their corner. Fundamental criteria are an excellent gauge of the prospects for a company over a lengthy period of time. Technical indicators provide important clues about the short term momentum in the market, effectively reflecting the fear and greed of traders.

Investors with long time horizons can use technical indicators to enhance their returns. Studies have demonstrated that using technical indicators to time the entry and exits of long term investments can increase the basis return by over 4% points. It makes sense to use technical screening in conjunction with your fundamental examination of potential equity selections to boost your portfolio.

The good news is that technical indicators are not magical voodoo, most have sound theories behind their logic that all derives back to the innate psychology of the market. Additionally, technical values are simple to understand and helpful in implementing your market execution decisions so it behooves investors to comprehend them.

The overview below describes one of the common technical indicators - Moving Averages, and provides insights on how to utilize it in your stock selection. Hopefully this outline will provide traditional fundamental investors with some solid insight on how to incorporate technical indicators into their screening. The free HingeFire Stock Screener which can be found at is one of the few tools available that includes a wide selection of fundamental and technical criteria for selecting stocks. Using a combination of fundamental and technical screening is a powerful tool for winning in the market.

Moving Averages

Moving Averages Overview

There is an old expression that “Bulls live above the 200 Day Moving Average and Bears live below the 200 Day Moving Average”. In many ways this adage holds true. Associating a stock’s price level with its moving average is a very reliable approach to determine the trend.

The two most common types of Moving Averages are SMA (Simple Moving Average) and EMA (Exponential Moving Average). Simple Moving Averages are created by simply totaling the closing prices for the defined time period and dividing the total by the total number of days.

An EMA applies more weight to recent prices relative to older prices. The weighting applied to the most recent price depends on the specified period of the moving average. The shorter the period of an EMA, the greater the weight applied to the most recent price.

An exponential moving average will always tend to be closer to the current price then a simple moving average. From a reliability perspective, EMA has a tendency to “whip-saw” more then SMA moving averages, providing short-term false breakout and directional change signals, due to its reliance on more recent information. Conversely EMA provides a quicker indication of the underlying changes in the pricing of the equity, allowing an investor to jump on board changes in trend. The question of which moving average is best is subject of a “religious debate” among theoreticians. Investors should try both and determine which is most useful for their selection process.

The HingeFire tool provides support to incorporate moving averages in your creation of screens for stocks. Support for both SMA and EMA is included. Users can scan to determine if a stock price is greater than or less than a particular moving average, and also determine if the price just crossed above (JCA) or below (JCB) the moving average today. The tool also provides the capability to compare the levels of different moving averages.

How to use Moving Averages in screening

The HingeFire screener supports allowing users to determine if today’s closing price is above or below the SMA or EMA for multiple time frames. Most investors view that closing prices above or below the moving average in longer time frames such as 200 day, 100 day, or 50 day provide a solid indication of a stock being bullish or bearish. Many investors use this assessment as a filter for their entries, typically going long on stocks whose prices are above their long term moving averages and tending to short stocks below these levels.

Short-term moving averages provide information on quick price acceleration or deceleration. A stock that is above its 5 day and 20 day moving average is likely to be accelerating in an uptrend and is prone to continue an upside breakout. A cross-over back below a short-term moving average can serve as a signal that a stock upswing is exhausted and it may be time to take profits.

AeroCentury Corp (ACY) recently broke out above its 20 day and 5 day SMA. Many momentum investors look for these conditions as entry points, and would view the stock price dropping back down below these levels as a sign of exhaustion and exit the trade. ACY was simply one of many stocks found when using the HingeFire tool to screen for the closing price being above the 20 day and 5 day SMA levels.

The HingeFire tool also supports determining if the pricing has just crossed above (JCA) or just cross below (JCB) a moving average level. These cross-overs potential indicate a change in trend from bearish to bullish or visa-versa. Many investors screen for these cross-over changes in order to scope out stocks that have potential before they become widely exploited by the market.

For example the stock price of Techwell (TWLL) just recently broke out above its 200 Day SMA near $12.65; this many times serves as notice of a change in momentum for the stock. Many investors would view this as a possible entry point if they believed that the stock had sound fundamentals.

The comparative level of moving averages to each other also reveals noteworthy information about stocks. The HingeFire screener supports comparisons such as the 200 and 50 day moving average levels. Support for JCA and JCB is also provided for comparing these moving averages. Many investors view that when a 50 day moving average crosses over the 200 day moving average, it serves as confirmation of the bullish signal for the stock. This type of confirmation usually lags the exact start of the trend but helps investors avoid situations where the trend quickly reverses.

Recently the 50 Day SMA of Avon Products (AVP) crossed above the 200 Day SMA; many investors would view this as solid confirmation of the bullish trend. Avon is one of the stocks that came up this past week in a scan of the 50 day SMA (red line) crossing above the 200 day SMA (blue line) using the HingeFire stock screener.

Moving averages can also serve as a support level, occasionally news will come out about a stock that causes the price to drop near its 200 day or 50 day support level. Sometimes the stock price will bounce-off of these support levels rather then diving below them with significant volume. Numerous investors screen for these situations as entry points and purchase their stocks near these support levels.

A recent example is CSCO dropping to its 200 day support level shortly after its recent earnings report. A regular screening of Cisco would show the price dropped slightly below the 200 day moving average (blue line) near the 9th of November. Many investors with a bullish fundamental long-term outlook on the stock would view this as an entry point to purchase CSCO.

Note that long term moving averages can also serve as resistance levels with some stocks having difficulty penetrating this barrier with volume sufficient to carry them higher. Investors focused on shorting commonly screen for scenarios where prices fail to breakout solidly above larger time frame moving averages.

In summary, many knowledgeable investors use the HingeFire tool to screen for the following situations with moving averages:

  • Equity prices being above or below long term moving averages function as a filter to either purchase the stock long or sell the stock short.
  • Prices rising above or dropping below short term moving averages act as a momentum breakout indicator or serve as a profit taking point.
  • Prices crossing over larger time frame moving average levels indicate a change in long term momentum. This serves as a possible entry point for investors to beat the crowd.
  • Comparison of moving average levels act as a confirmation of a trend.
  • Moving average levels serving as support or resistance levels.

Combining technical indicators such as moving averages with commonly used fundamental criteria when selecting your investments helps put the market edge in your corner. The HingeFire Stock Screener provides support for both fundamental and technical indicators, a powerful combination that will enable your success in the market.

Saturday, November 17, 2007

“We have not seen a nationwide decline in housing like this since the Great Depression"

The maze of weekend reading has produced some gems this week. The first was the quote above from Wells Fargo Chief Executive John Stumpf. Once in a while a banking industry insider hits on the exact correct perspective and provides a real zinger of a quip that puts the state of affairs in context.

Wells Fargo: All's Not Well

Earlier this week, Fortune provided commentary questioning the soundness of Wall Streets practices. The banking firms continual implement repetitive cycles of destructive behavior, never learning from previous lessons while always chasing higher fees.

In the past I have commented on the cycle of greed trumping common sense and adequate risk control in the banking sector.
Banks: The Worse is Ahead

Fortune declares “In pure destructive power, the subprime mess has become Wall Street's version of Hurricane Katrina.” From any perspective, the investment banks have finally stepped in a bog where there is no easy way to pull their foot out. The size of the carnage triggered by the credit meltdown is dazzling. A couple further quotes from the article provide additional perspective:

“Predictable because whether it's junk bonds or tech stocks or emerging-market debt, Wall Street always rides a wave until it crashes. As the fees roll in, one firm after another abandons itself to the lure of easy money, then hands back, in a sudden, unforeseen spasm, a big chunk of the profits it booked in good times.”

"The fee engine becomes so huge that these products take on a life of their own," says Tiger Williams, CEO of Williams Trading, a leading financial services firm for hedge funds. "Everyone rationalizes that it's safe because they're making so much money. But it's far from safe."

The Fortune article is a worthwhile read; the bulk of the article outlines how Merrill Lynch created mortgage backed CDO packages while failing to follow sound risk control practices.

Wall Street's money machine breaks down
How Merrill Lynch broke down in the subprime mess
The subprime mortgage crisis keeps getting worse-and claiming more victims. A Fortune special report.

Friday, November 16, 2007

Credit Crunch = $2 Trillion Shock

A number of recent estimates have calculated the projected direct losses of the mortgage related credit crunch at over $500 Billion. This figure primarily focuses on the write-downs at banks and other institutions.

A recent estimate on the overall impact of lending by Goldman's chief U.S. economist, Jan Hatzius, places the reduction in lending at over $2 Trillion. This type of scale-back has the significant probability of triggering a recession or causing a subpar growth scenario over the next few years. Remember the old expression about 'the economy slides on a slippery slope of loaned money." Any type of reduction in mainstream lending to worthy creditors has a negative impact on macro-economic growth.

Economist: U.S. facing $2 trillion lending shock
Goldman Sachs analyst predicts impact from credit crunch

Thursday, November 15, 2007

Finally: Some Truth in Real Estate Projections

Most of the articles about real estate prices are sunny, projecting a quick pricing rebound in all local markets by late 2008. The majority of these media items almost read like a press release from the real estate industry, regularly quoting NAR and other stakeholders who have an interest in positive spin on the deteriorating situation.

Finally an article has come out that looks at the cold, hard facts and attempts to perform some realistic real estate market evaluation based on math. A recent article in Fortune projects the prices five years from now using the most reliable indicator of all, price-to-rent rates. The results clearly demonstrate that the quick recovery jubilantly projected by the real estate industry is fiction, and homeowners better be prepared for a multi-year cycle of pain.

Price-to-Rent rates are like a P/E for home prices. Similar to P/E’s for stocks, the price-to-rent ratios are mean reverting, and will always eventually come back to the mean once a speculative real estate market bursts. From 2000 to 2007 the nationwide P/R jumped from 15 to 24, an increase of 60%; this steep climb is not sustainable, and housing prices will eventually correct or rents rise to properly remedy the situation. Performing P/R calculations brings some disturbing conclusions; real estate will have to drop in price by an average of 16% across all markets to reflect proper pricing. This includes the expectations of increasing rents. Some local markets will show far worse downside performance.

The results for 54 areas around the country can be found in this table:

On average, a home that sells for $436K will drop in price to $372K five years from now. A house in San Francisco will be worth $1,568M in five years if the current value is $1,732M. In Raleigh, a house currently valued at $447K will be worth $381K in five years.

The information demonstrates that the real estate price decline is likely to last for a significant period of time, now that the era of lax lending standards has come to an abrupt halt. In the long run, the return to traditional lending standards and non-speculative valuation is a solid positive for the economy. However existing homeowners need to be able to deal with some valuation pain over the next few years as the situation corrects itself.

Real Estate: Buy, Sell, or Hold?
by Shawn Tully
Thursday, November 15, 2007,-Sell,-or-Hold

Wednesday, November 14, 2007

ETF to Short China

For those who believe that the Chinese stock market is a bubble, there is now an easy way to take action on your convictions. The UltraShort FTSE/Xinhua China 25 ProShare (FXP) moves twice in the opposite direction of the Chinese stock market. The underlying index is the FTSE/Xinhua China 25 Index.

Doubling down on a global downturn
ProShares funds short booming Chinese stocks, other emerging markets

A Few Billion Here… A Few Billion There…

…And pretty soon you hit some serious write-downs. Today Bear Stearns announced they would write-off another 1.2 billion dollars in the fourth quarter. Yesterday Bank of America announced a write-down of 3 billion of mortgage-related investments and spent $600 million to prop up its money market funds. HSBC said it would write-down $3.4 billion in bad loans.

The total of write-offs at the large banks has now gone over the $50 billion mark, and this is just the beginning. Many industry watchers believe the world-wide bank losses will exceed $500B. Soon it will be a question if the capital structure of some of these institutions can handle the losses.

A number of banks such as Goldman Sachs have stubbornly refused to take write-downs, smugly secure with the notion that the credit crunch will pass. Recent announcements indicate that the firm has piled into a short position in housing debt to offset the loss on the price of other assets. Despite CreditSights and other firms estimating Goldman needs to take $5 billion in charges, the firm is still sticking by its line that it will have no significant write-offs.

With some banking firms taking a continual stream of write-downs and others with their heads apparently stuck in the ground, is it time to start a bank “death-watch” pool?

BOFA’s Turn: $3B Write-Down

Goldman's CEO sees no big write-down

Tuesday, November 13, 2007

Are your Brokerage Assets safe at E*Trade?

As outlined yesterday, there is an increasing probability that E-Trade Finanical will need file for bankruptcy. Customer assets at E-Trade are generally divided into two classes; the first being brokerage assets. These would be the stocks, bonds, mutual funds, and other items found in your brokerage account. Brokerage account assets are insured by SIPC up to a value of $500,000; this does not protect against market losses but guards your account in case the broker goes out of business. Usually the assets in your account will simply be transfered to another brokerage firm if the current one goes under. SIPC insurance has been demonstrated to work well in the past in situations where brokerage firms have declared bankruptcy. The following article provides an overview:

Investor assets said safe in E-Trade accounts

So what should you be concerned about at E-Trade?

Brokerage money market accounts offered directly by E-Trade and not backed by FDIC insurance are at risk. Many of these money market accounts are not likely to be covered by the SIPC if E-Trade goes under (despite the SIPC coverage for up $100K in cash and $500K in securities).

E-Trade also has a division which operates as a standard bank (E-Trade Bank). This is different then your brokerage account. If you perform your banking at E-Trade then these accounts are covered up to the $100,000 FDIC limit. However any money kept in your bank deposit accounts above this limit will be lost. This is why is is critical that you transfer cash above the FDIC limit out of your E-Trade bank account now.

Unless you have brokerage assets above $500K then the stocks, bonds, mutual funds, and other instruments in your brokerage account are also safe. There is no need to panic or take action with your assets at E-Trade if they are below the SIPC (brokerage) or FDIC (bank) insurance limits. Everyone should note that most of the analysts are giving E-Trade a 1 in 6 chance of going under, so it is important to transfer assets above these limits if you are not comfortable with the current sizeable risk of losing your money.

Monday, November 12, 2007

What are Level 3 assets?

The Financial Accounting Standards Board (FASB) recently issued the FAS 157 standard which is being implemented starting on November 15th. This standard requires that firms divide their assets into three categories called Level 1, Level 2, and Level 3.

Level 1 means assets that can be marked-to-market, where an asset's worth is based on a real price. One example would be a liquid stock traded on an exchange.

Level 2 are assets which are marked-to-model, an estimate based on observable market inputs but no direct available quoted prices. The firm can get several bids to derive the price, or base the pricing assumptions on what similar assets have sold for recently.

Level 3 values are based on "unobservable" inputs reflecting companies' "own assumptions" about the way assets should be priced. In other words, Level 3 assets are based on effectively best guess, or in many situations what firms want to value these items for in order to improve the situation in the books.

The majority of derivative instruments carried on the books of brokerages are Level 3 assets. The recent credit crunch has revealed the greater part of these items to be toxic waste, not worth pennies on the dollar of the value that the firms have them listed for in their books. Pressure from shareholder and regulators coupled with the new FASB standard are driving large banks to come clean about the proper value of these assets.

Just how big are the Level 3 assets?

Many of the banks have far more Level 3 assets than they have capital. Some examples that have been talked about in recent articles are provided below:

Equity base: $128 billion
Level 3 assets: $134.8 billion
Level 3 to equity: 105%

Goldman Sachs
Equity base: $39 billion
Level 3 assets: $72 billion
Level 3 to equity ratio: 185%

Morgan Stanley
Equity base: $35 billion
Level 3 assets: $88 billion
Level 3 to equity ratio: 251%

Bear Stearns
Equity base: $13 billion
Level 3 assets: $20 billion
Level 3 to equity ratio: 154%

Lehman Brothers
Equity base: $22 billion
Level 3 assets: $35 billion
Level 3 to equity ratio: 159%

Merrill Lynch
Equity base: $42 billion
Level 3 assets: $35 billion
Level 3 to equity ratio: 38%

This discussion does not even touch on the problems with Level 2 assets; many of these have lost value and are distressed. The disconcerting situation with Level 3 alone makes it evident that there are still significant write-downs at these firms which must occur. Recent information points to an expectation of losses over $500 billion across the sector. Some banking entities may be in such poor shape that they topple or are forced to merge.

In some sense the situation is both a liquidity crisis as well as a confidence crisis. Banks agreed to create the Super-SIV fund to improve liquidity, but the effective traction on implementation has been slow. Confidence further erodes with the continuing stream of bad news, and is not likely to improve over the upcoming month as banks reveal further losses. All of this leads to the likely situation of the credit crunch continuing for the forseeable future and having a broader economic impact.

FASB - Summary of Statement 157

FASB FAS 157 - Fair Value Measurements

Warning: Etrade

A good number of people use E-Trade for banking services as well as their brokerage. The bad news is there is a high probability that E-Trade is heading for bankruptcy and their banking deposits over the $100,000 FDIC limit are not safe.

"Citi Investment Research analyst Prashant Bhatia cut E-Trade's rating to "Sell" from "Hold." Bhatia said there is a 15 percent chance E-Trade will have to declare bankruptcy".

I would urge that investors take immediate steps to transfer bank deposit assets out of E-Trade that are above the $100,000 limit. Also keep in mind that money kept in money market accounts at E-Trade that are not backed by FDIC insurance may not be secure.

Out of the Gate: E-Trade Financial Falls

"Half of deposit accounts, representing about $15 billion, are higher than the Federal Deposit Insurance Corp.'s $100,000 threshold."

Sunday, November 11, 2007

Parallels: Winning Traits

I had the pleasure this weekend of watching my oldest daughter’s soccer team play in the Final Four of the State Cup. Her team overcame many obstacles this season and despite being rated an underdog made it to the Final and walked off the field with silver medals. My daughter’s personal journey included bouncing back from a serious car accident in the middle of the season. Fighting through injuries, struggling early on, and working to constantly improve during the season, the team of girls managed to peak going into the state cup tournament series held over the past three weeks.

While cheering for the team the banter among the parents on the sidelines included soccer, safe cars for teens, the weakening real estate market, public financing of sports venues, and personal finance. A couple thoughts struck me as I watched the game and conversed with the adults. The first was the disparity between the parents who were confident about their personal finances as compared to those whom were disorganized and adrift.

The immediate second thought was how the ideals that drive a victorious soccer team also align with the successful finances for families. Winning sports teams possess several attributes that also have investing parallels:

  • Have a plan - Each game is mapped from a plan of how you execute. Teams work towards creating strategies that play into their strengths and cover their shortcomings. Similarly, any financial plan is mapped to your strengths and needs. It is critical to have a well understood plan in sports or family budgeting.
  • Stick with the plan - It is not simply enough to have a plan, you must execute on the plan. Sports teams that don’t stick with a plan flounder, this is no different for the fiscal situation for families. Planning is important, but worthless if you do not stick with the plan over time. In order to have a successful financial situation, it is important for families to faithfully follow through each month to meet their objectives.
  • Solid Technicals - In soccer, technicals are how you touch the ball. In investing, it involves how you perform the minute details of the strategy. Do you know how to go online and sell your stock? Can you read a chart and figure out the current value? Can you go online and pay your bills easily while balancing your checkbook? Technicals are your “monetary touch”, in this case how you execute your basic financial tasks. Does every first touch in a soccer game need to be exactly perfect to win? Or should we ask do you have to always buy a stock at the exact low of the day to win? The answer is no, but the basic technicals must be place in order to be successful in either venue.
  • Tactical Strength – In soccer, tactical includes your structure, communication, and execution of your strategy. In a similar vein, the tactical side of investing involves proper implementation of diversification, and utilizing the instruments that will get you to the finish line.
  • Align with the Plan – On a soccer team all the players must be “rowing together” in order to be successful. Similarly, household finances quickly become shambles if one spouse saves while the other regularly runs up sizable credit card bills. It is important that both partners align with the same vision of planning their financial future and then jointly march to the same tune. Nothing causes chaos in households more quickly than not having members share the same fiscal outlook.
  • Passion – Athletes who win have a passion for the sport. Investors who win have a passion for making the right choices in terms of debt, credit, spending, investing, and finances. To triumph at personal finances it is important that you have passion to do what is right for your family over binge purchases using credit card debt and other prevalent omissions. In some sense passion is self-control. On the other hand, it is the ability to step up and make the right choices with heartfelt conviction.
  • Athleticism – Some facets of athleticism are innate; other aspects players can be trained on. Improvements in speed and strength can be achieved with training. In the same way, “financial athleticism” involves your understanding of investing. Similar to the situation on the field, it is not simply a situation of “what you are born with is what you got”. Investors can always work to improve their knowledge and savvy.
  • Proper Coaching – One of the most important aspects to winning is consistent, knowledgeable coaching. In addressing finances many families use paid planners; others may simply read advice from experts. There are a number of ways to get coaching for your investments. However it is critical that the coaching is does not drift all over the map, and is coming from sources with your best interest in mind as opposed as coming from someone who simply wants to make commissions or sell a product. Coaching for your finances is a valuable service, but it needs to be aligned with your long term needs with no improper bias.

    Clearly there is a mapping between qualities that drive achievement in sports and personal finance. More importantly, families that are successful financially demonstrate the attributes outlined above. Other families mired in debt and facing fiscal dilemmas appear to possess few of these characteristics. The good news is that it is always possible to turn around and become successful over time by focusing on the essentials; in the same manner that by concentrating on the fundamentals struggling soccer teams can become triumphant squads at the end of a season.

    I would like to thank the NCYSA for organizing another excellent State Cup playoff series, the Refs for putting up with the parents on the side lines, the Coaches for their dedication & time, and the Parents for their support of the players.

Friday, November 9, 2007

Lifecycle that makes sense

Many savvy financial experts are hesitant to recommend lifecycle or target-date funds because many are just a pyramid of fees; burdening the investor with the expenses of both the underlying funds and additional fees for the management of the life-cycle fund. These funds come across to many as just another way for fund families to increase their revenue. Coupled with the reality that very few of these funds outperform their associated indexes, most investors would be better off managing their own diversification.

The crux of the problem is the expenses; automatic lifecycle as a concept works if the fees can be reduced. Fortunately there are a number of ETFs now offered that provide expenses that are typical less then half of most life cycle funds in the market. Target date funds are popular conceptual with investors simply because you can “set & forget”; the advent of life-cycle ETFs are likely to enhance their broad acceptance with the probable added benefit of driving many large mutual fund families to reduce their fees for these vehicles.

TD Ameritrade and XShares have launched five new target-date ETFs; TDAX Independence 2010 ETF (TDD), TDAX Independence 2020 ETF (TDH), TDAX Independence 2030 ETF (TDN) and TDAX Independence 2040 ETF (TDV) and TDAX In-Target ETF (TDX). These target-date ETFs have expense ratios of 0.65%, compared with about 1.3% for the average comparable mutual fund, Other ETF underwriters plan to offer other lifecycle choices shortly, many of these will have even lower expense ratios.

The recent round of pension reform, in which QDIAs were defined by the U.S. Department of Labor, will place lifecycle offerings as the default investments in numerous 401K plans. Many of these retirement plans will likely start considering the ETF lifecycle products as employees clamor for lower fees.

New ETFs Target Retirement Market

Thursday, November 8, 2007

Washington Mutual: Going down in flames

First let me disclose my long term dislike for Washington Mutual; therefore it difficult to describe this bank without some level of bias. I heartily cheered when this institution stopped doing business in North Carolina after the state banking regulators basically told them to take a hike.

Even the most ardent optimists would have difficulty in seeing a shiny side of the WaMu coin now. The recent stock price slide pretty much tells the story as WM now hits lows not seen for over 7 years. All the risk items that I have outlined in the past about this bank have come home to roost, and this appears to be only the leading edge of the story.

In the opinion of many people, Washington Mutual has had a long history of shady business practices, abusive interactions with customers, and financial statements that are less then transparent. Some of the particular items that WaMu has been accused of include:

  • Improper handling of acquired loans in a manner that was abusive to customers with the sole intent of generating increased revenues for the firm.
  • Pushing people into improper loans that had higher fees. Regularly breaking the federal truth in lending laws in a deliberate manner.
  • Pushing for appraisal of homes above market value. WaMu is currently being investigated for this by N.Y. Attorney General Andew Cuomo.
  • Improper reflection of the both the loan write-downs and derivative pricing on company books. Failure to disclose the actual financial state of the company and follow standards consistent with GAAP.
  • Lack of proper understanding regarding the handling of credit risk and failure to disclose relevant business information to shareholders.

One of the classic articles about WaMu and their improper treatment of mortgage holders can be found at:
'I Can't Believe They Treat People Like This.'
Washington Mutual, the nation's no. 1 mortgage lender, calls itself a customer-friendly bank. Many customers beg to differ.

Further information critical of Washington Mutual can be found at:

I would urge people to read all of this information before doing business with Washington Mutual.

Recent Washington Mutual Press Articles:
N.Y. Attorney General says WaMu demanded higher appraisals

Washington Mutual: Things Are Worse

Washington Mutual Falls Hard, Again