GM/CHRYSLER BANKRUPTCY
In terms of headlines, I’m not focusing on North Korea. I am focusing on the potential GM bankruptcy. I won’t discuss Chrysler since it is not a public company, but I lump it into the same boat with GM.
A simple 6 month chart plotting GM against Ford shows that Ford has been outperforming GM and recently this divergence has increased. Ford is known to have a better balance sheet and has lower bankruptcy risk in the short term. To me, all things being equal, GM and F would be highly correlated. The fact that there is such a divergence tells me that the market believes GM’s risk of bankruptcy has increased within the past few weeks. The chart therefore appears to match up with the news articles discussing GM’s demise. I also think the firing of Waggoner is a worthy signal. I’ve followed a number of companies going into bankruptcy, and it seems quite commonplace for CEOs (and more often CFOs) to be swapped out before the bankruptcy filing comes to fruition. I won’t go into the reasons for it.
Moreover, one thing the government is becoming better at is managing the headline risk. Rather than blindsiding the market with an announcement of a bankruptcy, they tend to soften the blow by leaking the possibility to the media weeks before the ultimate event occurs. Obama has been talking tough for weeks. The firing of Waggoner. The new CEO is now talking tough.
What does it mean for trading this week? I think it could potentially be a downside catalyst. It would translate to massive layoffs, pensions plans being tossed into the PBGC (and not being paid off to the beneficiaries in full), cancellation of contracts with suppliers, dealerships being cut, etc. In short, it could trigger other bankruptcies and would certainly make the employment numbers much worse over the next few months.
Another possibility is that this media campaign by the government and GM’s new CEO about the bankruptcy is just a bluff to bring the unions to the table. I personally don’t think it is a bluff. I believe what the GM/F chart is telling me (if it was a bluff, I don’t think the market would be fooled). I also don’t believe the unions have the ability to make concessions which are required to get GM where it needs to be and even if the unions did step up to the plate I’m not sure it would be enough.
Additionally, I honestly cannot think of a better candidate for a Chapter 11 (reorganization) bankruptcy. The company could be profitable it was not bogged down with various creditors and other stakeholders. This is exactly what bankruptcy is for. A bankruptcy would permit GM to renegotiate deals with suppliers, banks and creditors generally. It would permit GM to void out the union contracts and cut its workforce. The pensions will be dumped into the PBGC so that the company can get back to producing cars instead of primarily being a benefits provider. Quite frankly, I’m not sure if there has ever been a better candidate for bankruptcy than GM.
What I am unsure about is what kind of action the government will take to smooth out the effects of the bankruptcy. The government will definitely be providing debtor-in-possession financing (DIP financing) to GM. This means that the government should be getting a senior position in front of other creditors in return for lending money to GM to keep it operating. In addition the DIP financing, I think the government will have other programs (ie., more bailouts) to assist the laid off workers, GM suppliers and other creditors and stakeholders impacted by the bankruptcy.
With that in mind, I could see the bankruptcy impacting the market in two ways. The bear case would be simply that the market sees this as higher unemployment (even with any short term stimulus provided to GM employees by the government) and more potential bankruptcies in the auto industry.
Also, let’s not forget about Ford. Ultimately, even if the headlines don’t mention it, Ford will be worse off because of the GM bankruptcy. The government may stay quiet, but part of this plan will mean a bankrupt Ford as well. It may take some time, but Ford cannot compete with legacy free GM. This is not the typical situation where a competitor goes down the tubes and the surviving company is left in a better position. Ford generally has all the legacy costs that GM has. This is similar to the airlines. It is very tough for the airlines with legacy costs to compete against airlines which have gone through bankruptcy.
The bull case would be the market “pricing all of this in” and receiving this auto bailout as positive news since because will create a lean GM and also provide assistance to all of the various GM stakeholders. The real feel for the market would be the collateral damage caused by the failure of GM (and Chrysler). If the government could sell the public that they are taking care of the collateral damage, perhaps the market could digest the news as positive.
I’m planning for the simpler bear case. I think price momentum is getting tapped out here and that makes it more likely for the market to digest this as bad news. I also think that as a practical matter this is bad news so it is the most intuitive way for the market to digest the news. If $SPX was at 670 and RSI was at 20, I might see this a little differently. If that were the case, it increases the chances of the market digesting the news in a way that would be considered counter-intuitive.
MARKET OVERVIEW
Moving on, without guessing the news, I’m looking at SPY, DIA, QQQQ and the VIX.
There is a lot of resistance from January-February on SPY. Price momentum has been marching along right at resistance as well. I think the market will have some trouble breaking above 85 on SPY and certainly above 88 on SPY without fantastic earnings news. With the GM news in the background, I’m not inclined to get long here.
DIA did breach $80 which was key to confirming the move up on $SPX. Still, it is a little early yet. This was just a small breach and rather than reading this a breakout I’m equally inclined to read this as bumping up against resistance (similar to the way I am reading the $SPX chart).
Generally, as I discussed
earlier in the week, I this the market is hard right here. We are at an action point, but I think there are decent arguments for both the long and the short side. This is why I am in “idle mode” rather than throttling up my portfolio in either a long or short direction.
As I mentioned last week, I had to respect the breakout on the QQQQs above the January and February highs and I closed my short position (which is why I am now in a hedged neutral portfolio rather than net short). Even I am not sold yet, I certainly respect the long side of the market right now.
The next chart I am looking at is the VIX. One reader had asked why I waiting for a drop in the VIX under 40 to confirm the move up as valid. The thought by the reader being that the market moves up when there is “fear” and therefore if the VIX goes down it shows the market is complacent which would actually be a bearish signal. Let me explain how I see it.
Under no circumstances is a VIX above 40 a healthy market. In the dot com crash, the VIX tapped out at 40. With the VIX at 40, we still have major fear in the market. Put another way, the market is not normal right now. If I see the VIX break under 40, it shows me that perhaps volatility is heading back to normal levels. If volatility goes back to being more normalized, then perhaps the market itself is becoming normalized. If the VIX were at 35, on an absolute basis, we certainly don’t have to worry about the market being complacent (if you are bullish).
The hard part about the market is nothing is white or black. While I see a dip below 40 in the VIX as showing a return to a more normal market and a confirmation of the move up, a VIX which is too low combined with other factors can certainly be evidence of complacency in the market and thus a bearish signal.
INDEXES
Semiconductors look pretty good to the long side right here. Easy to manage risk with a stop just below $19.
Thanks to Amazon.com, XRT looks good here to the long side. RSI is sky high but could be worth going long on a pullback to $24 or $22 (depending on what you want to risk). My stop would be just below $22. This would be a hard trade for me to take. My gut (which I don’t listen to) tells me that retail is set for a fall (especially with earnings coming), but the chart objectively looks good once RSI cools off.
I’m still short XLU with a stop at $26.75 (stop at the February highs). I think XLU is looking pretty good here to the long side and if I get stopped out here I might switch from long to short.
FXI could be a decent short opportunity here. The January high could be used as a stop out (maybe set a stop at $32.3).
PRECIOUS METALS
It looks like we may not have to listen to the radio commercials for “cashing in your gold jewelery” much longer. Or, at least perhaps it will taper off a bit.
Gold looks like it will fall hard if the $87-88 range does not hold.
Silver looks equally sick if $12.60 does not hold.
CURRENCY
I shorted FXY on Friday. I have my stop at $101.5. I think the break under $100 is significant.
The dollar looks like a classic bear flag type pattern with some upward consolidation after the big drop. This looks like it is going lower.
I will be updating my page listing my holdings shortly.
I’m having the chat at 8pm eastern which is accessible by clicking on “Charts and Coffee Chat Room”
I also posted over the weekend a few long ideas:
MNRO – Enter $27, stop just below $26.
NSH – Enter $21, stop just below $20.
SGR – Waiting on earnings on April 8th. Would jump in if earnings take it above $30.
MOO – Waiting for it to breakout above $31.