“Too Big To Fail.” We saw it with Countrywide Financial. We saw it with Bear Stearns. As the controversy expanded, there were more than a few smarties defending the need to save big financials because of the systemic danger their failure would inflict upon the world’s intertwined and complex financial structure. Chairman Bernanke suggested he really didn’t want to do what he did with Bear Stearns….only did it because of stuff associated with the “too big to fail” phenomenon….and doesn’t ever want to do it again. Personally, I doubt that Bear Stearns will be the only test of “too big to fail” before this mess is all over.

When I went through the charts this past weekend, I was struck by how many regional banks and S&L’s suddenly looked weak after some attempts at recent stabilization since mid-March. It caused me to think heavily about the other side of “too big to fail.” If the government is committed to only bailing out banks that would cause systemic national and international distress, then there is an inevitable concept coming that I call “Too Small To NOT Fail.” Okay, so National City got about $1 billion of pseudo Private Equity money from JP Morgan Corsair. Washington Mutual got $7 billion from TPG et al. There are rumors about other PE firms circling the S&L’s and regionals looking for opportunities. But the reality is there are thousands of these small financial firms and I suspect many of them are in big trouble. Their reserves for losses are insufficient. They need capital and some will get it. But there is not enough capital to cover it all and some of these banks will just not be appealing enough for new investors to put up the money.

In the early stages of the failures that will likely result, there won’t be a government bailout entity like we had with the S&L crisis. Instead, there will be a tough love stage where the banks will be allowed to fail. And then the politicos will start complaining why we could bail out the big guys on Wall Street at Bear Stearns (Too Big To Fail) and not the little guys on Main Street in small town America (Too Small To NOT Fail). Eventually, as the banks that could not obtain new capital topple, it will be tough to avoid small bank runs and then I expect that we will learn that even something small can lead to something big.

Americans and their ass-kissing politicians are at it again.  Watching the Chairman sit in front of the Congressional committee today was about as painful as it can get.  I always wonder why politicians, especially Republicans, love to suck up to Ben and thank him for his fearless leadership and great contribution to saving the American economy since August.  HMMMM!  I guess they are giving themselves and the administration a pat on the back for putting this guy in charge.  But just save it.  Please!   Enough of the bullshit.  The economy is a mess and it is impossible to know whether it would be more or less of a mess with or without Chairman Bernanke.  It is a mess because of us, all of us, not just Bernanke or Greenspan.  And not just because of some politicians who know so little about economics and finance that they cannot even figure out whether they are questioning the Fed Chairman or the Secretary of the Treasury.  It wasn’t funny.  It was pathetic.  But the worst of all is the discussion about a stimulus plan.  I guess everyone finally figured out that the greatest monetary interventionist policy in history couldn’t fix the problems.  So now it’s time to believe in a fiscal policy solution and hearing Bernanke plead for immediate help was about all I could handle.  I know the populists are demanding it and after all, they seem to be in charge these days.  But in the end, it will not work.  It may get a few votes for one political party or the other but it will not solve the problem.  At some point, and I fear that point will only be found after great financial pain, Americans may once again realize that the economy is their responsibility, not the responsibility of their government.

For whatever reason, there was a significant amount of improvement on the technicals of many financial stocks - mostly small regional banks. Almost all the repair came on Friday and looks pretty odd to be honest. I saw no fundamental reasons why this occurred and yet, the breadth of this move in financials was very strong. It really looked like a coordinated effort as I seriously doubt it was an accidental and highly coincidental decision by “bargain hunters”. If you are short the financials, I suspect you suffered enough to take notice. However, if this is all news to you, I strongly suggest you pay close attention.

Each day the mortgage crisis gets worse, a bigger problem is getting worse.

Each day the CDO / credit crisis gets worse, a bigger problem is getting worse.

At some point, we are going to have to be objective and evaluate the capital at the companies that provide financial guaranty insurance. Some people just look at companies like MBI, ABK, RDN, PMI, MTG, ACA etc. and say that the stocks have declined a lot already so that must mean the worst is priced in already. Of course, this is a ridiculous way to evaluate risk, but it’s certainly the easy way for far too many investors. Please take the time to consider each company in this space. Evaluate their capital vs. the value of the insurance they have written. If the company has capital that is a fraction of their exposure and there is a good chance that the products they have guaranteed will fail, this is more than a warning sign.

A year ago, when no one really looked at risk and exposure - these companies were humming along. Now it’s a giant circular problem. When the ratings agencies gave the financial guaranty insurers high ratings and the financial guaranty insurers provided the issuers with “protection”, it was a happy time for the money machines. Now that the underlying financial instruments have been shown for what they are, this happy circle of friends is broken. Each time a writeoff occurs, each time the borrowers struggle, each time a rating agency lowers its assessment, each time a financial guarantor is downgraded …. it is a vicious circle. So in the end, when the financial guarantor cannot deliver on its commitments I really wonder who will be making good for them. Which brings me to the heart of this post - reinsurance for financial guaranty insurance. Please give it some thought.

Oil is a great lesson on the price of fear. Of course, supply and demand is the primary component of what traders pay for a barrel of oil and a declining dollar doesn’t help, but when you look at the rest of the price - it’s fear. It’s convenient to blame the trading pits and hedge funds for speculative premiums in West Texas Intermediate Crude. However, I look at this one layer deeper - what is fueling the speculation?

In the spring, the hurricane “fearcasters” provide the anxiety so let’s blame them for $10. Why $10? Because it’s as good or bad as any other number that people throw at problems that are not quantifiable. My point is that the traders are only speculating based upon the opportunities they are given. They do not create the weather. They do not create the fearful weather forecast. Furthermore, they did not create the hype around the Katrina disaster and they did not disseminate it or perpetually remind us of it. You can blame the media for that - say $5 per barrel. In the spring, we start the gluttonous US driving season and for that, you can blame American consumers and of course, the media once again for reporting how much we continue to drive around the country all summer long. How about $2 per barrel for that one. For most of this year, geopolitical events have not provided a base of fear for the traders to speculate about. So now that the Dems have perfectly timed a 90-year late Turkey genocide resolution with the administration’s failures in Iraq, the traders have an opportunity to profit from fear. Again - the traders did not piss off the Turks, the Dems and Republicans did. So you can blame the politicians for the $7 per barrel that has been tacked on in the past two weeks. And of course, you can share some of that with the media once again for making this even more sensational and fearful than the real impacts Turkey’s threats would have on actual oil supplies.

Just add up all my SWAG on that fear speculation and you come to $24 for the price of fear. You might say that things like the driving season are over and the hurricane season is almost done so if you want you can cut down the current fear premium to about $15. But this is an important argument - there is no opposite to a fear premium. There are always remnants of fear. Even in peace, we fear the loss of peace. Even in perfect weather, we fear the oncoming storm. So you can take the temporary event away, but the fear is also real and it persists to build a base. While we may get pullbacks on the positive resolutions to dramatic events, the base keeps building.

In the end, global energy demand continues to rise and supplies are harder and harder to increase. But when it comes to fear, right now it’s only the supply side that is exploited. Until the emerging market growth slows and/or the US economy slows, I don’t see fear affecting the demand curve. We fear hurricanes because of supply disruptions and yet, we haven’t had any of those for 2 years, but we fear them anyway so the price goes up. We fear war in the MidEast because of supply and yet, the actual effects of all the war in Iraq has had little effect on worldwide crude supply.

Blame the traders and hedgies all you want. The price of fear is provided by others and until the demand side of this equation provides some balance, supply worries will present themselves and they will be exploited. Pullbacks are not movements towards a lower price, they are just abatements to the fear of the day, week or month. Home heating season is the next new opportunity, soon after that it’s time to hear the 2008 hurricane fearcast, driving season will undoubtedly return and so it goes. In the words of FDR, “the only thing we have to fear, is fear itself.” I know he wasn’t talking about oil prices, but it certainly applies.

When it comes to foreign telecoms, I feel like I’ve been disconnected from reality.  These stocks have had tremendous returns over the past few years and my performance on their signals has been poor.   For the most part, the fundamentals are at a discount to US-based telecoms but I am struggling with many chart patterns that continue to look top heavy.  Unfortunately, my pessimism on a bunch of these stocks has been incorrect.

Latin American stocks are en fuego! (”on fire” for you gringos).  China’s stock market gets a lot of attention but I am much more impressed by Latin America.  The Latin American 40 ETF (ILF) was in the low $30’s when the US bull market started 5 years ago, today it closed at $255.  Even more amazing are the returns since mid-August.  The ILF is up about 40% and the Brazil ETF (EWZ) has rocketed over 50% in the past two months.  You don’t need to buy ETFs to add some spicy stocks to your portfolio as you can pull up almost any stock from the region and you’ll see similar gains.  Compared to China, the fundamentals are much better and I like the superior liquidity and transparency you get with companies that have been around much longer than Chinese stocks.  I don’t like the socialist political tone in the region but most of the stocks have done well.  Putting it mildly, HEDGEfolios performance in individual stocks and ETFs of this region has been pathetic.  And to be honest, from a technical perspective I still don’t like the charts on many of these stocks.  But for the most part, I have been wrong.  So I am spending a tremendous amount of time this week trying to figure out how to do better.

Last week, there was massive and broad-based technical damage done to many interest rate sensitive stocks.  I saw a bunch of 5% to 10% declines in individual stocks while the associated ETFs had only minor moves.  This divergence is very troubling.

I rarely comment on things like this unless a situation is so dramatic that it biases my signal work. As I go through the technicals and can recognize what industry a stock is in solely because of a familiar chart pattern, it’s very rare and it’s worth mentioning. By the end, it becomes a game for me to see how many I can guess correctly before even looking at their symbol.

But losing money is no fun and it’s not a game, so please pay special attention to the banks, REITs and Utilities. I was a bit surprised to see the weakness given the Fed’s reduction to rates and the market’s supposed belief that they are committed to more cuts.  The media keeps suggesting that the financials have bottomed and there is an abundance of investment managers who support that view.  However, last week’s action was highly inconsistent with optimism for financials and I strongly recommend that you pay close attention to what is happening rather than what people want to happen.

Six months ago, I wrote about LEH, BSC, and GS Vaporizing Subprime and pushing the markets higher. In fact, if anything bailed out the markets from the three weeks of pain in February and March, it was the well-crafted earnings reports and comments from the investment banks. Hopefully, you’ll note a touch of sarcasm in my piece from 6 months ago. The idea that Wall Street firms were able to contain or hedge their risk to years of loose credit in subprime and other categories was not believable - but the markets bought it back then. Investors got what they wanted to hear - problem solved! But of course, the economic realities have only worsened and within only a few months, most of the containment crowd was exposed as overly optimistic if not recklessly ignorant.

So now that the investment banks are about to put out their numbers, will investors get what they want to hear? This time around, there is the sentiment that it would be comforting to see them “throw in the kitchen sink” and get all the bad stuff they didn’t admit to before out of the way. Isn’t that great?!? As I wrote the other day, I am not a fan of Financial Fudge whether they report good or bad numbers. But now that LEH just came out with a beat and the market is responding favorably, it might lead you to believe the worst is over -AGAIN. The old saying “Fool me once, shame on you…Fool me twice, shame on me” just doesn’t seem to apply here. Instead, the market seems to say “Keep on fooling me.” It will be fun to watch all the other financial firms post their numbers but just as I suggested 6 months ago, the economic facts are quite different. Investors may be tempted to assume that beating estimates means all is well or they may also be willing to believe that bad numbers mean the worst has been already factored in. I just happen to have a different view.

Pull up the WFC chart and you’ll see a financial stock that is not in trouble. Despite all the hype that financials (primarily the banks) have gotten excessively oversold and are tremendous bargains - I just don’t see it. I know it’s important for the bulls to lift up the financial sector. After all, it is the biggest percentage contributor to the S&P 500 index and many fundamentalists and market historians will tell you how important it is that the financial sector lead and participate in stock market moves. But back to WFC - the stock has appreciated 15% over the past two weeks and it is trading at record highs. You can thank Ben and Warren for that.  So much for the concept that all financials have been unfairly punished because of subprime. WFC is not alone. Just look at a sample of stocks that have had huge moves (about 20% on average) in the past two weeks:

ALAB, AMFI, ASBC, BFIN, BKMU, BOH, BPFH, CATY, CBH, CBU, CFFN, CFR, CHCO

CHFC, CINF, CMTY, CNB, CSBK, CTBK, CYN, DCOM, FBC, FCBP, FCF, FED, FFBC

FFCH, FFIN, FFIC, FFG, FMER, FNB, HOMB, LBAI, MTB, NBTB, NPBC, OMEF, OSBC

ONB, PEBO, PFS, SASR, SBIB, SBNY, SFNC, STBA, SUBK, TCBI, TMP, UBSI

WCBO, WFSL, WSBC, WSFS, WTFC

Do you feel sorry for the financials now? I don’t. Certainly a few pure mortgage plays have suffered but with all the Fed intervention, many financials have benefited greatly and are actually higher than July 19th. Personally, I look at all this and start to wonder whether these companies are better now than they were 2 or 3 months ago. I agree that many of them were oversold and the Fed intervention and short covering have certainly pushed their stock prices higher. However, it’s important to take a look at the fundamentals and ask whether their business prospects are better now than they were a few months ago. I guess if you are in the camp that believes the economy is great and there is no chance of a recession you might like their valuations. If that is the case, then what was all that Fed intervention about?