Friday, May 28, 2010

Summer Rally Trying to Begin

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

Before I went into the meat of last week’s contribution, analyzing what’s now known as the Flash Crash on May 6 (“flash” referring to flash trading or warp speed computer trading), I touched on the stock market’s behavior and what I expected to occur over the coming days and weeks. As I wrote about in February during the last pullback, Bottoming Process Continues, I offered similar analysis last week.

“Often times, the low of the crash day is revisited at least once over the coming weeks and months, known as a retest.”

“ It’s ugly in the markets and lots of blood in the streets. While I don’t sense true panic, yet, there is certainly lots of worry and concern. If history is any indication, this correction should wrap in the next week or so and lead to another rally.”

We are now one week later, and after sticking my neck out here and on CNBC, I feel a little better, having seen several constructive trading sessions where the bears were first rejected at the same level as they were in February and then hit hard on Thursday.

Where do we go from here? On Thursday during a recent interview, I offered that we’ve seen enough historic oversold and washed out indicators to warrant at least a short-term, if not an intermediate-term, rally. Think of stretching a rubber band. The harder you pull, the harder it snaps back when you let go. It’s essentially the same with the markets. The band has been pulled pretty darn tight this month!

Those of you who are more technical in your analysis can look at popular indicators like the McClellan Oscillator, which measures the number of stocks going up and down on a given day, sentiment surveys among individual investors, the ARMS index, which is also a measure of stocks going up and down on a day along with volume as well as the behavior in small time (and usually wrong) options traders.

So many indicators were stretched about as far as they get unless we were on the cusp of an all out crash, something I did not think would happen and the odds were heavily stacked against. And now, the major indices are in a position to rally substantially into what is now my longstanding time target of Memorial Day to Labor Day for the final peak in this bull market. I will be keenly watching how bullish investors become should we see this rally, along with the number of stock market sectors participating in the rally and which are leading the way. This should clue us in on a potential top during the summer.

And until proven otherwise, I have to stick to my Dow projection of 11,500 to 13,000. You can bet I was mighty worried about that during the throes of the selling. Risk/reward wise, I think the short-term downside is to 9,600 - while the upside is well above 11,000.

Stepping back and looking at 2010, stocks are still down significantly in May, having given back all gains on the year and now showing a loss for 2010. My forecast for the year hasn’t changed either, calling for a best case scenario of a few percent up and worst case of down double digits. And I also continue to believe, controversially so, that treasury bonds will end up as a surprisingly good investment for 2010. This was mentioned in my 11 Shockers for 2010.

Feel free to email me with any questions or comments at

Until next time…

Paul Schatz
Heritage Capital LLC

Friday, May 21, 2010

Markets Run Amuck - Part II

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

Before I get into part II of Markets Run Amuck and discuss what I believe really happened on May 6, let me add some comments on what’s going on in the markets.

Generally speaking, I believe the weakness we are seeing right now, although being blamed on geopolitical events, is nothing more than normal and expected market digestion from the mini crash of May 6.

Historically, crashes and mini crashes are short-term events with an accelerant, something like pouring a torrent of gas on an already existing fire. It makes the fire much hotter, bigger, stronger and out of control. In market terms, crash-like behavior is volatility expanding to an extreme in a very short period of time. Stocks may have been seeing moves of +1% to -1% and all of a sudden that expands to +5% to -5%.

In the days and weeks (and sometimes months) following the crash or mini crash, volatility remains high, but steadily decreases, think of an ice cream cone that gets smaller and smaller the farther down you go. That’s what we are likely seeing right now. Volatility was at an extreme on May 6 during the mini crash and is still digesting that huge, outsized move. Often times, the low of the crash day is revisited at least once over the coming weeks and months, known as a retest.

So now, it’s ugly in the markets and lots of blood in the streets. While I don’t sense true panic, yet, there is certainly lots of worry and concern. If history is any indication, this correction should wrap in the next week or so and lead to another rally. Until proven otherwise, I continue to forecast the ultimate bull market peak this summer between Dow 11,500 and 13,000, something that seems as hard to believe now as it did last summer when I first mentioned it!

Getting back to the title of this piece, I want to spend some time talking about what I think really happened, who is to blame and what should be done. As I mentioned last week, I do NOT think this was the result of human error or a fat-finger mistake. The S&P 500 futures market and exchange traded fund (ETF) products was where the real crash began. It then spilled over and hit almost every stock as bids (buyers) totally evaporated and that giant sucking sound you heard was that of liquidity being drained.

Rather, the market was weak to begin with and buyers were not showing high conviction. Stocks were trading “heavy” and some large computer driven sell programs hit the market after 2:30 p.m. This triggered more computer driven selling and the specialists on the floor of the New York Stock Exchange (NYSE) saw something strange and decided, with good reason, to slow everything down. BUT, as they were trying to find order, the computers continued to pummel stocks that were also listed on the NASDAQ, forcing even more selling into a vacuum.

As an aside, this has been happening much more frequently since stocks went to decimalization, trading in pennies rather than 1/8, early last decade causing the NYSE specialists to reduce their risk appetite since reward was cut. Couple the increased involvement of computer driven trading and decimalization with the less price sensitive foreign market participant, and you’ve got a whole sea change of behavior in the financial markets.

Back to computers. Keep in mind, these are not your typical Dell or Apple computers. As I just learned at a conference on May 4, the most powerful computers can execute more than 1,000,000 trades in one second. Multiply that by the numbers of firms using them and the amount of capital at their disposal. It gets kind of scary! And when the specialists on the NYSE stepped away to try and slow the action down, mayhem broke out.

The reason you saw stocks trading at pennies or ridiculous amounts below their recent prices was because as bids dried up and the NYSE folks took a pause, computers searched for other bids to sell into, even if they were placeholder bids at a penny or a few dollars. In short, the system was totally broken for 20 minutes.

While it’s easy to blame all parties involved, and I watched the NYSE blame the NASDAQ and vice versa, I really think the computers got out of hand, just like they did in 1987, 1997, 1998 and 2008. Events the programmers assign a minute chance of occurring in 1000 years continue to happen with regularity. And computers are only as good as those programming them.

Since that day, Congress and the SEC have done a great job demanding explanation and assuring people that they will get to the bottom of the incident. To date, there has been little uncovered because it all happened in the norm of trading and there were no mistakes as far as I can see. Everyone is screaming for more circuit breakers to be added in order to stem the tide automatically when this happens again. I have mixed feelings when it comes to artificially manipulating the market. It makes sense from a populist point of view, but it has never been proven to do anything other than in the really short-term. Water finds its own level regardless of what you put in its way and all this does is put off the inevitable.

The problem I see is that you have a purely electronic market at the NASDAQ and a hybrid market at the NYSE. They are fiercely competitive and love to blame each other rather than work with each other. I would put them in a room with a mediator and not them leave until they agree on a compromise. My ignorant two cents is that when volatility really expands, I would rather have humans involved to try and keep a fair and orderly market moving than letting the computer run amuck. That may mean slowing down computer driven trading during extreme movements but not eliminating it. The tighter and tougher regulation there is, the more likely that business will move to a foreign market where conditions are more favorable. And that will cause liquidity, the prime source of market fuel, to disappear.

If you are interested, I will be interviewed on WTNH this Saturday, May 22, at 7:35am. Additionally, I will be on CNBC’s Squawk Box, today (May 21) at 9:40 a.m. as well as this Thursday, May 27 at 6:10 a.m.

Please feel free to email me with any questions or comments at

Until next time…

Paul Schatz

Heritage Capital LLC

Friday, May 14, 2010

Markets Run Amuck – Part I

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

Let me start off by apologizing for not posting this last week.  As the markets were supposedly coming unglued, I was in the midst of trying to attend four conferences in a row in Florida along with spending some time with my family in Orlando.  I ended up attending three of the conferences, had my first Hole-In-One and most importantly, was able to take my family to Disney before heading over to Fort Lauderdale for the annual NFL Players Association Financial Advisor meeting. 

While the Hole-In-One was definitely exciting and something that’s eluded me for 37 years playing golf, there was nothing better than watching my kids enjoyment level hit all time high levels as they ran around the various Disney parks with our whole extended family!  Getting back to the NFL conference, I met some truly special players who agreed to be interviewed for this blog and share their stories.  I think you will be very surprised.  It’s going to take me some time to get this all organized, but you can plan on reading more as summer hits.

So, I am sitting at lunch last Thursday (May 6), watching the market through my phone.  As you can see from the chart below, it had been weak for the past week or so, a pullback I had been expecting, wrongly so,  for some time based on the fears of Greece defaulting on their bonds and that spreading to the other PIIGS countries: Portugal, Ireland, Italy and Spain.  Since markets have become so globalized and connected over the past 10 years, such problems would certainly have ripple effects on our shores.  In my 11 Shockers for 2010, I listed a European government debt default and subsequent run on the Eurozone as a potential disaster.

Getting back to May 6, the markets were all weak as lunch finished up and I headed back to my room to prepare some buy orders for the close. As you can see from the chart below, the Dow was down 400, and it had the feel of more selling coming during the final hour and the potential for a turnaround on Friday as the most important economic report of the month, the employment figures, was scheduled to be released at 8:30am. What happened that afternoon was simply incredible and something I have only seen a handful of times, if that, in my 22 year career.

Those of who are active in the markets probably know that the final 90 minutes are often the most important and interesting of the day. We typically see the final wave of margin calls between 2:30pm and 3:00pm and many mutual funds begin to see their inflows and outflows beginning at 2:30pm. The treasury bond market also closes at 3:00pm, so volatility usually increases as managers rebalance their asset allocations at that time. There’s an old traders adage that says “never trust a rally that begins before 2:30pm” when looking for the market to reverse a downtrend.

As 2:30pm hit, a tsunami of selling hit the market. The following is a 1 minute chart so you can really see what happened. Each colored bar represents 1 minute of trading. The chart above shows you what happened from the opening at 9:30am until just before 2:30pm. The next chart below shows you the action over the next 15 minutes.

During this crashette or mini crash, the Dow imploded another 600 points in 15 minutes and my first reaction was that of a geopolitical event, like an attempted assassination on the president or another world leader or some kind of nuclear terrorist attack. It looked liked trading was about to be halted as stocks reached one of the circuit breakers instituted since the 1987 Crash and then I figured it would be closed for the day and open down another 1000 points on Friday as the world digested whatever was going on.

That was until the next 10 minutes hit as stocks reversed course on a dime and soared higher by 500 Dow points. At that point, I started scratching my head and thinking about trader error.

Zooming out a little so that each bar represents 5 minutes of activity, you can get a better idea of the whole day. Stocks were weak, crashed and then snapped back to pre-crash, but still weak levels.

Within minutes of the snapback, the media began floating the idea of a fat finger error, where someone meant to sell millions in stock, but ended up selling billions in stock. While that’s perfectly logical and does happen from time to time, I was dubious right from the start that a single trader could cause such a widespread collapse.

Additionally, as the market was cascading lower, I called up a watch list of some 200 stocks and exchange traded funds (ETFs) to see how they were individually behaving. A fat finger error would certainly not implode every stock. But what I saw was simply amazing.

Bids, the price and amount of stock someone is trying to buy below the current price, completely evaporated, something I’ve only seen during the Crash of 1987, mini crash of 1989 and 1998 and maybe another time during 2008. Traders and investors en masse looked as though they all ran for the hills. At the same time, someone or SOMETHING continued bombarding the market with sell orders of all size, regardless of price.

That last sentence is key. “someone or SOMETHING” and “regardless of price”.

What the heck happened?

Next week, in part II of this topic, I will discuss what I believe occurred, who will be blamed and what should be done in the future.

Stay tuned!
Speaking of tuning in, if you are interested, I will be interviewed on WTNH this Sunday, May 16, between 7:15am and 7:35am. Additionally, I will be on CNBC’s Worldwide Exchange this Tuesday, May 18 from 5:30am to 5:55am.

Please feel free to email me with any questions or comments at

Until next time…

Paul Schatz

Heritage Capital LLC

Thursday, May 13, 2010

Disbarred attorney sentenced to federal prison for mortgage fraud scheme

U.S. District Judge Mark R. Kravitz in New Haven court sentenced Douglas Sheehan, 39, of Meriden, to six months in prison, followed by three years of supervised release for his role in a Hartford-area fraud scheme.

Kravitz also ordered Sheehan to serve the first six months of his supervised release in home confinement, and to perform 200 hours of community service.

According to court documents and statements made in court, between September 2003 and November 2007, Sheehan, a former attorney, conspired with George Hajati, who owned Connecticut Partners Mortgage (CPM), Justin Williams, a CPM employee, and others, to deceive mortgage lending institutions into providing falsely inflated loans to real estate buyers. The properties were worth less than the amount of the loans, federal records show.

CPM provided fraudulent financial statements to the lending institutions that inflated the sales prices of the properties, the down payments made by purchasers and the amount due to sellers, as well as other fraudulent information, to induce the institutions to provide the funds.

The various lenders have suffered a loss of more than $1 million as a result of the mortgage fraud scheme. Between $200,000 and $400,000 in losses can be attributed to Sheehan’s role in the conspiracy, federal officials said.

On November 20, 2008, Sheehan pleaded guilty to one count of conspiracy to commit wire fraud and three counts of wire fraud. He has been disbarred.

On April 5, 2010, Hajati pleaded guilty to one count of conspiracy to commit wire fraud and eight counts of wire fraud. On October 21, 2009, Williams pleaded guilty to one count of conspiracy to commit wire fraud and three counts of wire fraud. Each awaits sentencing.

This case is being investigated by the Federal Bureau of Investigation and prosecuted by Assistant United States Attorney Paul H. McConnell.

The U.S. Attorney’s Office, the Federal Bureau of Investigation and the Connecticut Mortgage Fraud Task Force encouraged you to report any suspected mortgage fraud activity by calling 203-333-3512 and requesting the Connecticut Mortgage Fraud Task Force, or by sending an email to

Friday, May 7, 2010

2010 Window Open for Roth IRA Conversions

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

In 2010, anyone, regardless of income level, may open or transfer funds from an IRA account to a Roth IRA, thanks to the Pension Protection Act of 2006.

Prior to this year, only taxpayers with an Adjusted Gross Income of $100,000 or less have been allowed to convert funds from their (individual retirement account)  IRA into a Roth IRA. With a Roth IRA, all contributions are after-tax (i.e. non-deductible), however, earnings from the account can be withdrawn free of federal income taxes once the individual reaches retirement.

Earnings from assets transferred from an IRA account, are not available for tax free withdrawal until five years have passed since conversion and the account holder is at least 59½ years old. There are no minimum distribution requirements for a Roth IRA.

To convert existing IRA funds to a Roth IRA, taxes must be paid on any pre-tax IRA contributions, but there's another benefit to converting in 2010. For funds converted in 2010, the tax liability can be paid one half in tax year 2011 and half in tax year 2012. Convert in 2011, and taxes will be due on the full conversion amount for tax year 2011.

Before you opt to convert to a Roth, however, you need to run the numbers. Although all earnings from a Roth IRA are exempt from federal income taxes, by paying taxes on all contributions in advance you lose the earning power of those funds. You may also be paying taxes at a higher rate than you might if you held your IRA into retirement when your tax rate might be less.

Typically, a Roth conversion will make the most sense for individuals with years to go before they retire. The closer you are to retirement, the less value a Roth might have unless your goal is to pass on the IRA to your heirs.

There are no distributions required from a Roth IRA during your lifetime and by converting to a Roth and paying the necessary taxes, you will shrink your taxable estate. That could mean bequeathing a pool of income-tax-free money to your heirs.If you have an IRA in which after-tax contributions have been made, you only need to pay taxes on accumulated earnings to convert to a Roth IRA.

As always, please consult your tax and/or financial advisor before making any irreversible decisions!

Please feel free to email me with any questions or comments at

Until next time…

Paul Schatz

Heritage Capital LLC

Wednesday, May 5, 2010

Federal court orders SEC to return $795,000 lost in Connecticut fraud scheme

The federal district court in New Haven has ordered the U.S. Securities Exchange Commission to return $795,000 to the Connecticut Retirement and Trust Funds for the benefit of investors who were harmed investors by a fraudulent scheme perpetrated by the former president of the Connecticut State Senate, William A. DiBella.

On May 18, 2007, following a seven-day trial, a jury returned a verdict finding DiBella liable for aiding and abetting violations of various securities laws.

In its 2004 complaint, the SEC alleged that DiBella and his consulting company, North Cove, participated in a fraudulent scheme with former state Treasurer Paul Silvester, concerning Silvester's investment of $75 million on behalf of the Connecticut Retirement and Trust Funds with investment advisor, Thayer Capital Partners.

Although neither Mr. DiBella nor North Cove had any role in the investment of the funds with Thayer, and performed no meaningful work related to the investment, Silvester nevertheless requested that Thayer pay DiBella fees based upon a percentage of the total investment with Thayer.

Thayer ultimately paid DiBella a total of $374,500 through North Cove, according to court records.

On March 24, 2008, the court entered a final judgment against DiBella ordering him to pay a civil penalty and disgorgement and prejudgment interest. Due to Mr. DiBella's continued non-payment of the judgment, the SEC instituted contempt proceedings with the federal court in New Haven.

DiBella finally paid more than $795,000 on March 12, and the money will now be distributed to the Connecticut Retirement and Trust Funds.