Certainly looks like it.

Futures are down across the board.

As I said last night, the divergences showing up in this market are disturbing for the health of this "rally". Looks like we're headed lower today at the open.....

Last night after the market closed Countrywide (CFC) announced a 4 billion convertible offering. I am typically incredibly bearish on these things, and this one smells more than most.

Companies issue convertibles when they need cash and also want to entice people with something more than just a plain bond offering. The "carrot" is the conversion feature which acts kind of like a warrant - a right to the common stock at a given ratio. In this case the acquisition price is quite high, there's a discount off LIBOR (which I wouldn't buy) and, perhaps more troubling, there is the dynamic of what nearly always happens when these are issued.

That is, short interest spikes.

Why? Because if you buy the convertible then the risk you're taking on is that the stock (or perhaps the company itself!) will go severely into the ditch, destroying any value of the conversion feature and perhaps impairing your principle on the "bond" portion itself. (The nightmare, of course, is that the coupon doesn't get paid!)

Anyway, the way you hedge against this is by shorting the stock - either directly or you go into the options market and sell CALLs against the conversion "feature". You're really short now but its a "covered" write because the conversion feature "saves" you if the stock runs, yet you profit if it collapses. This creates a "neutral" position that is very-well insured against loss, yet you still have the coupon.

The problem is that a deal like this is not worth the risk unless you hedge like this, especially when we're talking about doing it under LIBOR! After all, you can just buy 10 year Treasuries with zero risk at 4.7% or so (if the government goes bust you've got bigger problems!)

Anyway, the consequence of an offering like this for common stock holders is that it is dilutive and generates instant short interest, neither of which is good for the share price.

It may also indicate desperation.

The company claims $55b in cash on the balance sheet. Is this "real" cash or is it impaired in some fashion? One must wonder - $3b looks awfully puny sitting next to a $55b pile of cash, so what's up here? And why issue this debt in part to buy back shares (although the buyback is extremely small too - $900m or thereabouts, which sounds big, but its only about 2.5 days worth of average trading volume.)

So what's going on here? My read on this is that the company has a liquidity problem, and this is the only way to get their hands on some truly liquid money fast. $3b for "general corporate purposes" eh? I suppose Mozillo expects us to all believe that they their $55b shown on the balance sheet is good money when they issue toxic crap like this into the market?

Oh, and lest anyone think the M&A rumors are real, this deal threw about a ton and a half of Arsenic on the balance sheet too. It includes a "PUT" option allowing the holders to force the company to buy back the full face value of the bonds (all $4b of them!) in the event of a change in control. This sort of "poison pill" is universally hated by the LBO guys because it effectively adds a $4b cost in sunk cash to the deal requirements. In other words, to do it you have to throw $4b down the toilet instantly for which you receive zero value!

That ought to kill the M&A rumor mill, at least for those market participants who have an IQ larger than their shoe size.

One more thing - the 10 year bond is now at 4.74%, out of the trading channel. While conventional wisdom is that this is money flowing out of treasuries and into stocks, I'm not buying that explanation. I instead believe this may be an indication that US Debt is being sold due to currency and market price concerns, and the money is starting to rotate into international currency-denominated assets.

If this is in fact happening, and I believe the argument can easily be made based on money flows for both acquisition and dispersion over the last few days, as I've noted in the blog before, then this is the credit markets doing what it always does - its presaging trouble in the equity markets.

When you add to this the bearish divergence between the Russell/Nasdaq and the DOW, I believe that this is a time to be extremely cautious. Today and tomorrow we are subject to large whipsaws due to options expiration, but ignoring this for a moment, we have the S&P getting squeezed by its channel, which is going to force either a breakdown or breakout within days.

Given the pattern here - first the Russell rolls over, then the Nasdaq, and now the S&P is weakening, leaving the DOW as the "last bastion", I would be extraordinarily cautious with long positions here and I'm completely out of my Russell and Nasdaq longs across the board - including in my IRA.

While conventional wisdom is that the S&P is going to break its all-time high, I'm not taking the bet - and if it does, that is not necessarily an indication that we will continue to run. On the contrary - we may ping off it and then roll over!

PS: The LEIs came in negative 0.5%. The index is now 0.7% below the April 2006 level. Based on revised data, we now have an official recession marker, in that it decreased through April on a composite 0.2%. Six months of declining LEIs on a composite basis is a recessionary marker and indicate that a recession is imminent.

Good luck.......