• "One more thing."

 - Lt Columbo

Monitise (MONIF) appears to be making a filing for an ADR today.

• Thanks so much for reading my Diary today. I hope it was value-added.

Enjoy your evening.

P.S. I have Matt McAndrew to win The Voice in tonight's finale

I end the day about 13% net long.

• As of 3:49 p.m. there was $125 million to sell market on close.

• Break in!

The great break in the price of crude oil continues with the price now near $55 a barrel.

• I am up to a near-15% short bond position.

• Via @bradnews.

• Real estate maven Mark Hanson on mortgage fraud.

On Friday, the new annual LexisNexis mortgage fraud reportfor 2013 was released.

Bottom line:74% of all loans contained loan application fraud and misrepresentations, higher than in 2006 by a wide margin.

"Application fraud and misrepresentation has been climbing steadily over the past three years. Seventy-four percent of loans reported in 2013 involved some kind of fraud or misrepresentation on the loan application. In 2012, that number was 69 percent; and in 2011, 61%.  The application form is comprehensive in collecting borrower personal identity, employment, asset, and liability information (all of which present verification challenges).  Application fraud and misrepresentations includes, but is not limited to, the following categories on the loan application:  Incorrect names(s) used for the borrower(s); occupancy; income; employment; debt and asset misrepresentation; different signature(s) for the same name(s); invalid social security number(s); misrepresented citizen/alien status; incorrect address(es) or address history; and incorrect transaction type."

Over the past couple of weeks, following the investigative story in the Journal entitled "Dodgy Home Appraisals Make a Comeback", I have dug deep into my previous work on the topic and new era appraisal fraud.

Bottom line:Mortgage fraud is as rampant today as in 2006, which is no surprise given all of the correlations I have uncovered and brought to light, coupled with the parabolic house-price inflation over the 2.5 years ending June 2014, which was greater than the parabolic rise in the 2.5 years ending 2006, affectionately known as "peak bubble".

Link:  LexisNexis 16th Annual Mortgage Fraud Report

Important Note on Appraisal Fraud: LexisNexis reports that hard "appraisal fraud" was found in 15% of loans, down from last year, and at a 5-year low, which seems to contradict the Journal story.  But, this discrepancy is mainly due to a "definitional difference" between what LN considers "fraud" and what was covered in the Journal. That is, the rampant fraud highlighted by the WSJ is largely a different type of fraud -- more of a 'fraud by omission' and laziness -- and occurs on much more than 15% of loans.  The pervasive fraud by omission, or laziness, is a product of the procyclicality of the sector when prices "always go up" in choosing comparables that "make the deal work" versus the "best comparables" for the subject property. 

Even so, it is important to remember that 15% of appraisals being fraudulent is far more than enough to artificially raise the value of every house in America, as it only takes four or five fraudulent appraisals in a one square mile region to push the values of hundreds of houses higher.

As a result of this LexisNexis report, I have to add another 10% downside to house prices over the next two-years, on top of my 10% to 20% forecast.  

The following is my most recent note on appraisal fraud released on Friday, Dec 12, 2014:

12-12 Hanson...Systemic Loan / Appraisal Fraud & Incompetence;  Same conditions as in 2005-07;  House Price Headwind

1) Conditions that precipitate systemic loan origination and / or appraisal processincompetence & fraud rearing its head again, as investigated in the recent WSJ article entitled "Dodgy Home Appraisals Make a Comeback:

a)  Persistently weak loan origination volume like over the past 18 months, following a lengthy prosperous period, such as the multiple Fed-induced refi-boomette's from 2009 to May 2013, which puts appraisers under pressure to strengthen existing lender-client relationships, dig deep and make lofty commitments for new business, fiercely fight competition, and make every deal "work".  

b)  The previous must occur in the context of stable and higher house prices after an extended period of house price inflation. This makes lenders and appraisers feel confident and / or receptive to suggestions, or business relationship and volume intimidation and / or threats, promoting procyclicality in appraisal valuation methodology, most notably in comparable analysis and choices.  Obviously, this occurs in reverse as well, as we saw in 2009-12.

2)  New-vintage appraisal process incompetence and fraud is highly psychological and late-stage bubble type stuff;  

Investor & Government investigations will lead to tighter appraisal policy & the stiffest house-price headwind since 2008               

When house prices have been inflating for an extended period of time and are stable and higher;  no significant problems have occurred on appraisals during the past couple of years due to parabolic house price inflation;  and sentiment towards housing is relatively bullish, then appraisers feel more confident, which leads to pro-cyclical valuation analysis. 

In other words, when there are numerous comparables from which to chose (many recently fully rehabbed that commanded top sales prices);  business is extremely slow due to slow market conditions;  lender-clients are pressuring appraisers to "turn deals quickly" and "make them work";  and appraisal firms feel their lender-client relationships are highly volatile (or vulnerable) and subject to change based upon the performance of the last job done;  then it's easy to understand why quality suffers, as staff spends less time researching the "best" comparables to their subject property.  Rather, it's far less time consuming and stressful to simply chose the three or four comparables, out of many, that have the values to "make the deal work".  Under these market conditions, it's also easy to understand why -- on an Appraisal Management Company (AMC) corporate level -- expensive due-diligence and post-appraisal auditing is pared back.   

Because the science of appraisal is highly subjective -- when there are so many comparables from which to chose -- selecting a certain four comparables with higher values over a certain other four comparables with average or below average values, is easily defensible "in-house".  However, upon independent appraisal review, or audit by the investor or regulator, the deficiencies become clear, which is what is happening now in the appraisal segment.  

3)  When the procyclicality suddenly ends, the "appraisal fraud delta" evaporates, removing the "air-pocket" under house prices in a short period of time

As investors and regulators dig deeper into recently discovered deficiencies and fraud, find that appraisal quality has dropped significantly over the past couple of years, and call for more investigations -- or send back to lenders an increasing volume of loans for repair or buyback --, the procyclical practices will immediately come to a halt. This is akin to a credit tightening event.

Back in 2008, I called this phenomenon the "appraisal delta".  That is, the valuation differential between an appraiser using the comparables "that make the deal work" vs the "best" comparables for the subject property. At that time, I figured an industry wide appraisal tightening would be worth 15% to 20% in house prices, and I was probably pretty close.  I think we are close to another appraisal tightening event.  And because in this cycle a small number of large, appraisal bucket shops do the lion's share of the appraisals, fear and tightening will spread quickly versus during the 2005 - 2007 period, when 10s of thousands of independent appraisers all had to tighten in order to create a catalyst.  

Bottom line:  The past 2.5 years of parabolic house price inflation ending June 2014 -- that exceeded the inflation in the 2.5 year period ending at the peak in 2006 -- precipitated the exact same fraud and will end the exact same way.  That is, with the "appraisal delta" coming in and house prices hitting a stiff headwind over the next year or more, making the consensus estimates of + 4% to 8% YoY gains, 10% to 20% heavy.

4)  MBA loan volume vs the Case-Shiller 20

Bottom line:  Anemic loan volume (orange) following a busy period with underlying rising and lofty prices (white) are the exact same conditions that precipitated the massive loan and appraisal incompetence and fraud era, from 2005 to 2007.

5)  If house prices increased 33% in the 2.5 years ending at peak-bubble 2006 and in the 2.5 years ending June 2014 they increased more, then why do people think it's different this time?

6)  4 or 5 fraudulent appraisals impact hundreds of houses...

As a visual example of the insidiousness of appraisal fraud, in the one square mile section of South Phoenix, if only 4 or 5 appraisals are pushed by 20% or more, then all these hundreds of houses increase by a like amount because most apprisers use the "best" comp, which is generally the highest comp.  If the Journal article is accurate and 20% of all appraisals are pushed "by at least 20%" then the air pocket under markets like these is enormous.

Bottom line:When the market eventually flips from the pro-cyclical mania to counter-cyclical  on fear, crashes happen. 

• Benzinga interview.

Here is a great interview on my book that I had with my friends at Benzinga last week.

• Did you get your chicken dinner?

I wanted to triple check whether all trivia winners have received autographed copies of my new book.

If you haven't, please e-mail me with your address at dkass@seabreezepartners.net

• TLT to the Best Ideas list.

To demonstrate my conviction on my short bond position, I am adding the iShares 20+ Year Treasury (TLT) to my Best Ideas list (short) at $126.25.

• More from Sir Arthur Cashin.

Oil came off the morning low and stocks followed.

Morning reversal brought a bump in volume.

Run rate at 12:15 project to an NYSE final volume of 880/960 million shares.

• I am trying to be more and more transparent.

I have recently identified my conviction levels in both individual equity positions (long and short) as well as on the market, by characterizing stock positions (from small to large) and net exposure (by percentage).

In keeping with this, my short bond position today has gone from small to large and now represents about 10% of my portfolio. (Please Note: When I give my aggregate net long/short exposure in my portfolio, I do not include my bond short.)

The fixed-income market is ignoring the precipitous oil price drop and its positive impact on domestic growth.

This is being manifested in strength in bonds and bond-equivalent stock sectors over the last month.

At this point, with the 10-year yield under 2.10%, the market is likely overstating the economic impact.

As I have often written recently, I expect some contagion, but not to the degree the fixed income is directing.

• At $107.80.

I have covered the balance of my Apple (AAPL) short at $107.80 and I am taking the stock off of my Best Ideas list.

I suspect I will have a better shorting point later this month.

• Tradeable rally may be approaching.

The S&P futures are now -11 and Nazzies are -38.

I have covered the balance of my SPY ($199.30) and QQQ ($101.50) shorts in the belief that we are approaching a tradeable rally into year end.

My conviction level is low, however, and I am only at a 13% net long position now.

• From The Street of Dreams.

MetLife (MET) was downgraded by a small investment boutique this morning.

As I recently wrote, the life insurance industry is exposed to low interest rates and a vulnerable stock market.

• There is little new news at Bon-Ton Stores (BONT).

I view the company as a continued attractive, but speculative, play in the retail sector.

I view the  objections I have recently read in the comments section with regard to the company's balance sheet/debt load as reasonable ones, but my estimates for the company's EBITD ($160 million and above The Street's  forecast for the final quarter of this year), free cash flow ($30 million+) and the low interest rate (on the debt) render the risks acceptable to me at current prices.

BONT, as previously conveyed, serves small- to medium-sized markets, predominantly in the northern section of the country.

Management has recently changed, and given the new CEO's record of success I remain optimistic that the company can reverse weak comps and gain market share.

The drop in the price of gasoline is an important plus to this company considering its geography. 

The company is a potential takeover target, with Belk or Dillards (DDS) as potential acquirors.

The float is small and short interest is high. 

I recently added to this spec under $7 a share.

I am not really pushing this idea hard, as I have learned from experience that too many embrace speculative stocks (read: Monitise (MONIF)) without realizing the risks to it or any other speculative investment.

Just staying real and being honest.

BONT remains a small investment in my portfolio.

• Mid-morning musings from Sir Arthur Cashin.

Opening bounce in Dow and S&P took you back to 3:00 p.m. Friday, regaining the final hour selloff.  Weakness in oil made the rally evaporate.

S&P and Dow tested and then violated their respective 50 day moving averages.

• Here are my trades so far today.

I have added to my Twitter (TWTR) long, reduced further my Caterpillar (CAT) short and taken my net long exposure up modestly in the market's reversal to flat trade.

I am adding further to my long position in ProShares Short 20+ Year Treasury (TBF) at $25.29. I placed this ETF on my Best Ideas list this morning.

• Tighten your seatbelts.

Fare you well my honey

Fare you well my only true one

All the birds that were singing

Have flown except you alone

Going to leave this broke-down palace

On my hands and my knees I will roll roll roll

Make myself a bed by the waterside

In my time, in my time, I will roll roll roll..

--Grateful Dead, "Brokedown Palace"

The cyclical bull market is in jeopardy -- the light of Mr. Market's message may not yet be red, but it most assuredly is amber. To paraphrase The Grateful Dead's Jerry Garcia:

I have been shopping around for something to do that no one will like" (a bear market?)

'Cause "if the thunder (fundamentals) don't get ya then the lightning (technicals) will.

My cautious fundamental views seem to be gaining legitimacy of late. Now the technicals might be confirming my fundamental view.

For seven consecutive weeks since the October swoon, the market -- which had risen until recently -- had not undergone two consecutive down days.

"I mean, whatever kills you kills you, and your death is authentic no matter how you die." ¿Jerry Garcia

That streak has been broken -- with a vengeance.

This week brought three down days in a row and a rapid rise in volatility -- the CBOE Volatility Index (VIX) registered at its highest level in two months. The week also featured the first 90% down day since early October, more NYSE new lows than new highs for five consecutive trading days and the worst weekly loss in 60 days.

Moreover, correlations have begun to break down, a condition that typically presages market weakness at worst, or a two-way market at best.

The average correlation for each of the 10 industry sectors in the S&P 500 is down to 58.4% over the last month. . . . This is by far the lowest observation we've seen in the last five-plus years. . . .

Research from S&P Dow Jones Indices that compares individual stocks shows a similar trend. The firm found that in November, correlations among S&P 500 components was less than 10%, the lowest since January 2001."

-- The Wall Street Journal

Over the weekend, Mohamed El-Erian writes on this subject: 

In the coming year, 'divergence' will be a major global economic theme, applying to economic trends, policies, and performance. As the year progresses, these divergences will become increasingly difficult to reconcile, leaving policymakers with a choice: overcome the obstacles that have so far impeded effective action, or risk allowing their economies to be destabilized.

-- A Project Syndicate article, "A Year of Divergences"

Over history, divergences have produced pockets of unevenness and I believe that will be an overriding theme in 2015.

A two-way market will provide increasing opportunities on both the long and short side, but it also is often accompanied by adverse economic and financial consequences as investment managers, central planners and other policy makers face a more difficult landscape to navigate.

-- Kass Diary, The Emergence of a Two Way Market (Dec. 11)

Oil Vey

"Once in a while you get shown the light, in the strangest of places if you look it right." --Jerry Garcia

The proximate cause for the reversal of fortunes was the swift southerly move in oil prices. This is an event -- caused by weakening demand and rising supply -- that I strongly feel will hold negative consequences for the financial markets and for the profit levels of S&P 500 companies.

Subpar global economic growth produces a fragile condition, as more than one-quarter of the world's economies are experiencing a recession or under 1% in real gross domestic product growth. This, in turn, exposes the trajectory of economic growth to numerous exogenous shocks, be they geopolitical, currency-based -- as in a rising U.S. dollar -- or of a multiple-standard-deviation decline in energy prices.

As I expressed over the weekend in The Wall Street Journal, $58-per-barrel oil is sending a signal of slowing global economic growth. It represents, much like Penn Square Bank did in the early 1980s, the potential for contagion risk. It is also vividly underscored by the strength in utilities, in the bond market and in other fixed-income-equivalent equity sectors. 

As chronicled below, there are already substantive signs of stress in the credit markets. 

We have already seen the impact of lower oil prices on a vulnerable high-yield market. Last week, high-yield selling intensified as yields and spreads rose to more than two-year highs. $90 billion of the $210 billion worth of outstanding energy bonds are now trading below $90, and a contagion into non-energy high-yield has begun in earnest. The J.P. Morgan Domestic High Yield Index is now pricing in default rates of close to 5% over the next one-and-a-half years. 

I also remain concerned about energy bank loans. Commercial banks have started to trim the value of oil reserves tied to credit lines, creating pressure on some of the more leveraged energy enterprises through lessened credit availability.

Numerous exploration companies are cutting back exploration activity. I mentioned Oasis Petroleum (OAS) a week or so ago, but others, such as Petrobras (PBR), have announced exploration cutbacks in order to shore up cash and preserve liquidity. Drilling activity has begun to fall rapidly -- and rigs targeting oil are experiencing the largest weekly drop since late 2012.

What has surprised me thus far is that there has been quite limited profit guide-downs in the oil patch. But profit cuts will be coming fast and furious in the weeks ahead. 

During the weekend, the head of the Organization of the Petroleum Exporting Countries (OPEC) said the organization has no fixed price target, but he thinks the decline has gone beyond levels justified by the market's fundamentals. On the other hand, a United Arab Emirates energy minister said OPEC won't change its mind on production "because prices went to $60, or to $40." 

The recent downside oil shock will also create a meaningful economic challenge to those countries that are dependent on higher energy prices. Not only will the price drop adversely impact countries' gross national product (GNP), it will also serve to threaten the ability to meet social spending targets -- and thus holds the potential for both economic (slowing global growth) and social unrest in 2015 and 2016. 

Pretend and Extend -- The Final Chapter

Pretend and Extend in China, Japan and in Europe will be tested as secular debt, demographic and structural headwinds have not been addressed. Monetary solutions have gone about as far as they can go -- at least in the U.S. that policy has grown more and more ineffective and has contributed to an exclusive prosperity that has penalized savers and distorted the divide between the "haves" and the "have nots." 

The Technical Deterioration Intensifies

"There is a road, no simple highway, between the dawn and the dark of night, and if you go, no one may follow, that path is for your steps alone" ¿Jerry Garcia

Importantly, the market's drop last week was against the backdrop of technical divergences and lowered correlations. 

In the past I have argued that the sort of developing divergences that have taken place in the past few months -- when occurring within the context of a rising market and ever-climbing bullish investor sentiment -- are the preconditions of a correction, or a bear market.

I still believe this to be the case.

Here are some additional technical sign posts that are flashing an amber light:

• The NYSECompositeIndex failed at the previous all-time closing high it had achieved six months ago.

• The percentage of NYSE stocks that are trading above their 200-day moving averages made a lower low, peaking at 67% recently, as compared with 84% at the July 2014 high and 72% in September 2014. (I don't have Friday's closing percentage, but as of Thursday's close only 49% of NYSE stocks were trading above their respective 200-day moving averages).

• The Russell 2000 Index failed again at the January 2014 high.

• NYSE, the Nasdaq and Wilshire 5000 common stock -- only breadth has non-confirmed the previous highs.

• Cumulative weekly NYSE breadth peaked in September 2014, and the 26-week total of declines exceeded the same week total of advances for the first time this year. (This cross has historically been a tip off to larger corrections -- e.g., that of 2011).

A breakdown in correlation -- which I've previously discussed as worrisome -- can be clearly seen in the fall of new NYSE individual stock new highs and rising new lows during December. (This is part of the "Hindenberg Omen" calculation.) Significantly, the 10-day average of new lows -- at more than 190 -- rose above the 10-day average of new highs, 175. The last time this negative cross occurred was back on Sept. 22 -- two days after the high in the S&P 500 Index and right before the near 10% pullback in the first half of October.

Bottom Line

Fool me once, shame on you; fool me twice, shame on me. --Proverb

This morning's opening missive covers the breakdown in correlations, the recent apparent market slide and developing divergences in some important fundamental and technical market indicators.

The lessons of the past (e.g. Penn Square Bank and the slicing and dicing of mortgages into derivatives), particularly as it relates to contagion's long reach, have seemingly been forgotten.

Unfortunately, the Mr. Fusion Home Energy Reactor is ready to power the time machine's "flux capacitor" -- as we appear to be beginning our flight Back to the Future.

Tighten your seatbelts.

• Some updates on Friday's trades

Since I was out on Friday on research assignments, I wanted to update my portfolio changes made late that day -- mostly into the teeth of the steep market decline.

Most of these changes were detailed in my Columnist Conversations posts late in the trading day, but since many readers might have already left for the week at that point, I wanted to highlight the most important changes.

I moved from a relatively sizeable net short exposure, as of the middle of last week, to a slightly net long position by the close of trading on Friday -- and this for the first time in a while. This move was a tactical one in which I attempted to capitalize on the 4% market decline. I still am of the view that the market has topped out for the year, and possibly for much longer. But I am aware that the last couple of weeks are seasonally strong.

The magnitude of the oil shock and the ensuing market decline probably reduced bullish sentiment to the point at which a trading move toward the recent highs is possible. As well, the emergence of a two way market -- written about on Thursday in my Diary -- suggests that some long opportunities have developed in the energy patch and elsewhere.  

Here are the changes I mentioned in Columnist Conversation:

• I covered some of my Apple (AAPL) short. I remain strongly in the bearish corner on the company, owing to my belief that the iPhone upgrade is the last important upgrade cycle for the company for several years (see here and here). However, the shares are down by $10 from the recent highs. I was averaging up into the ramp, and now hold a profitable short position. I would short more Apple at the $114-to-$116 area.

• I eliminated my FibroGen (FGEN) long at about $28.95, as the shares have quickly moved up by $11 from the initial public offering (IPO) and $7 from the level achieved in the first day of trading following that IPO. I would be a buyer under $25.

• I covered my trading position in PowerShares QQQ (QQQ) and reduced my short in SPDR S&P 500 (SPY). I remain short SPY and QQQ, but both positions are now smaller. I would add back to the QQQ trading short at the $104-to-$105 level.

• I covered more of my investment short in Caterpillar (CAT) -- the shares have dropped from $106, where I put the short on my Best Ideas List to $90, in less than three "short" weeks. The shares will continue on my Best Ideas list as a short position.

• I covered my JPMorgan Chase (JPM) short -- which I had picked up against my Citigroup (C) long -- and I am now net long banks. (I had previously sold Northwest Bancshares (NWBI)). I plan on re-shorting JPMorgan on strength.

• I added to my Twitter (TWTR) long. I believe that there is option value to Twitter, as it is a unique social-media property that represents a potential takeover target for Google (GOOGL) and/or Apple (AAPL). Note: This morning, JMP initiated Twitter with a Buy rating and a price target of $49 per share.

• I added to my short bond position. The 10-year yield on U.S. Treasury bonds dropped below 2.10% on Friday afternoon. The reward vs. risk now is tipped more dramatically, and I am adding ProShares Short 20+ Year Treasury ETF (TBF) -- at Friday's closing price -- to my Best Ideas list.

• I have added to my large oil longs after selling out the trading portion midweek -- though I am keeping my investment position in it.

While I see more of a two-way market -- one in which money can be made on longs and shorts -- my opening missive, "Brokedown Palace," follows -- and it outlines the foundation of the fundamental and technical reasons for why I remain cautious on the markets in 2015.

• There will be no Market Setup this morning.

My opening missive is taking a while to write!