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The financial sector is embroiled in a toxic subprime situation, which will persist for many months and will undoubtedly leave a trail of carnage in its wake. More evidence of that was revealed this week and with the departure of Merrill Lynch’s CEO, Stanley O’Neal followed this weekend by the quick departure of Charles Prince the CEO of Citigroup, but there is great concern that these financial behemoths have covered up much larger losses.

Notwithstanding O’Neal’s ill-conceived attempt to discuss a merger with Wachovia’s executives, the largest quarterly loss in the company’s history sealed his fate. Moreover, the end of the week brought reports that Merrill would need to write down as much as $10 billion and there had been transactions made with other financial entities, namely hedge funds, to effectively hide some losses from public scrutiny. The Wall Street Journal was reporting that the SEC had now opened an informal investigation of the treatment given to these mortgage backed securities.

In the case of Citigroup, a report by CIBC World Markets caused a sharp slide Friday in Citi’s stock price suggesting that they may need to cut their dividend in order to raise cash. Other possibilities include asset sales and raising capital in order to come up with more than $30 billion due to the problems stemming from acquisitions, write-downs, and off-balance sheet structured investment vehicles (SIV).

Our favorite financial theory not written in a textbook, the cockroach theory, indicates that there is a high likelihood that further problems have yet to be uncovered and that many other companies will be affected as the contagion spreads. (The cockroach theory states that there is never just one cockroach.) The financial giants of Wall Street have begun revealing the damage triggered by the meltdown in the housing industry and by extension, mortgage backed securities, however the true extent of the damage will only be revealed one quarter at a time as various investments reach maturity and attempts to refinance them fail.

Technically Speaking

Fear was very evident on Thursday when the Dow Jones slid 362 points, which though small on a percentage basis still represented a harshly negative comment in the stock market. Of course, the DJ was not acting alone and indeed the S&P 500 as well as the Nasdaq twins shared in the slaughter. The report of the situation at Citigroup outlined above was the catalyst for the slide in stocks and the financial sector bore the brunt of losses.

All movements were not negative however as the tech sector actually finished the week in positive territory. Wednesday’s rate decision by the FOMC to cut the overnight interest rate charged by the Federal Reserve to 4.5% was perceived as a boost to economic prospects and initiated a rebound in all stock markets on heavy volumes. The subsequent reversal on Thursday was startling in both its percentage move and its even heavier volumes, but while the effects were most pronounced on the broader markets, the tech sector managed to close out the week with a small gain.

The MACD charts mentioned in previous weeks continue to develop and now the Nasdaq twins have clear crossovers signaling some near-term bullish activity. They’re supported by stronger signals from the broader markets where the weekly charts show the beginning of a crossover on the S&P and a bottoming in the fast MACD on the DJ-30. The difference in strength between the tech sector and the rest of the market is reflected in the relative performance of these MACD curves.

New Buy Recommendations (in order of preference):

Evergreen Solar (ESLR) – With the intense competition for fossil fuels heating up prices in crude futures, alternative energy stocks especially solar-related energy are benefiting from the attention. We wish to add ESLR, which gapped higher on Oct 26 and continues to edge up with heavy volumes on up-days and distinctly lower volumes on down-days. On Friday, it closed at a new high for 2007 and is now in a strong position to test the high reached in 2006 of $17.50.

New Short Sales

Morgan Stanley (MS) –

Bear Stearns (BSC) –

Credit Suisse (CS) –

JP Morgan (JPM) – We recommend shorting this group of financial stocks of which two are banks and two are investment brokerages. We prefer to short groups of stocks and not rely on individual picks as a safer method of spreading risk. All four of these stocks are prepared to fall to new lows with failure at their respective August lows a highly likely scenario after having experienced sharp price drops in trading this week.

Stock Positions to Sell/Exit:

The increased volatility resulted in three more positions being liquidated on their respective stops this week and we recommend selling DISH as it would appear to have weakened considerably over the past couple of weeks and threatens to drop much further now. Though it may simply be a test of the Oct 22 low, we view it as a breakdown, which will not survive this test.

Portfolio Comments:

New stops have been added to the list while others have been modified. Those that have blanks are being carried unstopped for now. Please see our complete list of stops in the table below.

List of Current Stock Recommendations:

Action Ratings. The following is the legend for designating immediate action
for our stock recommendations. The first is B, meaning the stock is timely
to buy but the case for doing so right here is not overwhelming. Either the
stock may have gotten ahead of itself and may be vulnerable to a retracement or
else the stock has been performing disappointingly but may simply be
regrouping. B+ and B++ indicate stocks for which there is a technical case
to buy now, with plusses adding weight according to how many there are, up
to a maximum of two. Stocks rated H are ones to hold, awaiting confirmation
to buy more or to sell. SELL, of course, means what it says. It seldom pays
to override this designation. In the case of stocks held short, the rating is S where positions should be retained. S+ and S++ indicate stocks for which there is a technical case to add to the positions with plusses adding weight similar to long positions. The maximum number of plus signs is 2.

N.B. There are no longer restrictions on foreign stocks held in Canadian retirement savings accounts.

¹ Peabody Energy spun off its coal assets into Patriot Coal on Oct 31 at a ratio of 1 share of PCX for every 10 shares of BTU held.

New stops in BOLD

* Stop on a closing basis

** Buy if above entry price

*** Split-adjusted price