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Company File

Company: Freddie Mac

Symbol: FRE

Sector: Financial

Industry: Consumer Financial Services

Elliott Wave File

  • One complete cycle equals eight waves
  • One complete cycle has two distinct phases: motive and corrective.
  • The motive phase includes 5 waves
  • The corrective phase follows the motive phase
  • The corrective phase includes 3 waves
  • After the eight wave cycle ends, a similar cycle ensues
 
Figure 001 (Click to enlarge)
Figure 002 (Click to enlarge)
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"The path of prices is not a product of news. Its movement reflects a repetition of forms that is independent both of presumed causal events and of periodicity.”

Frost and Prechter, Elliott Wave Principle – Key to Market Behavior
Freddie Mac (FRE) is the government- sponsored corporation that greases the wheels of the mortgage lending industry. In January 2002, investors had every reason to like the stock: interest rates were falling and homeownership was climbing. Freddie Mac's earnings had reached a record level in 2001, as did its new business purchase volume and total mortgage portfolio growth.

In the eyes of Wall Street, Freddie Mac was a "sure thing." Not only did the stock take part in the 1990s bull market, it even bucked the bear trend and rebounded from a 36.88 low in March 2000 to a new all-time high of 71.25 in November 2001.

With all this in mind, how could anyone see a different "sure thing" just ahead for FRE stock -- an extreme price move in the opposite direction? Better yet, what did we see, just by looking at a price chart?

R.N. Elliott said the most basic form that price movements follow is an up-down-up-down-up sequence, or five-wave pattern. (Fig. 001)

 Now, all investors know that stock prices go up and down all the time; as long as a stock's main direction over time is "up," most see no reason to worry over a few steps back here and there. Of course, they never expect "down" to become the dominant trend, either. That's where Elliott wave analysis comes in.

But first, imagine what Elliott's basic form would look like if you held it under a microscope. Did you picture something like Figure 002?

There are a lot more details, but look closely. You'll see that the original pattern is still there, and that each "up" wave now looks like (and is) a smaller version of the original -- it subdivides into an up-down-up-down-up sequence of its own.

So the same pattern recurs, but at varying degrees of scale.

Back to Freddie Mac. We issued a "sell" recommendation to our Prime Stocks Flash service subscribers on January 23, 2002. Among other important signs, we noted the end of a five-wave pattern in FRE -- at smaller and larger timeframes. Here's the actual Flash:

Sell Freddie Mac (FRE) Now
1/23/2002 3:33:17 PM
INVESTORS:
Call your broker and say: SELL 100 [or fill in the number] shares of FRE at market, to Open. As a stop, BUY 100 [or fill in the number] shares of FRE at 80.26, to Close. GTC.

or Do this online: SELL 100 [or fill in the number] shares of FRE at market, to Open. As a stop, BUY 100 [or fill in the number] shares of FRE at 80.26, to Close. GTC.

The Freddie Mac Corporation (FRE) makes itself hard not to like. You've probably seen the happy-family images Freddie Mac advertises as it claims to "expand opportunities for homeownership and affordable rental housing." This Federally-chartered outfit buys mortgages from lenders, repackages the debt as securities (guaranteed by FRE), and sells the securities to investors.So what's NOT to like? Plenty, not the least of which includes a series of looming extremes (see below) and a price chart with a pattern that says "sell!" Short FRE now with a stop at 80.26.

Let's look at the extremes that surround this stock.

* Interest rates have reached historic lows. This trend has gone as far as it could, and likely has no place to go but up (as Treasury Bond and Note prices suggest). Rising rates will hurt home sales.

* Homeownership has reached historic highs. This suggests homeownership in the general
population is at or near saturation. What's more, a significant percentage of mortgage lendingin recent years has been predatory("subprime"), with no regard for borrowers' ability to make payments.

Who is left to buy?* FRE's earnings in 2001 reached a record level, as did its new business purchase volume and total mortgage portfolio growth. With the above two bullet points in mind, this performance is not sustainable.

* Option players are assuming a "never-ending" FRE advance, as the put/call ratio (open interest basis) is a remarkable .20, the lowest reading in a year - yet another extreme.

Predictably, FRE has a "buy" rating among 21 of 22 Wall Street analysts. You'd think they might somehow, maybe, just perhaps realize that a host of extremes often appear just before a major change in trend. But we know why they don't: the analysts themselves are part of the extreme.

The issues above duly noted, the most important consideration for FRE is this: A decade-long, five-wave bullish pattern now at its end. Note how prices fell after the peak in 1998 (blue label 3); that also was the end of a five-wave move at a lesser degree. Now that the bigger wave (5) is in place (blue label, actually a fifth-of-a-fifth), an even larger decline lies just ahead.

Finally, momentum has "diverged" at several degrees of trend, as it should at the end of a fifth-of-a-fifth wave. Fewer and fewer buyers are pushing prices higher.

Sell FRE now with a stop at 80.26

Recall that there was "every reason to like" FRE at that time. In fact, as our flash pointed out, FRE had a "buy" rating from 21 of 22 Wall Street analysts. Of course, this scenario had only one problem: Everyone who LIKED the stock ALREADY owned it.

Which brings us to the "other important signs" the Flash noted -- namely, psychology. Elliott Wave Principle, Key to Market Behavior explains that fifth waves occur as optimism runs high. At the end of patterns of larger degree, the optimism (and bullishness) becomes extreme.

The extremes here played out in everything from homeownership, "subprime" mortgage lending, and Freddie Mac's business growth.

But a major trend change reflects more than a price reversal: Events change to suit the new psychology. As for Freddie Mac's experience in recent months, it's a case in point.

You may have seen the headlines it earned this past June, when the corporation's top three executives resigned or were dismissed amidst allegations of financial misconduct related to derivatives.

The stock lost nearly ten dollars in one session (June 9), even though Wall Street and the ratings agencies couldn't circle the wagons around Freddie fast enough -- after all, Freddie (and its sister entity Fannie Mae) own or guarantee nearly half of all U.S. home mortgages.

All this is worth noting; sentiment and the "news" have a role in market analysis, though rarely in the way that most investors think.

Freddie Mac's price declines actually began a year before the stuff hit the fan in June, and prices remain down more than 20% from the fifth wave peak that told us it was time to sell.

More news will likely surface as investigators untangle the derivatives mess; it's been following the script of a small scandal that grows into a bigger one. Still, Freddie Mac will remain hard not to like -- if you're on the right side of the trend that is.



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