The Dow ended the day up 190 points while the S&P rose 24 points. It sure wasn't because of the stellar economic news. Afterall, GDP dropped .3%; consumer spending declined 3.1%, the first decline in 17 years and the biggest falloff in 28 years; and inflation-adjusted after tax income fell 8.7%. The other good economic news was initial jobless claims were steady at 479,000 while spending on durable goods plunged 14.1% and non-durable goods fell 64%, the lowest in 58 years. At this pace, the DOW will skyrocket another couple of thousand points.
Companies continued to report weaker expectations for the next quarter and dispalyed plenty of uncertainty in their business outlooks for next year. The fourth quarter promises to be much worse than the third quarter as layoffs seem to be picking up steam with American Express and Goldman Sachs both making cuts up to 10% of their workforces. This trend will continue right into the new year as spending is slowing by the consumer and the holiday season will be a disaster.
The real estate market continues to see a drop in home prices. Even The Hamptons, an affluent community on Long Island, is seeing 18% declines. As Wall Street bonuses are cut this year and people tally up their diminished net worths, spending will continue to fall. 2009 promises to bring on new focuses for financial institutions as the consumer default rates on credit cards, auto loans, student loans, and home equity loans start to ratchet up. We haven't even addressed the continued fallout from the credit default swap market, the weakening commercial real estate market, and the huge downsizing of the auto industry. The expectations for next year only seem to be gloomy.
At least interest rates are almost at zero. Once they reach that level, the Federal Reserve can turn their full attention to the impending inflation in the next few years but first they need to deal with the near-term deflation problem.
The economic news is horrific yet the markets have risen a lot this week. Markets always anticipate the turnaround in the economy and rise well before it bottoms. Are we now at that point? We still believe October 10th may have been the bottom of the market but we are likely having a bear market trap right now. Stocks are rising and could move up another 5-10% but they won't go straight up. When we listen to earnings calls it is obvious that most companies are retrenching. This will likely cause the economy to get much weaker and drag out the recession for a while. The stock market may be in a bottoming phase but this recent rally will at some point come back down to earth. Markets usually lore investors in before they shake them out. This weekend the papers will likely be talking about the next bull market. Nobody wants to miss the next big climb in stocks. People will start to buy again and just as this new bear rally peaks, everybody will feel good again. That is when it will once again be "All About The Economy".
The market will have a sustained rally at some point and we will have another bull market. It just isn't ready yet. If you need to chase the rally, continue to buy quality but be careful. The economy is going to be bumpy for a while and before the stock market can go on its next big run, it will need to come down first. This could be a a few month process and the ride could cause nausea so be cautious.
Thursday, October 30, 2008
Wednesday, October 29, 2008
Is The Bull Back?
The DOW soared 10% yesterday and most investors were feeling good. The impetus was likely expectations of a Federal Reserve interest rate cut today. The Yen, which has been gaining strength against all currencies, finally broke down which provided positive news on the economic front.
We wrote on Monday that investors should expect a rally in anticipation of the Fed's next move but it was hard to predict the skyrocketing move. It is unlikely the beginning of the new bull market. It was probably hope that lower rates will spur the economy, lots of short covering, and the inching closer to the end of earnings season.
Many more companies reported third quarter earnings yesterday and most companies are focused on the economic recession. USG, Masco, and Whirlpool all reported yesterday and on their calls they sounded alike. They are focused on containing production, improving working capital, minimizing capital expenditures, curtailing stock buybacks, improving liquidity, and reducing payrolls. Each of the companies also tried to assure investors that they had strong credit lines, cash, and plenty of flexibility to deal with any debt maturities. We are definitely in a recession and companies are hunkering down. Unfortunately, the conservative posture being taken by companies will act as an additional catalyst to slowing down the economy.
Fear is everywhere and the market is flying. We expect to see some other days like yesterday but it feels like it is too soon. Perhaps the market will go up a little again this morning but unless huge volume pushes it to the new heights, we think the market will start to drift down again after a rate cut. Lower Fed Funds are not going to improve the economy. Leverage needs to continue to work its way out, bankruptcies need to pick up steam, housing needs to hit bottom, and banks need to begin to lend again. The market will forecast these events well in advance of the economy bottoming but we still need to see some additional shakeout in the market.
As always, don't chase the ralleys. Buy quality and buy on weakness.
We wrote on Monday that investors should expect a rally in anticipation of the Fed's next move but it was hard to predict the skyrocketing move. It is unlikely the beginning of the new bull market. It was probably hope that lower rates will spur the economy, lots of short covering, and the inching closer to the end of earnings season.
Many more companies reported third quarter earnings yesterday and most companies are focused on the economic recession. USG, Masco, and Whirlpool all reported yesterday and on their calls they sounded alike. They are focused on containing production, improving working capital, minimizing capital expenditures, curtailing stock buybacks, improving liquidity, and reducing payrolls. Each of the companies also tried to assure investors that they had strong credit lines, cash, and plenty of flexibility to deal with any debt maturities. We are definitely in a recession and companies are hunkering down. Unfortunately, the conservative posture being taken by companies will act as an additional catalyst to slowing down the economy.
Fear is everywhere and the market is flying. We expect to see some other days like yesterday but it feels like it is too soon. Perhaps the market will go up a little again this morning but unless huge volume pushes it to the new heights, we think the market will start to drift down again after a rate cut. Lower Fed Funds are not going to improve the economy. Leverage needs to continue to work its way out, bankruptcies need to pick up steam, housing needs to hit bottom, and banks need to begin to lend again. The market will forecast these events well in advance of the economy bottoming but we still need to see some additional shakeout in the market.
As always, don't chase the ralleys. Buy quality and buy on weakness.
Tuesday, October 28, 2008
The Market Can Still Rise on Good News
Verizon brought some relief to the market as it reported very good earnings and its stock soared 10%. It looked like it would be enough to propel the rest of the market up but negative news from Loews Corp. and Morgan Stanley shook up the financial sector, again. General Motors is desperately seeking a loan from the government in order to pursue a merger with Chrysler. The concern about job losses in the auto industry will weigh heavily on the economy. A weak auto industry and a weak real estate environment will guarantee a long recession.
The market looked like it might rise for a day but swooned in the last hour as the S&P dropped 3.2% and the DOW slid 2.4%. The markets were also focused on how much the Fed will cut rates and there doesn't seem to be much doubt that they will.
The overseas markets didn't seem to take their cue from the U.S. Foreign markets have been taking a beating on depressed economies and a rising dollar. In fact, the dollar seemed to be rising against every currency except the Yen. The strong Yen helped to put a big damper on the Nikkei but last night the dollar finally rose against the Yen. The result was souring Asian markets. Lower rates in Europe and cheap valuations also became a powerful force to cause a rally in Europe.
Everything seems great again and the U.S. markets appear to be ready for a big rally. The stock market always rises before the economy turns positive but are we ready for that moment yet? You should expect volatility to continue and today happens to be starting with good volatility. Perhaps it is related to a potential cut in rates and strong overseas markets but at the end of the day "It's All About the Economy". The banking system needs to start to lend again, housing needs to bottom out, and corporate bankruptcies need to be flushed out of the system.
There were some positive Tea Leaves again yesterday as new homes sales for the month of September were positive and beat all estimates. Also, a couple of new acquisitons were announced as J&J acquired a wellness firm and CenturyTel bought Embarq, a telephone carrier. These may not be huge acquisitions but it adds to the consolidation we are seeing in the banking industry and it is just another positive event in our pursuit of growth in the economy.
Investors will certainly be confused today, at least this morning, as the market rises but discipline is key. Stay with strong companies and don't chase the rising market.
The market looked like it might rise for a day but swooned in the last hour as the S&P dropped 3.2% and the DOW slid 2.4%. The markets were also focused on how much the Fed will cut rates and there doesn't seem to be much doubt that they will.
The overseas markets didn't seem to take their cue from the U.S. Foreign markets have been taking a beating on depressed economies and a rising dollar. In fact, the dollar seemed to be rising against every currency except the Yen. The strong Yen helped to put a big damper on the Nikkei but last night the dollar finally rose against the Yen. The result was souring Asian markets. Lower rates in Europe and cheap valuations also became a powerful force to cause a rally in Europe.
Everything seems great again and the U.S. markets appear to be ready for a big rally. The stock market always rises before the economy turns positive but are we ready for that moment yet? You should expect volatility to continue and today happens to be starting with good volatility. Perhaps it is related to a potential cut in rates and strong overseas markets but at the end of the day "It's All About the Economy". The banking system needs to start to lend again, housing needs to bottom out, and corporate bankruptcies need to be flushed out of the system.
There were some positive Tea Leaves again yesterday as new homes sales for the month of September were positive and beat all estimates. Also, a couple of new acquisitons were announced as J&J acquired a wellness firm and CenturyTel bought Embarq, a telephone carrier. These may not be huge acquisitions but it adds to the consolidation we are seeing in the banking industry and it is just another positive event in our pursuit of growth in the economy.
Investors will certainly be confused today, at least this morning, as the market rises but discipline is key. Stay with strong companies and don't chase the rising market.
Sunday, October 26, 2008
Do You Have The Gold Bug?
The Federal Reserve has flooded the financial system with liquidity. This drastic production of dollars and the extraordinary growth of the Monetary Base should reduce the value of the dollar, create hyper inflation, and cause gold to escalate. I could see gold heading to $2000.
So why has gold been moving down. I think there are two reasons and both are short-term in nature. We have not seen any inflation yet. In fact, we are witnessing the beginning of a deflationary environment. The weak economy globally has resulted in most, if not all, commodities declining precipitously. Oil is leading the charge but copper is also falling like a rock. Lower commodity prices will deflate the cost of products that use them as inputs. A deflationary environment is likely to temporarily halt the inevitable rise in gold. Gold thrives on inflationary expectations.
Commodities is the first reason for gold's weakness and the strong dollar is the second. Typically, low interest rates and a weak economy lead to a weak dollar. In the current state of the global economy, the U.S. is in bad shape but most of the world is in worse condition. Hence, the U.S. looks like a place of stabilty to the rest of the world and global investors want to hold on to dollars. This has produced a major strengtheneing of the dollar in the past month. A strong dollar typically results in weaker gold prices.
These theories seems plausible for the short-term but there is no free lunch. The government can't keep printing money without consequences. Too much money must mean inflation is around the corner. The question is when that will occur. Today we see deflation and a strong dollar but those trends will change. Gold may not be moving up today but at some point, it will roar like a lion and be a great investment.
So why has gold been moving down. I think there are two reasons and both are short-term in nature. We have not seen any inflation yet. In fact, we are witnessing the beginning of a deflationary environment. The weak economy globally has resulted in most, if not all, commodities declining precipitously. Oil is leading the charge but copper is also falling like a rock. Lower commodity prices will deflate the cost of products that use them as inputs. A deflationary environment is likely to temporarily halt the inevitable rise in gold. Gold thrives on inflationary expectations.
Commodities is the first reason for gold's weakness and the strong dollar is the second. Typically, low interest rates and a weak economy lead to a weak dollar. In the current state of the global economy, the U.S. is in bad shape but most of the world is in worse condition. Hence, the U.S. looks like a place of stabilty to the rest of the world and global investors want to hold on to dollars. This has produced a major strengtheneing of the dollar in the past month. A strong dollar typically results in weaker gold prices.
These theories seems plausible for the short-term but there is no free lunch. The government can't keep printing money without consequences. Too much money must mean inflation is around the corner. The question is when that will occur. Today we see deflation and a strong dollar but those trends will change. Gold may not be moving up today but at some point, it will roar like a lion and be a great investment.
Can This Week Be Any Worse Than Last
Investors seem to be losing patience with the volatility in the markets and the losses that follow right behind. The market seems to swing hundreds of points up and down every day. Friday easily could have ended on a positive note but the fear of what might happen over the weekend brought many sellers into the market at the end of the day. The DOW and the S&P ended the day down around 3.5%
This week many more companies will report third quarter numbers. There will be some good reports and some bad ones but most likely the majority of the companies will forecast a bleak future. The market focus will continue to be "All About the Economy". There are high expectations that the Federal Reserve Bank will cut interest rates again. This may happen and we may get a rally in the stock market but we doubt it will have a long lasting effect.
Great companies such as Walmart, McDonald's, Google, DOW and Oracle have become cheap in this market but it doesn't mean they won't get cheaper. Fear is here and it probably will be around for a while. Many individuals with equity portfolios have lost 30%-50% this year. It is easy to say my broker is horrible and I don't know what to do. In these uncertain times, as we have been writing, one needs to have safe liquid assets to be ready to take advantage of the opportunities that will present themselves in the market. Most people don't want to recognize the losses they have. That is a bad strategy. Take the losses if you don't have high quality investments. The sale of losing positions creates a tax loss carry forward. Use the cash for safe fixed income liquid positions (i.e. Treasuries) or high quality stocks with few debt maturities in the next couple of years. This repositioning will maximize your opportunity to grow the portfolio and rid yourself of low quality stocks with much higher risk in an economy which is heading into a deep recession.
This week might be just as volatile as last. Friday, before the market opened, it looked like we were heading into the Abyss. The Dow could easily have dropped 1000 points but the heavy selling never appeared and the day was much smoother than expected. Any day now, we could have that calamity and one should not be surprised if it happens. The VIX fear index reached new heights again at the end of the week and until we get a huge wipe out in the market, we may not see a new positive trend. Buckle up and wait to see the excitement this week promises to bring.
This week many more companies will report third quarter numbers. There will be some good reports and some bad ones but most likely the majority of the companies will forecast a bleak future. The market focus will continue to be "All About the Economy". There are high expectations that the Federal Reserve Bank will cut interest rates again. This may happen and we may get a rally in the stock market but we doubt it will have a long lasting effect.
Great companies such as Walmart, McDonald's, Google, DOW and Oracle have become cheap in this market but it doesn't mean they won't get cheaper. Fear is here and it probably will be around for a while. Many individuals with equity portfolios have lost 30%-50% this year. It is easy to say my broker is horrible and I don't know what to do. In these uncertain times, as we have been writing, one needs to have safe liquid assets to be ready to take advantage of the opportunities that will present themselves in the market. Most people don't want to recognize the losses they have. That is a bad strategy. Take the losses if you don't have high quality investments. The sale of losing positions creates a tax loss carry forward. Use the cash for safe fixed income liquid positions (i.e. Treasuries) or high quality stocks with few debt maturities in the next couple of years. This repositioning will maximize your opportunity to grow the portfolio and rid yourself of low quality stocks with much higher risk in an economy which is heading into a deep recession.
This week might be just as volatile as last. Friday, before the market opened, it looked like we were heading into the Abyss. The Dow could easily have dropped 1000 points but the heavy selling never appeared and the day was much smoother than expected. Any day now, we could have that calamity and one should not be surprised if it happens. The VIX fear index reached new heights again at the end of the week and until we get a huge wipe out in the market, we may not see a new positive trend. Buckle up and wait to see the excitement this week promises to bring.
Thursday, October 23, 2008
More of the Same
Today the market was like a yo-yo. It went up then down then up then down and the S&P and DOW ended up. However, the Russel 2000 index of small stocks was down for the day. The concern by investors is likely that smaller less capitalized companies may have fewer resources to withstand a deep recession and limited capital raising opportunities. The volatility in the markets is certainly increasing investor stress and most people will be happy when Friday is over.
Many more companies reported earnings today with few upside surprises and many warnings of difficult times ahead. The sectors that seemed to have the most losers today were home building, gaming, airlines, auto parts and wireless. A weakening consumer will definitely hurt these industries.
The Asian markets are down 3-7% overnight and will likely set a negative tone for trading in the United States. Take a deep breadth. This is a long race. As stocks decline, the opportunity only gets better as long as you maintain liquidity and invest in high quality stocks.
Many more companies reported earnings today with few upside surprises and many warnings of difficult times ahead. The sectors that seemed to have the most losers today were home building, gaming, airlines, auto parts and wireless. A weakening consumer will definitely hurt these industries.
The Asian markets are down 3-7% overnight and will likely set a negative tone for trading in the United States. Take a deep breadth. This is a long race. As stocks decline, the opportunity only gets better as long as you maintain liquidity and invest in high quality stocks.
Wednesday, October 22, 2008
Where's The Good News
The Federal Reserve and its counterparts around the world as well as the U.S. Treasury and its global partners injected enormous amounts of liquidity into the financial system to relieve the strain of the credit crisis. The goal was to improve lending and lower rates. The objective seems to be on track as money market rates dropped significantly, the commercial paper market is open again, libor has moved below 4%, and investment grade bond yields are falling. The conclusion must be that we are back to normal and the stock market is ready to march ahead again.
Wrong. It is still all about the economy. Today was another painful day in many markets all around the world. The question is where to look first for trouble. The commodity markets are in free fall led by copper which was down 7.8%, oil down by 6.5% and gold down by 5%. Inflation has been a concern for most investors as oil was spiking and now its precipitous drop is leading the way toward deflation and all commodities are following. The reason these commodities are declining is that consumers and businesses are spending less as demand dries up. OPEC may be getting ready to discuss production cuts to stabilize oil prices but it is unlikely to be successful. Demand for oil will continue to fall and the OPEC countries as well as Russia are likely to cheat on their production as oil revenues are desperately needed to feed their economies and stimulate their stock markets.
Next on the list is Argentina. The Argentinian government is planning to take over 10 private pension plans. The country is enraged as it is rumored that the government will dip into the funds for its own use. A weak economy and a sour stock market were caused by the rout in commodity exports. The expectations for this potential government theft resulted in bond yields reaching 30% as the market believes the Government's weak financial situation could result in a default.
Pakistan even made the economic news as S&P may cut its credit rating given its weak current account balance. Belarus needs aid from the Monetary Fund. Iceland is a disaster. South Korea's government is pumping liquidity into its financial system to keep markets afloat. Australia is likely to see its economy and currency tumble as the commodity bear market continues to pick up steam. Europe, as we have mentioned in other posts, may be weaker than the U.S. The Euro dropped another 2% today and doesn't seem to be turning around anytime soon. The point is that there is no place to hide. Pick your market. Pick your country. Pick your stock. Pick your commodity. We are in a Global Recession and the bear market abounds.
Let's get to the United States. The dollar is rising against most currencies and falling against the Yen. One would think the economy and the stock market was doing okay. However, we aren't. It is just that the rest of the world is in worse shape. The U.S. led the world down and it will have to lead it to better times. The stock market wasn't fun at all today. Last night Apple reported strong numbers and its stock flew. It was easy to believe the rest of the market would follow along. It clearly didn't. Many companies reported today. McDonald's had terrific numbers but AT&T didn't. It looked like more companies reported numbers that beat analyst expectations but it didn't matter. Why? Most companies lowered future earnings guidance or tabled giving guidance as the economic uncertainties clouded their judgement. The result was a 6% drop in the S&P to its lowest level since 2003.
Fear is rising again as panic is everywhere. It looked like capitulation struck on October 10th but after days like today, we wonder whether new lows can continue to be set. Capitulation will likely come on the day we throw the towel in. At 4PM, it was nice to have the markets close as Amazon was going to report their third quarter numbers. Thankfully good news would be coming and it did. They beat the analyst expectations for the quarter. Internet shopping is picking up market share and the Kindle is a hot product. Sounds great but the economy is about to bite Amazon too. They drastically cut their 4th quarter forecast, the stock dropped like a rock, and the day ended on a weak note.
Asia is falling over night and new challenges will be in front of us tomorrow. Hope is out there for the Fed to cut interest rates again. We don't think that is the way to go. The banking system is improving, liquidity is ample, and the deleveraging process is underway. The economy will be weak for a long period and the markets need to be flushed out. Lowering rates may give some short-term relief but it is still all about the economy. Time is the only healer of the mess we are in. As long as the Great Depression II can be avoided, the leverage needs to be addressed through infusions of equity, bankruptcies, or consolidation of industries. This is a private market problem. The government is doing their part but the excesses of the past decade won't vanish over night. It may be painful but eventually the United States economy will recover, the stock market will rise, and perhaps the U.S. will reappear as an economic power and lead the global economy back to prosperity.
Wrong. It is still all about the economy. Today was another painful day in many markets all around the world. The question is where to look first for trouble. The commodity markets are in free fall led by copper which was down 7.8%, oil down by 6.5% and gold down by 5%. Inflation has been a concern for most investors as oil was spiking and now its precipitous drop is leading the way toward deflation and all commodities are following. The reason these commodities are declining is that consumers and businesses are spending less as demand dries up. OPEC may be getting ready to discuss production cuts to stabilize oil prices but it is unlikely to be successful. Demand for oil will continue to fall and the OPEC countries as well as Russia are likely to cheat on their production as oil revenues are desperately needed to feed their economies and stimulate their stock markets.
Next on the list is Argentina. The Argentinian government is planning to take over 10 private pension plans. The country is enraged as it is rumored that the government will dip into the funds for its own use. A weak economy and a sour stock market were caused by the rout in commodity exports. The expectations for this potential government theft resulted in bond yields reaching 30% as the market believes the Government's weak financial situation could result in a default.
Pakistan even made the economic news as S&P may cut its credit rating given its weak current account balance. Belarus needs aid from the Monetary Fund. Iceland is a disaster. South Korea's government is pumping liquidity into its financial system to keep markets afloat. Australia is likely to see its economy and currency tumble as the commodity bear market continues to pick up steam. Europe, as we have mentioned in other posts, may be weaker than the U.S. The Euro dropped another 2% today and doesn't seem to be turning around anytime soon. The point is that there is no place to hide. Pick your market. Pick your country. Pick your stock. Pick your commodity. We are in a Global Recession and the bear market abounds.
Let's get to the United States. The dollar is rising against most currencies and falling against the Yen. One would think the economy and the stock market was doing okay. However, we aren't. It is just that the rest of the world is in worse shape. The U.S. led the world down and it will have to lead it to better times. The stock market wasn't fun at all today. Last night Apple reported strong numbers and its stock flew. It was easy to believe the rest of the market would follow along. It clearly didn't. Many companies reported today. McDonald's had terrific numbers but AT&T didn't. It looked like more companies reported numbers that beat analyst expectations but it didn't matter. Why? Most companies lowered future earnings guidance or tabled giving guidance as the economic uncertainties clouded their judgement. The result was a 6% drop in the S&P to its lowest level since 2003.
Fear is rising again as panic is everywhere. It looked like capitulation struck on October 10th but after days like today, we wonder whether new lows can continue to be set. Capitulation will likely come on the day we throw the towel in. At 4PM, it was nice to have the markets close as Amazon was going to report their third quarter numbers. Thankfully good news would be coming and it did. They beat the analyst expectations for the quarter. Internet shopping is picking up market share and the Kindle is a hot product. Sounds great but the economy is about to bite Amazon too. They drastically cut their 4th quarter forecast, the stock dropped like a rock, and the day ended on a weak note.
Asia is falling over night and new challenges will be in front of us tomorrow. Hope is out there for the Fed to cut interest rates again. We don't think that is the way to go. The banking system is improving, liquidity is ample, and the deleveraging process is underway. The economy will be weak for a long period and the markets need to be flushed out. Lowering rates may give some short-term relief but it is still all about the economy. Time is the only healer of the mess we are in. As long as the Great Depression II can be avoided, the leverage needs to be addressed through infusions of equity, bankruptcies, or consolidation of industries. This is a private market problem. The government is doing their part but the excesses of the past decade won't vanish over night. It may be painful but eventually the United States economy will recover, the stock market will rise, and perhaps the U.S. will reappear as an economic power and lead the global economy back to prosperity.
Apple of Our Eye
Apple Computer came through with strong numbers again but clearly had cautious comments. Even in these tough economic times, Apple sold 6.9 million iPhones last quarter which on the face of it is enormous. What is more impressive is they outsold Blackberry. Can Apple alone keep us out of recession? There aren't many companies showing growth like them. Google is the other exception. Many companies are reporting numbers that beat analyst estimates but it is still All About The Economy.
In that light, most companies , including Apple and Google, expect a slower economy and an uncertain future. We are also seeing a slew of announcements about layoffs. The stock market may have risen on Monday, as expected, but the economic realities have set in and the markets swooned yesterday and will follow that trend this morning. As we have said in the past, don't get anxious to buy into the rallies. Be patient and buy quality. The recession is here and having strong liquidity is the most important position to be in. It is better to miss the run up in a stock than to run out of cash. New opportunities will always appear but one needs to have the resources to take advantage of them.
In that light, most companies , including Apple and Google, expect a slower economy and an uncertain future. We are also seeing a slew of announcements about layoffs. The stock market may have risen on Monday, as expected, but the economic realities have set in and the markets swooned yesterday and will follow that trend this morning. As we have said in the past, don't get anxious to buy into the rallies. Be patient and buy quality. The recession is here and having strong liquidity is the most important position to be in. It is better to miss the run up in a stock than to run out of cash. New opportunities will always appear but one needs to have the resources to take advantage of them.
Monday, October 20, 2008
Acquisitions Are Coming
Today Exelon, a power company, made a bid to buy NRG, another power company. This acquisition attempt may result in a prolonged battle and it may never occur. However, it is just another Tea Leaf we have been discussing. Well capitalized strong companies, like individual investors, are searching for bargains in the stock market. These corporate acquirers set values in the market that the rest of us can use when analyzing stocks. Novartis also indicated today that they are scouring the markets for small biotech companies to buy. The market is developing a bottom and it will become more clear as other acquisitions are announced.
Today, the DOW and the S&P 500 were both up about 4.5%. Investors are getting more bullish as the credit markets appear to be functioning a little bit better and the bailout plan has some positive momentum. We even had some positive news out of the California housing situation as new home sales increased 65%, albeit at very low prices and many of the houses were foreclosures. Any good housing news seems to be a positive as the market would like to see the inventory of homes decline.
We cannot forget our key motto: It Is All About The Economy. Mattel and Hasbro both reported today and indicated toy sales are not going to be that strong this Christmas season. They are praying to pick up market share but one should not invest or run a business on hope. In fact, Hasbro's stock traded down today and left us a little concerned that their inventories may be a too high if the December quarter is weak. (Full disclosure: we have been short Hasbro stock). Google, a stock we love for the long term (and own), made some cautious comments today about potential softness in their business also. American Express reported today and their numbers surpassed analyst expectations but the company expressed concerns about the economy in the next few quarters. In the technology sector, Texas Instruments reported weak numbers and a dour forecast while Sun Microsystems had similar thoughts. Tomorrow the market will be waiting to hear from Apple and Yahoo.
The market could continue to run up but it is likely to come down again. Keep buying quality and don't chase upward moving stocks. Wait to be an aggressive buyer when the fear is back and the market is dropping a few hundred points. As long as you buy strong companies with good balance sheets, the returns will be there in three to five years.
Today, the DOW and the S&P 500 were both up about 4.5%. Investors are getting more bullish as the credit markets appear to be functioning a little bit better and the bailout plan has some positive momentum. We even had some positive news out of the California housing situation as new home sales increased 65%, albeit at very low prices and many of the houses were foreclosures. Any good housing news seems to be a positive as the market would like to see the inventory of homes decline.
We cannot forget our key motto: It Is All About The Economy. Mattel and Hasbro both reported today and indicated toy sales are not going to be that strong this Christmas season. They are praying to pick up market share but one should not invest or run a business on hope. In fact, Hasbro's stock traded down today and left us a little concerned that their inventories may be a too high if the December quarter is weak. (Full disclosure: we have been short Hasbro stock). Google, a stock we love for the long term (and own), made some cautious comments today about potential softness in their business also. American Express reported today and their numbers surpassed analyst expectations but the company expressed concerns about the economy in the next few quarters. In the technology sector, Texas Instruments reported weak numbers and a dour forecast while Sun Microsystems had similar thoughts. Tomorrow the market will be waiting to hear from Apple and Yahoo.
The market could continue to run up but it is likely to come down again. Keep buying quality and don't chase upward moving stocks. Wait to be an aggressive buyer when the fear is back and the market is dropping a few hundred points. As long as you buy strong companies with good balance sheets, the returns will be there in three to five years.
Where Do WE Go From Here II?
Last week we saw a huge rally on Monday followed buy an extremely volatile market that fluctuated all day long every day. The markets ended up about 4.5% for the week even though Friday was in negative territory. It became clearer that we are in a recession as the retail numbers, housing numbers, and industrial production numbers were reported. Oil prices are half of what they were not long ago when market prognosticators were predicting $200 per barrel. Gold is also down to $800 as the new concern is deflation. Pessimism reached its peak and many money mangers have begun to believe the market has hit bottom.
What can we expect now? Markets will remain very volatile. This week might show another uptrend as more and more investors don't want to miss a potential rally. In the end, it will again all be about the economy. Many more earnings reports will come out this week and there will likely be surprises which will lead to more volatility. State and City municipalities are struggling and will become an increasing focus in the newspapers and a huge drag on the economy as taxes will have to go up or services and employment will have to go down. States and Cities can't print money like the Federal Government. Lower all prices should help the consumer as their gas bills will decline and their purchasing power incrementally improves. Will the consumer spend those savings? Perhaps, but when each individual counts up his/her losses in the value of their home, the losses in the 401K, and the significant drop in their stock portfolio, the excess cash may move right into the bank to rebuild some savings.
There is reason to feel better. The government bailout plan and the massive global liquidity injections into the financial system has prevented The Great Depression II. Interbank interest rates are finally declining and perhaps some confidence is being restored in the banking system. The corporate credit markets are still concerned with bankruptcies, which will sure be coming, but activity has been extremely busy as investors rejigger their portfolios and hedge funds continue to liquidate some assets. Market pundits should start to feel good about the effect of a lower Libor rate and the prediction of better times ahead could produce a big market rally. Don't get sucked in. Continue to buy quality stocks slowly and watch the tea leaves. Christmas season will be slow and corporate earning will be weak. Lower oil prices will be a positive but housing isn't turning around anytime soon. Companies aren't about to expand capital expenditures and Government debt will continue to soar. Eventually these trends will improve but it will take time. We might see the big rally but we are also likely to see stocks reach the lows again. Be cautious and safe in your investing as there will be plenty of time to take big risk.
What can we expect now? Markets will remain very volatile. This week might show another uptrend as more and more investors don't want to miss a potential rally. In the end, it will again all be about the economy. Many more earnings reports will come out this week and there will likely be surprises which will lead to more volatility. State and City municipalities are struggling and will become an increasing focus in the newspapers and a huge drag on the economy as taxes will have to go up or services and employment will have to go down. States and Cities can't print money like the Federal Government. Lower all prices should help the consumer as their gas bills will decline and their purchasing power incrementally improves. Will the consumer spend those savings? Perhaps, but when each individual counts up his/her losses in the value of their home, the losses in the 401K, and the significant drop in their stock portfolio, the excess cash may move right into the bank to rebuild some savings.
There is reason to feel better. The government bailout plan and the massive global liquidity injections into the financial system has prevented The Great Depression II. Interbank interest rates are finally declining and perhaps some confidence is being restored in the banking system. The corporate credit markets are still concerned with bankruptcies, which will sure be coming, but activity has been extremely busy as investors rejigger their portfolios and hedge funds continue to liquidate some assets. Market pundits should start to feel good about the effect of a lower Libor rate and the prediction of better times ahead could produce a big market rally. Don't get sucked in. Continue to buy quality stocks slowly and watch the tea leaves. Christmas season will be slow and corporate earning will be weak. Lower oil prices will be a positive but housing isn't turning around anytime soon. Companies aren't about to expand capital expenditures and Government debt will continue to soar. Eventually these trends will improve but it will take time. We might see the big rally but we are also likely to see stocks reach the lows again. Be cautious and safe in your investing as there will be plenty of time to take big risk.
Friday, October 17, 2008
The Volatility Continues
Yesterday was a day in the market everyone should get used to--Big swings up and Big swings down. Fear was high and the market floundered but as oil prices started to decline new confidence developed that inflation would be curtailed and costs of consumer and industrial products will decline. Gas prices are dropping and consumers may save some money at the pump and use it to purchase some discretionary goods. The markets are not easy to figure out but it is all about reading the Tea Leaves.
The problems we have today relate to a lack of confidence in our financial system, ubiquitous leverage, a sinking housing market, and a weak global economy. The government is focused on stabilizing the banking system and improving the flow of money among banks while hoping to generate new lending to consumers and businesses. There are some positive signs beginning to take shape in the financial system, albeit slowly. Some interbank lending rates are slowly declining and the injection of $125B of equity into banks this week is a big step forward. Bond insurers such as AMBAC and MBIA are working with the government to rid themselves of distressed assets which will be another step in the right direction to improve America's financial system.
The government reported yesterday that industrial production was weak last month while today housing starts dropped more than expected. These numbers point to the recession we are in and the low consumer confidence we have. There is no magic to turn around the economy and the weakness may last a long time. Hence, it is important to continue to see the glimmers of hope on the horizon. Google announced terrific earnings so the advertising market is not dead. IBM met their expectations and AMD solidly beat expectations. The world is not coming to an end. A recession is here but The Great Depression II is likely off the table.
We will continue to see disappointing news everyday as we saw Citigroup take larger than expected write-offs yesterday and rumors that ING Bank may need a cash infusion due to its weak balance sheet. On the other hand, everyday will also produce tidbits of good news. The discussions of a merger with GM and Chrysler would be great news for the auto manufacturers and the corporate bond market. JP Morgan has about $4B of Chrysler loans marked at par on their books. They are in a long-term account and have not been written down. These loans alone could produce a $2.6B loss for JPM. A merger will likely result in a restructuring of all the debt at GM and Chrysler with many losses taken but it will also be one more positive step to improving the corporate bond and loan markets.
We are going to start to see merger and acquisition activity pick up as strong companies prey on their weak competitors. Private equity firms are also gearing up to pounce on financial institutions as the government's $700B basket starts to fill up with distressed assets. As you see this type of activity, read the Tea Leaves. The economy will be strong again and the stock market will forecast that. Keep buying quality in this market. You may not make money today but in a few years, you will look back and be thankful you did.
Today is option expiration expiration day. In normal markets, option Friday usually brings large swings in the stock market. Today should be no different. Weak housing numbers this morning will clearly focus the market on the recession and drive prices lower. News will help create volatility all day as more companies report earnings and oil and gold prices remain a focus for investors.
The problems we have today relate to a lack of confidence in our financial system, ubiquitous leverage, a sinking housing market, and a weak global economy. The government is focused on stabilizing the banking system and improving the flow of money among banks while hoping to generate new lending to consumers and businesses. There are some positive signs beginning to take shape in the financial system, albeit slowly. Some interbank lending rates are slowly declining and the injection of $125B of equity into banks this week is a big step forward. Bond insurers such as AMBAC and MBIA are working with the government to rid themselves of distressed assets which will be another step in the right direction to improve America's financial system.
The government reported yesterday that industrial production was weak last month while today housing starts dropped more than expected. These numbers point to the recession we are in and the low consumer confidence we have. There is no magic to turn around the economy and the weakness may last a long time. Hence, it is important to continue to see the glimmers of hope on the horizon. Google announced terrific earnings so the advertising market is not dead. IBM met their expectations and AMD solidly beat expectations. The world is not coming to an end. A recession is here but The Great Depression II is likely off the table.
We will continue to see disappointing news everyday as we saw Citigroup take larger than expected write-offs yesterday and rumors that ING Bank may need a cash infusion due to its weak balance sheet. On the other hand, everyday will also produce tidbits of good news. The discussions of a merger with GM and Chrysler would be great news for the auto manufacturers and the corporate bond market. JP Morgan has about $4B of Chrysler loans marked at par on their books. They are in a long-term account and have not been written down. These loans alone could produce a $2.6B loss for JPM. A merger will likely result in a restructuring of all the debt at GM and Chrysler with many losses taken but it will also be one more positive step to improving the corporate bond and loan markets.
We are going to start to see merger and acquisition activity pick up as strong companies prey on their weak competitors. Private equity firms are also gearing up to pounce on financial institutions as the government's $700B basket starts to fill up with distressed assets. As you see this type of activity, read the Tea Leaves. The economy will be strong again and the stock market will forecast that. Keep buying quality in this market. You may not make money today but in a few years, you will look back and be thankful you did.
Today is option expiration expiration day. In normal markets, option Friday usually brings large swings in the stock market. Today should be no different. Weak housing numbers this morning will clearly focus the market on the recession and drive prices lower. News will help create volatility all day as more companies report earnings and oil and gold prices remain a focus for investors.
Wednesday, October 15, 2008
The Fear is Rising and The Market is Swooning
Today was another ugly day in the market. The VIX indicator of fear jumped 25% today as the DOW accelerated its fall in the afternoon to end down 733 points. Most of the earnings reports matched or beat estimates for this quarter but the expectations for the fourth quarter proved gloomy. This morning September retail sales were announced and they dropped .6% which was three times worse than expected. The market hated those numbers and discussion about how bad and how long the recession would be dominated the chatter all day.
The precipitous decline in all the stock markets at the end of the day leaves us in a position to potentially test last Friday's lows tomorrow morning. Many more companies will report their third quarter earnings tomorrow including Continental Airlines, Southwest Airlines, Citigroup, CIT and GAP. However, there will be great anticipation for Google's numbers which come out after the close of the markets tomorrow. Google's stock price is half of what it was at the beginning of this year and it should be able to grow 15-20% for the foreseeable future. This company doesn't have any debt and it holds plenty of cash so it is definitely a survivor. If the company reports weak numbers, the stock will likely drop and it should be bought and put away for five years when its price will likely be much higher than it is today. A weak Google number would also give a negative tone to the market for the rest of the week.
It looked like we had capitulation last Friday when the market dove in the morning on high volume and record fear but then recovered in the afternoon. It was then followed by the 900 point gain on Monday. We said the market likely bottomed on Friday but there will remain much volatility in the market. Tomorrow may be the true test. Mutual funds may again see redemptions and the continued selling by hedge funds might also provide weakness but a swift sell off in the morning will also likely generate new buy orders as the day closes out. Last week we had high hopes for the government to put equity into some banks as a catalyst for positive news. Tomorrow there doesn't appear to be any good news coming. Fear is high and volatility will continue. Cash is the most precious asset in these markets and we reiterate that quality companies are the only ones that should be bought.
The precipitous decline in all the stock markets at the end of the day leaves us in a position to potentially test last Friday's lows tomorrow morning. Many more companies will report their third quarter earnings tomorrow including Continental Airlines, Southwest Airlines, Citigroup, CIT and GAP. However, there will be great anticipation for Google's numbers which come out after the close of the markets tomorrow. Google's stock price is half of what it was at the beginning of this year and it should be able to grow 15-20% for the foreseeable future. This company doesn't have any debt and it holds plenty of cash so it is definitely a survivor. If the company reports weak numbers, the stock will likely drop and it should be bought and put away for five years when its price will likely be much higher than it is today. A weak Google number would also give a negative tone to the market for the rest of the week.
It looked like we had capitulation last Friday when the market dove in the morning on high volume and record fear but then recovered in the afternoon. It was then followed by the 900 point gain on Monday. We said the market likely bottomed on Friday but there will remain much volatility in the market. Tomorrow may be the true test. Mutual funds may again see redemptions and the continued selling by hedge funds might also provide weakness but a swift sell off in the morning will also likely generate new buy orders as the day closes out. Last week we had high hopes for the government to put equity into some banks as a catalyst for positive news. Tomorrow there doesn't appear to be any good news coming. Fear is high and volatility will continue. Cash is the most precious asset in these markets and we reiterate that quality companies are the only ones that should be bought.
Tuesday, October 14, 2008
Earnings Season Will Drive the Market
As expected the market salivated this morning over the news of the government taking equity stakes in the nine large financial institutions. These companies saw their stock prices take-off (except for J.P. Morgan) but then concerns about the economy led to the stock market finishing with a weaker tone. During the day, there was great anticipation for Apple's presentation of new products but Steve Jobs couldn't pull off his usual magic. He introduced some new computers and lowered the price on others. The result was an expectation from the financial community that it won't be enough to drive sales growth in this weak consumer environment and margins could shrink. The stock took a swan dive and so did the market.
The next bellwether was Intel reporting after the close. They announced numbers which met analyst expectations but their uncertainty with regards to the fourth quarter caused some concern after the stock initially rose 5%. It looks like it will open down tomorrow. This won't bode well for the overall market as it might foreshadow negative results for the computer industry and other technology companies.
As we have said all along, the market is now for stock pickers and those companies that are economically sensitive in nature should be avoided until they report their numbers and the stock declines. We would continue to avoid building products companies, auto supply companies, and any company that could be hurt by a lousy Christmas season.
An interesting area to start to look at is the bank loan market. Typically bank debt trades close to 100 cents on the dollar or par value. On average it is now trading at historical lows of 75 cents on the dollar and is the most senior part of the capitalization. Bank debt is typically secured by the assets of the company and if the company should go into bankruptcy, the loan holder has first claim. Most times these loans will return 70 cents on the dollar after a reorganization. Hence, even if 5-10% of the loans default in this deep recession, the loans should have minimal downside. The best way to play this market is by buying a mutual fund or closed-end fund for leveraged loans. If you are compelled to buy securities, bank loans are a safer bet than the stock market. You will receive interest payments and have far less downside risk.
We are in earning season and tomorrow has many companies reporting. A few which will give us some insight into the economy are Marriott, J.P. Morgan, Wells Fargo, CSX, Delta, Spansion, EBAY and AMR. Some bad news here could result in a sloppy market as those who profited on Monday could turn around and sell stock tomorrow. Don't expect the market to go up tomorrow. We will be lucky to see a little rally during the day unless we get surprisingly good earnings.
The next bellwether was Intel reporting after the close. They announced numbers which met analyst expectations but their uncertainty with regards to the fourth quarter caused some concern after the stock initially rose 5%. It looks like it will open down tomorrow. This won't bode well for the overall market as it might foreshadow negative results for the computer industry and other technology companies.
As we have said all along, the market is now for stock pickers and those companies that are economically sensitive in nature should be avoided until they report their numbers and the stock declines. We would continue to avoid building products companies, auto supply companies, and any company that could be hurt by a lousy Christmas season.
An interesting area to start to look at is the bank loan market. Typically bank debt trades close to 100 cents on the dollar or par value. On average it is now trading at historical lows of 75 cents on the dollar and is the most senior part of the capitalization. Bank debt is typically secured by the assets of the company and if the company should go into bankruptcy, the loan holder has first claim. Most times these loans will return 70 cents on the dollar after a reorganization. Hence, even if 5-10% of the loans default in this deep recession, the loans should have minimal downside. The best way to play this market is by buying a mutual fund or closed-end fund for leveraged loans. If you are compelled to buy securities, bank loans are a safer bet than the stock market. You will receive interest payments and have far less downside risk.
We are in earning season and tomorrow has many companies reporting. A few which will give us some insight into the economy are Marriott, J.P. Morgan, Wells Fargo, CSX, Delta, Spansion, EBAY and AMR. Some bad news here could result in a sloppy market as those who profited on Monday could turn around and sell stock tomorrow. Don't expect the market to go up tomorrow. We will be lucky to see a little rally during the day unless we get surprisingly good earnings.
Monday, October 13, 2008
The Stock Market Flies
The DOW was up 936 points today as investors were pleased with the global efforts by governments to inject capital into their financial institutions. Rumors of a meeting in Washington at 3pm with our esteemed Secretary of the Treasury and a handful of CEO's from major financial institutions lead to a second leg up in the markets in the last hour. Speculation was rampant about what was going to be said at that meeting.
Tonight some details have been released. The government is investing $125B (out of the $700B bailout fund) in 9 top tier banks, They are Wells Fargo, JP Morgan, Citigroup, Goldman Sachs, Morgan Stanley, State Street, Bank of NY, and Merrill Lynch. The complete terms are not available but it looks like the government will buy a 5% preferred in these institutions and receive warrants to buy common stock. This may dilute common shareholders if the banks cannot buy back the warrants but this is a major commitment by the government to restore confidence in the financial sector.
What should investors do now? The market will clearly rise again tomorrow morning as the investment community will love this deal. However, we should not lose sight that the economy will have an overriding affect on stock prices. Stocks have been beaten down in the last year and great companies with strong cash flow and little debt burdens over the next few years might be heading into their own new bull market. On the other hand, some economically sensitive companies may report really disappointing earnings and keep a lid on their stocks. As we said a few days ago, the overall market may have hit a bottom on Friday but it will now be a stock pickers market after the current euphoria subsides.
Tonight some details have been released. The government is investing $125B (out of the $700B bailout fund) in 9 top tier banks, They are Wells Fargo, JP Morgan, Citigroup, Goldman Sachs, Morgan Stanley, State Street, Bank of NY, and Merrill Lynch. The complete terms are not available but it looks like the government will buy a 5% preferred in these institutions and receive warrants to buy common stock. This may dilute common shareholders if the banks cannot buy back the warrants but this is a major commitment by the government to restore confidence in the financial sector.
What should investors do now? The market will clearly rise again tomorrow morning as the investment community will love this deal. However, we should not lose sight that the economy will have an overriding affect on stock prices. Stocks have been beaten down in the last year and great companies with strong cash flow and little debt burdens over the next few years might be heading into their own new bull market. On the other hand, some economically sensitive companies may report really disappointing earnings and keep a lid on their stocks. As we said a few days ago, the overall market may have hit a bottom on Friday but it will now be a stock pickers market after the current euphoria subsides.
Sunday, October 12, 2008
The Government May Finally Get It Right
Friday was the most volatile day I have ever seen in the market and fear reached it's all time peak. Mr. and Mrs. Main Street were anxious as they called their brokers to investigate whether it was time to sell their 401Ks. Volume on the stock exchanges soared and the indices plummeted. This is what we called for on Thursday night. We are clearly close to capitulation and Friday probably represented the lows of the market. Volatility will persist and it wouldn't be surprising to see a rally of 700 to 1000 points in the DOW one day next week.
The problem is it is still all about the economy and the credit crisis. The passing of the government bailout plan and the injection of much needed liquidity around the world has not renewed any confidence in our financial system. On 9-29-08 we wrote "We Need A New Plan" which called for direct injections of capital into financial companies to stabilize the banking system and rebuild the capital bases of those institutions. It appears that this is the new focus of the government bailout. The government should focus on three key companies which seem to need help in confidence. They are Morgan Stanley, Goldman Sachs, and Citigroup. Others will also need capital infusions but those three have swooned and need to be stabilized. Such an injection will likely result in a major stock market rally.
Trouble won't be over as it will take two to four years for the economy to flush out the excesses of leverage. Expect weak earnings reports for a while and negative GDP for a few quarters but eventually the United States will move back on a path of growth as long as the global financial system avoids catastrophe.
The problem is it is still all about the economy and the credit crisis. The passing of the government bailout plan and the injection of much needed liquidity around the world has not renewed any confidence in our financial system. On 9-29-08 we wrote "We Need A New Plan" which called for direct injections of capital into financial companies to stabilize the banking system and rebuild the capital bases of those institutions. It appears that this is the new focus of the government bailout. The government should focus on three key companies which seem to need help in confidence. They are Morgan Stanley, Goldman Sachs, and Citigroup. Others will also need capital infusions but those three have swooned and need to be stabilized. Such an injection will likely result in a major stock market rally.
Trouble won't be over as it will take two to four years for the economy to flush out the excesses of leverage. Expect weak earnings reports for a while and negative GDP for a few quarters but eventually the United States will move back on a path of growth as long as the global financial system avoids catastrophe.
Thursday, October 9, 2008
Capitulation is Close
As we discussed two nights ago, the global rate cut would give a short-term boost to the market but the economy would lead all stock markets down. Today clearly proved that point as the DOW dropped 7.3% and the S&P declined 7.5%. Panic is starting to set in as the VIX reached new record levels of fear. If the Federal Reserve doesn't cut rates again tomorrow to stem stock declines, we could see true panic as mutual funds will get bombarded with sell orders from main street and hedge funds will continue their liquidations. Another huge drop in the DOW and S&P of 8-10% could be the final capitulation that the markets need in order to bottom out.
Today's news seemed to all be negative as Morgan Stanley's stock plunged; GM fell off a cliff; many insurance company stocks anticipated big write-offs and capital needs and followed the fate of Metropolitan Life's stock; and AIG needs Billions more from the Federal Reserve. Another shocking event is the precipitous fall of leveraged loans. These are the safest part of a company's debt structure and the average price of these loans are now 71.1%. 100% is full value. Low prices for loans will make it extremely difficult for companies to refinance their debt and we can expect an escalation in default rates in the next year or two. Record defaults are likely.
The Asian markets are plummeting tonight led by the Nikkei down 10% where a Japanese life insurance company filed for bankruptcy. We are having a global recession. Financial institutions are in a liquidity squeeze and there is no simple fix. Lowering rates, adding equity to banks, injecting liquidity into the banking system are all proactive attempts by many governments working to prevent a depression. Time is the only cure as the financial system is close to being on a respirator. Look out for an ugly day tomorrow unless the Mr. Bernanke tries to pull another rabbit out of his hat.
Today's news seemed to all be negative as Morgan Stanley's stock plunged; GM fell off a cliff; many insurance company stocks anticipated big write-offs and capital needs and followed the fate of Metropolitan Life's stock; and AIG needs Billions more from the Federal Reserve. Another shocking event is the precipitous fall of leveraged loans. These are the safest part of a company's debt structure and the average price of these loans are now 71.1%. 100% is full value. Low prices for loans will make it extremely difficult for companies to refinance their debt and we can expect an escalation in default rates in the next year or two. Record defaults are likely.
The Asian markets are plummeting tonight led by the Nikkei down 10% where a Japanese life insurance company filed for bankruptcy. We are having a global recession. Financial institutions are in a liquidity squeeze and there is no simple fix. Lowering rates, adding equity to banks, injecting liquidity into the banking system are all proactive attempts by many governments working to prevent a depression. Time is the only cure as the financial system is close to being on a respirator. Look out for an ugly day tomorrow unless the Mr. Bernanke tries to pull another rabbit out of his hat.
Wednesday, October 8, 2008
It's All About The Economy
As we anticipated in our story last night, all the global markets were down 5%-10% coming into this morning when a first-time coordinated global interest rate cut was instituted by the Reserve Banks around the world. The result was a quick stock market turnaround to positive territory. This effort had the short-term result of improving the stock markets while also nudging the economic impact around the world.
However, a true flush out of the markets today might have been a better recipe to get the markets on a better long-term path. The rate cuts may be good for the economy but for the stock markets, it is all about the economy. We now have TARP, Lower Interest Rates, and Massive Liquidity Injections that will hopefully loosen the conditions in the credit markets but until signs of improvement in business is apparent, the stock market will not make investors happy.
However, a true flush out of the markets today might have been a better recipe to get the markets on a better long-term path. The rate cuts may be good for the economy but for the stock markets, it is all about the economy. We now have TARP, Lower Interest Rates, and Massive Liquidity Injections that will hopefully loosen the conditions in the credit markets but until signs of improvement in business is apparent, the stock market will not make investors happy.
Tuesday, October 7, 2008
Dow Down 508--Tomorrow Morning Could Be Ugly
Today was a scary market as the market started to decline as Mr. Bernanke was speaking. It rallied back a little until President Bush had a word or two to say about the economy and the financial crisis. The market proceeded to go down but was volatile as rumors of the Morgan Stanley deal with Mitsubishi was in trouble. Both companies denied this. Then there was Bank America saying they were going to raise $10B at a 32% discount from Monday's closing price while also cutting its dividend in half. They reported poor third quarter numbers. The fear in the market continued and finished very heavy with a big drop in the last hour of trading.
Thankfully the day was over but it wasn't as Alcoa reported very disappointing numbers. Next came Met Life. It pre-announced its third quarter numbers with many write-offs and an announcement that is is going to issue 75mm shares tomorrow which will raise about $2.7 billion if it is completed at today's closing price. Alcoa is typically the first company in the Fortune 500 to report quarterly numbers and it may be a prelude to a very very weak quarter. Does Met Life's announcement foreshadow trouble with other Life Insurance companies such as the Pru and Principal Financial?
The chatter continued globally all day as many countries in Europe are scrambling to shore up their own financial systems and ease the global credit crisis. As we have said in the past, the credit crisis is leading the charge but ultimately a weak economy will hurt companies, increase unemployment, stretch the consumer, and lead to a prolonged recession.
As we enter tomorrow, Asian markets and European markets are likely to have had major declines over night. Unless the Federal Reserve and its European counterparts announce some major interest rate cuts, I would anticipate the Dow could take a dive in the first two hours of the day and maybe bottom at 1000 points down if the market moved into a capitulation phase where volume increases and everybody is a seller. The Vix will reach new heights of fear but if you have maintained liquidity, new opportunities will be created in the market. Buy high quality stocks that do not have large capital requirements or sit on the sidelines until it is clear that the market has settled down and headed back up.
Thankfully the day was over but it wasn't as Alcoa reported very disappointing numbers. Next came Met Life. It pre-announced its third quarter numbers with many write-offs and an announcement that is is going to issue 75mm shares tomorrow which will raise about $2.7 billion if it is completed at today's closing price. Alcoa is typically the first company in the Fortune 500 to report quarterly numbers and it may be a prelude to a very very weak quarter. Does Met Life's announcement foreshadow trouble with other Life Insurance companies such as the Pru and Principal Financial?
The chatter continued globally all day as many countries in Europe are scrambling to shore up their own financial systems and ease the global credit crisis. As we have said in the past, the credit crisis is leading the charge but ultimately a weak economy will hurt companies, increase unemployment, stretch the consumer, and lead to a prolonged recession.
As we enter tomorrow, Asian markets and European markets are likely to have had major declines over night. Unless the Federal Reserve and its European counterparts announce some major interest rate cuts, I would anticipate the Dow could take a dive in the first two hours of the day and maybe bottom at 1000 points down if the market moved into a capitulation phase where volume increases and everybody is a seller. The Vix will reach new heights of fear but if you have maintained liquidity, new opportunities will be created in the market. Buy high quality stocks that do not have large capital requirements or sit on the sidelines until it is clear that the market has settled down and headed back up.
Monday, October 6, 2008
The Diving Market Came Back To Life
It looked like Armageddon as the Dow dropped almost 800 points during the day yesterday but it came back to fall only 370. The professional traders heard rumors and anticipated a cut in interest rates by the Federal Reserve Bank. The Fed is likely to cut rates as much as 3/4 to 1% to try and force banks to lend to each other which might loosen up the credit markets a little. We can also expect many countries to start to cut rates in order to improve the global credit bind we find ourselves in. This kind of coordinated action could propel stock markets to rally but I would expect it to be short lived.
Leverage needs to unwind and financial institutions still need to be recapitalized. The last I looked the economy is falling off a cliff everywhere. This market will bottom before the economy turns positive but stocks need to get decimated before that happens. Value will be created in some stocks everyday but massive selling needs to occur before the stock market as a whole can begin a new upward trend.
Leverage needs to unwind and financial institutions still need to be recapitalized. The last I looked the economy is falling off a cliff everywhere. This market will bottom before the economy turns positive but stocks need to get decimated before that happens. Value will be created in some stocks everyday but massive selling needs to occur before the stock market as a whole can begin a new upward trend.
Sunday, October 5, 2008
What Will Happen to the Export Engine?
Many investors for the past year or two have been gravitating to the companies who sell many products overseas. The export boom has driven the earnings of many global companies based in the United States. As the U. S. economy has weekend, those companies have stood tall and outperformed their domestic only brethren. Is the party over?
Economic trouble and the financial crisis have finally reached across our borders as financial institutions have required government bailouts in countries such as the United Kingdom, Germany, Belgium, Netherlands, Luxembourg, Italy, and Ireland. I am sure there are others that are having problems also but it is clear that Europe is following the slippery slope of the United States.
The Federal Reserve has been consistently injecting liquidity into the financial system as a means to unlock the illiquid credit markets and in order to stimulate lending amongst banks globally. Mr. Bernanke's European counterparts have been acting in concert to provide additional liquidity. It seems clear that the next move could be a coordinated drop in interest rates. Will this help? It is hard to say but it won't hurt. The scare of triggering inflation has been mitigated by the sudden collapse of commodity prices and the Fed is likely to let rates ratchet down to zero.
Corporations who have depended on that export demand to drive their businesses are likely to see some revenue softness in the next few quarters. Of course their bottom lines may not decline as much in the short-term as they benefit from lower commodity costs but in time, earnings will also slow. The stock market may appear cheap to many experts but if a global recession ensues, earnings projections will be cut, and stock prices will continue to fall. It is important in these declining markets to maintain sufficient liquidity in treasury bills and notes to be able to take advantage of the many opportunities ahead. If you are buying stocks in this volatile market, don't buy a full position right away. Buy a little at a time as the price declines and only buy well capitalized companies with plenty of free cash flow.
Economic trouble and the financial crisis have finally reached across our borders as financial institutions have required government bailouts in countries such as the United Kingdom, Germany, Belgium, Netherlands, Luxembourg, Italy, and Ireland. I am sure there are others that are having problems also but it is clear that Europe is following the slippery slope of the United States.
The Federal Reserve has been consistently injecting liquidity into the financial system as a means to unlock the illiquid credit markets and in order to stimulate lending amongst banks globally. Mr. Bernanke's European counterparts have been acting in concert to provide additional liquidity. It seems clear that the next move could be a coordinated drop in interest rates. Will this help? It is hard to say but it won't hurt. The scare of triggering inflation has been mitigated by the sudden collapse of commodity prices and the Fed is likely to let rates ratchet down to zero.
Corporations who have depended on that export demand to drive their businesses are likely to see some revenue softness in the next few quarters. Of course their bottom lines may not decline as much in the short-term as they benefit from lower commodity costs but in time, earnings will also slow. The stock market may appear cheap to many experts but if a global recession ensues, earnings projections will be cut, and stock prices will continue to fall. It is important in these declining markets to maintain sufficient liquidity in treasury bills and notes to be able to take advantage of the many opportunities ahead. If you are buying stocks in this volatile market, don't buy a full position right away. Buy a little at a time as the price declines and only buy well capitalized companies with plenty of free cash flow.
Where Will The New Trouble Rear Its Ugly Head?
The $700B Bailout Bill finally passed and as expected the stock market ran up on Friday morning in anticipation and came crashing down once it was likely to pass. As we have been saying it is a band-aid and the future will be driven not only buy the credit crunch and the financial sytem but by the economy. The economic truths were best displayed by last week's Institute for Supply Management's index of manufacturing which tumbled to 43.5% in September. This was the lowest reading since October 2001. A reading under 50 means manufacturing is contracting. We are in much worse shape today as October 2001 reflects 9/11 where all business in America came to a screeching halt but rebounded in Novermber. We shouldn't expect a sizable, if any increase, in this index in the near term. On Friday, the payroll employment number for September came out and there were 159,000 fewer jobs. This is not a pleasant number and I suspect the next few months could be worse. If the economy is not in a recession now, I would be shocked.
Just as it seems like all the bad news is out, Arnold Schwarzenegger, Governor of California, seems to be short a few pennies to pay the state's bills and payroll. He is now asking the Federal Government for a small loan of $7B. This is one of the next major problems facing the mighty America. I think Hank Paulson is waiting for the year to end quickly so he can hand off the baton to the next unlucky sole to take the position of the Secretary of the Treasury. The need for capital never seems to end in this crisis.
The municipal bond market, where all Cities and States raise money to fund their capital projects and supplement tax collection has come to a halt like many other credit markets. If the economy is sinking, then business will be softer, earnings will decline, and taxes will also shrink. City and State budgets are calculated with the expectation that their expenses will primarily be covered through the revenues generated by the tax base. Weakened companies pay smaller tax bills and since unemployment is rising, individuals will pay fewer taxes also. Where will the municipalities get the necessary revenue to pay salaries, bills, and pensions to the government workers? They might normally raise money in the municpal bond market but as I stated above, that market is not currently functioning as it should. There are two choices: slash costs as Governor Patterson of New York is attempting or go hat in hand to the Federal Government and ask for a loan as Governor Schwarzenegger is attempting.
If a plethora of Cities and States starts to run a deficit and need to turn to Mr. Paulson for a loan, this will be troubling. Not only is the government trying to fix the financial sytem, it will need to find billions more to keep the municipalities across America from defaulting. In 1979, New York City bonds yieded something like 14% and it looks like similar investment opportunities may be coming.
Just as it seems like all the bad news is out, Arnold Schwarzenegger, Governor of California, seems to be short a few pennies to pay the state's bills and payroll. He is now asking the Federal Government for a small loan of $7B. This is one of the next major problems facing the mighty America. I think Hank Paulson is waiting for the year to end quickly so he can hand off the baton to the next unlucky sole to take the position of the Secretary of the Treasury. The need for capital never seems to end in this crisis.
The municipal bond market, where all Cities and States raise money to fund their capital projects and supplement tax collection has come to a halt like many other credit markets. If the economy is sinking, then business will be softer, earnings will decline, and taxes will also shrink. City and State budgets are calculated with the expectation that their expenses will primarily be covered through the revenues generated by the tax base. Weakened companies pay smaller tax bills and since unemployment is rising, individuals will pay fewer taxes also. Where will the municipalities get the necessary revenue to pay salaries, bills, and pensions to the government workers? They might normally raise money in the municpal bond market but as I stated above, that market is not currently functioning as it should. There are two choices: slash costs as Governor Patterson of New York is attempting or go hat in hand to the Federal Government and ask for a loan as Governor Schwarzenegger is attempting.
If a plethora of Cities and States starts to run a deficit and need to turn to Mr. Paulson for a loan, this will be troubling. Not only is the government trying to fix the financial sytem, it will need to find billions more to keep the municipalities across America from defaulting. In 1979, New York City bonds yieded something like 14% and it looks like similar investment opportunities may be coming.
Friday, October 3, 2008
Wells Fargo Begins the Market Value Play
Today Wells Fargo announced an aggreement to merge with Wachovia. This is clearly a surprise to Citigroup which thought they were buying Wachovia in a deal brokered by the government. This deal will be challenged by Citi as they thought they had an exclusivity agreement but the Wells deal certainly looks like it is better for shareholders and perhaps taxpayers.
More importantly, this deal is great for the long-term trends of the markets and the economy. We have discussed value investors in the past and that is what Wells Fargo apparently sees in its merger with Wachovia as it expects this combination to create great value at a bargain price. This is likely to be the first of many other banking mergers that will consolidate the industry, strengthen the bankinging system, and ease the credit crisis. The process may take a year or two but today marks the beginning of a positive movement toward propelling our economy in the right direction.
Other signs to look for which will indicate a bottoming in asset values will be increased acquisition activity in the corporate sector. Large, well-capitalized companies will sift through their industries to find the competitors who are overleveraged or have weak business models. These companies likely have taken a beating in the stock market and can be acquired at discounted prices. We should also expect to see leveraged companies who have cash announce that they have bought back their debt at discounted prices. The purchase of a company's bonds at a discount will not only reduce the interest expense of the company but also result in a capital gain. Of course, the company will end up with less debt and a stronger balance sheet.
The bottoming of a market will need to see help from many places. In addition to the above examples, we can expect the so called "smart money" will begin to deploy some of the cash they have socked away as they read the tea leaves of the market. A vote of confidence from CEO's on the acquisition trail will clearly indicate there is value in the market and investors can now forge ahead to buy stocks and distressed debt.
The economy is still weak and will likely get softer but the stock market will likely bottom out before the economy does. Today is the most recent sign of positive events to come.
More importantly, this deal is great for the long-term trends of the markets and the economy. We have discussed value investors in the past and that is what Wells Fargo apparently sees in its merger with Wachovia as it expects this combination to create great value at a bargain price. This is likely to be the first of many other banking mergers that will consolidate the industry, strengthen the bankinging system, and ease the credit crisis. The process may take a year or two but today marks the beginning of a positive movement toward propelling our economy in the right direction.
Other signs to look for which will indicate a bottoming in asset values will be increased acquisition activity in the corporate sector. Large, well-capitalized companies will sift through their industries to find the competitors who are overleveraged or have weak business models. These companies likely have taken a beating in the stock market and can be acquired at discounted prices. We should also expect to see leveraged companies who have cash announce that they have bought back their debt at discounted prices. The purchase of a company's bonds at a discount will not only reduce the interest expense of the company but also result in a capital gain. Of course, the company will end up with less debt and a stronger balance sheet.
The bottoming of a market will need to see help from many places. In addition to the above examples, we can expect the so called "smart money" will begin to deploy some of the cash they have socked away as they read the tea leaves of the market. A vote of confidence from CEO's on the acquisition trail will clearly indicate there is value in the market and investors can now forge ahead to buy stocks and distressed debt.
The economy is still weak and will likely get softer but the stock market will likely bottom out before the economy does. Today is the most recent sign of positive events to come.
Thursday, October 2, 2008
The VP Debate to The House Vote to The Economy
The much anticipated Vice Presidential Debate is over and both candidates held their own. The economic crisis was a focus but no new solution was articulated. Tomorrow we may move to the floor of The House of Representatives to see if a vote on the Bailout Plan will take place. It is likely nothing will occur unless there are enough votes to produce a "Yes" vote. Either way, the focus will shift back to the economy.
Today's stock market tanked again and the VIX fear index escalated to levels close to its high last week. Is it the uncertainty of the Congressional vote that drove the market down or the weakness in auto sales, durable goods, manufacturing, jobs, and eroding home prices? It is a little of both but ultimately it will only be the economic factors.
Today, a bunch of insurance company stocks took a beating. Why? The reality that the assets they hold will also have to be marked down has finally hit the radar screens of investors. Most industries are being plagued by the financial crisis or from the weakness in the economy. Today's stock market saw the fertilizer companies get creamed. Why? Commodity prices dropped on average 9.9% this week, so far. Lower prices mean lower margins for farmers. These farmers may produce fewer crops because of the lower profit potential and/or because they won't be able to borrow money to finance their businesses. Fewer crops means less fertilizer and thus lower earnings for fertilizer companies. Hence, lower stock prices for fertilizer producers.
It seemed like most industries were affected by today's market downdraft. Some of the industries that had many stock prices drop more than 1% today were homebuilders, gaming, auto parts, paper, broadcasting, technology, wireless, airlines, auto manufacturers, building materials, and cable. Homebuilders declined because of the reported drop in home prices. Airlines have been driven by oil prices but today oil prices dropped again. This decoupling indicates that the weakness in the economy is now the driving force. Auto manufacturers and auto parts companies are weak as even a company like Toyota, the number one global car company, is showing weakness. We can cover each industry in a similar manner but the bottom line is that the extensive weakness throughout the economy, the credit crisis, housing, and the tapped out consumer are finally leading the decline in the stock markets globally.
We will need a restructuring of America and it will be a painful process. Businesses will be deleveraged either with new equity or the bankruptcy process. Many value oriented investors have performed poorly this year but new opportunities will arise in this restructuring process. The wealth building will likely come from four areas. Opportunities in treacherous markets usually arise when fear is greatest. Strong, well-capitalized companies will suffer stock price declines with the rest of the market but will be long-term winners. Let's take Warren Buffetts' deals with Goldman Sachs and General Electric. Berkshire Hathaway clearly got sweet deals so I wouldn't say today's stock prices for those companies won't go lower. In fact, they probably will go lower. However, both companies will likely be survivors with much higher stock prices in five years. It takes guts and risk to buy them but a long-term investment style will likely prove that Mr. Buffett has picked winners again. The second lucrative investment will be in distressed mortgages that professionals buy from financial institutions. The third winner will be sifting through the commercial real estate market upon its true decline in the next couple of years. This may not be an opportunity for most investors but the puchase of a home at distressed prices will likely produce nice returns in a five to ten year time horizon. Finally, distressed corporate debt will garner excessive returns either because the prices moved back to par (100 cents on the dollar) or through a restructuring of a company in bankruptcy where the investor exchanges debt for equity.
Most investors will remain on the sidelines in these volatile markets and let the professional money managers take the risks in a down market. The key is to maintain cash in order to be able to buy stocks when the economy starts to get better and the stock market begins to rise again. Be patient because it may be a year or two away for that scenario to present itself.
Today's stock market tanked again and the VIX fear index escalated to levels close to its high last week. Is it the uncertainty of the Congressional vote that drove the market down or the weakness in auto sales, durable goods, manufacturing, jobs, and eroding home prices? It is a little of both but ultimately it will only be the economic factors.
Today, a bunch of insurance company stocks took a beating. Why? The reality that the assets they hold will also have to be marked down has finally hit the radar screens of investors. Most industries are being plagued by the financial crisis or from the weakness in the economy. Today's stock market saw the fertilizer companies get creamed. Why? Commodity prices dropped on average 9.9% this week, so far. Lower prices mean lower margins for farmers. These farmers may produce fewer crops because of the lower profit potential and/or because they won't be able to borrow money to finance their businesses. Fewer crops means less fertilizer and thus lower earnings for fertilizer companies. Hence, lower stock prices for fertilizer producers.
It seemed like most industries were affected by today's market downdraft. Some of the industries that had many stock prices drop more than 1% today were homebuilders, gaming, auto parts, paper, broadcasting, technology, wireless, airlines, auto manufacturers, building materials, and cable. Homebuilders declined because of the reported drop in home prices. Airlines have been driven by oil prices but today oil prices dropped again. This decoupling indicates that the weakness in the economy is now the driving force. Auto manufacturers and auto parts companies are weak as even a company like Toyota, the number one global car company, is showing weakness. We can cover each industry in a similar manner but the bottom line is that the extensive weakness throughout the economy, the credit crisis, housing, and the tapped out consumer are finally leading the decline in the stock markets globally.
We will need a restructuring of America and it will be a painful process. Businesses will be deleveraged either with new equity or the bankruptcy process. Many value oriented investors have performed poorly this year but new opportunities will arise in this restructuring process. The wealth building will likely come from four areas. Opportunities in treacherous markets usually arise when fear is greatest. Strong, well-capitalized companies will suffer stock price declines with the rest of the market but will be long-term winners. Let's take Warren Buffetts' deals with Goldman Sachs and General Electric. Berkshire Hathaway clearly got sweet deals so I wouldn't say today's stock prices for those companies won't go lower. In fact, they probably will go lower. However, both companies will likely be survivors with much higher stock prices in five years. It takes guts and risk to buy them but a long-term investment style will likely prove that Mr. Buffett has picked winners again. The second lucrative investment will be in distressed mortgages that professionals buy from financial institutions. The third winner will be sifting through the commercial real estate market upon its true decline in the next couple of years. This may not be an opportunity for most investors but the puchase of a home at distressed prices will likely produce nice returns in a five to ten year time horizon. Finally, distressed corporate debt will garner excessive returns either because the prices moved back to par (100 cents on the dollar) or through a restructuring of a company in bankruptcy where the investor exchanges debt for equity.
Most investors will remain on the sidelines in these volatile markets and let the professional money managers take the risks in a down market. The key is to maintain cash in order to be able to buy stocks when the economy starts to get better and the stock market begins to rise again. Be patient because it may be a year or two away for that scenario to present itself.
Wednesday, October 1, 2008
What Will Happen If A New Plan Is Passed?
The Senate has passed a slightly altered Plan tonight and perhaps the House will move in the same direction as it meets tomorrow. I continue to believe that the plan might not have the best structure (See my alternative plan) but some Bill will be better than no Bill. Let's assume a Bailout Plan passes, what can we expect to happen in the economy and the markets? The Government will now proceed to buy distressed assets from the balance sheets of financial institutions with the intention of freeing up capital. The goal would be to improve lending and strenghthen the credit markets. It sounds good but first many of these financial institutions will need an injection of fresh capital. Why does Warren Buffett want the plan to succeeed? Many new opportunities to provide attractive equity capital will become available to him. Hence, the plan will allow for more dilution of current shareholders and perhaps lower stock prices.
Does the Bailout improve all the credit markets? Absolutely not. The worst is yet to come. We should expect to read alot about auto loans, credit cards, home equity loans, construction loans, and corporate loans. What we will hear and read about is Default, Default, Default. The consumer is tapped out as his/her home value has declined and his/her ability to borrow against it has disappeared. Instead of consolidating debt through a home equity line, credit cards will be used. The problem is that banks are tightening those credit lines also. It won't be so easy to get a new credit card with stricter credit standards being imposed. The consumer will feel pinched and may not be able to pay off those auto loans or home equity lines. How can this happen all at once? Well, the economy is clearly heading toward a severe recession and the unemployment rate will rise. Fewer jobs and lower incomes mean a weakened consumer.
The new Bill proposes to alleviate the homebuilding industry by removing the bad mortgages off the books of banks but if home prices continue to fall, it may be awhile before homeowners can sell their current homes to buy new ones; and it may cause new potential buyers to delay their home purchases. The Bill doesn't seem to focus on commercial real estate but that problem is brewing. The retail industry is suffering and bankruptcy's have begun. This will start to put some stress on shopping centers. During the past decade, commercial real estate also boomed. Leverage was easy and rents were rising. As businesses fail, rents will fall, competition for new tenants will rise, vacancies will be bountiful, and leverage will be a huge problem. We should expect to see cracks in the commercial real estate market. Furthermore, construction lending was another large profit center for banks, both large and small, but a weakened corporate environment will result in defaults on many of those loans also.
What is amazing during the past year is the strength of corporations. The LBO Boom created the greatest opportunity to add leverage to balance sheets while requiring only a sliver of equity. It was great for a while as private equity firms reaped huge profits after reselling selling those companies or recapitalizing them with huge dividends to themselves. However, the musical chair game is about to be over and not everyone will have a seat when the music stops. We should expect to see a plethora of corporate bankruptcies as the economy weakens, revenues decline, cash flow disappears, and the banks balk at providing new loans. Leverage is great when business is strong but it will kill a company on the way down. Many of the leverage buyouts have capital structures which could delay bankruptcies as the terms of the bank loans will forestall defaults but they won't prevent many forced restructurings. The domino effect could potentially negatively impact suppliers, competitors, and customers of these failed corporations.
Unfortunately, many of these issues won't only affect the United States. These will be global problems and will create a global recession. Buckle up and hold on tight. Invest in only high quality stocks where leverage won't be an issue and free cash flow is available.
Does the Bailout improve all the credit markets? Absolutely not. The worst is yet to come. We should expect to read alot about auto loans, credit cards, home equity loans, construction loans, and corporate loans. What we will hear and read about is Default, Default, Default. The consumer is tapped out as his/her home value has declined and his/her ability to borrow against it has disappeared. Instead of consolidating debt through a home equity line, credit cards will be used. The problem is that banks are tightening those credit lines also. It won't be so easy to get a new credit card with stricter credit standards being imposed. The consumer will feel pinched and may not be able to pay off those auto loans or home equity lines. How can this happen all at once? Well, the economy is clearly heading toward a severe recession and the unemployment rate will rise. Fewer jobs and lower incomes mean a weakened consumer.
The new Bill proposes to alleviate the homebuilding industry by removing the bad mortgages off the books of banks but if home prices continue to fall, it may be awhile before homeowners can sell their current homes to buy new ones; and it may cause new potential buyers to delay their home purchases. The Bill doesn't seem to focus on commercial real estate but that problem is brewing. The retail industry is suffering and bankruptcy's have begun. This will start to put some stress on shopping centers. During the past decade, commercial real estate also boomed. Leverage was easy and rents were rising. As businesses fail, rents will fall, competition for new tenants will rise, vacancies will be bountiful, and leverage will be a huge problem. We should expect to see cracks in the commercial real estate market. Furthermore, construction lending was another large profit center for banks, both large and small, but a weakened corporate environment will result in defaults on many of those loans also.
What is amazing during the past year is the strength of corporations. The LBO Boom created the greatest opportunity to add leverage to balance sheets while requiring only a sliver of equity. It was great for a while as private equity firms reaped huge profits after reselling selling those companies or recapitalizing them with huge dividends to themselves. However, the musical chair game is about to be over and not everyone will have a seat when the music stops. We should expect to see a plethora of corporate bankruptcies as the economy weakens, revenues decline, cash flow disappears, and the banks balk at providing new loans. Leverage is great when business is strong but it will kill a company on the way down. Many of the leverage buyouts have capital structures which could delay bankruptcies as the terms of the bank loans will forestall defaults but they won't prevent many forced restructurings. The domino effect could potentially negatively impact suppliers, competitors, and customers of these failed corporations.
Unfortunately, many of these issues won't only affect the United States. These will be global problems and will create a global recession. Buckle up and hold on tight. Invest in only high quality stocks where leverage won't be an issue and free cash flow is available.
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