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.