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.
Friday, October 17, 2008
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.
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