Sunday, October 19, 2008

Observations And Market Sentiment

Observations And Market Sentiment

By Teresa Lo | 14 October 2008

'Stocks are not trading based on valuation, but as a source of cash.'
— Marc Pado, Cantor Fitzgerald

I’m sure traders have had a field day following the bungee jump of the equity markets.

The spike bottom we alerted members to on October 9 unfolded as expected and did its thing. At yesterday’s high, the bounce had almost reached the target of the top of the Wave 4 running triangle. The easy money is over. Rather than dwell too much on what happens tomorrow or the next day, let’s hang back and ask some important questions about the macro picture going forward.

Observation #1
In spite of what Bernanke, Volker and Paulson say, their actions— and common sense— tells you that the "liquidity problem" is a euphemism for insolvency. Maybe I’m using the term too loosely; maybe the situation doesn’t meet the technical definition, but let’s face it: the jig is up. Otherwise, why would they deviate from the original TARP plan and move to direct capital injections?

  • Bernanke: We’re Laying the Groundwork for Recovery
    History teaches us that government engagement in times of severe financial crisis often arrives very late, usually at a point at which most financial institutions are insolvent or nearly so. In these conditions, the consequences and costs of inertia and inaction can be staggering. Fortunately, that is not the situation we face today. The Congress and the administration acted at a time when the great majority of financial institutions, though stressed by highly volatile and difficult market conditions, remain capable of fulfilling their critical function of providing new credit for our economy.

  • Volker: We Have the Tools to Manage the Crisis
    For months, the real economy, apart from housing, had not been much affected by the developing crisis. Now, a full-scale recession appears unavoidable. Important state and local governments face deficits they may be unable to finance. Recessionary forces are apparent in other important countries and exchange rates are unstable.

  • Paulson Plans to Invest in ‘Thousands’ of U.S. Banks
    "Leaving businesses and consumers without access to financing is totally unacceptable," Paulson said in Washington. He rolled out the emergency program after a crisis of confidence in the financial system last week spurred the biggest stock sell-off since 1933. Paulson told companies getting the government funds to "deploy" the money in loans. The Treasury chief was forced to change tack from an initial plan to buy distressed assets from banks after the financial panic caused banks to hoard cash and send money market rates to record levels. In its biggest effort yet to halt the 14-month credit rout, officials will also offer guarantees on new bank debts and start purchasing commercial paper in two weeks.

Observation #2
'Alternative investments' as an asset class is finished. Most stock and bond arbitrage strategies are either suffering from broken model syndrome or they can no longer use enough leverage to make them economic. Many funds are now 50% cash in anticipation of additional redemptions. How these funds will make it back to their high water marks is beyond me. The game is over.

  • High-Flying Hedge Fund Falls Back to Earth
    But the fortunes of the hedge fund industry matter to nearly every investor big or small. In recent years, public and corporate pension funds, endowments and foundations poured money into these private investment vehicles in the hope of reaping market-beating returns. So far this year, the average hedge fund is down 17 percent, about half as much as the Standard & Poor’s 500-stock index. As losses mount, hedge fund managers are consulting lawyers to determine whether their fiduciary duty dictates that they should shut their doors, liquidate their holdings and use the proceeds to pay back investors— before the losses get worse— or stay in business and try to trade their way out of the hole.

  • Tudor, SAC Capital Said to Have Raised Cash as Markets Tumbled
    Jones, who has been running Tudor Investment Corp.’s biggest fund for 22 years, made his move after watching the Mexican peso tumble 16 percent since the start of October, said two people with knowledge of the decisions by the Greenwich, Connecticut-based firm. Tudor manages $18 billion. Cohen, who oversees $16 billion at his SAC Capital Advisors LLC in Stamford, Connecticut, ordered traders to sell amid the worst equity rout since the 1930s, a person familiar with the firm said. The firm now holds about 50 percent of assets in cash.

  • Hedge Funds Concede Errors, Profess Optimism After Worst Losses
    Hedge funds, which endeavor to make money whether markets rise or fall, lost an average of 4.7 percent in September, the biggest monthly decline since August 1998, according to data compiled by Hedge Fund Research Inc. … Managers have been selling assets, both to raise cash for what they expect to be a surge in year-end redemption requests and to preserve capital as market volatility has risen to record levels. … David Slager, manager of the Atticus European Fund, told investors that more than 50 percent of his fund is now in cash or U.S. Treasuries after he lost 43.5 percent so far this year.

Observation #3
Goldman Sachs, GE, and Morgan Stanley made a pact with the devil. In hopes of attracting private money, marquee investors exacted terms that involve paying usurious amounts of interest or dividends that will materially impact their earnings going forward. Stick a fork in dividends?

  • Mitsubishi UFJ Gets Better Terms From Morgan Stanley
    Under the revised deal, Mitsubishi UFJ receives $7.8 billion of preferred shares that convert to stock at a price of $25.25, down from the previous level of $31.25. The remaining $1.2 billion is in non-convertible preferred stock. Both classes pay a 10 percent dividend. The $900 million interest payment to Mitsubishi UFJ is about 16 percent of Morgan Stanley’s adjusted net income next year, based on the average of nine analysts’ estimates. . . . Buffett bought $5 billion of perpetual preferred stock in Goldman, the Wall Street firm that has best navigated the credit market turmoil. He also secured the right to buy an additional $5 billion of common stock at any time in the next five years. His preferred shares will pay 10 percent interest.

  • GE Raises $15 Billion; Buffett Gets Preferred Stake
    Buffett’s Berkshire Hathaway Inc. will buy $3 billion in preferred shares that pay an annual 10 percent dividend and are callable after three years at a 10 percent premium, Fairfield, Connecticut-based GE said today in a statement. The 78-year-old investor also gets warrants to buy $3 billion of common stock with a strike price of $22.25 a share for five years.

Observation #4
Most importantly, no one is talking about the real problem: the middle class, the little engine that could, is now mostly underwater. Equity evaporated but their debts are still valued at 100 cents on the dollar. Maybe banks will lend again, but to whom? Until consumers on Main Street can get their debt ratios down, where will growth come from? Hmm…

  • For consumers, the long era of easy credit may be at an end
    Experts say that even when the current credit crunch eases, the nation may finally have maxed out its reliance on borrowed cash. Today’s crisis is a warning sign, they say, that consumers could be facing long-term adjustments in the way they finance their everyday lives.
    "I think we’re undergoing a fundamental shift from living on borrowed money to one where living within your means, saving and investing for the future comes back into vogue," said Greg McBride, senior analyst at "This entire credit crunch is a wake-up call to anybody who was attempting to borrow their way to prosperity."

  • U.S. says no to protectionism
    Democrats also are lining up behind House Speaker Nancy Pelosi’s plan to bring lawmakers back to Capitol Hill after the Nov. 4 election to work on a second economic relief plan. The idea is
    "give the middle class and the average citizen the same kind of relief that we try to give the financial sector," said Democratic Rep. Barney Frank of Massachusetts, chairman of the House Financial Services Committee. Top Democrats are suggesting a $150 billion measure [[since raised to $300 billion: normxxx]] that would extend jobless benefits, provide more money for food stamps and finance some construction projects, such as rebuilding bridges and roads. It would also include either a tax rebate or tax cut.

Observation #5
To top it all off, remember there was no money for anything before, not even health care, but somehow hundreds of billions of dollars have been "found" to prop up the banks? Where did all this money come from?

Historical Perspective
To sum up, no matter how we slice it, the smoke has yet to clear. Let’s just back up a moment and look at a chart.

Dow Jones Industrial Average, Present Day

No comments:

Post a Comment