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Wall Street Daily

The musings and opinions of a recently graduated student of the financial markets.

Updated: 2018-03-02T07:35:57.762-08:00


New Location!


Given the excessive break since my last post, I have decided to get a fresh start at a new location.  In the 18 months since I quit on this blog, I have gained considerable depth of understanding on financial markets and feel that the analysis and insights to be found at the link below will exceed those on this blog by a considerable margin.

Oil and the Big 3


Well oil just keeps on falling. It closed today at $43.65, down almost 7% for the day and down a jaw-dropping 70% from its peak in July. Today's close marks a 4 year low. What happened to $200 oil that Goldman was predicting this summer? Merrill analysts today said that they are predicting oil at $25 next year. I remain a long term oil bull but am not making any plays until the market shows some signs of correction, beyond a week long bounce. When I say long term, I mean over the course of my working life. I am 22, so my investment horizon for oil plays is up to 35 years.

Moving on to the Big 3. Today they said they would be willing to accept strong government oversight in exchange for immediate aid (Chrysler and GM have said they need help soon, while Ford says they hope not to have to tap potential government credit lines, but would like to have them available just in case). They are looking for a total of $34B. I don't think they should get it, bankruptcy is a better option. My thinking is as follows: if the Big 3 enter Chapter 11 bankruptcy (something firms do regularly - think airlines), they will gain leverage in negotiations with both their creditors and the United Auto Workers (UAW). That is, they will be able to say to these parties "if you don't come to the bargaining table, we will go under and then we are all ******". They will be able to negotiate better terms on their outstanding debt, as well as cutting pay and benefits to UAW (which in my opinion are both excessive). Without entering bankruptcy, they will not have this advantage at the negotiating table and, while the UAW is granting some concessions, they are not nearly what they need to be for these firms to return to profitability.

The argument against bankruptcy is as follows: if the firms enter bankruptcy, customers will be unwilling to buy cars from these firms because they will be worried about the car companies' abilities to live up to their warranty obligations. This is where the government plays a role: they set up a fund to guarantee the warranties on these vehicles in the case of any of the Big 3 shutting down, much like the FDIC insures bank deposits.

I must confess, these opinions are not my own, I believe I read them on The Big Picture, but it may have been elsewhere. Regardless, now you've heard the much less publicized bankruptcy argument.

The market rallied again today. More choppy action, no surprises there. The question I am wanting answered is: when (if ever) is the precipitous fall in the price of oil going to stimulate the global economy?

Washout, Rally and Elizabeth Warren


So it seems I was right about a pull back this week. Man was yesterday harsh. After that I was not surprised at all by the rally we saw today. This range bound trading accompanied by high volatility is what I anticipate over the next 6 to 9 months. While we may set new lows over this period, I think it depends on how rough the recession gets over the coming quarters. I feel the market has priced in something pretty serious, but only time will tell whether the drop has been sufficiently large. As far as the recovery, I really can't see it happening until we get some good news (or no bad news for a while from financials). A string of earnings that surprise on the upside, or a series of better than expected economic data are the kind of catalysts I am looking for. Not sure exactly what is causing the unprecedented levels of volatility, but it seems to be here to stay as well.

Moving on, I saw an excellent video on YouTube last night. It is a speech Elizabeth Warren gave at Berkeley about the death of the American middle class. I found a lot of the information she presented somewhat surprising, but she has clearly done her homework, so I don't have any reason to doubt her. It is nearly an hour, but in my opinion time well spent (you can skip the first 6 minutes). There is also a story on Naked Capitalism quoting her talking about the lack of method surrounding application of TARP funds. She is the head of the TARP oversight committee and doesn't have good things to say about Paulson's methodologies.

Finally, another interesting piece on major university endowments selling private equity stakes at huge discounts. Apparently private equity has different accounting rules which has allowed them to not mark down the value of their holdings by as much as they should.

Oil Outlook


Interesting piece on Bloomberg about OPEC's failure to agree on production cuts, a situation the author likens to 1998, where oil fell to $10 per barrel. There is also some discussion of future oil prices, and there seems to be a large discrepancy between the analysts respective forecasts. Merrill Lynch sees oil trading at an average of $50 per barrel next year, while Barclays sees the price averaging at $100.50. In my opinion it is good to see divergent analyst estimates, rather than the usual clumping of estimates by analysts who want to play it safe. Nassem Nicholas Taleb has a good discussion of this in his book "The Black Swan", which should be read by all.

Getting Back to It


Okay so I made an early New Year's resolution to keep this thing updated. Let's see if we can make that happen.

There is an excellent video posted on The Big Picture of an interview with the Chairman of Blackstone Pete Peterson. It seems a little dated though, I must admit. Regardless, this is a sit down with a truly wise man He talks straight about the real problems America faces long term - ever mounting debt, social security and healthcare pledges etc. He also discusses what's wrong with the current American mindset and some possible causes. 15 minutes well spent.

Black Friday sales figures seem to be pretty good as well. Marketwatch reported that they are up 3% from last year (here), a figure which surprised me somewhat. Maybe consumers are feeling a little more confident now that Obama has been elected and oil continues to fall? I'm sure the sales were also enormous.

Also, another story I read that made me smile was that Trump Entertainment is to miss an interest payment. I have always hate a very strong hate for Mr. Trump and always felt that he was an incredibly self-important charlatan. Looks as if another Trump company is hitting the skids. I feel sorry for the employees if this firm folds, but I will not feel sorry for Mr. Trump.

It will be interesting to see what the coming week brings. A new month, maybe some cheer off the back of the Black Friday numbers? Hard to say though. Given the rally we saw last week I would have to put my money on a pullback to start it off.

First Post In a While


Wow. It has been an awful long time since I have posted here. Let's see what do we need to catch up on? First off, both Lehman and WaMu went, as I said needed to happen, although not in the way I expected. Second, in the face of unprecedented market stress, Goldman and Morgan became bank holding companies - something I didn't foresee happening. Third, Wachovia was bought by Wells Fargo. The TARP didn't pass, then it did. The TARP's mandate was changed to buying stakes in banks with the first $150B or so (a move I fully support). We had the 17th worst month ever for the Dow and the 9th worst for the S&P. Within that month was the worst week ever, and the best week in 34 years for the Dow. The volatility index (VIX) was also at historic highs, reflecting panic in the markets. Oh and oil dropped from $110 to $64 at last check. Finally, we saw enormous coordinated moves by a number of Central Banks to address the freeze up in credit markets following the G7 meeting.If you want some comedy amongst all this bad news, we also had some moron at blaming Cramer for that awful week. Don't even get me started on that tool.What else? It's looking like Chrysler and GM are going to merge, eliminating thousands of jobs (the UAW is clearly unhappy and trying to block the deal). Wachovia also exposed a massive hole in its balance sheet that Wells Fargo needed it to write of before the merger was complete.Okay, that wasn't in chronological order, but I think that about does it. Where are we now? Well the credit markets are starting to thaw, as evidenced by the steady falling of the TED Spread and LIBOR over the last few weeks. As this occurs, it seems that some confidence is returning to the market. By no means are things good, but it doesn't seem like the whole system is going to collapse - at least not immediately. Therefore, some investors are starting to pick up bargain stocks. There are so many good companies which have been thrown out with the bad. Some real fortunes can be made in the market right now for people who have strong stomachs and a long term outlook. I read one interview with an institutional investor who said he has never seen opportunities like those that prevail in the current market.It seems that earnings are going to be bad for a couple quarters - especially in financials, but I feel that has already been priced in. I guess I am throwing my lot in with the others who say that buy the good companies now. Good companies include those that won't need to go to the credit markets anytime soon, are well diversified internationally, have a consistent long term track record, pay a safe dividend and ideally have relatively recession-proof products (consumer staples and pharmaceuticals to name a few).I would stay away from credit card companies for sure though. I remember back in July I opened my Mastercard bill and read that my minimum payment was optional this month, and took that as an indication that they were trying to lowball writeoffs due to delinquint customers. Shorting Mastercard would have returned ~50% since then. It seems to me that the consumer credit bubble will be the next to burst. I also watched a really interesting movie called In Debt We Trust that reaffirmed my opinions. That means stay away from credit card companies and discretionary consumer products.Finally, it looks like Obama will win tomorrow night (I was ambivalent until that hack Sarah Palin was nominated for Vice). It will be interesting what the market's reaction will be either way...[...]

Lehman and WaMu Need to Go


Today I received a message from my discount broker Tradefreedom Securities (owned by Scotia Bank) saying that they have removed trading on margin for Washington Mutual and reduced the margin from 70% to 50% for Lehman Brothers. It seems that they think they are going to go under and don't want to see anyone with long positions on margin do down with these firms. I can't fathom who would be long these companies on margin, but apparently someone, somewhere is.

In my opinion, Lehman and WaMu need to go before the market can stage a recovery. I am not sure why I think this (I usually want a more justifiable opinion), but I feel that the market needs to see at least one, if not both, of these firms to be bought out in order for people to feel good enough about the strength of financials for anyone to place a bid. I heard a rumour that Goldman bid for Lehman at $11.50 per share on Tuesday. I for one would feel a lot better if Goldman stepped in here. Perhaps they will wait for their traders to short the stock to $2 before launching a hostile takeover this weekend. All here say though, only time tell.

It also seems that Merrill is the target of vicious shorting. It is down as much as 18% today and has set a new 52 week low around $19 (previous $22). I have some put positions on this stock and noticed that volume exploded today on the $15 January put, which traded 17,000 contracts today. Almost 15,000 of this volume came from two purchases, where the ask price of $3.00-$3.05 was paid. This tells me that someone is willing to bet big money that Merrill's stock price has a long way to go down before it recovers. Good news for me :)

Also, Petrobas (PBR) released details of another big oil field off the coast of Brazil. With the price of oil plummeting, PBR is on sale and I plan to buy for the long term as soon as oil starts to show sings of recovery. This is also bullish for Transocean (RIG) who supplies Petrobas with the deep water, harsh drilling environment rigs that Petrobas needs to extract this oil. The supply for such rigs is far outstripping demand (including future production), which will allow Transocean to raise rates. Both are long term buys for me.

More Thoughts on Lehman


This morning Lehman preannounced it's quarterly results: a loss of $2.8 billion, or $5.92 a share. Lehman was forced to say something to Wall Street after it's share price nosedived 45% yesterday. Unfortunately all they could say was that they are in "advanced talks" to sell 55% of Neuberger Berman and discussions with Black Rock to sell some of it's UK mortgage portfolio. In my opinion, the failure to pull any deals off reflects very poorly on Lehman. Additionally, the fact that the Korean Development Bank and Lehman broke off talks due to differences on valuations makes me question Lehman's capability to properly mark assets to market. All told, I really think they are going to have a tough time staying independent. I foresee a buyout of the firm in the next week or two.

What is different about this capitulation in Lehman's stock price is that is wasn't driven by rumours. After the SEC began investigating firms and hedge funds for spreading what were supposedly false rumours in order to make their short sales more profitable, I have noticed a marked decrease in these rumours flying around the airwaves. In fact, according to Reuters:

"Goldman is a willing counterparty to Lehman across all our businesses," spokesman Michael DuVally told Reuters.

"Morgan Stanley continues to trade as usual with Lehman Brothers," spokesman Mark Lake said.

Spokesman at Credit Suisse AG and Citigroup Inc also said they continued to trade with Lehman across all their businesses.

This is a full 180 from what we were hearing a few months ago.

Finally, I read that the price of insuring Lehman and Wamu debt skyrocketed yesterday. With AIG shedding 20% yesterday as well, it makes me think that they were writing a whole lot of CDS's on these firms last quarter (remember that AIG took a $5.57B loss on their CDS portfolio last quarter). That doesn't bode well for AIG's upcoming results.

A Few More Thoughts on FRE, FNM Bailouts


One thing that I liked about the FNM and FRE bailouts is that the Fed set the precedent that in the inevitable future bailouts, equity holders will be wiped out. That is why while the broader financial industry rallied, in some cases very strongly, certain stocks (think Lehman and WaMu) took big hits. These firms are pegged to be the next to go and investors realized that the Fed is going to do nothing for those foolhardy enough to hold their common stock. I was surprised Merrill ended the day up though, as I would have liked to see it come down hard (I wouldn't be surprised if MER took a hit as big as 10% tomorrow, in what I foresee as a diving market). I wish I had some access to CDS quotes so that I could see what the derivative market is thinking of these firms' future.

Another thing I read on was that someone at a rating agency said a few months back that the U.S. assuming responsibility for FRE and FNM's debt may result in the U.S. debt rating being cut. Somehow I feel that political pressure will prevent that from happening...

This move will definitely help revitalize the MBS market, and I have read that the government will be refinancing mortgages with borrowers in order to reduce defaults (I am unsure whether the latter was speculation or explicit policy). Either way, I'd say homebuilders and strong financial stocks will benefit from the move. Despite this, be on the lookout for rumours having even larger effects on weaker financials than they did during the July panic selling...

Fannie and Freddie Bailout


So the Fannie Mae, Freddie Mac bailout finally happened. I am certainly not surprised, but I definitely had not fully considered the ramifications of such a move. Many of the comments on discussion boards that I have read express anger on the part of the U.S. taxpayer. At least in this circumstance, anyone stupid enough to own common or preferred of either company is getting thrown under the bus with the taxpayer. I still have yet to read enough to fully understand the details of the bailout (and will update when I do), but I think that it reinforces a worrying precedent which was set with the bailout of Bear Stearns. Essentially the heavy weights in the financial industry can be managed in whatever way is necessary to ensure big bonuses for upper management, and if the risks taken prove to be too extreme, the government will step in to "save the system" and the CEO will walk with millions in severance pay (not to mention his bonuses he earned before that). Such bailouts cost taxpayers billions, representing another way that the rich are reinforcing the class barriers that the last few generations worked so diligently to break down.

What taxpayers fail to recognize is that the cost of not bailing out these enormous companies is much greater than the cost of doing so. If Fannie and Freddie were simply allowed to fail, there would be an accelerated flight to capital and no one would get any mortgages (the two companies have been responsible for 70% of mortgages originated in recent months), and the housing market would literally free fall as a result of zero demand, not to mention the plethora of secondary effects that such a failure would cause. The government realizes the above and acts accordingly, but a new system must be devised.

Some sort of regulation which prevents firms from taking on too much risk while still allowing them freedom of operation must be enacted, otherwise bailouts of this magnitude, costing into the hundreds of billions of dollars, will become part of the financial, economic and political landscape of the future. Such a landscape would offer perverse incentives to managers of huge financial institutions, and cost the common taxpayer.

The market will inevitably rally, but the long term implications are yet unknown. One other final thought: why are the bondholders ensured while the equity holders are shafted?

Goldman Sachs Earnings a Crystal Ball for Broader Sector?


My favorite financial stock has been Goldman Sachs for the last year. I find many of their calls to be incredibly accurate and their analysts to possess foresight unparalleled in the industry. Let's not forget to mention their excellent risk management, the fact that they were short subprime mortgages, and that they continue to earn billions while most of their competitors are losing them.

This firm is reporting earnings on the 16th and the stock has been suffering the ill effects of multiple earnings estimate cuts in recent weeks. This is not surprising. It should be noted that Goldman likes to manage expectations, as the market has grown used to them blowing estimates out of the water, so they feel the need to continue to do so. I remember in December, they beat earnings by 10% and the stock dove because that "was not enough" as one professional I spoke with put it. So looking forward to this quarter's earnings, when the recent cuts in expectations are taken into consideration, I would like to see Goldman beat by at least 20%. If they fail to do this, I will consider it as bad news for the financial sector in the medium term. If Goldman manages to post huge numbers, I do not necessarily feel that it will invigorate the financial sector, although I don't deny that it may cause a short term pop. Either way I will still endorse Goldman as a buy for the next 3-5 years.

Oil Drop An Excellent Buying Opportunity


Oil has been making a lot of headlines lately. It's precipitous fall from $147 to $108 has been tagged as a big reason for the rally we have seen from lows in the Dow of under 11,000 (although lately the market has been trading in a bounded range). It should be noted that the decline has been slowing of late (except a big drop after Hurricane Gustav failed to inflict heavy damage on oil infrastructure). I posted earlier that I didn't expect oil to drop far below $110, and am pretty much sticking to that thesis, although will concede that it will probably drop to the $100 per barrel range. It was clear to me that oil's astronomical rise in the first half of this year was unsustainable and was simple speculation (bearish news for oil elicited bullish reactions, an indication to me of price manipulation). Regardless, I do feel that despite any demand destruction we may have seen in the Western countries, the developing countries will continue to increase demand, resulting in consistently higher prices for the next period of years.

I feel that this drop in prices is an excellent opportunity to buy oil companies. My personal favorites are Transocean (RIG) and Petrobrasilias (PBR), with PBR being my number one long term pick right now. They are sitting on an estimated 50B barrels, but it is in deep water, so you need to believe that future prices will be high in order for their stock to really move.

How To Value A Stock


How to properly value a stock is among the most hotly disputed topics on Wall Street. There are a number of different valuation techniques, such as price-earnings multiple, price-cash flow multiple, book multiple, and discounted cash flow analysis. My personal opinion is that the discounted cash flow (DCF) analysis is the best method if only one method is to be used (combining DCF analysis with a couple valuations by multiples to affirm your estimates is better yet).

The basic idea behind the discounted cash flow analysis is that a dollar today is worth more than a dollar tomorrow. That is, a dollar today can be invested for say 7% and be worth $1.07 in one year, so a dollar today is worth $1.07 in one year. Conversely, $1.07 in one year is worth $1 today ($1.07/1.07 where the denominator is equal to one plus the return available on an investment over the period under consideration rate - in this case one year). That 7% is called a discount rate. One of the jobs of the stock analyst is to determine the appropriate discount rate for a given stock - the higher the perceived risk of the stock, the higher the discount rate. Academics like to compare the given stock's price fluctuations relative to the overall market and use this comparison to determine the risk and therefore discount rate. For example, consider a stock that does very well in economic upturns and very poorly in economic downturns, this stock would have higher risk than the overall market and therefore a higher discount rate. I don't feel that this approach is adequate when valuing a business, but have yet to come across a better method.

Once the discount rate has been established, let's say in this case it is 10%, an analyst must forecast the future earnings of a stock. For this simple example, let's assume that the analyst predicts earnings of $5 per share one year from today, $8 per share two years from today, and $10 per share three years from today. After the end of the third year, the company will be shut down and all past earnings paid out to shareholders in a special dividend (for simplicity let's assume they have no assets other than retained earnings and no debt - unrealistic, but simplifying). It is important to note that the second year's earnings must be discounted at 10% twice, once to determine their value at the end of the first year, and again to determine their value today (or present value). Therefore, the second year's earnings are worth $7.27 at the end of the first year ($8/1.1) and $6.61 today ($7.27/1.1). A similar process must repeated threefold for the third year's earnings.

Considering the above, first year of earnings would be worth $4.54 today ($5/1.1), the second year earnings would be worth $6.61 today ($8/[1.1*1.1]), and the third year's earnings would be worth $7.51 ($10/[1.1*1.1*1.1]), for a total value per share of $18.66 today.

This is a very simple valuation, but I hope it gives you a better idea of how the valuation process is carried out.

What is a Stock?


I have had a few friends who are not in finance ask me to explain to them how the stock market works. These discussions usually end up occurring over a few beers and the lack of a written record tends to leave my audience with a bunch of confused ideas. As a result, I have decided to add a series to my blog to educate the layman on just how the stock market (should) function.

The most basic question to be answered is "what is a stock?". If an investor buys a share of a company, they are buying an interest in that company which represents a claim on a proportion of the companies earnings (after payouts to debt holders and preferred shareholders - more on them later). For example, if an investor buys one share of Company X and there are 100 total shares on the market (and no debt or preferred shares), that investor essentially owns 1% of the company. Therefore, if the company earns $500 net of taxes, the shareholder has a claim to $5 of those profits ($500 X 1% = $5). Additionally, publicly owned corporation are run as a democracy and the shareholder who owns 1% of the company has 1% of the votes in this democracy.

Since it is too cumbersome to hold a shareholder vote for each business decision, the shareholders elect a Board of Directors to oversee running the company. The Board appoints a management team (CEO, CFO, COO, etc.) who they see fit to best run the company and if the shareholders are unhappy with any of them, they can vote them out.

A Few Thoughts On ARS Buybacks


In my last post I mentioned the huge buybacks of the Auction-Rate Securities (ARSs) by major banks and brokerages. The story here is that that these banks and brokers sold what were liquid securities to retail investors with the promise that the market would remain liquid. As was the case with many financial instruments, when the credit crunch hit, the market for ARSs dried up completely, leaving investors with securities they could not sell.

It is suspected that the financial institutions knew that the markets for these securities could seize up, but that they sold them despite this. Most institutions have neither admitted nor denied any wrongdoing (usually a pretty strong indication that something is amiss), but Merrill has an especially weak case. It has come to light that at Merrill Lynch, a research analyst put together a report which concluded that the market for ARSs would freeze if credit conditions deteriorated, but a fixed income saleswoman got her hands on the report and pressured management to blackball it. Ultimately the saleswoman won the argument and the report was never released. So much for Chinese Walls at Merrill. Everyone knew they didn't exist and this is proof.

Subsequent to the market drying up, the retail investors filed a lawsuit and New York State Prosecutor Mario Cuomo strong armed the banks into a settlement where they would buy back the securities from the investors at par and pay a relatively small fine. Financial institutions (including Citi, JPMorgan, Wachovia and Merrill I believe) have thus far agreed to buy back $50B worth of these securities, with expected realized losses totaling a few billion.

A lot of media attention has been given to this case, focusing on the expected losses and fines to be paid. While these are important issues, there has been little discussion on the adverse effect that this will have on the banks' balance sheets. The banks in question will have to use billions in cash to buy back these securities, which they will probably have to classify as Tier III assets (I am assuming the market does not recover, because who among the banks would be buying these illiquid assets?). This will lower banks' capital adequacy ratios and will have the effect of removing at least $50B in liquidity from already extremely stressed credit markets, which is not good news for the financial institutions.

Mid-Quarter Writedowns?


Something I can't recall having seen in the two years of following the markets happened yesterday. JPMorgan reported a $1.5B writedown to the SEC based on their valuations of their MBS portfolio. Apparently when Merrill Lynch completed sale of their mortgage securities to Lone Star Capital at 22 cents on the dollar (it was essentially a call option sold to Lone Star for 7 cents on the dollar when the details are considered), the rest of the MBSs were marked down to similar levels. I would like to say that I think that the Merrill was quite foolish for the brokerage. But the real story here is JPMorgan's mid-quarter write down. I think that the bank is using the relative strength in the market to get away with this writedown, so at the end of the quarter (when I am assuming they think financial stocks will be much weaker), this writedown will be no surprise to the market. Sneaky, but my interpretation does not bode well for financials. But when you are a bear, you see bearish explanations for such moves.

Also, Wachovia joined Citi and Merrill in taking losses on sales in the auction-rate securities markets. The writedowns just do not stop. Not to mention the implications of the business practices for these institutions. I should wouldn't be bringing my business back to a firm who told me that the securities I am buying would always be liquid, then having to file a lawsuit in order to resell my securities because the market completely dried up. The whole system needs some work. Even my sector favorite Goldman Sachs was selling MBSs to their clients while quietly shorting the MBS market. At least Goldman had the foresight not to be holding that garbage...

The Fed, Freddie Mac, and AIG


Let's see, where do we start? The Fed didn't cut rates. No surprise there. They are handcuffed between spiraling inflation (headline inflation is at a 27 year high and core inflation is well outside of their 2% upside target), and a very weak economic outlook. Unemployment is approaching 6% and the housing market shows no sign of an upturn. If anything, I could see them cutting if the outlook gets much worse. It is worth pointing out that according to academic economics (which most of the Fed governors are devout followers of), inflation which is derived from rising commodity prices is outside of the control of monetary policy and should be treated as a one-time shock. This means that (according to academia) they should not adjust monetary policy to address the inflation the U.S. is experiencing. While I am not here to argue whether or not academia is correct in this thinking, it is an interesting thought to consider. I don't really see any action any time soon, because I feel the Fed wants to keep some "dry powder" if things really start weakening. I forecast 2% being the Fed Funds target rate into 2009. It should be pointed out that the Fed Fund futures do not agree with my analysis, as they are anticipating a probable hike in one of the next two months.

Freddie Mac and AIG brought more bad news to the financial sector this week, posting losses well in excess of forecasts, with FRE losing over $800M and AIG losing in the range of $5.4B. I was in no way surprised by FRE's results, actually part of me was surprised they weren't worse, but I must admit I didn't see AIG coming. They had unrealized losses of $5.57B on their "super senior credit default swap portfolio". I don't like this at all. First off, what is an insurance company doing in the credit default swap market? Second, why were they on the wrong side? I must admit, long term, they will probably be able to write this portfolio back up once the value of the swaps decline, but they may have to take another big writedown next quarter. Makes me wonder how the are going to be able to meet obligations from any big disaster in the short term...

I think I see some pessimism creeping back into financials. But I am bearish, so perhaps I am just seeing want I want to see here. But I can't see the price of oil falling much below $115, so I see the crude-driven rally fading here.

Down With the Financials


The inevitable appears to be happening. Today financial stocks led the broader market down. It was not as ugly as it could have been thanks to a large sell-off in oil which sparked a hundred point rally in the Dow. Regardless, the Dow ended down 42 points, while the S&P 500 and the Nasdaq were both down around 1%. There were two notable occurrences in the market today. First, as mentioned above, the financial stocks led the market down. This has not happened since the huge rally in mid-July began. Also, sliding oil prices could not lift the indexes out of the red. Over the last month or so, any day oil slid, the market popped. Today oil was down 3% and the market could not muster a rally. This does not bode well for the immediate future of the market. There are too many drags for it to go anywhere but down for a while (consider headline inflation, housing prices, unemployment, looming writedowns at the banks, credit card companies looking shaky...).

It will be interesting to see what the Fed has to say tomorrow, as well as Freddie Mac's earnings, which are sure not to be good. I, along with pretty much everyone else don't think the Fed is going to cut or raise rates, but every word of their release will be scoured for a hint of what is to come. I don't want to make a call for tomorrow because the market's reactions on rate decisions days never really make sense to me, but if I was a betting man I would place my chips on red...

My Own Little Conspiracy Theory


I read habitually for news (with little or no meaningful analysis) about the American markets, and I always get a laugh from the conspiracy theorists who comment on the stories. If I had a dime for every time I've heard about the Plunge Protection Team, government manipulation of all types of economic figures, pending economic collapse, and well, you get the idea...

I was recently reading "The Intelligent Investor" and Mr. Graham pointed out that in inflationary environments, debt issuers benefit because they repay purchasers with devalued dollars. Which led me to think of a plot which would explode all over the Marketwatch discussion boards. It goes something like this: the unsustainable U.S. Federal debt is a well documented fact (see any youtube video of the Comptroller General of the United States for testimony to this). My conspiracy is simple: the U.S. Federal Government sees this mountain of debt they will never be able to pay off and note that trillions of it is held by foreigners. Therefore, they collaborate with the Federal Reserve to engineer inflation in order to reduce the present value of the outstanding debt to the detriment of the foreign debtholders (and I guess the average American).

I'm not saying that I endorse this theory, I'm just throwing my spin into the fray of BS currently flying around those Marketwatch discussion boards.

An Early Bottom Call By Cramer?


Well he did it. Cramer called a market bottom today. He cited good earnings across the board (apart from financials). I mentioned recently that excluding energy and financial companies, earnings were up 2% since last quarter. While I think it is possible that we have touched bottom, I don't agree with the timing of Cramer's call. Here is why:

Although he didn't say it, I think Cramer may have been influenced by the ADP jobs figure, which came out today and indicated that private sector jobs grew by 9,000 over the last week. This survey is notoriously inaccurate and there will be a more precise figure released by the government Friday. I feel that Cramer may have got so caught up with the idea of calling a bottom he may have forgotten about the traditional inaccuracy of the ADP figure. If I were Cramer I would have at least waited for GDP data to come out tomorrow. If those figures meet or beat expectations, then he could feel a lot more comfortable with his call. Waiting for better jobs figures on Friday would be even more prudent.

I am not saying that Cramer is wrong. If GDP figures beat expectations tomorrow, I think there is a distinct possibility that we have seen the bottom. If not, I think we will be seeing new lows before the real recovery begins.

Jason Zweig and Financial Stocks


I recently read the cover story on (one of my favorite sites for more sophisticated analysis). In sum the story analyzes Jason Zweig's contention that Benjamin Graham (the author of value investing Bibles "The Intelligent Investor" and "Security Analysis") would not buy financial stocks. The article may be found here:

The author, Tom Brown, argues (in my opinion, ineffectively) that Mr. Graham would invest in financials at the current levels. I posted a response to this article which I feel part of is worth sharing:

"I have a few points...

Second, I am currently reading "The Intelligent Investor" by Benjamin Graham with updated commentary by Jason Zweig and I have to say that thus far I have found Mr. Zweig to be very self-important (putting his contributions in capitals in the index of the book) and his contributions to be exhibiting an incomplete understanding of Mr. Graham's techniques and arguments (for a prime example, see his embarrassingly incomplete Michael Jordan analogy at the end of the third chapter).

I must admit that I have not had a lot of exposure to Mr. Zweig's work, and his resume is very impressive, so he must be worth his salt, but based on what I have seen I really do not feel that his analysis carries much weight.

Additionally I would tend to agree with the author of this article, to a limited extent. There are a very few financial institutions that I would be interested in investing in if I had a longer investment horizon (Goldman Sachs is the only one I would definitely invest in and sleep soundly holding), but also agree with Zweig. I feel that it really isn't possible to analyze how far the housing market is going to fall and how many credit-worthy people are going to be affected by this slump. As a result, it is very hard to tell how low various grades of investment securities will fall before they recover. With mark to market accounting, even if they will ultimately be written back up, a precipitous decline may force a financial institution to raise capital where it would not be necessary without such accounting practices. I was surprised by Amex saying that the current crisis was even affecting some of their "super-prime"... customers. To be perfectly honest, I don't feel that even sophisticated investors have the time nor the ability to value financial institutions. I feel that only the very best analysts can get a rough estimation of the true value of financial stocks, and oftentimes their compensation structure is such that we may not even get the true result of their analysis..."

Can't Say I Saw That Coming...


Well I guess I was a little timid in my analysis this morning. Today the market was killed. The Dow, S&P and Nasdaq ended down 240, 23 and 46 points down, all around 2% on the day. As I expected, financials and airlines were hit, with the ^XAL declining 6.21% and the ^XLF dropping around 4% (although a lot worse than I anticipated). It is looking more and more like last weeks rally was a sucker's rally and we are going to be moving to new lows over the coming weeks. The VIX is also on the rise again, after bottoming last Wednesday. A few notable pieces of news today: Merrill Lynch announced plans to raise another $8.5B in stock, oil inched about 1% higher and the White House unveiled a record projected deficit of $482B. That represents a decline from a surplus of $128B in Bush's first year in office. That works out to the the surplus decreasing/the deficit increasing by just over $76B per year of Bush being in office. Wow. As if the United States isn't suffering from excess debt already.

Despite the awful day in the markets, I saw an interesting piece of analysis on the Business News Network which said that this earnings season, when financial stocks (which suffered heavily declining earnings) and energy stocks (which enjoyed large rises in earnings) are removed from the calculation, corporations reported a 3% increase in earnings over the last quarter. To me, that is very bullish and tells me that there is light at the end of the tunnel. Don't get me wrong, I am not saying that this piece is going to turn the market around, but I do feel that when the financials find a bottom, the market will find a bottom and a powerful rally will follow. That has been said numerous times by others, but I am now seeing concrete evidence.

Week 2


Looking forward into this week I cannot say I have have a very good feel for what it will bring. Futures are indicating the market will open modestly lower this morning, dragged by financials. I will say that I see financials modestly lower by the end of the week and airlines considerably lower. That is barring surprise jobs, housing, or GDP numbers (due out on Friday, Tuesday and Thursday respectively). I feel that there are bulls waiting to seize any piece of good news and turn it into huge market gains this week.

The GDP is expected to come in at an annualized 2.1%, a number I find surprisingly high given all the doom and gloom talk by CNBC pundits about the pending "deep recession". I have made a point of not listening to these people and personally don't feel that the economy will even suffer a textbook recession - defined as two straight quarters of negative GDP growth - but do feel that this 2% growth here is optimistic. Any surprise here (especially to the upside) will have a big effect on the market.

The Case-Shiller index is out on Tuesday where economists are expecting it to show a 16-17% decline in housing prices since last July. Again an upside surprise here would be huge in my opinion, especially for the homebuilders. A surprise here though would not have an effect of the same magnitude of a surprise in GDP numbers.

Jobs I feel are the least important economic data to be released this week. Economists are looking for a drop of 70,000 in July non-farm payrolls. Unless there is a BIG surprise here I don't really feel that these numbers will have much of an impact.

All told, I feel that this market will move sideways, possibly with a small downtrend, barring any major surprises in the economic data. If I were to bet which, of any, of these numbers were to surprise, I would have to say the GDP figure is looking a little high, even for me.

A Little More Like It


Well today the market lost big. The Dow was down 286 points, the Nasdaq was down 46 and the S&P 500 ended down 3o points. In my opinion it was long overdue. As I predicted this morning, financials and airlines got it really bad. Big financial names were down as much as 15% on news that institutional depositors had withdrawn almost all of their deposits from WaMu. I read today that there were only $100M of such deposits left, down from $2.5B last quarter and $11B a year ago. Additionally, credit default swaps have priced in a 24% chance of default at WaMu this year and 50% over the next five years. This is certainly not good news. It appears my idea to short WaMu into earnings would have been a profitable trade, but I did not have the nerve due to the hot money pouring into financials at the time. Wow do things change fast. It looks like select financials may be testing their lows of last week during trading next week. Add the $2B loss at National City to round out financial earnings and the euphoria surrounding financials seems like ages ago. I foresee a long, slow downtrend in the financials until the next crop of good news.

Other points for the financials I found funny: the new CEO of Wachovia bought 1 million shares at an average price of $16.24 Tuesday. Unless he dumped them in a hurry, you would think he could have timed the market a little better. Also, the shorts that fled financials after the new SEC rule proposals have returned en masse, with net short positions increasing 10% or more at Wachovia, WaMu, and Banc of America. There was a similar trend in the automakers after Ford and Diamler's big losses. I read a JPMorgan report today that said that at the end Q2, financials were the second most heavily shorted industry in the history of Wall Street records. The first? Automakers. Such high levels of pessimism do not inspire faith in the markets moving forward...

Rally Fading?


It seems that this rally may be ending. After only posting marginal gains the last two days, futures are indicating that stocks are set to lose on the back of a $9.6B loss at Ford. Weekly unemployment and housing figures are also expected to be released today. It is really hard to say with any conviction which way the market is going to go before seeing these figures, but I am certainly bearish overall. Airlines as well as financials have seen unbelievable runs over the last few days and are due for a pull back. Automakers I also see falling (as they have been) further. A $9B quarterly loss at Ford? To me that means that it is pretty much all over for them. We also haven`t seen any bullish analyst calls on financials, which we witnessed yesterday. Mike Mayo called for Wachovia at $30 in the long term and Dick Bove made a bullish call for Wachovia at $17.

Well Wachovia was trading at $18.40 at the time of writing, above Dick Bove`s call, a bearish signal. Also, the rally in financials I believe will look like the rallies in financials that we saw from February to May (big run up over a few days, then a tapering off for a week or two, followed by another big fast run up on good news which brings them higher than at the end of the preceding run up). I believe that if we see a sustained up trend in financials that is what it will look like.

May I add that although oil has dropped $20 to $124 over the last 5 or so trading sessions, lubricating the rise in equities, I feel that the oil will hit resistance at $120 and will start to rise or stagnate around that level. This will stop the rally in airlines and give take some optimism from the market. Now we wait and see what happens.