Troubled energy trader Enron (NYSE:ENE) took a turn for the worse Wednesday. Standard & Poor's lowered its credit rating on Enron earlier in the day. The downgrade gave Dynergy (NYSE:DYN), Enron's proposed merger partner, reason to step away from the deal. A Dynergy press release cited "Enron's breaches of representation, warranties, covenants, and agreements" as the reasons for pulling out of the deal. Shares of Enron lost more than 80 percent of their value on more than 340 million shares traded -- record one-day volume for a single stock.
The Enron debacle has far reaching implications. The adverse impact was felt in the energy sector. Fears of exposure to Enron pressured the Natural Gas (XNG) sector. Shares of El Paso (NYSE:EPG) and Williams (NYSE:WMB) were especially hard hit. The Bank Sector (BKX) was pressured lowered, with Citigroup (NYSE:C) and J.P. Morgan Chase (NYSE:JPM) taking the brunt of the selling. The two banks reportedly backed the proposed merger with loans and equity investments.
A bankruptcy filing appears imminent. Enron's bonds reflected that end Wednesday. Most of the company's debt lost around 85 percent of its value in the bond market. The fears induced a flight to quality that lent a bid to Treasuries. Although Treasuries finished well off their highs, they did finish higher as evidenced by the drop in yields across the curve.
Unfortunately, Enron was a much-loved stock among institutions. According to the most recent filings, the biggest institutional holders of the stock include: Janus, Putnam, AXA Financial, Barclays Bank, Citigroup, Fidelity, State Street, Aim, Taunus, and Vanguard.
The worst ramification of the Enron debacle is the impact on its employees' 401(K) accounts. I read a story in the New York Times about an Enron employee who had put his entire retirement into the stock several years back. He had worked for the company for several decades and was approaching retirement. He lost nearly all of what was left of his retirement today. Indeed, I'd guess that more than a few of our readers own directly or indirectly shares of Enron.
I don't want to make an example of anyone. I sincerely sympathize with the Enron employee I read about and anybody in a similar situation. But I think there are a few lessons to be either learned or reinforced in the wake of Enron's demise:
1) The identification and management of risk is a lost art. Far too many investors don't fully understand the risk that is involved with the stock market.
2) Diversification is a step towards the management of risk. It's simple: remove the non-systematic risk through diversification.
3) Wall Street is the world's greatest salesmen. Analysts are salesmen and saleswomen. That's why they are referred to as the "sell side" of Wall Street. There are currently 15 analysts covering Enron, 6 recommend the stock a Strong Buy!?!
4) Gurus are not. In October's Money Magazine, Abbey Joseph Cohen said Enron represented a "good value" in the energy sector. The stock traded above $30 at the time.
5) Price doesn't lie. Somebody knew in late October and early November. They were selling. Technical analysis is a step towards the management of risk. I'm not a very good technician, but even I knew something bad was happening with Enron over the past two months.
If there's one thing that I hope to impress upon my readers it's the necessity for risk management. It's given scant emphasis by the sales machine that is Wall Street and not nearly enough credence by the financial media. Instead of asking yourself how much money you can make from an investment, try: How much can I lose? Ask that question and you're one step closer. And remember, it can always get worse:
I'm not sure how much more of an impact the Enron debacle is going to have on the broader markets. Going into Wednesday's session, the major averages remained overbought in the short-term. The Enron debacle may have been the catalyst to start the necessary consolidation process before the next leg higher. The selling was heavy and broad which helped to work off part of the overbought nature of the averages.
The Dow Jones Industrial Average ($INDU) shed about 300 points from its recent peak up around 10,000 to its close around 9700. The S&P 500 (SPX) pulled back sharply and so did the Nasdaq-100 (NDX). The daily oscillators across each of the averages made some progress to the downside and although the numbers weren't available at the time of writing, I'd be willing to bet that the bullish percent figures across the major averages moved lower.
Like I wrote earlier, there may be more negative consequences from the Enron disaster. Sectors that may fall under additional pressure might include Banks and Energy. But there may be a few buying opportunities in insulated sectors such as the Biotechs (BTK). The biotech group has been among the strongest since the September 21 bottom. Additional market-related weakness might pressure the BTK back down to support, where bulls might look for strong biotech stocks to bounce. The BTK has been trending higher since 09/21, using an aggressive ascending support line. It has bounced from the line several times and is again approaching the support level. The ascending line sits around 580, which may be a good spot to target the biotechs in the event of further weakness.
The tech sector will remain subject to earnings news and guidance in Thursday's session. Brocade (NASDAQ:BRCD) reported numbers after the bell that edged past estimates but the company provided a less-than-bullish outlook for its next quarter. Brocade officials provided flat guidance in the quarter-over-quarter period. The downbeat guidance pressured shares lower in the after hours session. Brocade is a component of the Hardware (GHA) sector and the Nasdaq-100.
In the Networking (NWX) space, ADC Telecom (NASDAQ:ADCT) reported a loss for its most recent quarter that was in-line with expectations. The company's guidance was downbeat too. ADC Telecom forecasted modest growth for next year, but nothing spectacular. The stock edged lower in the evening session.
Altera (NASDAQ:ALTR), a make of programmable logic devices, reaffirmed its current quarter guidance, which calls for a decline in revenues between 5 and 10 percent from the third- to the fourth-quarter. The company was expected to reaffirm guidance, so the news may have already been discounted in the stock. Nevertheless, shares edged higher in the after hours sessions.
While not much good can come for the Enron calamity, it may have served as the catalyst to remove some of the bulls from the market and work off the overbought condition of the averages. The drop from Tuesday's peak and Wednesday's subsequent decline took a lot of froth out of the bulls' charge. That's a good thing as Jim suggested Tuesday in his Market Wrap piece. If everybody's a bull, who's left to buy and carry prices higher? Stocks are again approaching support levels and may start bouncing in the next day or two. The dip-buying pattern has been prevalent since September 21. We'll find out in the next couple of days whether the pattern holds or if a protracted sell-off is in the mix. The beauty of buying stocks near support is that a tight stop can accompany those entries. And with a tight stop, risk is managed.