You should not be surprised by the Dow's -350 point drop from the pre-announcement level to the 13430 close for the day. I cautioned on Sunday "a lukewarm, backpedaling, post meeting Fed statement will be sold faster than Macrovision after announcing they were buying Gemstar." The Fed did not satisfy the market's need to be reassured that the Fed is in control and would act fast enough to stave off a recession. With the next Fed meeting not until the very end of January traders are worried the Fed will not act again for nearly 8-weeks.
Rate Cut Support for Housing
The Fed cut rates by 25-points on both the Fed funds rate and the discount rate. The markets wanted 50-points on each side and traders felt the Fed had telegraphed a 50-point cut in at least the discount rate. The expectations for a full 50-point cut in the Fed funds rate had diminished over the last week. While there was a lot of hope they would take the big step there was a lingering reality that they would not do it. The announcement was still a disappointment and the statement left a lot to be desired.
The statement change tense from "Fed action should help forestall adverse effects on the broader economy" to "economic growth is slowing" and "today's action should help promote moderate growth over time." The statement went from "staving off weakness" to "weakness exists" and over time we will fix it. Traders did not want a long-term fix. They wanted a quick fix in the form of forceful action and a strong statement. It just didn't happen.
These are the main paragraphs from the announcement. I underlined the key points.
Incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending. Moreover, strains in financial markets have increased in recent weeks. Todays action, combined with the policy actions taken earlier, should help promote moderate growth over time.
Readings on core inflation have improved modestly this year, but elevated energy and commodity prices, among other factors, may put upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.
Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.
The Fed clearly sees the economy weakening and credit markets in trouble but they refused to take strong action. The Fed continues to use inflation as a crutch for not making a major move even after saying readings have improved. In the last paragraph they mention "increased uncertainty" but fail to follow up with a strong point of action. "Continue to assess" is the equivalent of Nero fiddling while Rome burned. If you were in a bus that was headed for a cliff with the driver asleep at the wheel you would not sit back casually and assess the effects until the bus goes over the cliff. You would take control of the situation and get the bus back on the highway. The economic bus is headed for a cliff but only one Fed member is watching the road. Boston Fed President Eric Rosengren, a relative newbie, dissented and voted instead to cut the rate by 50-points. For the Fed to watch all the economic indicators weaken and still expect economic growth is true irrational exuberance.
Bernanke Press Conference
This was a big news day and unfortunately a lot of it came at exactly the same time and it was all bad. Within minutes of the FOMC announcement Citigroup named Vikram Pandit as CEO to replace Prince. Interim CEO was Win Bischoff and he will return to his roll as chairman of the executive board. Interim Chairman had been Robert Rubin and he will return to his prior duties as chairman of the executive committee. The market was not happy about Pandit. He was formerly Morgan Stanley's head of investment banking and capital markets but he has never run a public company or had responsibilities as large and diverse as Citigroup. Analysts said Pandit was a good manager but was just a segment manager not CEO material. Pandit was seen as a last resort choice. He has only been at Citi for 6-months. Citi had the opportunity to really make a statement and hire somebody with major experience running a major public corporation and they could find no takers. Either nobody wanted the job or they wanted the capability to make major changes and the board would not agree. Merrill won praise for their new CEO choice of John Thain and traders were hoping for a similar move at Citi. Dow component Citi fell -5% on the news. Citi also reported that they had reduced the size of their SIV portfolio from $80 billion to $66 billion by selling off some of the assets. On a related note Bank America closed a $12 billion money market fund after the net asset value fell below $1 to 99.42 cents. The fund had some investments in SIVs that defaulted.
GE released new guidance about the same time as the Fed announcement. Their guidance for the rest of 2007 was within a penny of expectations and not a problem. They normally report within a penny of expectations. The problem came with their 2008 guidance of $2.42 compared to prior estimates of $2.49 or a -7 cent drop. GE stock was quickly whacked for a -1.68 drop from the pre FOMC high. GE is also a Dow component so that aggravated the drop already in motion. Later on the conference call they added "at least $2.42" to the guidance and the stock recovered slightly. They also authorized a new $15 billion share buyback and raised their dividend by 11% to 31-cents per share.
Morgan Stanley made waves with a forecast that the economy would fall into recession in 2008. They are expecting consumer demand to fall by 1% over the next three quarters and for zero growth in GDP. They are also expecting a 5% to 10% drop in corporate earnings. For all of 2008 Morgan Stanley expects only 1% economic growth. They also expect the Fed to cut another 100-points off the Fed rate over the next 7-months. They do not see a rebounding in homebuilding until 2010 with less than one million starts in 2008 and 2009. That is a level not seen since 1959. They said consumers were facing the perfect storm of slowing job growth, falling home prices and rising energy prices. Analysts using the data inputs for Q4 GDP warned today that based on Q4 economics already reported the GDP for Q4 will be negative. A recession is defined as two consecutive quarters of negative GDP.
Fannie Mae(FNM) and Freddie Mac(FRE) said at a conference that they expected continued weakness in the housing sector through 2009. Freddie CEO, Richard Syron, said FRE would lose another $5.5 to $7.5 billion over the next few years from subprime defaults. He expects conditions to get worse before they get better. Fannie CEO Daniel Mudd also thought things would get worse through 2009 and called the defaults and foreclosures the worst crisis in recent memory. Both agencies have announced changes in their loan acceptance policies. They added a .25% fee, which would equate to $750 on a $300,000 loan, closed after March 9th. Both companies are adding surcharges to loans to borrowers with credit scores below 680 and who are borrowing more than 70% of the homes value.
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Warren Buffett was on CNBC twice today and in one interview said his retailers were reporting soft sales but their hopes were still high for a year-end pickup. Even with a pickup in sales Warren did not think sales would meat last years levels. Multiply that across the entire retail spectrum and Q4 earnings could be a challenge.
We are seeing signs of weakness in other areas that suggest conditions are worse than previously expected. Yesterday we heard that delinquencies in the auto loan sector have ticked up to their highest level in years. Defaults in 2006 loans made to top credit buyers have risen to 4.5% as of the end of September compared to 2.9% the prior month. Lehman said 12% of subprime borrowers were now delinquent. That is the highest level since the 2001 recession. GSC Group, a firm that runs debt-related entities, said the numbers would get worse before they get better. The pace of auto loans has dropped about 30% over the last nine months and that is putting pressure on the automakers. Unlike 2001 where automakers offered low interest loans to stimulate sales they are not likely to do it this time because of default pressure already growing on their existing loans. Sales of autos are down about 2.5% in 2007 and interest rates on auto loans are up about 2%. AmeriCredit (ACF) makes about 500,000 auto loans per year and they reported Q3 income fell to $61.8 million from $74.2 million in the prior year. They have already warned for 2008 blaming rising defaults in 2006 loans. AmeriCredit, CarMax, GMAC and Ford Motor Credit all raised their loan standards in 2007 as defaults began to rise and this is slowing auto sales.
Goldman cut Starbucks (SBUX) from buy to neutral noting slower same store sales, declining new store profitability, margin erosion, concerns over saturation and competition. They also removed them from their America's buy list. SBUX fell -4% and very close to a new multiyear low.
Boeing (BA) said its troubled 787 Dreamliner was still on track to meet it's revised schedule set back in October. They said the first power test would be the end of January and the first test flight would be by the end of Q1 and first delivery in late Nov/Dec 2008. They hope to deliver 109 planes by the end of 2009. However, they are still having problems getting parts. Parts for this plane are made in a dozen countries and shipped to America for completion. Boeing is still having problems just getting bolts to hold it together. Traders were not impressed with the press release and BA lost -$4 for the day.
AT&T bucked the trend today gaining +1.56 after they announced a dividend increase and expanded its share buyback. They are now going to raise their buyback to $16 billion and complete it by the end of 2009. AT&T bought back $13 billion in 2006. They also said they were seeing only minor weakness in their sales related to the current economy. AT&T also announced an aggressive push into cable TV with its U-verse product. AT&T expects to have one million subscribers by the end of 2008 and make it available to 30-million homes by 2010.
Texas Instruments (TXN) also bucked the trend gaining slightly after raising guidance after the close Monday night. It was a minor change of a penny or so but contradicted expectations for a possible miss after Nokia said they were going to work with other suppliers other than TXN. Morgan Stanley cut a basket of chips stocks today on fears the consumer weakness would slow sales of electronics.
Dow Chart - 90 Min
Nasdaq-100 Chart - 180 min
In the broader markets it was an ugly day AFTER the Fed announcement. The Dow was up over 50 points just prior to the announcement but plunged -350 points after the decision. Financial stocks were crushed on the assumption the 25-point cut and weak statement would do nothing to ease the credit crisis. Anything related to financials, housing and retail suffered worse than the overall market. Housing fell -10%, mortgage banks -9%, brokers -7%, REITs -6% and retailers -6%. The financial sector is in trouble and that trouble could get worse on Thursday. Lehman is scheduled to release earnings and according to analysts there are still some skeletons in the closet. Lehman's tier 3 assets, those that can't be valued by the market have risen to $34 billion from $22 billion over the last quarter. Basically if Lehman could not find a valuation they liked in the market they pushed them to the side and declared them a tier 3 asset so they would not have to value them on the balance sheet. Eventually those assets will have to be move back as tier 2 assets and assigned a fair value according to the recently enacted FASB 157 rule. Analysts claim there is already a valuation but just not one Lehman likes. Lehman has a market cap of $30 billion and $34 billion in tier 3 assets. Obviously a serious write-down is going to hurt. Lehman has only written off pennies on the dollar on these assets and contrary to the massive write-downs by other brokers. Some analysts think Lehman could announce some of these moves on Thursday and the results could be ugly. That puts additional risk on the entire financial sector. Financials are 21% of the S&P. That does not bode well for market direction if Lehman stinks up the place.
The next major economic report is the Producer Price Index on Thursday followed by the Consumer Price Index on Friday. The Fed had this data when they made their decision today. Because they only cut a quarter and cautioned again on inflation that could mean those reports will show a sharp increase in inflation. If they don't show an increase the Fed will be ridiculed even further for only a quarter point cut.
The sell off today was way overdone. The selling was accelerated by the simultaneous announcements of events in Dow stocks GE and Citigroup. Boeing's delay announcement did not help. The combination of events pushed the Dow below Friday's support at 13600 (S&P-1503) and that triggered sell stops across all sectors. Winners were dumped as well as losers. For instance Foster Wheeler (FWLT) was crushed for -$8 on no news simply because it was up +$40 from the Thanksgiving low. Same with JEC -4, GOOG -19, BIDU -19 and RIMM -5. They had nothing to do with a Fed rate cut but were crushed by profit taking. Mastercard (MA), which has been unstoppable lately still finished in the green but more than $10 off its highs. It was simply a stop run day on multiple bad news events.
The crash was no respecter of indexes or sectors. With the Dow off -294, Nasdaq -66, S&P -38 and Russell -25 the damage was widespread and even further cemented the stop run thesis. After two weeks of gains with the Dow up +1,050 points from its November lows there was simply too much profit and too many trailing stops to protect those profits.
S&P-500 Chart - 120 min
For tomorrow I would love to see the drop continue and quickly go to extremes again. It is the only way to flush out the weak holders and give the bulls an entry point they are willing to buy. Personally there is little reason to buy stocks right now. The press is going to pick the Fed to pieces over the next couple of days and financials are going to be weak ahead of Lehman's earnings on Thursday. Traders will want to see where the market stops and the conviction of any bounce before stepping out in traffic again. It is safe to say that the shorts have loaded up again and any eventual rebound could be just as vertical. Today I don't see any events on the horizon that might trigger a short squeeze but if the signs were readily apparent there would never be a squeeze. We are getting more and more signs and analyst predictions for a recession and the Fed is apparently on hold until the end of January. That is not a good signal to send to the markets. I would continue to use the S&P-500 as our guide. The support at 1490 was broken by the fall and pretty severely. That is a strong sell signal in its own right. Next support is 1460 but I would expect that to fail if tested. That would mean the weakness is more widespread than it appears tonight and there could be something else afoot. I would continue to be short under 1490, long over that level. I might buy a bounce for a short-term trade at 1460 but would double up on shorts if that level fails.
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