For market watchers this has been one heck of a week and this is only Tuesday. Monday's bankruptcy rescue of Bear Stearns came close to really tanking the market. The bailout by the Fed and the added financing opportunities by non-banks provided enough support to keep the markets from imploding. Expectations for the Fed to make another major rate move were enough to overcome a negative PPI at today's open and send the Dow +300 points higher. The Fed announcement knocked -175 points off the gains but the dip was quickly bought and the rally continued. When the smoke cleared the Dow closed up +420 points at 12376. Even the Nasdaq was able to post a +91 point gain.
Dow Chart - Daily
The morning economics were only a prelude to the volatility that was to come. The Producer Price Index (PPI) rose only 0.35% on the headline number and only about a third of last month's gains. It was inline with the consensus estimates. However, core inflation rose sharply. Excluding food and energy, prices for finished producer goods rose by +0.5% and the fastest rate of inflation since Nov-2006. Core prices for intermediate goods rose +0.6% and core prices for crude goods rose +3.3%. This was a bearish report and suggests inflation is accelerating and will become a problem for the Fed very soon.
The big news of the day was of course the FOMC meeting and the change in interest rates. The Fed cut rates by 75 basis points to 2.25% and left the door open for a future cut. This brings the total cuts to 3% since they started slashing rates in September. The 2.25% Fed funds rate is the lowest level since early 2005. After the meeting the Fed funds futures were projecting a 90% chance of another 50 point cut at the April 29th meeting. Two FOMC members, Fisher and Plosser, voted against the cut and favored a "less aggressive action." The FOMC also cut the discount rate 75-points to 2.50%. They had previously cut it by 25-points over the weekend.
The Fed statement was much more bearish than recent statements and much more lengthy. The key paragraph is this:
Recent information indicates that the outlook for economic activity has weakened
further. Growth in consumer spending has slowed and labor markets have softened.
Financial markets remain under considerable stress, and the tightening of credit
conditions and the deepening of the housing contraction are likely to weigh on
economic growth over the next few quarters.
About the only thing they left out were worries about global warming. On the positive side they continue to be wildly optimistic that inflation will slow even in the face of the PPI showing the biggest jump since Nov-2006. They may be the only group on the planet that expects inflation to slow.
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The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully.
Despite their concerns on inflation they are still focused on slowing growth and the bias remains for further rate reductions.
Todays policy action, combined with those taken earlier, including measures to foster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain. The Committee will act in a timely manner as needed to promote sustainable economic growth and price stability.
The combination of the Bear Stearns rescue over the weekend, the new rules allowing non-banks to borrow from the Fed, the assurances by everyone in the administration that the financial system will remain solid and today's rate cut gave investors the comfort level they needed to cover their shorts. The earnings from Goldman and Lehman didn't hurt either. There had been widespread expectations that the Fed would cut by a full percentage point. The last time they did that was 1991.
There is a persistent rumor that there is a deal in the works to allow Fannie and Freddie to buy additional mortgage paper. Fannie has $10 billion in excess capital and some analysts are suggesting that part of the weekend bailout was a side deal with the administration to allow them to buy additional mortgage paper to support the mortgage market. The $10 billion in capital would allow them to buy up to $100 billion in mortgages. JP Morgan said they could possibly buy up to $40 billion in mortgages for every $1 billion in capital. FNM/FRE have agreed to produce some additional share offerings to raise additional capital if the oversight committee agrees to remove the capital restraints. The spreads between mortgage backed securities and treasuries narrowed sharply over the last two days and Fannies swaps have improved significantly. Somebody knows something or at least they are actively betting there is a change in the wind. There has been a call for the Fed to buy mortgages in some form to put a floor under the market. Having Fannie step in the gap in place of the Fed would keep the Fed's balance sheet intact and still accomplish the same result. FNM spiked +27% on the improving financial news. Mortgage lenders like Countrywide and Bank America would benefit almost immediately from the relaxed controls at FNM/FRE. The mortgage market would open up again once the pipeline of unsold mortgages was absorbed. Thornburg Mortgage (TMA) rose another +32% on the news.
FNM Chart - Daily
The markets were probably more excited about the better than expected earnings from Lehman and Goldman than the Fed statement. Traders were very worried about Lehman with their business seen as the closest comparison to Bear Stearns. There were fears they would announce some of the same problems and massive additional write-downs.
Lehman's Q1 net income dropped -57% to 81-cents per share and they took another $1.8 billion mark-to-market write-down. They still beat analyst estimates of 73-cents and were very open about their financial condition. The conference call lasted an hour compared to the normal 20 minutes. The CFO sought to assure investors that Lehman was not in the same shape as Bear Stearns and went to great lengths to answer questions related to its finances. The CFO assured investors that Lehman had broad access to all the capital it needs. LEH rebounded +46% to close at $45.51 and well above Monday's panic low of $20.25. Lehman was helped when Goldman Sachs added it to their recommended list.
Goldman Sachs said profits fell to $3.23 per share or $1.51 billion. This was down from $3.2 billion in the comparison quarter. Analysts had expected earnings to be in the range of $2.57 per share so this was a large beat. Goldman had losses of only $1 billion on mortgages and another $1 billion on corporate loans. This strong report along with the Lehman earnings helped to generate significant short covering in the financial sector. After the Bear Stearns meltdown we saw the shorts load up on stocks like Lehman in hopes of a repeat performance. Those shorts were crushed on the dual results from LEH and GS. GS rose +$24.31 on the news.
Morgan Stanley (MS) spiked +18% to $43 on the positive GS/LEH news. Morgan reports earnings on Wednesday and there are several analysts that believe Morgan wrote down all its distressed debt in the prior quarter and could be the first to write-up those assets as the markets recover. Morgan is also expected to get some of the prime brokerage business that is fleeing Bear Stearns. A positive report from MS tomorrow would be additional fuel for the financial rally.
Bear Stearns (BSC) rose +23% to close at $6.05 after trading as high as $8.50 earlier in the day. With a $2 per share take under agreement on the table why is the share price rising? They say the first stage of grief is denial and it is possible that investor simply can't believe that a $70 stock last week is worth $2 today. I don't think that is it. The catch here is that shareholders have to approve the takeover. Reportedly employees already control a third of the shares and it would not be hard to gain a controlling stake as a group. Since it will be almost 3-months before a shareholder meeting can be scheduled the financial picture may be significantly different by then. The building alone is reportedly worth $8 per share and Bear has billions in other assets on the books that are not affected by the liquidity squeeze. Is Bear going to rise from the ashes and become a going concern once again? Who knows but you can bet the vultures are circling to see if there are any scraps worth grabbing. Nothing precludes anyone from making a better offer and creating a bidding war. One thing for sure this story is a long way from over.
This has all the appearances of a bottom in the financial sector and quite possibly the markets as a whole. The Fed's actions beyond the rate cuts have convinced many that there is no further danger. There will still be losses from mortgage loans but as long as the credit markets are functioning those losses are more than manageable. That does not mean everything is back to normal. The Goldman CFO said their cash position has never been stronger but still expressed caution about the markets. He said until there is a greater certainty and people start feeling better about the markets I don't see banking activity picking up dramatically. Getting deals done will still be hard until the crisis is clearly behind us. I doubt anybody complained about the monster gains in the sector today. The Broker Dealer Index (XBD) spiked +11% for the biggest gain since April-2001. The Financial Index Sector SPDR (XLF) rose +8.4% for the biggest gain since March-2000.
The weak financial markets did not stop Visa from proceeding with their record breaking IPO. Visa (V) priced its shares at $44 per share to raise $17.9 billion. That surpasses the $10.6 billion AT&T IPO in 2000 to become the largest on record. $10.2 billion will be used to redeem shares from stakeholders including JPM, NCC, BAC and C. Another $3 billion will be reserved for litigation costs. The remaining $5 billion will be used for general corporate purposes.
Yahoo surprised investors today with better than expected guidance through 2010. The unscheduled announcement suggested revenue minus commissions would climb more than 70% over the next three years to reach $8.8 billion in 2010. Revenue expectations for 2008 are only $5.7 billion. This was obviously an attempt to boost their value in the market and encourage Microsoft to raise their bid. YHOO stock rose +1.81 on the news to $27.66. The Microsoft stock offer was valued at $29.49 at days end or roughly $41 billion. Analysts have suggested that Microsoft may be willing to pay as much as $35 per share to avoid a bitter fight that could alienate employees. Analyst Clayton Moran said the chances of a significantly raised offer could be fading daily as the possibility of a recession deepened. The Yahoo news helped push the entire Internet sector higher.
After the bell today Adobe reported earnings that rose +52% but kept its annual guidance the same. Adobe said it would not be immune to any recession so they were not going to modify their guidance until the visibility was clearer. Adobe is benefiting from a very diversified product line and a new product called Photoshop Lightroom that is really catching on with photographers.
Intel and Microsoft announced they were donating $20 million to build computing research centers at the University of Illinois and the University of California. The "Universal Parallel Computer Research Centers" (UPCRC) will attempt to accelerate development of parallel computing or using massive numbers of multiple computer cores. Intel has experimented with an 80-core research processor. Current top end commercial processors utilize 4-cores but have multiple processors per computer. This will be an effort to manage vast numbers of cores per processor. Can Skynet be that far away? (grin)
Oil prices recovered from Monday's massive sell off to close almost $4 higher at $109.60. The pending expiration of the current April futures contract on Wednesday was a major cause for the jump. Open interest in the contract was many times larger than available storage for delivery and the extreme volatility this week has been the result as positions are closed ahead of expiration. After the futures closed today Venezuela said they were no longer going to supply oil to the Chalmette refinery, which is jointly owned by PDVSA and Exxon. It was unclear when this decision was made but crude prices spiked nearly $2 on the news in the last 5 minutes of trading. It was also announced that Exxon lost a court battle in England against Venezuela and the $12 billion freeze on Venezuelan assets was lifted. Exxon still has a $12 billion freeze in courts in the Netherlands and Dutch Antilles and a $300 million freeze in the United States. Exxon is trying to get compensation for $5 billion in assets Venezuela nationalized last year. Exxon pursued the asset freezes because they are afraid Venezuela will try and encumber or liquidate assets that can be attached by an eventual court ruling in Exxon's favor. Historically Fed rate cuts also tend to support higher prices for oil on expectations that the economy will recover.
April Crude Oil Futures Chart - Daily
It should require no stretch of the imagination to realize that the market was heavily shorted going into trading on Monday and even with the end of day buying on Monday the shorts were still loading their boat to brim. Lehman was going to be the next carcass to rot in the sunshine of earnings disclosure. Unfortunately for the shorts that scapegoat jumped up and trampled them with better than expected earnings. This is a quadruple witching expiration and the options were predominately on the short side. It was a powder keg primed for an explosion.
The Dow exploded for +420 points to 12392 or +632 points from Monday's low of 11760. The close put the Dow above last week's resistance high of 12300 and could actually be the start of a new trend. Of course the bears are pointing out that we have seen rallies of as much as 1000 points in a bear market only to go back and set new lows. I am not in that camp today. I do believe that the majority of the gains were still just another short squeeze after five months of short squeezes but this one has the potential to stick. The fundamentals in the credit markets are starting to improve given the Fed actions. If Fannie and Freddie or the Fed itself actually starts buying mortgage paper to free up the pipeline for new homebuyers then the sector should slowly improve. I could be completely wrong but baring any new revelations or company meltdowns I think the bottom is behind us. It may take a while for any positive sentiment to take hold but the bargain hunters are circling in mass. Assets are attractively priced and firms with money today can snap up those bargains once the pipeline begins to move. Goldman Sachs has been the most bearish of the major brokers and they came out today and said they believe the worst is over. This is a major change in sentiment and it should be contagious.
TThe Nasdaq rallied for +91 points and a very strong return almost to resistance at 2275. There were several positive tech stories that provided additional lift to the short covering. I am less excited about the prospects on the Nasdaq until they move over 2275 and maybe even over the next resistance level at 2350. These companies should be immune to the credit crunch but they are not immune to any recession slowdown. I would want them to prove they were going to continue higher before I jumped on board.
Nasdaq Chart - Daily
S&P-500 Chart - Daily
The S&P gained +54 points but also failed to break initial resistance at 1335-1340. Because the S&P is 21% financial I think continued short covering could test that resistance tomorrow. A move over 1340 hits down trend resistance at 1375 very quickly.
The Russell ran headfirst into resistance at 680 and came to a dead stop. This should be our market indicator for the rest of the week. If fund managers are buying the concept from Goldman/Lehman that the worst is behind us then they may begin to venture back into the small caps. That would be the key indicator that it is safe to venture back into the market. Watch Russell 680 for confirmation.
Russell-2000 Chart - Daily
Ordinarily I would be very cautious about a +600 point Dow rebound and suggest
there could be profit taking in our future. I am still cautious this week but I
believe the current scenario could negate much of that. We have a quadruple
witching to unravel and the shorts are the ones in trouble. I would be
cautiously optimistic tonight but want to see some confirmation before I dive
in. We are approaching the "sell in May and go away" period but given the drop
of the last five
months I am not convinced we are going to see that seasonal
weakness in 2008. If the recession indicators did increase significantly then
hiding in cash over the summer might be the move money managers would take. We
need to play it one week at a time and see where it takes us. This is also a
holiday week with the markets closed on Friday and many traders will be moving
to the sidelines probably as early as today. All of these factors suggest
continued volatility but not necessarily
negative volatility. If we get a
breakout tomorrow then Thursday could be a follow through day.