Facebook gave back all its opening gains and would have gone negative if not for underwriter support.
I am so glad the Facebook IPO is over. The constant hype despite the extreme valuations had grown to the point where every news headline was related to Facebook. The stock opened on Friday at $42 and then declined almost immediately to the offer price at $38. Massive intervention by the underwriting syndicate prevented it from going negative and eventually some new buyers came to the market. The stock rebounded to $42 again before collapsing at 2:PM to trade at $38 for the rest of the day. Tens of millions of shares were traded in the last 30 min in the $38.00 to $38.05 range. JP Morgan and Morgan Stanley stepped in as buyers to prevent the shares from falling below $38 but it was a monster fight.
There were 82 million shares traded in the first 30 second of trading. Volume continued to be very heavy as the price declined but almost immediately there were problems at Nasdaq. Trade allocations and confirmations were delayed for several hours. Most investors did not know how many shares they had in their account until after 2:PM when Nasdaq said the messaging problems had been fixed. However, major brokers including Fidelity said confirmations for millions of shares had still not been delivered by the market close. Many Etrade customers did not learn until after the close that they had not received any IPO shares.
Had the systems been functioning normally the volume would have been significantly greater than the 581 million shares traded. Investors who were allocated shares in the IPO but had no confirmation could not sell them into the market. They were forced to watch the price decline without knowing "IF" they had any shares or how many shares they owned.
Despite the confusion, which would have allowed even more selling had it not been present, the volume was the largest for any U.S. IPO ever surpassing GM's record. The underwriters, all 33 of them, were able to keep the price at or above $38 but only after a major intervention. Underwriters want to have an IPO finish positive on the first day as evidence it was priced correctly and eagerly anticipated by the investing public.
Before the IPO we were hearing the shares were oversubscribed by 10:1 or even 30:1. Facebook raised the anticipated price twice and raised the number of shares being offered. Apparently the hype was just that, hype. Every person and institution that requested shares got those shares. In a normal IPO if a person asks for 1,000 shares he might get 300. An institution might ask for 300,000 and get 100,000. Because of this allocation lottery everyone always asks for more than they want. For instance the individual may ask for 3,000 shares and hope to get 1,000. The institution may ask for 600,000 and hope to get 300,000. Because of the hype this was probably rampant for Facebook. Investors that received allocation confirmations before the open found they got all the shares they requested. That means the majority of those investors/institutions needed to sell shares ASAP.
In the chart below you can see where the underwriters supported the price at 11:45 and again in the 30 min before the close. They were successful in preventing any trades below $38 even by a penny. They had to absorb significant volume to keep the price over $38. In the level 2 image below at 11:53 there were huge bids outstanding at $38. Compared to the relatively small share amounts at the ask. There was no way FB shares were going under $38.
Later in the afternoon the volume was not especially heavy but it was in the tens of millions of shares. For a space of about 15 min the price was dead flat at $38.
Facebook Order Depth
Bid/Ask (Image source @bourbon_meyer)
Underwriters can support prices in a variety of ways. They can physically buy the shares at no higher than the offering price. This can become expensive in an IPO of this size. They can also short the shares at the open by over allocating shares to their clients. Say they were given 50 million shares to allocate to their clients. They are also allowed a "greenshoe" option which in this case was 15%. That means they had an extra 7.5 million shares to hand out in the case of excess demand. That gives them 57.5 million shares. If they believe the IPO is going to be in trouble they can over allocate that extra 7.5 million shares and give their clients more shares than the underwriter was allocated. In this example let's say they distribute 57.5 million shares to their clients even though 50 million was the official allocation. That means they are short 7.5 million at $38. As the price in the open market declines back to $38 they can maintain a buy at $38 to cover that 7.5 million share short. Multiply this by all 11 underwriting managers and they had 63 million shares short to cover at the issue price if needed. Morgan Stanley was the official "stabilization agent" for the IPO. If the price never returned to the $38 level then those over allotment shares would be left in the market.
Friday was only the first step in the Facebook share saga. They have three lockup dates at 90, 150 and 180 days. They issued roughly 440 million shares on Friday but that number will increase by 172 million shares in 90 days and then more than double by 180 days. By year end there will be 1.8 billion Facebook shares available to trade. August 20th is the first lockup to expire with 172 million additional shares coming to market.
The odds of Facebook trading significantly below their offer price are very close to 100%. Facebook priced at 100 times 2013 earnings compared to Apple at 13 times 2012 earnings. Facebook will have 1.8 billion shares at year end compared to Apple at 935 million. Do the math. Facebook closed the day with a market cap of $105 billion and 3,200 employees. Hewlett Packard has a market cap of $42 billion and 325,000 employees.
For comparison other recent tech IPOs included Linkedin (LNKD) had a +109% spike on its first day. Groupon (GRN) rose +31%. The much hyped Facebook turned in a face-flop with a zero gain. The Facebook disaster caused investors to dump other social networking stocks. Zynga fell -13.4% to $7.14 after being halted for trading twice due to excessive price swings. Linkedin (LNKD) fell -5.7% and Groupon (GRPN) -6.7%.
Pivotal Research started coverage of Facebook with a "Sell" rating with a price target of $30.
More than 1,000 Facebook employees became millionaires on Friday. Some early employees and investors owned the shares at as little as $1.50 each. That could make employee retention a little difficult over the next several months. Zuckerberg ended the day worth $19.25 billion. Not bad for 8 years of work.
There was not a lot of news other than Facebook on Friday. There were no economic reports to move the market. Next week is going to be very slow in terms of economics. There are a couple housing sales reports and a couple regional manufacturing reports but nothing really market moving.
The Dow completed its 12th daily decline out of the last 13 days. That is the worst streak of losses since 1974. Pushing the global markets lower is the continuing flow of bad news from Europe. Greece dissolved its parliament in order to allow the new elections on June 17th. The elections are being seen as a vote on staying in the euro or committing economic suicide by defaulting on the bailout agreements and going back to the drachma. On Friday Germany's Merkel supposedly suggested adding a euro question to the June 17th ballot so citizens could decide if they wanted to stay in the euro with austerity or abandon the euro and face the chaotic consequences. However, late in the day her office said the rumor was incorrect.
Greece was downgraded again by Fitch from B- to CCC and the lowest rating for a country that is not in default. Fitch warned of a "probable" exit from the euro if the June elections produce an anti austerity government as expected. Fitch said a euro exit and forced redenomination of euro debts into drachmas would be considered a default. The parties winning the most votes in the May election said Greece should tear up the bailout agreements because the eurozone could not afford to kick Greece out of the union as it would trigger the entire currency union's collapse. A new anti austerity government will believe it is playing with a stacked deck and demand serious concessions from the eurozone but Germany is likely to balk at further concessions and let Greece commit economic suicide by voluntarily leaving.
Moody's downgraded 16 Spanish banks late Thursday citing concerns over the economic crisis. Moody's said numbers released last week showed bad loans at an 18-year high and said it was not confident Spain could continue to recapitalize its banks indefinitely. If Spain needed its own bailout the EU, ECB and IMF would be hard pressed to come up with sufficient funding. Germany countered on Friday saying it saw no reason why Spain could not continue to bailout its own banks without seeking outside aid. Ireland had the same problem in 2010 and required a bailout when it could not continue to fund its banks due to excessive bad loans. Moody's downgraded Italian banks earlier in the week. There is a serious run to withdraw bank deposits in Italy, Spain and Greece. The Financial Times said $1.5 billion flowed out of Greek banks on Monday/Tuesday alone.
This continued downward spiral by the weak European countries pushed the global markets into seriously oversold levels. In theory the oversold markets are due for a rebound soon but the clock is working against us. With the June 17th Greek election still four weeks away and the outcome likely to be an exit from the euro, most investors are looking for a safe haven. Nobody really knows what a Greek exit would do to the global financial system but there will be an impact. Economically most of the damage will be inside Greece but financially it will be widespread as euro denominated debts are forcibly denominated into drachmas. Banks and businesses will fail while thousands of others outside Greece will take major losses. The great Greek unknown will linger as a cloud over the market for the next month.
That cloud has even bigger storms behind it in Italy and Spain and investors worry that once Greece leaves the euro they will eventually follow suit. Most analysts believe this won't happen but investors hate uncertainty. It is the not knowing that causes the biggest problems.
Late Friday Spain was forced to revise its 2011 deficit estimate up to 8.9% of GDP from 8.5% in the last release. The initial target was 6%. Spain said despite the upward revision it was sticking with its 2012 deficit target of 5.3%. Fitch warned that despite the affirmation there was still a risk those 2012 targets would be missed.
The G8 meeting at Camp David this weekend is expected to focus on the Greek problem and the ramifications to other countries. President Obama is expected to partner with the new French socialist president Hollande in attempting to push through expanded stimulus through social programs aimed at generating economic growth in Europe. The G8 leaders will probably be drawing up contingency plans for a Greek exit from the euro. Even if they don't actually expect it they can't allow themselves to be unprepared.
The worries over the deteriorating conditions in Europe pushed the interest rate on the U.S. ten-year note to 1.702% and a new record low. U.S. treasuries are being seen as a safe haven once again despite our own rapidly deteriorating financial situation. We are still the dog with the least fleas.
Ten Year Note Interest Rate Chart - Monthly
Gold prices rebounded $70 since Wednesday's low of $1526 to close at $1591 on Friday. The power behind the move is the newfound expectations for the FOMC to add further stimulus to the market when they meet in June. The worsening European situation was mentioned in the FOMC minutes last week as a potential reason for additional stimulus. Add in the three-week decline in the stock market and what appears to be slowing U.S. economics and analysts suddenly found themselves expecting new stimulus. The Philly Fed Manufacturing Survey on Thursday declined sharply to -5.8 in May from 8.5 in April. Expectations were for a rise to +10.0.
Philly Fed Manufacturing Chart
I think this stimulus expectation is misplaced today but the June meeting on the 19th is two days after the Greek election so the outcome there could influence Fed members currently on the stimulus fence to join the party once again. This prospect and the oversold conditions in gold caused a strong bout of short covering.
Gold had fallen sharply on the rising dollar and selling by hedge funds. The CFTC reported on Friday that investors had dumped $2 billion in gold futures since May 1st. Net longs fell by $2.2 billion to $12.2 billion for the week ended May 15th. Net long contracts fell from 92,498 to 78,619. This was the smallest net long position in gold since December 2008 and the financial crisis forced liquidation in commodities to cover losses in equities. Gold prices on the June contract fell -$82 for the week ended May 15th before rebounding sharply late in the week.
Also weighing on the market was the decline in the financial sector. Not only was Europe weighing on financials but the JP Morgan trade disaster was also a factor. JPM has lost $30 billion in market cap since it announced the $2 billion loss. Now that trading loss is up to $3 billion and it could go as high as $5 billion. This is prompting Congress to call for more rules for banks that are deemed too big to fail. Jamie Dimon has agreed to testify before Congress about the trade. The division inside JPM responsible for the loss was managing a portfolio of $326 billion in bonds and derivatives. JPM has a reported $71 trillion in derivatives on its books.
The decline in the S&P Financial Sector was -$127 billion in market cap last week. Eventually this cliff dive by JPM shares will end. The stock is already trading below tangible book and I think the bargain hunters will appear in quantity as it nears $30.
The financial sector lost more than -7% for the week.
Financial Sector ETF
JP Morgan Chart
With the Facebook IPO out of the way we may see traders return to the market. Clearly a lot of that $18 billion that was sucked out of the broader market in hopes of capitalizing on a big Facebook win will return next week. Most retail traders and probably a lot of institutions that received an IPO allocation have either already sold their shares or will do so once FB trades under $38. New money will take their place but the point here is that the retail trader will have their cash back and it could move back into tech stocks.
The Volatility Index closed at a six month high at 25.10 and this was an expiration Friday when the VIX is normally tame because of low premiums for puts. However, the market is imploding so put prices were still elevated.
Volatility Index Chart
Note the massive volatility spike back in August. That was the debt limit increase spike where S&P lowered the credit rating on the USA. For the long term thinkers out there we have an even bigger event coming in January. It is being called the "Fiscal Cliff." Bloomberg expects the impact of these events to cut -4% from the 2013 GDP. For those unaware that cliff includes:
Expiration of Bush tax cuts.
Payroll tax cut holiday from 6.2% to 4.2% expires.
Doctors get a 27% pay cut for Medicare patients.
Alternative Minimum Tax spikes for middle class workers.
Dividend Tax rises from 15% to 45%.
$1.2 billion in automatic spending cuts kicks in.
The $16.4 trillion debt limit will have to be raised to $18 trillion.
Four of the 20+ taxes for Obama Care begin. Full list (PDF)
Just getting past the current market decline does not mean it will be clear sailing into year end. Worries over all those events above will weigh on any future rebound.
After three weeks of declines everyone is looking for a bottom. After months of vertical gains the concept of three weeks of declines is foreign to most traders. The S&P closed right on the 300-day average on Friday and just above the 200-day. (The 300-day is an interesting average. Some stocks completely ignore it while others treat it like an electric fence. Add it to your chart program and then look how well some stocks pay attention. Indexes are not normally reactive to it, only stocks.)
The S&P has declined -8.4% from the May 1st high of 1415 and -8.9% from the April 2nd high close at 1422. The index is approaching correction territory at -10%.
The AAII bullish and bearish percentages are very close to levels where reversals usually occur. The bullish percentage at 23.58% is actually below the levels seen during the market implosion in August 2011. The bearish percentage at 45.97% is nearing the level seen in August 2011 at 49.85%. That was a two year high.
AAII Bullish Sentiment
AAII Bearish Sentiment
What is so strange here is that it only took three weeks for a major change in sentiment and the S&P has only declined -8.4%. Are we just getting more risk adverse as we age or is it that traders are starting to understand the complex market relationships with Europe and the potential for a really ugly second half?
Regardless of the reason for the decline it has impacted all the various indicators. For instance the McClellan Oscillator has fallen to 110.33 and level that normally is reserved for major market events where a bottom is formed.
McClellan Oscillator Chart
In a Bloomberg survey of top strategists from major investment banks they found that recommendations to buy stocks as an asset class had fallen to levels not seen since the bottom of the 2009 crash.
Bloomberg Analyst Chart
Stocks have suddenly fallen out of favor and there are NO SIGNS of a pending bottom. However, volume has picked up dramatically. That is especially true of declining volume. We have gone from 5-6 billion total shares per day three weeks ago to 8.5 billion for the last two days. Declining volume averaged 6.4 billion shares per day and that was equal to total volume per day just a couple weeks ago. Daily up volume has only averaged 1.6 billion shares for all of last week.
Granted option expiration had something to do with that as well as 570 million FB shares on Friday but volume has definitely increased. Option volume has also increased and it is significantly weighted to puts. The CBOE Put/Call Ratio rose to 0.99 on Friday. Historically that represents extreme bearishness due to the volume of puts to calls in the market. That 0.99 level is very close to the extreme levels reached in August 2011 over 1.05. Also note the MACD at the bottom of the chart. It has also risen to extremes.
Put Call Ratio Chart
While we know the bearishness has reached the point of being extreme there has not been a pivotal day in the decline. That is a day where the A/D volume is 10:1 to the downside. Some call it a capitulation day. While bearishness increased significantly over the last three days there was no sign of capitulation. There were still people nibbling at the intraday dips. Nobody appears ready to chuck it all and throw in the towel.
Larry McMillan was pondering the same question on Friday and he said the odds of a powerful short term rebound were growing but he sees it as an opportunity to get short at a higher level. At this point I agree with him. The short term bearishness has reached the point where an unexpected news event could create a monster short squeeze. However, the longer term problems with Europe and economics should force the markets lower in the weeks ahead.
Bernanke could make an appearance at any time and say something about a potential QE3 program and the shorts would be crushed. He does not have to wait for the June FOMC meeting. He has shown in the past that he can telegraph his intentions and move the market. The ECB is also likely to print more money possibly with LTRO-III. They need to slow the downward spiral even more than the Fed does. Coming the week after the G8 meeting would be perfect timing for an announcement of some sort and possibly a coordinated announcement.
The S&P could continue to the 200-day support at 1275 next week or it could rebound at any point. With the Dow down 12 of the last 13 days the rebound spring is coiled pretty tight. Nothing prevents it from being wound tighter but we have to be nearing an explosive rebound.
There are analysts talking about a dip to 1250 or even 1200 so be prepared for a continued decline even if we get a short term bounce.
S&P Chart - Daily
S&P Chart - Daily
The Dow is not normally reactive to the moving averages because of its thin 30 stock construction. That being said there is a convergence ahead of several different support points including the 200-day average. While I think the Dow will be controlled by Europe and economics we could see a rebound or at least a pause at the 200-day as traders search for something to pin their hopes on.
Dow Chart - Daily
Dow Chart - Daily
There is a scene in the Twilight Zone movie where a character asks a pending casualty, "Do you want to see something really scary?" He could have been referring to the Nasdaq chart from last week. The Nasdaq lost -155 points or -5.28% in a single week and there next support level could still be several percent lower. However, the Nasdaq has lost 306 points or -9.919% since the May 1st high at 3085. In theory only a couple more points will qualify as a 10% correction and the selling pressure will ease. Unfortunately I have found out from three decades of market watching that market theory seldom corresponds with market reality. If it was that easy nobody would every buy any stock after the first 2-3% decline and everyone would wait for the bell to ring a -10.1% and then go long.
There is no sign of a bottom in the Nasdaq and the Facebook flop could sour the tech sector next week as well. The opposite view I suggested earlier is that sellers of Facebook now have cash to reinvest and that could be directed towards techs. Those investors now holding cash they had hoped to see double in the Facebook IPO may be disillusioned and seeing the market in freefall they may want to lick their wounds before rushing to catch the next falling knife.
The Nasdaq is about to test the 200-day average at 2740 and that could become support. However, market sentiment has turned so negative that any support may prove brief until the sellers run out of stock.
Apple (AAPL) did halt its decline on the 100-day average on Thursday and actually closed positive on Friday but still on that supporting average. A break below that $528 level could see another 30 points disappear very quickly as technical sell stops are triggered.
Nasdaq Chart - Daily
The Russell 2000 chart may be a window into our future. The Russell has broken below all the major averages and the 785 level that were support since January. The break below the 200-day suggests the big cap indexes may soon follow suit. The head and shoulders on the Russell completed and that formation now targets 725. In times of market stress most support levels are exceeded as the decline overshoots the technical targets. For that reason I am expecting to see a retest of 700-715 in the weeks ahead.
I don't expect to see that occur in a straight line. There is a short squeeze or two in our future but I think any rebound will fail unless there is a surprise announcement by the Fed and ECB.
Russell 2000 Chart - Daily
The Total Stock Market Index has shown in the past to be reactive to the 200-day average. That is currently 13,370 and about 145 points below our current level. The TSM is not impacted by large moves in individual stocks and is therefore an accurate picture of market sentiment. That sentiment is ugly today.
Dow Total Stock market Index Chart - Daily
If we go one step further and chart the NYSE Composite we see that index has already fallen below the same relative support levels the other indexes are just now approaching. The NYSE has a lot of energy stocks plus ADRs for foreign stocks. The energy sector has been decimated with the decline of oil prices to $92 and natural gas prices briefly falling below $2. The ADRs have been crushed by double digit declines in the indexes of other countries. China, India, Brazil, Spain, Italy, and others are all down significantly on the European crisis.
The NYSE may be a better indicator of world markets but the U.S. economy is relatively stronger than the rest of the world at present. The NYSE may be the worst case and hopefully the S&P and Nasdaq don't go to these extremes.
NYSE Composite Index Chart - Daily
The Dow Transports lost -5% for the week despite plunging oil prices. The transports should have reacted positively to the prospects for lower fuel prices but worries over lower shipment volumes and slowing economies weighed heavily on the carriers.
Dow Transport Chart
The charts paint a vivid picture of a market in the process of a serious collapse. The -10% correction thresholds could be hit as early as Monday but there is not yet anything in the headlines to energize buyers. There has been little bargain hunting on the dips and money flows out of equity funds and back into bonds is accelerating rapidly.
This picture suggests there are lower lows ahead but as we all know the market direction can change just as easily as changing the channel on TV. No market move is guaranteed and no move lasts forever. The Dow down 12 of the last 13 days is a streak begging to be ended. Something will cause a short squeeze soon but as long as the Greek cloud hangs over the market the long term outlook is negative.
Enter passively, exit aggressively!
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