Broadmarket analysis is presented here courtesy of Cashflow Heaven.
WHICH WAY THIS MARKET IS HEADED
As you can see the
majority of the market gains were in one big leap on Wednesday. The
follow through to Wednesday's rally was almost nonexistent. Bernanke's
Thursday night comments sent stocks soaring again at Friday's open--but
again stocks faded before the close—this lack of follow-through is
bearish.
As the week began
the Fed was presenting a united front against cutting rates until Vice
Chairman Donald Kohn suggesting lower rates may again become necessary.
Bernanke also sounded soft on rates when he spoke later in the week and
indicated that consumer data had weakened and the rise in food and
energy prices were producing growing stress on budgets. He specifically
mentioned that stress in the financial markets had resulted in further
tightening in financial conditions, which have the potential to impose
additional hardships on the housing market and other credit sensitive
sectors.
St. Louis Fed President Richard Poole closed the week with a speech that
sounded almost like the Fed was promising a cut in December. Poole said,
"The Federal Reserve would not hesitate to act to prevent financial
strains from damaging the economy…
Poole also said,
"Provided that the central bank does not sacrifice long-term price
stability, it can and should respond to new information indicating an
increased risk of recession."
Needless to say that after this last round of Fed speakers including
Bernanke, the market is already pricing in the next cut. It is actually
pricing in more than just a cut and more like a 50% chance of a 50-point
cut rather than 25 points.
With a huge Fed
induced rally behind us and no improvement in the economics the market
is setting itself up for another sharp sell-off—just like after the last
rate cut. Earnings estimates for Q4 are still falling and now 2008
numbers are weakening. Tough to build a bullish case but that may not
keep a few short term spikes from scaring the heck out of the shorts.
The financial
sector did get a small reprieve on Friday from the potential for a
short-term resolution of the subprime crisis. Treasury Secretary Paulson
met with Federal regulators and bankers on Thursday. Attending the
meeting were officials from Citigroup, Wells Fargo, Washington Mutual,
and all major mortgage lenders.
FDIC Chairman
Shelia Bair also attended. Bair has proposed letting borrowers with
adjustable rate subprime mortgages, who are living in their homes and
unable to afford resets, get extensions of the starter rate for up to
5-years. They could also be offered 30-year fixed rate deals at bargain
rates. Office of Thrift Supervision John Reich also in attendance
prefers a three-year freeze.
The idea is to make
the current mortgages in risk of default more sustainable and take the
pressure off the banking system and the housing sector. Over 100,000
subprime loans will reset each month for the next two years according to
UBS. The FDIC estimates there are 1.54 million nonprime mortgages valued
at $362 billion that will reset by the end of 2008.
There are currently
$7.1 trillion in securities backed by all kinds of mortgages and all
securities are taking some kind of valuation hit due to the subprime
meltdown. A whopping seventeen percent of all adjustable rate subprime
loans were in default as of July according to the Mortgage Bankers
Association. Fixing the subprime portion would allow the other $5
trillion of greater than subprime credits to return to parity and
relieve a lot of potential wealth destruction. The markets cheered the
various proposals and the comments by Paulson that a solution could be
in place by year-end.
It has been nearly
10 years since Long Term Capital blew up in 1998 and tanked the markets
knocking the Dow back -1900 points (20%) in about five weeks. This was
seen as a major catastrophe and had the potential to wreck the entire
global financial system. To put this in perspective the LTCM blowup was
only a $4.6 billion loss. The subprime crisis has already caused banks
to write-down over $120 billion and that amount is expected to double
before it is over.
There may be more
fallout to come but it appears there are many solutions in the pipeline
and eventually one will stick and while the problem won't go away it
could be pushed aside as old news. The financial sector bounced +5.8%
this week on hopes the solution is near while the Banking Index
rebounded over 10% from its Monday lows.
The subprime crisis
may be nearing an end if you believe the current hype but the damage is
real and will have a longer term affect than last week’s bounce would
have you believe.
The problems are so
far-reaching, analysts say, that this emerging plan -- nicknamed
"teaser-freezer" by one economist -- won't spare many borrowers, or
bankers, from the pain of escalating foreclosures and defaults.
For example a $27
billion state run investment fund in Florida halted withdrawals this
past week after losing $12 billion in deposits over the last two weeks.
The fund disclosed it had $900 million in defaulted subprime debt and
$2.4 billion in asset-backed paper. Investors quickly began to withdraw
deposits and the fund was forced to halt withdrawals to avoid
bankruptcy.
In addition the
Montana Board of Investments, which manages the states money, saw $247
million in withdrawals from governments in the last three days. The
Montana fund has $90 million in Axon Financial an SIV that has been
downgraded and is reorganizing. They have $500 million in other SIVs.
Plus a $4.8 billion
fund run by King County Washington was warned by S&P that it could be
downgraded because of subprime exposure. This type of creeping
deterioration of major funds is happening all across the U.S. and much
of the damage is still unknown.
The bottom line is
the government and the Fed will do everything they can to talk up the
markets and encourage investors—so we’re liable to see more short term
buying spikes like we saw last week—but the bottom line is the economy
is still slowing and as long as real estate prices are falling it will
continue to slow. The question is…
HOW DO WE MAKE
MONEY ON IT?
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