After experiencing the worst one day loss on Monday since the market crash on October 19, 1987, markets rallied hard, with the Dow closing up nearly 500 points. There were several reasons for the gain.
1. The market was oversold
When only one stock in the S&P 500 goes up and the downside volume to upside volume is 26.5:1, as it was on Monday, a snapback rally is no surprise.
2. Belief that the government will still bail out the market.
This was the main reason why the market was up. Frankly, I am in disbelief of the market's credulity on this one. Yesterday, I wrote that Washington has no credibility on Wall Street, given that the House sandbagged the market, voting down TARP. I was wrong. Apparently Washington has a great deal of credibility on Wall Street, despite getting blindsided yesterday. I want Washington to do something, but there is a part of me that would like to see this fail just to wring the gullibility out of Wall Street. If the legislators fail and a bill does not pass and the market falls another 1000 points, then Wall Street will have no one to blame but themselves.
3. Suspension of mark-to-market accounting
Investors were under the impression that mark-to-market accounting, FASB 157, would be suspended. The SEC released a statement clarifying the interpretation of mark-to-market but did not say it would be suspended. The idea is that banks would not have to mark down their assets to recent market transactions if FASB 157 were suspended. The proponents argue that current market transactions represent distressed sales and not the true value of the underlying assets, but companies have to mark their assets to those unrealistic levels. Suspending the accounting rule will stop the death spiral of financial companies.
I think this is a canard. It would be yet another gimmick akin to suspending short selling. Financial companies are not collapsing because of mark-to-market accounting. They are collapsing because they did really dumb things and took on too much debt. Investors aren't stupid. Increasing opacity in the financial statements does not help investors understand the risks of the company in which they are investing. Compare the likes of AIG, Freddie Mac, Fannie Mae, Bear Stearns, IndyMac, and Lehman with the likes of US Bancorp and Wells Fargo. The former collapsed because they made bad business decisions whereas the latter are near 52 week highs because they didn't over-lever their balance sheets and make stupid investments.
Also, there are pools of capital out there waiting to invest in distressed assets. However, few transactions have occurred. Many of these pools of capital have long-term lock-ups of three or more years. They can handle the volatility of mark-to-market accounting if distressed sales are below intrinsic value because their investors cannot call their capital. Yet, few transactions are being done. Why? Could it be that the funds do not believe that the assets for sale are ridiculously cheap?
4. Stocks did not collapse so traders bought.
This is perhaps the most discouraging reason for the market's gain today. The willingness to buy in front of news after a hard down day does not seem to me to be behaviour one sees at the bottom. I would have preferred that investors puked out stocks rather than believe Washington will come to their rescue and buy the dips hopefully.
5. The possibility of an increase in FDIC insurance.
Today, the government of Ireland guaranteed bank deposits. There was chatter that the FDIC may increase insurance from $100,000 to $250,000. Some were saying that deposit insurance may become unlimited. Never mind that the FDIC might not be capitalized enough to handle all the bank failures to come, the government stepping up to guarantee all deposits was probably the single most bullish news today as it would make bank runs less likely. It could tank the dollar, but there are so many factors that could also tank the dollar, what's another one, eh?
6. ECB rate cut
Rumours had it that the ECB would cut rates soon. This very well may be true. The bank will start cutting rates shortly. Given the incredible stresses on the financial system, the rate cut may come sooner rather than later.
7. Money market pressures ease.
Slightly. The TED spread was over 3.5% today before easing to 3.15%, still very high but not as high as earlier in the day. The 3-month Treasury bill oscillated between 0.5% and 1% while swap spreads, though still high, were lower than yesterday. The Fed has pushed in an enormous amount of liquidity over the past few weeks to meet the insatiable demand for dollars. You could see the tremendous volatility in the Fed funds market, with rates as high as 7% this morning and falling to 0.125% this afternoon. Such volatility has been the norm as of late. This is why I'm not sure rate cuts by the Fed would be helpful in the near term.
8. Better than expected economic news
Forgotten by many was that the Chicago PMI and the Conference Board's consumer confidence index came in better than expected this morning.
9. Month and quarter end.
Month and quarter ends often bring unusual activity.
Volume was lighter than yesterday. Upside volume was 9.1:1 to downside volume, good but was dwarfed by Monday's 26.5:1 volume to the downside. It appears that the rally merely brings the indices back to within range where one would expect the market to start selling off again.
I keep hearing investors claim the market is cheap. I do not think so. I use $75 as my normalized earnings estimate, assuming a 7.5% margin, which is well above the long-term average of 6%. At $75, the market is trading at 15.5x earnings. That is not cheap. It is not expensive but it is not where bear markets have historically bottomed.
The average bear market since World War II has generated losses of 28%. To the lows yesterday, the market was down 30%, top to bottom. I contend that the worst credit crisis since the Depression will not lead to an average bear market in stocks.
The two worst bear markets during this time were 1973-74 and 2000-02, both of which saw declines of 50%. I do not think the decline in this bear market will be 50%, but instead will be somewhere between 30% and 50%. I'll pick 40% because it is a nice round number, which would take us to around 1000 on the S&P 500.
I do not know if the near-term bottom is in but I highly doubt the ultimate bottom is in. Thus, rallies remain to be sold.
No comments:
Post a Comment