Daily Market Reports | Mar 18 2008
By Greg Peel
Do not underestimate, say the wise heads on Wall Street, the monumental nature of the Fed’s actions over the past few days. In invoking an obscure clause in its charter, unused since 1932, it has signalled to the market it is prepared to put its own balance sheet behind the US financial system in order to restore confidence.
In so doing, the Fed has not “bailed out” Bear Stearns, supporters are quick to point out, and not taken the “moral hazard” to new levels at the expense of the American taxpayer. Bear Stearns has effectively gone under, given its US$2 offer from JP Morgan which values the firm at US$236m against one analyst’s quick calculation that its businesses if operable are worth US$7.7bn. Thousands of employees will lose their jobs and most were shareholders. Management, as individuals, have been financially wiped out.
That Bear could capitulate to a US$2 offer speaks volumes about the extent of toxic waste which must lie on its balance sheet – positions that were 30x leveraged, that sparked a run on Bear liquidity and, most importantly, a crisis of confidence around the world. It is this crisis of confidence that the Fed needed to address as swiftly and definitively as possible, for no longer was it a story of earnings potential or even available funds – it was a story of potentially destructive panic wrought by simple human emotion.
The Fed elected to throw its support behind JP Morgan – a commercial bank large enough to resolve the situation. The Fed provided backstop liquidity to Bear via JPM as the latter worked furiously over the weekend to come up with a package. That package ultimately is a big win for JPM, as not only has it picked up Bear (yet to be finalised, but not expected to be countered) for US$2, including its valuable brokerage and clearing operation, it has been given a guarantee by the Fed for US$30bn to cover “Level 3” assets – those assets which do not trade often enough to determine a market value, such as CDOs. It has further been granted indemnity from any class action that may be taken against the former Bear Stearns.
JP Morgan shares rose 10% last night.
The Dow closed up 21 points. It had opened down 195 points on the bell as the market’s initial reaction was more doomsday than rescue. From there it rallied back into the green briefly before collapsing again. It turned positive once more and this time surged forward to be up 125 points. Finally it lost momentum toward the close.
The Dow’s was the only positive result of the three majors. It was supported by component JP Morgan. In the broader market it was a case of more weakness in the greater financial sector. The S&P500 closed down 0.9%. Tech stocks were turned into cash as the Nasdaq fell 1.6%.
Financial sector panic was no more evident than in the day’s trading of Lehman Bros. Lehman is another investment bank which specialises in mortgage securities, and despite being due to release its earnings tonight it lost 48% of its value at one point in the session, before recovering to be down 20%. Lehman was last night a bellwether of whether Bear Stearns would prove to be the whale that signals the bottom of the market, or the cockroach that indicates there is more trouble elsewhere.
Similar volatility was seen in other investment banking stocks, with Merrill Lynch down 5%, Morgan Stanley down 8%, Goldman Sachs down 4% and Citigroup down 6%.
While half of the market was in panic mode, the other half was noting bottoming signals. The VIX volatility index shot back above 30%, which is as high as it usually reaches and indicates a peak in the panic. Many stocks on the NYSE established new lows in the session, another occurrence that usually precedes a rally. And the Dow did actually close in positive territory – a good sign. Although we have had many a false dawn before now.
Lost in all the Bear Sterns mayhem has been the fact that one of the biggest IPOs the market has ever seen will list tonight – that of Visa. Traders will be watching closely to see whether this listing will be well supported, particularly given many missed out on what proved to be a very successful listing of Mastercard in 2006.
In the meantime, last night was all about a dash to cash. It was a time to deliver everything and restock the coffers for what could be another wave of disaster in the liquidity crisis or what could be an opportunity to pick up some shattered stock names cheaply. The victim last night was commodities. This was a bubble waiting to burst anyway, and clearly many speculators have been directing their leveraged funds towards this market while other markets have wavered, given the falling dollar and inflation fears.
Gold actually closed up US$2.50 from Friday’s close to US$1005/oz. However, this belies a big sell-off in the New York session following an earlier rise as high as US$1028/oz in Asia yesterday.
Oil fell US$4.53 to US$105.68/bbl. Oil had earlier touched US$114/bbl.
Across the board, commodity prices fell for everything from platinum to grains and coffee. Many moves were substantial.
Base metal markets in London were similarly hit. Nickel fell 9.7% in the late London session. Aluminium was down 4.5%, copper 4%, and zinc and lead 5%.
Commodities markets were not assisted by economic data released last night. US industrial production fell 0.5% in January against a 0.1% expected fall. The Empire State (NY) manufacturing index fell to -22.23 in February from -11.72 in January. A figure of only -6.3 had been expected.
The global financial markets are now in a rush to deleverage. Bear Stearns has shown just what can happen if you find yourself overextended. Everyone is trying to get out at the same time. There was a familiar flight to quality, as the US two-year bond yield fell 14bps to 1.35% and the ten-year 14bps to 3.30%. The market expects the Fed to cut the cash rate tonight by 100bps.
Yen carry trade unwinding is part of that deleveraging process. As the US dollar fell to 97.35 yen over yesterday and last night, the Aussie fell US1.7c to US$0.9202.
Such a Fed cut will be another piece of the rescue package, and cement the view that the Fed has stepped up to a new level of pro-action. While all around are bringing cash back onto balance sheets, the share market is indicating a possible return to confidence. Deleveraging has already largely occurred in the share market, as share prices have been decimated by ongoing margin calls.
There was also a slight easing of credit spreads last night, which is also a good sign. Wall Street is heartened that the Fed has now moved away from its concentration on trying to reinvigorate the market via the commercial banks alone. It has effectively taken investment banks into its domain and granted them commercial bank status. The question now is to as whether the plan will work.
In the meantime, Congress will be working furiously on tightening up derivatives market regulations and mandatory capital requirements. But this will take time, and is still a case of shutting the gate after the horse. What will emerge from the dust, however, will be a very different US investment banking system.
Whatever happens, there is currently still no end in sight for the US housing crisis, which is at the heart of the entire global credit collapse. Until the Fed’s actions are backed up by some equally extraordinary fiscal measures from the government in an attempt to save mortgages, then the problem has not gone away.
So it is a case of pure confusion and uncertainty. Some are calling Bears Stearns the whale which will ultimately mark the beginning of the end of the credit crisis. Others are terrified Bear is only the cockroach which appeared from under the fridge. Shift the fridge, and a whole lot more cockroaches will go running. In which case it may yet be another beginning.
The SPI Overnight was up 4 points.
