Daily Market Reports | Mar 19 2008
By Greg Peel
Last night the Dow rose 420 points or 3.5%. The S&P and Nasdaq both posted outstanding gains of 4.2%.
The eyes of the world were on the Fed last night, with consensus expectation having settled on a 100 basis point cut as the final element to the rescue package begun last week. But the Fed was not due to make its announcement until 2.15pm, and before the open, first quarter profit reports were due out from leading investment bank Goldman Sachs and the investment bank voted most likely to be the next Bear Stearns – Lehman Bros. The market was fearing the worst.
But the results were sensational.
Both banks posted EPS results in excess of Wall Street consensus. There is no Armageddon. The Dow immediately opened up 300 points higher. The financials sector took off to establish a rally which would prove to be the best one-day move for the sector since April 2001.
So how good were the results? Well both banks managed to make less than half of what they made in the first quarter 2007. The greater than 50% earnings falls included US$2 billion in losses from Goldman on mortgage and other credit securities. Lehman was forced to write down another US$1.8bn on a mark to market basis. It was one of the worse quarters in the history of both companies. But it still beat dire estimates from the Street, and given the market was wondering whether Lehman Bros might even last the week, it was great news.
It makes one wonder what sort of result Bear Stearns might have posted had a liquidity crisis not seen it evaporate in two days. Is the current crisis really about earnings? Both companies were quick to point out their strong liquidity positions. As did Bear last Wednesday.
By the end of the day, shares of Lehman Bros would rally 46%. Goldman posted a 16% gain. Yet to report banks also joined in the euphoria, with Morgan Stanley rising 18%, Merrill Lynch 13%, Citigroup 11%, JP Morgan 6%. Hell even Bear Stearns rallied 24% to almost US$6.
(Bear stock is still trading, as the deal with JP Morgan is not yet a fait accompli. News that some shareholders will vote against the US$2 sale has given speculators something to have a punt on, but as yet there has been silence from any other potential buyers, as far as we know. Scenes of downcast Bear employees leaving the building with their belongings in cardboard boxes tends to suggest that hope is not springing eternal.)
The market held its gains all the way through lunch, and then held its breath. Then the Fed announced only a 75 point rate cut.
The market halved its gains in a flash, but it was not to last. While the first 300 point jump was probably as much about short-covering as anything else, buyers rolled in in the afternoon, deciding that overall the day’s news was positive. The Dow pushed on and accelerated to its 420 point gain.
The Fed has now cut its cash rate to 2.25%, down from 5.25% before the crisis began. You can either call that a 3% cut or a 57% cut whichever way you like to look at it. The 75 point cut was only the third of such magnitude since 1989 (the last was in January). Throughout the whole crisis, Fed cuts have been looked upon by the market in either one of two ways.
If the Fed has made a big cut, half the market has said “Hooray!” while the other half has ultimately said “Well the situation must be worse than we thought”. So initial Fed cuts sparked a belief the cavalry had arrived but wiser heads were right in believing things must be grave – and they proved to be so. So last night the Fed only cut by 75 instead of 100, and the initial call was to sell.
But to extend the thinking there was clearly a good portion of the market that believed a lesser cut was actually better news. A full 100 could perhaps signal the Fed is still in extreme Red Alert mode. 75 tends to suggest that the Fed believes the full package of measures, including the move to allow investment banks to approach the discount window with its investment grade (that’s BBB- and above) paper to exchange for Treasuries, is enough. The good news from Goldman and Lehman tended to vindicate this belief. In a way, perhaps Bear was the sacrificial lamb. Or to return to our earlier analogy, perhaps Bear is the whale.
So it is all rosy again now for investment banks? Not according to the Lehman Bros CFO Erin Callan. Callan spent the day talking to analysts and the media, and while she was upbeat about the company’s own liquidity position, and emphatic that the bank had “opened its kimono” and allowed the world to gaze upon all that lay beneath, she saw no end to the credit freeze or the economic downturn at this point. There is “no reason to be optimistic,” Callan told CNBC. Second quarter results are likely to be as dismal as the first. It would be more likely toward the end of the year before improvements were seen.
But the stock market is a leading indicator, and as such it will “look through” the current mess and head for the light at the end of the tunnel. After so many false dawns, last night’s trading gave many a sense of optimism, despite Callan’s comments. Credit spreads did ease on the news, but the question now is can they continue to do so?
It was a good night for the US dollar. With only a 75 point cut instead of 100 it was a case of covering dollar shorts. The dollar bounced 2 yen to be back over 99 yen and took over one cent off the euro, to US$1.5628. With renewed yen selling the Aussie recovered to be up over half a cent to US$0.9269.
Assisting the dollar’s rise, and to some extent the stock market reaction, was a sudden recognition by the Fed of the inflation problem. The committee lowered its economic growth forecasts last night, and noted:
“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,”
But it also increased its inflation forecasts and added:
“Inflation has been elevated, and some indicators of inflation expectations have risen. The Committee expects inflation to moderate in coming quarters, reflecting a projected levelling-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.”
This may indicate that interest cuts are over for now. Either way, the market seemed happy the Fed is no longer being seen to play rescuer of the financial markets at the expense of the dollar all the while pretending inflation was not a problem. While last week’s CPI numbers were spurious at best, last night the February PPI showed a rise of 0.3% on the headline – in line with expectation – and a 0.5% rise on the core (ex food& energy) – ahead of expectation. With all the extraordinary steps the Fed has taken this last week, it appears, with a 75 point cut, that Bernanke looked at what he had done and saw that it was good.
Bond markets had an understandable rapid reaction to the cut, with the two-year yield rising a full 25bps to 1.60% to account for the 25bps cut it didn’t get, and the ten-years also adding 18bps to 3.48%.
Gold was the victim on the night. With a bouncing US dollar gold fell US$23.60 to US$981.40/oz.
It was back to business as usual in the oil pit however, as crude rose US$3.74 to US$109.42/bbl. There were all sorts of mixed messages for base metal markets, so they closed relatively stable.
The other economic data released last night were February housing construction – down a worse than expected 0.6% – and building permits – down a full 7.8% to the worst pace sixteen years. With the immediate investment bank liquidity issue seemingly now tamed, the focus has swung back to the other side of the equation – the housing market. The call is growing for the government to step in and do its bit, and actually buy distressed prime mortgages outright. While many see this as the necessary final move to bring the whole disaster to an end, one CNBC commentator suggested (and he is no lone voice) that “you might as well stick a hammer and sickle on the flag”.
There is hope of some solution however, and shares in sponsored lender Fannie Mae rose 27% last night.
The move in the Dow was the biggest in five years, but then we’ve already had one of those earlier this month. It remains to be seen whether fresh optimism can now prevail. It would not be unusual to see a bear market rally of 1000 Dow points, commentators have suggested, but it would still be a bear market rally. Whatever transpires, today’s move was good news for Visa, which will list tonight in the biggest IPO in US history.
The SPI Overnight was up 148 points.
