Daily Market Reports | Feb 26 2009
By Greg Peel
The Dow closed down 80 points or 1.1% while the S&P and Nasdaq also lost 1.1%.
On the opening bell the Dow fell immediately to be down 194 at around 11am, but from then on Wall Street stuttered its way through a rally, hitting a high up 54 points at 3.30pm. A familiar late sell-off took us back to down 80.
The early drop was a clear reaction to President Obama’s speech to Congress delivered the previous evening local time. Not that there was anything wrong with the speech, but as I concluded yesterday (See “Still None The Wiser”) there was nothing in it to placate Wall Street’s hollow view. The Street has been yearning for detail on the bank rescue plan for weeks now, and in the wake of a well-received speech from Fed chairman Bernanke earlier in the day, Wall Street was primed for the double punch. Obama’s speech turned out not to have any KO.
I also concluded that the speech would thus likely be followed up rather quickly with something from Treasury Secretary Geithner, and so it was that last night during the trading session detail began to trickle out. The detail so far regards the bank “stress test” and capital injection proposal.
The stress test is intended to be completed by the end of April on a selection of 19 major banks. Sensitivities will be conducted under two scenarios, which are called “baseline” and “adverse” but which we might call “bad” and “worse”. “Baseline” sees the GDP dropping 2%, unemployment rising to 8.4% and house prices dropping 14% in 2009. “Adverse” sees 3.3%, 8.9% and 22%. In simple terms, the banks in question must be able to show they can survive such outcomes.
Having passed the tests, the banks are then eligible for fresh capital injections from the existing TARP pool. These will take the form of preferred shares, paying a 9% coupon, but which are convertible into common stock at a 10% discount to the bank’s closing price of February 9.
Let’s pick one bank as an example – Bank of America. On Feb 9, BA closed at US$6.89, meaning a 10% discount equates to US$6.20. The stock closed last night at US$5.16, so the conversion premium is currently 20%. But consider that (a) BA has rallied back in the period from a low of US$2.53, which would have implied a conversion premium of 145%; and (b) the stress testing period will last until end-April. Two months is a long time on Wall Street, and volatility reigns.
Wall Street clearly liked the deal. It differs from the original deal in the time of Secretary Paulson only in its convertibility, although just how big a capital injection the government will make is not yet known and clearly stress test-dependent. Wall Street prefers the government to take common stock as it slots the investment in alongside existing shareholders rather than over the top of them.
This detail was no great shock, and has been speculated about for weeks, but it seems that any detail release at this point is a good thing. There was hopefully going to be more good news as President Obama called a press conference towards the end of the trading session, having been in conference with Geithner and the usual suspects of the banking and Congressional fraternity. Could this be the toxic debt plan? The Bad Bank?
No. It was all about regulation – an inevitable evil which Main Street demands and Wall Street cringes from. Obama outlined a seven point wish-list of regulatory robustness, which it is now up to Congress to deliver. Strict oversight, accountability, transparency, supervision of consumer product regulation, an acknowledgement that a globally concerted effort must be made (with America leading) – nothing was a shock. Nothing, however, could be considered a conclusion either.
As for Bad Bank – still we wait. This Chinese water torture is not good for the market, but any detail is good. If the plan cannot be quantified and communicated quickly then Wall Street is going to keep slip-sliding away.
The banking sector was unsurprisingly a leader of the indices last night, with energy in a rear-guard action. Oil jumped 7% or US$2.80 to US$42.76/bbl. Wall Street positivity would have helped, but it was a weekly inventory drop of 3.4m barrels of gasoline that had Nymex traders agog. Refineries have cut back their capacity utlisation to 81.4%, thus encouraging a supply-side squeeze, but gasoline demand in the week rose 1.7% from the same week twelve months ago. Demand, it seems, is finally returning at low prices.
Gold continued its tumble last night, dropping another US$20.80 to US$943.90/oz. Don’t be surprised if gold pulls all the way back to US$900, particularly if this bank rescue detail encourages Wall Street into further rallies. It’s not just about stocks, but about a more general feeling of fear abatement. Last night the yen was sold again – the strongest indicator of risk appetite. The Aussie slipped back to US$0.6492.
Consider also that if Obama’s suite of rescue plans finally wins over market sentiment conclusively, the safe haven of US Treasuries will also lose its appeal. If the market shifts out, the US dollar will fall like a stone.
Base metals had another strong session of 1-4% increases, with nickel the leader.
The Spi Overnight closed down 10 points.
