Daily Market Reports | Mar 20 2008
By Greg Peel
The Dow closed down 293 points on its lows or 2.4%, while the S&P gave back 2.4% and the Nasdaq 2.6%.
It’s heartbreaking stuff, but it may yet prove to be all part of a protracted bottoming process.
Just when Wall Street believed it was safe to go back into the financial sector water news came out that Merrill Lynch may have to write-down a further US$3bn which it had not anticipated. This is due to an insurance firm questioning its obligations to pay Merrills on coverage of US$3bn of credit default swaps. Merrill Lynch intends to sue the insurance firm to recover the money, but another seed of doubt has been sown in Wall Street’s financial sector.
The news overshadowed a first quarter result from Morgan Stanley which mirrored the results of Goldman Sachs and Lehman Bros yesterday. Morgan lost 42% compared to the same quarter last year, but it did beat the Street on earnings estimates. Its shares rallied initially on the news, until Merrills-related selling saw them pull back to only a slight gain.
It was not the case elsewhere in the sector. After euphoric gains yesterday, Merrills lost 8%, Goldmans 5%, Lehman 9% and Bear Stearns 11%, for what the latter is worth. The commercial/investment banks held up better, with Citigroup only losing 1.5% and JP Morgan 0.5%.
But while the financial sector turnaround was disappointing, the sector that really copped a beating today was materials.
The word on the Street is that in light of the Bear Stearns collapse, the implications thereof for all investment banks, and the lifeline provided by the Fed rescue package, investment banks are telling their hedge fund clients that the days of extreme leverage are over. At the very least, positions running in the realms of 10x leverage will need to be pulled back to more like 5x. To achieve this, hedge funds are thus forced to reduce some of their high leverage investments.
And what has been the popular target of hedge fund investment lately? Commodities. Last night saw a major rout across the commodity spectrum, from gold to oil to metals and grains.
Gold fell US$37.90, or close to 4%, to US$943.50/oz. Silver fell US$1.28, or 6.5%, to US$18.37/oz. Platinum, which traded close to US$2300/oz this month, has now fallen to US$1907/oz.
Oil fell US$4.94, or 4.5%, to US$104.48/bbl. Oil was not helped by the weekly figures that showed demand for both heating oil and gasoline had actually fallen. Wheat fell 7.7%.
Aluminium and copper were down over 2%, nickel and zinc were down around 4%, and lead was down close to 5%.
The sell off in commodities hit the materials sector, which in turn dragged down the indices. Dow components Exxon, Chevron, Alcoa and DuPont accounted for 40% of the Dow fall alone. Another catalyst for the selling was the fact the US dollar had another stable-to-up day, falling against the yen but rising slightly against the euro and significantly against the pound.
Expectations are that while the US has had Bear and a Fed bail-out, the next market to feel such pressures will be the UK. In the meantime, yen buying and a higher US dollar elsewhere is a double-whammy for the Aussie, which lost over US1c to US$0.9125.
The good news in the financial sector last night was the listing of Visa. The credit card giant was expected to settle its IPO in the US$37-42 range but achieved US$44. On listing the shares immediately shot up 33% to US$57-ish and managed to hold that gain as the rest of the market crumbled. One might be reminded of the similar Blackstone listing – one which occurred just before the credit crunch hit and private equity deals evaporated – and thus one might also wonder at the popularity of a credit card company listing ahead of a likely consumer spending freeze. However, one of the great success stories on Wall Street these last two years has been that of rival Mastercard, which listed under US$40 in May 2006 and closed last night at US$208, having fallen only slightly (in a relative sense) from its 2007 high of US$227.
The other good news on Wall Street last night related to housing. There have been strong cries across the market that the government should stymie the housing crisis once and for all by jumping straight in and buying distressed prime mortgages. These cries have been met with visceral criticism from others who bemoan the socialising of the market. However, the government did reach a compromise last night by reducing the capital ratio requirement of the government sponsored mortgage lenders from 30% to 20%.
The result is a fresh US$2bn-odd of capital that can be used to buy mortgages. Throughout the credit crunch the Fed has been slashing the cash rate, but despite an initial drop, the 30-year mortgage rate began to rise again in 2008 as banks simply refused to lend money to mortgage securitisation, no matter how AAA, prime, safe-as-houses those mortgages were. This has meant that while the Fed has saved first the commercial banks, and now the investment banks, it has been incapable of actually getting any relief at all to the source of the problem in the first place – the housing market.
This news sent the Fannies and Freddies of the world shooting up 10-15% last night, and provided yet another element to the relief package being worked through between the Fed, the Treasury and the regulators. However, it could not save Wall Street, which still needs to go through the deleveraging process.
FNArena has suggested, right from the beginning of this crisis, that the crisis will not end until all the leverage is out of the market. Or at least back to the manageable levels of yesteryear. From margin lending in stocks, to margined mortgage securities, and now to margined speculative commodity funds, that process is still its way working through. Traders have spent the last several months switching between bonds and equities, between failing sectors (financials) and safe sectors (tech), and between traditional investments and new kids on the block (commodity funds). Then they have switched back again. Deleveraging means taking overblown valuation out of all markets.
The bad news is it takes the prices of all markets down. The good news is it ultimately takes prices down to where they are cheap.
The SPI Overnight closed down 100 points.
In keeping with the pagan origins of the Easter period, Wall Street will see quadruple witching tonight, meaning quarterly stock options, index options, stock futures options and index futures options all expire, in what could be a fun session.
A reminder that the US does not celebrate Easter Monday, so there will be an Overnight Report for both tonight’s trading and Monday’s trading before Tuesday morning. As to when exactly depends on whether I can squeeze in some kind of break. Happy Easter to all our readers.
