Daily Market Reports | Sep 19 2008
This story features MACQUARIE GROUP LIMITED. For more info SHARE ANALYSIS: MQG
By Greg Peel
The Dow rallied 410, points or 3.9% while the S&P jumped 4.3% and the Nasdaq a whopping 4.8%.
I once again warn that developments are ongoing as this report is being written.
When the NYSE opened last night it quickly rallied 190 points, which is not an unusual response to the sort of carnage witnessed in Wednesday’s 450 point crash. There would have been a deal of short-covering amongst those who had made a profit. It wasn’t to last however, and as the morning unfolded reality returned. The Dow fell about 340 points to be down 150 at lunch time as the market again focussed on a completely crippled financial system. To put things into perspective, number two investment bank Morgan Stanley’s shares fell another 45%.
At 1pm news hit Wall Street that the UK financial regulator had placed a complete ban on short selling in financial sector stocks. The ban will last until January, and in 30 days time the regulator will assess whether such a ban should be extended to other sectors. Britain’s banks have been suffering from the same credit freeze fallout as their US counterparts, as has every financial sector across the globe.
On the news, the Dow turned and rallied 300 points in thirty minutes. This time the short-coverers were madly looking to lock in profits or cover losses. The rally peaked, and again we fell – back down another 150 to be pretty much where we closed on Wednesday. How’s your heart?
If you were trying to get your breath back, you didn’t have long. At around 2.45pm CNBC broke the news that the US Treasury was planning an “RTC solution” to financial turmoil. From 2.45pm to 4pm the Dow rallied 400 points. Add up all the peaks and troughs, and last night the Dow moved through about 1200 points – which is 11% of its value. The financial sector saw some extraordinary rallies on the close.
The VIX volatility index – the proxy measure of uncertainty and fear – hit 42 last night, which is the highest it has ever been since the collapse of hedge fund LTCM in 1998 – the last time the world thought the global financial system would implode. On the close it had returned to 33.
While many comparisons have been made to the LTCM affair and similar impact in today’s market (except that LTCM went down with US$6bn, Lehman Bros with US$600bn), we have to go back almost another decade to find a more worthy comparison. In the early nineties the US was suffering from the Savings & Loans crisis, brought about by the collapse of that decade’s junk bond market – the famous leveraged buyout bonds of the day. Savings & Loans institutions are small, usually regional banks that provide deposit and loan co-operative style services within a small range. Australia’s best comparison would be the old building society model or the credit union. (If you’ve ever seen the movie It’s A Wonderful Life, Jimmy Stewart ran an Savings & Loan).
The reason this history lesson is relevant is that in that period so many S&L’s went to the wall that the then government decided to establish a body called the Resolution Trust Corporation. Then, as now, the intention of the RTC was not to save foolish S&L owners but to save innocent Little Americans caught up in deposit losses and forced foreclosures. Instead of attacking the problem on a spot-fire basis, the government used the RTC to step in as an “equity partner” and take over management of all of the assets of all of the S&Ls who were in trouble. For this the RTC earned a distribution once the market had stabilised and assets could be disposed of in an orderly fashion.
At the end of the whole exercise, the US taxpayer walked away with a profit.
As of last night we now understand that the US Treasury is definitely working on an all-encompassing plan, and that the plan in question may be “RTC-like”. In this case the government would step in and take on board management of all of the toxic asset-backed securities in the market in exchange for an equity interest. This would equate to nationalising, or at least partially nationalising, the entire US financial system. Karl Marx would be loving it.
Wall Street consensus is that a plan of this nature is a necessary one. It will, of course, greatly upset the free market philosophers but the reality is that the Treasury and the Fed were running out of ammunition to keep saving the Fannies, Freddies, AIGs, and whoever else was next to come along, on a reactive basis. The only thing that was going to prevent a financial market meltdown was a proactive solution. Stop running around trying to put out the spot-fires, attack the heart of the inferno.
Ah – the newsflash is that Treasury secretary Paulson and Fed chairman Ben Bernanke will meet with Congressional leaders at 9am Sydney time.
It is still unclear as to exactly what the plan would look like. The difference between now and 1990 is that the RTC of that day was stepping in and taking control of the assets of the S&Ls that had already failed. And there were hundreds of them. But those hundreds would not go anywhere close to adding up to one AIG. This time the plan involves “saving” institutions that have not yet failed. Thus there is a small matter of what becomes of all the shareholders of all those institutions.
Thus the ultimate solution might not actually be one of an RTC, but of an RFC – a Reconstruction Finance Corporation. This model, already suggested by Senator Schumacher, has the government lending money to financial institutions rather than assuming an equity partnership. As a comparison, consider that an RTC is the type of model used on Fannie and Freddie and an RFC is the type of model used on Bear Stearns. However, there is still talk of the government’s loan taking the structure of a super-preferred stock position paying a high coupon. Realistically, there is still a lot of talk – period.
There is thus no point in speculating further. One assumes we will know more as the morning unfolds in Australia. But assuming whatever solution is decided upon is of a universal, financial market-saving nature, how should investors respond?
Well we know how Wall Street responded – with a 400 point rally. But the great bulk of this rally would have been driven by hedge funds madly covering their short positions. Doesn’t it break your heart? Needless to say, however, we will still have to find out just how this dust may yet settle. It is definitely a positive move, but it may take time to come to fruition and there could still be more market volatility ahead. We really are in unchartered waters here.
Reactions in other markets were predictable. The US dollar stabilised, and carry trade unwinding stabilised, allowing the Aussie to rise over a cent to US$0.8049. After its massive rally yesterday gold fell US$7.80 to US$854.30/oz. Oil rose another US$1.98 to US$97.88/bbl. Base metals in London missed the last hour rally on Wall Street, so early gains had been pared back to provide little in the way of significant price movement.
The SPI Overnight closed 126 points higher.
Is this the end of the bear market? The short answer is no. Whatever US government solution is implemented will have the effect of stabilising the market and preventing the slippery-slope falls of financial institutions across the globe. The reason the share prices of institutions such as Morgan Stanley and Macquarie Group ((MQG)) have been on a slippery slope is because global credit markets have not just tightened but completely frozen. The system had broken down. No credit availability in a financial system is like no oxygen for the rest of us. The US Treasury is trying to provide an oxygen bottle.
So the solution should halt the unnecessary slide, but the roots of the credit crunch still remain. US house prices are still falling, the entire world is still deleveraging, asset values are still collapsing as attempts are made to prop up balance sheets, earnings growth will still be hard to come by, economic hardship will still be a very real possibility. Indeed, the activity of the original RTC spanned the period 1989-1995 but the world still went into deep recession in 1991-92.
The long answer is, however, that if this is not the end of the bear market maybe we can see it from here. When the US government’s solution comes into play then a base may be formed for stock markets to begin to recover. If the experience of the early nineties is a guide, the stock market peaked in 1989, fell 25% in 1990, bounced back 30% in 1991 (still leaving it short of the highs) and then went sideways for two years as the recession played out. We did not begin the rally that would take us to the tech boom until late 1993.
Today’s crisis is a far more fundamental one, and that’s why comparisons are made not to the 1990s, but to the 1930s. Do not assume a rally back to previous highs anytime soon.
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