Daily Market Reports | Apr 21 2009
By Greg Peel
The Dow fell 289 points or 3.6% while the S&P fell 4.3% and the Nasdaq 3.9%.
Wake up – you’re only dreaming. The rally from March 6 which was led first by financials and then by resource stocks suffered a bone-jarring crunch last night as the banks came back to earth. The impetus was the first quarter earnings report from Bank of America, but it only got worse from there.
BA announced with great fanfare that it had tripled its profit in the first quarter, attributing most of its success to its acquisition of former investment bank Merrill Lynch. But Wall Street immediately saw through the number, and it wasn’t pretty.
While Merrills indeed contributed to the bottom line through commissions gained from equity trading and wealth management inflows in the rally, BA also wrote-down US$13.4bn of “Main Street” loan exposures including mortgages and credit card debt. As unemployment continues to climb, Wall Street fears these numbers will continue to blow out. And digging further into the BA result, net income gains appeared to be of a lesser and lesser quality. BA booked a US$1.9bn gain from selling a stake in the China Construction Bank. Analysts consider this a short term gain for a long term loss of what was otherwise going to prove a valuable asset. The real doozie is a US$2.2bn gain booked on the devaluation of Merrill Lynch debt.
This little ploy is right up there in the accountants’ handbook of the conjuror’s art. Merrill Lynch had, prior to the BA acquisition, raised debt capital by issuing a particular form of structured note. The value of that debt fell in the first quarter given market concerns over the capacity of Merrills to repay it. BA thus booked a profit, on the implication that if it wanted to, the parent bank could buy back that debt at a lesser price.
Absolute smoke and mirrors. And for all its gloss, BA shares were trashed 23% on the day. Citigroup was trashed by association by 19%. Even favoured JP Morgan copped a 10% beating.
The matter was made only worse as the government suggested that, post stress-testing, it may need to convert the billions of TARP money injections into US banks held as preferred stock (which pays a fixed coupon) into ordinary stock (which pays a discretionary dividend) in order to provide the boost to lending which has so far proved elusive. The effect of such a move would be to greatly dilute existing equity holders. The March rally on Wall Street began as banks claimed they were making money and included assurances that it was not the intention of the government to convert the TARP capital. Now the goal posts are moving again, and Wall Street will not participate in a game in which the rules change every week.
Then to make matters worse, JP Morgan bank analysts (from the stockbroking division) released a report suggesting US banks are still going to need further capital injections from the government as the recession deepens and loan losses increase. The rally in bank stocks has been helped by the likes of Goldman Sachs suggesting it intends to pay its TARP money back ASAP, and JP Morgan (the bank) suggesting it could pay back its TARP right now if it wanted to. Wall Street took this to mean all banks could quickly dig themselves out of their holes, but nothing could be further from the truth. There is a clear divide between those surviving and those clearly still struggling. And the recession will only get worse before it gets better. US banks are not making real profits – they are mostly digging into government capital and cutting costs.
Last night Icarus’ wings began to melt.
The reaction was swift across all markets. There was a sudden renewed flight to safety as the US dollar was bought heavily against the euro and the yen carry trade was rapidly reversed. Gold shot up US$17.40 to US$884.70/oz as the fear traders piled back in. The Aussie collapsed two and a half cents to US$0.6967.
It did not help that ECB president Jean-Claude Trichet announced he was mulling over another rate cut.
The spike in the US dollar immediately killed the reflation trade. Commodity prices took a bath. Oil fell US$4.45 or 9% to US$45.88/bbl. Aluminium and tin fell 2%, copper 4%, and nickel, lead and zinc over 5%.
The VIX volatility index jumped 15% to 39.2.
As FNArena has often pointed out, the fiercest rallies occur not in bull markets but in bear markets. Within those rallies there are typically very sharp corrections as well. This rally had clearly run too far in a short space of time on what can only be described as a spurious basis. For the most part, it was a rally of hope rather than a rally of reality. However, one bad night does not mean we’re heading straight back down into a new kind of Hell. A correction from here does not necessarily imply the March 6 bottom will be breached. But it might be tested.
The measure of US leading economic indicators for March was released last night. This is an index which offers a window into economic conditions 6-9 months ahead. Economists were expecting a 0.3% decline and got it. March represents the ninth consecutive month of weakness and implies a 2.5% decline in the last six months. The indicators showed only a 1.4% decline in the six months prior. The recession should thus accelerate from here.
While Wall Street has been building on a euphoric hope that the end of the recession is shortly nigh, the indicators continue to say it’s a long way off yet.
There was, however, some positive news last night. All of a sudden there was an M&A scramble. Oracle said it would buy Sun Microsystems. GlaxoSmithKline said it would buy Steifel Laboratories. These were only two among about half a dozen announcements worth some US$28bn. While M&A at the bottom of the market implies one company has conceded to another, it also implies money is “moving from weak hands to strong” – the sort of consolidation needed to halt the slide.
There was also plenty of activity in the after-market as tech giants IBM (a Dow component) and Texas Instruments reported first quarter earnings. While both companies beat the Street, IBM’s revenue result was marginal and its stock has lost 1.5% after hours. Texas, however, beat the Street with a profit when a loss was expected. Its shares are up 2.5%. Neither are big moves, but that’s exactly what we want.
The SPI Overnight was down 69 points or 1.8%. It appears the January high was just a bridge too far after all. The ASX 200 will now have to regather itself for a later assault. The question is: How much money missed the March-April rally and would like a chance to get in on a pullback?
