Sunday, April 13, 2008

Talk of Bigger Bailout in the Works

- GE shocks the market as its financial services division runs aground.
- Import prices surge as the US is in fact importing inflation.
- Sentiment falls to 1982 levels in the great north.
- Talk of a bigger bailout in the works.
- Volatility not budging with the Fed and the feds acting as the backstop.
- Low volume Friday holds out possibility market can heal itself, but more than ever it needs good guidance, a lot of good guidance, to pull things back together.

Market gets tired of swallowing bad news.

The market was looking for a catalyst and it got one, just not the right kind. The indices were set up well and Thursday showed indications an upside breakout was close. Then a big name issues a big surprise. You expect disappointments from AMD and AA, and they didn't disappoint by disappointing for yet another quarter earlier last week. But GE?

GE missed earnings by 7 cents and lowered its 2008 guidance. Just three weeks ago it said earnings would be in the 50 to 53 cent range with analysts expecting 51. 44 cents hurt. How was GE so wrong so late in the quarter? The financial services business hit the reef when BSC blew up. It is apparent that the entire financial sector came to a standstill at that point, and that left everyone wondering if one part of GE's business could drag earnings down so much when its other business units are in excellent shape, what is going to come out of the financial stocks whose sole means of income is form the financial sector.

Indeed, GE's revenues, while down from the financial unit, were up 8% overall. The overseas revenues rose 23%. Goodness gracious. Yet . . . GE warned for the year. Does it see things as that bad? Probably not. What it sees is that three weeks ago things looked super and then one business unit imploded with almost unprecedented speed. It simply does not know what lies ahead for that part of the company and thus it pulled in its guidance as a matter of prudence. Of course that doesn't mean everyone can let out a big 'whew' that all is clear. While it has been bad in the financial sector, GE is showing it could be a lot worse than everyone expects even with all of the write-downs at this point.

Maybe. While GE's results were hurt in the finance sector there are signs the credit crunch just in the past few weeks is better. The amount bid at the Fed auctions is on a rapid decline. Primary dealers bid only $39.5B last week of the $50B available. People who watch these say that is showing the dealers have liquidity again. Investment bank borrowing fell to $26.5B last week from $34.4B the prior week and $37B two weeks ago. Slowing at the discount window means improved liquidity. Seems opening the discount window was just in time. GS says there is a light at the end of the tunnel and that the credit crisis is in the beginning of the fourth quarter in sporting terms. MS CEO kept the sports analogy saying the crisis was in the final innings.

GE was bad and then there was piling on. Import prices surged with China jumping 148% year/year. Michigan sentiment for April flopped to a 26 year low. We wanted China to stop controlling its currency as much and it is doing so. As we said would happen over a year ago, when that happened the yuan would rise against the dollar and our imports from China would increase in price, basically importing inflation to the US. As discussed Thursday, we are doing this elsewhere as well with oil, metals, and other commodities priced in dollars. As the dollar falls foreign producers require more dollars to remain whole. We may export more but we pay more for just about everything. To top it off we are on this kick of burning food for fuel, driving world prices higher and helping cause food riots around the globe. That makes you really take a hard look at this ethanol issue and ask 'is this really the best solution to the problem given all the troubles in the world?' Sure doesn't look like it.

This was more than enough bad news to undercut the nice rally set up. Industrials were hammered but the weakness was market wide though not as intense as in the GE wannabes. Indeed many quality stocks held up well even as other big names (e.g. AAPL) took hits. It is definitely trouble when a big name that never misses, or at least has not missed in a decade, is blindsided because things turned so fast you have to wonder, and the market is, what is next? There was widespread downside but it was not an across the board wipeout. Volume was actually lower; there was no dumping overall and a lot of recent leaders held up well. There was some culling, and of course, GE was moving into leadership.

TECHNICALLY the action was weak as you would expect. The indices started low and moved lower, never able to put together a recovery as a midmorning attempt rolled over into a steady afternoon slide lower and lower. The market was overcoming bad news time and again, but there is a point where you are so full of bad food that you just cannot swallow another bite. If you are lucky it doesn't all come back up. It didn't Friday, but next week with all of the earnings reports is now even more important given the GE miss.

INTERNALS: Breadth jumped back to those levels seen during the selling and the up and down gyrations as the indices tried to put in that double bottom in January through March. Not surprising given the import of GE and the magnitude of its miss. -3.6:1 NYSE, -3.7:1 NASDAQ; it was not just GE and the industrials though many stocks were just weaker and were not selling off hard. Volume was the quite interesting technical aspect. It was lower on both NASDAQ (-11%) and NYSE (-1.6%), the latter even with GE trading 36M shares, 7 times its average volume. All of the heavy selling was in GE.

CHARTS: SP500, burdened by GE, had a bad day, blowing out the bottom of its lateral consolidation. It managed to hold some support at 1330. DJ30 also had to bear the yoke of GE, and it caved in its lateral consolidation a the 10 day EMA. It managed to hold its support at 12,250, not even getting there. NASDAQ did the same, making a new low on this pullback, but it did hold its long term trendline on the close and on very low volume. There is hope but it has to find the bottom here.

LEADERSHIP: There were definitely some implosions; you cannot have that kind of news and not see some stocks that were building nicely get plowed under. Overall, however, leadership held up well and our stocks mirrored that action. That is always good to see in a negative environment. Still, they cannot hold up if the market is not able to shake off GE and look to brighter futures elsewhere. Translated that means with all of these earnings coming out this week there need to be some big names with strong reports and upside guidance that is enough to wash GE right out of investors' hair. The market has no chance if other stocks don't show that GE was truly related to the March financial issues related to BSC financial decline.


Import prices confirm what the trade deficit told.

Prices for foreign products rose 2.8% in March, surging back from the 0.2% February gain, and back on path more with the trend that saw January rise 1.6%, December fall 0.2%, but November surge 3.2%. A lot of that has to do with oil imports, but even if you take out oil foreign goods rose 1.1%, the strongest in the last five months.

A lot of that was due to rising Chinese prices, up 4% for the month and 148% year over year. Oil imports were not cheap, however, rising 9.1% in March. Volatile number that was down in February, up 4.8% in January, down again in December, and up 12.4% in November. Follow the bouncing ball, but that ball is still bouncing uphill.

Some say the falling dollar is just a normal correction after years and years of a rising dollar that took it out of a normal relationship to other economies. Is that a bad thing? We had a strong dollar and we could buy goods from all over the world and do so cheaply. That is called raising your standard of living, and that is not a bad thing in just about everyone's book. You don't suffer inflation because of your strength. Now we have to spend more for oil and gasoline leaving less money to go elsewhere for things we typically enjoy in our standard of living. We have to spend more for everything. Our economy is in recession, helped along by hugely surging oil prices, surging metals prices, food prices and goods in general gratis a weaker and weaker dollar. Again, this is a good thing? Used to be we just complained about the cost of medical care and education. Now you wonder whether you want two-ply or single-ply. THAT is the definition of a lower standard of living.

Michigan Sentiment is . . . how do you say it? . . . crappy.

At 63.2 sentiment was bad. Well off the 69.0 expected, the 69.5 in March, etc. Steady downtrend and still heading lower. A combination of high gas prices, higher food prices, rising unemployment, politics, and general gloom in the media. Feeds off itself.

Sentiment is at recession levels in an absolute number sense, but the decline from 78 to 69 in just two months shows the rate of change indicative of a recession even without hitting historical recession ranges. That is a moot point now; it is there.

Present conditions were the stalwart at 78.4. The outlook is a pathetic 53.4, truly a recession level.

Comparisons to the past are of course widespread and somewhat appropriate. The big one thrown out was the worst showing in 26 years. Back in March 1982 the US was suffering through a horrible recession after the 1970's, the worst period in economic history since the Great Depression. In 1982 the economy was starting to emerge from that truly disastrous period after the Reagan Emergency Economic Recovery Tax Act of 1981 was passed and in place.

While the economy is likely in recession right now, it is hard to argue it is emerging from it. If it is, it is a shallow one. If it is we will see the stock market emerge ahead of it as it was trying to do before Friday and the GE miss. May still do it, but as noted above, it will take other widely followed stocks to put up some good guidance. If not then there is likely more downside for stocks and the economy.

Resolution Trust Fund Part 2?

It was only a matter of time. The Feds are talking about a bill to bailout those mortgagors who cannot pay their mortgage and the builders and lenders who became overextended and are now in trouble. Once more our government, in order to ensure domestic tranquility and the pursuit of financial irresponsibility, is preparing to bail out those that knew better but didn't act accordingly.

Today we heard it: the feds need to form an entity similar to the Resolution Trust Corporation back in the early 1990's to clean up the mortgage mess. In the early nineties the RTC was in charge of the Resolution Trust Fund that was basically a mechanism to throw money at the savings and loan collapse that occurred after the real estate market fell to pieces all across the south and other parts of the country. An entire branch of case law developed in the courts to assist in expediting the clean up by limiting claims of borrowers against lenders to keep the hundreds of billions in losses from growing into trillions. At the same time the 'trust fund' (a.k.a. a tax dollar fund) was used to pay off both sides in order to keep the nation's financial sector from collapsing altogether (it was not only S&L's that failed but bank after bank was taken over by other banks to avoid outright failures).

It worked but it cost a lot of taxpayer dollars that went to the wrongdoers. Basically it was a decision to grease the system and get through the mess even if it meant assisting those that were major players in the problem in order to avoid a larger economic collapse. The feds meant business. The Federal courts were given jurisdiction (no invasion into state's rights there) and the judges knew what the legislation was enacted for: to clean up the mess and limit the losses, and that meant harsh rulings. I was a newbie lawyer at the time and the case law that developed in favor of the lending institutions was so strong I had no trouble starting off my career with several summary judgment victories for defendant financial institutions. I liked to think I was smart and resourceful, but I knew better: the deck was stacked in the lender's favor as long as the bank hadn't done something like promise to place gold coins in the borrower's account every Monday. Even then you could probably get them off.

Anyway, after GE's sudden and unexpected miss, many Friday were saying the mess is going to be much larger than expected, even with the billions already written off. Who can sweep billions of dollars lost due to inappropriate actions under the rug? The federal government, a.k.a. the candy man. Of course it would mean more if the dollar had some weight behind it, but why quibble. With talk of a second stimulus package already you can bet that an offshoot of that will be some sort of federal creation to deal with the issue if earnings guidance does not improve drastically in the near term.

By: Jon Johnson, Editor

Jon Johnson is the Editor of The Daily at

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1 comment:

Anonymous said...

and every time there is a bailout there is a consequent increase in the money supply. I read a while ago that the M3 money supply increased 16% in the last year!

Well to some extent it doesn't matter what else happens since with this amount of credit there needs to be a serious amount of malinvestments being wiped out, a process that I think is far from over...

My advice: Buy gold, silver, other PGMs or commodities and wait the depression out