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Weekly Wrap 9-5-08
Last Update: 05-Sep-08 16:31 ET
Several things returned to the market this week following the Labor Day holiday: people, volume and nervousness.
In a sense, all of those elements were inextricably linked. The nervousness actually began ahead of last weekend as participants eyed what was feared to be a destructive storm in the form of Hurricane Gustav.
Gustav, of course, did its fair share of damage, just not the damage that was feared most. By and large, the oil infrastructure in the Gulf of Mexico survived essentially unscathed, as did the city of New Orleans, which dealt with flooding of a much more manageable kind than what was witnessed after Hurricane Katrina.
With Gustav's relatively benign passing, a relief rally was forged to begin this holiday-shortened week. That rally followed a plunge in commodity prices and saw the S&P gain as much as 1.6% at its high on Tuesday. Then, things reversed in sudden fashion.
The S&P closed Tuesday with a loss of 0.4% as bids disappeared and leadership fell by the wayside. Like the early rally, the subsequent selloff was pinned on the behavior of commodity prices. Technical analysts also called attention to the S&P hitting resistance yet again at the key 1300 level.
Oil prices fell as much as $10, or 9%, Tuesday in a move that was out of line considering oil prices hardly moved in the buildup to Gustav's arrival.
Had oil prices spiked ahead of the hurricane, it would have made more sense to see such a decline when the storm didn't live up to its advanced billing. There were two competing notions to explain the peculiar action. The first was that it was consistent with an asset bubble popping. The second was that it was a reflection of heightened concerns about a slowdown in global economic growth.
There is legitimacy in both viewpoints, yet by the end of the week the slowdown perspective looked to have prevailed.
Earnings and/or sales warnings from several technology companies, including Corning (GLW), the Fed's Beige Book report, guarded comments from the ECB President about growth in the Euro zone, a batch of relatively weak same-store sales results, and a disappointing employment report for August all contributed to the growth concerns.
Other items, meanwhile, added to the prevailing sense of nervousness in the week.
In particular, the manager of the world's largest bond fund said the U.S. needs to step up and buy assets to avoid a "financial tsunami," a big commodity hedge fund closed after suffering large losses, and Russia was selling foreign currency reserves to prop up the ruble after foreign capital fled the country following Russia's invasion of Georgia.
Festering concerns about the potential for further write-downs at financial firms and speculation that more hedge funds could be in trouble and on the verge of liquidating assets also cast a pall on the market, which technically slipped back into bear market territory during the week (a bear market move is defined as 20% pullback from a peak).
The August employment report marked a fitting end to an otherwise disappointing week.
Before the open Friday, the government reported nonfarm payrolls declined by 84,000 positions last month. Although that represents a mere 0.06% decline on a nonfarm employment base of 137.6 million, downward revisions to the payroll numbers for June and July didn't sit well with the market.
The real sticking point, though, was the report that the unemployment rate jumped from 5.7% to 6.1% -- its highest since September 2003. It's not unusual to see such a spike at this point in the cycle, but it nonetheless fueled concerns about the pace of consumer spending in the months ahead.
The market's response to the jobs data was decidedly negative in early trading Friday. The S&P fell as much as 1.6% after shedding 3.0% in a broad-based selloff Thursday.
Friday's early losses, though, ended up getting recouped and then some.
News that there might be an interested buyer of Lehman Bros.' (LEH) real estate and asset management units and bargain hunting in the beaten-up technology and materials sectors helped pace the recovery effort. Also, there was a sense that the large losses on Thursday already accounted for the weak jobs report.
Still, the week overall left a lot to be desired for market bulls.
The losses were accompanied by a pickup in volume, key leadership sectors (i.e., energy and technology) were among the hardest hit areas, and the broader market didn't respond favorably to an 8% drop in oil prices.
The latter was arguably the most telling development as it relates to the slowdown concerns.
Strikingly, though, the financial and consumer discretionary sectors exhibited relative strength. That disposition didn't fit with the market's framework this week and suggests we'll likely see more roller coaster trading action as the growth debate continues.
--Patrick J. O'Hare, Briefing.com
**For interested readers, the S&P 400 Midcap Index, which isn't included in the table below, declined 3.7% for the week and is down 8.5% year-to-date.
Index Started Week Ended Week Change % Change YTD
DJIA 11543.96 11220.96 -323.00 -2.8 % -15.4 %
Nasdaq 2367.52 2255.88 -111.64 -4.7 % -14.9 %
S&P 500 1282.83 1242.31 -40.52 -3.2 % -15.4 %
Russell 2000 739.5 718.85 -20.65 -2.8 % -6.2 %
Stunning is a word that sums up this week's action. It fits because it can be used in proper context for all parties involved in the capital markets, regardless of whether they held short or long positions.
The behavior of stocks? Stunning. The behavior of Treasuries? Stunning. The behavior of commodities? Stunning. The behavior of currencies? Stunning. The behavior of the government? Stunning.
Recounting all that transpired with sufficient detail would make this wrap a rival to War and Peace in length. Accordingly, we'll spare you the nitty-gritty and will focus on the larger happenings.
To begin, the week began with a washout of sorts as the market dropped 4.7% in the wake of reports that investment bank Lehman Bros. was filing for bankruptcy, that Merrill Lynch (MER) agreed to sell itself to Bank of America (BAC) in a hastily arranged transaction, and that insurer AIG (AIG) might be headed for bankruptcy if it couldn't raise a large amount of capital in a hurry.
The focus on the financial sector on Monday was apropos since the Wall Street universe revolved all week around that area, which was both a black hole and shining star depending on the day, or even the hour, one looked at it.
All other developments, like a warning from Dell (DELL) about slowing demand, a disappointing earnings report from Best Buy (BBY), a reassuring report on consumer inflation, and a decision by the FOMC to leave the fed funds rate unchanged, were a distant second to the behavior of the financial sector and the credit market, which were inextricably linked.
After recouping a portion of Monday's losses on Tuesday, the market suffered another seizure Wednesday, dropping 4.7% in the wake of news the Fed agreed to a 2-year, $85 billion secured loan for AIG. Although that loan was structured on very attractive terms for the Fed, the major concern for the market Wednesday was that it failed to do anything to put the credit market at ease since it didn't fix the underlying problem.
Strikingly, the TED spread, which is a barometer of credit risk and is the difference between the 3-month Libor rate and the 3-month T-bill rate, blew out to 302 basis points. That level compared to a 135 basis point spread the preceding Friday and marked the widest spread since just before the stock market crash in 1987.
Other credit spreads also widened considerably, particularly the spreads on credit default swaps for investment banks Morgan Stanley (MS) and Goldman Sachs (GS). That widening reflected heightened anxiety about their ability to repay their debt which, in turn, reflected a pressing concern that those firms were at risk of going the way of Bear Stearns and Lehman Bros.
From their close last Friday to their lows for the week, the stocks of Morgan Stanley and Goldman Sachs plummeted 69% and 44%, respectively. Remarkably, that move occurred despite both firms posting better than expected fiscal third quarter earnings results.
Their losses were indicative of some of the panic selling that took place during the week as participants fretted about the government's inability to stem a collapse in the financial system (more on this in just a bit). That selling was exacerbated, too, by reports that the value of the Reserve Primary Fund, which is a money market fund, broke below $1.00 per share, an extremely rare happening for a money market fund.
The confluence of the disconcerting headlines surrounding the financial sector precipitated a massive flight-to-safety bid in gold and the U.S. Treasury market.
At their high on Thursday, gold futures were up $161.50, or 21.1%, from their close last Friday. Meanwhile, the yield on the 3-month T-bill hit 0.02% on Wednesday, marking a 149 basis point drop from where it went out last Friday.
The fear in the market was palpable. For traders it manifested itself in the VIX Index, commonly referred to as the fear gauge, which hit its highest level in six years Thursday.
Thursday and Friday, frankly, were two days for the trading ages.
Thursday began well enough as stocks initially reacted favorably to reports of a coordinated effort among central banks to inject more dollars into the global financial system. Those good feelings proved to be fleeting. Stocks rolled over upon seeing there had been no real improvement in the credit market and upon hearing more worrisome headlines about money market funds.
In an instant, though, the tone of the market again changed in favor of the bulls when the U.K. announced a temporary ban on the short-selling of financial stocks.
Sensing that the SEC might follow suit in the U.S., a short-covering rally ensued. However, it wasn't until a report late in the day that Treasury Secretary Paulson was entertaining the idea of a financial system fix equivalent to the Resolution Trust Corporation solution used during the S&L crisis that stocks really took off.
From its low on Thursday to its close, the S&P surged 6.4%.
Sure enough, Friday brought a tidal wave of news regarding government proposals to return stability to the financial system.
In particular, the SEC banned short-selling of 799 financial stocks until Oct. 2 and the Treasury provided a guaranty program for money market mutual funds. The big game changer, though, was a proposal put forth to have the government (er, the tax payer) take the illiquid mortgage assets off the balance sheets of financial companies.
Administrative officials and Congressional leaders intend to work over the weekend to iron out specific details of the plan, but it was clear in Friday's session that participants liked the implications of what was being discussed since it got to the heart of implementing a comprehensive and targeted solution to fixing the root of the financial system's problems, which is housing and mortgage-related assets.
By implementing a program that removes the illiquid assets from the balance sheet of the financial companies, the government is literally buying the time that is necessary to turn the illiquid assets into liquid assets again through a more rational price discovery process.
The cost of the program won't be cheap. Secretary Paulson estimates it will run into "the hundreds of billions of dollars" since it has to be sufficiently large to have a maximum impact. However, the cost entails buying actual assets which can deliver cash flow, possibly in excess of the amount of the price the government will pay.
Time will tell, but the thinking that this plan can succeed in stabilizing the financial system and the housing market translated into heavy buying interest Friday. In fact, Friday's session, which also happened to be a quarterly options expiration day, saw the most volume (2.98 bln shares) ever traded at the NYSE.
For some perspective on the magnitude of the rebound over the final two days, consider the following: from their low on Thursday to their high on Friday, the Dow, Nasdaq, S&P 500, Russell 2000 and S&P 400 Midcap Index surged 9.8%, 12.0%, 11.6%, 13.2% and 12.0%, respectively. As an aside, the stocks of Morgan Stanley and Goldman Sachs rebounded as much as 189% and 69%, respectively, from trough to peak.
If two lessons are to be learned by investors from this week's action, it is that panic selling isn't a recommended portfolio management strategy and that you can't try to time the market. Neither works in the ongoing effort to build long-term wealth by investing in the stock market.
--Patrick J. O'Hare, Briefing.com
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