U.S. stocks took a beating, even as they pared losses in the final hour of trading, as global equity indices were pounded the night before and that flowed into our trading session. Concerns that the credit market seizure will continue to spread and have larger ramifications than just the typical economic downturn continue to grow.
I’m not willing to share this belief just yet, but we have to get these troubled assets out of the way, or banks will continue to hoard cash. Personally, removing current accounting rules that make zero sense, and in fact results in a death spiral we’re watching play out, would do the trick but apparently not all share this view. As a result, the assets must be removed and housed by an entity that has the resources to hold these assets through the current crisis – and obviously that is government – I’m not one that normally embraces intervention, but in this case it seems very much necessary.
The broad market, as measured by the S&P 500 was down 8.3% at it worst level yesterday but stocks rallied 4.8% from that nadir in the final hour of trading. The NYSE Composite plunged 9.12% with an hour to go, but jumped 5.0% in the final 60 minutes – the index lost $760 billion in market value.
Market Activity for October 6, 2008
This latest decline has sent the Dow Industrial Average back to where it traded in the spring of 2005. The S&P 500 hasn’t seen this level since December 2003 – ouch!
Credit markets remain extremely frozen. As most readers know, the following charts illustrate this point. These graphs show the level of risk aversion in the marketplace – put simply all you really need to know is when they jump to this degree, it ain’t good.
For new readers, the TED Spread is the difference between three-month LIBOR rate (an interbank lending rate) and the rate on three-month Treasury bills. (Banks are charging more as they are unwilling to lend for anything longer than overnight and three-month T-bill yields have plunged as many run for the safety of the Treasury market.
And speaking of the credit markets, we’ve talked about how everything suddenly changed on September 15 when Lehman went down; this is the date credit markets tightened up, and outside of a two-day blip when the TARP plan was initially laid out, hasn’t eased.
For instance, business spending had been on a very nice upswing for three months, but came to a screeching halt in September. Firms obviously have the resources to continue to buy equipment, but a high level of caution has caused a respite.
A prime example of this is SAP AG’s latest earnings report. The software giant had offered bullish comments up until two weeks ago, but yesterday explained that things changed dramatically in the back-half of the month. The firm cited that customers have put orders on hold amid the global financial crisis. The good news is this is not for lack of capital, but credit markets have to free up or activity is going to remain subdued at best.
Another good indication of how quickly things have changed is news Bank of America cut its dividend by 50% after the bell. One can only trust these managers as far as you can throw them these days, but CEO Ken Lewis has been pretty straight up over the past year. The fact that he stated there was not reason to cut the dividend just a couple of weeks ago when they bought Merrill Lynch shows how quickly things have deteriorated within the financial markets
On Fed Action
One reason being given for yesterday’s dramatic sell-off – prior to that late-session rally – is the market had expected a coordinated rate cut by the various central banks and when there was not an announcement of such a plan by mid-day, the market came under intense pressure.
What the Fed did announce is that they will be doubling their TAF (Term Auction Facility) program to $900 billion. This is a new program put in place last December that allows the Fed to accept a wider range of collateral and provide increased liquidity. This is a good step, although it didn’t do much to unfreeze the flow of credit. It’s a step though.
On this topic of a coordinated rate cut by several central banks, I wouldn’t hold your breath. For one, our Fed has tried to bring the ECB (European Central Bank) along on this before and they’ve been obstinately opposed. Secondly, the Fed is now offering interest on deposits at the Federal Reserve – this is what many term quantitative easing. It’s essentially a stealth rate cut.
Banks must keep a required level of reserves with the Fed and sometimes there is an excess amount. Banks will now be paid interest on both required and excess reserves – interest on those excess reserves will be the targeted fed funds rate (2.00%) minus 0.75 on those excess reserves. So, what they have done is effectively moved fed funds down to 1.25%.
This serves two purposes. One, it gives the Fed greater scope to use its lending programs by expanding its balance sheet. They will have more firepower to shoot liquidity to where it is most needed. Two, it keeps a floor on fed funds. (During times of big liquidity injections, such as now, banks are left with excess reserves and thus are willing to lend this money overnight for an amount that is often much lower than the target the Federal Reserve sets – this is why we’ve seen the rate trade at 0.50% on occasion over the past three weeks. See below:
By paying interest on excess reserves at the Fed it sets a floor on fed funds – why lend it out overnight at 0.50% when the Fed is going to pay you 1.25%? Now the Fed is free to pump massive amounts of liquidity without pushing fed funds to levels that would spark inflation – well, at least not as severe as would be the case otherwise. I still believe we’ll have an inflation problem to deal with when things return to normal, but it is obvious that’s a secondary concern right now.
On a more optimistic note, there are some really compelling valuations and opportunities in stock-land – if anyone cares to hear about it in this environment.
There seems to be a marvelous opportunity in energy here; many names in this group are trading at lower multiples than they did in 1998 when oil was $10 per barrel.
Same is true for defense, industrials and medical equipment markers in most cases – awesome opportunities. Same can be said for technology shares.
Of course, we may have to wait a while for these opportunities to result in a sustainable upswing, but patience is key for stock market investing – a reality that has become obvious to all over the past several years.
While diversification is key – one must not abandon positions in many economic sectors and asset classes, stocks in the aforementioned industries may lead the economy once again. We are coming off of a 10-15 year period in which financials led the economy, now that leverage within the industry will move from 30 times to a level that is more appropriate and sustainable the more traditional industries appear positioned to lead the way
Patience will be needed though as locked up credit markets cause quick deterioration and some pretty substantial damage to both domestic and global growth has occured.
Have a great day!
Brent Vondera, Senior Analyst
I’m not willing to share this belief just yet, but we have to get these troubled assets out of the way, or banks will continue to hoard cash. Personally, removing current accounting rules that make zero sense, and in fact results in a death spiral we’re watching play out, would do the trick but apparently not all share this view. As a result, the assets must be removed and housed by an entity that has the resources to hold these assets through the current crisis – and obviously that is government – I’m not one that normally embraces intervention, but in this case it seems very much necessary.
The broad market, as measured by the S&P 500 was down 8.3% at it worst level yesterday but stocks rallied 4.8% from that nadir in the final hour of trading. The NYSE Composite plunged 9.12% with an hour to go, but jumped 5.0% in the final 60 minutes – the index lost $760 billion in market value.
Market Activity for October 6, 2008
This latest decline has sent the Dow Industrial Average back to where it traded in the spring of 2005. The S&P 500 hasn’t seen this level since December 2003 – ouch!
Credit markets remain extremely frozen. As most readers know, the following charts illustrate this point. These graphs show the level of risk aversion in the marketplace – put simply all you really need to know is when they jump to this degree, it ain’t good.
For new readers, the TED Spread is the difference between three-month LIBOR rate (an interbank lending rate) and the rate on three-month Treasury bills. (Banks are charging more as they are unwilling to lend for anything longer than overnight and three-month T-bill yields have plunged as many run for the safety of the Treasury market.
And speaking of the credit markets, we’ve talked about how everything suddenly changed on September 15 when Lehman went down; this is the date credit markets tightened up, and outside of a two-day blip when the TARP plan was initially laid out, hasn’t eased.
For instance, business spending had been on a very nice upswing for three months, but came to a screeching halt in September. Firms obviously have the resources to continue to buy equipment, but a high level of caution has caused a respite.
A prime example of this is SAP AG’s latest earnings report. The software giant had offered bullish comments up until two weeks ago, but yesterday explained that things changed dramatically in the back-half of the month. The firm cited that customers have put orders on hold amid the global financial crisis. The good news is this is not for lack of capital, but credit markets have to free up or activity is going to remain subdued at best.
Another good indication of how quickly things have changed is news Bank of America cut its dividend by 50% after the bell. One can only trust these managers as far as you can throw them these days, but CEO Ken Lewis has been pretty straight up over the past year. The fact that he stated there was not reason to cut the dividend just a couple of weeks ago when they bought Merrill Lynch shows how quickly things have deteriorated within the financial markets
On Fed Action
One reason being given for yesterday’s dramatic sell-off – prior to that late-session rally – is the market had expected a coordinated rate cut by the various central banks and when there was not an announcement of such a plan by mid-day, the market came under intense pressure.
What the Fed did announce is that they will be doubling their TAF (Term Auction Facility) program to $900 billion. This is a new program put in place last December that allows the Fed to accept a wider range of collateral and provide increased liquidity. This is a good step, although it didn’t do much to unfreeze the flow of credit. It’s a step though.
On this topic of a coordinated rate cut by several central banks, I wouldn’t hold your breath. For one, our Fed has tried to bring the ECB (European Central Bank) along on this before and they’ve been obstinately opposed. Secondly, the Fed is now offering interest on deposits at the Federal Reserve – this is what many term quantitative easing. It’s essentially a stealth rate cut.
Banks must keep a required level of reserves with the Fed and sometimes there is an excess amount. Banks will now be paid interest on both required and excess reserves – interest on those excess reserves will be the targeted fed funds rate (2.00%) minus 0.75 on those excess reserves. So, what they have done is effectively moved fed funds down to 1.25%.
This serves two purposes. One, it gives the Fed greater scope to use its lending programs by expanding its balance sheet. They will have more firepower to shoot liquidity to where it is most needed. Two, it keeps a floor on fed funds. (During times of big liquidity injections, such as now, banks are left with excess reserves and thus are willing to lend this money overnight for an amount that is often much lower than the target the Federal Reserve sets – this is why we’ve seen the rate trade at 0.50% on occasion over the past three weeks. See below:
By paying interest on excess reserves at the Fed it sets a floor on fed funds – why lend it out overnight at 0.50% when the Fed is going to pay you 1.25%? Now the Fed is free to pump massive amounts of liquidity without pushing fed funds to levels that would spark inflation – well, at least not as severe as would be the case otherwise. I still believe we’ll have an inflation problem to deal with when things return to normal, but it is obvious that’s a secondary concern right now.
On a more optimistic note, there are some really compelling valuations and opportunities in stock-land – if anyone cares to hear about it in this environment.
There seems to be a marvelous opportunity in energy here; many names in this group are trading at lower multiples than they did in 1998 when oil was $10 per barrel.
Same is true for defense, industrials and medical equipment markers in most cases – awesome opportunities. Same can be said for technology shares.
Of course, we may have to wait a while for these opportunities to result in a sustainable upswing, but patience is key for stock market investing – a reality that has become obvious to all over the past several years.
While diversification is key – one must not abandon positions in many economic sectors and asset classes, stocks in the aforementioned industries may lead the economy once again. We are coming off of a 10-15 year period in which financials led the economy, now that leverage within the industry will move from 30 times to a level that is more appropriate and sustainable the more traditional industries appear positioned to lead the way
Patience will be needed though as locked up credit markets cause quick deterioration and some pretty substantial damage to both domestic and global growth has occured.
Have a great day!
Brent Vondera, Senior Analyst
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