Daily Insight

U.S. stocks slid in the final hour of trading yesterday as concern grew the credit-market situation, which tightened further, will spread into other industries, according to the financial press. I believe that was a concern already, if fact we all know it was the case. The sell-off was more a function of de-leveraging and growing fear, which drives things well-below justified valuations.

The fact that things fell apart to such a degree in the final hour likely suggests the plunge was due to hedge-fund deleveraging. Look at the most liquid stocks, many of which took the worst beating; those that had to sell when redemptions flooded in sold whatever they could. It’s quite likely in my view large-cap stocks will show the largest bounce when the indices rally again.

The Dow moved to the 8,000 handle, closing at 8579 for the first time since May 2003 – the index has lost 16% this week, which I believe is on pace for the worst weekly performance ever. The broad market, as measured by the S&P 500, has plunged 27.4% since September 19 – down 17.2% for the week.

First chart represents yesterday’s session; the second shows the last 18 months.

So much for the thought that removing the short-sell ban would push the indices higher, that was a moronic statement. (The logic was that hedge funds may come back to the market as they would now be able to put on the appropriate hedge – can scrap that idea).

Market Activity for October 9, 2008


I don’t know call me crazy, but maybe the charts below (pay-to-play odds on the election outcome) have something to do with the pummeling too. When investors, especially those of whom may not have a multi-year time horizon, fear that capital gains and dividend tax rates may be jacked higher, I’m going to guess it doesn’t exude a pleasant feeling to say the least.

I’m going to guess, with all that is occurring, specifically the credit markets shutting down and the economic contraction that is quite likely to ensue, investors probably aren’t getting a great feeling about a filibuster-prove Senate either.

The activity in the stock market over the past three weeks and specifically the past seven trading sessions, seems to be pricing in a serious recession. We’re are not headed for a downturn that is worst that anything we’ve seen in 30 years – the typical recession seems about impossible to escape though the longer credit markets remain this locked up; heck, the stock market activity alone will surely push spending lower, whether it be the consumer or business as caution is heightened. However, if the market is pricing in an Obama victory – and much worse an Obama/Reid/Pelosi run government – it means it is pricing in higher tax rates and tariffs (major changes in our international trade agreements). That would mean an economic coma in this environment.

And before any Obama lovers send me hate mail, I’m going to rip on the current administration below – this is not about whom I want to win in this election, it’s about policy and it’s about proper communication.

Another Treasury Proposal

The Treasury Department reported they may begin a program to inject capital into banks, much like the UK plan announced the day prior. The TARP plan includes the ability to do this – using some of the $700 billion to directly inject capital in exchange for currently traded preferred shares to protect the taxpayer. These positions must be sold back to the private sector once the crisis passes, that’s imperative.

As the Editorial Board of the WSJ stated yesterday, when the private sector won’t provide the capital in this current period of fear public-sector funds must be used to throw the life-preserver.

As we touched on yesterday, it is better for Hank Paulson to wait until something is put in place before making statements. The market could give a damn about talk, it wants action.

Besides, everyone knows that I believe a couple of the Treasury’s major plans will work quite well. But they have a problem with communication – a contagion within the Bush Administration. It’s quite likely poor communication has meant a 2,000-point swing in the Dow – instead of losing 1,000 from 9500 it very well should have rallied 1,000 to 10,500.

Take this capital injection, for instance. Do not state such a plan without specifics, the market will think they’re going to bring out the hatchet. Moral hazard? This is something many have worried about with all of this government intervention. Not with these guys.

This capital injection plan can work very well, but Treasury must make it clear that they won’t do what they did with Fan and Fred – destroying the preferred shareholder, many of which were the very banks that need help. Lay the plan out when you bring it, and it must state three things loud and clear with regard to government stakes in preferred stock:

• No voting rights
  
• Not senior to any other preferred series (so the currently held shares won’t be blown out – don’t penalize shareholders here; support them)
  
• Get out ASAP (as soon as this crisis has waned)
  

Commercial Paper

Total commercial paper (CP) outstanding fell $56 billion in the week ended October 8, which puts the total decline over the past four weeks at $264 billion -- total outstanding is $1.55 trillion.

Financial company CP fell $42 billion and is down $175 billion over the past month – financial CP stood at $825 billion a month ago, that $175 billion decline marks a 21% plunge. Non-financial CP outstanding rose $3.6 billion in the past week to a total of just over $200 billion, that’s the bright side.

The dark side is that financial and asset-backed CP continues to decline rapidly and signals the need for the Fed to get its Commercial Paper Funding Facility operating in quick order.

On the economic front, the Labor Department reported initial jobless claims fell 20,000 in the week ended October 4 – although, the figure remains elevated due to the hurricanes that tracked through the Gulf in September. The report showed these weather-related events added 17,000 in jobless claims so adjusting for this claims would have dropped substantially.

The four-week average of claims rose 8,250 to 482,500.

The hurricanes resulted in an increase of 50,000 in claims in last week’s data, but the overall figure only rose 2,000 – so plenty of distortions then as well. This is good news but we should be prepared for claims to remain elevated as small business in particular has been hurt by the credit market freeze up.

Continuing claims remain elevated, the highest level since June 2003 – which was three months before the labor market began to turn around coming out of the 2001 downturn. Thirty-five states and territories reported an increase in new claims, while 18 reported a decrease. These aspects of the data likely underscore the deterioration in the job market we’ve seen of late.

The G7 will convene this weekend and I’ll go out on a limb and say they’ll come back and have decided on two things:

One, they;ll state global governments will guarantee lending between banks.
Two, there will be a coordinated effort to suspend mark-to-market accounting for securities that currently have no market. (The U.S. has proposed this but I do not believe it has become offical. Besides the standard needs to be change on a global scale for conformity’s sake)

These two events should bring inter-bank lending rates lower and a willingness to lend to one another. At which point businesses, specifically small business, will begin to see capital and credit flow in their direction again. I’m still waiting for a tax-rate response as well, which would provide a big boost to confidence – to offer nothing in this regard is a major mistake in my view

Hang in there and have a great weekend!

Brent Vondera, Senior Analyst