Special Report: Can Dow Hold 11,000?
Monday, September 15, 2008 | Marie AlbinRating:
The financial markets are in turmoil. Lehman Brothers (LEH), the nation’s fourth largest investment bank, filed the biggest bankruptcy in history this morning, defaulting on $613 billion in debt.
Merrill Lynch (MER) sold itself to Bank of America (BAC) for $50 billion as the company bled $17 billion over the past four quarters.
Plus, there are on-going fears that AIG (AIG) and Washington Mutual (WM) are next to fail. AIG has lost more than $18 billion in the wake of the subprime mortgage crisis, and sources say it only has two to three days to survive should the company fail to raise enough cash.
Our own Teeka Tiwari is in high demand today as several news outlets including Fox Business News have asked him to comment on the Lehman Brothers/Merrill Lynch fallout. I’ve asked him to give Tycoon readers his analysis of the situation.
Teeka: Hey everybody. This is Teeka Tiwari from Point & Profit and the Tycoon Report. Crazy, crazy day. We are witnessing history today. Complete breakdown over at Lehman Brothers (LEH). You know, venerable 158-year-old investment bank just gone to the wind. I’ve got a soft spot in my heart for Lehman. That’s where I got my start.
Marie asked me to weigh-in and really let you know what’s going on ... how it is going to affect everybody ... where there may be some opportunities. I spent most of this morning talking to various news networks about what’s going on. Obviously, the big question here is, ‘What’s going to be the effect of Lehman? It’s a $613 billion bankruptcy. How is this going to affect everybody?’
I think at the end of the day, the people most affected by Lehman are other counterparties - the other people that bought and sold and traded with Lehman Brothers. But much of this Lehman Brothers news has already been priced into the market. So while we’re seeing turmoil today, we’re not seeing a complete meltdown in markets.
Usually, on a disaster of this magnitude, in terms of sentiment, you would see a 700 or 800 point drop in the Dow. Today, so far, we’ve been going down 200 or 300. 12:30 in the afternoon right now, the real key test is going to be what happens between 3 pm and 4 pm. It’s that final hour of trading that tells us where we go.
If we break 11K on the Dow, then chances are, outside of some very, very strong words from the Fed or global rate cuts, we will go significantly lower: 10.5K, 10K, maybe even to the 9,000 level. And if that’s the case, if we break 11K, the only bet is to go short across the board and that’s something myself and both Chris at the Trend Rider has already been doing.
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Now there is a lot of scuttlebutt that the Fed might come out and cut rates, if they cut rates tomorrow and the market buys into it, it could be a good shot that we would get either a tradable rally or put in some kind of short term bottom there. It is far too early to make that call, though.
The other key consideration that all investors are looking at is AIG and Washington Mutual. Are these the next two major institutions to fall? WaMu, with their ill-fated foray into sub-prime, is just getting absolutely hammered. But really the bigger picture in my mind is AIG. AIG, the huge insurance company, have insured lots of losses called debt swaps. Basically, AIG insures companies where if they go out of business or there’s a default on their bond, AIG will make the bond whole.
They’ve done that on about a trillion dollars worth of bonds. So that’s just enormous risk over there in AIG. But again, this is risk that the rest of the market knows about. So we’ve got to ask ourselves - the market is only down 200 - 300 points - what’s going on here?
And I think the real key that is propping this market up now is oil prices. The fact that oil is down big today, down about $7, this acts as a global tax cut for all companies all over the world. So I think this is actually lending some strength to equity markets. This might lead to a Q3, Q4 bump in earnings. But again, all of that can kind of get thrown into a cocked hat if we’re down 500 - 600 points in the last hour of trading. It all comes down to the last hour of trading today.
Marie: What do you think will happen if the Fed doesn’t come in and lower rates? Because remember they were thinking about raising rates.
Teeka: Well the Fed was thinking about raising rates. And in a normal environment, it would probably be the right thing to do. I think a large part of the Fed’s decision-making process is going to key off on how we close today. If we have a strong close or if we close above 11K, they might be less likely to cut. But again, we’re dealing with market expectations and will the tail wag the dog again? I don’t know, but I can tell you there will be some disappointed people if tomorrow morning there is no Fed cut. And that disappointment will be expressed. And the only way it can be expressed is lower stock prices.
Marie: The Fed jumped in on Bear Stearns because it was apparently too big to fail, but Lehman was bigger than Bear Stearns and the Fed let them go under, so do you think the government has run out of money?
Teeka: The Treasury has backstopped Fannie and Freddie for $5 trillion. I think they said, ‘You know what? Enough is enough. You know, we’re not handing out any more free money.’ And the bottom line is if Lehman was going through this even two months ago or a month ago, they probably would have been safe. But they just waited too long and there really were no other options. You know, after backstopping Fannie and Freddie, after backstopping Bear, there was just no more money to go around.
Marie: Thanks, Teeka!
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Marie Albin
Managing Editor
The Tycoon Report
Economic Calendar for the week of September 15 to September 19
Monday, Sept 15
9:15 Industrial Production, Capacity Utilization
* Importance (A-F): This release merits a B-.
* Source: Federal Reserve.
* Release Time: 9:15 ET around the 15th of the month (data for month prior).
* Raw Data Available At: http://www.federalreserve.gov/releases/G17/Current/g17.txt.
The index of Industrial Production is a fixed-weight measure of the physical output of the nation's factories, mines, and utilities. Manufacturing production, the largest component of the total, can be accurately predicted using total manufacturing hours worked from the employment report. One of the bigger wildcards in this report is utility production, which can be quite volatile due to swings in the weather.
Severe hot or cold spells can boost production as increased heating/cooling needs drive utility production up.
In addition to production, this monthly report also provides a measure of capacity utilization. Though the rate of capacity utilization is seen as a critical gauge of the slack available in the economy, the market does not completely trust this measure. Capacity is very difficult to measure, and the Fed essentially assumes that growth in capacity in any given year follows a straight line. One can therefore predict the capacity utilization rate quite accurately based on the assumption for production growth. The 85% mark is seen as a key barrier over which inflationary pressures are generated, but given revisions to these data and the difficulties with capacity measurement, the 85% mark should be viewed cautiously. It would be appropriate to look for corroborating inflation indications from commodity prices and vendor deliveries.
Highlights
* The second straight month of increase for industrial production shows that resilience of the manufacturing sector to weakness in other sectors of the economy.
* The manufacturing component of production was up for the second straight month, as the end of the auto parts strike helped boost this core component. Further modest gains are likely, as factor orders have remained strong.
* The decline in utilities reflected cool weather across the country, which reduced demand for air conditioning. It should be near flat in July.
* Mining ouput posted a solid gain of 0.9%. The rate of increase will probably slow in the months ahead.
Big Picture
Surprising resilience in manufacturing is a major reason the period of weak economic growth late last year and early this year did not turn into a recession. Industrial production in June was 0.3% above the year-ago level. In recessions, production tends to drop sharply to well below year-ago levels. For example, just prior to the 2001 recession and through 20021 and into early 2002, industrial production fell every single month. Fourteen straight monthly declines were posted, with an average decline of 0.5% per month. Year-over-year production fell to -5%. This cycle, there have been monthly declines and a leveling off in production, but that reflects considerable resilience relative to the 2001 recession.
Tuesday, Sept 16
8:30 Consumer Price Index (CPI)
* Importance (A-F): This release merits a B .
* Source: Bureau of Labor statistics, U.S. Department of Labor.
* Release Time: 8:30 ET, about the 13th of each month for the prior month.
* Raw Data Available At: http://stats.bls.gov/news.release/cpi.toc.htm.
The Consumer Price Index is a measure of the price level of a fixed market basket of goods and services purchased by consumers. CPI is the most widely cited inflation indicator, and it is used to calculate cost of living adjustments for government programs and it is the basis of COLAs for many private labor agreements as well. It has been criticized for overstating inflation, because it does not adjust for substitution effects and because the fixed basket does not reflect price changes in new technology goods which are often declining in price. Despite these criticisms, it remains the benchmark inflation index.CPI can be greatly influenced in any given month by a movement in volatile food and energy prices.
Therefore, it is important to look at CPI excluding food and energy, commonly called the "core rate" of inflation. Within the core rate, some of the more volatile and closely watched components are apparel, tobacco, airfares, and new cars. In addition to tracking the month/month changes in core CPI, the year/year change in core CPI is seen by most economists as the best measure of the underlying inflation rate.
Wednesday, Sept 17
8:30 Housing Starts, Building Permits
* Importance (A-F): This release merits a B-.
* Source: The Census Bureau of the Department of Commerce
* Release Time: 8:30 ET around the 16th of the month (data for one month prior).
* Raw Data Available At: http://www.census.gov/const/www/newresconstindex.html.
Housing Starts are a measure of the number of residential units on which construction is begun each month.
A start in construction is defined as the beginning of excavation of the foundation for the building and is comprised primarily of residential housing. Building permits are permits taken out in order to allow excavation. An increase in building permits and starts usually occurs a few months after a reduction in mortgage rates. Permits lead starts, but permits are not required in all regions of the country, and the level of permits therefore tends to be less than the level of starts over time.
The monthly national report is broken down by region: Northeast, Midwest, South, and West. Briefing recommends analyzing the regional data because they are subject to a high degree of volatility. The high volatility can be attributed to weather changes and/or natural disasters. For example, an unexpectedly high level of rain in South could delay housing starts for the region.
Highlights
* The large drop in housing starts and permits in July was partly aberrant. There was a surge in both data series in June due to a change in the housing permit process in New York. That led to a speed-up in permits and starts, and a subsequent reduction in June.
* It may be a month or two until the underlying trend is evident. For now, it may be best to look at the June-July averages. For starts, this was a 1.015 million annual rate. That compares with an average 990,000 annual rate in the three prior months.
* Permits for June-July averaged a 1.054 million rate. That is up from an average of 964,000 for the three months of March-May.
* It therefore appears that, regardless of the swings in the June-July data, that the housing sector remains in a bottoming phase.
Big Picture
The housing sector has been in a deep recession. Fortunately, there are now some signs that the rate of decline is slowing, and even that some stabilization is occurring. The rate of decline in existing home sales has slowed over the past half year. Sales are not picking up, but a bottoming is preceded by a leveling off. Now, housing starts and permits are starting to level off as well. It may well be that the housing sector stabilizes over the summer months, and picks up in the third quarter. Lower mortgage rates and a stabilizing economy will help. Lower prices on homes will ulitimately stimulate demand, but for now may inhibit sales as the urgency to buy is mitigated. The housing sector is a long way from anything that can be called a recovery, but even a general stabilization would help boost GDP numbers by eliminating what has been a major negative on the numbers the past year.
Thursday, Sept 18
10:00 Philadelphia Fed Index
* Importance (A-F): The Philadelphia Fed Index merits a B.
* Source: The Philadelphia Federal Reserve bank.
* Release Time: Third Thursday of the month at 12 ET for the current month.
* Raw Data Available At: http://www.phil.frb.org/
There are many regional manufacturing surveys, and they tend to be ranked in order of timeliness and the importance of the region. The Philadelphia Fed's survey is first each month, actually coming out during the third week of the month for which it is reporting. Several smaller surveys are then released before the Chicago purchasing managers' report on the last day of each month. A few, such as the Atlanta and Richmond Fed surveys, are released after the NAPM and are of little value. The purchasing managers' reports are measured like the national NAPM - 50% marks the breakeven line between an expanding and contracting manufacturing sector. For the Philadelphia and Atlanta Fed indexes, 0 is the breakeven mark.
These surveys can be of some help in forecasting the national NAPM - particularly the Philadelphia and Chicago surveys which are more closely watched due to their timeliness and the fact that these regions represent a reasonable cross section of national manufacturing activities.
