Staring Again At 1200 on the S&P 500, the Government Again Tries to Intervene -
including more commentary on global growth
By Dr. Duru written for One-Twenty
September 8, 2008
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As much of the nation mourns a potentially season-ending injury to New England Patriots star quarterback Tom Brady, it might miss that this weekend also marked a sad milestone for American "free-market" capitalism. The Federal government finally did what almost everyone surely assumed as a foregone conclusion: the Feds seized Freddie Mac and Fannie Mae and placed them into the conservatorship of their regulator, the Office of Federal Housing Enterprise Oversight (OFHEO). Treasury Secretary Henry M. Paulson, Jr. threatened the market with a "bazooka" in the hopes that he would not actually have to use it, and the market instead pressed the pedal to the metal in calling the bluff.
And of course the market called the bluff. Over and over during America's on-going financial crisis, we have had to suffer through claim after claim by the people that run and regulate our financial institutions that either all is well and sound, no additional capital is needed, liquidity is adequate, the bottom is at hand, and/or the entire kitchen sink of broken plumbing has been thrown into the write-off garbage bin - only to hear sooner than later that the exact opposite is the case. Here we go again. As late as July 11, Paulson claimed that "Today our primary focus is supporting Fannie Mae and Freddie Mac in their current form as they carry out their important mission." Bloomberg went on to report that "Paulson's remarks indicate he wants to reassure shareholders they won't be wiped out by any government efforts to ensure the stability of the firms..." Fannie Mae spokesman Chuck Greener chimed in that Fannie Mae "...has access to ample sources of liquidity, including access to the debt markets, and Freddie Mac added that it was "...adequately capitalized, highly liquid..." Let's not even mention the analysts who declared July's swoon to be an excellent buying opportunity (which it was - for short-term traders). How little is the understanding of so many people "in the know" about what is going on - Meredith Whitney has been a breath of fresh air although her dose of hard reality checks have been hard for folks to swallow.
This is a sad day for American capitalism because, despite rhetoric that may suggest the contrary, the hard-earned taxes of the American people will be put to work to socialize the risks of speculators who over-reached in search of private profits. (kudos to Paulson for at least appearing to try to protect the interests of taxpayers by spreading the pain to Freddie and Fannie stockholders...who probably will also feel like victims here. Paulson has also made it clear he is not happy about what he has "had to do").This intervention will occur on a massive and historic scale. We also must wonder how much better can the government manage this mess than the private market did? The main advantage that the government has over the private sector is its power to tax the people and its power to print more dollars. This conservatorship has confirmed for me that both are in play in a major way. Thus, this has confirmed my continued lack of faith in the U.S. dollar. I am also disappointed to read the Wall Street Journal report that the current CEOs of Fannie and Freddie may walk away from this disaster with attractive exit packages: "Mr. Syron may walk away with an exit package that could total as much as $15 million, says David Schmidt, a senior consultant at James F. Reda & Associates LLC, a compensation consulting concern in New York. That includes a pension and deferred compensation, about $3.7 million in severance pay and a possible payment of $8.8 million to compensate for forfeiting recent equity grants. Mr. Mudd's exit package, including stock he already owns, could total $14 million, Mr. Schmidt estimates. That includes $5 million in pension and deferred compensation, $4.2 million in severance pay and $3.4 million of restricted stock, based on Friday's closing price. That value of that stock could fall sharply, however." With these kinds of potential pay-offs for achieving such poor results, can we honestly say there was enough incentive to do well? Yikes... Anyway, a good outcome from all this might be a simpler tax code that discourages the abuse of leverage in financing homes, and a social ethos that re-focuses on owning a home outright (home security) and frowns upon staying indebted to a house for a lifetime (home insecurity).
Now, is it any accident that the government's latest market intervention comes just as we are staring again at 1200 on the S&P 500, and the major indices threaten fresh 52-week lows? I think not. Since last Fall, every bounce we have had from climactic lows has come after the government announced some surprise intervention. The small difference this time is that the market seems to have anticipated the intervention in time to buy into the close on Friday ahead of the government's move. Financials and housing stocks were especially strong beneficiaries of the bounce after the morning despair from another horrible jobs report - this time showing the unemployment rate has popped up to 6.1%, the highest rate in five years. (And for all of you "lagging indicator" people, I finally have to agree that this number is lagging...it apparently cannot keep up with the real decline in the economy!). Another difference is that this intervention has come after the failure of a very weak rally from the last government-induced bounce in July.
I now find myself torn on what to do next. I suggested buying into the July lows for the S&P 500 because the selling had reached historic proportions. Less than a month later, I found myself backing off given the weakness I saw in the ensuing rally. Both recommendations proved timely on the S&P 500. This time around, I have a lot less confidence in guessing at the market's next moves. On the one hand, I think I made a decent case for a bear market rally that takes us back to the May highs before year-end. On the other hand, the rally off July's low was tepid and unconvincing while the sell-off that began post-Labor Day trading was sharp and quite convincing. Before Friday, I was getting ready to write an extremely bearish missive, but after Friday I still wonder just how many times government intervention will "work" to prop up the stock market.
If I believed that the remaining financial problems in the world come from Fannie and Freddie, I would have to bang the table ever more loudly for another bear market bounce that finally takes us to the May highs in less than four months. But we can have little comfort that Freddie and Fannie are behind us. Additionally, global stock markets have sold off hard for months not because of Freddie/Fannie fears but because the global growth story has been slowly unraveling. Even worse, from a technical perspective, we are nowhere close to a selling climax. As faithful readers know, I keep my eye on the T2108 indicator, and it tells me we have a lot further to fall before reaching a new climactic low. TraderMike, as usual, puts together a good story on this and includes the T2108 indicator. His September 5th recap is also good reading for those of you with a technical eye. Essentially, the markets are primed for a nice short-term bounce that short-term traders will love, but the sustainability of such a bounce is highly doubtful. Overhead resistance should prove tough to break, and only such a break would bring back my confidence (for example, a high-volume move over 1300 on the S&P 500). So, if I was forced to make a conclusion, I would say sell this rally until "further notice." Alan Farley has a good related piece called "Wait for Proof of a Turnaround."
At the time of writing, global stock markets are rallying, presumably as a positive response to the Fannie/Freddie action. I can understand the trigger-finger excitement. Institutions and governments worldwide hold substantial financial interests in the toxic paper of Fannie Mae and Freddie Mac, and they have been given fresh reasons to believe in the magic of America's currency printing presses. But as Congress slugs it out over the plan and as the enormity of the financial commitment sinks in again, we should not be surprised to see the excitement quickly fade. Interestingly, Paulson included the following caution in his take-over announcement: "Nothing about our actions today in any way reflects a changed view of the housing correction or of the strength of other U.S. financial institutions." Buyer beware.
I want to conclude with a few more quick observations. Some of which are quite delayed in the making, but I want to go ahead and take this opportunity to make them...
Jim Cramer is asking for the Federal Reserve to cut rates again. I guess because rate cuts have worked so well so far. Maybe the Freddie/Fannie action forestalls such a move, but it sure seems to me that the U.S. will not stand idly by as the rest of the world moves quickly to debase their currencies in efforts to stoke their own growth.
As governments around the world begin to worry about the health and growth of their economies, American CEOs are still telling us the global growth story remains largely intact...with few exception. Here is my latest sampling of commentaries:
Joy Global (JOYG) - mining equipment and related machinery
The CEO of JOYG defends his company on Mad Money in the aftermath of an ugly 19% crash in the stock price following earnings on September 2. I believe the market did not like the outlook on margins, but JOYG RAISED earnings guidance and reaffirmed revenue guidance. I chose to get long JOYG and competitor Bucyrus (BUCY) after this collapse in anticipation of a strong relief rally from this (short-term?) over-reaction.
Terex (TEX) - industrial equipment
TEX issued a major earnings warning on September 4th and was crushed for a 20% one-day loss: "While our Cranes and Materials Processing & Mining segments continue to perform better than our expectations, continued market softening and input costs in the Aerial Work Platforms and Construction segments in Western Europe and the United States are expected to more than offset those positive factors..." In other words, TEX is claiming that the commodity-related business remains quite robust.
Pan American Silver (PAAS) - silver mining
During the August 13th conference call, PAAS insisted that "...we are witnessing some short term trading volatility and I remain very optimistic that we will see silver and gold trend much higher over the balance of this year and in the 2009." President and CEO Geoff Burns even offered: "I personally do not believe that the fundamentals it took silver to over $20 per ounce in March of this year and helped the silver price average close to $17.50 for the first six months of 2008 have significantly changed."
Dryships (DRYS) - dry bulk shipping
The transcripts on Seeking Alpha from the August 22 earnings report provide us the following revealing quotes:
"Taking a look at the Baltic Dry Index or BDI we can see from the dark blue lines representing 2008 that the market has reached historic highs earlier this year. The seasonal slowdown we are witnessing these days is expected to reverse as China comes back from the Olympics and demand picks up again. We expect the tight supply and demand balance and the continued strong input of iron ore and coal into Southeast Asia and particularly China to continue for the balance of the year."
95% of analyst's questions covered financial and shipping topics unrelated to speculations about global growth. However, toward the very end, Jay Goodgal of Castalia Advisers asked: "Can you talk about the market in the fourth quarter with current levels of inventory stock levels at 64 million metric tons for iron ore in China or above depending upon estimates and thatís either normal levels or higher and anywhere between three and half and four and a quarter percent estimate of the fleet being delivered to the balance of the year, why do you think rates are going up?" Here is the response from George Economou: "I think you are going to see increase in coal movement. You have a tradition dull moment in the summer. You have a lot of the Europeans that take the coal during the summer and they start increasing again in September, you will see the same in coal in Southeast Asia. Iron ore, 64 million tones is high but not exorbitant and we still think that there was a slow down because of the Olympics and we believe that you would see a gain and increased activity in terms of tone mile. "
In other words, DRYS confirms suspicions that China brought its economy to a "halt" for the Olympics. In addition to seasonal lulls, this stoppage should prove to be a temporary halt in the global growth story.
Fluor Corp (FLR) - infrastructure
The transcripts on Seeking Alpha from the August 11 conference call provided a lot of good material on the outlook for global growth:
"Overall, we continue to see very strong demand across many of our markets including oil and gas, infrastructure and mining. We're seeing the market for power pick up as well."
"For Industrial and Infrastructure, the two most active markets here are certainly mining and infrastructure which includes transportation. Touching on mining first...there are some very sizable projects slated for the second half of the year. These continue to be driven by investment to expand both copper and iron ore supply and by very strong commodity prices. We also see viable prospects associated with alumina, gold, tar sands, nickel and uranium. We anticipate strong demand for large capital projects in this market segment, well past the end of the year."
"...the whole sector [has] moved down with oil over the last month to six weeks, which [is] amazing because oil is still at a price that is significantly more than what I would need [to warrant] investments in the projects we are all looking at. So I think if there is if anything that the market works out today represents a great opportunity for the overall... for the whole segment as oil prices are still at a very strong level to justify the capital programs that our clients have."
"...we've been really focused on the... what I call the downstream side of solar. To me, that's where the real opportunity lies because the plants that are necessary to make the product to create a solar cell are a lot more complex, lot more capital intensive than actual solar farm would be. And so that's what we're focused to our chemicals businesses producing the polysilicon that goes into those cells"
I particularly like the nod to solar...!
Global growth summary
So, what does it mean when all these corporate executives declare that the global growth story is intact even as the market sells off in contradiction? Your guess is as good as mine. The market's imperfect discounting mechanism is trying to predict a global recession ahead of the game. For reference, the U.S. stock market has experienced repeated sell-offs since 2005 in anticipation of a significant slowdown in America, and we still have yet to record two consecutive quarters of economic contraction. The company executives are not going to give you any advance warning. What you choose to do depends on how you balance chart technicals vs market fundamentals, short-term vs long-term, and your own analyses independent of what is broadcast in mainstream media. I still prefer to buy into deep sell-offs in the commodity space and sell on the subsequent sharp rallies. I now believe that commodity-related names are well oversold and are worth playing for another sharp bounce. But further out, I do think that global growth is at risk and will be even more convinced the more that global governments act to intervene in their respective economies.
Be careful out there!
Full disclosure: Long S&P 500 in an index mutual fund, JOYG, BUCY. For other disclaimers click here.