6/3/08 (Lehman under fire, GM, New Math)

Traders,

Yesterday saw some serious pressure to the downside, we did have a fairly decent recovery going into the close, but still managed to close down -1% pretty much across the board. The VIX also got back up to almost 20, where it probably should be with all the whip-saw action this market has been seeing.

It was the big blow to the financial sector – when S&P finally stepped up to the plate and leveled an across the board credit down grade. I am sure after the Moody’s story about their own risk analytic depart rating AAA companies (like AMBAC and MBIA) to Junk status, yet Moody’s kept them at AAA? The credit rating agencies have lost tremendous amount of creditability – so maybe S&P’s downgrade yesterday help restore some of that. One thing for sure it blasted the Financial sector pretty good.

____________________________________
Lehman under fire

Lehman is squarely in the sights of investors, traders, and the credit rating agencies. It had a MASSIVE drop when the Bear Stearns news was released, but rebounded. It has tremendous amount of put trading activity (the skew curve is pretty steep), S&P has downgraded them, and now – analyst expect they will HAVE to raise capital as the credit crunch and housing unwind continues to drag on them.

Analyst are predicting that Lehman will report its first quarter loss since 1994 and they may be forced to raise capital. The S&P downgrade brought more aggregated eyeballs to the problem and has put some negative pressure on the stock. Expectations are for a .50-.75 per share loss for the 1st quarter.

The problem remains that they maintain very huge illiquid positions that rely on mark-to-market – write-downs continue to be concern. Even though that many of these positions have insurance (AMBAC and MBIA), Merrill Lynch can already testify that it may be no use – as Merrill had to cover some of their own losses on insured positions. The big financial insurance companies (even though STILL rated AAA) are short capital to cover the losses and THEY are looking for money. Lehman will not be able to rely on them to cover short-falls and defaults – that leaves them with one option – RAISE MORE MONEY. The foreign sovereign funds are getting pretty sick of hearing the same story “The worst is behind us”, only having to put in more money after more problems surface. The doubling up on investments in Citi have done nothing to save them and they have cut their dividend to make up short falls in capital.

So what is Lehman to do? Well, they could issue more bonds – but what kind of rate do you think they would get after the S&P downgrade? They could look to foreign sovereign funds (like everyone else), but they will DEMAND warrants, special shares, guarantee payments, and pretty much take the company for a song. They could sell shares, but that does not paint a pretty picture for investors and puts more pressure on the stock.

No doubt it will be volatile. However that is not stopping those investors “The Worst Is Behind Them” or the “It is already priced into the stock” buyers out there. After the downgrades, the put buying, and the high probability of needing more money – the bottom pickers are making their head long charge and starting to buy the stock in the pre-market.

Suggestion – don’t get caught up in speculation that the “worst is behind them” mentality. It is better to stay on the side lines or take small soft delta directional bets. One thing you can bet on they will remain volatile AND the probability has INCREASED in those OTM puts!

_________________________________________
GM derailed

The once giant in the industry that had made a massive rebound in 2007 up to $40 a share is currently trading $17 a share as they continue to get pounded on all sides, Union Strikes, weak dollar, increased competition in China, GMAC finance choking on losses, gas prices, and a drop in sales (since they are focused on SUVs and other gas guzzlers). So they have a plan (don’t they always?)
They are making one of the largest shifts in recent history and not just a cyclical change based on seasons or consume style demands – they are going to refocus their efforts on SMALLER fuel efficient vehicles. Most would say “Day Late and Dollar Short!” – but I guess it is more better late than never. The problem – will it be enough?

I think the U.S. auto makers are very much in the same camp as the airline industry – with rail thin margins. I don’t expect the company to be a growth company and it is probably fairly priced in the 15-25 range. They still face massive hurdles and the slowing economy and weak consumer buying power in the U.S. will make sales domestically very difficult (also commodity prices are hurting production). They have expanded overseas – but China and India are making HUGE strides in the auto sector and have been stealing market share in the Asian/Pacific region from GM in the consumer auto sector. GM can NOT compete on price with the big Chinese manufactures where sedans cost between $3-$5k.

The stock is getting a boost because it is a solid plan and something they NEED to do – and we may see it get back above $20 in the near future. But any play in the auto sector should be very short-term because the longer term horizon looks very volatile.

Expect some upside in GM – the stock is up in the pre-market as the CEO announces their huge plans. This should give the INDU a boost and give a little strength to the general market. However – it is really going to be about how much the investors out there “BUY” the restructuring story and willing to speculate on a POSTIVE future for the company. Investors stay away – traders come out and play.

________________________________________________
New Math -2 + -2 = 4 ?

I don’t want to spend too much time on this, but after you read this and then reread what I just wrote about Lehman – I think you views about the financial sector will NOT look positive.

Bloomberg’s story about the new math that defies common sense shows that the financial sector may be in bigger trouble than initially thought. The rule, known as Statement 159, adds the number of account techniques that are now surfacing that make almost no sense. Ironically the lobbying effort to introduce this rule was led by (guess who), Merrill, Morgan, Goldman, and Citi. Are those not the same companies that are seeing serious write downs now?

From the Bloomberg article:
Here's how it works, according to Richard Bove, an analyst at New York-based Ladenburg Thalmann & Co. A company decides to designate $100 million of its subordinated bonds as subject to mark-to-market accounting. The price of the bonds drops to 80 cents on the dollar from 100 cents. So the firm books $20 million on the ``presumed savings that you have on your liabilities,'' Bove said.
``In the real world you didn't save a dime,'' he said. ``You still owe the $100 million. It's another one of these accounting rules that basically takes you further and further away from reality.''

For the full story: http://www.bloomberg.com/apps/news?pid=20601109&sid=a2ppBYA0ELaU&refer=home

_________________________________________________
Futures Pre-Market

The futures are getting a small boost as oil comes off and GM talking about the “big change” – however the cash is fairly flat so we are seeing a little spread occur. Expect Arb traders to short futures into the opening as the spread narrows. We may get a boost at the opening to narrow the spread – but it seems rather weak at this point.

_________________________________________________
Support / Resistance

We are still in that range – even with the big pull back – not a place to take a long-term bias either way – but a great place for traders with gamma to play.

INDU 12400 / 12800 (12500 could be considered a short-term support, but not a place for investors to get long – traders can play it with gamma. Even if we close below 12500 it is really that 12400 area that I am concerned about holding. GM is showing some strength in the opening that may boost the INDU – but unless euphoria enters into the market – I am not sure how much strength we can see.)

NDX 2000 (That pivot point above it or below it – this is no doubt a big volatility area. We had see 1990 and 2020 – the new range seems to be the 1950 – 2050 area – but it is big volatility – and the range probably will not last too long.)

SPX 1375 / 1400 (Again still in the range – play the support/resistance if you are trading this – but investors should look to roll up their hedges right NOW because a break on the 1375 level does not look pretty down below. Yeah we could revisit 1400 – but why hope when you can hedge?)

RUT 720 / 740-750 (The upper resistance band has some volatility in it and but a solid break out close above 750 could help the market as a hole. This is the index to watch to see if money is flowing in or out on the broad scale. So far we have made a great two month climb – slowly – in the wake of an economic squeeze.)

________________________________________________
Conclusion

These financial companies cannot catch a break, or should I say get out of their own way – CEO’s getting fired, more write-downs, credit down grades, financial accounting issues, what next. I am surprised that they have still held their previous lows. We are at a SERIOUS support area in most the financials, back down to their lows during the Bear Stearns problem. This sector has given back almost ALL the gains from their recovery from March lows. If confidence and buying does NOT come in at these levels – those March supports will crack (some have) and we could see another big knock down in this sector. This is not a place to take long hard deltas based on technical supports (sure get long with some soft deltas and leveraged gamma – but don’t get naked long these stocks.) – so far the news continues to be negative in the financial sector. The accounting story from Bloomberg yesterday does NOT paint a sound picture that things will be any better and has added MORE skepticism as to their write downs and ANY profit reporting.
I was thinking that the summer could be a quite eye in the storm – but maybe I was wrong.

Bernanke is going to talk – can he bring confidence back – AGAIN? I hope he doesn’t quote the “CORE” as if inflation is moderate – that will shoot his creditability all to hell!