6/2/08 (Paulson / Wachovia CEO fired / Dividend Cuts)

Traders,

The DNC meeting over the weekend brought as much clarity to the political race as the financial news has brought to the economic landscape.

Bloomberg had a report on Treasury Sec. Paulson speech over the weekend. He said it will take months before financial market turmoil ends and says he is commitied to a strong dollar. However, SAYING you are for a “Strong Dollar” is a lot different than what they are actually doing. The rate cuts, injections of capital, and special deals at the discount window – is the exact opposite of a strong dollar. Additionally, many multi-national firms are seeing huge benefits from the weak dollar as their domestic revenue dries up. What would happen if the dollar go stronger?

Paulson was speaking in Abu Dhabi when he made the comments. When questioned he went on to say “We’re taking aobut months and there will continue to be bumps in the road.” He was continually asked what is he going to do with the weak dollar, which has fallen 14% against the Euro. But dodging the question directly (while supporting a supposed “Strong dollar”) he simply said, “Every economy is going to have its ups and downs, and the U.S. is going through a tough period. I believe the long-term economic fundamentals will be reflected in our currency.”

However, it seems what is on the mind of the Middle East is what is the strength of the dollar and concerns about the future political change (new administration in the coming year) and their concern about private equity and sovergin fund investments, would the U.S. still welcome foreign investments? Of course Paulson can only say for now – because the future is most uncertain. There is much concern because they have already seen that the Democrats have been against Soverign Fund investments – and with the current administration popularity reaching an all-time low, combined credit problems, and weak dollar – they too must plan for their own future.
Continue to expect volatlitiy.

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Another CEO bites the dust

It was only time before another CEO made the permante move to the golf course, this time it is Mr. Thompson of Wachovia (the 4th largest U.S. bank). Shareholders and board members demanded that he quit after the company posted its first quarter loss since 2001 because of writedowns in the subprime loan area – coupled with ongoing risk in the rising home loan defaults. Something must be down now – and firing the CEO seems like a short-term solution – even though it doesn’t address the risk on the books – it sure makes the shareholders feel a little better. Thompson did steer the ship into rough waters, their largest home loan exposure is in Florida and California (two of the largest states that are seeing pressure in the continuing home problem), additionally the take-over of Golden West Financial in 2006 was in his words “ill-timed”.

So far writedowns at financial institutions have almost reached $400 billion and according to Goldman there is about another $150-$250 billion yet to come. Citi, Merrill Lynch, Wachovia – we should start a office pool – who is next?

WHACK-ovia is seeing a little pressure in the pre-market – as uncertainity remains on the forefront in the financial sector.

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Dividends at risk?

Citi was the first that promised they would NOT cut their dividend, but they did. Now more companies that have taken serious writedowns, looking to raise money via bonds or other methods, are looking to cut dividends to shore up cash flow. Bloomberg ran a story about these big companies and their ongoing issues – and what the dividend means to the company.
Companies like GM which are seeing the hurt on all sides (from a slowdown in sales, GMAC finance writedowns in the sub-prime, loan payments, and union fights) have been paying out a nice dividend. But is it at risk of being cut? If we were to believe the likes of Citi – it would be no, but they may not have a choice. Bloomberg went on to point out other companies in similar situation.
But there is an additional issue for derivative traders – dividends play a significant part in option pricing models. As history has shown huge distruptions and risk when Microsoft issued a dividend a few years ago – created issues in both MSFT option and also indices that MSFT is in.

Additionally – moving the X-Date, one-time special dividends, dividend removal, etc – cause disruption and risks. Typical pricing models only assume two variable risk factors the big one traditionally being Volatility (VEGA) and the second being Interest (RHO) – is their now a new Greek to calculate dividend RISK (as per being cut, increased, or decreased) – no doubt it will affect reversal / conversion arbitrage and other dividend capture plays. The question we must ask – is the dividend at risk in the issue we trade and if we are hedged out on the long side – we could expect losses. I guess the reversals are smiling all the way to the bank – when and if those dividends get cut!

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Futures Pre-Open

Even with oil pulling back down in the pre-market to the support area (125-126) the futures are seeing pressure as renewed concerns in the financial sector continue to surface. Paulson didn’t given any good news to the future – but instead talked about more bumps. The futures are seeing some pressure on the opening and are front running the cash about a couple of points. Expect ARB traders to put pressure on the cash-basket in the opening as the leg from the long side on the futures.

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Support / Resistance

We saw a good bump in the indices last week off the short-term supports – and volatility continues to be the major factor in the markets. The VIX had hit 20, but then pulled off as the markets rallied. Continue to watch this range – it so far has not indicated that we are out of the woods, yet.

INDU 12,400 / 12,800 (We got a good few day run in, but Friday started to show weakness. We are still in the range and is not really a place to get long or short. Stay neutral and keep gamma working for you. Don’t take a hedged directional delta until we get to one of the end points.)

NDX 1950-2000 / 2040 (we got up above the short-term resistance – now short-term support of 2000 and back into the top part of the band. Several of the over-weights pushed hard and drove this higher. 2000 is not a place to get long, but rather neutral – watch the 2040 area. This is a neutral trading band)

SPX 1400 (This is a pivot point that we rallied back up to last week. We had been above it and almost to 1450 only to see it retrace down to the 1380 area. It IS a short-term resistance and we look to be coming off this morning – as the futures are seeing some pressure (about 7 points). Let’s see if we can close above it at the close.)

RUT 720 / 740-750 (Again we are back into this resistance band – there is volatility in this range – but remains resistance unless we can get above it and turn it into support. The RUT is seeing about 3 -4 points to the downside at the opening.)

The volatile market has made reisitance and support larger bands due to volatility. It is less of an exact number that determines these short-term points – because of the increase in volatility. Traditionally – the slippage is fairly narrow – but now we are seeing several points in these bands. Just another indication of volatility.

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Conclusion

Last week was a short week but saw the dollar strengthen and oil make a serious pull back. However, as Paulson pointed out and with the ousting of Wachovia CEO the problem in the financial markets is still with us.

I am seeing home prices here in Florida fall more that 50%, yeah more than 50%. Example – two houses in my neighborhood, which had just sold a year to 2 years ago (one that sold at $2 million currently listed at $1.1 million by the bank and another that sold for $1.6 million being offered at $700k). The sad thing – neither has sold and have been REO since Jan. (that’s 6 months). I think we may be getting close to a bottom in the market – but the problem is no one is buying. The question is, do the banks lower the prices on these REOs to get them off the books or hold them and hope? So far we are seeing slight price drops – and some could argue the prices are already very low – but they are still not moving. Not a single house in my hood has sold and more are being listed (more and more REOs). So it will soon be up to the banks if we find a bottom. If the majority become REOs and the bank decides to HOLD them at price and not lower them – then we could say we found a bottom, but the bottom could last a long time. So far – sales are moving at a snail’s pace. There are some houses that are selling. We maybe at a bottom – but I think rather than foreclosures it will be banks determining prices (depending how long they can hold them.)

The dollar has seemed to find a bottom and oil has also seemed to top out – however every pause has seemed like a place where buyers just step back in. The dollar may see strength if investors think that the FED will raise rates – but for now that is a gamble. The economic landscape still looks weak at this point and oil is still up above $100. I don’t think getting long the green-back for any size is anything – but a gamble.