1/15/09 (Write Down Lesson, Apple, ECB cuts)

Traders,

The question we were asking – is it support or not – well I think yesterday we realized that the reality of the news can sometimes bring down the hope and optimistic perception. The market just couldn’t hold up – after the retail numbers (down double what was expected) along with the mounting jobless claims had just sucked any optimism right out of the market.
Be that as it may – I still have “faith” that Obama’s inauguration will rise to the occasion and people will rush back in on the “Hope & Change” train that could spur a decent rally yet. Of course that is just another optimistic call. We as a people, nation, government, and president face a difficult road a head – we certainly do NOT know or should even pretend to know the correct course of action – we can only “Hope” that the leaders steer us in the right direction. One thing you can bet on with Obama (regardless if you agree with his policies or not) – unlike Bush – he can SELL the “Hope & Change” better than anyone – and that is a big step in bringing a positive mind set forward. Let’s hope that we don’t bring too much socialistic change that will suck the “life” out of this country and the road to prosperity (or serfdom).

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More Write Downs?

Sure…why not. Let me explain the write down game in the most simplistic measure so we are all on the same page. I am not trying to justify or get into any complex methods of accounting – but just to give us the “1000 foot view” so we understand why we can and will continue to see them.

1. The balance sheets of these companies are based on “Mark to Market” values of assets. Now “Mark-to-Market” works GREAT with listed and liquid securities – that have daily price discovery. Example – stock, options, futures – can all use Mark-to-Market accounting because you can SEE the price of each of these products as it trades throughout the day, in fact you can TRADE that product throughout the day. Investors use “mark-to-market” accounting to see their unrealized gains and losses in their stock portfolios. However, what happens when you want to “mark-to-market” something that does NOT have price discovery. Such as a house, a collectible item, or anything that is not traded on a daily basis? In the case of a home you hire an appraiser that looks at similar homes in the neighborhood and does some research and he/she comes up with an appraisal. Since your house is not traded every day there really is NO price discovery. You could say the appraiser is creating a theoretical value based on that moment in time – a “mark-to-market” value. It is important to remember that the value is not MARKET value but perceived market value. There is NO guarantee that you can sell your home for that price – it could sell for higher or lower. The appraisal value is really in the hands of the appraiser and how good are they at assessing the market value. Two appraisers will come up with two different prices. There is NO REAL MARKET value for the home – ONLY appraised value. That is important to remember as we move forward.
Well – many of these banks and brokerage firms hold illiquid assets (like the house example) and they are using a theoretical value from their own appraisal department. Since these assets don’t trade every day – they have to come up with a best guess as to their value if they DID sell them (not too much unlike the appraiser). This is one of the reasons that Buffet calls this “Mark-to-Myth” – since there is NO MARKET the MARK value is really the best guess and as liquidity dries up there is additional unseen volatility in the price (just like a home – if no homes have sold in 6 months in your area – maybe there are really no buyers at those levels – regardless of the appraised value). A good appraiser is one with experience, foresight, and knowledge of the area – the same is true for these financial appraisers. Thus – a big part of the balance sheet at these banks is based off a MARKED appraisal value, rather than an actual market value.

2. Banks have to maintain a certain level of capital to loan value, as well as reserves. Believe it or not – banks are very heavily regulated – between the Fed and FDIC, as well as the banking committees. This means they have to have so much capital vs. those positions they have. These banks held massive illiquid positions that were valued on Mark-to-Market, but since there was no real market for them, they used a theoretical value to mark these massive illiquid positions to. Part of the values were based on credit ratings, volatility, revenue, insurance, etc. It was a complex mess of theoretical numbers – but NONE of it contained ACTUAL market value – because there is no daily liquid market to price them to. The bank assumed, we assumed, the banking committee assumed, the Fed assumed, Congress assumed – everyone ASSUMED that these values were FAIR and ACCURATE – little did they know.


When the bottom fell out of the credit/housing market – and these banks held massive illiquid positions – based on access mark-to-market (remember these are theoretical values) – they started seeing losses. There was no one that wanted to buy them, since every bank was holding them. When they DID go out to the market to find a REAL price, not a theoretical price, the value of the assets were pennies on the dollar. That IS the REAL market. However they were in a pickle – if they actually used REAL market value of these assets (where they could actually sell them) – they would be out of business. They certainly would run out of capital and they banks would be upside down.
Quick – what to do? Well they couldn’t sell them and they couldn’t use REAL market values – so they needed a game plan and here it was and is. Going forward I will refer to Mark-to-Market value against actual market prices and Buffet’s “mark-to-myth” value as assumed theoretical value of the assets.

1. Lower the mark-to-myth value enough so that the bank can stay in business. WRITE DOWN
2. Raise more money for the next quarter to bring up the balance sheets against the debt.
3. Lower the mark-to-myth value enough so that the bank can stay in business. WRITE DOWN
4. Raise more money by selling stock to bring up the balance sheets against the debt.
5. Lower the mark-to-myth value enough so that the bank can stay in business. WRITE DOWN
6. Raise more money via TARP or mergers to bring up the balance sheets against the debt.
7. Lower the mark-to-myth value enough so that the bank can stay in business. WRITE DOWN

I think you get the picture. It really is that simple. Eventually (hopefully) they will actually get to the mark-to-MARKET value, rather than the theoretical value.

Now – I actually had someone argue with me that this is not the case at all. That the mark-to-market values were accurate. But it would stand to reason that if that were true – A. they would not continue to write down more losses and/or B. They would/should of sold them. You would think that after the 2nd quarter of massive losses they would just dump that paper, only and idiot would hold on to a losing position for 7-8 quarters. Additionally – while it did take some time – just looking through their balance sheets and quarterly report states the case. And lastly – if you are in the market you understand the difference between theoretical value and actual market values and what illiquidity means. Feel free to disagree with me – but I think if you take the simple 1000 foot view, look at the math, quarterly reports, capital raising, write downs per quarter versus balance sheet versus money they raised = the math is fairly clear.

So on with the story – and sorry for the boring lesson –

JP Morgan profit drops 76% on $2.9 billion of Write Downs – feel free to read more into that if you’d like, but I think I explained it above.

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Apple and Jobs

Steve Jobs has stepped away and very unfortunately the internet rumors were true – he is possibly going in for surgery. Let’s just hope he will be better soon. The question is how much is Apple’s stock price Jobs vs. Apple. Not to be morbid – but Job’s possible surgery is costing Apple about $4 in the pre-market of about 5%. I wrote a more detailed story about this several Market Previews ago – which can be reviewed at http://marketpreview.blogspot.com/2009/01/1609-us-post-apple-jobs-green-back.html

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ECB cuts!

ECB seems to be following Bernanke in the race to the bottom, but they forgot that Bernanke won – he reached Zero first. Europe is a different animal – because each country still issues bonds, have different GDPs, interest rates, etc. – but they do share a common currency. There are definitely some bond plays going on – but the key Euro rate is now at 2% (still higher than the USD). The policy has seemed to shift from currency protection (inflation) to bailing out, but we are seeing it in stages with Germany recently injecting 70 billion in bailout money. I think the ECB and the European Union is a hard and more complex animal to understand – because while they do share a currency – they still are independent countries.

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Futures Pre-market

The futures are seeing some volatility – Producer Prices Fall 1.9% but Initial Jobless claims rise more than forecast – the push-pull in the news and perception is really giving the futures a good jerk around in the morning. So far the spreads are in – so Arb traders will be buying the futures to sell the stocks at the opening – expect some pressure at the opening, but it COULD turn around quickly.

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Support / Resistance

Well it didn’t look good yesterday and we could certainly see more pressure to the down side – but Obama is about to make history and a historic speech that could bring optimistic euphoria back into the market. Who knows – but expect some more volatility.

INDU 8200 / 8500 (We are at another support area – do we rally or continue to sell off?)

NDX 1100 – 1150 / 1200 (We are at a first level of support 1150, but 1100 is a more solid support area – where are we to go?)

SPX 800 (850) 900 (850 could be support or just a massive pivot point to send us to 900 or 800 - ???)

RUT 400 (450) 500 (Again 450 is support or a pivot point - ????)

I think we could see some support at these numbers – if people feel and believe the bad data is “priced in” – but it is really about perception at this point.

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Conclusion

Let’s hope that Job’s recovers soon – he is an American Icon. Also – let’s HOPE that Obama can spark some more optimism. Notice I used “hope” twice already – I really hate using Hope to make any value or judgment calls – as I tend to be more of a realist – rather than an optimist or pessimist. The market is getting seeing some knock down by more bad news – the storm looks to get worse – the question we all are asking is the new captain going to lead us through the storm?

Does hope spring eternal? I think so – but hope can’t avoid math either.