1/16/09 (Banks struggle, TARP round two, MLK)

Traders,

Interesting action yesterday – the market sold off pretty hard and then rebounded and closed up at the end of the day. Investors seem to be taking the bad news very well – maybe they are just Punch Drunk – like Rocky. Also we are all waiting with excitement for the Obama inauguration. Even a friend of mine (who is a die-hard Republican and really dislikes Obama) – went as far as to say – he appreciates that he brings Hope and Optimism to the table because in times like these that is all we may have. If HE is saying that – then the theory that we may get a sizeable rally off the inauguration (in my mind) is a pretty decent possibility.

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Banks still struggle….

Yesterday was JPMorgan and today it’s Citi and Bank of America. Remember the lesson I spoke of yesterday (raise money to write more down) – well these companies are not only going back to the well, but are seriously looking at ways to even stay afloat. Citi, whose biggest problem is that they are in too many markets is talking about a break-up of services after a $8 billion dollar write-down. Bank of American is going DEEP with a $138 billion bailout – expect more write downs. I guess the Countrywide and Merrill purchase had more strings attached.
A very good and wise friend of mine pointed out yesterday (about the WRITE DOWN lesson) – is that while assets maybe illiquid – there is a possibility that mark-to-market value maybe higher than anticipated if the underlying asset can show a revenue stream. Example that he gave – a house which might not sell at the perceived market value, may still be generating revenue via rent – which could cover a decent portion of the nut. So true he is and I certainly didn’t want my Lesson to make assumptions that the illiquid assets are worth ZERO – rather that they are worth significantly less than what the banks assume via their mark-to-myth. Thanks JP.

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Round Two….what to do with the banks.

Paulson used the Tarp money to make investments into the bank equity line – was it the right thing to do? It’s hard to tell – there is a large assumption (under Paulson’s method) that the banks will use it to stabilize balance sheets. The advantage to his method is certainly to the bank – as they can hold bad assets, write them down, and hope they can make money in the future. The problem – it keeps those illiquid assets on the book.
If you been following the bailout debate – round two looks to take a different approach and instead of giving the banks money in exchange for equity, they are going to BUY the assets themselves. There is good and bad with this method as well.
The good – it certainly takes those assets off the books of the banks – giving them more room to breathe. It also (if the government does it RIGHT) allows for a more transparent method to create a mark-to-market value. That is if the government creates a transparent market to post and trade price discovery of these products (something that has been talked about with a couple of exchanges). These assets COULD (that is a big IF) actually make money down the road. I seriously doubt it – as they will probably have to assume future losses before a bottom is found.
The bad – the government now holds these positions and at what price they assume them from the bank means the government could be taking future write-downs instead of the banks. Additionally (as JP pointed out) some may be good value and showing returns – while others may be fully junk! Additionally – the government will not participate in any appreciation in equity as the banks could rally off the lows as they are freed up of the toxic waste. Leaving the government holding the garbage.
Regardless – both approaches have their good and bad – the question is really which is going to get us to move forward? Personally – I think either way will work, why you ask? Because in either method the toxic assets WILL reach their REAL mark-to-market value (be that ZERO or some value slightly above it) – the question is WHO is going to mark them to their actual value first. So far the banks have been mark-to-mything them down each quarter – their problem is that they may NOT want to unload those toxic positions anymore because they could be closer to their actual value pretty soon – meaning that if they find a bottom they could eventually start to see profits again – so why give that up.
The debate is raging in Washington – as the controlling Democrat party is not happy with Paulson’s method and look to shift to purchasing the assets outright. It’s not about right or wrong – it’s about getting everyone to the same page to find the REAL value of these assets.
The bigger question – which is continual avoided – is how much MORE money is the government going to print and how much more debt can the government assume. The hidden stress on the dollar is building and that is something I am VERY concerned about . What might seem like the right thing to do today (bailout companies and people) may put the bigger economic backbone (national debt and the dollar) further into the whole.
It is interesting that the new stimulus package $700 billion – will in such a short-time will dwarf both the Katrina and Iraq war debt. This is not to pass the buck – but to show between War, National Disaster, and Economic Bailout – how much MORE can we load up the national credit card before foreign countries say – “Sorry, we are reducing your spending limit!”

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Treasuries vs. equities

Only a few short weeks ago we saw the lemmings chase the treasury yield curve to a negative number (which has never been done before) – people ACTUALLY paid the government to loan the government money. Talk about idiocy – but fear and greed make investors do stupid things. Now the flood of money is coming back out of the treasuries and surging back into equities – maybe we WILL see that Obama rally (abet short) before they rush back into treasuries. It’s like everyone is flip-flopping between fear and greed, will bottom picking ever end? Probably not. Keep an eye on the yield curve – getting in front of the lemmings maybe the winning trade. Remember retail investors are always the last one on the train and as the old J.P. Morgan story goes “When the shoe shine boy is giving you a stock tip – there is no one left to buy!” Sell Sell Sell. I’ll let you figure out the rest.

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Futures pre-market

Futures are getting a rally – in spite of the bank news. The spreads are in – so expect the Arb traders to short futures and buy the basket – thus sending a good jolt up in the market at the opening.

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Support / Resistance

INDU 8200 / 8500 (We went below 8200 most of the day – but rallied back above it. Remember it’s about the close!)

NDX 1100-1150 / 1200 (We again are between the 1150 – 1200 range. 1150 short-term support – which again we closed above it.)

SPX 800 (850) 900 (That 850 is the pivot point – did we sing hard and then rally or what. Watch the close and the 850 line)

RUT 400 (450) 500 (Again that 450 pivot / support saw some action yesterday.)

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Conclusion

Today is expiration so expect some action into the close. It will be interesting to see if we get any pin – risk, watch after hours trading with your do/do not exercise notices. It’s also a long weekend so we may see the decay priced in early.

Whether you are an Obama fan or not – this weekend MLK day – is a very special occasion. MLK would be 80 this year (I think) and it is a very emotional day for this country. I am a big fan of the Constitution – our founding fathers clearly understood what freedom was and regardless of their times – many knew that ALL MAN ARE CREATED EQUAL. It has taken this nation a long time to figure that out – we judge men by their actions and words – not their beliefs, color of their skin, or sexual orientation. It is a great move forward in this country (regardless of your political leanings). While I am certainly not a Democrat (nor Republican) and I don’t like many of the plans laid forth by the new administration – I am still very proud to be an American and to show the rest of the world – that in these times that a black man (of mixed race) with a Muslim name can hold the highest office in this country. This is a big achievement in a country with our history.
While this is a historical mile stone and we finish patting ourselves on the back for this occasion – we will be back to focusing on what we SHOULD do. I certainly will not be giving Obama any free passes (because of his achievements – which are very admirable) – just like I don’t give a pass to Ben, Hank, or Congress. We have serious work to do – so this weekend let us wave the flag as all Americans should be proud – but then we should quickly get back to friendly debate of what is the right course of action.

Have a great weekend.