Monday, September 15, 2008

September 15, 2008: Morning Call

September 15, 2008: Morning Call

Fair Value: SP500 – 1253.75; NDX: 1778.33; DOW – 11427

Technical Levels:

SPX: 1136-1142, 1205 support/1235, 1250, 1298-1300, 1337, 1365 resistance

NASDAQ: 2210 support /2264, 2303, 2341, 2386, 2428 resistance:


08:30: Empire Manufacturing (Sep): 1.0 (weaker –7.4%).
09:15: Industrial Production (August): -0.3%; Capacity Utilization: 79.6%
10:00: NCC Shareholders Meeting
14:00: WMT presenting at Bank of America Investment Conference
17:00: HPQ Analyst Meeting

Foreign Market Summary/Key Macro News/Commentary:

Are you the consensus view?

SP futures are trading approximately 45-50 points below fair value on the LEH Chapter 11 filing and the collapse in AIG’s shares at 09:30am ET. AIG has been down as much as 50% this morning on news reports that the company has attempted to obtain a $40 billion dollar bridge loan from the Federal Reserve. The consensus view continues to underestimate the impact of the collapse in the credit and housing markets. Market participants must continue to be creative in terms of assessing risk (VaR has been useless ever since August of 2007). There is currently an enormous range of possibilities in terms of the direction of asset prices so most market participants utilizing leverage will continue to get killed. Recall that just a few short weeks ago very few traders believed Crude oil would drop below 100 and just last week nobody thought the Fed would cut rates tomorrow; right now, Fed Funds futures are discounting a 80% chance of a 25 basis point cut tomorrow. Risk management and capital preservation remain paramount because, as Bill Gross noted in his September commentary, the “current deleveraging has managed to sink all three primary asset classes in aggregate… the current year-over-year decline of over 10% has never really been witnessed since the Great Depression”. Even though AIG has been in the bear’s crosshairs for some time, the decline in the stock should remove any doubt that additional stress at major financial institutions is highly likely. Of course, I would never completely discount the possibility that the housing market could stabilize which would trigger a massive rally in equities. The broader averages have held up remarkably well despite the carnage underneath the surface. The performance in the broader averages reflects the fact that the consensus continues to bet on a V-shaped recovery in the economy and the markets (Another thesis could be that absolute return managers are short indexes against some of the more crowded hedge fund sectors). The dip buyers have been proved incorrect and the path of least resistance is still to the downside in the short-term despite the firm layer of initial support at the July 15 lows. My next support level on the S&P 500 stands at 1136, which is the April 22, 2005 weekly low. It appears risky to attempt to position for a big bounce off the initial test of the July 15, 2008 index lows.

But, here is a look at how various sectors reacted in the trading days following the March 17 and July 15 lows.

The best performing sectors in the 10 trading sessions following the March 17 lows included the homebuilders (up 18.5%), REITs (up 15.6%), Mortgage and Thrifts (up 14.6%). Outside the financial and housing related sectors, the biggest bounce off the March 17 lows was in the Internet sector (up 8%), hotels (up 7.5%), and Fertilizer (7.17%). The best performing sectors in the 10 trading sessions following the July 15, 2008 lows included the diversified financials (up 52%), Regional Banks (up 42.9%), Insurance (up 20.5%). Outside the financials and housing sectors, the biggest bounce off the July 15 lows included the Railroads (up 18.3%), Hotels (17.9%), and Internet sectors (up 13.1%). The Gold and Semiconductor equipment sectors were the weakest during the sharp bounce off the March and July lows. Gold stocks fell 12.8% in March and 5.0% in July in the 10 sessions after the low was established. Semiconductor equipment stocks were also weak off the March lows (down 6.5%) and July lows (4.3%).

Impact Research Calls/Market Moving News:

AIG (12.14): NY Times DealBook reports that AIG is seeking a $40B bridge loan from the Fed: It was reported earlier that AIG would announce plans Monday to sell assets including ILFC and perhaps receive a capital injection from private equity firms. The WSJ subsequently reported that AIG turned down private equity firms and had asked the Fed for help. DealBook reports that AIG is seeking a $40B bridge loan from the Fed, and says that JC Flowers, KKR, and TPG all withdrew expressions of interest at the last minute, citing fear for the company's financial health. DealBook also reports that AIG will not sell ILFC due to concern that certain tax advantages of the unit cannot be realized by any other owner. Both DealBook and the WSJ said it is unclear how the Fed will respond to AIG's request.

LEH (3.65): Lehman Brothers files for Chatper 11 bankruptcy
Lehman lists assets as of 31-May of $639B and total debts of $613B. Lehman has asked the court to extend the deadline to file a list of all equity security holders and is asking for an extension to the 15-day period by an additional 45 days.

BAC (33.74); MER (17.05): Bank of America (BAC) acquires Merrill Lynch in $50B all stock deal: Under terms of the transaction, Bank of America would exchange 0.8595 shares of Bank of America common stock for each Merrill Lynch common share. The price is 1.8 times stated tangible book value. Bank of America expects to achieve $7B in pre-tax expense savings, fully realized by 2012. The acquisition is expected to be accretive to earnings by 2010. The transaction is expected to close in Q1 of 2009.

LEH (3.65): Oppenheimer's Meredith Whitney comments on Lehman Brothers:
Whitney believes the immediate impact of LEH's liquidation will be dramatic credit spread widening and ultimately negative valuation marks for the remaining players in the market. Oppenheimer anticipates a broad-based decline in marks on asset values within the financial markets and says the liquidation of LEH's assets will force the other brokers to mark down their assets accordingly and pressure all capital ratios. Whitney says the liquidation by LEH's counterparties and asset sales will be swift and volatility and pricing pressure will be dramatic. Oppenheimer says the financial markets will likely be under unprecedented strain over the next several days as players respond to outsized industry deleveraging.

JPM (41.17); GS (154.21): JPMorgan (JPM) and Goldman Sachs (GS) downgraded at Merrill Lynch: JPM is downgraded to underpeform from neutral. GS is downgraded to neutral from buy

BAC (33.74); MER (17.05): Oppenheimer's Meredith Whitney comments on Bank of America (BAC) purchase of Merrill Lynch (MER): Oppenheimer says MER's wealth management business is second to none, and with ~$1.6 trillion in client assets; it will greatly augment BAC's ~$589B in wealth management assets. Oppenheimer says that while they view this clearly as a long-term positive for BAC, the stock will likely not respond accordingly as investors near term will focus on greater systemic risk, and BAC's sizable consumer loan exposure will overshadow any long-term positives in the deal. The firm values MER at ~$27 to ~$35 per share and notes the difference between the purchase price and their valuation is likely due to a valuation discount for risky assets still on the balance sheet and for the fact that MER was in a vulnerable position.

AAPL (148.94): Apple reiterated buy at Citi: Firm cites Asian checks, geographic expansion of iPhone and declines of component prices, and valuation reaffirm stance. Target price, $287

GOOG (437.66): Google smartphone to be launched in US this month - Dow Jones:
A High Tech Computer (2498.TT) executive gives the timeframe.

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