Friday, September 19, 2008

September 19, 2008: Morning Call

September 19, 2008: Morning Call

Fair Value: SP500 – 1209.28; NDX: 1708.95; DOW – 11031

Technical Levels:

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

NASDAQ: 2020 support /2210, 2264, 2303 resistance:


Pre-market EPS:
10:00: Treasury Secretary Paulson announces press conference to discuss comprehensive plan for financial markets.
13:00: Fed’s Evans speaks on Economy

Foreign Market Summary/Key Macro News/Commentary:

Up is Down and Right is Wrong

The S&P futures are trading 40 points above fair value and the NASDAQ futures are trading 48 points above fair value at 8am ET capping one of the most emotional and tumultuous trading weeks in US financial market history. The S&P 500 futures have bounced 100 points (8.8%) off the 1136-1142 support area sending the broader average toward key technical resistance at 1250 on the news of an epic government intervention in US financial markets. Asian markets surged higher in the overnight session with stunning gains of 10% in China on the confirmed news that the Federal Reserve and US Treasury are proposing a plan to remove troubled assets off the balance sheets of financial firms and speculation of a plan to insure money market funds (the Treasury just officially announced the money-market fund guarantee plan at 7:29am ET). In addition, the SEC has banned short selling in 799 financial companies for the next 10 trading sessions and this news is certainly fueling some of the gains in world markets (UK was up nearly 9% at the highs and is poised to have its biggest percentage gain on records). But, the stronger bid in the markets related to short selling will likely prove temporary. There are certainly open questions about how the levered short ETF’s (SKF, SDS, DUG, FXP, SRS, QID, ect) will trade given these rules. Option traders should also expect and position themselves for significant skews in October and longer-dated option contracts in the financial sector. The regulators cannot ban put buying and there will definitely be a market-maker exemption so that the counter-party to the put purchase can establish short-hedge. Given the enormity of the rule changes, I would not rule out significant derivative skews in the broader markets and other sectors that are not impacted directly by the SEC rule because the short-sale proposal does significant damage to the efficient functioning of equity markets. The S&P 500 is now testing the 1250 resistance area and I would be scaling out of long exposure here. After the dust settles and the forced buying eases, the market will begin to focus on Q3 earnings/Q4 guidance and EPS estimates will certainly be under pressure because the global economy has effectively grounded to a halt. Initiating short positions at current levels (1253 area on the S&P futures) also makes sense but recognize that trading conditions are highly emotional. Although some type of a RTC bailout became inevitable over the last few days, the magnitude of the intervention in the markets is nothing short of remarkable and will definitely lead to a more treacherous and uncertain trading environment particularly while the short-sale rules are in place.

Impact Research Calls/Market Moving News:

Treasury announces guaranty program for money market funds
The move had been one of those contemplated by the WSJ and other media sources, as part of the administration's efforts to address the financial crisis. Funds must pay a fee to participate in the program, and those whose NAVs fall below $1 will be notified that they are eligible for the insurance program. President Bush has authorized up to $50B from the Treasury's Exchange Stabilization Fund to finance the program. The Treasury says: "This action should enhance market confidence and alleviate investors' concerns about the ability for money market mutual funds to absorb a loss."

MS (22.55): Potential Morgan Stanley-Wachovia Corp (WB) deal has Blue Devil feel to it – NYT: Sources say MS would prefer to remain independent, but the talks are picking up pace. MS CEO John Mack and WB CEO Robert Steel are both trustees of Duke University. One option being considered is to split WB into a good bank and bad bank, and then have MS merge with the good bank. The two parties are also discussing the possibility of bringing in a third-party investor like China Investment Corporation, which is run by Gao Xi-Qing, another Duke trustee.

MS (22.55): China Investment Corp (CIC) official says Morgan Stanley (MS), Goldman (GS) can solve their own problems -- Xinhua (Bloomberg): The CIC is "cautious" on overseas investment. Xinhua is citing an unidentified CIC official. Recall there were several reports yesterday that MS CEO Mack was talking on selling a minority stake to China, with some reports indicating that stake may be as high as 49%.

Short-selling scrutiny may prevent financials from bottoming - WSJ
In a "Heard on the Street" column, the Journal reports that by targeting short-sales of financial stocks, regulators in the US and UK may make it difficult for financials to find a true bottom. The article notes that short selling is a crucial component of risk management, while adding that a ban could also wreak havoc for large pockets of the derivatives market. The column goes on to note that short-selling restrictions could also dampen the debate surrounding the health of companies.

Large oil firms think about consolidation - WSJ: The financial crisis and falling oil prices are presenting conditions favoring consolidation, as smaller producers have ample drillable land but inadequate access to debt and equity markets. Buyers are expected to be major players with lots of cash like Royal Dutch Shell (RDS.A), BP (BP), Exxon Mobil (XOM), Devon Energy Corp (DVN), or Occidental Petroleum Corp (OXY). Targets are expected to include Petrohawk Energy (HAWK) and Southwestern Energy (SWN).

BG (69.77); ADM (21.53): Archer-Daniels (ADM), Bunge Ltd (BG) target price reduced at Citi: ADM tp reduced to $25 from $30; BG top reduced to $82 from $95. Firm says companies appear to be poised for negative EPS revisions on weakening fundamentals in soybeans.

Credit default swaps quickly dropping, according to CMA: WB, MS, GS (Bloomberg): WB default swaps fall 94bp to 552 bps (was 638 bp in 07:16ET comment) MS default swaps fall 168bp to 700 bps (was 829 bp in 07:16ET comment) GS default swaps fall 120bp to 372 bps (was 440 bp in 07:16ET comment).

Wilmington Trust (WL), KeyCorp (KEY), Pacific Capital (PCBC) upgraded at RBC Capital
All three banks were upgraded to sector perform from underperform. The banking sector was upgraded to overweight.

U.S. Financial stocks raised to overweight from neutral at Morgan Stanley--Bloomberg

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