The market was crushed, again. An up-and-down session ran into a brick wall late in the day when it became apparent that any bill to rescue the nation’s automakers would, at best, be delayed until December. And from there, the market corkscrewed itself into the ground, led by the financial stocks, which once again were routed. Citigroup dropped 26%; General Electric fell 11.1%. Chris Johnson, CEO and chief investment strategist at Johnson Research Group, once again pointed to that old saw about the markets hating uncertainty, and in this case, a new element of uncertainty was introduced as a result of halting approach by Congress with regard to the automakers. There are many who would argue that these companies should, in fact, not be bailed out, but from there plenty wonder just how bad the economy will get (and expectations are already for a 4% decline in GDP for the fourth quarter). “Any time the market has a predisposition, it seems to be jerked out from under them,” Mr. Johnson says. Still, he’s not expecting this to be the end of the selling — pointing to positive commentary on television regarding buying the market now that the Chicago Board Options Exchange’s volatility index kicked itself up over 80 again. For that vaunted capitulation to occur, “we need to see people stop trying to buy these bottoms,” he says, and for investors to realize after the fact that the cathartic selling had occurred when they, too, were selling (presumably including himself). What’s happening now, he says, is that investors are “trying to catch a falling knife.” Once investors have been shorn of their fingers, they’ll learn.
Given the current situation, it would seem to behoove the heads of major public companies to ensure to shareholders and the general public that they are doing as much as they can to make sure their companies are in the kind of shape necessary to weather the current economic and financial crisis, no matter how difficult. That’s an enormous job, particularly for financial-services firms, who face short-term funding needs, a liquidity crunch and a lack of confidence from investors. Some have a different approach — convince everybody that the market is sound as a pound, and it will be thus. The Wall Street Journal reported that Citigroup officials are lobbying lawmakers and the SEC to reinstate the ban on short-selling of financial stocks, citing people familiar with the matter. (Does this only extend to financial stocks? After all, look at General Motors. Where is the line drawn?) One official in the article huffs that “you would think the regulators would want to exercise some leadership and protect the integrity of the financial-services world.” That’s a rich statement for two reasons: first, one could argue that — with the exception of naked shorting — allowing investors to sell the heck out of any stock does protect the integrity of the financial-services world, and second, the nation’s largest banks consistently pooh-poohed regulations for years on end. In the meantime, investors will continue to hammer the stock. While Saudi Prince Alwaleed bin Talal was buying in, options activity showed plenty willing to bet on Citigroup shares falling below $5 before expiration Friday. The stock closed at $4.71 Thursday.
The Markit LCDX Index shows a marked deterioration in insurance on senior secured loans. (Markit.com)There’s a constant preoccupation with the idea that stocks are not fully discounting the depths of the coming recession — particularly with earnings estimates still around $87 a share for the S&P 500 for 2009. But credit markets have been hit dramatically (when it costs nearly $500,000 to insure $10 million of Berkshire Hathaway’s debt for five years, people are priced for pessimism). One indication of this can be seen in certain credit-default swap indexes, such as the LCDX, which tracks the insurance cost for senior secured loans. Markit’s key LCDX Index currently trades at about 78 cents on the dollar, just a few cents more than Markit’s high-yield index, which was lately at about 73.5 cents on the dollar, according to Phoenix Partners Group. Logically, this makes little sense — in the capital structure, the loan-holders will get paid back long before those who hold the debt, and it shows how fear has enveloped the credit markets. “The senior secured loans are at absurd levels,” says George Feiger, head of Contango Capital Advisors, the wealth management arm of Zions Bancorporation. “We can’t believe the scenarios that are implied. I’m not a raving optimist here, and I can’t make heads or tails of this.” Part of the reason prices have dropped, he says, is because of the lack of retail demand, saying “they’re on a buyers’ strike.”
Through the middle of September, the major averages were sporting double-digit declines, but the fourth average — the Russell 2000, which tracks small-cap stocks — was actually hanging in reasonably well. The Russell had given up just 1.6% of its value, while the S&P 500 was off by 14.5% and the Nasdaq Composite was down 14.3%. Those who took their losses in small-cap names then did the prudent thing, as those stocks have become toxic. The heavy sales of both large- and small-cap stocks may have initially concentrated on the more liquid big-cap names as investors reduced significant levels of leverage. But small-caps have been subjected to a steady stream of selling as the outlook has changed, and the Russell is down 49% while the S&P, in that time, has lost 38%. As the recession continues and as lending institutions continue to take a tight-fisted approach, smaller firms that might be more reliant on loans and debt are riskier plays. Furthermore, with so much of the fund management industry geared toward holding as little cash as possible (due to requirements from endowments and other companies that need money managers), as redemptions continue, more selling occurs. “There’s a lot of pressure to stay fully invested,” says Eric Cinnamond, manager of the Intrepid Small-Cap Fund. “Nobody had liquidity on the way down, and so now there are redemptions, and of course, there’s no cash.”
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