7 years ago today the markets were in turmoil.
America had been attacked, Wall Street was shut down and did not even re-open until the 17th, when the market gapped down about 400 points and finished the day at 8,920 after closing 9/10 at 9,605 (down 7.1%). We dropped another 10% over the next 4 sessions on huge volume (about 2Bn a day on the Dow) but then began a rally on September 24th, 2001 that took us from our worst close of 8,235 to 10,021 on December 31st (despite concerns of a new year's attack).
Overall, the market decline had begun in late May of 2001, when the Dow fell from 11,301 and, despite the bounce, the final bottom was not hit until early October, 2003, when the market fell all the way to 7,286, 35% off it's peak. From that day forward we had a spectacular run that topped out at 14,164 on October 9th of last year, a gain of 94% off the bottom. From there we have fallen to a March 10th low of 11,740 (17%), recovered back to 13,058 but then fell all the way to 10,750 on July 15th, 24% off the peak. Looking at today's pre-market, I am very concerned that 24% was not enough to give us a bottom.
I've been thinking the bottom was here for quite some time, since the July 15th drop, where we put in a nice bottom and a great 300-point reverse the next day but we have had a dozen 200-point days since then, both up and down, as the market has gyrated between 11,200 and 11,600 since July 16th. Today we are certainly going to be testing 11,200 again but of more concern is the Nasdaq breaking a huge trend by falling below 2,200, which violates some very long-term support trends. I've said for a long time we need Tech to lead us because it was the most likely sector to rotate into as the commodity bubble burst but it was led down by the SOX and now threatens to take out our best hope for a recovery.
Why is this 9/11 looking worse than the last one? Leadership. Back in 2001, the President came on TV, made some stirring speeches and people like Rudi Guiliani became national heroes, displaying courage under fire. In 2008, we haven't heard a word from our leaders in months as the financial markets spin in turmoil with the only appearance made in the past week being Hank Paulson telling us he's foreclosing on America and taking over Freddie Mac and Fannie Mae. Bill Gross is happy, PIMCO made $1.7Bn in one day thanks to Paulson's largess. “We’re not usually advocates of the government fist vs. free market’s hand. But we have (advocated federal aid) because of what’s happened,” Gross says of the horrific economic implications of the steep housing downturn. “It was self-serving because that was our forecast.” Boy is that an understatement!
It's not so much the bailout itself that is worrying but the lack of assurances for the market since it happened. Barely a word has been said and nothing at all like an official announcement to explain how the government takeover of the GSEs was absolutely necessary and, if so, what is the government's plan moving forward? Without leaders – without leaders who have a clear plan and a vision of a future that is not simply full of despair, how can we expect the markets to recover from this disaster?
In this leadership vacuum, there is a rising danger of bank failures. LEH is not falling apart like BSC because they have access to the discount window and, so far, other investment banks are still doing business with them but their rating has sunk to single A level and a further downgrade will make it impossible for certain institutions to keep their money there. LEH has $691Bn of assets under management but only $20Bn in cash against $668Bn in debts. Should $60Bn worth of clients want their money – where will it come from. This fear of forced liquidation by LEH, WM et al is what's driving the markets lower but it could be a real house of cards if LEH is downgraded and then they can't pay MER or MS or GS the money they owe them, which will cause the next crisis and the next and the next.
On Wednesday, the annual cost of insuring $10 million of Lehman debt for five years rose to a high of $610,000, versus $475,000 late Tuesday, according to Phoenix Partners Group. What happens when other firms start having to pay those rates? What happens to the insurance companies if they have to pay those debts off (see AIG for a preview). This is dire stuff but, having been forced to liquidate myself, I suggest everyone consider that something may indeed be better than nothing if we really start to snowball downhill.
This is not the kind of problem that can be solved by the government tossing some money their way. As I've been saying for more than a year, the fundamental problem in the system is people can't pay their mortgages. That causes the defaults and the foreclosures in the Trillions of dollar worth of notes held by these institutions. The government needs to stop trying to help institutions after they fail and start helping homeowners make their mortgage payments. That will stabilize the housing market and allow the Financials to upgrade their balance sheets if, for example, the government offered a 3-year program to backstop the homeowners who are suffering in the millions.
Is that unfair? No more unfair than just handing Bill Gross $1.7Bn while destroying $10Bn worth of shareholder value. Why was a deal not made with the bondholders? If the GSE's had to reorganize you can be damn sure the bondholders would have taken a haircut and I'm sure they would have been thrilled to have a government backed 3% (for example) rather than a dubious 4%. On $5Tn worth of outstanding debt, that's quite a bit of interest! I said on Monday I was not thrilled about this deal and the SKFs I talked about that morning are still a good hedge against further declines as the SKFs were as high as $211 on July 15th.
As expected by us but not "economists", our Trade Deficit jumped to $62.2Bn in July on rising oil prices and June was revised up from $56.77Bn to $58.84Bn. Oil imports alone jumped from $34.8Bn to $42.6Bn and the very weak dollar made the stuff we sold worth less. Our exports were well up, but nowhere near enough to offset the jump in crude to the $140s in the first half of the month. Unemployment claims fell very slightly to 445,000 but still 5,000 higher than estimated and but continuing claims hit nearly a 5-year high at 3.525M, also higher than expected. Note that the 5-year high was October and November of 2003, the very bottom of that market. Unemployment is so high in California that the State Unemployment Fund is running out of money.
Don't forget we have a hurricane barreling down on the heart of the US refining operations. This may not affect crude but gasoline production could be severely curtailed and gasoline prices will head sharply higher into the weekend. The CME has announced they will open Sunday to trade energy futures.
Internationally, Asia continued their rapid decline with the Hang Seng falling another 3% and the Nikkei down another 2%. Governments are stepping in to protect their rapidly falling currencies and that can lead to some wild fluctuations in those markets. European markets are down about 1.5% across the board and things are looking very scary out there. I wish I had better news but history is, unfortunately, repeating itself on this day.
