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Recap of Last Week
By Steve Romasko
Despite the short trading week due to the Thanksgiving holiday, the market managed to spark a 12% rally, largely driven by government action. The week opened with the announced rescue of Citigroup, Obama’s new economic team and an $800 billion plan from the Federal Reserve.
The financial sector displayed the biggest gains, surging 31% respectively. The move was led by the weekend announcement by the government to provide Citigroup with a guarantee on roughly $300 billion worth of assets listed as troubled. The plan, then, went on to provide Citi with an additional $20 billion of TARP funds in exchange for preferred shares by the bank. Traders saw four silver- linings to Citi’s cloud. (1) Citigroup will not be allowed to fail. (2) Common shareholders were not wiped out. (3) Core assets were not forcibly divested at depressed prices to raise capital and (4) if necessary, other distressed financials would most-likely be eligible for comparable guarantees.
Following Citigroup’s announcement, came the Federal Reserve. Along with the Treasury Department, the Federal Reserve announced the creation of a new $200 billion facility in an initiative to provide liquidity in the securities markets that aid auto loans, student loans, credit card loans, and small business loans. Along with this measure came an additional $600 billion that will be put toward the obligations of the GSEs and securities backed by Fannie & Freddie, as well as Ginnie Mae. This action was taken in an effort to lower mortgage rates; as this would improve the housing market by giving consumers an ‘incentive to buy’ which consequently, would eventually clear the housing glut.
The latter attempt proved true as mortgage rates did fall week-over-week (30-yr rates fell from 6.04 to 5.97) and improved the overall attitude of the market. However, many traders remained skeptical about the sustainability of the rally. As in the past, rallies following government intervention were corrected downward, continuing the bear market trend. Skepticism is evident in increasing o/n and 3-month Libor rates, as well as the plunging yield on the 10-yr note (2.91%). If investors were convicted of the success of the new initiatives, then Libor rates should have come down (as banks become more willing to lend) and yields should have risen (as investors become less risk-averse). Since this was not the case, take it as a short-lived bear market rally to the upside and move on.
On the economic front, investors were unreceptive to the data as they expected the reports to come on below consensus.Q3 GDP was revised downward to -0.5% from -0.3%, durable orders fell 6.2%, and existing home sales and new home sales fell 3.1% and 5.3%, respectively. Personal spending fell 1% and, although marginally improved from last week, unemployment data still showed a +500,000 reading.
In stock action, Citigroup soared 111% on the week, erasing all of the +60% loss from the prior week, General Motors (GM) in a boost of confidence jumped 71% and Goldman Sachs road the financial sector wave—finishing up 48%.
In light of an extremely volatile month, with the S&P being up as much as 4% to down 23.5%, the market managed to considerably rebound off the lows in the last week of trading and finish down ONLY 7.5% for November.Despite the short trading week due to the Thanksgiving holiday, the market managed to spark a 12% rally, largely driven by government action. The week opened with the announced rescue of Citigroup, Obama’s new economic team and an $800 billion plan from the Federal Reserve.
The financial sector displayed the biggest gains, surging 31% respectively. The move was led by the weekend announcement by the government to provide Citigroup with a guarantee on roughly $300 billion worth of assets listed as troubled. The plan, then, went on to provide Citi with an additional $20 billion of TARP funds in exchange for preferred shares by the bank. Traders saw four silver- linings to Citi’s cloud. (1) Citigroup will not be allowed to fail. (2) Common shareholders were not wiped out. (3) Core assets were not forcibly divested at depressed prices to raise capital and (4) if necessary, other distressed financials would most-likely be eligible for comparable guarantees.
Following Citigroup’s announcement, came the Federal Reserve. Along with the Treasury Department, the Federal Reserve announced the creation of a new $200 billion facility in an initiative to provide liquidity in the securities markets that aid auto loans, student loans, credit card loans, and small business loans. Along with this measure came an additional $600 billion that will be put toward the obligations of the GSEs and securities backed by Fannie & Freddie, as well as Ginnie Mae. This action was taken in an effort to lower mortgage rates; as this would improve the housing market by giving consumers an ‘incentive to buy’ which consequently, would eventually clear the housing glut.
The latter attempt proved true as mortgage rates did fall week-over-week (30-yr rates fell from 6.04 to 5.97) and improved the overall attitude of the market. However, many traders remained skeptical about the sustainability of the rally. As in the past, rallies following government intervention were corrected downward, continuing the bear market trend. Skepticism is evident in increasing o/n and 3-month Libor rates, as well as the plunging yield on the 10-yr note (2.91%). If investors were convicted of the success of the new initiatives, then Libor rates should have come down (as banks become more willing to lend) and yields should have risen (as investors become less risk-averse). Since this was not the case, take it as a short-lived bear market rally to the upside and move on.
On the economic front, investors were unreceptive to the data as they expected the reports to come on below consensus.Q3 GDP was revised downward to -0.5% from -0.3%, durable orders fell 6.2%, and existing home sales and new home sales fell 3.1% and 5.3%, respectively. Personal spending fell 1% and, although marginally improved from last week, unemployment data still showed a +500,000 reading.
In stock action, Citigroup soared 111% on the week, erasing all of the +60% loss from the prior week, General Motors (GM) in a boost of confidence jumped 71% and Goldman Sachs road the financial sector wave—finishing up 48%.
In light of an extremely volatile month, with the S&P being up as much as 4% to down 23.5%, the market managed to considerably rebound off the lows in the last week of trading and finish down ONLY 7.5% for November.
Outlook for Next Week
By Ryan Wheeler
After a week of mixed emotions stemming from mixed news and big families, this week could bring more of the same uncertainty in the financial markets. Investors will be looking for reassuring signs to support last week’s rally and could be disappointed with the line-up of economic indicators due this week. There will also be more talk about the auto makers in congress this week about whether or not to save the failing giants.
The tug-of-war between corporate bonds and risky equities will be fueled by further questions about the security of coupons and principle as talks of renegotiated terms on GM’s unsecured debt could start a new trend in the High Yield market. Spreads in the high yield bond market remain at extremes and are attractive for investors with an appetite for high risk. The result of GM’s offer to PIMCO and other large bond holders to accept a reduced principle will certainly move spreads as investors make moves in reaction to the news. Holders of distressed bonds might see this situation as an indicator of some of the solutions companies might take to reduce debt at investors’ expense.
On the economic calendar, the employment situation for November will be measured by unemployment, non-farm payrolls, average wages and the average hourly work week. Unemployment is expected to raise 20bp to 6.7% due to further layoffs in most industries. While a 20bp increase is generally significant, investors seem to have developed a stronger stomach for depressing economic numbers. Any number relatively close to 6.7% should not jolt investors into panic selling. The Fed’s Beige Book issued on Wednesday will show the state of local economies and could give clues about the action of the FOMC at their next meeting in two weeks. Across the ocean, the BOE and ECB monetary policy committees will announce any decisions they make during their meetings to jumpstart growth in their jurisdictions. The markets will look at these announcements as indications of the Fed’s move after the coordinated rate cuts last month.
Oil will certainly react to OPEC’s decision to wait another two weeks until they decide whether or not to cut production to support prices. OPEC stated that they believe $75 a barrel is a “fair price” for oil and investors who are heavily weighted in drillers will undoubtedly agree as their investments have tanked as oil prices have dropped. It is not likely that oil will get back to $75 in the near term due to increasing destruction of consumer demand, but OPEC’s moves will help drillers plan for the intermediate term. Expect movement in both up and down stream energy names this week.
Retailers will report on Black Friday results this week and the market will listen closely. Estimated results from research firm ShopperTrak RCT Corp have indicated a 3% increase compared to 8.3% last year. Investors are surly expecting weakened demand on Main Street this year, but the severity of the weakness is still up in the air. The start to the busiest shopping season of the year will help gauge how retailers’ earnings will fair in the 4th quarter and investors will attempt to position themselves early to take advantage or avoid loss when those results come out in January.
At this point the Fed seems to be running out of firms to bail out. Just about every large-cap bank has seen some sort of aid from the US government in the last few months, leaving the Fed no choice but to look for other industries to save. This week will not paint the whole picture for the future of the US economy, but it will speak loudly to the extent the government is willing to go to support the current corporate landscape. Wall Street will look at the government’s action as a measure of the thickness of their safety net that, up until now, has seemed infinite. This week might be a wake up call. After a week of mixed emotions stemming from mixed news and big families, this week could bring more of the same uncertainty in the financial markets. Investors will be looking for reassuring signs to support last week’s rally and could be disappointed with the line-up of economic indicators due this week. There will also be more talk about the auto makers in congress this week about whether or not to save the failing giants.
The tug-of-war between corporate bonds and risky equities will be fueled by further questions about the security of coupons and principle as talks of renegotiated terms on GM’s unsecured debt could start a new trend in the High Yield market. Spreads in the high yield bond market remain at extremes and are attractive for investors with an appetite for high risk. The result of GM’s offer to PIMCO and other large bond holders to accept a reduced principle will certainly move spreads as investors make moves in reaction to the news. Holders of distressed bonds might see this situation as an indicator of some of the solutions companies might take to reduce debt at investors’ expense.
On the economic calendar, the employment situation for November will be measured by unemployment, non-farm payrolls, average wages and the average hourly work week. Unemployment is expected to raise 20bp to 6.7% due to further layoffs in most industries. While a 20bp increase is generally significant, investors seem to have developed a stronger stomach for depressing economic numbers. Any number relatively close to 6.7% should not jolt investors into panic selling. The Fed’s Beige Book issued on Wednesday will show the state of local economies and could give clues about the action of the FOMC at their next meeting in two weeks. Across the ocean, the BOE and ECB monetary policy committees will announce any decisions they make during their meetings to jumpstart growth in their jurisdictions. The markets will look at these announcements as indications of the Fed’s move after the coordinated rate cuts last month.
Oil will certainly react to OPEC’s decision to wait another two weeks until they decide whether or not to cut production to support prices. OPEC stated that they believe $75 a barrel is a “fair price” for oil and investors who are heavily weighted in drillers will undoubtedly agree as their investments have tanked as oil prices have dropped. It is not likely that oil will get back to $75 in the near term due to increasing destruction of consumer demand, but OPEC’s moves will help drillers plan for the intermediate term. Expect movement in both up and down stream energy names this week.
Retailers will report on Black Friday results this week and the market will listen closely. Estimated results from research firm ShopperTrak RCT Corp have indicated a 3% increase compared to 8.3% last year. Investors are surly expecting weakened demand on Main Street this year, but the severity of the weakness is still up in the air. The start to the busiest shopping season of the year will help gauge how retailers’ earnings will fair in the 4th quarter and investors will attempt to position themselves early to take advantage or avoid loss when those results come out in January.
At this point the Fed seems to be running out of firms to bail out. Just about every large-cap bank has seen some sort of aid from the US government in the last few months, leaving the Fed no choice but to look for other industries to save. This week will not paint the whole picture for the future of the US economy, but it will speak loudly to the extent the government is willing to go to support the current corporate landscape. Wall Street will look at the government’s action as a measure of the thickness of their safety net that, up until now, has seemed infinite. This week might be a wake up call.
