Bad News Scuttles Stock Market Rally
Kurt Brouwer January 17th, 2008
I tuned in to CNBC this morning, which had live coverage of Federal Reserve Chairman Ben Bernanke in testimony before the House of Representatives. From his testimony, it became pretty obvious that the Fed intends to drop its Fed Funds rate at the next meeting which will be on January 29-30. While watching, I noticed lots of selling on the ticker which runs at the bottom of the screen. Share prices in the two big bond insurors — MBIA and Ambac — absolutely plummeted. Turns out that Moody’s announced a review of Ambac’s rating and that was the cause of a slump in the shares of both insurors. Also, the the Fed announced a decline in manufacturing activity and suddenly a race was on for the exits. This story spells out what happened [emphasis added]:
Dow Ends Down 307, Economic Angst Mounts (Associated Press / Yahoo, January 17, 2008, Tim Paradis)
Wall Street extended its 2008 plunge Thursday, tumbling after a regional Federal Reserve report showed a sharp decline in manufacturing activity and as investors feared that downgrades of key bond insurers could trigger further trouble with souring debt.
The Dow Jones industrial average lost more than 300 points, or nearly 2.5 percent, and skidded to its lowest close since March 16. The Standard & Poor’s 500, the index closely watched by market professionals, fell nearly 3 percent.
Stocks opened higher but quickly gave up their gains after the Philadelphia Federal Reserve said its survey of regional manufacturing activity registered a negative 20.9 from a revised reading of negative 1.6 in December. The reading came in well short of what Wall Street had been expecting and underscored the seriousness of the economic concerns that have gripped both Wall Street and Washington in recent weeks.
Credit concerns also dogged Wall Street after rating agency Moody’s Investors Service placed bond insurer Ambac Assurance Corp. on review for a possible downgrade. That possibility alarmed Wall Street because it would place all bonds insured by Ambac on review as well. Ratings agencies are concerned that bond insurers would be unable to absorb a spike in claims…
…The Philadelphia manufacturing reading caught Wall Street by surprise — igniting fears that the economy is slowing precipitously and that policymakers might be too late in aiding it.
Economists had expected the Philadelphia index would come in at a negative 1.5, according to Dow Jones Newswires. Instead, the negative 20.9 figure was the weakest since October 2001 when the economy was reeling from the shock of the Sept. 11 terror attacks…’
At this point, there is bad news as far as the eye can see. Credit crisis, impending recession, higher inflation and so on. Either the world is coming to an end — which I seriously doubt — or we are in a pretty typical stock market correction. From the October 9th high point, the S&P 500 was down approximately 14% as of the market close today so we are clearly in a correction (defined as a stock market decline of anywhere from 10-20%). However, many financial stocks are priced as those the end of the world is in sight, if not immediately at hand. Though they are undervalued, the timing on picking a bottom in an out-of-favor industry is tricky (see Bank of America Snaps Up Countrywide).
For those concerned about a pending recession, click on this post to learn more on how stocks reacted in past recessions (see History Lessons On Recessions). But it is not just stocks that have been hit. Last year, muni bonds had their worst year since 1999 so muni bonds funds look good to me (see Bad Year For Muni Bonds).
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How did you determine that financial stocks are “undervalued”, because they’ve dropped so much in price? Many have had to raise multiple billions of dollars in fresh capital to stay afloat. What impact does that dilution have on existing shareholders? And more importantly, do you think these firms will be less risk averse going forward and, if so, what does that mean for their ability to generate profits?
Because not all financial companies are alike, yet they have all been hammered. Is Merrill Lynch or Citigroup going out of business? In my opinion, the answer is no. And, even for the troubled companies such as Countrywide, at a price they might be a bargain. Bank of America seemed to think an 80% discount on Countrywide was a deal. Who am I to suggest BA is wrong?