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Sub Prime Shock
Wave: OverBlown or Real Deal? |
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Sometime ago I wrote an article suggesting
the doom and gloomers who were predicting Armegeddon in the stock market
from the sub prime melt down were Chicken Little types.
While, I still believe the sub prime
melt down is not as pervasive as the media would have you believe, there
are some major ripple effects happening in the stock market that I did
not anticipate, and it's worth having a look at. Here's what's happening:
Actual earnings and earnings estimates
for Q3 and Q4 of '07 are falling off a cliff for the financial sector.
In September, the estimate for Q3 earnings for companies in the financial
sector of the S&P 500 was about $9.60. They are coming in at
about $6.75 today. For Q4, earnings estimates for the same group
have dropped from $10.50 to about $8.50.
Sometime ago I wrote an article suggesting
the doom and gloomers who were predicting Armegeddon in the stock market
from the sub prime melt down were Chicken Little types.
While, I still believe the sub prime
melt down is not as pervasive as the media would have you believe, there
are some major ripple effects happening in the stock market that I did
not anticipate, and it's worth having a look at. Here's what's happening:
Actual earnings and earnings estimates
for Q3 and Q4 of '07 are falling off a cliff for the financial sector.
In September, the estimate for Q3 earnings for companies in the financial
sector of the S&P 500 was about $9.60. They are coming in at
about $6.75 today. For Q4, earnings estimates for the same group
have dropped from $10.50 to about $8.50.
You are looking at a current chart
of a pool of mortgages which are AAA rated and have a near zero
default rate. As you can see from the chart, back in July this pool of
mortgages was trading at just under Par value- about $99. Today, that same
pool of funds, is trading at about $70. The accountants are forcing the
holder of this pool of funds to mark the value down on their balance sheet
to the current bid- which is already a very illiquid and opaque market
environment. This practice is known as marking to the market.
While the sub prime melt down is
a problem, this spill over effect to the good portfolios of mortgage backed
securities is causing shockwaves throughout the financial community and
the stock market. The financials, including gigantic banks, brokerage firms
(see Merrill Lynch), and mortgage companies are all getting absolutely
hammered as these publicly traded entities are forced to take huge writedowns,
and therefore losses, on perfectly good mortgage backed securities. Earnings
estimates for the financial sector are falling off a cliff.
Here's what's going to happen- At
some point, perhaps late this year or early next, the media is going to
start reporting that it might not be so bad. Very smart money is going
to start shopping for cheap mortgage back securities, and bids will
come back. The money that was artificially taken away from balance
sheets is going to find its way back on to balance sheets, creating earnings
events.
I am reminded of the death of Junk
Bonds. In the 80's, Michael Milken of the now defunct Drexel
Burnham virtually invented junk bonds. Hundreds of small to medium
sized pub cos were financed by junk bonds. When Milken and some
of his other cohorts were hauled off to jail for insider trading violations,
those junk bonds got absolutely hammered.
As it turned out, Milken's
indiscretions were not mimicked by the companies he financed, and many
of those bonds were purchased by very smart money with huge, perfectly
good coupons.
Today this artificial price deflation
is mainly funny money, but it's is causing a serious and real ripple effect
throught the economy. The "L" word- Liquidity, is a problem. There is little
or no liquidity in our economy right now, which is causing a blip in the
retail sector. Since the American Consumer represents about 80% of GDP,
it's hurting the stock market right now. Consumer confidence numbers are
down, as are same store sales at some of our biggest retail institutions.
The turn should come soon. Here's
how you will know it has happened. When one or two of these financinal
behemoths announce further "write downs", and the stocks don't go down
in kind, you will know the market is about to get healthy.
Until then, this market is very shaky,
and you might want to pay careful attention to SSLs (suggested stop losses)
on our ideas.
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