Bear Markets Abound, Bond Insurers In Peril, Another Chinese Boom, and More!

by Addison Wiggin & Ian Mathias

  • Wall Street sells off again… critical chart reveals the end of the markets’ 4-year rally
  • Bears abound: Several markets 20% off their highs… Gunner on where money could still be made
  • Dan Amoss on the little-discussed crisis threatening to slam the struggling market
  • Washington gets “stimulus” fever… Bernanke’s advice broken down
  • A Chinese growth trend too incredible to ignore
  • Plus, I.O.U.S.A. at the Sundance Film Festival… our first views from the front lines

Wall Street didn’t buy Bernanke’s “economic stimulus” fervor yesterday. Sellers took the Dow down another 2.5%. The Nasdaq got whacked for 2%. And the broader S&P 500 fell precipitously… just short of 3%.

Both the Dow and Nasdaq are now at 10-month lows. The S&P 500 has been beaten back to levels not seen since early 2006.

If you’re the charting type, the S&P 500 has clearly broken out of a four-year uptrend. The multiyear rally on the S&P is likely over:

But that’s not all. The Russell 2000, the best-known U.S. small-cap index, is in a technical bear market. The index fell 2.8% yesterday and slipped over 20% past its all-time high. All gains made after July 2006… poof… gone.

“I would expect to see more seesaw action in most small caps, with the downside usually winning,” advises our small-cap man Greg Guenthner. “At the same time, if and when the market starts to turn around, penny stocks will see some blockbuster gains. We’re buying alternative energy penny stocks on the drops, especially energy bill plays. Also, there are some real cellar dwellers — small caps that are way too oversold, even in this market — that are worth looking at.”

Gunner’s Bulletin Board Elite subscribers, despite the current dreadful small-cap market, have several positions in the black, including one open position up over 90% in five months. For the latest from Gunner, click here.

But the real story today is happening behind the scenes in the credit markets.

In 2007, our Strategic analyst Dan Amoss broke the word of the year “subprime” story months before it was on the lips of soccer moms around the country. He helped us unpack SIVs, decode CDOs and even chimed in on the influence of SWFs. Among these arcane investment acronyms, you would have found — and will likely continue to find — the most influential investment trends on the planet.

This morning, Dan is on about the latest disaster: bond insurers.

First, the news: Ambac, the embattled insurer, announced yesterday both a $3.5 billion write-down as well as the surprise departure of its CEO, Robert Genader. Soon after, credit agency Moody’s threatened to cut Ambac’s AAA credit rating, stating it was putting the whole bond insurance sector under review.

Ambac, one of the heavy hitters of the industry, was served a triple helping of bad news. It fell over 50% within the first few minutes of trading… you can currently pick up a share for about $6. Only eight months ago, this was a $90 stock… oy.

Now… behind the scenes: “Basically, the bond insurers like Ambac have a huge, but hard-to-quantify liability,” explains Amoss. “This liability is the promise to start covering losses on bonds/mortgages when they default.

“Under normal circumstances, this liability is more than offset by a huge, but hard-to-quantify balance sheet asset — cash inflows from the premiums they earn. But these are not normal times. The accounting works fine in normal times, but it does not work well during a credit crisis.

“Mortgage defaults will force the mortgage insurers to pay out much more than they earn in premiums — perhaps to the point at which they lose the ability to meet payments on their debt. Bond defaults — especially in structured credit like collateralized debt obligations (CDOs) — will force the bond insurers like MBIA and Ambac to pay out much more than they earn in premiums.

“I’m not sure how it will play out… But I’m guessing that the new Berkshire Hathaway bond insurance subsidiary will step in and write reinsurance on the municipal bonds that lose protection in the event of ABK/MBI failure. But Warren Buffett is very unlikely to insure structured credit. He’s long been a critic of that particular business.”

The bottom line? We’re likely to see more big billion-dollar write-downs at the megabanks…and a few more quarters in which the financial sector takes a beating. But don’t worry; Mr. Amoss is on the case. As you know, we’ve been beta testing Dan’s Strategic Short Report.

Tomorrow, you’ll be first to get into his trades… keep an eye on your inbox. This may be one of the only ways to both avoid mayhem in the markets and make gains from the chicanery practiced daily in New York.

Washington Mutual maintained this week’s trend of depressing financial earnings reports — the bank announced a nearly $2 billion loss yesterday. Such losses included a $1.6 billion write-down of dead and dying home loans. The bank also stated that it has set aside another $1.5 billion to cover losses likely to occur in the current quarter.

Having trouble keeping track of the billions of dollars vanishing every day? Here’s a quick-and-dirty rundown of the carnage thus far:

In Washington, they’re talking “stimulus.”

“Fiscal and monetary stimulus together may provide broader support for the economy than monetary policy alone,” suggested Ben Bernanke yesterday in front of the House Budget Committee. “To be useful, a fiscal stimulus package should be implemented quickly and structured so that its effects on aggregate spending are felt as much as possible within the next 12 months or so.”

Bernanke went on to estimate current subprime losses to be somewhere in the $100 billion range and growing, and suggested that a $150 billion congressional stimulus would be “reasonable.” What is reasonable about enticing people with cheap and easy credit for years… and then bailing them out with taxpayer money after they make bad financial decisions… he didn’t say.

“Any [stimulus] program should be explicitly temporary, both to avoid unwanted stimulus beyond the near term horizon and, importantly, to preclude an increase in the federal government’s structural budget deficit.”

Still, if there was any prevailing sentiment among his audience of Congressional budget planners, it was this: The “stimulus” is in the bag. They’re not asking “if” anymore… now it’s just, “How much?”

The English are officially suffering a bear market. As the world oohs and ahhhs at the daily strife here in the States, the FTSE 250, an English mid-cap benchmark index, has quietly fallen 20% from its all-time high set last May. English big caps, measured by the FTSE 100, are doing their part to catch up, down an average 13% from their all-time highs.

“The U.K. has problems much like the U.S., only on a smaller scale,” reports Chuck Butler. “It won’t be long before interest rates there begin to come down. This all weighs on pound sterling, and will continue to do so going forward.”

Gold couldn’t buck the selling trend overnight. Prices trended down for the second day in a row yesterday, and overnight sellers were just as unkind… as we write, gold sells for about $877.

Currencies traded flatly in the past 24 hours. Prices for most major currencies remained the same: euro $1.46, pound $1.96, yen 107. The dollar awaits its stimulus package, too.

China had over 210 million “Internet users” by the end of 2007, the Chinese government announced this morning. At their current rate of growth, Chinese Web surfers will soon become the largest national online population in the world. Chinese officials estimated that their population is only 5 million away from the U.S. online community, currently the world’s largest.

Suffice to say, consumer tech growth in China is stunning. China added over 73 million Internet users last year alone, including 127% growth in rural areas. Despite all this stunning expansion, less than 20% of the country’s 1.3 billion people are Internet users… talk about potential growth… yikes. China already has the world’s largest population of cell phone users, about 540 million.

“I’m not entirely sure where you stand on this issue,” writes a reader, “but if one there is one truth in Corporate America, it is that CEOs in many companies are overpaid.

“I would not only limit salaries of those who drive their companies down, but also those who do well. The ones who need to be driven out should get nothing. It seems that the only jobs these company leaders won’t offshore are their own.

“I’m positive we could get someone from India or China who will do the job for one-tenth the price. The best answer is to have the shareholders (exempting the shares owned by upper management and the board) write a figure on their annual meeting ballot. Throw out the highest and lowest and average the rest.”

“Does Congresswoman Kaptur not realize that the board of a corporation makes or breaks the salaries of a CEO, not Congress?” asks another reader. “Since when does the government tell a company how much of a salary cap the head of it may have? Hey, Congresswoman… get a real job.”

“My bets are,” suggests another reader, “the Bernanke and Pelosi ‘stimulus package’ will drive the dollar down, plus drive the price of gold and oil up. The so-called leaders in Washington fail to understand money, capital and employment, and productivity goes to the low-cost quality producer. Also, money goes where it is treated the best… taxes and red tape destroy business growth.”

“Congratulations on your movie selling out!” writes our last reader. “I also hope that it’ll fulfill the purpose for which you made it and that the audiences won’t be 95% Agora subscribers, though that’d be fun in its own right. Anyway, congrats on filling the theaters. I hope it becomes as profitable as it will be satisfying to see the fruit of your labor ‘on the silver screen.’”

The 5 responds: Thank you. We arrived here at the Yarrow Hotel after midnight last night. It serves as the Sundance Festival headquarters. After checking in, we turned on local access cable and caught an interview with Robert Redford. He was putting the festival in context for a bevy of journalists from around the world. The movies presented here, specifically the documentaries, were chosen to help filmmakers on the fringe of society express their fears, anxiety and hopes about what they see going on around them.

“Filmmakers are often the first to react artistically to changes in society,” we paraphrase Redford, who was sporting a ski sweater and North Face vest, saying. “Last year, we were all about the wars in Iraq and Afghanistan. This year, the anxiety has moved deeper into the culture, beyond the overtly political.”

It should prove to be an interesting couple of days. I.O.U.S.A. is going head-to-head with an expose of steroid use in America; a doc on the life of Gonzo journalist Hunter S. Thompson made by the guy who directed Enron: The Smartest Guys in the Room; a couple other topical films on water, war and rape in the Congo; and a couple of guys who have gone on a “whirlwind journey to unravel America’s addiction to oil.”

Have a nice weekend. The markets are closed Monday. So we’ll be reporting back from Sundance on Tuesday, after the premiere and our brunch featuring David Walker and his coterie.


Addison Wiggin
The 5. Min Forecast

P.S. Don’t forget…. tomorrow, you’ll get Dan Amoss’ first Strategic Short Report alert. As we write, the market is well on its way to another day of big losses. During times like these, only savvy short sellers and options players can make consistently profitable trades. If you’re looking to hedge your long-term buys by betting on market losses, or just looking for some quick cash in a turbulent market, be sure to check out Dan’s alert tomorrow.


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