Manic Markets, The First $250 Billion, Extreme Values, Who’s Running the Rescue, and More!

by Addison Wiggin & Ian Mathias

  • Manic-depression strikes equity traders… stocks’ record rise after their record fall
  • Bank nationalization: There goes another $250 billion… who’s getting it, and why
  • Dan Denning with a historical look at the bear trap being set for investors today
  • Chris Mayer with an example of “extreme value” still in the markets
  • Where the “smart money” flowed on Monday, and where it will stay till 2009… probably not where you think
  • Just who is running the $700 billion rescue? Would you believe an aerospace engineer?

  11%… really? The U.S. stock market is functionally bipolar.

After Friday’s dip into the 7,000 range on the Dow, investors were looking for an excuse to buy. And they found one in the G-7 central bank “unlimited liquidity” announcement. The Dow enjoyed its fourth best percentage gain ever, rising just over 11%. Pointwise, at 936 points, it was the biggest rally since 1939. 

Energy and materials, we’re happy to point out, led the way all day.

  Stock markets in Germany and France had their biggest gains ever, too. After taking yesterday off, Japan’s Nikkei 225 leapt 14% overnight, its best day ever.

  Now, to keep the rally going… the U.S. Treasury will pump $250 billion directly into American financial institutions. Half of that sum has already been granted to eight of the nation’s biggest banks, in exchange for preferred shares and limits on CEO compensation. Thanks to the NYT for the breakdown:

“This is an essential short-term measure to assure the viability of America’s banking system," President Bush assured us this morning. "These measures are not designed to take over the free market, but to preserve it." Right… government ownership of banks, to preserve free markets. What happened to the plan to simply buy up bad assets?

The president also announced that the FDIC will now insure all noninterest-bearing bank accounts. No matter how much money businesses have sitting in banks, the government is now good for it.

And while they were at it, they decided to guarantee all new bank debt. Best we can tell, for the next three years, the debt of these eight banks will be backed by the full faith of the U.S. government… a guarantee meant to encourage banks to make loans to each other and consumers. If you recall, banks in Europe did the same yesterday

  You might also remember one of Congress’ provisions of the bailout bill… that the president would have to ask for an additional $100 billion after the Treasury had spent the first $250 billion. He formally asked for it this morning. There’s your government: It spent $250 billion in a week — and had nothing to show for it except for a manufactured rally in stocks.

  Indeed, the Dow opened up another 300 points this morning.

   “The Fed must think,” writes Dan Denning, “it’s done what its counterparts in the Depression did not: prevent the transmission of the crisis from the financial markets to the real economy. By quarantining the banking sector and injecting new capital into it, the authorities hope the financial crisis will have ended with the steep falls in share markets — and not translate into a fundamental contraction in global economic activity. The share market will ultimately decide how bad it thinks the economy will be in the next year.

“The optimistic view is that it already HAS decided and stocks are clear to rally from here. But keep in mind, earnings analysts have yet to downgrade their expectations for the next two quarters. When they do, shares could head lower. In fact, we believe the market (in the U.S.) will eventually test the 2003 lows. But it may not happen just yet. Take a look at the two charts below:

The Crash of ’29: 49% in Less Than a Month

A 52% Rally and Then an 86% Fall

“After the ’29 crash, between November 1929 and April 1930, the market zoomed up 52% in just five months. It didn’t make a new high. But the price action was surely enough to sucker many investors back in, believing the worst was over. It wasn’t. Over the next two years, stocks fully priced in the debt deflation in the economy and fell 86%.

“This is precisely the scenario the Fed wants to prevent. It’s willing to risk a hyperinflationary melt-up in order to avoid prolonged debt deflation. We just don’t know, historically, what the result will be.”

   “You shouldn’t really expect a low much before 2010,” Jeremy Grantham recently suggested. The fair value on the S&P is about 1,025, he says. “This was not only a monetary event, but it coincided with the first truly global bubble in all assets. You had inflated housing in almost every country in the world, except for Japan and Germany. You had overpriced stocks in every country in the world. And you had too much money and too low interest rates. I was confident about very little, but I was confident that this would be different from anything we had seen before, and potentially more dangerous…”

How does Grantham suggest you invest? Conservatively, with a focus on high-quality U.S. blue chips.

  “Some valuations have become truly extreme out there,” notes our resident value investor, Chris Mayer. “According to the WSJ, nearly one in 10 stocks trades below the value of its per share cash holdings, ‘an even greater proportion than Graham found in 1932.’
“The year 1932 was horrific for stocks, and Ben Graham was the foremost practitioner of bargain hunting on Wall Street. That July 9, the close put the Dow Jones industrial average down 91% from where it was three years before. Yet there are more stocks trading below their cash balances now than in 1932. Amazing.

“Or to put it more specifically, of the 9,194 stocks Standard & Poor’s tracks, about 876 trade below their per share cash holdings. In theory, you could drain the cash in these companies’ treasuries to buy the whole company and get everything else for free.”

No surprise to your 5 Min. editors, Chris told us that one of those 876 little-known companies is in the Capital & Crisis portfolio. In our opinion, the ticker alone is worth the price of subscription… get it now, while this stock — and the C&C portfolio — still trades at a discount.

  Mitsubishi’s financial group completed its $9 billion injection in Morgan Stanley yesterday. In return, Japan’s biggest lender gets 21% of the company and some juicy preferred stock, yielding 10%.

According to Bloomberg, the $900 million annual paycheck to Mitsubishi will account for 16% of Morgan Stanley’s annual income next year. Nevertheless, Morgan shares skyrocketed 85% on the news.

  Here’s news: The National Association of Home Builders index of builder sentiment rose from its all-time low in September. The index rose 2 points above the lousy 16 recorded in July and August. Much of the improved sentiment can be attributed to the decline in mortgage rates since Fannie Mae and Freddie Mac were nationalized. The average 30-year fixed is down to 5.9%, from 6.3%.

Still, the index is one-third of the 50-point measure that signals “positive sentiment” among builders.

  Despite yesterday’s record rally, some $400 billion in hedge fund capital has been stashed in money markets over the past few days.

Steven Cohen, who manages the $14 billion SAC Capital Advisors, told The Wall Street Journal he put half his funds in cash and intends to keep it that way until the end of the year. Israel Englander of the Millennium Partners Fund and John Paulson — the recent benefactor of a massive short position in subprime mortgages — both copped to a similar strategy.

All three men have outperformed the market this year.

  The dollar continued to trend down today in light of the government’s plan to invest greenbacks in troubled financials. The dollar index is down a full point from yesterday’s high, to about 81.

  As the dollar drifts down, commodities are moving up ever so slightly. Oil has now pushed back to $81 a barrel, for example. And after dipping as low as $820 yesterday, the spot price for gold is around $835 as we write.

  “What do you think the real value of gold is right now?” writes a reader. “Don’t tell me to look at the spot price. It’s now such a heavily distorted, unrealistic number that is being manipulated by the financial establishment. All this horrendous bailout money everywhere means that horrendous inflation will soon be upon us, but they have to keep a lid on this by distorting gold.

“There is a disconnect from the spot gold reported on the exchanges to what the physical gold sells for now. And that disconnect is about $300 higher for the physical to the exchange spot price.

“Check eBay, coin dealers and everywhere else and try to buy an ounce of gold — you’ll pay around $1,200 for the physical ounce, versus the high $800-low-$900 spot price, if you can even find such. People are not letting go of their physical pieces for the depressed exchange figures. Just check the daily newspapers and all the ads by coin dealers offering to buy precious metals or scraps they can buy from the gullible and ignorant public. Even if they had to pay the current spot price, they’ve got customers ready and willing to pay these more realistic higher ones.

“So if gold is really around $1,200 an ounce right now, it’s correctly forecasting a significant inflation soon down the line. Don’t believe anything that is touted from the establishment now. Everything is being done to distort the real mess we’re in.”

The 5 responds: We always thought the price disparity between the spot price and physical pieces reflected a retail market versus what traders — who don’t necessarily have to take receipt of and pay storage on the physical gold — are willing to pay. Are we being deceived?

  “While I’m no expert on currencies,” admits a reader, “I believe that the reason we haven’t seen the dollar collapse is because we still have frozen credit markets. Once the lending ramps up again and unleashes the fiat dollars into the economy, we’ll finally see the devaluation many have been expecting. The dollars can’t devalue if they are locked up in a vault (or computer) and not being circulated or utilized.”

The 5: Again, we concur. The fundamentals behind the dollar are getting worse, not better. But as we’ve been pointing out, during the crisis, the greenback has reasserted itself as the flight to safety trade. The hedge fund guys we mentioned above, for example, dumped $400 billion in dollar-denominated money markets in the last few days alone. A clear signal that the credit markets have thawed… and less volatility in the stock markets… will have to emerge before the dollar resumes its meandering path toward its intrinsic value.


Addison Wiggin
The 5 Min. Forecast

P.S. The man Secretary Paulson has tapped to lead this historic bailout is a 35-year-old aerospace engineer. After developing technology for NASA, Neel Kashkari parleyed his Wharton MBA into a job at Goldman Sachs (big surprise), where he specialized in information tech for the Mergers and Acquisitions group. Paulson gave him his first government gig two years ago as an adviser at the Treasury.

Hmmmn. We’re about to spend $700 billion — perfect, let’s go find a young, brainy technocrat to decide where. That ought to do the trick. Why bother with history, economics, philosophy or any of those trite humanistic trades?

P.P.S. The local CBS affiliate from D.C. came by last night to discuss the 11% rally. This is what they aired on their 11 p.m. newscast.


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