Stocks Tank Again, But Is The Worry Warranted?

It was a rough week in the stock market as the S&P 500 fell -4.52% and now finds itself down-5.88% for the year. The key to the current decline, which was highlighted by six straight down days on the Dow, was the worry that we have not yet seen the end of the credit crisis or the damage being inflicted in the banking industry.

To be sure, it was the big banks that were front and center in the latest dive. Worries over more writedowns, more capital raisings, and the need for more governmental assistance drove stock prices of the big banks lower on a daily basis with the saga’s headliners, Citi (C) and Bank of America (BAC) losing 50% or more in the last 7 sessions.

So, with Bank of America’s stock now sitting at a hat size ($7.18) and Citi breaking to a new closing low of just $3.50, the question that begs to be asked is if the current fretting over the financials is warranted.

Déjà vu All Over Again

The bears argue that the cycle of capital destruction in the banking industry continues unabated. The problem here is twofold. First, those toxic assets that have been the root problem in this bear market are unfortunately, still out there. And second, there are still no buyers for these mortgage-backed securities.

If you rewind the tape back a few months, you may recall that the original idea behind the Troubled Asset Relief Program, as the name suggests, was to buy up a bunch of these toxic assets to (a) get them off the books of the banks and to (b) create a buyer of last resort for the securities. But, with the banking system on the verge of collapse (and no, we are not exaggerating), the dynamic duo of Paulson and Bernanke felt it was best to instead inject money directly into the biggest banks so that they may live to fight another day.

While this plan did work, it now appears we’re staring at a case of déjà vu all over again with regard to the securities nobody wants. The problem is these troubled assets have not been written down completely. The original thinking was that these securities did have some value (not every mortgage is going to be defaulted on) and with time, buyers would emerge.

But unfortunately, this has not been the case. Therefore, we’re back to banks being forced to write down more assets, which means they need to raise more capital, which, of course means more assistance from the government, which, in turn, means that the shareholders of the bank gets diluted, which causes stock prices to go down.

So with the stock prices of the big banks now in single digits, the stock market is telling us that the need for additional capital (which they will get) means the government is likely to own the majority of the bank in the near future. And unfortunately, this leaves the current shareholders potentially holding a big bag of nothing.

These Problems Are NOT New

On the other side of the aisle, one of the arguments the bulls have been quietly making over the past couple of weeks is the issues causing today’s problems are not new. In short, our heroes in horns remind us that the concerns in the banking industry currently causing the carnage are the very same problems we were looking at in October and November. And since this time around, Financial Armageddon is not on the table, the glass-is-half-full crowd suggests that the market’s recent visit to the lows does not make a lot of sense.

Bill Gross Says “It’s Over”

But perhaps the biggest argument the bull camp has on this subject came after the close on Friday. In an interview with Reuters, PIMCO’s Bill Gross, who is the world’s largest manager of bonds said, “We have probably seen the worst of the credit crisis from the standpoint of the banking balance sheets.”

If Mr. Gross is correct; we may be nearing and end of the cycle of writedowns and capital raisings. And the bottom line here is that this, dear readers, would be a boon to the stock market.

Now combine this with the idea that the FDIC’s Sheila Blair is beginning to warm up to the idea of a government sponsored “bad bank” structure (ala the S&L Crisis’s RTC) and one could argue that we just might have a way out of this mess. And in short, this means it may not be too much longer before investors can begin to look ahead again.

Bottoming Phase Intact

While this admittedly upbeat view of the investment world may indeed be a bit too rosy for the present conditions, the biggest thing to take away from this week’s big picture missive is that despite the most recent adventure tot the downside, the bottoming phase in the stock market appears to still be intact.

As such, this is not the time to be looking for new lows in the stock market (although retests are always a possibility for another month or so). This is not the time to be frightened out of long positions when the news is bad (it will be) and things get ugly. And this is not the time to be pressing your shorts.

If we are correct on our assessment, this is the time where we should be looking for the volatility to calm down. This is the time to be nibbling at the dips. And for those trader-types among us, this is the time to be looking for a “tradable rally” to begin in the near term. However, we’d watch last week’s lows on the charts very closely, just to be on the safe side.

Wishing you all the best for a profitable week ahead,

David D. Moenning
Founder TopStockPortfolios.com

Positions in Stocks Mentioned: None

 

The Week in Review        Week Month YTD Dow Jones Industrial Average -3.70% -5.64% -5.64% S&P 500 Index -4.52% -5.88% -5.88% NASDAQ Composite -2.69% -3.02% -3.02%

 

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