Friday, January 25, 2008

Wrap Up: A Wild Week

An astounding week on Wall Street with a wild roller-coaster ride in the market. The market started deeply down on Tuesday following significant drops in world markets on Monday, which was the MLK holiday in the U.S. By the end of the week, the markets have recovered most of their losses while rising in significant counter-trend rallies on Tuesday and Wednesday.

The business news flow this week was no less shocking; starting with the story about the lack of risk control at Societe Generale. This French bank revealed that a low level trader was able to cost the firm $7.2 Billion in unauthorized bets on stock markets. More interesting, the trader did not make any money off of his actions.

In the meantime, the 31-year-old employee at the center of the situation, Jerome Kerviel, has magically disappeared according to most press reports. Some reports claim he has fled while others state his lawyers say he will be available for questioning.

The major banks and brokerages have constantly harped on how they have improved risk control over time. Once again this appears to be a fantasy! First the CDO / SIV crisis, and now a situation where a low-level employee has perpetuated the largest financial fraud in history by an individual.

The absurdity of the situation has led many pundits to question if Societe Generale is being truthful about the situation, or if this “news” has just been cooked up to cover their CDO losses. It seems ludicrous that an employee would be able to by-pass even basic risk control systems at this level of magnitude. Especially since the sell-off earlier this week in European markets is now being tagged to the need of Societe Generale to exit these unauthorized positions.

In the meantime, the housing situation in the U.S. does not appear to be improving. Two key reports underlined the dismal condition of real estate. The sales of single family homes dropped by the largest amount in 25 years. The median price of a home fell for the first time in four decades, dropping 1.8% to $217K. The entire country has not experienced a decline in home prices for an entire year since the Great Depression.

The outlook is not pretty; the housing bottom is not likely to be reached for many months. In some reports, prices nationwide will fall by another 5%. This implies that the drop in hot speculative markets will be much greater. Lasting Housing Woes Paint a Grim Economic Picture

Hoping to improve the economy, law makers in Washington implemented a stimulus plan that will provide most tax payers an additional $600 to $1200 in their refund. The hope is that people will spend this money and stimulate the economy rather than simply paying off debt or shoving it into their bank account. The concept seems counter-intuitive, but with a consumption driven economy it is understandable. Some press questions if the American consumer is too strapped to spend.

Offsetting the news from Washington, the unemployment rate continues to increase. The major banks were at the front of the employment press; Citi announcing more cuts, Goldman Sach’s about to axe 1000, Morgan Stanley trimming another 1000, and the expectation that Bank of America & others will add to this trend.

The Bond insurance situation continues to play out with regulators from New York and other states urging that institutions rescue these firms which insure most municipal bonds. Most states are very concerned because their ratings on existing bonds will dive and cost to borrow additionally money will rise immediately when these insurers become insolvent. Wilbur Ross may be stepping up to purchase Ambac (ABK). MBIA Inc (MBI) appears to be treading water hoping for a deal of some type. ACA Capital Holdings (ACAH.PK) has a mere month to live after receiving a forbearance extension to February 19th from its creditors.

The question remains if the market has arrived at the bottom. Stock markets normally approach the bottom in a very volatile manner, with many violent upside counter-rallies over a period of months. Usually the bottom is re-tested multiple times before a new significant uptrend starts. This can be seen by studying the charts of past troughs in the markets. This also implies that the probability is that this week has not been the local bottom for the market; in light of weakening economic conditions there will be a further slide over the upcoming months. Only time will tell how the entire situation plays out.

In the meantime, investors should focus on the long term with their retirement savings and not attempt to trade the market. Maintain a properly diversified portfolio and understand that the stock market moves in cycles… and in due time will bounce back.