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Five Things You Need to Know: Crisis Averted, Now Back to Reality


Bear Stearns aside, the symptoms that first revealed the debt crisis remain well in place.


Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Crisis Averted, Now Back to Reality

Yesterday's sharp move higher in stocks was widely attributed to a collective sigh of relief: The Bear Stearns (BSC) implosion has been averted. That surely sounds like good news, but after the initial euphoria wears off we're still stuck right where we were before the Bear Stearns situation even began. The Bear Stearns crisis only served to temporarily mask the underlying structural shift taking place.

This remains an ongoing debt crisis and deflationary credit unwind. And Bear aside, the symptoms that first revealed the debt crisis remain well in place.

  • The S&P/Case Shiller home price index fell 10.7% year-over-year, the largest decline on record, and 2.4% month-over-month, the 13th consecutive monthly decline. All 20 cities tracked by the index showed housing prices fell last month.

That sounds grim. Maybe too grim. Is there another home price index that sounds better? Sure there is.

  • Home prices fell a mere 1.1% on a seasonally-adjusted basis in January, according to the Office of Federal Housing Enterprise Oversight's (OFHEO) new monthly House Price Index. For the 12 months ending in January, U.S. prices fell just 3.0%. And even going back to the peak for this new index in April 2007, the monthly index is down only 4.1%.

Whew, feel better? Then take a look at the rate of change of this index going back quarterly to its inception in 1992.

Click to enlarge

That is how steep and quick the rate of change in prices has been. No wonder the models used by banks - many of which didn't anticipate home prices would decline in the first place - left them vulnerable to falling home prices.

Meanwhile, the market for auction-rate securities remains frozen. About 70% of auctions in the once-$330 billion market now fail, according to Bloomberg.

And remember late last year when everyone was worried about soaring European money market fund rates, a clear sign that banks were hoarding cash? The cost of borrowing in euros on money markets rose to the highest level this year overnight, Bloomberg reported. The euro interbank offered rate (EURIBOR), for three-month cash rose 3 basis points to 4.70%, the highest level since December 27, and the 14th straight daily gain.

And don't forget about the consumer. Unlike Bear Stearns - which as recently as a year ago was less than half the market cap of Lehman Brothers (LEH), which was less than half the market cap of Morgan Stanley (MS), which was less than half the market cap of JP Morgan (JPM), which was still 35% smaller than Citigroup (C) - consumer spending still makes up around 70% of Gross Domestic Product.

Today we learned Consumer Confidence fell more than forecast and Americans' economic outlook is its bleakest since Richard Nixon was in office. Consumer outlook on employment also declined. Those who said jobs are plentiful declined to 18.8% from 21.5% last month. And those who said jobs are hard to get increased to 25.1% from 23.4%.

This is the macro environment we are in. The cocktail of debt, asset deflation and rising unemployment has already been poured. This is not doomsday. Like always, we will trudge through it and endure, but the important thing to remember is this is a marathon, not a sprint. Days in the market like yesterday can obscure the reality of our situation.

2. Nothing Goes Up, or Down, In a Straight Line

Of course, equally important to remember is that nothing goes up, or down, in a straight line. Our measures of risk, the stock market index bullish percents, continue to improve.

Below is where we stand with the point and figure bullish percent indicators for equities, based on Investors Intelligence data.

The NYSE Bullish Percent remains negative, though is within 2% of reversing up. The High Low Indexes for the Nasdaq and NYSE also are still negative. There will be plenty of time for raising equities allocations when the NYSE Bullish Percent does reverse up.

3. Happy Days Are Here Again

Although it is the topic foremost on the market's collective mind, we couldn't care less about what constitutes a market "bottom." What does that even mean? A bottom compared to what? Last week? Last month? Last year? What about last century? Those time markers are arbitrary at best. Instead, what we are obsessed with is risk.

The macro context for sentiment indicators such as the bullish percent indicators we looked at in number two is everything. What do we mean by that? Well, consider the following. Back in the day when I was at Dorsey Wright we looked at these bullish percent indicators in the context of two long-term market periods - the secular bear market between 1966 and 1981, and the secular bull market between 1981 and 2000. What we found is that despite the labels, the indicators spent roughly the same amount of time either positive or negative. The only difference was the magnitude of the draw-downs when negative, and the magnitude of the moves higher when positive. That is important to understand because the macro environment gives a context to what the loose terms "positive" and "negative" mean.

Happy Days Are Here Again?

Take a look at the following charts. We'll add the context in a moment.

What this chart shows is a 59% rally over the course of 11 weeks. Man, sure would be nice to have a piece of that, no? Any idea when it took place? It's the Nasdaq-100 Index from about mid-September to December in 2000. The NDX still finished the year down 36%.

What about this chart?

It shows a healthy 24% rally over the course of seven weeks. Seven weeks is a long time. It's especially a long time during the absolute heart of the 2002 deflationary scare. The index above is the S&P 500 early October to early December 2002. The S&P 500 still finished 2002 down 23%.

The point of this exercise is simply to illustrate that nothing goes up or down in a straight line. It's all about risk and context. Risk and context; those are the only two variables that matter, and the two variables you must select on your own.

4. Credit STILL Tightening

Related to today's number one - and a topic we covered yesterday - is this New York Times piece on tightening credit conditions for small firms ("Small Firms Find Credit Is Tightening").

Last month, the Federal Reserve's Senior Loan Officer Survey report found that a third of banks in the United States had tightened their lending standards for small-business loans.

As weak companies draw on pre-established credit lines, even as the banks extending those credit lines are simultaneously attempting to shrink their balance sheets, this leaves little credit leftover for other firms, even credit-worthy ones.

"One small-business owner who has been running into problems obtaining new credit is Tate M. Linden, who opened his marketing consulting business three years ago. Last May, he said, he had no trouble obtaining a $35,000 line of credit for Stokefire, his branding consulting business in Alexandria, Va.

But when he went back several weeks ago to the same institution to add another $15,000 to his credit line, the answer was no.

"We just thought it would be as simple as making a check mark in the box because we have revenues coming in," said Mr. Linden, 36

5. Real Estate Only 5% of GDP, But Apparently 100% of Everything Else

One of our sharp editors caught this rather bizarre tale of real estate fallout this morning.

New York City's Metropolitan Transit Authority, the agency that runs the city's bus and subway systems, said it will put on hold $30 million in scheduled bus and subway transit improvements scheduled to begin in June. Why the delay? The troubled real estate market. Seriously.

Revenue from MTA real estate transactions came in $32 million below expectations in the month of March alone. Year-to-date revenue from real estate transactions are $21 million below budget.

To add insult to injury, the delay comes only weeks after the MTA enacted a broad-based fare hike.

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