Mirable Dictu! The Journal is Skeptical About the Stock Rally

The normally cheerleading Wall Street Journal, contrary to its usual form, voices considerable doubts about the near-200-point runup in the Dow yesterday:

Stocks soared to a new all-time high….suggesting that investors already are shrugging off the problems that rocked global financial markets only weeks ago….. The scamper to new highs comes despite surging mortgage defaults, the collapse of big buyout deals, a plunge in the dollar and growing fears of a recession.

Just yesterday….Citigroup Inc. announced a $5.9 billion hit….UBS AG said it was taking $3.41 billion in write-downs….

Rather than disrupting financial markets, the revisions seemed to bolster investor confidence that banks are taking their lumps and losses are mainly in the rearview mirror. Both banks saw their shares rise.

The optimists’ key assumption is that the Federal Reserve has the situation under control….

Yet housing, the source of the market’s late-summer woes, remains unstable. Over the next 12 months, Americans holding home mortgages with a total value of nearly $480 billion will face revised interest rates, typically as the low “teaser” rates that drew them in are reset at higher, market rates, according to data from Moody’s Economy.com. About 55% of these mortgages, or $260 billion, are loans given to subprime borrowers, generally people with poor credit, the data show.

Normally the stock market reflects expectations for the economy’s direction, which is why housing skeptics are scratching their heads over the Dow’s surge. One factor may be that, amid low interest rates and the freezing of credit markets, people with cash to invest feel little alternative but to put it in stocks.

It also may be that stocks are experiencing a false dawn. On several occasions during the collapse of the technology bubble early this decade, investors grasped at straws to argue the crisis had passed. Instead, the stock market’s down trend lasted for 2½ years, and the real resolution came after tech and telecommunications companies had completed several painful rounds of shedding debt and refocusing their businesses….

If more mortgages go bad, that could force banks and other financial firms to take repeated write-downs of the value of securities backed by mortgages. That could further roil debt markets and affect the stock market, given that financial institutions comprise 30% of the profits of the companies in the Standard & Poor’s 500 stock index.

“I think you’re going to get this constant flow of hits going forward, spread out over multiple quarters,” said Bill Laggner, a partner at hedge fund Bearing Fund LP, which has bet against financial institutions and other stocks involved in the housing market.

“A lot of people think that it doesn’t matter what happens, that the Fed will rush in and find some way to save some of these larger institutions and the various assets that they own,” Mr. Laggner said. “But I don’t see how there’s going to be a market for a lot of this paper for a long, long time.”

This much openly-stated skepticism in a front-page Journal story is a big near term bullish signal. Even if you don’t believe in this rally, I’d give it at least a couple of weeks based on this story alone.

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  1. Yves Smith

    Anon of 4:14 AM,

    We don’t give investment advice, and if you read this blog, we don’t see much reason for optimism. However, the best way to sum up this post is that old Wall Street expression, “don’t fight the tape.”

  2. burnside

    If your object were to game an options-driven market, then Wall Street looks rational lately.

  3. Bill Laggner

    How much longer do you think the financials can ignore over $7 trillion in MBS/ABS/CDO/CLOs which can’t be priced? Why do you think the ABCP market is still having problems. Credit bubble has a gaping hole but few seem to realize the problem.

  4. Yves Smith


    I wish I had a simple answer, or any answer. I can only point to a couple of things that I think are contributing.

    One is that market participants have every reason to divert attention from the structured finance problem. To the extent that hedge funds, institutional investors, and securities firms are still carrying these assets on their books at stale, and therefore almost certainly too high, values, they have an incentive to keep the game going as long as possible. They may genuinely believe that the Fed will cut rates deeply enough that if they defer the day of reckoning, they won’t have to realize much if any losses. And in fairness, if the stuff really isn’t trading, what price do you assign? This isn’t a trivial problem. (My sense, BTW, is that the investment banks aren’t carrying much of this paper except in in-house hedge funds. There were stories that suggested they lightened up on their trading inventory over the summer).

    And no one seems to have the foggiest idea how much paper is problematic. It ought to be the case that the simpler structures (meaning traditional pass throughs and ABS that have reasonably homogeneous assets, like only residential mortgages) probably have been remarked (indeed, they may never have suffered from much illiquidity). But my sense is the CDOs are still a problem, and likely the CLOs as well (there my belief is that they would have trouble when the underlying assets are heterogeneous and thus very hard to model accurately).

    The second problem relates to the first. The reason no one has any good information is that fixed income markets are over the counter. No centralized exchange, no centralized reporting. This makes it harder for both the media and regulators to know what is going on.

    The financial media has always given proportionately more attention to the equity market. In the stone ages of finance, it was because stocks traded and bonds almost never did, so there was legitimately more to talk about in the stock market. And retail investors bought stocks and maybe held a few munis way back then.

    This stock-centric approach continued when the financial media expanded in the 1990s. The doc com era made stocks exciting, so again the focus went there.

    Now I think the issue with the media is partly habit per above, and partly the phenomenon of the drunk looking for his keys under the street light, because that’s where he can see best. It’s comparatively easy to report on the equity markets, difficult to report on fixed income. And for the most part, only the pros are interested anyhow.

  5. Bill Laggner


    A recent survey of the top 50 institutions indicates over $7 trillion in structured finance assets currently in limbo. Now we know why they don’t want to lend to one another, hence the 100bps cut in discount rate. Dan Taylor at Aberdeen asset mgmt indicates a 1% decline in national RE prices results in a 40% haircut in CDO collateral (CDO market approximately $2 trillion. Now go back and look at the top 8 institutions in the US and compare level 2/3 assets with shareholder equity-game over. The credit contraction has begun and asset prices should eventually follow.


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