Six months of 2008 are now behind us and the stock market has not been a friendly place to most investors. Stability that was once found in household names that were industry giants is gone, and they have now been brought to their knees.
Many of them were the stocks we might have looked to in the past for stability, so you can be sure I put forward my five candidates with a little trepidation, but forward I go anyway. First a little review is in order.
Citigroup Inc. (NYSE: C) dropped from around $53 per share last year to around $30 in January and we can buy it today for around $17. Even at that price Goldman Sachs (NYSE: GS) has downgraded it to a sell and thinks there is more bad news to come. Citigroup was the largest bank in the world. Not any more.
General Motors (NYSE: GM) was the largest car maker in the world. That was before the stock tumbled from $43 to its current $11 range. A crushing blow to long time investors hoping that someone in the company could stop the ship from sinking.
The Wall Street Journal's "The Game" column speculates that one of the results of the Bear Stearns crash could be the push of investment banks and commercial ones closer together, which could result in better handling of volatility with more stability. Some observers think Merrill Lynch & Co (NYSE: MER), Morgan Stanley (NYSE: MS) or The Goldman Sachs Group Inc (NYSE: GS) could go that route by buying a commercial bank. Any move would force them to adhere to better reserve ratios, affect short term bank funding, and shrink balance sheets.
The Wall Street Journal reported that Google Inc (NASDAQ: GOOG) will soon make available a new service that measure hits on the Internet with the intent of helping advertisers decide where to buy ads online and would directly compete with comScore Inc (NASDAQ: SCOR) and Nielsen Online. Ad executives said Google's method could make targeting markets more efficient.
A Manhattan judge dismissed four claims made by American International Group Inc (NYSE: AIG) in its fight to regain control of a block of its shares held by Starr International, a company that once founded a lucrative compensation plan for AIG executives. AIG believes the shares held by Starr should continue to be used to fund employee compensation, the Financial Times reported.
WEB SITES:
According to Scorpio Partnership, Bloomberg reported that UBS AG (NYSE: UBS) and Merrill Lynch had slower growth in assets under management last year due to losses connected to the U.S. subprime crisis.
Merrill Lynch (NYSE:MER) is recently down $1.63 to $36.04. MER call option volume of 10,479 contracts compares to put volume of 69,715 contracts. MER July option implied volatility of 77 is above its 26-week average of 51 according to Track Data, suggesting larger price movement.
H&R Block (NYSE:HRB) is recently down 46 cents to $22.66. HRB is scheduled to report Q4 EPS on June 30. HRB July 20 puts have traded 27 times on transaction volume of 10,492 contracts, above its open interest of 3,670 contracts. HRB July option implied volatility of 47 is above its 26-week average of 43 according to Track Data, suggesting larger price movement.
Option Update is provided by Stock Specialist Paul Foster of theflyonthewall.com
Merrill Lynch & Co. (NYSE: MER), at least according to rumors running amok on trading floors, may issue a profit warning and take additional writedowns on its mortgage holdings. MER shares plunged over 5.5% as a result.
I always cringe a bit when I hear of trading floor rumors. Like it or not, traders have a vested interest so it's harder for me to take what they say at face value. Much different than when newspapers report without naming sources. At least there, I'd like to believe, journalistic standards should prevail.
Indeed, while Reuters says that "A Merrill spokeswoman declined to comment on the rumors," CNBC says that sources told it the U.S. broker "is not preparing to issue a profit warning Friday."
With $30 billion worth of writedowns under its belt, it's not difficult to believe that Merrill will indeed require additional writedowns, capital raising, or asset sales. Especially in light of what's been happening the last few weeks. Not only did peers Lehman Brothers (NYSE: LEH) -- down 4% -- and Morgan Stanley (NYSE: MS) -- down 3.5% -- posted weak results this week, but financials in general announced one writedown, or capital raise, one asset sale after another.
Indeed, analysts have been cutting their forecast on financials these days, including Merrill. If a month ago analysts had predicted earnings of 44 cents a share, today the average estimate runs at 16 cents a share.
So-called chatter can have its own agenda among traders so I'm wary of such unsubstantiated rumors. Yet, in this case, its more than likely such a warning would be out sooner or later. Just look at what Citigroup (NYSE: C) -- down 3.6% -- said Thursday.
TheStreet.com's Jim Cramer says the acquired Bear Stearns portfolio is worth even less than he thought.
How bad was that Bear Stearns portfolio? I am beginning to believe that JPMorgan's (NYSE: JPM) (Cramer's Take) buy of Bear is looking like a big mistake. It can only be justified by what might have been an even bigger problem for JPM -- the collapse of the trades that Bear made, which were being processed by JPM's clearing.
We are now beginning to get a real sense of the worthlessness of the mortgage portfolios. Not that we got any help from the SEC, which has taken a "we don't care what's in the mortgages as long as you tell us you have mortgages" attitude. That's been worthless for investors, and maybe even for JPMorgan.
The losses now exceed $400 billion, according to my modeling (if you simply assumed that 50% of the exotic mortgages that were issued from 2005 to 2007 eventually went into default). That's amazing, but it looks like I dramatically underestimated the losses. UNDERESTIMATED!
The most egregious issuers of these exotic mortgages were Bear, Merrill Lynch (NYSE: MER) (Cramer's Take) and Lehman Brothers (NYSE: LEH) (Cramer's Take). I believe that JPM has taken in a huge number of uninsurable, non-hedgeable mortgage instruments that are a pure write-off. And that means they are probably underwater on everything they took in.
According to Yahoo! Inc (NASDAQ: YHOO), the Wall Street Journal reported that a severance plan investor Carl Icahn said is "excessively expensive" would come into play if Icahn is successful in his plan to take control of the company's board; Yahoo! maintained that the plan is structured to prevent Yahoo! from altering or dismantling it while under a proxy challenge.
The Financial Times reported that Lehman Brothers Holdings Inc (NYSE: LEH) almost reached a strategic deal with a group of Korean financial institutions as part of its recent capital raising initiative, and the investment bank may still sign an agreement with the Korean companies this year, inside sources said.
A source familiar with the matter told dealReporter that Barnes & Noble Inc (NYSE: BKS) is conducting due diligence, but has not established whether it will competitively bid for Borders Group Inc (NYSE: BGP). Should Barnes & Noble indicate real interest, the biding process could be delayed, the source said.
OTHER PAPERS:
The Detroit News reported that Ford Motor Company (NYSE: F), in an effort to keep up with changing consumer demand in the U.S., is assembling a plan that will shift entire truck plants to car production.
Bloomberg News reports that 10 of the biggest names in investment banking are blocking investors from getting their hands on their share of the $330 billion Auction Rate Securities (ARS) that they were told was as safe as a money market fund.
I first posted about this back in February and now it has 4,325 comments from people trying to get at their money. Bloomberg quotes one victim of frozen ARS syndrome: Franklin Biddar, a 65-year old real estate investor who can't get his $100,000. "I can't do anything," said Biddar, who was so eager to unlock his money that he was willing to accept 11 percent less than what he paid for the securities. "Bank of America (NYSE: BAC) got me into these securities that are supposed to be as safe as a money market, and now they won't get me out."
Here's a list of the banks involved in this money blocking operation and the volume of municipal ARSs they issued between 2001 and 2007:
Lehman Brothers Holdings (NYSE: LEH) has approached a Korean sovereign wealth fund (SWF) about investing. But Lehman probably won't get the money it seeks. Reuters reports that Korean Investment Corp (KIC), an SWF that manages about $20 billion and is an investor in Merrill Lynch (NYSE: MER), is unlikely to invest in Lehman.
Meanwhile, Bloomberg reports that investors on the Einhorn side of Lehman -- those hoping its stock will drop -- are increasing their wager. It notes that options traders increased their bearish positions to a two-month high yesterday. With one analyst expecting Lehman to report a second-quarter loss of 50 cents a share during the week of June 16, put option volume rose to 283,676 contracts, or quadruple the 20-day average, and bearish bets on the company exceeded bullish ones by 1.6-to-1.
As I mentioned during my talk at Stanford in April, SWFs have been burned by their investments in the U.S. finance industry. One of them, the Citic Group, was lucky it was able to bail out of its commitment to invest $1 billion in Bear Stearns. But that close call is likely to keep other SWFs from throwing good money after bad.
Bloomberg News reports that Lehman Brothers Holdings (NYSE: LEH) wants to sell $4 billion in equity. But it already raised $6 billion so why does it need more? It should be no surprise -- but thanks to a chorus of statements by financial leaders that "the worst is over" -- including Lehman's CEO Richard Fuld, Jamie Dimon, Hank Paulson, and Barton Biggs some are surprised that there are still problems.
Since the crisis began -- last August when the Fed began cutting rates from 5.25% to 2% -- banks have been trying to reduce their ratio of debt to equity below the hugely risky 32:1. But it's hard when they hold $500 billion worth of Level 3 assets -- which don't trade and therefore have no objectively set market value. To maintain or improve their capital ratios, banks have been writing down the value of the securities on their books -- $276 billion worth so far -- and simultaneously raising capital. Citigroup (NYSE: C) has raised the most -- $44 billion.
S&P downgraded Lehman, Morgan Stanley (NYSE: MS) and Merrill Lynch (NYSE: MER) saying they may disclose more write-downs for devalued assets. And hedge fund manager David Einhorn -- who's short Lehman -- got into a verbal debate with Lehman CFO Erin Callan arguing that Lehman had failed to disclose $6 billion worth of such Level 3 assets -- known as Collateralized Debt Obligations (CDOs) and it needed to raise capital. Today's announcement suggests that Einhorn was right.
Just because executives act like cheerleaders, it doesn't mean investors should take them at their word.
The problems of executive compensation at big financial companies like Merrill Lynch (NYSE: MER) and Citigroup (NYSE: C) are obvious. Executives who led their companies into massive losses on risky bets walked away with huge parting gifts, even as shareholders nursed billions in losses. Congress held hearings and financial journalists everywhere cried foul. But corporate governance helps people who help themselves and, for whatever reason, most shareholders have made the inexplicable decision that they don't even want an advisory vote on executive pay.
The Wall Street Journalreports (subscription required) that "At CitigroupInc., J.P. Morgan Chase & Co., Merrill Lynch & Co. and Morgan Stanley, proposals that would let investors weigh in every year with a nonbinding vote on compensation got an average of just 37% of shareholder votes, according to the latest tallies. Similar proposals in last year's proxy statements for the same companies got 43% support."
How is that even possible? When the problem of pay gone wild is so obvious that even laissez-faire capitalists are saying something is screwed up, why would shareholders reject an opportunity to have their nonbinding voices heard? It just doesn't make any sense at all.
Part of the problem may be that individual investors aren't voting. But I also wonder whether there's some home cooking going on. Are the large institutional shareholders that control the bulk of these companies voting to keep the executive pay gravy train flowing because they have a personal stake in it?
If so, they should remember that their fiduciary duty lies with the investors for whom they own the shares. If regulators want to make themselves useful, they should take a look at this possible conflict of interest.
Merrill Lynch and Co., Inc. (NYSE: MER) CEO John Thain said today that the risk in the housing market is "much lower" than it has been recently as the credit crisis in the U.S. is "getting better." Leave it to the leader of a company which has written off over $30 billion in mortgage lending investment to make this claim. But the thing is, could he be right?
Although Thain said "economic pressure" will remain high over the next year, he expressed confidence that the end of the housing bubble, which is still popping in many parts of the country, is now in sight. Thain also indicated that food prices and shortages as well as higher unemployment will continue to have an impact on the U.S. economy. Of course Merrill has had three quarters of disastrous results like other large investment banks, and the company is still toiling with the idiocy of incredibly risky investments that have left it weakened financially.
Even if Thain had been hired by Citigroup, Inc. (NYSE: C) last year, he'd be in the same mess in the same industry. I'm not sure what "much lower" risk in the housing market means, although he's probably talking about his company's reduced exposure to those SIVs and other vehicles from the Flintstone era that start off fast before the wheels fall off.
I hope Thain is correct in his assessments, and Merrill Shareholders are probably wanting the same thing, just much more badly than myself.
TheStreet.com's Jim Cramer says they won't fail, but they can't be bought yet.
What do the words "we have enough capital" mean? It means get ready for an offering. Merrill (NYSE: MER) (Cramer's Take) last week said they had enough capital. So did Citigroup (NYSE: C) (Cramer's Take). Of course they left themselves some sort of out. Merrill said it had enough "equity" capital, so it did a huge preferred deal. Citigroup stressed that it had more than it needed, but they just made you look like a moron if you bought stock the other day at $27.
But if you did buy, I have no sympathy for you, none whatsoever. I have no sympathy for you because I have said over and over again that as bank stocks go up, they must issue equity until housing stops going down. Every uptick must be met by equity if the downcycle is elongated.
MER board of directors declared a quarterly regular dividend of 35 cents payable May 28. MER call option volume of 41,626 contracts compared to put volume of 70,459 contracts. MER May option implied volatility was at 44; below a level of 74 from April 16. MER average option implied volatility over the last 26-weeks is 48 according to Track Data, suggesting flat price movement.
Options Update is provided by Stock Specialist Paul Foster of theflyonthewall.com
The Wall Street Journal reported that New York state's attorney general, Andrew Cuomo, has launched an investigation into auction-rate securities and is seeking information from some of Wall Street's biggest institutions including UBS AG (NYSE: UBS), Citigroup Incorporated (NYSE: C) and Merrill Lynch & Co Inc (NYSE: MER), a person familiar with the matter said.
According to the Financial Times, Deutsche Bank AG (NYSE: DB) and other investment banks are working on plans to develop a clearing house for the credit derivatives markets. In an attempt to reduce counterparty risk, the banks are trying to develop a system that would only allow institutions with strong capital bases and credible trading histories to clear trades in the credit default swap markets with a central counterparty.
OTHER PAPERS:
The news that The Royal Bank of Scotland Group Plc (NYSE: RBS) is planning a rights issue of between GBP5B and GBP12B received mixed reviews from British analysts and investors, the Telegraph reported. The analysts expect the bank to cut its dividend.
Six months of 2008 are now behind us and the stock market has not been a friendly place to most investors. Stability that was once found in household names that were industry giants is gone, and they have now been brought to their knees. 
Merrill Lynch
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