The Bear Stearns Fiasco
by Paul J. Nolte, CFA
March 17, 2008
Eliot Spitzer and Bear Stearns. Not an unlikely couple in a statement in any given week, as Mr. Spitzer was known to take a swing at any financial company that may be doing wrong. However, last week both were bowed low � Eliot by personal demons, Bear Stearns by what may be called an old fashioned run on the bank. Eliot may wind up on the wrong side of prison bars and Bear Stearns may become nothing more than a historical footnote. The Fed and JP Morgan have come to the temporary rescue of Bear Stearns, however given the very intertwined dealings of financial instruments, investors began to wonder how many others might suffer the same fate in the weeks ahead. The coming week may provide jittery investors with some answers as many investment firms from Goldman Sachs to Lehman Brothers report earnings and likely will comment upon their ability to weather the current financial storm. Although Bear only a few days prior to Friday's announcement said they had plenty of liquidity. Oh, and the Fed earlier in the week offered up $200 billion in asset swaps to help shore up some balance sheets enough to allow loans to once again be made upon solid backing. The combination of all the above meant nothing to the financial markets by the time of the closing bell � the OTC finished exactly unchanged for the week � oh, but what a ride!! A bottom or bottomless pit? Next week should provide some answers.
While the markets wound up essentially unchanged, the mood was anything but � from the highs of a 5-year best rally to the brink of bankruptcy. Our longer-term indicators point toward a coming bottom, however noticeably missing is the price at when the bottom will be reached. The SP500 has come tantalizing close to actually breaking the lows of late January both early and late last week. If that floor is broken, then another 3-5% lower is certainly possible. We highlighted volume last week as providing some hope and this week we also noticed that the markets have generally been opening weak and finishing strong. Going back to the market bottom in �02-�03 this indicator turned higher on the initial bottom and continued to rise as the markets finally carved out a bottom over the next nine months. The indicator turned higher at yearend � just as (our guess) we entered a recession. If past is indeed prologue we could spend the next six months bouncing up and down as much as 20% before the third and final time exactly five years ago. If the markets do indeed act poorly until something breaks, the Bear Stearns news might be the capitulation that many are looking for to finally put the first nail in the bear�s coffin � but it won't be easy getting the rest pounded in.
Our bond model continues to bounce between signals, now indicating that interest rates are going lower, after last week pointing to higher rates. While the news of the past week now points to a rate cut by the Fed of three-quarters of a percent, we are likely getting near the end of this cutting cycle (there really isn't much left to cut!) as we are in the early phases of being helped by the rate cuts of last August. The key to any benefit of lower interest rates will be the opening of the �loan window� by banks. However, as was made crystal clear last week, their asset base remains under pressure from further erosion in the assets they hold - hence the rush to the safety of treasury bonds. While we still believe bonds will provide better returns than stocks, that difference is beginning to narrow in favor of stocks.
© 2008 Paul J. Nolte, CFA
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.
Paul J. Nolte, CFA