Thursday, July 26, 2007

An AAPL Today Did Not Keep the Bears Away

As it turns out, the market didn’t pay much attention to the AAPL news we mentioned in our last post. There were other things going on besides the AAPL story. When we finished last night’s post, the futures were up about 10 points and when we reviewed them before the market opened today they were down over 10 points. This being the case, we surmised that maybe something was going on besides AAPL.

We have been talking about the credit markets for some time now and in fact we have based our blog on the idea that the housing market (including the mortgage market) would ultimately drive the stock market down. What has happened along with the mortgage market is extreme credit type activity generally. The biggest culprit could be the LBO, leveraged buy-out.

This is the idea where a company is bought out by a group that has borrowed money, debt which the company being purchased carries on their books. The concept revolves around much the same idea as buying a house with a big mortgage. The interest is deductible and of course the “value” of the purchased item is going to go up so it can be sold for a profit. The plan for Private equity firms is to do the LBO’s and hold companies off the market for maybe five years and then bring them back to market and do an IPO, initial public offering. Then the whole thing starts over.

You can readily see some fallacies in the paragraph above especially as it relates to prices going up. This is the time when the financers of the LBO, banks or general investors, start to get a little nervous just like the investors in the subprime mortgage market got a little nervous when the defaults started pouring in. In this case, the LBO deals just can’t get done because there isn’t enough money being offered for the potential buyers. In other words, investors are getting risk averse and do not want to “invest” their money in LBO’s. In our last post, we indicated that the Chrysler buy-out was having trouble getting financing.

On Thursday, Tyco Electronics withdrew a $1.5 billion note citing “unfavorable conditions in the debt markets.” That’s another way of saying that they couldn’t get investors to commit to the deal or they would have had to raise the interest rate too much in order to get the deal done. The credit markets were suffering losses as more and more investors are getting, or trying to get, out of riskier bonds. In the Treasury market the water was fine and many investors jumped in, with the safety of Treasuries being very tempting.

This brings us to one of our favorite topics, the FED. Today, more people believe that the next interest rate change the FED will make will be down. The WSJ reported that the market has now priced a 100% probability that the FED will Lower rates to 5% by December. We can’t say we told you so tonight because it hasn’t happened but there are now more people speaking our language (which always makes us just a little nervous).

We don’t think you missed the news that the Dow was down over 300 points at the close after being down over 400 earlier in the day. You may have read in these pages that the 13,670 level would give some support to the market but when it broke we would know that the bear has returned. Well, the Dow made a brave stand both on Wednesday and then again on Thursday morning to try and hold that level but in the end, it gave way. That level was about a down 115 point move and when it broke the Dow went quickly to 200 points and more as the day wore on.

This market has many fans even now and we do have a bit of an oversold situation here tonight but that is not such a big problem in a down market. We could get a little more in the way of a bounce but we think the market will continue its journey south for a while. This afternoon near the low our esteemed Treasury Sec’y Henry Paulson reminded us that the subprime mortgage problem would not dramatically affect the economy. That seemed enough to bring buyers back late in the day. The Dow rallied from down about 435 points to the closing level of down 311 for a nice 130 point rally right at the end of the day. There may be some more upside on Friday but we do believe there is much more downside to come in the next few months.

By the way, AAPL was up over 6% on the day and as part of the NDX, NASDAQ 100, it helped contain the losses in that index to only 1.22% compared to over 2% in most other indexes. The “four horsemen” is a concept put forth by Jim Cramer who says these are the stocks that “take no prisoners”. One of them is AAPL and on Thursday it was up as all the world around it was collapsing. The other three, RIMM, AMZN and GOOG, were down but not by very much so the four horsemen did remarkably well together. We will monitor these four stocks to see how they do in the coming months. We expect that it will not be pretty.

Jim Cramer's "Four Horsemen" article

The other news today was the new home sales which were down 6.6% even though this news was almost ignored. The number from last month was revised from down 1.6% to down 2.2% and this month’s number was expected to be down 1.6%. Again, did anyone even hear this news?

Then there was the news on durable goods. The total number missed estimates only by a little, 1.4% compared to expectations of 1.5%; but, the number excluding transportation goods was down by 0.5% which did get some attention but not much.

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