Tuesday, July 24, 2007

Dow Down on Countrywide News

The news on Tuesday overwhelmed the bulls as the Dow ended down about 226 points. The biggest early news came from Countrywide, the nation’s largest home lender. The company said that losses on certain types of PRIME mortgage loans had been part of the cause for a one third drop in their quarterly income. Slashing their 2007 earnings forecast, Countrywide said the housing and mortgage markets are expected to be increasingly challenging.

Earlier in the year, the company had expected a rebound by next year but is now looking out to 2009 for that rebound. The company stated that loss provisions and write-downs of securities of prime home-equity loans caused much of the problem in their earnings. The so called “piggy-back” loans that have allowed borrowers to avoid paying for mortgage insurance are partly responsible.

Normally, 20% down is required to avoid the mortgage insurance. With creative financing, a borrower has been able to bring much less than 20% to closing by covering the missing part with a piggy-back home-equity type loan. There is a first mortgage covering the normal 80% and then a second mortgage/home-equity loan added to cover up to the rest of the purchase price. Falling home prices have squeezed even the best of borrowers, it seems.

A little later in the day, Bill Gross, manager of the world’s largest bond fund, said that the subprime mortgage problems are spreading to junk bonds. His comments are generally unique and simple and Tuesday’s comments are no exception. He wrote that borrowers and lenders may have bit off more than they can chew and even those who swallow their hot dogs whole are having a serious bout of indigestion. He emphasized that corporate lenders will feel a pinch from subprime housing defaults as well. One LBO, in the form of GM, was postponed, probably due to the higher cost of borrowing in the depressed junk bond market.

Our comments this evening are to point out the precarious nature of the aftermath of the housing bubble as it now exists. Prices have been dropping and all manner of credit is now being exposed. The stock market will have to pay attention to this news very soon if it hasn’t started already.

In other news, AAPL received a body blow from AT&T when it reported that not as many iPhones had signed up for service as Wall Street was expecting. AT&T said that in the first two days of launch about 146,000 iPhones buyers signed up for service but Goldman Sachs had projected sales of 700,000 iPhones in the first three days. AAPL dropped over 6% on that news as reality bites.

After the market closed on Tuesday, AMZN reported earnings had tripled which was better than estimates. In late trading, AMZN jumped about 20% on the news. This raises the question of how the company was able to deliver. The answer lies in the new promotion called Amazon Prime which charges “members” $79 a year to get free two day shipping with no minimum purchase required. There was some expectation that with the new Harry Potter book in release this month that AMZN will continue its success into the next quarter. [Skeptics, like we are, may wonder if everyone orders an $18 book,which is about half the cover price, with free shipping whether AMZN can really make any money but that’s just being so negative.]

As we write this the futures are up quite a bit, on the AMZN news most likely. The market has the right to bounce here but we need to see a drop that takes out some of last month’s support levels right around 13,670 in the Dow. At that time we will be more confident of our earlier call that the market is ready to go down. You did notice that the Dow had one close just above the 14K level and now it is struggling. More to come…

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