Wednesday, January 23, 2008

Rebound in Order

Top Line: The intraday reversal to the upside probably indicates we have seen a short term low with some month end strength. The market has been very oversold and Wednesday's action should lead to a sizable bounce.

We thought we should start with the answer to the question in the comment section, "where does all the money go if everyone is selling?" We have to add a second question, what happens to the value of the company if the price of the stock goes down?

Remember that whenever a stock is sold, someone actually buys it. As some say, there are just as many buyers as sellers. If you sell your stock to someone, you get their money and they get your stock. No money is lost, it just transfers from one person/entity to another. So, the real question is "if a stock is worth $20 one day and $15 the next, where did the 25% value go?" This is a tricky concept, one that may ellude us all a bit. But, let's start with a simple setup, that being one share of stock going for $100 today.

Why is the stock $100 today? Well, it's $100 today because that's what someone is willing to pay for it. When companies say their "capitalization" is so much, they take the price of the stock times the number of shares outstanding. The result is how much the company is worth, or its capitalization. In our little example, we have just one share of stock that we paid $100 to own. Tomorrow, when there are no buyers willing to pay $100 for the stock, it's not worth $100 anymore. If we choose to sell it, then we have to go find a buyer and that buyer may be willing to pay only $75 for the share we own.

What does this mean? This means you lost 25% of your money. The person that sold it to you for $100 is now pretty happy. If you can understand this concept, that the value has just vanished, you can see how tenuous the stock market can be at times. The value of stock is only as high as someone is willing to pay. If the owners of the stock are comfortable with their company's prospects and they don't sell all at once, then buyers will have to pay more in order to entice the owners into selling.

If, on the other hand, the owners are Not comfortable with the prospects, they will want to sell their holdings. And, if the owners want to sell, there are few, if any, willing buyers to take it off their hands unless they lower their offer price.

This brings us to the Fed and its panic attack on Tuesday morning. Why did the Fed lower rates just a week before their next meeting? Well, they didn't want owners of stock to sell their positions creating a situation where prices fall and continue falling. The entire stock market only functions well when the owners are comfortable. Any other time, the market drops and the powers that be start wanting to do something about it.

Thanks for the timely question.

Back to the market action. Wednesday was something to see. The market dropped at the open due mostly to the AAPL news, along with MOT (Motorola) who works with AAPL. AAPL's drop inspired a drop in the four horsemen, and in turn our FSI (For Speculation Index) dropped right along with it.

The market fell out of bed in the morning and our favorite index, NDX, was being trampled due to the four horsemen mainly. We saw a drop of nearly 6% at one time in that index as GOOG and AAPL were both getting double digit percentage losses.

From the lows in the Dow and other indexes, we saw a massive rally, to the tune of 600 points in the Dow, which is over 5% in a few hours. The NDX, which had been down 100 points or about 6% rallied back to nearly even by the end of the day. The stage is set for some more rallying in the next week or so. We'll keep you posted.

The Asian markets were bought on Tuesday evening, after the Fed's move, and again this evening on the back of the big reversal in the US stock market. That would be all except the Japanese market which, while it has come back up a little, it wasn't very much.

Our primary thought this evening is that the stock market has marked a low on Wednesday for the time being. If at any time it breaks those lows, we are going down more. For now, we need to expect a decent sized rally. The high volume of the past few trading sessions has exhausted some buying power and we need to respect the bear. That is why we look for other opportunities for the down move yet to come, and at the same time keep a lookout for a break in the established lows.

We will provide more guidance on where we see a rally going tomorrow after we see the kind of follow through buying we see on Thursday.

The reason cited for the bounce was the banks' efforts to get some capital to the bond insurers we mentioned here last week, MBI and Ambac (MBIA and ABK). The market must think that if the insurer can stay rated AAA, then the problems must be behind us. Right. We think the market was due for a bounce especially with the spike low we had on Wednesday. The media needed a good story.

FSI: 82.51 (ouch, on December 28th this index was 108.15, a 25% loss in a month)

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