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US Stocks
set to open down 6-7%
Earlier this
month, we described the "Great Margin Call of 2008" where
investors worldwide sell not because they want to, but because they have
to. Those margin calls took US
stock indexes to levels last seen in October 2002 on October 10th
and 16th, though each time stocks rallied back, including an
11% rally on October 13th.
This morning,
we're set for another round of forced selling in the US, with Asian
markets already down 8.3-10.5%, and European markets down 7.1-8.0%. This sell-off will occur despite a
number of positive factors:
· Oil is now below $64/barrel, down from $147 in mid
July. US consumers will save about
$630 billion/year relative to the peak price.
· Overnight LIBOR is back to normal, and three month LIBOR
is more than half way back to normal.
LIBOR is the rate that banks lend to each other so the reduction
in rate reflects the reduction of stress in the international banking
system.
· The US Treasury has invested $250 billion directly into 9
US banks through the purchase of preferred stock. An additional $450 billion will flow to
banks over the next several months as the treasury implements its TARP
program to buy distressed securities.
· The Treasury implemented a "Temporary Guarantee
Program for Money Market Funds" on October 7th to prevent
further disruptions in that sector.
· The Treasury will implement a program to buy commercial
paper on 10/27 should high quality borrowers such as General Electric
have problems.
· The Federal Reserve will cut rates to 1.0% on 10/30,
possibly even to 0.75%; other central banks are also aggressively cutting
rates.
· Worldwide, central banks are pumping trillions of dollars
and Euros into their banking systems to offset the capital destroyed over
the last year by losses on mortgage backed securities
· Earnings for US corporations have held up reasonably
well. Even if we aggressively
discount forward earnings, stock valuations remain at steep discounts
given low interest rates.
· World GDP is slowing, and might even turn negative, but is
not crashing.
None of this seems
to matter to leveraged investors, particularly the hedge funds. These funds have been hit hard by
redemptions and are selling every asset class, not only US and
International stocks, but also corporate bonds, municipal bonds,
preferred stock, and commodities.
About 30% of these funds will be out of business by year end, but
until they stop selling, it's hard for other investors to feel confident
about buying.
US stocks are down
31% since August 31st (comparable the decline in US stocks
seen in the October-November 1987 crash) and down 42% since the highs of
last October. US stocks declined
55% between March 2000 and October 2002.
How much farther can stocks fall?
In 2000, US stocks valuations were about 110% higher than fair
value estimates, but fell to a deep discount by October 2002. Although US GDP grew 35.8% from 2002
through June 2008, stocks remained discounted. Now stocks are deeply discounted. We're staying rational in the midst of
others' panic. We've sold a couple
of companies that appear too damaged by the credit crisis to survive, and
we will certainly take tax losses between now and year end to offset any
gains we may have taken earlier in the year. Other than that, we are holding the
stocks that we have and even buying a little on the dips.
As always, we are
available to discuss our clients' individual situations.
Yours sincerely,
David Edwards
President
The Heron Capital Management
client letter is published immediately following month end and when
market conditions require comment. The views expressed in this letter
represent HCMI opinion and strategy as of the date published and can
change at any time upon receipt of new information. Data quoted in this
letter are from sources deemed reliable, but no guarantee of such data is
implied.
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