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I thought the headlines on Friday were interesting.  There was ZERO good news about the economy, and all the economic and earnings reports were worse than expected.  But the stock market went up.  Makes no sense to me.

Here are the top headlines from Reuters Business news as of 12:57pm (ET) yesterday.

GM, Ford losses worse than expected, burning cash - 33 minutes ago

• General Motors Corp and Ford Motor Co reported far deeper-than-expected quarterly losses on Friday, and said their rate of cash burn was accelerating, as an extended slump in car sales raised question…

  · Pending home sales fall, tight credit bites - 18 minutes ago

  Pending sales of existing homes fell in September, reversing the previous month’s gains, as access to credit tightened, a private report showed on Friday, adding more gloom to the broader economic…

  · Bargain hunters buoy stocks, but GM slides - 10 minutes ago

  Stocks rose on Friday as investors followed two days of losses in the mood to buy beaten-down sectors, including energy and technology, offsetting a blitz of bleak news indicating economic gloom.

  · Job losses soar, jobless rate at 14-year high - 1 hour ago

  U.S. employers slashed an unexpectedly steep 240,000 jobs from payrolls last month and the jobless rate shot up to a 14-1/2-year high, the government said on Friday in a report underscoring the econom…

  · Microsoft CEO pours cold water on Yahoo interest - 2 hours ago

  Microsoft Corp Chief Executive Steve Ballmer dismissed speculation the software giant might still be interested in buying Yahoo Inc, sending shares of the Internet company down 14 percent.

  · Paulson considering all options for TARP funds - 30 minutes ago

  Treasury Secretary Henry Paulson is considering “all options” regarding implementation of the $700 billion financial rescue plan, including areas of the financial sector beyond traditional b…

  · JPMorgan sees consumer loan defaults rising - 2 hours ago

  JPMorgan Chase & Co (JPM.N) said on Friday it expects consumer loan defaults to increase in the current quarter and sees higher loan loss provisions.

  · Oil rises as U.S. jobs data hits dollar - 43 minutes ago

  Oil prices rose on Friday as the dollar slumped following bleak employment data in the United States, the world’s top energy consumer.

  · Sprint suffers loss as customers flee, shares slump - 36 minutes ago

  Sprint Nextel Corp (S.N), the No. 3 U.S. mobile service, posted a third-quarter loss and a 12 percent drop in revenue as customers fled to rival services.

  · Major banks ask Citadel to post more collateral: report - 28 minutes ago

  Citadel Investment Group, one of the largest hedge funds, is being asked by several major banks to post additional collateral to cover big losses on its investments, the Wall Street Journal said, citi…

Wow, lots of stories today about the “shocking” earnings miss (and lowered forecast) by GE.  MarketWatch said “GE’s warning pokes hole in recent sentiment that credit crunch has passed” and “The rebound had been fueled by renewed sentiment on Wall Street that the worst of the credit crisis — including the threat of spiraling financial bankruptcies — was past.”

A story on CNN said “My guess is that earnings forecasts for 2008 are still pretty high relative to the economic reality,” Davidson said.

I have one word for Mr. Davidson - Duh!

As I posted just yesterday, I don’t think we’re anywhere close to a bottom yet, and the earnings estimates for 2008 and 2009 are way too high.  Eventually, stock prices adjust to reflect earnings, and sometimes the adjustment process is long and painful - as we all learned in 2000 through 2003.

All the stories about Goldman Sachs’ and Lehman CEO’s saying that they can see the light at the end of the tunnel - while simultaneously upping their own writedowns - are crap.  If the CEO’s are so good at predicting the future, why couldn’t they tell us what losses their own companies were going to have?

Speaking of Goldman, I think the glitter is coming off.  This past week they announced that the amount of “Level 3 assets” increased from $69 billion to $96 billion during the first quarter.  If you haven’t been keeping score, “level 3″ assets are those for which there’s basically no market, no one wants them, so Goldman is stuck with them. 

Kinda like having a house that’s “worth” $1 million, but no one will buy it, so you’re stuck with the mortgage payments - but you can say you have a $1 million house.  At least until you have to sell it because you can’t make the payments any longer - then it suddenly becomes a $500k house - and you just lost $500k.

It also means that the value of those assets is a 100% guess.  In effect, Goldman is saying “we think we might have $96 billion in assets, but we really don’t know what they’d be worth if we tried to sell them.  They might be worth $96 billion (but we’re almost certain that that’s not right) but they might be worth 3 cents on the dollar.  We don’t have a clue, so we pulled that $96 billion number out of our butt.”

Level 3 assets are, by definition, “hard to value”.  In fact, they are impossible to value, because no one will buy them.  So companies use a “mark to model” method to come up with a number.  And since “mark to model” varies depending on the model used, we’re back where we started - no one has any idea what these assets are worth.

You may be asking why it’s a bad thing that the value of the assets rose so much in one quarter, and that’s a good question.  Wouldn’t it be a good thing if my $1 million house went up to $1.5 million in one quarter?   The answer to why it’s bad is that it’s a made up number.  I know that this is probably getting old but you need to understand it - NO ONE WILL BUY IT AT ANY PRICE RIGHT NOW!

Your next question is probably something like “why would they make up a higher number for these assets if that’s viewed as a negative?  Another good question, but the answer is easy.  You see, if you claim that your assets are worth more, you can use them as collateral so you can borrow more money.

Kinda neat isn’t it?  Goldman increased its’ ability to borrow by $27 billion in just one quarter.  But who would take these level 3 assets as collateral you ask?  You’re on your “A” game tonight dear reader - another good question.

The answer is that there’s only one place to go to borrow against these assets that no one will buy - the Fed.  You and me (via the government) are loaning Goldman billions of dollars by allowing them to give (I’m going to make up some numbers here - let’s call them “level 3″ numbers) the Fed $10 billion in level 3 assets.  In exchange, the Fed give Goldman $10 billion in Treasuries.

So you and I are now on the hook for $10 billion of basically worthless assets, while Goldman now has $10 billion of nice safe Treasuries.  Nice trick ain’t it?  That’s the Federal Reserve’s new Term Securities Lending Facility (TSLF) in a nutshell.

That’s one of the ways that the Fed is propping up the banks and brokerage houses right now - short of an indirect buyout like they did with Bear Stearns anyway.  But sooner or later, the losses from these made up level 3 assets need to be accounted for. 

The only question remaining is who will pay for the losses - the banks who made the risky loans, the investment houses that took the risky loans and leveraged them, or the taxpayer.  My best level 3 guess is that we’ll see a combination of the above, but taxpayers will eat a significant chunk of the losses.

As a result, the Fed will have to print more money to pay the bills, so the dollar will continue to fall, and the stock market will drop in inflation adjusted terms - and quite probably in real terms as well.  Within the next 12 months, Dow 9,000 is much more likely than Dow 15,000 in my opinion.

gk

I was reading an article on CNN tonight and happened to see these lines:

But sentiment seems to be shifting as of late.

“It’s still too early to tell,” said Thomas Nyheim, portfolio manager at Christiana Bank & Trust. “But I do think that when you have Ben Bernanke, the IMF, and all these strategists saying we are in a recession or about to see one, and the market doesn’t sell off much, that tells you something.”

I agree that sentiment is shifting - how else do you explain the stock markets’ reluctance to go down in the face of all the bad news?  It’s certainly possible that we’re “climbing a wall of worry” and that the short downturn in stocks is over - but I don’t think so.

There is too much optimism for me right now.  It seems that no matter how bad the news is, the stocks affected rally.  It’s like investors are thinking “At last, this is everything.  It’s all out there now.  Things can’t possibly get any worse, so there’s nowhere to go but up.”

I hate to be the bearer of bad news, but yes Virginia, things can get worse.  And I think they will. 

I’ve been playing with an Excel spreadsheet of earnings from Standard and Poors website.  Their 2007 estimate of $82.54 was high (actual was $70.83) and I think their 2008 estimate of $96.74 is way too high - by at least $20.

In other words, official estimates are looking for 2008 earnings to be HIGHER than the 2007 results.  I don’t think there’s anyway that’s going to happen.  The first quarter results will be a lot lower than last year (overall) and we are still in the early stages of the massive deleveraging that needs to happen as the housing market gets worse.

Stocks might be higher a month from now - but I doubt it.  They might be higher 6 months from now, but I doubt that too.  Unless there’s a massive (1500 to 2000 point) correction in the DJIA between now and then, stocks will continue to trade in the 12800 to 12200 range.

We may go down slowly, or we may see a huge two or three day slide, but stocks WILL eventually correct to reflect the earnings.  I’m just sitting on the sidelines waiting for that to happen.  If it doesn’t happen (I’ll be very surprised!) I’ll get back into the market when the 75 day EMA crosses over the 200 day EMA.  And we’re nowhere close to that happening.

gk

Some headlines from today for perspective.

Fed Officials Saw Contraction in Economy `Likely'

Washington Mutual to slash jobs despite cash injection

Pending home sales index off 1.9% in February: NAR

Credit crunch cost $1 trillion estimates IMF

Basically there was a lot of bad news that came out today, and the US stock markets were down a little for the day.  Given the news today, I don’t understand why they weren’t down more - but you can’t argue with the markets. 

The market is always right (no, I’m not being sarcastic) and no matter what I think are compelling reasons for it to drop, the market will do what it wants to do.  The market is the ultimate arbitrator of right and wrong, because it will do what it wants to do regardless of what I think.

That’s the short term view anyway, and successful traders already know this.  I’m not a trader - I look strictly at long term trends - but I confess to being annoyed when the market doesn’t do what I think it should do based on the fundamentals and the news.

I’ve started to do a little analysis of the S&P 500 earnings based on Standard and Poors own published data.  No conclusions yet, but the estimates for Q4 2007 were way high, and I expect the estimates for Q1 2008 will be even more off base. 

The estimates I’ve seen are for a 12% drop in earnings in Q1.  That’s simply wishful thinking.  I’m expecting a minimum of a 25% drop (year over year) and I will not be surprised if the total S&P 500 earnings ends up 50% lower that Q1 of 07.

Any takers?

gk

After the bell tonight, Alcoa released their first quarter earnings.  Earnings dropped 54%, from $662 million (75 cents/share) last year, to $303 million (37 cents/share) this year.  According to Bloomberg analysts were expecting earnings to be 50 cents/share.

Since they missed expectations big time, you’d think shares would drop, but no, shares of Alcoa are up 22 cents to $37.66 in after-hours trading.  Huh?  That’s what I said….

For some strange reason, the markets are shrugging off bad news lately.  No matter how bad the earnings, the stock price rises.  Kinda reminds me of 1999 and 2000, when tech related stock prices were bid up and up and up, even though the companies had zero earnings.

Ok, I’ll roll with it.  Just remember what happened in 2001 through 2003. 

gk