The week after the Black week

Weekly Recap - Week ending 17-Oct-08
Does it get any crazier than this past week? Let’s hope not, unless of course the end result remains the same.

In the week that just concluded the S&P 500 managed to record both its largest, single day point gain ever as well as its second largest, single day point loss ever. Meanwhile, the intraday swings throughout the week were epic.

The S&P moved in a 9.5% range in Thursday’s session alone. For some perspective, consider that the S&P gained 3.5% for all of 2007.

The volatility was a by-product of a host of factors that ranged from reports of forced liquidation by hedge funds to reports of strains easing in the credit market after massive liquidity injections by central banks.

To be sure, the week got off to an eye-popping start as the market soared 11.7% in a snapback rally from greatly oversold conditions.

Word that Morgan Stanley (MS) completed a deal to receive a $9 billion capital injection from Japanese bank Mitsubishi UFJ, central bank plans to provide as much dollar liquidity as needed for short-term funding markets, and news that several European countries were guaranteeing interbank lending provided the spark for Monday’s rally.

In addition, speculation that the U.S. Treasury would be making a direct capital injection of as much as $250 billion in U.S. banks, that it would guarantee bank debt, and that the FDIC would guarantee deposits in non-interest bearing deposit accounts also fueled the buying efforts.

The speculation turned to fact Tuesday when the Treasury formally announced like measures. In particular, it said it would invest $125 billion in the preferred stock of nine, major institutions – Goldman Sachs, Merrill Lynch, Bank of America, Wells Fargo, JPMorgan Chase, State Street, Bank of New York Mellon, Citigroup and Morgan Stanley – and direct another $125 billion toward other banks in a capital injecting initiative that mandated curbs on executive compensation for participating entities.

In the wake of Monday’s surge, however, the market stumbled Tuesday on some profit taking activity and lingering concerns about the economic outlook.

The economic concerns came home to roost on Wednesday in a battery of worrisome updates.
Specifically, it was reported that retail sales declined 1.2% in September, with declines seen across all discretionary spending categories. That news, combined with a downtrodden Beige Book report that revealed slowing activity in all 12 Fed districts, and a reminder from Fed Chairman Bernanke that the economic recovery won’t happen right away, even with a stabilization of the financial system, helped drive the market 9.0% lower, marking one of its worst percentage declines in history.

An escalation of selling interest late in Wednesday’s trade gave life to reports that there was forced selling by hedge funds.

That selling carried over into early trading Thursday. The S&P 500 fell another 4.6% and the volatility index (“VIX”), otherwise known as the fear gauge, spiked to an all-time high.
Then, in an instant, sentiment shifted and the market began a furious recovery effort that left it up 4.3% at the close.

That rally saw retailers and transportation stocks bounce back sharply with oil prices dropping below $70 per barrel at one juncture. The drop in oil prices followed a weak industrial production report and reflected underlying concerns about the prospect of a global recession.
OPEC is slated to meet Oct. 24 to discuss oil prices and it is expected that the cartel, having seen prices plummet more than 50% from the all-time high reached in July, will announce a production cut.

Friday’s session was another roller coaster ride.
The S&P 500 swung 7.2% between its low and high points of the day amid alternating feelings surrounding the weakest level of housing starts reported since January 1991, Warren Buffett’s acknowledgment that he is buying American stocks for his personal portfolio, and encouraging others to do the same, and a heavy load of expiring options on stock indexes, stocks and exchange traded funds.

In the midst of all that transpired, we’d be remiss if we didn’t mention that the third quarter earnings reporting season kicked in to full swing this week.

Financial and technology companies led the barrage of reporters that included the likes of Citigroup (C), JPMorgan Chase (JPM), Wells Fargo (WFC), Merrill Lynch (MER), Johnson & Johnson (JNJ), PepsiCo (PEP), Intel (INTC), IBM (IBM), Google (GOOG) and eBay (EBAY) to name a few.

Third quarter results themselves were largely mixed, yet the key consideration for the market was that few, if any, companies really extolled their near-term prospects. Several companies bemoaned a lack of earnings visibility on account of the economic environment.

So, both the earnings results and economic data this week were fairly unimpressive, yet the market still managed a 4.6% gain.

Then again, with the market plunging 18.2% in the prior week, some bargain hunting activity was to be expected.

Signs of improvement in the credit market aided in the buying efforts.
The overnight Libor rate dropped to 1.67% from 5.09% last week; overnight commercial paper rates fell to 1.05% from 3.50% last week; and the TED spread, the difference between 3-month Libor and the 3-month T-bill, narrowed 100 basis points from last week to 3.63%.

However, the fact that 3-month Libor rates didn’t come down nearly as much as overnight rates (only ~40 basis points from last week’s peak) contributed to a sense of uncertainty about the pace of recovery in the credit market.

Until that uncertainty is removed, the stock market is expected to keep trading in a rudderless fashion as emotion, more so than fundamentals, will steer the action.

--Patrick J. O'Hare, Briefing.com
**For interested readers, the S&P 400 Midcap Index, which isn't included in the table below, gained 0.9% for the week and is down 35.3% year-to-date